[Federal Register: August 3, 2005 (Volume 70, Number 148)]
[Notices]
[Page 44709-44711]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr03au05-223]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-52141; File No. SR-NASD-2004-009]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Approval of Proposed Rule Change and
Amendment Nos. 1, 2, 3, 4, and 5 Thereto To Modify Nasdaq's Clearly
Erroneous Rule
July 27, 2005.
I. Introduction
On January 21, 2004, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association''), through its subsidiary,
The Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the Securities
and Exchange Commission (``Commission'') a proposed rule change
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ to modify the Nasdaq's
clearly erroneous rule. On August 23, 2004, Nasdaq submitted Amendment
No. 1 to the proposed rule change.\3\ On May 5, 2005, Nasdaq submitted
Amendment No. 2 to the proposed rule change.\4\ On May 11, 2005, Nasdaq
submitted Amendment No. 3 to the proposed rule change.\5\ On May 16,
2005, Nasdaq submitted Amendment No. 4 to the proposed rule change.\6\
The proposed rule change, as amended by Amendment Nos. 1, 2, 3, and 4,
was published for comment in the Federal Register on May 26, 2005.\7\
On June 16, 2005, Nasdaq submitted Amendment No. 5 to the proposed rule
change.\8\ The Commission received no comments on the proposal. This
order approves the proposed rule change, as amended.\9\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Mary M. Dunbar, Vice President and Deputy
General Counsel, Nasdaq, to Katherine A. England, Assistant
Director, Division of Market Regulation (``Division''), Commission,
dated August 20, 2004 (``Amendment No. 1''). Amendment No. 1
replaced the original rule filing in its entirety.
\4\ Amendment No. 2 replaced Amendment No. 1 in its entirety.
\5\ Amendment No. 3 revised incorrect cross-references in the
rule text.
\6\ Amendment No. 4 revised an incorrect paragraph designation
in the rule text.
\7\ See Securities Exchange Act Release No. 51722 (May 20,
2005), 70 FR 30508.
\8\ See Amendment No. 5, which made technical corrections to the
rule text, is a technical amendment that is not subject to notice
and comment. The amended rule text proposed in Amendment No. 5 is
available on the NASD's Web site (http://www.nasd.com), at the
NASD's Office of the Secretary, and at the Commission's Public
Reference Room.
\9\ Nasdaq has represented that the proposed rule change would
take effect on a date specified in a Head Trader Alert to its
members, which date would be no later than three weeks after
Commission approval of the proposal. Telephone call on July 27,
2005, between John Yetter, Senior Associate General Counsel, Nasdaq,
and Terri Evans, Special Counsel, Division, Commission.
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II. Description of the Proposed Rule Change
NASD Rule 11890 governs the review and resolution of clearly
erroneous transactions. The NASD Rule permits Nasdaq to review, at the
request of a market participant, any transaction arising out of the use
or operation of any execution or communication system owned or operated
by Nasdaq to determine if such transaction is clearly erroneous. NASD
Rule 11890 also permits Nasdaq to review transactions on Nasdaq's own
motion under specific circumstances. The NASD Rule provides Nasdaq
officials with the authority to nullify a transaction or modify one or
more terms of the transaction. In addition, NASD Rule 11890 sets forth
the procedures for review of a transaction to determine whether it is
clearly erroneous and for appeal of a determination to the Market
Operations Review Committee (``MORC'').
The NASD proposes to amend NASD Rule 11890 to: (1) Specify the
supporting information that must be submitted in connection with a
complaint requesting review of a transaction to determine whether it is
clearly erroneous; (2) establish minimum price deviation thresholds
that would provide a ``bright line'' standard for determining whether a
transaction is eligible for review; (3) provide that complaints failing
to meet minimum price deviation thresholds or documentation
requirements would be rejected, and limit the grounds for review of
such rejections by the MORC; and (4) make several clarifying changes to
the rule text. These changes are described in more detail below.
Specify the Supporting Information To Be Submitted by a Complainant
The proposed rule change would amend NASD Rule 11890 to require
that a complaint, to be eligible for review, must include the following
information: approximate time of transaction(s), security symbol,
number of shares, price(s), contra broker(s) if transactions are not
anonymous, the Nasdaq system used to execute the transactions, and the
reason that the review is being sought.
Establish Minimum Price Deviation Thresholds
The proposed rule change also would establish minimum price
deviation thresholds that would provide a standard for determining
whether transactions are considered eligible for review. A transaction
price that meets the minimum price threshold would not automatically
trigger a clearly erroneous determination; however, if the transaction
price does not meet the minimum price threshold, the transaction would
not be considered as a clearly erroneous transaction. Thus, there would
be a conclusive presumption that a transaction to buy (sell) is not
clearly erroneous unless its price is greater than (less than) the best
offer (best bid) by an amount that equals or exceeds the minimum
threshold set forth below:
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Inside price Minimum threshold
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$0-$0.99............................... $0.02 + (0.10 x Inside Price).
$1.00-$4.99............................ $0.12 + (0.07 x (Inside Price--
$1.00)).
$5.00-$14.99........................... $0.40 + (0.06 x (Inside Price--
$5.00)).
$15 or more............................ $1.00.
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[[Page 44710]]
For a transaction to buy (sell) a Nasdaq listed security, the inside
price would be the best offer (best bid) in Nasdaq at the time that the
first share of the order that resulted in the disputed transaction was
executed, and for a transaction to buy (sell) an exchange-listed
security, the inside price shall be the national best offer (best bid)
at the time that the first share of the order that resulted in the
disputed transaction was executed.\10\ Nasdaq also proposes to adopt
IM-11890-3 to assist market participants in understanding the minimum
price deviation thresholds by providing an example of their
application.
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\10\ Trades in exchange-listed securities are reviewed under
NASD Rule 5265, which incorporates Rule 11890 by reference.
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Reject, as Ineligible, Non-Conforming Clearly Erroneous Complaints
In addition, in conjunction with providing standards as to required
minimum documentation and minimum price deviation thresholds, the
proposed rule would set forth clearly defined consequences for failing
to meet the minimum documentation requirements. Members failing to meet
the minimum documentation requirements within the initial 30-minute
time frame for complainants to submit any supporting written
information or failing to meet the minimum price deviation parameters
would not be eligible to maintain an action under NASD Rule 11890,
unless the member alleges a mistake of material fact. Nasdaq staff
would notify the complainant immediately of any deficiencies in the
filing so that the complainant can revise and resubmit the
documentation, if possible, within the 30-minute time frame.
In cases where a claim is not eligible for review because the
transaction does not meet the minimum price deviation thresholds or
because the complaint does not include the supporting documentation
required by the proposed amendment to the rule, the party appealing to
the MORC must allege a mistake of material fact upon which it believes
the Nasdaq officer's determination was based.\11\ The MORC would not
substantively review an appeal of a determination that does not allege
a mistake of material fact. Accordingly, if the MORC finds that a
mistake has not been alleged in an appeal, Nasdaq is not required to
notify the counterparty to the trade concerning the appeal or to submit
the decision for further review by the MORC. If the MORC concludes that
the appeal alleges a mistake of material fact, the counterparty would
be notified and the determination would be reviewed by the same panel.
If the MORC then finds that the determination was based on a mistake of
material fact, the MORC would remand the matter to the Nasdaq officer
for adjudication; otherwise, the determination would become final and
binding. If the matter is remanded to the Nasdaq officer, the right of
appeal to the MORC would be preserved.
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\11\ For purposes of NASD Rule 11890, a decision of the MORC may
be rendered by a panel of the MORC. In the case of a determination
by a Nasdaq officer under Rule 11890(a)(2)(C) that a transaction is
not eligible for review (including a review of the sufficiency of
allegations contained in an appeal regarding such a determination),
the panel may consist of one or more members of the MORC, provided
that no more than 50 percent of the members of any panel are
directly engaged in market making activity or employed by a member
whose revenues from market making activity exceed ten percent of its
total revenues. In all other cases, the panel shall consist of three
or more members of the MORC, provided that no more than 50 percent
of the members of any panel are directly engaged in market making
activity or employed by a member firm whose revenues from market
making activity exceed ten percent of its total revenues.
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Other Proposed Changes
Finally, in order to clarify the Rule's text and expedite
procedures under the Rule, Nasdaq is proposing the following additional
changes:
The text of IM-11890-2 would be amended to reflect the
proposed use of panels of one or more members of the MORC for purposes
of reviewing determinations that a transaction is not eligible for
review because the complainant failed to provide all the supporting
information or the transaction price does not meet or exceed the
applicable minimum deviation thresholds.
NASD Rule 11890 would be amended to provide that
adjudication of a complaint or an appeal is not required if the party
submitting the complaint or appeal withdraws it prior to the
notification of counterparties.
NASD Rule 11890 would be amended to provide that appeals
are focused solely on trades to which the party submitting the appeal
is a party. Thus, for example, if Broker A submits a complaint
regarding two separate trades with Broker B and Broker C, the trades
are broken, and Broker B appeals but Broker C does not, the appeal
would focus solely on the trade between Broker A and Broker B.
NASD Rule 11890 currently provides that facsimile machines
are the preferred method for submitting materials regarding clearly
erroneous adjudications. Nasdaq proposes to amend the rule to provide
that parties should use such telecommunications methods as are
announced from time to time through an NASD Notice to Members or a
Nasdaq Head Trader Alert.
In light of the upcoming retirement of the Nasdaq
Workstation II Service, Nasdaq also is proposing to replace a reference
to that service with a more general reference to Nasdaq
telecommunications protocols.
Cross references in NASD Rule 111890 would be amended to
reflect preferred NASD style, and references to the ``Committee'' would
be replaced with references to the ``MORC.''
III. Discussion
The Commission finds that the proposed rule change, as amended, is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
association,\12\ and, in particular, with the requirements of Section
15A of the Act.\13\ Specifically, the Commission finds that the
proposal is consistent with Section15A(b)(6) \14\ of the Act in that
the proposal is designed 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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\12\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
\13\ 15 U.S.C. 78o-3.
\14\ 15 U.S.C. 78o-3(b)(6).
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The Commission believes that the amendments to NASD Rule 11890 to
establish minimum price deviation thresholds and to specify the
information necessary to support a complaint are designed to provide
greater specificity and clarity with respect to the procedures Nasdaq
must follow in determining whether a transaction is clearly erroneous.
The amendments also would provide Nasdaq with objective bases for
rejecting clearly erroneous petitions that fail to provide complete
information or that relate to a transaction at a price sufficiently
close to the inside market that it should not be considered for review
as a clearly erroneous transaction. The Commission believes that it is
proper for Nasdaq's trade adjustment and nullification provisions to
provide for objective standards in determining whether a transaction is
eligible for clearly erroneous review and clear procedures in
conducting such a review or an appeal of such review, because they
would provide greater certainty to Nasdaq market participants
[[Page 44711]]
who are parties to trades that are claimed to be clearly erroneous. In
addition, Nasdaq officers who are called upon to review such trades
would be provided with transparent standards and procedures when
determining whether a transaction is clearly erroneous.
The amendments to NASD Rule 11890 also would require a Nasdaq
market participant to allege a mistake of material fact in order to
appeal a determination of a Nasdaq officer that a transaction is not
eligible for review and would permit the use of panels of one or more
members of the MORC for the purpose of reviewing such determinations.
If the MORC panel concludes that a mistake of material fact has not
been alleged in an appeal, the determination shall become final and
binding and Nasdaq would not be required to notify the counterparty to
the trade about the appeal. The Commission notes that, if the MORC
concludes that an appeal alleges a mistake of material fact, the
counterparty would be notified and a determination as to whether the
appeal alleges a mistake of material fact would be reviewed by the MORC
panel. In the event that the panel then determines that the appeal
alleges a mistake of material fact, the complaint would be remanded to
the Nasdaq officer and the right of either party to appeal would be
preserved. The Commission believes that these procedures, particularly
the requirement that the complaint be remanded to the Nasdaq officer
and the preservation of the appeal right in the event the MORC panel
determines that the appeal alleges a mistake of material fact, are
designed so that NASD Rule 11890 is exercised an efficient manner,
while the rights of the parties to an appeals process are preserved.
Finally, the amendments to NASD Rule 11890 would eliminate the
requirement for an adjudication of a complaint or an appeal if the
party submitting the complaint or appeal withdraws it prior to the
notification of counterparties and would provide that appeals be
focused solely on trades to which the party submitting the appeal is a
party. The Commission believes that these features of the amendments
are designed to provide additional certainty to Nasdaq market
participants that their trades would not be adjusted or nullified if
they decide not to appeal a particular trade or trades.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\15\ that the proposed rule change (SR-NASD-2004-009), as amended
by Amendments Nos. 1, 2, 3, 4, and 5, is approved.
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\15\ 15 U.S.C. 78s(b)(2).
\16\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-4120 Filed 8-2-05; 8:45 am]
BILLING CODE 8010-01-P