Document ID: SEC-2008-0730-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ Stock Market LLC
Posted Date: 2008-05-22T04:00Z

[Federal Register: May 22, 2008 (Volume 73, Number 100)]
[Notices]               
[Page 29802-29804]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22my08-96]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57826; File No. SR-NASDAQ-2007-001]

 
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of Amendment No. 3 to an Order Granting Accelerated 
Approval to Proposed Rule Change, as Modified by Amendment Nos. 2 and 3 
Thereto, To Amend Nasdaq's Clearly Erroneous Rule

May 15, 2008.

I. Introduction

    On January 22, 2007, The NASDAQ Stock Market LLC (``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 Rule 11890, Nasdaq's ``Clearly Erroneous Rule,'' and related 
Interpretive Material. Nasdaq filed Amendment Nos. 1 and 2 to the 
proposal on June 1, 2007 and June 12, 2007, respectively.\3\ The 
proposed rule change, as modified by Amendment No. 2, was published for 
comment in the Federal Register on June 27, 2007.\4\ The Commission 
received two comment letters regarding the proposed rule change.\5\ On 
May 15, 2008, Nasdaq filed Amendment No. 3 to the proposal.\6\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as modified by Amendment Nos. 2 and 3 and 
simultaneously is approving the proposed rule change, as modified by 
Amendment Nos. 2 and 3, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced the proposed rule change in its 
entirety and was withdrawn by Nasdaq on June 14, 2007. Amendment No. 
2 replaced the proposed rule change in its entirety.
    \4\ See Securities Exchange Act Release No. 55937 (June 21, 
2007), 72 FR 35279.
    \5\ See letter from Michael T. Dorsey, Managing Director, 
Trading Services & Compliance, Pink Sheets LLC (``Pink Sheets''), 
dated July 18, 2007 (``Pink Sheets Letter''), and letter from 
Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, 
Financial Industry Regulatory Authority (``FINRA''), dated August 
29, 2007 (``FINRA Letter'').
    \6\ Amendment No. 3 deleted the proposed revisions to the 
Clearly Erroneous Rule relating to the submission of unauthorized 
orders and use of an account for manipulative purposes and clarified 
the manner in which a request for review can be submitted.
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II. Description of the Proposal

    Nasdaq proposes several changes to its Clearly Erroneous Rule and 
related Interpretive Material. Specifically, Nasdaq proposes to: (i) 
Set forth price-based standards and provide guidance on the application 
of those standards when Nasdaq considers whether one or more 
transactions are clearly erroneous under Rule 11890; (ii) modify the 
numerical threshold as applied to trades occurring outside of the 
Regular Session; \7\ (iii) amend the time limits for market 
participants to file for review under Rule 11890(a) in cases where the 
price of the transaction is significantly different from the applicable 
inside price; and (iii) make several procedural modifications to the 
rule.
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    \7\ Regular Session means the primary trading session for a 
particular security on its Primary Market, which is generally 9:30 
a.m. through 4 or 4:15 p.m. Primary Market means: (i) For a Nasdaq 
security, the Nasdaq Market Center; and (ii) for a non-Nasdaq 
security, the market designated as the primary market under the 
Consolidated Tape Association Plan.
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    Nasdaq proposes to amend IM-11890-4 and IM-11890-5 to incorporate 
objective price-based standards and provide guidance regarding the 
application of those standards under Rule 11890. Under Rule 11890, 
Nasdaq is authorized to break trades when the execution price is more 
than a specified percentage (i.e., a Numerical Threshold) away from a 
``Reference Price'' that is indicative of prior market conditions. The 
Reference Price generally used under Rule 11890 would be, for Nasdaq 
securities, the best bid/best offer (``BBO'') in Nasdaq at the time the 
disputed transactions were first executed (or the national BBO for non-
Nasdaq securities) for trading during the Regular Session, and the 
closing price for the security on its Primary Market for trades outside 
the Regular Session. Nasdaq, however, may use a different Reference 
Price in unusual circumstances. Thus, in a case where material news 
about a security was released after the market close for the security 
and a trade occurred outside of the Regular Session, Nasdaq may use a 
Reference Price derived from after-hours trading activity rather than 
the closing price of the security. Similarly, in the case of several 
large orders that execute at multiple prices, a Reference Price based 
on a weighted average of the BBO at relevant times may be used rather 
than a Reference Price based solely on the BBO immediately prior to the 
execution of the first share of the order. Nasdaq proposes to amend the 
Interpretive Material to add examples of cases where Nasdaq may apply 
alternative Numerical Thresholds in determining which trades to break. 
Nasdaq also may use different Numerical Thresholds in events that 
involve other markets in order to coordinate a point beyond which 
trades would be adjusted or broken that is consistent across markets.
    The Interpretive Material would provide that Nasdaq could break or 
modify all trades in a security if a pervasive mistake resulted in 
trading that should not have occurred. For example, trades in a 
security that was incorrectly authorized for trading prior to the date 
of its actual initial public offering could all be broken. Similarly, 
if Nasdaq systems executed orders in the Nasdaq opening cross or 
closing cross at a price that was inconsistent with the rules governing 
the operation of the crosses, either due to a Nasdaq system error or 
because an underlying erroneous order resulted in an erroneous opening 
or closing price, Nasdaq could break or adjust all of the affected 
trades.
    Nasdaq also proposes to amend the Numerical Thresholds under IM-
11890-4 for trading outside the Regular Session, to establish wider 
ranges within which trades would stand. According to Nasdaq, this 
proposed change reflects the diminished depth of the market during 
after-hours and pre-market trading sessions. Accordingly,

[[Page 29803]]

Nasdaq proposes to double the Numerical Thresholds for transactions 
occurring during these times. For example, a trade at $40 per share 
could be broken if more than 10% away from the Reference Price during 
the Regular Session, but could not be broken during the pre-market or 
after-hours sessions unless it was more than 20% away from the 
Reference Price.
    In addition, Nasdaq proposes to amend the language of Rule 
11890(a)(2)(B) to set forth that persons seeking review of transactions 
must present a factual basis for believing that the trade is clearly 
erroneous. Nasdaq states that it cannot, within the context of an 
adjudication that must be conducted within a short period of time, 
determine all of the factual circumstances associated with a particular 
trade or set of trades. Nasdaq believes that it is generally incumbent 
on persons seeking review actually to allege a human or system error, 
rather than merely stating that the order was ``filled away'' or at ``a 
bad price.'' Requiring the statement of a factual basis also would 
allow FINRA to evaluate, after the fact, whether a particular market 
participant is abusing the clearly erroneous process or employing poor 
internal controls.\8\ According to Nasdaq, individuals and firms found 
to have misled Nasdaq about the cause of the alleged error would be 
subject to disciplinary action for misleading a self-regulatory 
organization.
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    \8\ FINRA performs certain regulatory functions for Nasdaq, 
including a review, in certain circumstances, of clearly erroneous 
transactions submitted by member firms. Telephone conversation 
between John Zecca, Vice President MarketWatch, Nasdaq and David 
Michehl, Special Counsel, Division of Trading and Markets, 
Commission on May 14, 2008.
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    Further, Nasdaq proposes to amend the time limits for market 
participants to file for an adjudication under Rule 11890(a) in cases 
where the price of the transaction at issue is more than 50% away from 
the applicable inside price (or the closing price, for trading outside 
Nasdaq's Regular Session or before the primary market has posted its 
first two-sided quote), provided that the value of the transactions at 
issue is more than $10,000. If these criteria are met, the transaction 
is defined as an ``Outlier Transaction,'' and the parties to the trade 
are given an extra hour to petition for review, if the trade occurred 
during the Regular Session or during pre-market hours, or until 9:30 
a.m. the next trading day if the trade occurred after hours. The reason 
for this change is to provide greater assurance that trades that are 
egregiously out of line with prevailing market prices are not permitted 
to stand, provided that the dollar value of the trades is significant 
and the request for review is made within the proposed timeframe.
    Finally, Nasdaq proposes to make several procedural modifications 
to Rule 11890 and the Interpretative Material to: (i) Allow Nasdaq to 
notify the counterparty to a trade about an erroneous event by 
telephone or other means consistent with the communications provisions 
of Rule 11890(d); (ii) specify that requests for review must be 
submitted to Nasdaq in writing, using an online complaint form, 
facsimile, or such other communications procedures specified by Nasdaq; 
(iii) rather than specifying that Nasdaq must act within 30 minutes, 
Nasdaq would be permitted to act as soon as possible, in circumstances 
when Nasdaq acts on its own motion under Rule 11890(b), except in 
extraordinary circumstances, in which case the time limit for a 
determination would be 9:30 a.m. the next trading day; (iv) replace 
references to Nasdaq ``officer'' with Nasdaq ``official'' throughout 
the Rule; (v) add a section listing definitions of terms used in the 
rule; and (vi) delete obsolete references to transactions entered into 
by a member of a national securities exchange with unlisted trading 
privileges in Nasdaq securities.

III. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange \9\ and, in 
particular, the requirements of Section 6(b) of the Act \10\ and the 
rules and regulations thereunder. Specifically, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\11\ in 
that the proposal is designed to promote just and equitable principles 
of trade, prevent fraudulent and manipulative acts, remove impediments 
to and perfects the mechanism of a free and open market and a national 
market system, and, in general, protect investors and the public 
interest.
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    \9\ 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).
    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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    The Commission considers that, except in extraordinary 
circumstances, trades that are executed between parties should be 
honored. On rare occasions, the price of the executed trade indicates 
an obvious error may exist, suggesting that it is unrealistic to expect 
that the parties to the trade had come to a meeting of the minds 
regarding the terms of the transaction and therefore that a clearly 
erroneous transaction may have taken place. In the Commission's view, 
the determination of whether a clearly erroneous trade has occurred 
should be based on specific and objective criteria and subject to 
specific and objective procedures.
    Nasdaq proposes to modify certain price-based parameters that it 
uses for review of transactions alleged to be clearly erroneous under 
Rule 11890 and related Interpretive Material. The proposed numerical 
thresholds in the Interpretative Material set forth a clear and 
objective methodology for use in determining whether a transaction or 
transactions executed on Nasdaq are clearly erroneous. The proposed 
amendments also establish specific and objective criteria governing the 
review of such trades.
    The Pink Sheets expressed general support for the proposal and 
stated that similar authority with respect to unauthorized use of 
accounts should be included in NASD Rule 11890.\12\ FINRA expressed its 
view that account intrusions are fundamentally a type of fraud that 
does not and should not fall within the scope of the Clearly Erroneous 
Rule.\13\ FINRA believed that the Clearly Erroneous Rule is not the 
appropriate way to address unauthorized or illegal activity such as 
account intrusions.\14\ In Amendment No. 3, Nasdaq proposes to delete 
the provisions relating to unauthorized use of an account and use of an 
account for manipulative activity. Given the fact that the Clearly 
Erroneous Rule is designed to address trades made in error and the more 
difficult factual analysis presented by expanding the rule's 
application beyond obvious errors, the Commission believes that it is 
appropriate for Nasdaq to retain the original scope of the rule.
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    \12\ Pink Sheets Letter, supra note 5. The Commission notes that 
revisions to NASD Rule 11890 are outside of the scope of the 
proposal before it.
    \13\ FINRA Letter, supra note 5.
    \14\ Id.
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    In addition, FINRA believed that numerical thresholds that can 
trigger a clearly erroneous determination should be set high enough to 
protect market integrity but not so low that the determination is most 
likely to primarily protect the individual who made the error.\15\ 
FINRA noted its view that thresholds of 10% to 20% are more appropriate 
because they will reduce

[[Page 29804]]

the incidence of regulatory intervention in market transactions while 
still maintaining the integrity of the marketplace.\16\ The Commission 
believes that Nasdaq's proposed Reference Price thresholds are 
commensurate with the manner in which Nasdaq currently applies its 
Clearly Erroneous Rule and are not unreasonable.
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    \15\ Id.
    \16\ Id.
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    The Commission finds good cause for approving the proposed rule 
change, as modified by Amendment Nos. 2 and 3 thereto, before the 
thirtieth day after the date of publication of notice of filing thereof 
in the Federal Register. Accelerating approval of this proposal should 
benefit investors by creating, without undue delay, greater certainty 
in the application of Nasdaq's Clearly Erroneous Rule because the 
proposal establishes objective standards to be applied by Nasdaq in 
reviewing clearly erroneous transactions. Therefore, the Commission 
finds good cause, consistent with Section 19(b)(2) of the Act,\17\ to 
approve the proposed rule change, as modified by Amendment Nos. 2 and 
3, on an accelerated basis.
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    \17\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 3, including whether Amendment No. 3 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NASDAQ-2007-001 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASDAQ-2007-001. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). 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, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASDAQ-2007-001 and should 
be submitted on or before June 12, 2008.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASDAQ-2007-001), as modified by 
Amendment Nos. 2 and 3, be, and it hereby is, approved on an 
accelerated basis.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-11429 Filed 5-21-08; 8:45 am]

BILLING CODE 8010-01-P