[Federal Register Volume 75, Number 179 (Thursday, September 16, 2010)]
[Notices]
[Pages 56613-56618]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-23076]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62886; File Nos. SR-BATS-2010-016; SR-BX-2010-040; SR-
CBOE-2010-056; SR-CHX-2010-13; SR-EDGA-2010-03; SR-EDGX-2010-03; SR-
ISE-2010-62; SR-NASDAQ-2010-076; SR-NSX-2010-07; SR-NYSE-2010-47; SR-
NYSEAmex-2010-60; SR-NYSEArca-2010-58]
Self-Regulatory Organizations; BATS Exchange, Inc.; NASDAQ OMX
BX, Inc.; Chicago Board Options Exchange, Incorporated; Chicago Stock
Exchange, Inc.; EDGA Exchange, Inc.; EDGX Exchange, Inc.; International
Securities Exchange LLC; The NASDAQ Stock Market LLC; National Stock
Exchange, Inc.; New York Stock Exchange LLC; NYSE Amex LLC; NYSE Arca,
Inc.; Order Granting Approval of Proposed Rule Changes Relating to
Clearly Erroneous Transactions
September 10, 2010.
I. Introduction
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''), and NYSE Arca, Inc. (``NYSE
Arca'') (collectively, the ``Exchanges'') 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, proposed rule changes to amend certain of their respective
rules to set forth clearer standards and curtail their discretion with
respect to breaking erroneous trades.\1\ On June 18, 2010, BX, EDGA,
EDGX, ISE, Nasdaq, NSX, and NYSE Arca submitted amendments to their
respective proposed rule changes. On June 21, 2010, CHX submitted an
amendment to its proposed rule change. The proposed rule changes, as
amended, submitted by BATS, BX, CBOE, CHX, EDGA, EDGX, ISE, Nasdaq,
NYSE, and NYSE Amex, were published for comment in the Federal Register
on June 28, 2010.\2\ The proposed rule change, as amended, submitted by
NYSE Arca was published for public comment in the Federal Register on
June 29, 2010.\3\ On June 30, 2010, CHX submitted an additional
amendment to its proposed rule changes.\4\ The Commission received nine
comment letters on the proposals.\5\
[[Page 56614]]
BATS responded to the comments in a letter dated August 16, 2010.\6\
This order approves the proposed rule changes, as amended.
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\1\ Also, on June 17, 2010, Financial Industry Regulatory
Authority, Inc. (``FINRA'') filed a similar proposed rule change
with respect to breaking erroneous trades. See Securities Exchange
Act Release No. 62341 (June 21, 2010), 75 FR 36756 (June 28, 2010).
The FINRA proposal also was approved today. See Securities Exchange
Act Release No. 62885 (Sept. 10, 2010).
\2\ 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; 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.
\3\ See Securities Exchange Act Release No. 62335 (June 21,
2010), 75 FR 37494.
\4\ In Amendment No. 2, CHX amended its proposed rule change to
conform defined terms in its proposed rule text to defined terms
used in the remainder of its rule. This is a technical amendment.
\5\ 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'').
\6\ 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 Proposals
On May 6, 2010, the U.S. equity markets experienced a severe
disruption.\7\ 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.\8\
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\7\ 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.
\8\ 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.\9\ 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, the Exchanges and FINRA worked together 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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\9\ 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 rules set forth procedures
the Exchanges must use to break trades. Specifically, the current rules
provide that the Exchanges 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 $25.00 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 rules do not give the Exchanges discretion to
break trades that do not exceed the Numerical Guidelines, they do
permit the Exchanges 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 the
Exchanges to deviate from the objective standards in their respective
rules when dealing with clearly erroneous transactions.
Under the proposed rule changes, the Exchanges 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 rules, 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, the
Exchanges propose to review, on their own motion, all transactions
triggering an individual stock trading pause and subsequent
transactions that may occur before the trading pause is in effect.\10\
The Exchanges would use the price that triggered the trading pause (the
``Trading Pause Trigger Price'') \11\ 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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\10\ 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.
\11\ The Exchanges propose 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 the Exchanges the Trading Pause Trigger Price for
such stock.
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[[Page 56615]]
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, the Exchanges propose to review on their 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, the Exchanges may use a Reference Price
other than the consolidated last sale. To ensure consistent application
across markets, the Exchanges will consult 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, the Exchanges propose to review
on their 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, the Exchanges 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 rules provide that the Exchanges may consider
``Additional Factors'' \12\ in determining whether to break trades. The
proposed rule changes limit the circumstances during which the
Exchanges may consider those Additional Factors. Specifically, under
the proposed rules, the Exchanges 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, the
Exchanges 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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\12\ Additional Factors that the Exchanges 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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Finally, the proposed rule changes limit the discretion of the
Exchanges to deviate from the Numerical Guidelines in the event of
system disruptions or malfunctions. The proposed rules make clear that
this provision only applies to a disruption or malfunction of an
Exchange system, not to that of a user of an Exchange system. The
proposed rules also remove the language ``extraordinary market
conditions or other circumstances'' as a basis for nullifying trades
outside of the Numerical Guidelines, further limiting the discretion of
the Exchanges. The proposed rules also retain the current requirement
that, absent extraordinary circumstances, an action taken in connection
with a review of a potentially erroneous transaction must be taken in a
timely fashion, generally within thirty (30) minutes of detection of
the erroneous transaction.
The Exchanges have proposed that these rule changes 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 the Exchanges and FINRA. Five commenters were
generally supportive of the principles underlying the proposed rule
changes, to provide greater transparency and certainty to investors,
market participants, and the public regarding the handling of clearly
erroneous transactions.\13\ However, these commenters also believed
that the proposed rule changes should go further, and offered a number
of suggestions as discussed below. Two commenters generally did not
oppose the proposed rule changes, but believed they were ``overly
complex and opaque'' \14\ and ``do not adequately address the most
significant flaws in the current rules.'' \15\ 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.\16\ 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.\17\ Additionally, BATS responded to the
comments.\18\ These comments are discussed in greater detail below.
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\13\ 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).
\14\ See CSS Letter, at 1.
\15\ See BlackRock Letter, at 1.
\16\ 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).
\17\ See Knight Letter, at 3.
\18\ See BATS Letter.
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A. Comments Recommending Other Comprehensive Approaches
Some commenters believed that the Exchanges' rules relating to
clearly erroneous trades should be more definitive, and expressed the
view that the proposed rule changes were not sufficiently clear in all
cases when trades would actually be cancelled.\19\ For example, one
commenter noted that the Exchanges ``appear 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.''
\20\ This commenter believed the Exchanges 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.\21\
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\19\ See Newedge Letter, at 4-5, and BlackRock Letter, at 2.
\20\ See Newedge Letter, at 4.
\21\ Id.
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Two commenters questioned whether the proposed rule changes would
achieve their stated goals of making the erroneous trade execution
review process more transparent and less arbitrary.\22\ Specifically,
these
[[Page 56616]]
commenters were concerned that the proposed rule changes did not
clearly establish a reference price upon which the Numerical Guidelines
would be based.\23\ They noted that the Exchanges retain 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.\24\
These commenters believed that if the Exchanges retained discretion in
these areas, the proposed rule changes may not achieve the goal of
making the trade break process more transparent and less arbitrary,\25\
or could create mass confusion.\26\
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\22\ See BlackRock Letter, at 2, and CSS Letter, at 1-2.
\23\ Id.
\24\ Id.
\25\ See BlackRock Letter, at 2.
\26\ See CSS Letter, at 1-2.
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In response, 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.'' \27\ 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.\28\ BATS believed its limited discretion
in this regard is necessary and appropriate for maintaining fair and
orderly markets.\29\
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\27\ See BATS Letter, at 1.
\28\ Id. at 5.
\29\ Id.
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With respect to the concern expressed by some commenters that the
proposed rule changes do not clearly establish a reference price upon
which the Numerical Guidelines would be based, BATS 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 * * * .'' \30\ 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.'' \31\ 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 to determine the
appropriate percentage at which trades would be broken.\32\
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\30\ Id. at 3-4.
\31\ Id.
\32\ Id.
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The Commission appreciates the suggestions and responses offered by
these commenters to make the process by which the Exchanges address
clearly erroneous executions more certain and transparent by reducing
their discretion. The Commission intends to continue working with the
Exchanges to further clarify, as appropriate, their processes for
breaking erroneous trades that arise in contexts not covered by the
proposed rule changes, as well as to continue to evaluate the
operations of and potential refinements to such processes in contexts
covered by the proposed rule changes. Nevertheless, the Commission
believes that the proposed rule changes represent a productive first
step by the Exchanges 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, the Exchanges should allow the trades to stand and
adjust the price in line with the market.\33\ 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 market when they thought they had a hedged position.\34\ 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.'' \35\ 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.\36\
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\33\ See GETCO Letter, at 3, Newedge Letter, at 5, BlackRock
Letter, at 2, and Knight Letter, at 2.
\34\ Id.
\35\ See GETCO Letter, at 3.
\36\ 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 rules
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.\37\ This commenter argued that the limit up/limit down
approach ``would virtually eliminate clearly erroneous trades.'' \38\
Another commenter also believed that the Commission should consider a
``limit up/limit down approach or hybrid approach.'' \39\ 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.\40\
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\37\ See GETCO Letter, at 2-3.
\38\ See GETCO Letter, at 3.
\39\ See SIFMA Letter, at 2.
\40\ 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 the
Exchanges address 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 changes represent a productive first
step by the Exchanges 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 changes were not
clear as to how news or information regarding the review and
cancellation of clearly erroneous trades would be disseminated to the
markets.\41\ This commenter believed that the proposed rules should
require the Exchanges to disseminate this information quickly and in a
non-discriminatory fashion to
[[Page 56617]]
market participants in order to minimize the market impact and not
favor any one group of market participants over another.\42\ In its
response letter, 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.\43\ In addition, BATS believes that
the existing requirement that an SRO promptly notify affected members
of clearly erroneous reviews and determinations is sufficient.\44\ BATS
also stated that communication between the exchanges and members should
remain flexible as such methods are constantly changing.\45\ 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.\46\
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\41\ See Newedge Letter, at 6.
\42\ Id.
\43\ See BATS Letter, at 2.
\44\ Id.
\45\ Id.
\46\ Id.
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Another commenter believed that the Commission should require the
Exchanges to clarify the application of the clearly erroneous execution
rules 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?'' \47\ That commenter also expressed concern that
the proposed rule changes 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.\48\
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\47\ See ICI Letter, at 3.
\48\ 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.\49\ 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.'' \50\ 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.'' \51\ This commenter also favored providing the
Exchanges discretion to break trades after the deadlines specified in
their rules in extraordinary circumstances.\52\
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\49\ See SIFMA Letter, at 2-3.
\50\ Id.
\51\ Id.
\52\ 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 the Exchanges 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, Web site 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 the Exchanges on additional ways to
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 proposals are sufficiently clear regarding
the applicability of the new rules. As to the specific example provided
by the commenter, under the proposed rules, 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
rules 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 the Exchanges to review the
operation of the amended rules, 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 the Exchanges and FINRA 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 changes are consistent
with the requirements of the Act and the
[[Page 56618]]
rules and regulations thereunder applicable to national securities
exchanges. In particular, the Commission finds that the proposed rule
changes submitted by the Exchanges are consistent with the requirements
of Section 6(b) of the Act \53\ and with Section 6(b)(5) of the Act
\54\ which, among other things, requires that the rules of national
securities exchanges 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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\53\ 15 U.S.C. 78f(b).
\54\ 15 U.S.C. 78f(b)(5).
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In the Commission's view, the proposed rule changes 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 changes 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 changes are being implemented on a pilot basis so that the
Commission and the Exchanges 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,\55\ that the proposed rule changes (SR-BATS-2010-016; SR-BX-2010-
040; SR-CBOE-2010-056; SR-CHX-2010-13; SR-EDGA-2010-03; SR-EDGX-2010-
03; SR-ISE-2010-62; SR-NASDAQ-2010-076; SR-NSX-2010-07; SR-NYSE-2010-
47; SR-NYSEAmex-2010-60; SR-NYSEArca-2010-58), be, and hereby are,
approved.
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\55\ 15 U.S.C. 78s(b)(2).
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-23076 Filed 9-15-10; 8:45 am]
BILLING CODE 8010-01-P