[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:
    <bullet> 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);
    <bullet> Shorten the time period to submit erroneous transactions 
complaints from same day submission to submission within 30 minutes of 
the transaction;
    <bullet> Clarify the procedures by which the parties to an 
allegedly erroneous transaction may submit written information 
concerning the transaction;
    <bullet> Provide Nasdaq officials the requisite authority to cancel 
or adjust erroneous transactions on their own motion;
    <bullet> 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;
    <bullet> Shorten the time period to appeal an erroneous transaction 
determination from four ``market'' hours to thirty minutes; and
    <bullet> 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