Document ID: SEC-2012-1044-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The NASDAQ Stock Market LLC
Posted Date: 2012-07-03T04:00Z

[Federal Register Volume 77, Number 128 (Tuesday, July 3, 2012)]
[Notices]
[Pages 39543-39545]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-16220]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67281; File No. SR-NASDAQ-2012-057]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Approving a Proposed Rule Change With Respect to the Authority of 
NASDAQ or NASDAQ Execution Services To Cancel Orders When a Technical 
or Systems Issue Occurs and To Describe the Operation of an Error 
Account

June 27, 2012.

I. Introduction

    On April 30, 2012, The NASDAQ Stock Market LLC (``Exchange'' or 
``NASDAQ'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend NASDAQ Equity Rule 4758 by adding a new 
paragraph (d) that addresses the authority of NASDAQ or NASDAQ 
Execution Services (``NES'') to cancel orders when a technical or 
systems issue occurs and to describe the operation of an error account 
for NES. The proposed rule change was published for comment in the 
Federal Register on May 16, 2012.\3\ The Commission received no comment 
letters regarding the proposed rule change. This order approves the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 66964 (May 10, 2012), 77 
FR 28905 (May 16, 2012) (SR-NASDAQ-2012-057) (``Notice'').
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II. Description of the Proposal

    NES, a broker-dealer that is a facility and an affiliate of NASDAQ, 
provides outbound routing services from NASDAQ to other market centers 
pursuant to NASDAQ rules.\4\ In its proposal, NASDAQ states that a 
technical or systems issue may occur at NASDAQ, NES, or a routing 
destination that causes NASDAQ or NES to cancel orders, if NASDAQ or 
NES determines that such action is necessary to maintain a fair and 
orderly market.\5\ NASDAQ also states that a technical or systems issue 
that occurs at NASDAQ, NES, a routing destination, or a non-affiliate 
third-party Routing Broker \6\ may result in NES acquiring an error 
position that it must resolve.\7\
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    \4\ See Notice, 77 FR at 28906, n.3 and accompanying text, and 
text accompanying n.4. See also NASDAQ Equity Rule 4758.
    NASDAQ also has authority to receive equities orders routed 
inbound to NASDAQ by NES from NASDAQ OMX BX and the NASDAQ OMX PSX 
of NASDAQ OMX PHLX on a pilot basis. See Notice, 77 FR at 28906, 
n.4. See also Securities Exchange Act Release No. 65554 (October 13, 
2011), 76 FR 65311 (October 20, 2011) (SR-NASDAQ-2011-142).
    \5\ See Notice, 77 FR at 28906. For examples of some of the 
circumstances in which NASDAQ or NES may decide to cancel orders, 
see id.
    \6\ NASDAQ states that, from time to time, it also uses non-
affiliate third-party broker-dealers to provide outbound routing 
services. In its proposal, the Exchange refers to these broker-
dealers as ``third party Routing Brokers.'' See Notice, 77 FR at 
28906, n.3.
    \7\ See Notice, 77 FR at 28906. Specifically, NASDAQ Equity Rule 
4758(d)(2) defines ``error positions'' as ``positions that result 
from a technical or systems issue at Nasdaq Execution Services, 
Nasdaq, a routing destination, or a non-affiliate third-party 
Routing Broker that affects one or more orders.''
    For examples of some of the circumstances that may lead to error 
positions, see Notice, 77 FR at 28906-07.
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    New paragraph (d) to NASDAQ Equity Rule 4758 provides NASDAQ or NES 
with general authority to cancel orders to maintain fair and orderly 
markets when a technical or systems issue occurs at NASDAQ, NES, or a 
routing destination. It also provides authority for NES to maintain an 
error account for the purpose of addressing, and sets forth the 
procedures for resolving, error positions. Specifically, paragraph 
(d)(1) of NASDAQ Equity Rule 4758 authorizes NASDAQ or NES to cancel 
orders as either deems necessary to maintain fair and orderly markets 
if a technical or systems issue occurs at NASDAQ, NES, or a routing 
destination. NASDAQ or NES will be required to provide notice of the 
cancellation to all affected members as soon as practicable.\8\
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    \8\ See NASDAQ Equity Rule 4758(d)(1).
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    Paragraph (d)(2) of NASDAQ Equity Rule 4758 will allow NES to 
maintain an error account for the purpose of addressing error positions 
that result from a technical or systems issue at NASDAQ, NES, a routing 
destination, or a non-affiliate third-party Routing Broker.
    For purposes of NASDAQ Equity Rule 4758(d), an error position will 
not include any position that results from an order submitted by a 
member to NASDAQ that is executed on NASDAQ and automatically processed 
for clearance and settlement on a locked-in basis.\9\ NES will not be 
permitted to (i) accept any positions in its error account from a 
member's account or (ii) permit any member to transfer any positions 
from the member's account to NES's error account.\10\ In other words, 
NES may not accept from a member positions that are delivered to the 
member through the clearance and settlement process, even if those 
positions may have been related to a technical or systems issue at 
NASDAQ, NES, a routing destination, or a non-affiliate third-party 
Routing Broker.\11\ If a member receives locked-in positions in 
connection with a technical or systems issue and experiences a loss in 
unwinding those positions, that member may seek to rely on NASDAQ 
Equity Rule 4626, which provides members with the ability to file 
claims against NASDAQ ``for losses directly resulting from the [NASDAQ] 
systems' actual failure to correctly process an order, Quote/Order, 
message, or other data, provided the Nasdaq Market Center has 
acknowledged receipt of the order, Quote/Order, message, or data.'' 
\12\ If, however, a technical or systems issue results in NASDAQ not 
having valid clearing instructions for a member to a trade, NES may 
assume that member's side of the trade so that the trade can be

[[Page 39544]]

automatically processed for clearance and settlement on a locked-in 
basis.\13\
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    \9\ See NASDAQ Equity Rule 4758(d)(2)(A).
    \10\ See NASDAQ Equity Rule 4758(d)(2)(B).
    \11\ See Notice, 77 FR at 28907, n.11. This provision would not 
apply if NES incurred a short position to settle a member's 
purchase, as the member would not have had a position in its account 
as a result of the purchase at the time of NES's action. Similarly, 
if a systems issue occurs that causes one member to receive an 
execution for which there is not an available counterparty, action 
by NES would be required for the positions to settle into that 
member's account. See id.
     If error positions result in connection with NASDAQ's use of a 
third-party Routing Broker for outbound routing and those positions 
are delivered to NES through the clearance and settlement process, 
NES would be permitted to resolve those positions. If, however, such 
positions were not delivered to NES through the clearance and 
settlement process, then the third-party Routing Broker would 
resolve the error positions itself, and NES would not be permitted 
to accept the positions. See Notice, 77 FR at 28906, n.3.
    \12\ See Notice, 77 FR at 28907, n.11.
    \13\ See NASDAQ Equity Rule 4758(d)(2)(C).
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    Paragraph (d)(3) of NASDAQ Equity Rule 4758 permits NASDAQ or NES, 
in connection with a particular technical or systems issue, to either 
(i) assign all resulting error positions to members or (ii) have all 
resulting error positions liquidated. Any determination to assign or 
liquidate error positions, as well as any resulting assignments, will 
be made in a nondiscriminatory fashion.\14\
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    \14\ See NASDAQ Equity Rule 4758(d)(3).
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    NASDAQ and NES will be required to assign all error positions 
resulting from a particular technical or systems issue to the members 
affected by that technical or systems issue if NASDAQ or NES:
    (i) Determines that it has accurate and sufficient information 
(including valid clearing information) to assign the positions to all 
of the members affected by that technical or systems issue;
    (ii) Determines that it has sufficient time pursuant to normal 
clearance and settlement deadlines to evaluate the information 
necessary to assign the positions to all of the members affected by 
that technical or systems issue; and
    (iii) Has not determined to cancel all orders affected by that 
technical or systems issue in accordance with NASDAQ Equity Rule 
4758(d)(1).\15\
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    \15\ See NASDAQ Equity Rule 4758(d)(3)(A)(i)-(iii).
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    If NASDAQ or NES is unable to assign all error positions resulting 
from a particular technical or systems issue to all of the affected 
members, or if NASDAQ or NES determines to cancel all orders affected 
by the technical or systems issue, then NES will be required to 
liquidate the error positions as soon as practicable.\16\ NES will be 
required to provide complete time and price discretion for the trading 
to liquidate the error positions to a third-party broker-dealer, and 
would be prohibited from attempting to exercise any influence or 
control over the timing or methods of such trading.\17\ Further, NES 
will be required to establish and enforce policies and procedures that 
are reasonably designed to restrict the flow of confidential and 
proprietary information between the third-party broker-dealer, on one 
hand, and NASDAQ and NES, on the other, associated with the liquidation 
of the error positions.\18\
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    \16\ See NASDAQ Equity Rule 4758(d)(3)(B).
    \17\ See NASDAQ Equity Rule 4758(d)(3)(B)(i).
    \18\ See NASDAQ Equity Rule 4758(d)(3)(B)(ii).
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    Finally, paragraph (d)(4) of NASDAQ Equity Rule 4758 requires 
NASDAQ and NES to make and keep records to document all determinations 
to treat positions as error positions; all determinations to assign 
error positions to members or to liquidate error positions; and the 
liquidation of error positions through the third-party broker-dealer.

III. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of Section 6(b) of the Act 
\19\ and the rules and regulations thereunder applicable to a national 
securities exchange.\20\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\21\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, 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; and are not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. In addition, the Commission 
believes the proposed rule change is consistent with Section 
11A(a)(1)(C) of the Act \22\ in that it seeks to assure economically 
efficient execution of securities transactions.
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    \19\ 15 U.S.C. 78f(b).
    \20\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission recognizes that technical or systems issues may 
occur, and believes that NASDAQ Equity Rule 4758, in allowing NASDAQ or 
NES to cancel orders affected by technical or systems issues, should 
provide a reasonably efficient means for NASDAQ to handle such orders, 
and appears reasonably designed to permit NASDAQ to maintain fair and 
orderly markets.\23\
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    \23\ The Commission notes that NASDAQ states that the proposed 
amendments to NASDAQ Equity Rule 4758 are designed to maintain fair 
and orderly markets, ensure full trade certainty for market 
participants, and avoid disrupting the clearance and settlement 
process. See Notice, 77 FR at 28908. The Commission also notes that 
NASDAQ states that a decision to cancel orders due to a technical or 
systems issue is not equivalent to the Exchange declaring self-help 
against a routing destination pursuant to Rule 611 of Regulation 
NMS. See 17 CFR 242.611(b). See also Notice, 77 FR at 28907, n.10.
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    The Commission also believes that allowing the Exchange to resolve 
error positions through the use of an error account maintained by NES 
pursuant to the procedures set forth in the rule, and as described 
above, is consistent with the Act. The Commission notes that the rule 
establishes criteria for determining which positions are error 
positions,\24\ and that NASDAQ or NES, in connection with a particular 
technical or systems issue, will be required to either (i) assign all 
resulting error positions to members or (ii) have all resulting error 
positions liquidated.\25\ Also, NASDAQ or NES will assign error 
positions that result from a particular technical or systems issue to 
members only if all such error positions can be assigned to all of the 
members affected by that technical or systems issue.\26\ If NASDAQ or 
NES cannot assign all error positions to all members, NES will 
liquidate all of those error positions.\27\ In this regard, the 
Commission believes that the new rule appears reasonably designed to 
further just and equitable principles of trade and the protection of 
investors and the public interest, and to help prevent unfair 
discrimination, in that it should help assure the handling of error 
positions will be based on clear and objective criteria, and that the 
resolution of those positions will occur promptly through a transparent 
process.
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    \24\ See NASDAQ Equity Rule 4758(d)(2).
    \25\ See NASDAQ Equity Rule 4758(d)(3).
    \26\ See NASDAQ Equity Rule 4758(d)(3)(A).
    \27\ See NASDAQ Equity Rule 4758(d)(3)(B).
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    Additionally, the Commission notes that it has previously expressed 
concern about the potential for unfair competition and conflicts of 
interest between an exchange's self-regulatory obligations and its 
commercial interest when the exchange is affiliated with one of its 
members.\28\ The Commission is also concerned about the potential for 
misuse of confidential and proprietary information. The Commission 
believes that the requirement that NES provide complete time and price 
discretion for the liquidation of error positions to a third-party 
broker-dealer, including that NES not attempt to exercise any influence 
or control over the timing or methods of such trading, combined with 
the requirement that NASDAQ establish and enforce policies and 
procedures that are reasonably designed to restrict the flow of 
confidential and proprietary information to the third-party broker-
dealer liquidating such positions, should help mitigate the 
Commission's concerns. In particular, the Commission

[[Page 39545]]

believes that these requirements should help assure that none of 
NASDAQ, NES, or the third-party broker-dealer is able to misuse 
confidential or proprietary information obtained in connection with the 
liquidation of error positions for its own benefit. The Commission also 
notes that NASDAQ and NES would be required to make and keep records to 
document all determinations to treat positions as error positions; all 
determinations to assign error positions to members or liquidate error 
positions; and the liquidation of error positions through the third-
party broker-dealer.\29\
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    \28\ See, e.g., Securities Exchange Act Release No. 65455 
(September 30, 2011), 76 FR 62119 (October 6, 2011) (SR-NYSEArca-
2011-61) at 62120, n.16 and accompanying text.
    \29\ See NASDAQ Equity Rule 4758(d)(4).
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    Finally, the Commission notes that the proposed procedures for 
canceling orders and the handling of error positions are consistent 
with procedures the Commission has approved for other exchanges.\30\
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    \30\ See, e.g., Securities Exchange Act Release Nos. 66963 (May 
10, 2012), 77 FR 28919 (May 16, 2012) (SR-NYSEArca-2012-22); 67010 
(May 17, 2012), 77 FR 30564 (May 23, 2012) (SR-EDGX-2012-08); and 
67011 (May 17, 2012), 77 FR 30562 (May 23, 2012) (SR-EDGA-2012-09).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change (SR-NASDAQ-2012-057) be, and it 
hereby is, approved.
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    \31\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-16220 Filed 7-2-12; 8:45 am]
BILLING CODE 8011-01-P