[Federal Register Volume 75, Number 179 (Thursday, September 16, 2010)]
[Notices]
[Pages 56641-56645]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-23075]
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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.
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\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'').
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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\
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\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.
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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.
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\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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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.
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\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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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.
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\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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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.
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\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.
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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 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\
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\17\ See Newedge Letter, at 4-5, and BlackRock Letter, at 2.
\18\ See Newedge Letter, at 4.
\19\ Id.
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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\
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\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.
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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\
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\25\ See BATS Letter, at 1.
\26\ Id. at 5.
\27\ Id.
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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\
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\28\ Id. at 3-4.
\29\ Id.
\30\ Id.
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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