Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Granting Approval of Proposed Rule Change Relating to Clearly Erroneous Transactions, 56641-56645 [2010-23075]
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Federal Register / Vol. 75, No. 179 / Thursday, September 16, 2010 / Notices
that the operation of PSX is conditioned
on the satisfaction of the following
requirements:
A. Examination by the Commission.
The Exchange must have, and must
represent in a letter to the staff in the
Commission’s Office of Compliance
Inspections and Examinations that it has
adequate surveillance procedures and
programs in place to effectively regulate
PSX.
B. Trade Processing and Exchange
Systems. The Exchange must have, and
must represent in a letter to the staff in
the Commission’s Division of Trading
and Markets that it has adequate
procedures and programs in place, as
noted in Commission Automation
Review Policy guidelines,120 to
effectively process trades and maintain
the confidentiality, integrity, and
availability of the Exchange’s systems.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.121
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010–23104 Filed 9–15–10; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–62885; File No. SR–FINRA–
2010–032]
Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Order Granting
Approval of Proposed Rule Change
Relating to Clearly Erroneous
Transactions
I. Introduction
September 10, 2010.
On June 17, 2010, the Financial
Industry Regulatory Authority, Inc.
(‘‘FINRA’’) filed with the Securities and
Exchange Commission (‘‘Commission’’),
pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (‘‘Act’’),
and Rule 19b–4 thereunder, a proposed
rule change to amend its rules to set
forth clearer standards and curtail its
discretion with respect to breaking
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120 On
November 16, 1989, the Commission
published its first Automation Review Policy (‘‘ARP
I’’), in which it created a voluntary framework for
self-regulatory organizations to establish
comprehensive planning and assessment programs
to determine systems capacity and vulnerability. On
May 9, 1991, the Commission published its second
Automation Review Policy (‘‘ARP II’’) to clarify the
types of review and reports that were expected from
self-regulatory organizations. See Securities
Exchange Act Release Nos. 27445 (November 16,
1989), 54 FR 48703 (November 24, 1989); and 29185
(May 9, 1991), 56 FR 22490 (May 15, 1991).
121 17 CFR 200.30–3(a)(12).
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erroneous trades.1 The proposed rule
change was published for comment in
the Federal Register on June 28, 2010.2
The Commission received nine
comment letters on the proposal.3 BATS
responded to the comments in a letter
dated August 16, 2010.4 This order
approves the proposed rule change.
II. Background and Description of the
Proposal
On May 6, 2010, the U.S. equity
markets experienced a severe
disruption.5 Among other things, the
1 Also, on June 17, 2010, each of BATS Exchange,
Inc. (‘‘BATS’’), NASDAQ OMX BX, Inc. (‘‘BX’’),
Chicago Board Options Exchange, Incorporated
(‘‘CBOE’’), Chicago Stock Exchange, Inc. (‘‘CHX’’),
EDGA Exchange, Inc. (‘‘EDGA’’), EDGX Exchange,
Inc. (‘‘EDGX’’), International Securities Exchange
LLC (‘‘ISE’’), The NASDAQ Stock Market LLC
(‘‘Nasdaq’’), National Stock Exchange, Inc. (‘‘NSX’’),
New York Stock Exchange LLC (‘‘NYSE’’), NYSE
Amex LLC (‘‘NYSE Amex’’), NYSE Arca, Inc.
(‘‘NYSE Arca’’) (collectively, the ‘‘Exchanges’’) filed
similar proposed rule changes with respect to
breaking erroneous trades. See Securities Exchange
Act Release Nos. 62330 (June 21, 2010), 75 FR
36725; 62331 (June 21, 2010), 75 FR 36746; 62332
(June 21, 2010), 75 FR 36749; 62333 (June 21, 2010),
75 FR 36759; 62334 (June 21, 2010), 75 FR 36732;
62335 (June 21, 2010), 75 FR 37494; 62336 (June 21,
2010), 75 FR 36743; 62337 (June 21, 2010), 75 FR
36739; 62338 (June 21, 2010), 75 FR 36762; 62339
(June 21, 2010), 75 FR 36765; 62340 (June 21, 2010),
75 FR 36768; and 62342 (June 21, 2010), 75 FR
36752. These proposals also were approved today.
See Securities Exchange Act Release No. 62886
(Sept. 10, 2010).
2 See Securities Exchange Act Release No. 62341
(June 21, 2010), 75 FR 36756.
3 See letter from Peter Ianello, Partner, CSS, LLC,
to Elizabeth Murphy, Secretary, Commission, dated
July 15, 2010 (‘‘CSS Letter’’); letter from Gary
DeWaal, Senior Managing Director and Group
General Counsel, Newedge USA, LLC, to Elizabeth
M. Murphy, Secretary, Commission, dated July 19,
2010 (‘‘Newedge Letter’’); letter from Karrie
McMillan, General Counsel, Investment Company
Institute, to Elizabeth M. Murphy, Secretary,
Commission, dated July 19, 2010 (‘‘ICI Letter’’);
David C. Cushing, Director of Global Equity
Trading, Wellington Management Company, LLP, to
Elizabeth M. Murphy, Secretary, Commission, dated
July 19, 2010 (‘‘Wellington Letter’’); letter from John
A. McCarthy, General Counsel, GETCO, to Elizabeth
Murphy, Secretary, Commission, dated July 20,
2010 (‘‘GETCO Letter’’); letter from Ira P. Shapiro,
Managing Director, BlackRock, Inc., to Elizabeth M.
Murphy, Secretary, Commission, dated July 20,
2010 (‘‘BlackRock Letter’’); and letter from Manisha
Kimmel, Executive Director, Financial Information
Forum, On behalf of the FIF Front Office
Committee, to Elizabeth M. Murphy, Secretary,
Commission, dated July 21, 2010 (‘‘FIF Letter’’);
letter from Ann Vlcek, Managing Director and
Associate General Counsel, Securities Industry and
Financial Markets Association, to Elizabeth M.
Murphy, Secretary, Commission, dated July 26,
2010 (‘‘SIFMA Letter’’); and letter from Leonard J.
Amoruso, General Counsel, Knight Capital Group,
Inc., to Elizabeth M. Murphy, Secretary,
Commission, dated July 27, 2010 (‘‘Knight Letter’’).
4 See letter from Eric J. Swanson, SVP and
General Counsel, BATS, to Elizabeth M. Murphy,
Secretary, Commission, dated August 16, 2010
(‘‘BATS Letter’’).
5 The events of May 6 are described more fully
in the report of the staffs of the Commodity Futures
Trading Commission (‘‘CFTC’’) and the Commission,
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56641
prices of a large number of individual
securities suddenly declined by
significant amounts in a very short time
period, before suddenly reversing to
prices consistent with their pre-decline
levels. This severe price volatility led to
a large number of trades being executed
at temporarily depressed prices,
including many that occurred at prices
dramatically away from pre-decline
levels. In response, the Exchanges and
FINRA exercised their authority under
their clearly erroneous execution rules
to break trades that were effected at
prices 60% or more away from predecline prices, using a process that was
not sufficiently clear or transparent to
market participants. There are reports
that the lack of clear guidelines for
dealing with clearly erroneous
transactions under circumstances such
as occurred on May 6, and the lack of
transparency surrounding the
Exchanges’ and FINRA’s decision to
break only trades at least 60% away
from the market, added to the confusion
and uncertainty faced by investors on
May 6.6
The Commission is concerned that
events such as those that occurred on
May 6 can undermine the integrity of
the U.S. securities markets.
Accordingly, it is working on a variety
of fronts to assess the causes and
contributing factors of the May 6 market
disruption and to fashion policy
responses that will help prevent a
recurrence. The Commission also
recognizes the importance of moving
quickly to implement steps that could
help limit potential harm from extreme
price volatility. On June 10, 2010, the
Commission approved rules, on a pilot
basis, that require the Exchanges to
pause trading in securities included in
the S&P 500 Index if the price moves
10% or more in a five-minute period.7
By establishing circuit breakers that
uniformly pause trading in these
securities across all markets, the new
rules are designed to facilitate
coordinated price discovery and provide
time for investors to trade at rational
prices. In addition to the individual
stock trading pause rules, FINRA
titled Report of the CFTC and SEC to the Joint
Advisory Committee on Emerging Regulatory Issues,
‘‘Preliminary Findings Regarding the Market Events
of May 6, 2010,’’ dated May 18, 2010.
6 See, e.g., Written Statement of Leonard J.
Amoruso, Senior Managing Director and General
Counsel, Knight Capital Group, Inc., Submitted
before the CFTC–SEC Advisory Committee on
Emerging Regulatory Issues, Panel Discussion, ‘‘The
events of May 6—views and observations regarding
liquidity, trading and the apparent breakdown of an
orderly market,’’ dated June 22, 2010.
7 See Securities Exchange Act Release Nos. 62251;
75 FR 34183 (June 10, 2010); and 62252, 75 FR
34186 (June 16, 2010).
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Federal Register / Vol. 75, No. 179 / Thursday, September 16, 2010 / Notices
worked with the Exchanges to develop
proposed amendments to their clearly
erroneous execution rules to provide
greater transparency and certainty to the
process of breaking trades.
The current clearly erroneous
execution rule sets forth procedures
FINRA must use to break trades.
Specifically, the current rule provides
that FINRA will break trades in
Exchange-listed stocks only if the price
of the trades exceeds a specified
‘‘Reference Price’’—usually the
consolidated last sale—by an amount
that equals or exceeds specified
‘‘Numerical Guidelines.’’ The Numerical
Guidelines vary depending on the price
of the stock and during the regular
trading session are 10% if the
consolidated last sale is $25 or less, 5%
if the consolidated last sale is more than
$25 and up to and including $50, and
3% if the consolidated last sale is more
than $50. These percentages double
during pre-open and post-close trading
sessions. For events involving five or
more securities, the Numerical
Guidelines currently are 10% during
pre-open, regular, and post-close trading
sessions.
While the current rule does not give
FINRA discretion to break trades that do
not exceed the Numerical Guidelines, it
does permit FINRA discretion to select
a percentage threshold at which trades
will be broken that is higher than the
Numerical Guidelines. As noted above,
on May 6 the Exchanges selected 60%
as the threshold for breaking trades in
a process that, from the perspective of
market participants, was not clear or
transparent, and led to further
uncertainty and confusion in the
market. Thus, the events of May 6
highlight the need to clarify the clearly
erroneous execution review process
across all markets, and reduce the
discretion of FINRA to deviate from the
objective standards in its rule when
dealing with clearly erroneous
transactions.
Under the proposed rule change,
FINRA will no longer have the
discretion to deviate from the specified
percentage threshold at which trades
will be broken in many situations,
including those where the single-stock
circuit breakers are applicable and in
other larger ‘‘Multi-Stock Events’’
involving five or more securities. Under
the proposed rule, a Multi-Stock Event
is determined by looking at the number
of securities with potentially erroneous
executions occurring within a period of
five minutes or less.
When an individual stock trading
pause is triggered, transactions could
occur before the trading pause is fully
implemented on all of the Exchanges
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and in the over-the-counter (OTC)
market. In such event, FINRA proposes
to review, on its own motion, all
transactions triggering an individual
stock trading pause and subsequent
transactions that may occur before the
trading pause is in effect.8 FINRA would
use the price that triggered the trading
pause (the ‘‘Trading Pause Trigger
Price’’) 9 as the Reference Price and
break trades that are 10% or more away
from the Reference Price for stocks
priced $25 or less, 5% or more away
from the Reference Price for stocks
priced from $25 to $50, and 3% or more
away from the Reference Price for stocks
priced more than $50. If the security is
a leveraged exchange-traded fund (ETF)
or exchange-traded note (ETN), these
percentage thresholds would be
multiplied by the leverage multiplier.
For situations in which a stock is not
subject to an individual stock trading
pause (e.g., because the stock is not in
the circuit breaker pilot program, or
when the stock is part of the pilot
program but the circuit breaker does not
apply because it is the beginning or end
of the day), the trade break rules will
differ based on the number of stocks
involved. In the event of Multi-Stock
Events involving 20 or more securities,
FINRA proposes to review on its own
motion and break all transactions at
prices equal to or greater than 30%
away from the Reference Price in each
affected security during the review
period selected. In such event, FINRA
may use a Reference Price other than the
consolidated last sale. To ensure
consistent application across markets,
FINRA will consult with the Exchanges
to determine the appropriate review
period, which may be greater than the
period (of five minutes or less) that
triggered the application of this
provision, as well as select one or more
8 Such reviews would be limited to transactions
that executed at a price lower than the Trading
Pause Trigger Price in the event of a price decline
and higher than the Trading Pause Trigger Price in
the event of a price rise. Where a trading pause was
triggered by a price decline (rise), FINRA shall
deem as clearly erroneous all such transactions that
occurred at a price lower (higher) than the Trading
Pause Trigger Price but only if such prices exceeded
the Trading Pause Trigger Price by an amount equal
to or exceeding the Numerical Guidelines.
9 FINRA proposes to use the Trading Pause
Trigger Price as the Reference Price for such clearly
erroneous execution reviews of a transaction
triggering a trading pause and the transactions that
occur immediately after such transactions but
before the trading pause is in effect. The Trading
Pause Trigger Price reflects a price calculated by the
primary listing market over a rolling five-minute
period and may differ from the execution price of
a transaction that triggered a trading pause. The
primary listing market that issued an individual
stock trading pause will determine and
communicate to FINRA the Trading Pause Trigger
Price for such stock.
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Sfmt 4703
specific points in time prior to the
transactions in question and use
transaction prices at or immediately
prior to the time(s) selected as the
Reference Price(s).
Similarly, in the event of Multi-Stock
Events involving five or more, but less
than twenty, securities, FINRA proposes
to review on its own motion and break
all transactions at prices equal to or
greater than 10% away from the
Reference Price. In such event, the
Reference Price will generally be the
consolidated last sale immediately prior
to the execution(s) under review.
However, if there is relevant news
impacting a security, periods of extreme
volatility, sustained illiquidity, or
widespread systems issues, FINRA may
use a different Reference Price, where
necessary for the maintenance of a fair
and orderly market and the protection of
investors, and where it is in the public
interest.
The current rule provides that FINRA
may consider ‘‘Additional Factors’’ 10 in
determining whether to break trades.
The proposed rule change limits the
circumstances during which FINRA
may consider those Additional Factors.
Specifically, under the proposed rule,
FINRA would only be permitted to
consider Additional Factors in the
context of clearly erroneous reviews that
do not involve Multi-Stock Events
involving five or more securities or
individual stock trading pauses, as
described above. In such event, FINRA
would consider the Additional Factors
with a view toward maintaining a fair
and orderly market and the protection of
investors and the public interest.
FINRA has proposed that this rule
change be implemented as a pilot that
would end on December 10, 2010.
III. Discussion of Comment Letters and
Commission Findings
The Commission received nine
comment letters on the proposed rule
changes filed by FINRA and the
Exchanges. Five commenters were
generally supportive of the principles
underlying the proposed rule change, to
provide greater transparency and
certainty to investors, market
10 Additional Factors that FINRA may consider
include but are not limited to: System malfunctions
or disruptions, volume and volatility for the
security, derivative securities products that
correspond to greater than 100% in the direction of
a tracking index, news released for the security,
whether trading in the security was recently halted
or resumed, whether the security is an IPO, whether
the security was subject to a stock split,
reorganization, or other corporate action, overall
market conditions, pre-opening and post-closing
session executions, validity of consolidated tapes
trades and quotes, consideration of primary market
indications, and executions inconsistent with the
trading pattern in the stock.
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Federal Register / Vol. 75, No. 179 / Thursday, September 16, 2010 / Notices
participants, and the public regarding
the handling of clearly erroneous
transactions.11 However, these
commenters also believed that the
proposed rule change should go further,
and offered a number of suggestions as
discussed below. Two commenters
generally did not oppose the proposed
rule change, but believed it was ‘‘overly
complex and opaque’’ 12 and does ‘‘not
adequately address the most significant
flaws in the current rules.’’ 13 One
commenter believed that trades should
only be cancelled in extraordinary
circumstances, stating that the
Commission and the SROs should
instead consider alternatives that would
prevent the execution of erroneous
trades rather than canceling them after
the fact.14 Another commenter
supported a ‘‘principles-based
approach’’ to handling clearly erroneous
trades instead of numerical thresholds,
particularly with respect to transactions
involving illiquid stocks and the
dissemination of news or a fundamental
change that requires a significant
reevaluation of underlying business
conditions.15 Additionally, BATS
responded to the comments on the
similar proposal by the Exchanges.16
These comments are discussed in
greater detail below.
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A. Comments Recommending Other
Comprehensive Approaches
Some commenters believed that
FINRA’s rule relating to clearly
erroneous trades should be more
definitive, and expressed the view that
the proposed rule change was not
sufficiently clear in all cases when
trades would actually be cancelled.17
For example, one commenter noted that
FINRA ‘‘appear[s] to be able to cancel
trades for many reasons other than
significant price discrepancies—
including, for example, systems
malfunctions, news released regarding a
11 See ICI Letter, at 1, FIF Letter, at 1, Newedge
Letter, at 1–2, GETCO Letter, at 2, and SIFMA
Letter, at 1–2 (also stating its belief that it is ‘‘critical
for the options markets to achieve consistency in
their existing clearly erroneous execution rules
before additional rule changes are implemented
* * * ’’). See also BlackRock Letter at 1 (supporting
amendments to rules that contribute to market
volatility).
12 See CSS Letter, at 1.
13 See BlackRock Letter, at 1.
14 See Wellington Letter, at 3–4. See also FIF
Letter, at 1–2 (supporting trade validation and
rejection mechanisms) and GETCO Letter, at 3
(supporting protections designed to reject clearly
erroneous orders that reach market centers).
15 See Knight Letter, at 3.
16 See BATS Letter. The response from BATS is
discussed in this Order because FINRA’s proposed
clearly erroneous rule is similar to those of the
Exchanges.
17 See Newedge Letter, at 4–5, and BlackRock
Letter, at 2.
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security, whether a security was subject
to a stock split or reorganization.’’ 18
This commenter believed FINRA should
adopt ‘‘no-bust’’ zones for transactions
executed within specified price ranges,
and cancel trades outside of the ‘‘nobust’’ zones absent a compelling public
interest to the contrary.19
Two commenters questioned whether
the proposed rule change would achieve
its stated goals of making the erroneous
trade execution review process more
transparent and less arbitrary.20
Specifically, these commenters were
concerned that the proposed rule
change did not clearly establish a
reference price upon which the
Numerical Guidelines would be
based.21 They noted that FINRA retains
the flexibility in certain circumstances
to use a Reference Price other than the
consolidated last sale, as well as to
determine the review period for MultiStock Events involving twenty or more
securities.22 These commenters believed
that if FINRA retained discretion in
these areas, the proposed rule change
may not achieve the goal of making the
trade break process more transparent
and less arbitrary,23 or could create
mass confusion.24
In response to comments made on
similar proposals made by the
Exchanges, BATS acknowledged that
the proposals do not ‘‘in all
circumstances provide 100% advanced
certainty with respect to whether a
particular execution will be deemed to
be clearly erroneous,’’ but stated its
belief that ‘‘its proposal reflects a
significant improvement * * * over its
existing rule.’’ 25 Specifically, BATS
noted that its discretion to utilize
‘‘additional factors’’ would now be
limited to instances involving less than
five securities under review and further
limited to securities that are not subject
to a single stock circuit breaker.26 BATS
believed its limited discretion in this
regard is necessary and appropriate for
maintaining fair and orderly markets.27
With respect to the concern expressed
by some commenters that the proposed
rule change does not clearly establish a
reference price upon which the
Numerical Guidelines would be based,
BATS, which proposed similar
discretionary provisions, stated that it is
18 See
Newedge Letter, at 4.
19 Id.
20 See
BlackRock Letter, at 2, and CSS Letter, at
1–2.
21 Id.
56643
‘‘critical’’ for it to retain some limited
discretion to use a different reference
price when applying the clearly
erroneous thresholds because ‘‘there are
circumstances under which last sale
would be an inappropriate reference
price. * * * ’’ 28 BATS noted, however,
that this discretion is limited because its
‘‘rule is designed to generally guide
BATS to look at the last sale as the
reference price’’ for those securities not
subject to a circuit breaker and its
proposal tries to be ‘‘abundantly clear
and objective that if a security is subject
to a single stock circuit breaker, the
reference price will be the circuit
breaker trigger price.’’ 29 BATS also
noted that the determination of the
point in time from which to derive the
reference price on May 6 had ‘‘nothing
to do’’ with the delay in announcing
which trades would be broken on May
6; rather, the delay was attributable to
the time it took the Exchanges and
FINRA to determine the appropriate
percentage at which trades would be
broken.30
The Commission appreciates the
suggestions and responses offered by
these commenters to make the process
by which FINRA addresses clearly
erroneous executions more certain and
transparent by reducing its discretion.
The Commission intends to continue
working with FINRA to further clarify,
as appropriate, its process for breaking
erroneous trades that arise in contexts
not covered by the proposed rule
change, as well as to continue to
evaluate the operations of and potential
refinements to such processes in
contexts covered by the proposed rule
change. Nevertheless, the Commission
believes that the proposed rule change
represents a productive first step by
FINRA in bringing greater clarity and
transparency to the process for breaking
clearly erroneous trades, and that these
improvements should not be delayed
pending consideration of further
changes.
B. Comments Recommending
Alternative Approaches
Four commenters were of the view
that, rather than breaking erroneous
trades, FINRA should allow the trades
to stand and adjust the price in line
with the market.31 These commenters
were particularly concerned about the
risk, when trades are broken, that
market participants suddenly may find
themselves exposed on one side of the
22 Id.
23 See
28 Id.
24 See
BlackRock Letter, at 2.
CSS Letter, at 1–2.
25 See BATS Letter, at 1.
26 Id. at 5.
27 Id.
29 Id.
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at 3–4.
30 Id.
31 See GETCO Letter, at 3, Newedge Letter, at 5,
BlackRock Letter, at 2, and Knight Letter, at 2.
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market when they thought they had a
hedged position.32 As one commenter
stated, ‘‘[t]his uncertainty is even more
problematic during periods of
heightened volatility in the markets,
when liquidity may be reduced as some
market participants limit their trading
until they are able to determine their
positions, or volatility may increase
further because of speculative hedging
in an attempt to protect unknown
positions.’’ 33 These commenters
believed that a price adjustment process
would substantially reduce the
uncertainty created by the potential for
broken trades, and thus would be a
better way to address erroneous
executions.34
Other commenters urged alternatives
to clearly erroneous execution rules. For
example, one commenter believed that
the proposed rule would ‘‘provide
market participants more certainty as to
whether or not their trades will stand in
the event of market volatility,’’ but urged
the Commission to move to a ‘‘futuresstyle limit up/down functionality’’ as a
better alternative to the circuit breaker
trading halt approach.35 This
commenter argued that the limit up/
limit down approach ‘‘would virtually
eliminate clearly erroneous trades.’’ 36
Another commenter also believed that
the Commission should consider a
‘‘limit up/limit down approach or
hybrid approach.’’ 37 Other commenters
suggested alternative procedures,
systems or rules to prevent erroneous
trades from occurring, such as by
rejecting orders that are materially away
from the market.38
The Commission appreciates the
suggestions offered by these
commenters to make more fundamental
changes to the way in which FINRA
addresses clearly erroneous executions.
In the coming months, the Commission
expects to continue to work with the
markets and market participants on
ways to reduce the occurrence of
erroneous trades and improve the
method by which they are resolved, as
well as on enhancements to the
mechanisms for addressing excessive
market volatility, such as those that
currently are reflected in the single32 Id.
33 See
GETCO Letter, at 3.
GETCO Letter, at 3, Newedge Letter, at 5,
BlackRock Letter, at 2, and Knight Letter, at 2.
35 See GETCO Letter, at 2–3.
36 See GETCO Letter, at 3.
37 See SIFMA Letter, at 2.
38 See FIF Letter, at 2, Wellington Letter, at 2–4,
and SIFMA Letter, at 2. See also CSS Letter, at 2
(suggesting that circuit breakers for individual
stocks based off of a percentage change from the
previous day’s closing price (or the opening price
to allow for the dissemination of overnight news)
would eliminate the need for erroneous trade rules).
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34 See
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stock circuit breaker pilot. As noted
above, however, the Commission
believes that the proposed rule change
represents a productive first step by
FINRA in bringing greater clarity and
transparency to the process for breaking
clearly erroneous trades, and that these
improvements should not be delayed
pending consideration of more farreaching initiatives.
C. Other Comments
One commenter was concerned that
the proposed rule change was not clear
as to how news or information regarding
the review and cancellation of clearly
erroneous trades would be disseminated
to the markets.39 This commenter
believed that the proposed rule should
require FINRA to disseminate this
information quickly and in a nondiscriminatory fashion to market
participants in order to minimize the
market impact and not favor any one
group of market participants over
another.40 In its response letter with
respect to its proposal, BATS stated that
it e-mails members with respect to
clearly erroneous reviews and
determinations according to a consistent
and well established protocol that,
according to BATS, strikes an
appropriate balance between notifying
members of significant market events
and avoiding notifications every time a
transaction is reviewed as potentially
clearly erroneous.41 In addition, BATS
believes that the existing requirement
that an SRO promptly notify affected
members of clearly erroneous reviews
and determinations is sufficient.42
BATS also stated that communication
between the exchanges and members
should remain flexible as such methods
are constantly changing.43 BATS
indicated that it is not aware of
discrimination amongst participants
with respect to the dissemination of
information in relation to clearly
erroneous reviews and believes that the
‘‘anti-discrimination requirements of the
Act would sufficiently restrain’’
discrimination.44
Another commenter believed that the
Commission should require FINRA to
clarify the application of the clearly
erroneous execution rule when an event
causes the price to cross to a different
specified percentage threshold for
breaking trades. Specifically, the
commenter asked, ‘‘if a market decline
triggers the CEE rules intra-day with
39 See
Newedge Letter, at 6.
40 Id.
41 See
respect to a stock that was priced at
$25.01, so the CEE price is below $25,
the proposed amendments do not
explain at what price trading would be
calculated for the next application of the
CEE rules. Would it be at 5 percent for
stocks between $25 and $50 or 10
percent for stocks priced less than
$25?’’ 45 That commenter also expressed
concern that the proposed rule change
might provide an opportunity for market
participants to manipulate events
involving multiple stocks that are not
subject to the single-stock circuit
breakers. This might occur, for example,
when an event subject to a 10%
threshold (e.g., involving 20 securities)
could be forced into the 30% threshold
category (e.g., by manipulating the 21st
security and causing an erroneous
trade), by a market participant seeking
the flexibility to trade at wider spreads
with respect to all impacted securities.46
Another commenter noted that, when
an individual stock trading pause is
triggered, trades will be broken at
specified percentages away from the
Trading Pause Trigger Price.47
According to this commenter, this
calculation ‘‘has the practical effect of
doubling the clearly erroneous price
window for most U.S. equity securities
and is a significant expansion of the
window for certain securities.’’ 48 This
commenter suggested using more
conservative parameters such as the
greater of 2% or $0.05 from the Trading
Pause Trigger Price or, alternatively,
using the Trading Pause Trigger Price,
in addition to a comparison to the last
sale, as part of an analysis for clearly
erroneous trades.’’ 49 This commenter
also favored providing FINRA discretion
to break trades after the deadlines
specified in its rule in extraordinary
circumstances.50
With respect to the dissemination of
information regarding the review and
resolution of clearly erroneous trades,
the Commission understands that the
practice of FINRA is to promptly notify
participants that specified trades are
under review and, once that review is
complete, to describe the resolution
thereof. Although the Commission
believes prompt communication by
e-mail, phone, website or otherwise
concerning erroneous trade reviews
should generally assure dissemination
in a non-discriminatory fashion, as
noted above, it intends to continue to
work with FINRA on additional ways to
45 See
ICI Letter, at 3.
46 Id.
BATS Letter, at 2.
47 See
42 Id.
43 Id.
49 Id.
44 Id.
SIFMA Letter, at 2–3.
48 Id.
50 Id.
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mstockstill on DSKH9S0YB1PROD with NOTICES
Federal Register / Vol. 75, No. 179 / Thursday, September 16, 2010 / Notices
improve the transparency of this
process.
With respect to an event that causes
the price to cross to a different specified
percentage threshold for breaking
trades, the Commission believes that the
proposal is sufficiently clear regarding
the applicability of the new rule. As to
the specific example provided by the
commenter, under the proposed rule, if
a stock triggers a trading pause, the
Trading Pause Trigger Price would be
used as the Reference Price. The
Trading Pause Trigger Price is
calculated by the listing market over a
rolling five minute period. If the
Trading Pause Trigger Price is
calculated at a level below $25.00, as
identified in the example, then the 10%
threshold would apply to clearly
erroneous execution reviews of the
Trigger Trade and other transactions
that occur immediately after a Trigger
Trade but before the trading pause is
fully implemented across markets. If
another series of transactions trigger a
second trading pause, the review
process set forth in the rule would be
repeated and a new Reference Price
would be calculated to determine the
appropriate percentage threshold.
With respect to the potential for
market participants to engage in
manipulation in order to achieve a
higher trade break percentage threshold,
the Commission emphasizes that it will
vigorously pursue instances of illegal
market manipulation. In addition,
during the pilot period, the Commission
will work with FINRA to review the
operation of the amended rule, and
make improvements as warranted,
including if it appears the selected
percentage thresholds create distortions
or incent improper or illegal behavior.
With respect to the chosen
parameters, the Commission notes that
the parameters that were selected were
the product of a coordinated and
deliberate effort by FINRA and the
Exchanges to improve the handling of
clearly erroneous trades. Regarding the
specific comment expressing concern
that breaking trades only when they are
10%, 5% or 3% away from the Trading
Pause Trigger Price has the practical
effect of doubling the trading pause
parameters, the Commission notes that,
as an initial matter, implementation of
the individual stock trading pause
should prevent most trades from
occurring at prices outside of the
Trading Pause Trigger Price. To the
extent trades occur outside of such price
before the trading pause is fully applied
across all markets, the Commission
believes that it is appropriate to break
these ‘‘leakage’’ trades only when they
are a meaningful percentage away from
VerDate Mar<15>2010
19:19 Sep 15, 2010
Jkt 220001
the Trading Pause Trigger Price. This is
consistent with the traditional approach
of the Exchanges and FINRA to take the
more extreme step of breaking a trade
only in cases where it occurs at a price
sufficiently away from the current
market price that the parties should
have been on notice it may be ‘‘clearly
erroneous.’’ Of course, the pilot program
may indicate that different parameters
are better to accomplish the stated goals.
If so, the parameters could be changed
as part of the overall initiative. The
Commission will further study and
consider the examples and suggestions
offered by the commenters during the
pilot period.
D. Commission Findings
The Commission finds that the
proposed rule change is consistent with
the requirements of the Act and the
rules and regulations thereunder
applicable to FINRA. In particular, the
Commission finds that the proposed
rule change is consistent with the
requirements of Section 15A(b)(6) of the
Act,51 which, among other things,
requires that the rules of FINRA be
designed to prevent fraudulent and
manipulative acts and practices, to
promote just and equitable principles of
trade, to remove impediments to and
perfect the mechanism of a free and
open market and a national market
system, and in general, to protect
investors and the public interest.
In the Commission’s view, the
proposed rule change will help assure
that the determination of whether a
clearly erroneous trade has occurred
will be based on clear and objective
criteria, and that the resolution of the
incident will occur promptly through a
transparent process. The proposed rule
change also should help assure
consistent results in handling erroneous
trades across the U.S. markets, thus
furthering fair and orderly markets, the
protection of investors and the public
interest. Finally, the Commission notes
that the proposed rule change is being
implemented on a pilot basis so that the
Commission and FINRA can monitor
the effects of the pilot on the markets
and investors, and consider appropriate
adjustments, as necessary.
56645
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010–23075 Filed 9–15–10; 8:45 am]
BILLING CODE 8010–01–P
DEPARTMENT OF STATE
[Public Notice 7173]
Bureau of Educational and Cultural
Affairs (ECA) Request for Grant
Proposals: Study of the United States
Institutes for Scholars and Secondary
Educators
Announcement Type: New
Cooperative Agreement.
Funding Opportunity Number: ECA/
A/E/USS–11–05–09.
Catalog of Federal Domestic
Assistance Number: 19.401.
Key Dates:
Application Deadline: October 27,
2010.
Executive Summary: The Branch for
the Study of the United States, Office of
Academic Exchange Programs, Bureau
of Educational and Cultural Affairs,
invites proposal submissions for the
design and implementation of five
different Study of the United States
Institutes to take place over the course
of six weeks beginning in June 2011,
pending the availability of funds. These
Institutes should provide a
multinational group of experienced
educators with a deeper understanding
of U.S. society, culture, values, and
institutions.
Four of these Institutes will be for
groups of 18 foreign university level
faculty, focusing on American Politics
and Political Thought, Contemporary
American Literature, Religious
Pluralism in the United States, and U.S.
Foreign Policy. The fifth Institute will
be a general survey course on the study
of the United States for a group of 30
foreign secondary educators.
Applicants may propose to submit
one proposal to host only one Institute
listed under this competition. Should an
applicant submit multiple proposals
under this competition, all proposals
will be declared technically ineligible
and given no further consideration in
the review process.
I. Funding Opportunity Description
IV. Conclusion
Authority
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,52 that the
proposed rule change (SR–FINRA–
2010–032), be, and hereby is, approved.
Overall grant making authority for
this program is contained in the Mutual
Educational and Cultural Exchange Act
of 1961, Public Law 87–256, as
amended, also known as the FulbrightHays Act. The purpose of the Act is ‘‘to
enable the Government of the United
51 15
52 15
PO 00000
U.S.C. 78o–3(b)(6).
U.S.C. 78s(b)(2).
Frm 00145
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]]>Agencies
[Federal Register Volume 75, Number 179 (Thursday, September 16, 2010)]
[Notices]
[Pages 56641-56645]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-23075]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62885; File No. SR-FINRA-2010-032]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Granting Approval of Proposed Rule Change
Relating to Clearly Erroneous Transactions
I. Introduction
September 10, 2010.
On June 17, 2010, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act''), and Rule 19b-4 thereunder, a proposed
rule change to amend its rules to set forth clearer standards and
curtail its discretion with respect to breaking erroneous trades.\1\
The proposed rule change was published for comment in the Federal
Register on June 28, 2010.\2\ The Commission received nine comment
letters on the proposal.\3\ BATS responded to the comments in a letter
dated August 16, 2010.\4\ This order approves the proposed rule change.
---------------------------------------------------------------------------
\1\ Also, on June 17, 2010, each of BATS Exchange, Inc.
(``BATS''), NASDAQ OMX BX, Inc. (``BX''), Chicago Board Options
Exchange, Incorporated (``CBOE''), Chicago Stock Exchange, Inc.
(``CHX''), EDGA Exchange, Inc. (``EDGA''), EDGX Exchange, Inc.
(``EDGX''), International Securities Exchange LLC (``ISE''), The
NASDAQ Stock Market LLC (``Nasdaq''), National Stock Exchange, Inc.
(``NSX''), New York Stock Exchange LLC (``NYSE''), NYSE Amex LLC
(``NYSE Amex''), NYSE Arca, Inc. (``NYSE Arca'') (collectively, the
``Exchanges'') filed similar proposed rule changes with respect to
breaking erroneous trades. See Securities Exchange Act Release Nos.
62330 (June 21, 2010), 75 FR 36725; 62331 (June 21, 2010), 75 FR
36746; 62332 (June 21, 2010), 75 FR 36749; 62333 (June 21, 2010), 75
FR 36759; 62334 (June 21, 2010), 75 FR 36732; 62335 (June 21, 2010),
75 FR 37494; 62336 (June 21, 2010), 75 FR 36743; 62337 (June 21,
2010), 75 FR 36739; 62338 (June 21, 2010), 75 FR 36762; 62339 (June
21, 2010), 75 FR 36765; 62340 (June 21, 2010), 75 FR 36768; and
62342 (June 21, 2010), 75 FR 36752. These proposals also were
approved today. See Securities Exchange Act Release No. 62886 (Sept.
10, 2010).
\2\ See Securities Exchange Act Release No. 62341 (June 21,
2010), 75 FR 36756.
\3\ See letter from Peter Ianello, Partner, CSS, LLC, to
Elizabeth Murphy, Secretary, Commission, dated July 15, 2010 (``CSS
Letter''); letter from Gary DeWaal, Senior Managing Director and
Group General Counsel, Newedge USA, LLC, to Elizabeth M. Murphy,
Secretary, Commission, dated July 19, 2010 (``Newedge Letter'');
letter from Karrie McMillan, General Counsel, Investment Company
Institute, to Elizabeth M. Murphy, Secretary, Commission, dated July
19, 2010 (``ICI Letter''); David C. Cushing, Director of Global
Equity Trading, Wellington Management Company, LLP, to Elizabeth M.
Murphy, Secretary, Commission, dated July 19, 2010 (``Wellington
Letter''); letter from John A. McCarthy, General Counsel, GETCO, to
Elizabeth Murphy, Secretary, Commission, dated July 20, 2010
(``GETCO Letter''); letter from Ira P. Shapiro, Managing Director,
BlackRock, Inc., to Elizabeth M. Murphy, Secretary, Commission,
dated July 20, 2010 (``BlackRock Letter''); and letter from Manisha
Kimmel, Executive Director, Financial Information Forum, On behalf
of the FIF Front Office Committee, to Elizabeth M. Murphy,
Secretary, Commission, dated July 21, 2010 (``FIF Letter''); letter
from Ann Vlcek, Managing Director and Associate General Counsel,
Securities Industry and Financial Markets Association, to Elizabeth
M. Murphy, Secretary, Commission, dated July 26, 2010 (``SIFMA
Letter''); and letter from Leonard J. Amoruso, General Counsel,
Knight Capital Group, Inc., to Elizabeth M. Murphy, Secretary,
Commission, dated July 27, 2010 (``Knight Letter'').
\4\ See letter from Eric J. Swanson, SVP and General Counsel,
BATS, to Elizabeth M. Murphy, Secretary, Commission, dated August
16, 2010 (``BATS Letter'').
---------------------------------------------------------------------------
II. Background and Description of the Proposal
On May 6, 2010, the U.S. equity markets experienced a severe
disruption.\5\ Among other things, the prices of a large number of
individual securities suddenly declined by significant amounts in a
very short time period, before suddenly reversing to prices consistent
with their pre-decline levels. This severe price volatility led to a
large number of trades being executed at temporarily depressed prices,
including many that occurred at prices dramatically away from pre-
decline levels. In response, the Exchanges and FINRA exercised their
authority under their clearly erroneous execution rules to break trades
that were effected at prices 60% or more away from pre-decline prices,
using a process that was not sufficiently clear or transparent to
market participants. There are reports that the lack of clear
guidelines for dealing with clearly erroneous transactions under
circumstances such as occurred on May 6, and the lack of transparency
surrounding the Exchanges' and FINRA's decision to break only trades at
least 60% away from the market, added to the confusion and uncertainty
faced by investors on May 6.\6\
---------------------------------------------------------------------------
\5\ The events of May 6 are described more fully in the report
of the staffs of the Commodity Futures Trading Commission (``CFTC'')
and the Commission, titled Report of the CFTC and SEC to the Joint
Advisory Committee on Emerging Regulatory Issues, ``Preliminary
Findings Regarding the Market Events of May 6, 2010,'' dated May 18,
2010.
\6\ See, e.g., Written Statement of Leonard J. Amoruso, Senior
Managing Director and General Counsel, Knight Capital Group, Inc.,
Submitted before the CFTC-SEC Advisory Committee on Emerging
Regulatory Issues, Panel Discussion, ``The events of May 6--views
and observations regarding liquidity, trading and the apparent
breakdown of an orderly market,'' dated June 22, 2010.
---------------------------------------------------------------------------
The Commission is concerned that events such as those that occurred
on May 6 can undermine the integrity of the U.S. securities markets.
Accordingly, it is working on a variety of fronts to assess the causes
and contributing factors of the May 6 market disruption and to fashion
policy responses that will help prevent a recurrence. The Commission
also recognizes the importance of moving quickly to implement steps
that could help limit potential harm from extreme price volatility. On
June 10, 2010, the Commission approved rules, on a pilot basis, that
require the Exchanges to pause trading in securities included in the
S&P 500 Index if the price moves 10% or more in a five-minute
period.\7\ By establishing circuit breakers that uniformly pause
trading in these securities across all markets, the new rules are
designed to facilitate coordinated price discovery and provide time for
investors to trade at rational prices. In addition to the individual
stock trading pause rules, FINRA
[[Page 56642]]
worked with the Exchanges to develop proposed amendments to their
clearly erroneous execution rules to provide greater transparency and
certainty to the process of breaking trades.
---------------------------------------------------------------------------
\7\ See Securities Exchange Act Release Nos. 62251; 75 FR 34183
(June 10, 2010); and 62252, 75 FR 34186 (June 16, 2010).
---------------------------------------------------------------------------
The current clearly erroneous execution rule sets forth procedures
FINRA must use to break trades. Specifically, the current rule provides
that FINRA will break trades in Exchange-listed stocks only if the
price of the trades exceeds a specified ``Reference Price''--usually
the consolidated last sale--by an amount that equals or exceeds
specified ``Numerical Guidelines.'' The Numerical Guidelines vary
depending on the price of the stock and during the regular trading
session are 10% if the consolidated last sale is $25 or less, 5% if the
consolidated last sale is more than $25 and up to and including $50,
and 3% if the consolidated last sale is more than $50. These
percentages double during pre-open and post-close trading sessions. For
events involving five or more securities, the Numerical Guidelines
currently are 10% during pre-open, regular, and post-close trading
sessions.
While the current rule does not give FINRA discretion to break
trades that do not exceed the Numerical Guidelines, it does permit
FINRA discretion to select a percentage threshold at which trades will
be broken that is higher than the Numerical Guidelines. As noted above,
on May 6 the Exchanges selected 60% as the threshold for breaking
trades in a process that, from the perspective of market participants,
was not clear or transparent, and led to further uncertainty and
confusion in the market. Thus, the events of May 6 highlight the need
to clarify the clearly erroneous execution review process across all
markets, and reduce the discretion of FINRA to deviate from the
objective standards in its rule when dealing with clearly erroneous
transactions.
Under the proposed rule change, FINRA will no longer have the
discretion to deviate from the specified percentage threshold at which
trades will be broken in many situations, including those where the
single-stock circuit breakers are applicable and in other larger
``Multi-Stock Events'' involving five or more securities. Under the
proposed rule, a Multi-Stock Event is determined by looking at the
number of securities with potentially erroneous executions occurring
within a period of five minutes or less.
When an individual stock trading pause is triggered, transactions
could occur before the trading pause is fully implemented on all of the
Exchanges and in the over-the-counter (OTC) market. In such event,
FINRA proposes to review, on its own motion, all transactions
triggering an individual stock trading pause and subsequent
transactions that may occur before the trading pause is in effect.\8\
FINRA would use the price that triggered the trading pause (the
``Trading Pause Trigger Price'') \9\ as the Reference Price and break
trades that are 10% or more away from the Reference Price for stocks
priced $25 or less, 5% or more away from the Reference Price for stocks
priced from $25 to $50, and 3% or more away from the Reference Price
for stocks priced more than $50. If the security is a leveraged
exchange-traded fund (ETF) or exchange-traded note (ETN), these
percentage thresholds would be multiplied by the leverage multiplier.
---------------------------------------------------------------------------
\8\ Such reviews would be limited to transactions that executed
at a price lower than the Trading Pause Trigger Price in the event
of a price decline and higher than the Trading Pause Trigger Price
in the event of a price rise. Where a trading pause was triggered by
a price decline (rise), FINRA shall deem as clearly erroneous all
such transactions that occurred at a price lower (higher) than the
Trading Pause Trigger Price but only if such prices exceeded the
Trading Pause Trigger Price by an amount equal to or exceeding the
Numerical Guidelines.
\9\ FINRA proposes to use the Trading Pause Trigger Price as the
Reference Price for such clearly erroneous execution reviews of a
transaction triggering a trading pause and the transactions that
occur immediately after such transactions but before the trading
pause is in effect. The Trading Pause Trigger Price reflects a price
calculated by the primary listing market over a rolling five-minute
period and may differ from the execution price of a transaction that
triggered a trading pause. The primary listing market that issued an
individual stock trading pause will determine and communicate to
FINRA the Trading Pause Trigger Price for such stock.
---------------------------------------------------------------------------
For situations in which a stock is not subject to an individual
stock trading pause (e.g., because the stock is not in the circuit
breaker pilot program, or when the stock is part of the pilot program
but the circuit breaker does not apply because it is the beginning or
end of the day), the trade break rules will differ based on the number
of stocks involved. In the event of Multi-Stock Events involving 20 or
more securities, FINRA proposes to review on its own motion and break
all transactions at prices equal to or greater than 30% away from the
Reference Price in each affected security during the review period
selected. In such event, FINRA may use a Reference Price other than the
consolidated last sale. To ensure consistent application across
markets, FINRA will consult with the Exchanges to determine the
appropriate review period, which may be greater than the period (of
five minutes or less) that triggered the application of this provision,
as well as select one or more specific points in time prior to the
transactions in question and use transaction prices at or immediately
prior to the time(s) selected as the Reference Price(s).
Similarly, in the event of Multi-Stock Events involving five or
more, but less than twenty, securities, FINRA proposes to review on its
own motion and break all transactions at prices equal to or greater
than 10% away from the Reference Price. In such event, the Reference
Price will generally be the consolidated last sale immediately prior to
the execution(s) under review. However, if there is relevant news
impacting a security, periods of extreme volatility, sustained
illiquidity, or widespread systems issues, FINRA may use a different
Reference Price, where necessary for the maintenance of a fair and
orderly market and the protection of investors, and where it is in the
public interest.
The current rule provides that FINRA may consider ``Additional
Factors'' \10\ in determining whether to break trades. The proposed
rule change limits the circumstances during which FINRA may consider
those Additional Factors. Specifically, under the proposed rule, FINRA
would only be permitted to consider Additional Factors in the context
of clearly erroneous reviews that do not involve Multi-Stock Events
involving five or more securities or individual stock trading pauses,
as described above. In such event, FINRA would consider the Additional
Factors with a view toward maintaining a fair and orderly market and
the protection of investors and the public interest.
---------------------------------------------------------------------------
\10\ Additional Factors that FINRA may consider include but are
not limited to: System malfunctions or disruptions, volume and
volatility for the security, derivative securities products that
correspond to greater than 100% in the direction of a tracking
index, news released for the security, whether trading in the
security was recently halted or resumed, whether the security is an
IPO, whether the security was subject to a stock split,
reorganization, or other corporate action, overall market
conditions, pre-opening and post-closing session executions,
validity of consolidated tapes trades and quotes, consideration of
primary market indications, and executions inconsistent with the
trading pattern in the stock.
---------------------------------------------------------------------------
FINRA has proposed that this rule change be implemented as a pilot
that would end on December 10, 2010.
III. Discussion of Comment Letters and Commission Findings
The Commission received nine comment letters on the proposed rule
changes filed by FINRA and the Exchanges. Five commenters were
generally supportive of the principles underlying the proposed rule
change, to provide greater transparency and certainty to investors,
market
[[Page 56643]]
participants, and the public regarding the handling of clearly
erroneous transactions.\11\ However, these commenters also believed
that the proposed rule change should go further, and offered a number
of suggestions as discussed below. Two commenters generally did not
oppose the proposed rule change, but believed it was ``overly complex
and opaque'' \12\ and does ``not adequately address the most
significant flaws in the current rules.'' \13\ One commenter believed
that trades should only be cancelled in extraordinary circumstances,
stating that the Commission and the SROs should instead consider
alternatives that would prevent the execution of erroneous trades
rather than canceling them after the fact.\14\ Another commenter
supported a ``principles-based approach'' to handling clearly erroneous
trades instead of numerical thresholds, particularly with respect to
transactions involving illiquid stocks and the dissemination of news or
a fundamental change that requires a significant reevaluation of
underlying business conditions.\15\ Additionally, BATS responded to the
comments on the similar proposal by the Exchanges.\16\ These comments
are discussed in greater detail below.
---------------------------------------------------------------------------
\11\ See ICI Letter, at 1, FIF Letter, at 1, Newedge Letter, at
1-2, GETCO Letter, at 2, and SIFMA Letter, at 1-2 (also stating its
belief that it is ``critical for the options markets to achieve
consistency in their existing clearly erroneous execution rules
before additional rule changes are implemented * * * ''). See also
BlackRock Letter at 1 (supporting amendments to rules that
contribute to market volatility).
\12\ See CSS Letter, at 1.
\13\ See BlackRock Letter, at 1.
\14\ See Wellington Letter, at 3-4. See also FIF Letter, at 1-2
(supporting trade validation and rejection mechanisms) and GETCO
Letter, at 3 (supporting protections designed to reject clearly
erroneous orders that reach market centers).
\15\ See Knight Letter, at 3.
\16\ See BATS Letter. The response from BATS is discussed in
this Order because FINRA's proposed clearly erroneous rule is
similar to those of the Exchanges.
---------------------------------------------------------------------------
A. Comments Recommending Other Comprehensive Approaches
Some commenters believed that FINRA's rule relating to clearly
erroneous trades should be more definitive, and expressed the view that
the proposed rule change was not sufficiently clear in all cases when
trades would actually be cancelled.\17\ For example, one commenter
noted that FINRA ``appear[s] to be able to cancel trades for many
reasons other than significant price discrepancies--including, for
example, systems malfunctions, news released regarding a security,
whether a security was subject to a stock split or reorganization.''
\18\ This commenter believed FINRA should adopt ``no-bust'' zones for
transactions executed within specified price ranges, and cancel trades
outside of the ``no-bust'' zones absent a compelling public interest to
the contrary.\19\
---------------------------------------------------------------------------
\17\ See Newedge Letter, at 4-5, and BlackRock Letter, at 2.
\18\ See Newedge Letter, at 4.
\19\ Id.
---------------------------------------------------------------------------
Two commenters questioned whether the proposed rule change would
achieve its stated goals of making the erroneous trade execution review
process more transparent and less arbitrary.\20\ Specifically, these
commenters were concerned that the proposed rule change did not clearly
establish a reference price upon which the Numerical Guidelines would
be based.\21\ They noted that FINRA retains the flexibility in certain
circumstances to use a Reference Price other than the consolidated last
sale, as well as to determine the review period for Multi-Stock Events
involving twenty or more securities.\22\ These commenters believed that
if FINRA retained discretion in these areas, the proposed rule change
may not achieve the goal of making the trade break process more
transparent and less arbitrary,\23\ or could create mass confusion.\24\
---------------------------------------------------------------------------
\20\ See BlackRock Letter, at 2, and CSS Letter, at 1-2.
\21\ Id.
\22\ Id.
\23\ See BlackRock Letter, at 2.
\24\ See CSS Letter, at 1-2.
---------------------------------------------------------------------------
In response to comments made on similar proposals made by the
Exchanges, BATS acknowledged that the proposals do not ``in all
circumstances provide 100% advanced certainty with respect to whether a
particular execution will be deemed to be clearly erroneous,'' but
stated its belief that ``its proposal reflects a significant
improvement * * * over its existing rule.'' \25\ Specifically, BATS
noted that its discretion to utilize ``additional factors'' would now
be limited to instances involving less than five securities under
review and further limited to securities that are not subject to a
single stock circuit breaker.\26\ BATS believed its limited discretion
in this regard is necessary and appropriate for maintaining fair and
orderly markets.\27\
---------------------------------------------------------------------------
\25\ See BATS Letter, at 1.
\26\ Id. at 5.
\27\ Id.
---------------------------------------------------------------------------
With respect to the concern expressed by some commenters that the
proposed rule change does not clearly establish a reference price upon
which the Numerical Guidelines would be based, BATS, which proposed
similar discretionary provisions, stated that it is ``critical'' for it
to retain some limited discretion to use a different reference price
when applying the clearly erroneous thresholds because ``there are
circumstances under which last sale would be an inappropriate reference
price. * * * '' \28\ BATS noted, however, that this discretion is
limited because its ``rule is designed to generally guide BATS to look
at the last sale as the reference price'' for those securities not
subject to a circuit breaker and its proposal tries to be ``abundantly
clear and objective that if a security is subject to a single stock
circuit breaker, the reference price will be the circuit breaker
trigger price.'' \29\ BATS also noted that the determination of the
point in time from which to derive the reference price on May 6 had
``nothing to do'' with the delay in announcing which trades would be
broken on May 6; rather, the delay was attributable to the time it took
the Exchanges and FINRA to determine the appropriate percentage at
which trades would be broken.\30\
---------------------------------------------------------------------------
\28\ Id. at 3-4.
\29\ Id.
\30\ Id.
---------------------------------------------------------------------------
The Commission appreciates the suggestions and responses offered by
these commenters to make the process by which FINRA addresses clearly
erroneous executions more certain and transparent by reducing its
discretion. The Commission intends to continue working with FINRA to
further clarify, as appropriate, its process for breaking erroneous
trades that arise in contexts not covered by the proposed rule change,
as well as to continue to evaluate the operations of and potential
refinements to such processes in contexts covered by the proposed rule
change. Nevertheless, the Commission believes that the proposed rule
change represents a productive first step by FINRA in bringing greater
clarity and transparency to the process for breaking clearly erroneous
trades, and that these improvements should not be delayed pending
consideration of further changes.
B. Comments Recommending Alternative Approaches
Four commenters were of the view that, rather than breaking
erroneous trades, FINRA should allow the trades to stand and adjust the
price in line with the market.\31\ These commenters were particularly
concerned about the risk, when trades are broken, that market
participants suddenly may find themselves exposed on one side of the
[[Page 56644]]
market when they thought they had a hedged position.\32\ As one
commenter stated, ``[t]his uncertainty is even more problematic during
periods of heightened volatility in the markets, when liquidity may be
reduced as some market participants limit their trading until they are
able to determine their positions, or volatility may increase further
because of speculative hedging in an attempt to protect unknown
positions.'' \33\ These commenters believed that a price adjustment
process would substantially reduce the uncertainty created by the
potential for broken trades, and thus would be a better way to address
erroneous executions.\34\
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\31\ See GETCO Letter, at 3, Newedge Letter, at 5, BlackRock
Letter, at 2, and Knight Letter, at 2.
\32\ Id.
\33\ See GETCO Letter, at 3.
\34\ See GETCO Letter, at 3, Newedge Letter, at 5, BlackRock
Letter, at 2, and Knight Letter, at 2.
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Other commenters urged alternatives to clearly erroneous execution
rules. For example, one commenter believed that the proposed rule would
``provide market participants more certainty as to whether or not their
trades will stand in the event of market volatility,'' but urged the
Commission to move to a ``futures-style limit up/down functionality''
as a better alternative to the circuit breaker trading halt
approach.\35\ This commenter argued that the limit up/limit down
approach ``would virtually eliminate clearly erroneous trades.'' \36\
Another commenter also believed that the Commission should consider a
``limit up/limit down approach or hybrid approach.'' \37\ Other
commenters suggested alternative procedures, systems or rules to
prevent erroneous trades from occurring, such as by rejecting orders
that are materially away from the market.\38\
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\35\ See GETCO Letter, at 2-3.
\36\ See GETCO Letter, at 3.
\37\ See SIFMA Letter, at 2.
\38\ See FIF Letter, at 2, Wellington Letter, at 2-4, and SIFMA
Letter, at 2. See also CSS Letter, at 2 (suggesting that circuit
breakers for individual stocks based off of a percentage change from
the previous day's closing price (or the opening price to allow for
the dissemination of overnight news) would eliminate the need for
erroneous trade rules).
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The Commission appreciates the suggestions offered by these
commenters to make more fundamental changes to the way in which FINRA
addresses clearly erroneous executions. In the coming months, the
Commission expects to continue to work with the markets and market
participants on ways to reduce the occurrence of erroneous trades and
improve the method by which they are resolved, as well as on
enhancements to the mechanisms for addressing excessive market
volatility, such as those that currently are reflected in the single-
stock circuit breaker pilot. As noted above, however, the Commission
believes that the proposed rule change represents a productive first
step by FINRA in bringing greater clarity and transparency to the
process for breaking clearly erroneous trades, and that these
improvements should not be delayed pending consideration of more far-
reaching initiatives.
C. Other Comments
One commenter was concerned that the proposed rule change was not
clear as to how news or information regarding the review and
cancellation of clearly erroneous trades would be disseminated to the
markets.\39\ This commenter believed that the proposed rule should
require FINRA to disseminate this information quickly and in a non-
discriminatory fashion to market participants in order to minimize the
market impact and not favor any one group of market participants over
another.\40\ In its response letter with respect to its proposal, BATS
stated that it e-mails members with respect to clearly erroneous
reviews and determinations according to a consistent and well
established protocol that, according to BATS, strikes an appropriate
balance between notifying members of significant market events and
avoiding notifications every time a transaction is reviewed as
potentially clearly erroneous.\41\ In addition, BATS believes that the
existing requirement that an SRO promptly notify affected members of
clearly erroneous reviews and determinations is sufficient.\42\ BATS
also stated that communication between the exchanges and members should
remain flexible as such methods are constantly changing.\43\ BATS
indicated that it is not aware of discrimination amongst participants
with respect to the dissemination of information in relation to clearly
erroneous reviews and believes that the ``anti-discrimination
requirements of the Act would sufficiently restrain''
discrimination.\44\
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\39\ See Newedge Letter, at 6.
\40\ Id.
\41\ See BATS Letter, at 2.
\42\ Id.
\43\ Id.
\44\ Id.
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Another commenter believed that the Commission should require FINRA
to clarify the application of the clearly erroneous execution rule when
an event causes the price to cross to a different specified percentage
threshold for breaking trades. Specifically, the commenter asked, ``if
a market decline triggers the CEE rules intra-day with respect to a
stock that was priced at $25.01, so the CEE price is below $25, the
proposed amendments do not explain at what price trading would be
calculated for the next application of the CEE rules. Would it be at 5
percent for stocks between $25 and $50 or 10 percent for stocks priced
less than $25?'' \45\ That commenter also expressed concern that the
proposed rule change might provide an opportunity for market
participants to manipulate events involving multiple stocks that are
not subject to the single-stock circuit breakers. This might occur, for
example, when an event subject to a 10% threshold (e.g., involving 20
securities) could be forced into the 30% threshold category (e.g., by
manipulating the 21st security and causing an erroneous trade), by a
market participant seeking the flexibility to trade at wider spreads
with respect to all impacted securities.\46\
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\45\ See ICI Letter, at 3.
\46\ Id.
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Another commenter noted that, when an individual stock trading
pause is triggered, trades will be broken at specified percentages away
from the Trading Pause Trigger Price.\47\ According to this commenter,
this calculation ``has the practical effect of doubling the clearly
erroneous price window for most U.S. equity securities and is a
significant expansion of the window for certain securities.'' \48\ This
commenter suggested using more conservative parameters such as the
greater of 2% or $0.05 from the Trading Pause Trigger Price or,
alternatively, using the Trading Pause Trigger Price, in addition to a
comparison to the last sale, as part of an analysis for clearly
erroneous trades.'' \49\ This commenter also favored providing FINRA
discretion to break trades after the deadlines specified in its rule in
extraordinary circumstances.\50\
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\47\ See SIFMA Letter, at 2-3.
\48\ Id.
\49\ Id.
\50\ Id.
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With respect to the dissemination of information regarding the
review and resolution of clearly erroneous trades, the Commission
understands that the practice of FINRA is to promptly notify
participants that specified trades are under review and, once that
review is complete, to describe the resolution thereof. Although the
Commission believes prompt communication by e-mail, phone, website or
otherwise concerning erroneous trade reviews should generally assure
dissemination in a non-discriminatory fashion, as noted above, it
intends to continue to work with FINRA on additional ways to
[[Page 56645]]
improve the transparency of this process.
With respect to an event that causes the price to cross to a
different specified percentage threshold for breaking trades, the
Commission believes that the proposal is sufficiently clear regarding
the applicability of the new rule. As to the specific example provided
by the commenter, under the proposed rule, if a stock triggers a
trading pause, the Trading Pause Trigger Price would be used as the
Reference Price. The Trading Pause Trigger Price is calculated by the
listing market over a rolling five minute period. If the Trading Pause
Trigger Price is calculated at a level below $25.00, as identified in
the example, then the 10% threshold would apply to clearly erroneous
execution reviews of the Trigger Trade and other transactions that
occur immediately after a Trigger Trade but before the trading pause is
fully implemented across markets. If another series of transactions
trigger a second trading pause, the review process set forth in the
rule would be repeated and a new Reference Price would be calculated to
determine the appropriate percentage threshold.
With respect to the potential for market participants to engage in
manipulation in order to achieve a higher trade break percentage
threshold, the Commission emphasizes that it will vigorously pursue
instances of illegal market manipulation. In addition, during the pilot
period, the Commission will work with FINRA to review the operation of
the amended rule, and make improvements as warranted, including if it
appears the selected percentage thresholds create distortions or incent
improper or illegal behavior.
With respect to the chosen parameters, the Commission notes that
the parameters that were selected were the product of a coordinated and
deliberate effort by FINRA and the Exchanges to improve the handling of
clearly erroneous trades. Regarding the specific comment expressing
concern that breaking trades only when they are 10%, 5% or 3% away from
the Trading Pause Trigger Price has the practical effect of doubling
the trading pause parameters, the Commission notes that, as an initial
matter, implementation of the individual stock trading pause should
prevent most trades from occurring at prices outside of the Trading
Pause Trigger Price. To the extent trades occur outside of such price
before the trading pause is fully applied across all markets, the
Commission believes that it is appropriate to break these ``leakage''
trades only when they are a meaningful percentage away from the Trading
Pause Trigger Price. This is consistent with the traditional approach
of the Exchanges and FINRA to take the more extreme step of breaking a
trade only in cases where it occurs at a price sufficiently away from
the current market price that the parties should have been on notice it
may be ``clearly erroneous.'' Of course, the pilot program may indicate
that different parameters are better to accomplish the stated goals. If
so, the parameters could be changed as part of the overall initiative.
The Commission will further study and consider the examples and
suggestions offered by the commenters during the pilot period.
D. Commission Findings
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to FINRA. In particular, the Commission finds
that the proposed rule change is consistent with the requirements of
Section 15A(b)(6) of the Act,\51\ which, among other things, requires
that the rules of FINRA be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system, and in general,
to protect investors and the public interest.
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\51\ 15 U.S.C. 78o-3(b)(6).
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In the Commission's view, the proposed rule change will help assure
that the determination of whether a clearly erroneous trade has
occurred will be based on clear and objective criteria, and that the
resolution of the incident will occur promptly through a transparent
process. The proposed rule change also should help assure consistent
results in handling erroneous trades across the U.S. markets, thus
furthering fair and orderly markets, the protection of investors and
the public interest. Finally, the Commission notes that the proposed
rule change is being implemented on a pilot basis so that the
Commission and FINRA can monitor the effects of the pilot on the
markets and investors, and consider appropriate adjustments, as
necessary.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\52\ that the proposed rule change (SR-FINRA-2010-032), be, and
hereby is, approved.
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\52\ 15 U.S.C. 78s(b)(2).
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-23075 Filed 9-15-10; 8:45 am]
BILLING CODE 8010-01-P
