Document ID: SEC-2012-1483-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2012-09-10T04:00Z

[Federal Register Volume 77, Number 175 (Monday, September 10, 2012)]
[Notices]
[Pages 55517-55519]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-22142]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67778; File No. SR-FINRA-2012-026]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change Relating to the 
Handling of Stop and Stop Limit Orders

September 4, 2012.

I. Introduction

    On May 24, 2012, 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'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend FINRA's rules relating to the handling of 
stop orders and stop limit orders. The proposed rule change was 
published for comment in the Federal Register on June 6, 2012.\3\ The 
Commission received four comment letters regarding the proposal.\4\ On 
July 19, 2012, the Commission designated a longer period to act on the 
proposed rule change, until September 4, 2012.\5\ On August 9, 2012, 
FINRA submitted a response to the comment letters.\6\ 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\ See Securities Exchange Act Release No. 67085 (May 31, 
2012), 77 FR 33537 (``Notice'').
    \4\ See Letters to Elizabeth M. Murphy, Secretary, Commission, 
from Ann L. Vlcek, Managing Director and Associate General Counsel, 
Securities Industry and Financial Markets Association, dated June 
26, 2012 (``SIFMA Letter''); Gary J. Sjostedt, Director, Order 
Routing and Sales, TD Ameritrade, Inc., dated June 27, 2012 (``TD 
Ameritrade Letter''); and Christopher Nagy, President, KOR Trading 
LLC, dated July 9, 2012 (``KOR Letter''); and web comment from 
Virgil F. Liptak, dated July 3, 2012 (``Liptak Letter''). The 
comment letters received by the Commission are available at http://www.sec.gov/comments/sr-finra-2012-026/finra2012026.shtml.
    \5\ Securities Exchange Act Release No. 67471, 77 FR 43620 (July 
25, 2012).
    \6\ See Letter to Elizabeth M. Murphy, Secretary, Commission, 
from Racquel L. Russell, Assistant General Counsel, Regulatory 
Policy and Oversight, FINRA, dated August 9, 2012 (``FINRA 
Response'').
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II. Description of the Proposal

    FINRA proposes to amend its rules governing the handling of stop 
orders. FINRA Rule 6140(h) currently provides that a member may, but is 
not obligated to, accept a stop order or a stop limit order in a 
designated security.\7\ A buy stop order becomes a market order when a 
transaction takes place at or above the stop price, and a sell stop 
order becomes a market order when a transaction takes place at or below 
the stop price.\8\ When a transaction occurs at the stop price, a stop 
limit order to buy or sell becomes a limit order at the limit price.\9\ 
Accordingly, FINRA rules provide that stop orders and stop limit orders 
are triggered (i.e., become a market or a limit order) by a transaction 
in a security.
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    \7\ FINRA Rule 6140(a) defines a ``designated security'' as any 
NMS stock as defined in Rule 600(b)(47) of Regulation NMS, 17 CFR 
242.600(b)(47).
    \8\ See FINRA Rule 6140(h)(1)(A)-(B).
    \9\ See FINRA Rule 6140(h)(2).
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    FINRA now proposes to also allow members to offer customers stop 
orders and stop limit orders that would be triggered by a transaction 
or by an event other than a transaction (e.g., a quotation).\10\ FINRA 
has indicated that some firms and their customers prefer alternative 
triggers for activating stop orders and stop limit orders.\11\ 
According to FINRA, some members believe that, for certain securities, 
quotations may serve as a better indicator of the current price than 
transactions.\12\ For example, quotations for thinly traded securities 
may be continuously updated, whereas there may be limited trading in 
the securities.\13\ However, FINRA also states that some members and 
customers prefer to have transactions trigger stop orders and stop 
limit orders, and believe that customers could be disadvantaged

[[Page 55518]]

if quotations trigger stop orders and stop limit orders.\14\ For 
example, some members are concerned that using quotations as a trigger 
could result in an execution at a price that the stock had never traded 
at on that day.\15\
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    \10\ FINRA previously proposed to delete in its entirety Rule 
6140(h). See Securities Exchange Act Release No. 63256 (November 5, 
2010), 75 FR 69503 (November 12, 2010) (SR-FINRA-2010-055). The 
Commission disapproved that proposed rule change. See Securities 
Exchange Act Release No. 63885 (February 10, 2011), 76 FR 9062 
(February 16, 2011) (Order Disapproving SR-FINRA-2010-055).
    \11\ See Notice, supra note 3, at 33537.
    \12\ See id.
    \13\ See id.
    \14\ See id.
    \15\ See id. FINRA states that some members expressed concern 
that quotations may be more vulnerable to abuse because they can be 
manipulated to trigger stops and then withdrawn or changed, while 
other members noted that using transactions also could result in the 
improper triggering of a customer's stop order due to trades at 
prices outside of the current market. See id. at 33537 n.6.
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    FINRA proposes permitting a member to accept an order type that 
activates as a market or limit order using an event other than a 
transaction at the stop price as the trigger, such as a quotation.\16\ 
The member may not label the order type a ``stop order'' or a ``stop 
limit order,'' and must clearly distinguish it from a ``stop order'' 
and a ``stop limit order.'' \17\ For example, an order type that 
triggers using a quotation at the stop price may be labeled a ``stop 
quotation order.'' \18\ FINRA believes that requiring members to 
distinguish orders triggered by an event other than a transaction from 
stop orders or stop limit orders will allow members and customers to 
share a uniform understanding that transactions serve as the triggering 
event for stop orders and stop limit orders.\19\ In addition, FINRA 
proposes that the member offering such an order type must disclose to 
the customer, in paper or electronic form, prior to the time the 
customer places the order, a description of the order type including 
the triggering event.\20\ A member that permits customers to engage in 
securities transactions online must also post the required disclosures 
on the member's Web site in a clear and conspicuous manner.\21\
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    \16\ FINRA proposes to move the stop order definition from FINRA 
Rule 6140(h) to proposed FINRA Rule 5350. FINRA states that this 
will ensure that the existing and proposed stop order provisions 
apply uniformly to both OTC Equity Securities and NMS stocks. See 
id. at 33538.
    \17\ See Proposed FINRA Rule 5350, Supplementary Material .01.
    \18\ See Notice, supra note 3, at 33538.
    \19\ See id.
    \20\ See Proposed FINRA Rule 5350, Supplementary Material .01. 
For example, the disclosure can be made at account opening. See 
Notice, supra note 3, at 33538.
    \21\ See Proposed FINRA Rule 5350, Supplementary Material .01.
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    FINRA further proposes that a member that routes a customer stop 
order or stop limit order to another broker-dealer or exchange for 
handling or execution must take reasonable steps to ensure that the 
order is handled or executed by the other broker-dealer or exchange in 
accordance with proposed Rule 5350(a).\22\ Similarly, under the 
proposal, a member that routes an order type using an alternative 
trigger (i.e., a trigger other than a transaction) to another broker-
dealer or exchange must take reasonable steps to ensure that the order 
is handled or executed by the other broker-dealer or exchange in 
accordance with the terms of the order as communicated to the customer 
placing the order.\23\
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    \22\ See Proposed FINRA Rule 5350, Supplementary Material .02.
    \23\ See id.
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    FINRA believes that, given the various risks and benefits of each 
triggering event, members and their customers should determine the 
appropriate triggering event for stop orders and stop limit orders.\24\ 
In addition, FINRA believes that providing customers and members with 
the flexibility to select and offer other triggering events for 
alternative order types in accordance with their investment objectives 
and business models, while requiring members to disclose a description 
of the order type, including the triggering event, prior to the time 
the customer places the order, will promote just and equitable 
principles of trade.\25\
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    \24\ See Notice, supra note 3, at 33538.
    \25\ See id.
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III. Summary of Comments Received and FINRA's Response

    The Commission received four comment letters on the proposed rule 
change.\26\ KOR Trading LLC (``KOR''), the Securities Industry and 
Financial Markets Association (``SIFMA''), and TD Ameritrade, Inc. 
(``TD Ameritrade'') generally supported FINRA's objective to provide 
members with flexibility regarding the triggers for stop orders, but 
preferred a disclosure-based approach over creation of a new order 
type.\27\ An individual commenter believes that FINRA should retain and 
enforce Rule 6140(h) as written rather than amend it to accommodate 
members that were offering stop orders and stop limit orders triggered 
by events other than a transaction and disclosing the triggering event 
in brokerage agreements.\28\
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    \26\ See supra note 4.
    \27\ See KOR Letter; TD Ameritrade Letter; SIFMA Letter.
    \28\ See Liptak Letter.
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    KOR stated that the use of disclosures, especially those requiring 
affirmative consent, would allow investors flexibility to choose the 
trigger for stop orders and stop limit orders, and would reduce the 
burden on the industry to create new order types.\29\ KOR also stated 
that brokers should increase efforts to educate their customers about 
stop orders and stop limit orders.\30\
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    \29\ See KOR Letter.
    \30\ See id.
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    SIFMA stated that, although some of its members would like 
flexibility in choosing the applicable trigger for stop orders and stop 
limit orders and others would prefer to have one established trigger 
point, SIFMA members agree that FINRA should not introduce a new order 
type to provide for the desired flexibility.\31\ Instead, SIFMA 
advocates a disclosure and negative consent approach in which a firm 
would be required to disclose what would trigger a stop order or stop 
limit order and, if the customer does not object to the disclosed 
trigger, the firm may conclude the customer consents to the use of that 
trigger.\32\ SIFMA believes this approach would avoid the costs and 
burdens of creating a new order type, including the cost of educating 
investors about the new order type.\33\
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    \31\ See SIFMA Letter.
    \32\ See id.
    \33\ See id.
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    TD Ameritrade raised concerns that FINRA's proposal would create an 
undue burden on the industry by requiring it to incorporate a new order 
type without clearly defined benefits, and may create unnecessary 
investor confusion.\34\ In addition, TD Ameritrade believes creating a 
new order type identifying stop orders and stop limit orders triggered 
by a quotation is unnecessary as there is no evidence investors 
misunderstand or are harmed by such orders.\35\
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    \34\ See TD Ameritrade Letter.
    \35\ See id.
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    FINRA responds that the proposed rule change addresses concerns 
related to the potential for investor confusion with respect to the 
operation of stop orders and stop limit orders, while providing members 
the flexibility to offer orders types based on other triggers.\36\ 
FINRA notes that it has engaged in extensive discussions with its 
member firms about the proposed rule change and has taken into account 
the input provided by members in formulating the proposed rule 
change.\37\ For example, FINRA had considered removing the current 
definition of ``stop order'' and substituting a disclosure provision 
that would require members to disclose to customers how stop orders 
would be triggered.\38\ FINRA states that its members expressed a 
number of concerns about this approach, including that it could lead to 
investor confusion regarding the handling of stop orders, errors when 
routing stop orders for

[[Page 55519]]

execution to another broker that uses a different trigger for stop 
orders, and executions of quotation-triggered stop orders at prices at 
which the stock had not traded that day.\39\ FINRA also had considered 
retaining the existing rule to require that only transactions trigger 
stop orders and stop limit orders.\40\ However, certain FINRA members 
were concerned that trades outside the current market, whether 
permissible transactions or clearly erroneous trades, could improperly 
trigger transaction-based stop orders and stop limit orders, and 
believed that quotations may serve as a better indicator of current 
market price for thinly traded securities.\41\
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    \36\ See FINRA Response at 4.
    \37\ See id. at 3.
    \38\ See id.
    \39\ See id.
    \40\ See id. at 4.
    \41\ See id. at 3.
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    FINRA believes the proposed approach--to retain the default trigger 
while permitting the use of other triggers and requiring disclosure of 
those triggers--strikes the appropriate balance in addressing the views 
expressed by FINRA members.\42\ In particular, FINRA believes that the 
proposal would provide members with flexibility in offering various 
order types, while also addressing concerns regarding the potential for 
investor confusion with respect to the operation of stop orders.\43\
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    \42\ See id. at 4.
    \43\ See id.
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    FINRA states that the purpose of the proposed rule change is to 
make explicit in FINRA rules that firms are permitted to offer stop 
orders and stop limit orders that are triggered by an event other than 
a transaction, such as a quotation, as long as that order type is 
clearly differentiated from stop orders and stop limit orders triggered 
by a transaction.\44\ Contrary to views expressed by commenters, FINRA 
does not believe the proposed rule change would impose additional costs 
on members that offer stop orders and stop limit orders given the 
current requirement to use a transaction-based trigger for orders 
labeled as ``stop'' or ``stop limit,'' thus requiring order types that 
use an alternative trigger to be labeled differently.\45\ In addition, 
FINRA is concerned that allowing the trigger for stop orders and stop 
limit orders to vary solely based on customer consent may diminish the 
level of certainty for customers as to how stop orders would be treated 
and would result in less uniformity in the handling of stop orders and 
stop limit orders.\46\
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    \44\ See id. at 2.
    \45\ See id. at 4.
    \46\ See id. Finally, FINRA notes that it will provide an 
implementation period of no less than 90 days following Commission 
approval of the proposed rule change to provide members that 
determine to offer stop orders and stop limit orders with 
alternative triggers with time to make necessary technology changes. 
See id.
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IV. Discussion and Commission's Findings

    After careful review of the proposed rule change, the comment 
letters received, and FINRA's response, the Commission finds that the 
proposed rule change is consistent with the requirements of Section 
15A(b) of the Act \47\ and the rules and regulations thereunder 
applicable to a national securities association.\48\ In particular, the 
Commission finds that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act,\49\ which requires, among other things, 
that FINRA rules be designed 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.
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    \47\ 15 U.S.C. 78o-3(b).
    \48\ 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).
    \49\ 15 U.S.C. 78o-3(b)(6).
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    FINRA's proposal would allow the use of transaction-based stop 
orders and stop limit orders by providing a uniform definition of 
``stop order'' and ``stop limit order'' while also allowing member 
firms to offer order types that are triggered by an event other than a 
transaction (e.g., a quotation).\50\ The Commission notes that a member 
that provides an order type that is triggered by an event other than a 
transaction at the stop price cannot label the order type a ``stop 
order'' or a ``stop limit order,'' and must clearly distinguish the 
order type from a ``stop order'' and a ``stop limit order.'' \51\ In 
addition, the member must disclose to the customer, in paper or 
electronic form, prior to the time the customer places the order, a 
description of the order type including the triggering event.\52\
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    \50\ See Proposed FINRA Rule 5350.
    \51\ See Proposed FINRA Rule 5350, Supplementary Material .01.
    \52\ See id.
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    While several commenters advocated for an alternative approach and 
raised concerns regarding a potential burden as a result of the 
proposal, the Commission believes that FINRA's proposal would allow 
members flexibility in the types of orders they offer and provide for 
disclosure to customers regarding the operation of such orders. In this 
regard, the Commission notes that FINRA weighed various alternatives 
and took into account extensive input from its members in formulating 
the proposal.\53\ In addition, the Commission notes FINRA's belief that 
the proposal should not impose additional costs on firms that continue 
existing practices consistent with FINRA rules.\54\ Further, the 
Commission notes FINRA's concern that permitting stop order triggers to 
vary solely based on customer consent, as suggested by commenters, 
could undermine the ability of customers to understand how their stop 
orders would be handled.\55\
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    \53\ See Notice, supra note 3, at 33537; and FINRA Response at 
2.
    \54\ See FINRA Response at 4.
    \55\ See id.
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    The Commission believes that FINRA's proposal sufficiently 
addresses issues regarding FINRA's previous proposed rule change, which 
would have deleted in its entirety the provisions of FINRA Rule 6140 
relating to the handling of stop orders by member firms.\56\ The 
Commission believes that FINRA's proposal should enhance the ability of 
investors to understand the key attributes of order types offered by 
their brokers so that they can make informed choices as to whether to 
use a particular type of order.
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    \56\ See Securities Exchange Act Release No. 63885 (February 10, 
2011), 76 FR 9062 (February 16, 2011) (Order Disapproving SR-FINRA-
2010-055).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\57\ that the proposed rule change (SR-FINRA-2012-026) is approved.
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    \57\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\58\
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    \58\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-22142 Filed 9-7-12; 8:45 am]
BILLING CODE 8011-01-P