[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