Document ID: SEC-2011-0220-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2011-02-16T05:00Z

[Federal Register Volume 76, Number 32 (Wednesday, February 16, 2011)]
[Notices]
[Pages 9062-9064]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-3416]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63885; File No. SR-FINRA-2010-055]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Disapproving Proposed Rule Change To Amend FINRA 
Rule 6140 (Other Trading Practices)

February 10, 2011.

I. Introduction

    On October 29, 2010, 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'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend FINRA Rule 6140, Other 
Trading Practices. The proposed rule change was published for comment 
in the Federal Register on November 12, 2010.\3\ The Commission 
received two comments on the proposal.\4\ On December 21, 2010, the 
Commission extended the time period in which to either approve the 
proposed rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to disapprove the proposed rule 
change, to February 10, 2011.\5\ On January 24, 2011, FINRA submitted a 
response letter to the comments.\6\ This order disapproves the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 63256 (November 5, 
2010), 75 FR 69503 (``Notice'').
    \4\ See Letters from Gary S. Sheller, CFP, Sheller Financial 
Services, dated November 24, 2010 (``Sheller Letter''); and Michael 
S. Nichols, PhD, Principal/Financial Advisor, Cutter Advisors Group, 
dated November 29, 2010 (``Cutter Letter'').
    \5\ See Securities Exchange Act Release No. 63582 (December 21, 
2010), 75 FR 81704 (December 28, 2010).
    \6\ See Letter to Elizabeth M. Murphy, Secretary, Commission, 
from Stephanie M. Dumont, Senior Vice President and Director of 
Capital Markets Policy, FINRA, dated January 24, 2011 (``FINRA 
Response Letter'').
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II. Description of the Proposal

    FINRA Rule 6140 provides that FINRA members may, but are not 
obligated to, accept stop orders in NMS stocks, as that term is defined 
in Rule 600(b)(47) of Regulation NMS.\7\ In addition, FINRA Rule 6140 
provides that a stop order becomes a market order, or a stop limit 
order becomes a limit order, when a transaction takes place at or above 
the stop price (in the case of a buy stop order) or at or below the 
stop price (in the case of a sell stop order).\8\ Thus, under FINRA 
Rule 6140, a stop order cannot be triggered by the publication of a 
quotation at the stop price, but only by a transaction.\9\ FINRA 
proposes to eliminate these provisions governing the handling of stop 
orders in their entirety.
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    \7\ See FINRA Rule 6140(h) and (i).
    \8\ See FINRA Rule 6140(h).
    \9\ See FINRA Rule 6140(h) and (i).
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    In support of its proposal to eliminate entirely from its rules 
those provisions governing the handling of stop orders, FINRA states 
that its members believe quotations may be a better indicator of the 
current price of a security than transactions, and have requested that 
FINRA provide members the flexibility to determine whether the trigger 
of a stop order will be based on transactions or quotations at the stop 
price. FINRA represents that its rules do not typically define the 
parameters of the various order types that members may accept and that 
FINRA believes that members should have the ability to define the 
triggering event for stop orders as well as to design their systems 
consistent with such determination. In addition,

[[Page 9063]]

FINRA notes that it expects that, irrespective of whether a transaction 
or quotation is used as the trigger for a customer stop order, each 
member will apply the approach consistently firm-wide to all customer 
orders and fully disclose its practice to its customers.
    Finally, FINRA proposes to relocate the definition of ``initial 
public offering'' from Rule 6220 (Definitions) to Rule 6130 
(Transactions Related to Initial Public Offerings). FINRA proposes no 
substantive changes to this definition.

III. Summary of Comment Letters and FINRA's Response

    The Commission received two comment letters objecting to the 
proposed rule change. The commenters generally were concerned with the 
use of quotations as a trigger for stop orders.\10\ One commenter 
believed that the triggering event for a stop order should be a 
transaction, and expressed concern that activating a stop order ``based 
solely upon a bid opens the process to manipulation by those inclined 
to do so by flashing bids during market turbulence.'' \11\ In response, 
FINRA notes that FINRA Rule 5210 already prohibits the publication of a 
quotation that is not bona fide, and therefore the practice of flashing 
quotations for the sole purpose of activating a stop order, without the 
intention of trading at the price and volume quoted, is 
impermissible.\12\
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    \10\ See Cutter Letter and Sheller Letter, supra note 4.
    \11\ See Sheller Letter, supra note 4.
    \12\ See FINRA Letter, supra note 6, at p. 2.
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    The other commenter expressed concern that investors and financial 
advisors would not know whether the triggering event was a quote or a 
trade, and believed that investors would have a legitimate complaint if 
their stop order was triggered by a quote and there was no evidence it 
ever traded at that price.\13\ FINRA responds that it does not believe 
that it is appropriate at this time for FINRA to dictate the 
definitions for the order types offered by a member to its customers, 
and notes that numerous member firms have concluded that quotes are the 
more appropriate triggering event for stop orders. FINRA believes that 
each member should be permitted to determine whether it will use quotes 
or transactions to trigger stop orders, provided that the member's 
approach is disclosed to its customers and is consistently applied.
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    \13\ See Cutter Letter, supra note 4.
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IV. Discussion

    Under section 19(b)(2)(C) of the Act, the Commission shall approve 
a proposed rule change of a self-regulatory organization if it finds 
that such proposed rule change is consistent with the requirements of 
the Act, and the rules and regulations thereunder that are applicable 
to such organization.\14\ The Commission shall disapprove a proposed 
rule change if it does not make such a finding.\15\
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    \14\ See 15 U.S.C. 78s(b)(2)(C)(i).
    \15\ See 15 U.S.C. 78s(b)(2)(C)(ii); see also 17 CFR 
201.700(b)(3) (``The burden to demonstrate that a proposed rule 
change is consistent with the Exchange Act and the rules and 
regulations issued thereunder * * * is on the self-regulatory 
organization that proposed the rule change * * * A mere assertion 
that the proposed rule change is consistent with those requirements 
* * * is not sufficient.'') The description of a proposed rule 
change, its purpose and operation, its effect, and a legal analysis 
of its consistency with applicable requirements must all be 
sufficiently detailed and specific to support an affirmative 
Commission finding. See 17 CFR 201.700(b)(3). Any failure of a self-
regulatory organization to provide the information elicited by Form 
19b-4 may result in the Commission not having a sufficient basis to 
make an affirmative finding that a proposed rule change is 
consistent with the Exchange Act and the rules and regulations 
issued thereunder that are applicable to the self-regulatory 
organization. Id.
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    After careful consideration, the Commission does not find that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities association.\16\ In particular, the Commission does not find 
that the proposed rule change is consistent with Section 15A(b)(6) of 
the Act, which requires that the rules of a national securities 
association be designed, among other things, ``to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade * * * and, in general, to protect investors and the 
public interest.'' \17\
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    \16\ In disapproving the 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).
    \17\ 15 U.S.C. 78o-3(b)(6).
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    FINRA proposes to delete in its entirety the provisions of Rule 
6140 relating to the handling of stop orders in NMS stocks by member 
firms. Those provisions currently require that stop orders offered by 
member firms be triggered (i.e., become a market order or limit order) 
by a transaction in the security. Accordingly, this requirement should 
be providing customers certainty with respect to the operation of a key 
element of their stop orders.
    By proposing to eliminate this provision, FINRA effectively would 
allow member firms to offer stop orders to customers that are triggered 
by a transaction, a quote or another mechanism altogether. While FINRA, 
in its ``Statement of the Purpose'' of the proposed rule change, notes 
that it ``expects'' each member to apply its approach to stop orders 
consistently and fully disclose its practice to its customers, FINRA 
has not clearly made this expectation enforceable by requiring 
consistency and customer disclosure in its rules.
    The Commission acknowledges that some may believe a quotation is a 
better trigger mechanism for stop orders than a transaction, and there 
may be good reasons for allowing FINRA to provide flexibility for this 
in its rules. FINRA, however, has not articulated any such reasons. In 
addition, the Commission believes that, if FINRA rules were to permit 
members flexibility in the types of stop orders they offer, those rules 
should clearly require, at a minimum, that the member disclose to 
customers the type of stop order it offers. The Commission believes the 
regulatory framework should promote the ability of investors to 
understand the key attributes of order types offered by their brokers 
so that they can make an informed choice as to whether to use a 
particular type of order. This is especially true with more complex 
order types, such as stop loss orders, and particularly if FINRA rules 
permit a variety of stop loss orders to be offered.
    Because of this potential investor confusion, and resulting 
investor harm, that could result from FINRA's proposed rule change, the 
Commission is concerned the proposal is not designed, among other 
things, to protect investors and the public interest, and promote just 
and equitable principles of trade, as required by Section 15A(b)(6) of 
the Exchange Act. The proposed rule change filed by FINRA, and its 
subsequent response to comments, does not adequately address these 
concerns. FINRA's proposal simply states that ``FINRA believes that 
adopting the proposed rule change will provide members with the 
flexibility to determine whether the execution of stop orders will be 
triggered by transactions or quotations in the subject security without 
compromising investor protection.'' \18\ Neither the proposed rule 
change, nor FINRA's subsequent response to comments, offers any 
substantive explanation as to why providing flexibility in the types of 
stop orders offered by members--particularly without a clearly 
enforceable disclosure requirement--is consistent with the provisions 
of Section 15A(b)(6) referenced above. The Commission notes that Rule 
700(b)(3) of its Rules of Practice reiterates that ``[t]he burden to 
demonstrate that a proposed rule change

[[Page 9064]]

is consistent with the Exchange Act * * * is on the self-regulatory 
organization that proposed the rule change'' and that a ``mere 
assertion that the proposed rule change is consistent with those 
requirements * * * is not sufficient.'' \19\ For the reasons 
articulated above, the Commission does not believe that FINRA has met 
that burden in this case.
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    \18\ See Notice, supra note 3.
    \19\ 17 CFR 201.700(b)(3).
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IV. Conclusion

    For the foregoing reasons, the Commission does not find that the 
proposed rule change is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities association, 
and, in particular, with Section 15A(b)(6) of the Act.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-FINRA-2010-055) be, and hereby is, 
disapproved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-3416 Filed 2-15-11; 8:45 am]
BILLING CODE 8011-01-P