Document ID: SEC-2009-1721-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2009-12-07T05:00Z

[Federal Register: December 7, 2009 (Volume 74, Number 233)]
[Notices]               
[Page 64117-64119]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07de09-940]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61080; File No. SR-FINRA-2009-068]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Granting Approval of Proposed Rule Change 
Relating to FINRA's Rules Governing Clearly Erroneous Executions

December 1, 2009.

I. Introduction

    On October 19, 2009, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities

[[Page 64118]]

Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to adopt NASD Rule 11890, IM-11890-1, and IM-
11890-2 into a new consolidated rulebook (``Consolidated FINRA 
Rulebook'') as part of a new FINRA Rule 11890 Series governing clearly 
erroneous transactions. The proposed rule change was published for 
comment in the Federal Register on October 28, 2009.\3\ The Commission 
received no comment letters on the proposal. This order grants approval 
to 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. 60851 (October 21, 
2009), 74 FR 55606 (the ``Notice'').
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II. Description of the Proposal

    As part of the process of developing the Consolidated FINRA 
Rulebook, FINRA proposes that NASD Rule 11890, IM-11890-1, and IM-
11890-2 be moved into the Consolidated FINRA Rulebook as part of a new 
FINRA Rule 11890 Series governing clearly erroneous transactions. FINRA 
also proposes amending these rules as part of a market-wide effort 
designed to provide transparency and finality with respect to clearly 
erroneous executions.\4\ This effort seeks to achieve consistent 
results for participants across U.S. equities exchanges while 
maintaining a fair and orderly market, protecting investors, and 
protecting the public interest. Unlike the rules of the U.S. equities 
exchanges, FINRA's rules also address clearly erroneous executions in 
OTC Equity Securities.\5\
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    \4\ See Securities Exchange Act Release No. 60706 (September 22, 
2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-2009-
36) (the ``Arca Order'').
    \5\ For purposes of the proposed rule change, the term ``OTC 
Equity Security'' has the same meaning as defined in FINRA Rule 
6420, except that the term does not include any equity security that 
is traded on any national securities exchange.
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    FINRA's new clearly erroneous rule series includes: (1) A general 
provision (Rule 11891) with accompanying Supplementary Material; (2) a 
rule governing clearly erroneous determinations for transactions in 
exchange-listed securities (Rule 11892) with accompanying Supplementary 
Material; (3) a rule governing clearly erroneous determinations for 
transactions in OTC Equity Securities (Rule 11893) with accompanying 
Supplementary Material; and (4) a rule governing review of FINRA staff 
determinations by the UPC Committee (Rule 11894).

Definition and General Guidelines

    The proposed rule defines the term ``clearly erroneous'' and 
specifies that ``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.'' 
\6\
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    \6\ See proposed Rule 11891. The language in the rule is based 
on the definition in the recently approved Arca Order.
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Review of Transactions in Exchange-Listed Securities

    Proposed Rule 11892 and its Supplementary Material set forth the 
standards FINRA uses to determine whether a transaction in an exchange-
listed security is clearly erroneous. Specifically, for OTC 
transactions in exchange-listed securities that are reported to a FINRA 
system, such as a FINRA Trade Reporting Facility (``TRF'') or 
Alternative Display Facility (``ADF''), FINRA will generally follow the 
determination of a national securities exchange to break a trade (or 
multiple trades) when that national securities exchange has broken one 
or more trades at or near the price range in question at or near the 
time in question (in FINRA staff's sole discretion) such that FINRA 
breaking such trade(s) would be consistent with market integrity and 
investor protection. When multiple national securities exchanges have 
related trades, FINRA will leave a trade(s) unbroken when any of those 
national securities exchanges has left a trade(s) unbroken at or near 
the price range in question at or near the time in question (in FINRA 
staff's sole discretion) such that FINRA breaking such trade(s) would 
be inconsistent with market integrity and investor protection.
    For OTC transactions in exchange-listed securities that are 
reported to a FINRA system, but for which there is no corresponding or 
related on-exchange trading activity, FINRA will generally make its own 
clearly erroneous determination.\7\ However, to ensure that 
transactions in exchange-listed securities are treated consistently 
regardless of where the trade is executed (on an exchange or OTC), 
proposed Rule 11892 replicates the numerical thresholds adopted by the 
exchanges to determine whether a transaction is eligible for 
consideration as clearly erroneous. The proposed rule also establishes 
alternative reference prices to be used in unusual circumstances, 
additional factors that FINRA may consider when making a clearly 
erroneous determination, and numerical guidelines applicable to 
volatile market opens.\8\
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    \7\ The FINRA rules do not allow members to initiate reviews of 
transactions. All reviews conducted by FINRA are conducted on 
FINRA's own motion.
    \8\ Each of these provisions is modeled on similar provisions in 
the recently approved amendments to NYSE Arca Rule 7.10.
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Review of Transactions in OTC Equity Securities

    Proposed Rule 11893, which governs transactions in OTC Equity 
Securities, is structured similarly to the provisions for transactions 
in exchange-listed securities under proposed Rule 11892, including 
numerical guidelines, the use of alternative reference prices in 
unusual circumstances, and additional factors FINRA officers may 
consider when making a clearly erroneous determination. However, as is 
the case under the existing rule, the proposed numerical guidelines for 
transactions in OTC Equity Securities are not the same as the 
guidelines used for exchange-listed securities.\9\ The provisions in 
proposed Rule 11893 regarding alternative reference prices and 
additional factors are substantially similar to those set forth in Rule 
11892 for exchange-listed securities. FINRA is also proposing to adopt 
Supplementary Material to Rule 11893 to emphasize FINRA's historical 
use of its clearly erroneous authority in very limited circumstances, 
in particular with respect to OTC Equity Securities.
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    \9\ See proposed Rule 11893(b)(1).
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Review Procedures

    FINRA proposes removing language that currently allows a FINRA 
officer to modify one or more of the terms of a transaction under 
review. Under the proposed rules, the FINRA officer will only have the 
authority to break the trades. This proposed change is intended to 
conform with the rules of other exchanges and attempts to remove the 
subjectivity from the rule that is necessitated by an adjustment. An 
Executive Vice President of FINRA's Market Regulation Department or 
Transparency Services Department, or any officer designated by such 
Executive Vice President, may, on his or her own motion, review any 
transaction arising out of or reported through any FINRA facility.
    With respect to determinations involving transactions in exchange-
listed securities, absent extraordinary circumstances, the officer 
shall take action generally within 30 minutes after becoming aware of 
the transaction. When extraordinary circumstances exist, any such 
action of the officer must be taken no later than the start of trading 
on the day following the date of execution(s) under review. With 
respect

[[Page 64119]]

to determinations involving transactions in OTC Equity Securities, a 
FINRA officer must make a determination as soon as possible after 
becoming aware of the transaction, but in all cases by 3 p.m., Eastern 
Time, on the next trading day following the date of the transaction at 
issue.
    If a FINRA officer declares any transaction null and void, FINRA 
will notify each party involved in the transaction as soon as 
practicable, and any party aggrieved by the action may appeal such 
action in accordance with Rule 11894, unless the officer making the 
determination also determines that the number of the affected 
transactions is such that immediate finality is necessary to maintain a 
fair and orderly market and to protect investors and the public 
interest.
    FINRA is also proposing to codify in Rule 11894 the provisions 
governing the appeal to the UPC Committee of a FINRA officer's 
determination to declare an execution clearly erroneous.\10\ IM-11890-
2, which concerns review by panels of the UPC Committee, will be 
incorporated into the text of the new rule. Under the rule, an appeal 
must be made in writing and must be received by FINRA within thirty 
minutes after the person making the appeal is given the notification of 
the determination being appealed. With respect to appeals regarding 
exchange-listed securities, determinations by the UPC Committee will be 
rendered as soon as practicable, but generally, on the same trading day 
as the execution(s) under review. On requests for appeal received after 
3:00 p.m., Eastern Time, a determination will be rendered as soon as 
practicable, but in no case later than the trading day following the 
date of the execution(s) under review. With respect to appeals 
regarding OTC Equity Securities, determinations by the UPC Committee 
will be rendered as soon as practicable, but in no case later than two 
trading days following the date of the execution(s) under review.
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    \10\ A FINRA officer's determination not to break a trade is not 
appealable.
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III. Discussion and 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 a national securities exchange.\11\ In 
particular, the Commission finds that the proposed rule change is 
consistent with Section 15A(b)(6) of the Act,\12\ in that it is 
designed, among other things, 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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    \11\ 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).
    \12\ 15 U.S.C. 78o-3(b)(6).
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    The Commission considers that, under ordinary circumstances, trades 
that are executed between parties should be honored. On rare occasions, 
the price of the executed trade indicates that 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.
    The Commission believes that the proposed rule change sets forth a 
specific methodology for reviewing potentially erroneous trades in 
exchange-listed securities and should increase transparency and 
certainty for participants with respect to such trades. The Commission 
also believes that the proposed rule change is designed to increase the 
likelihood that that clearly erroneous execution rules will be 
consistently applied across markets, while also helping to facilitate 
the fair and orderly operation of the markets and protection of 
investors and the public interest. Specifically, with respect to OTC 
transactions in exchange-listed securities that are reported to a FINRA 
system, FINRA will generally follow the determination of a national 
securities exchange to break a trade (or multiple trades) when that 
national securities exchange has broken one or more trades at or near 
the price range in question at or near the time in question (in FINRA 
staff's sole discretion) such that FINRA breaking such trade(s) would 
be consistent with market integrity and investor protection.\13\ With 
respect to OTC transactions in exchange-listed securities for which 
there is no corresponding or related on-exchange trading activity, Rule 
11892 replicates the numerical thresholds used by the exchanges to 
determine whether a transaction is eligible for consideration as 
clearly erroneous. In addition, similar to the rules of the exchanges, 
the proposed rule also provides for the use of alternative reference 
prices in unusual circumstances, additional factors that FINRA may 
consider when making a clearly erroneous determination and numerical 
guidelines applicable to volatile market opens.
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    \13\ See proposed Rule 11892, Supplementary Material .01.
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    With respect to OTC Equity Securities, proposed Rule 11893 sets 
forth a specific methodology for reviewing potentially erroneous trades 
in OTC Equity Securities and should increase transparency and certainty 
for participants with respect to such trades. Proposed Rule 11893 is 
structured similarly to the provisions for transactions in exchange-
listed securities under proposed Rule 11892, including numerical 
guidelines, the use of alternative reference prices in unusual 
circumstances, and additional factors FINRA officers may consider when 
making a clearly erroneous determination. However, the proposed 
numerical guidelines for transactions in OTC Equity Securities and the 
proposed timeframes for review and appeal of transactions involving OTC 
Equity Securities vary from the guidelines used for exchange-listed 
securities. The Commission believes that it is reasonable for FINRA to 
adopt different numerical guidelines and timeframes for these 
securities due to the differences in the OTC equity and exchange-listed 
markets, including the lack of compulsory information flows in the OTC 
equity market that are a result of the listing process and the fact 
that aberrant trading in the OTC market may be due to issues other than 
systems problems or extraordinary events.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-FINRA-2009-068), be, and it 
hereby is, approved.
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    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-29043 Filed 12-4-09; 8:45 am]

BILLING CODE 8011-01-P