03-2017. Self Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval to Proposed Rule Change and Amendment No. 1 Thereto Amending Rule 11890 Concerning Clearly Erroneous Transactions

January 22, 2003.

I. Introduction

On September 24, 2002, the National Association of Securities Dealers, Inc., through its subsidiary, the Nasdaq Stock Market, Inc. (“Nasdaq”) filed with the Securities and Exchange Commission (“Commission”), pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and rule 19b-4 thereunder,^[2] a proposed rule change to amend NASD rule 11890, which provides Nasdaq with authority to nullify or modify transactions. On November 1, 2002, Nasdaq filed Amendment No. 1 that entirely replaced the original rule filing.^[3] The proposed rule change, as amended, was published for comment in the Federal Register on December 9, 2002.^[4] The Commission received no comments on the proposal. This order approves the proposed rule change, as amended.

II. Description of the Proposal

Nasdaq proposes to amend NASD rule 11890, which provides Nasdaq with the authority to nullify or modify transactions.

a. Review of Transactions Pursuant to Complaint of Market Participant

Under NASD rule 11890, Nasdaq has the authority to receive petitions from market participants requesting that designated officers of Nasdaq review the terms of a transaction and nullify or modify it if the transaction is found to be clearly erroneous. Among other things, NASD rule 11890, as amended by this proposal, will explicitly limit Nasdaq's purview to transactions arising out of the use or operation of Nasdaq execution or communication systems and explicitly require that the parties to a reviewable transaction be readily identifiable by Nasdaq through its systems. Amended NASD rule 11980 will also clarify, in part, that it covers transactions entered into by a member of a UTP exchange through a Nasdaq execution system. Thus, the rule will cover transactions executed between a Nasdaq member and a member of a UTP exchange that had agreed to accept automatic executions through SuperSOES or SuperMontage, but will not cover transactions where the UTP exchange merely posted a quote and was accessible only via telephone. The amended rule would also clarify that information submitted by parties to Nasdaq must be received by Nasdaq within the time frames specified in the rule.

b. Review of Transactions on Nasdaq's Own Motion

Nasdaq proposes to amend NASD rule 11890 to state that Nasdaq's authority to review transactions based upon its own motion may be exercised in the event of extraordinary market conditions or other circumstances in which the nullification or modification of transactions may be necessary for the maintenance of a fair and orderly market or the protection of investors and the public interest. Amended NASD rule 11890 will also clarify that Nasdaq's authority to review transactions based upon its own motion may be applied to any transaction arising out of or reported through a Nasdaq quotation, execution, communication, or trade reporting system, including transactions entered into by a member of a UTP exchange through a Nasdaq execution system (but excluding transactions entered into through, or reported to, a UTP exchange).

Additionally, the proposed rule change will amend the time frame for action to require that the Nasdaq officer, either the Nasdaq President or Executive Vice President designated by the President, on Nasdaq's own motion, act, except in extraordinary circumstances, no later than 3 p.m. on the next trading day. Finally, Nasdaq is adding interpretative material after the rule to provide that it shall be considered conduct inconsistent with just and equitable principles of trade for a member to refuse to take action that is necessary to effectuate a final decision of a Nasdaq officer or the Market Operations Review Committee (“MORC”).

c. Review by the Market Operations Review Committee

NASD rule 11890 governs review by the MORC, a standing committee composed of representatives of member firms as well as “non-industry” representatives. Persons seeking to appeal a determination by Nasdaq must submit their appeal within the time parameters specified by the rule. Both parties are then given the opportunity to submit supporting arguments in writing, and the matter is submitted to the MORC for a determination. Nasdaq proposes, however, that an officer empowered to review transactions on Nasdaq's own motion (i.e., the President or an Executive Vice President) may determine that the number of transactions affected by a decision to break or modify trades on Nasdaq's own motion is such that the decision must be accorded immediate finality in order to maintain a fair and orderly market and to protect investors and the public interest.

d. Communications Between Nasdaq and Market Participants

Amended NASD rule 11890 will describe in greater detail the parameters for communications between Nasdaq and market participants. Specifically, the proposal will provide that materials submitted to Nasdaq or the MORC must be submitted via facsimile machine and must be received within the time parameters specified by the rule. However, if requested, Nasdaq staff may authorize submission of materials via electronic mail on a case-by-case basis.^[5] Materials shall be deemed received at the time indicated by a facsimile machine or computer that receives the materials. Nasdaq reserves the right to reject or accept material that is not received within the time parameters specified by the rule.

Nasdaq will provide notice of determinations under the rule via facsimile machine, electronic mail, or telephone (including voicemail). However, in cases where an officer nullifies or modifies a large number of transactions pursuant to Nasdaq's authority to act on its own motion, individual notice may not be practicable. In that case, Nasdaq may provide notice to market participants via the Nasdaq Workstation II Service, a press release, or any other method reasonably expected to provide rapid notice to many market participants.

III. Discussion

The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association,^[6] and in particular, the requirements of section 15A(b)(6) of the Act,^[7] which, among other things, requires that the association's rules 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. Specifically, the Commission believes that Nasdaq's proposal may clarify the scope of Nasdaq's authority to review erroneous transactions and the procedural aspects of reviewing such transactions.

Nasdaq proposes to delineate, in part, the conditions under which Nasdaq will consider petitions by market participants to review transactions. Proposed NASD rule 11890 explicitly limits its purview to transactions arising out of the use or operation of Nasdaq execution or communication systems and explicitly requires that the parties to a reviewable transaction be readily identifiable by Nasdaq through its systems. The Commission believes that the amended rule better reflects Nasdaq's interpretation of the scope of its rule. Nasdaq has represented that in the past it has declined to adjudicate petitions on the grounds that the transaction would be more appropriately reviewed by the market center on which it was executed. Therefore, the Commission believes that the proposed rule change clarifies the application and operation of the rule for market participants.

Nasdaq also proposes to amend NASD rule 11890 to state that Nasdaq's authority to review transactions based upon its own motion may be exercised in the event of extraordinary market conditions or other circumstances in which the nullification or modification of transactions may be necessary for the maintenance of a fair and orderly market or the protection of investors and the public interest. The Commission believes that the proposal clarifies Nasdaq's authority to nullify or modify transactions on its own motion and provides Nasdaq with the flexibility to address a variety of extraordinary market conditions expeditiously. The Commission notes that Nasdaq expects to assert its authority primarily in circumstances where the disruption or malfunction of a system resulted in the execution of trades with obvious errors, such as a price substantially unrelated to the inside market. Nasdaq has also represented that it will not attempt to break or modify trades entered into through, or reported to, a UTP exchange. Nasdaq will endeavor to coordinate its actions with other market centers to achieve consistent treatment of trades outside Nasdaq's jurisdiction.

Regarding the review of Nasdaq determinations by the MORC, Nasdaq proposes that an officer empowered to review transactions on Nasdaq's own motion (i.e., the President or an Executive Vice President) may determine that the number of transactions affected by a decision to break or modify trades on Nasdaq's own motion is such that the decision must be accorded immediate finality in order to maintain a fair and orderly market and to protect investors and the public interest. The Commission believes that Nasdaq's proposal is reasonable and that the market may be well served by the finality it provides. Furthermore, Nasdaq has represented, and the Commission expects, that Nasdaq would use this authority only on rare occasions. For example, Nasdaq believes that there may be circumstances in which review by the MORC of a large number of trades would be impractical and could expose market participants to unacceptable levels of risk.^[8]

Finally, Nasdaq proposes to describe in greater detail the parameters for communications between Nasdaq and market participants. The Commission believes that the proposal may clarify procedural aspects of the process of reviewing transactions and therefore promote the fair and efficient resolution of disputes.

IV. Conclusion

For the reasons discussed above, the Commission finds that the proposal, as amended, is consistent with the Act and the rules and regulations thereunder. It is therefore ordered, pursuant to section 19(b)(2) of the Act,^[9] that the proposed rule change (SR-NASD-2002-127), as amended, be and hereby is approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[10]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See letter from Mary M. Dunbar, Vice President and Deputy General Counsel, Nasdaq, to Katherine A. England, Assistant Director, Division of Market Regulation, Commission, dated November 1, 2002.

4.  See Securities Exchange Act Release No. 46939 (December 3, 2002), 67 FR 72994 (December 9, 2002) (SR-NASD-2002-127).

5.  For example, if a party wishes to submit, pursuant to subparagraph (a)(2)(A) of the amended rule, a large document containing supporting information, it may be preferable to submit the document via electronic mail. Electronic mail may be used only when specifically authorized by Nasdaq staff, however, because it is impossible to control the delivery time of electronic mail.

6.  In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

7.  15 U.S.C. 78o-3(b)(6).

8.  For example, Nasdaq believes that if an erroneously priced order or quote causes a large number of transactions to occur at prices far in excess of a security's true value and if a decision is made to break all of the affected trades, some sellers may appeal the decision to break the trades. If a market participant is a party to trades on both sides of the market, and some remain broken while others are appealed and reinstated, it will suffer losses that arise solely from the inconsistent treatment of its trades.

9.  15 U.S.C. 78s(b)(2).

10.  17 CFR 200.30-3(a)(12).