[Federal Register Volume 62, Number 19 (Wednesday, January 29, 1997)]
[Notices]
[Pages 4368-4371]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-2099]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38196; File No. SR-NASD-96-51]
Self-Regulatory Organizations; Notice of Proposed Rule Change by
the National Association of Securities Dealers, Inc. Amending Rule
11890 Regarding Clearly Erroneous Transactions
January 22, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December
17, 1996, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the NASD and The Nasdaq Stock Market, Inc. (``Nasdaq''). On January
17, 1997, the NASD and Nasdaq submitted to the Commission Amendment No.
1 to the proposed rule change.\1\ The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ See letter from Robert E. Aber, Vice President and General
Counsel, Nasdaq, to Katherine A. England, Assistant Director, SEC,
dated January 17, 1997. Amendment No. 1 corrects typographical
errors in the text of the proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
Pursuant to Section 19(b)(1) under the Act and Rule 19b-4
thereunder, the NASD and Nasdaq are submitting this rule filing to
amend Rule 11890, the rule related to clearly erroneous transactions.
The proposed amended language for Rule 11890 is set forth below. [new
text is italicized; deleted text is bracketed].
11890. Clearly Erroneous [Trades] Transactions
(a) Authority to [Declare] Review Transactions [Void]
(1) [In circumstances in which the Association deems it necessary
to maintain a fair and orderly market and to protect investors and the
public interest, the Association may, pursuant to the procedures set
forth in paragraph (b) below, declare any transaction arising out of
the use or operation of any automated quotation, execution, or
communication system owned or operated by the Association or any
subsidiary thereof and approved by the Commission, null and void on the
grounds that one or more of the terms of the transaction are clearly
erroneous.
(2)] For the purposes of this Rule, the terms of a transaction are
clearly erroneous when there is an obvious error in any term, such as
price, number of shares or other unit of trading, or identification of
the security.
(2) Officers of The Nasdaq Stock Market, Inc. (``Nasdaq'')
designated by the President of Nasdaq shall, pursuant to the procedures
set forth in paragraph (b) below, have the authority to review any
transaction arising out of the use or operation of any automated
quotation, execution, or communication system owned or operated by
Nasdaq and approved by the Commission. A Nasdaq officer shall review
transactions with a view toward maintaining a fair and orderly market
and the protection of investors and the public interest. Based upon
this review, the Officer shall decline to act upon a disrupted
transaction if the officer believes that the transaction under dispute
is not clearly erroneous, or, if the officer determines the transaction
in dispute is clearly erroneous, he or she shall declare that the
transaction is null and void or modify one or more terms of the
transaction. When adjusting the terms of a transaction, the Nasdaq
officer shall seek to adjust the price and/or size of the transaction
to achieve an equitable rectification of the error that would place the
parties to a transaction in the same position, or as close as possible
to the same position, that they would have been in had the error not
occurred. Nasdaq shall promptly provide oral notification of a
determination to the parties involved in a disputed transaction and
thereafter issue a written confirmation of the determination.
(b) Procedures for Reviewing [Declaring a] Transactions [Void]
(1) Any member or person associated with a member that seeks to
have a transaction reviewed [declared null and void] pursuant to
paragraph (a) hereof, shall submit a written complaint, via facsimile
or otherwise, to Nasdaq Market Operations in accordance with the
following time parameters:
(A) for transactions occurring prior to 10:00 a.m., Eastern Time,
complaints must be submitted 10:30 a.m., Eastern Time; and
(B) for transactions occurring on or after 10:00 a.m., Eastern
Time, complaints must be submitted within thirty minutes.
[notify an officer of the Association designated by the President of
the transaction during Nasdaq operating hours on the same business day
the transaction occurs, and shall provide such official all facts and
information necessary for a determination under paragraph (a).
Information communicated orally shall be confirmed promptly in
writing.]
(2) Once a complaint has been received in accord with subparagraph
(b)(1) above:
(A) the complainant shall have up to thirty (30) minutes, or such
longer period as specified by Nasdaq staff, to submit any supporting
written information concerning the complaint necessary for a
determination under paragraph (a)(2), via facsimile or otherwise;
(B) the counterparty to the trade shall be verbally notified of the
complaint by Nasdaq staff and shall have up to thirty (30) minutes, or
such longer period as specified by Nasdaq staff, to submit any
supporting written information concerning the complaint necessary for a
determination under paragraph (a)(2), via facsimile or otherwise; and
(C) either party to a disputed trade may request the written
information provided by the other party pursuant to this subparagraph.
(3) Notwithstanding paragraph (b)(2) above, once a party to a
disputed trade communicates that it does not intend to submit any
further information concerning a complaint, the party may not
thereafter provide additional information unless requested to do so by
Nasdaq staff. If both parties to a disputed trade indicate that they
have no further information to provide concerning the complaint before
their respective thirty-minute information submission period has
elapsed, then the matter may be immediately presented to a Nasdaq
officer for a determination pursuant to paragraph (a)(2) above.
(4) Each member and/or person associated with a member involved in
the transaction shall provide the Association with any information
requested by the Association in order to resolve the matter on a timely
basis notwithstanding the time parameters set forth in paragraph (b)(2)
above.
(5) Once a party has applied to Nasdaq for review, the transaction
shall be reviewed and a determination rendered, unless both parties to
the transaction agree to withdraw the application for review prior to
the time a decision is rendered pursuant to paragraph (a)(2).
[[Page 4369]]
[(2) An officer of the Association designated by the President
shall review the information submitted and determine whether the
transaction in dispute is clearly erroneous and detrimental to the
maintenance of a fair and orderly market and the protection of
investors and the public interest and may declare that the transaction
be null and void. The official may decline to act upon a disputed
transaction if he or she believes that action is unnecessary or
inappropriate. The Association shall immediately issue a written
determination of the matter, setting forth the actions taken and the
reasons therefor.]
(c) Procedures for Reviewing Transactions Executed During System
Disruptions or Malfunctions
In the event of a disruption or malfunction in the use or operation
of any automated quotation, execution, or communications system owned
or operated by Nasdaq and approved by the Commission, Nasdaq, acting
through an officer designated by the President of Nasdaq pursuant to
paragraph (a)(2), may, on its own motion pursuant to the standards set
forth in paragraph (a), declare transactions arising out of the use or
operation of such systems during the period of such disruption or
malfunction null and void or modify the terms of these transactions;
provided that, in the absence of extraordinary circumstances, a Nasdaq
officer must take action pursuant to this paragraph within thirty (30)
minutes of detection of the erroneous transaction(s), but in no event
later than 6:00 p.m., Eastern Time, on the next trading day following
the date of the trade at issue. When Nasdaq takes action pursuant to
this subparagraph, the member firms involved in the transaction shall
be notified as soon as is practicable and shall have a right to appeal
such action in accordance with paragraph (d)(1) below.
(d) [(3)] Review by the Market Operations Review Committee (``MORC'')
(1) A member or person associated with a member may appeal a
determination made under paragraphs (a)(2) or (c) [the determination
under subparagraph (2)] to the MORC [Market Operations Review
Committee] provided such appeal is made in writing, via facsimile or
otherwise, within [four market hours of] thirty (30) minutes after the
member or person associated with a member receives verbal notification
of such determination. [For the purposes of this Rule, ``market'' hours
shall mean those hours the Nasdaq market is open in the United States,
Eastern Time.] Once a written appeal has been received, the
counterparty to the trade will be notified of the appeal and both
parties shall be able to submit any additional supporting written
information, via facsimile or otherwise, up until the time the appeal
is considered by the Committee. Either party to a disputed trade may
request the written information provided by the other party during the
appeal process. An appeal to the Committee shall not operate as a stay
of the determination made pursuant to paragraph (a)(2) above. Once a
party has appealed a determination to the Committee, the determination
shall be reviewed and a decision rendered, unless both parties to the
transaction agree to withdraw the appeal prior to the time a decision
is rendered by the Committee. Upon consideration of the record, and
after such hearings as it may in its discretion order, the Committee,
pursuant to the standards set forth in paragraph (a), shall affirm,
modify, reverse, [dismiss,] or remand the determination made under
[sub]paragraph (a)(2) or (c) above.
(2) [(4)] The decision of the Committee shall be final and binding
upon any member or person associated with a member and shall constitute
final Association action on the matter in issue. Any adverse
determination by a Nasdaq officer pursuant to paragraph (a)(2) or (c)
or any adverse decision by the Committee pursuant to paragraph (d)(1)
shall be rendered without prejudice as to the rights of the parties to
the transaction to submit their dispute to arbitration.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD and Nasdaq included
statements concerning the purpose of and basis for the proposed rule
change and discussed any comments it received on the proposed rule
change. The text of these statements may be examined at the places
specified in Item IV below. The NASD and Nasdaq have prepared
summaries, set forth in Sections (A), (B), and (C) below, of the most
significant aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The NASD and Nasdaq have determined to amend Rule 11890, the NASD's
rule governing the review and resolution of erroneous transaction
complaints. In general, the proposed amendments provide greater
specificity regarding declarations of erroneous transactions. As
explained in more detail below, the proposed amendments would:
Provide Nasdaq officials the authority to efficiently and
expeditiously adjust the price and size of erroneous transactions
(currently Nasdaq officials may only nullify, affirm, or decline to act
with respect to an allegedly erroneous transaction);
Shorten the time period to submit erroneous transactions
complaints from same day submission to submission within 30 minutes of
the transaction;
Clarify the procedures by which the parties to an
allegedly erroneous transaction may submit written information
concerning the transaction;
Provide Nasdaq officials the requisite authority to cancel
or adjust erroneous transactions on their own motion;
Discourage regulatory arbitrage by prohibiting a member
from withdrawing an erroneous transaction complaint unless the other
party to the trade agrees to withdraw the matter;
Shorten the time period to appeal an erroneous transaction
determination from four ``market'' hours to thirty minutes; and
Clarify that an appeal of an erroneous transaction
determination does not operate as a stay of the determination.
A. Background
In April 1990, the SEC approved an NASD proposal to add Section 70
to the Uniform Practice Code (now NASD rule 11890) to permit the NASD
to declare clearly erroneous transactions null and void if they arise
out of the use or operation of any automated quotation, execution, or
communication system owned or operated by the NASD. Previously, the
NASD had no authority to cancel a transaction, even if one or more
terms of the transaction clearly was in error. For example, one of the
catalysts for adopting Rule 11890 was that a member had complained that
a trade executed over Nasdaq's SelectNet service was ten points away
from the inside quotation, clearly an error, but the contra party
refused to cancel the trade. With the adoption of rule 11890, the NASD
now has the ability to resolve disputes involving obvious errors in an
expeditious manner, akin to an exchange floor governor ruling.\2\
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\2\ See, e.g., New York Stock Exchange Rule 75.
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[[Page 4370]]
Briefly, the current procedures for canceling a clearly erroneous
trade require one party to contact the NASD on trade day and in writing
state the basis for the requested action. Thereafter, an officer of
Nasdaq: (1) advises the contra party to the trade that the transaction
is in dispute; (2) obtains additional information concerning the
transaction, if necessary; (3) reviews the trade information; and (4)
makes a determination as to whether the trade should stand or be
broken. If either party wishes to appeal the staff determination, it
may seek review by the MORC.
While the current Erroneous Transaction procedures have served as a
vehicle to correct or cancel erroneous transactions, experience with
the operation of Rule 11890 has shown that the Rule can be improved to
enhance the fairness and expediency with which erroneous transaction
complaints are resolved. Experience with the Rule also has revealed
shortcomings in the scope of Nasdaq's authority to take action with
respect to clearly erroneous transactions. In particular, there have
been instances in the past where it would have been appropriate for
Nasdaq to declare a series of transactions erroneous even though the
parties to the transactions were immediately unaware of any error. The
proposed changes to the rule are intended to eliminate the shortcomings
and to provide additional capabilities to resolve clearly erroneous
transactions.
B. Proposed Changes to Rule 11890
(i) Authority of Nasdaq Officers to Adjust the Terms of Erroneous
Transactions: While Nasdaq officers and the MORC both have the
authority to nullify, affirm, or decline to act with respect to an
allegedly erroneous transaction, only the MORC can presently adjust the
terms of an erroneous transaction. In order to enhance the efficiency
with which erroneous transaction disputes are resolved, it is
appropriate to grant Nasdaq officers the requisite authority with
respect to allegedly erroneous transactions that the MORC possesses.
Accordingly, the NASD and Nasdaq propose that Rule 11890 be amended to
afford Nasdaq officers the authority to adjust the terms of a clearly
erroneous transaction. In particular, the NASD and Nasdaq believe
Nasdaq officers should be able to adjust the price and/or size of a
transaction to achieve an equitable correction of an error that would
place the parties to the transaction in the same position, or as close
as possible to the same position, that they would have been in had the
error not occurred.
(ii) Time Parameters For the Submission of Erroneous Transaction
Complaints: Rule 11890 presently provides that a member can submit an
erroneous transaction complaint ``during Nasdaq operating hours on the
same business day the transaction occurs. . . .'' Because members can
file erroneous transaction complaints any time during the trading day,
however, the rule has been used by some firms to seek to cancel trades
that were not erroneous at the time of execution, but which became
unprofitable due to subsequent market movement. For example, when a
trade occurs on SelectNet at 10:00 a.m. and a party does not complain
of an error until 5:00 p.m., the complainant has had the opportunity to
watch for positive or negative market movements, prior to requesting
NASD action. If the market moves in a direction that is unfavorable to
the trade, the member will contact the NASD to cancel the trade after
the close of the market, leaving the other side of the transaction at
risk, without giving adequate notice of the disputed trade in close
proximity to the time of execution.\3\
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\3\ In essence, the rule grants a free call option when a
potential complainant sold stock and a free put option when the
potential complainant bought stock.
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Accordingly, the NASD and Nasdaq believe that Rule 11890 should be
amended to require the timely submission of notifications of allegedly
erroneous transactions. The NASD and Nasdaq are proposing two different
time periods depending upon the time of day when the allegedly
erroneous transaction occurred to take into account the peak trading
period that occurs at the market's opening. Because of the pace and
volume of trades that occur in the first half hour of trading each
morning, the proposal establishes a separate timeframe for reporting
clearly erroneous transactions that occur between 9:30 and 10:00. Thus,
notifications would be required according to the following time table:
(a) for transactions occurring prior to 10:00 a.m., Eastern Time,
complaints must be submitted by 10:30 a.m., Eastern Time; and
(b) for transactions occurring at or after 10:00 a.m., Eastern
Time, complaints must be submitted within thirty minutes.
In addition, the NASD proposes to amend Rule 11890 to clarify
several procedural aspects concerning the submission of erroneous
transaction complaints. Specifically, the amendments would clarify
that:
(a) a complaint will not be deemed to have been submitted until
Market Operations receives a written complaint, via facsimile or
otherwise;
(b) once a timely complaint is received, a complainant will have up
to thirty minutes to submit any supporting written information
concerning the complaint, via facsimile or otherwise;
(c) once a timely complaint is received, the counter-party will be
notified by Market Operations of the complaint and afforded a thirty-
minute period to submit any supporting written information concerning
the disputed trade, via facsimile or otherwise;
(d) either party to a disputed trade may request the written
information submitted by the other party;
(e) notwithstanding the thirty-minute period to submit information,
once a party to a disputed trade communicates that it has no further
information to provide, it may not thereafter provide additional
information unless requested to do so by the staff; and
(f) if both parties to a disputed trade indicate that they have no
further information to provide concerning the complaint before their
respective thirty-minute information submission period has elapsed,
then the matter may be immediately presented to a Nasdaq officer for a
determination.
(iii) Authority of Nasdaq to Cancel or Adjust Clearly Erroneous
Trades on its Own Motion: Presently, only members can seek to have an
allegedly erroneous transaction nullified. There have been occasions,
however, where Nasdaq system malfunctions have caused erroneous trades.
Accordingly, in order to promote fair and orderly markets, the NASD and
Nasdaq believe it would be appropriate to provide designated Nasdaq
officials the authority to cancel or modify the terms of transactions
in the event of a disruption or malfunction in the use or operation of
any automated quotation, execution, or communication system owned or
operated by Nasdaq.\4\ Under this provision, the NASD and Nasdaq also
believe such senior officials should be authorized to cancel or adjust
an erroneous transaction on their own motion within thirty minutes of
detection of the erroneous transaction, absent extraordinary
circumstances, but in no event later than 6:00 p.m. on the next trading
day after the date of the trade(s) in dispute. As with any other
erroneous transaction determination, members would have the right to
appeal such actions to the MORC.
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\4\ A list of the Nasdaq officials that have the authority to
cancel or modify the terms of a transaction shall be maintained by
the Nasdaq Corporate Secretary.
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(iv) Withdrawal of Erroneous Transaction Complaints: Rule 11890
[[Page 4371]]
currently permits a member to withdraw an erroneous transaction
complaint at any time. Because there are no restrictions on when a
complaint can be withdrawn, market participants have in the past
withdrawn their complaints when the market moved in their favor
subsequent to filing the complaint. Accordingly, in order to facilitate
the maintenance of fair and orderly markets and the equitable
resolution of erroneous transaction disputes, the NASD and Nasdaq
believe that Rule 11890 should be amended to prohibit the withdrawal of
a complaint or an appeal of an erroneous transaction determination
unless both parties to the trade agree to withdraw the matter.
(v) Time Parameter to Appeal Erroneous Transaction Determinations:
Presently, members have four ``market'' hours to appeal an erroneous
transaction determination. This period of time is too long in that it
unduly extends the period of time that both parties to the trade are
subject to market risk. Accordingly, the NASD has proposed that, once a
member has received verbal notification of an erroneous transaction
determination from the staff, it shall have thirty minutes to appeal
the determination. The NASD and Nasdaq also propose that Rule 11890
should be amended to clarify that once a written appeal has been
received, the counter-party to the trade will be notified of the appeal
and both parties will be able to submit any additional supporting
written information up until the time the appeal is considered by the
Committee. In addition, the NASD and Nasdaq believe that the Rule
should be amended to provide that either party to a disputed trade may
request the written information provided by the other party during the
appeal process.
(vi) Clarification of the Appeal Process for Erroneous Transaction
Determinations: In order to clarify the current operation of the appeal
process for erroneous transaction determinations, Rule 11890(b)(3)
should be amended to provide that:
(a) an appeal of an erroneous transaction determination does not
operate as a stay of the initial ruling; and
(b) any decisions by the MORC or the staff are rendered without
prejudice as to the rights of the parties to seek arbitration of the
disputed transactions.
In proposing these rule changes, the NASD and Nasdaq believe that
the process for resolving erroneous transaction complaints will become
fairer, more efficient, and more timely, thereby promoting the
maintenance of fair and orderly markets and exposing the parties to an
allegedly erroneous transaction to less market risk. In addition,
allowing Nasdaq officials to cancel or adjust erroneous transactions on
their own motion in the event a disturbance or malfunction with a
Nasdaq system will serve to protect the interests of investors.
Accordingly, the NASD and Nasdaq believe that the proposed rule change
is consistent with the provisions of Section 15A(b)(6) in that it
promotes the protection of investors and the public interest.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD and Nasdaq do not believe that the proposed rule change
will result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received from Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to File No. SR-NASD-96-51 and should
be submitted by February 19, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-2099 Filed 1-28-97; 8:45 am]
BILLING CODE 8010-01-M
