[Federal Register Volume 68, Number 19 (Wednesday, January 29, 2003)]
[Notices]
[Pages 4525-4527]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2017]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47233; File No. SR-NASD-2002-127]


Self Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval to Proposed Rule Change and 
Amendment No. 1 Thereto Amending Rule 11890 Concerning Clearly 
Erroneous Transactions

January 22, 2003.

I. Introduction

    On September 24, 2002, the National Association of Securities 
Dealers, Inc., through its subsidiary, the Nasdaq Stock Market, Inc. 
(``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 NASD rule 11890, which provides Nasdaq 
with authority to nullify or modify transactions. On November 1, 2002, 
Nasdaq filed Amendment No. 1 that entirely replaced

[[Page 4526]]

the original rule filing.\3\ The proposed rule change, as amended, was 
published for comment in the Federal Register on December 9, 2002.\4\ 
The Commission received no comments on the proposal. This order 
approves the proposed rule change, as amended.
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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, Commission, dated November 
1, 2002.
    \4\ See Securities Exchange Act Release No. 46939 (December 3, 
2002), 67 FR 72994 (December 9, 2002) (SR-NASD-2002-127).
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II. Description of the Proposal

    Nasdaq proposes to amend NASD rule 11890, which provides Nasdaq 
with the authority to nullify or modify transactions.

a. Review of Transactions Pursuant to Complaint of Market Participant

    Under NASD rule 11890, Nasdaq has the authority to receive 
petitions from market participants requesting that designated officers 
of Nasdaq review the terms of a transaction and nullify or modify it if 
the transaction is found to be clearly erroneous. Among other things, 
NASD rule 11890, as amended by this proposal, will explicitly limit 
Nasdaq's purview to transactions arising out of the use or operation of 
Nasdaq execution or communication systems and explicitly require that 
the parties to a reviewable transaction be readily identifiable by 
Nasdaq through its systems. Amended NASD rule 11980 will also clarify, 
in part, that it covers transactions entered into by a member of a UTP 
exchange through a Nasdaq execution system. Thus, the rule will cover 
transactions executed between a Nasdaq member and a member of a UTP 
exchange that had agreed to accept automatic executions through 
SuperSOES or SuperMontage, but will not cover transactions where the 
UTP exchange merely posted a quote and was accessible only via 
telephone. The amended rule would also clarify that information 
submitted by parties to Nasdaq must be received by Nasdaq within the 
time frames specified in the rule.

b. Review of Transactions on Nasdaq's Own Motion

    Nasdaq proposes to amend NASD rule 11890 to state that Nasdaq's 
authority to review transactions based upon its own motion may be 
exercised in the event of extraordinary market conditions or other 
circumstances in which the nullification or modification of 
transactions may be necessary for the maintenance of a fair and orderly 
market or the protection of investors and the public interest. Amended 
NASD rule 11890 will also clarify that Nasdaq's authority to review 
transactions based upon its own motion may be applied to any 
transaction arising out of or reported through a Nasdaq quotation, 
execution, communication, or trade reporting system, including 
transactions entered into by a member of a UTP exchange through a 
Nasdaq execution system (but excluding transactions entered into 
through, or reported to, a UTP exchange).
    Additionally, the proposed rule change will amend the time frame 
for action to require that the Nasdaq officer, either the Nasdaq 
President or Executive Vice President designated by the President, on 
Nasdaq's own motion, act, except in extraordinary circumstances, no 
later than 3 p.m. on the next trading day. Finally, Nasdaq is adding 
interpretative material after the rule to provide that it shall be 
considered conduct inconsistent with just and equitable principles of 
trade for a member to refuse to take action that is necessary to 
effectuate a final decision of a Nasdaq officer or the Market 
Operations Review Committee (``MORC'').

c. Review by the Market Operations Review Committee

    NASD rule 11890 governs review by the MORC, a standing committee 
composed of representatives of member firms as well as ``non-industry'' 
representatives. Persons seeking to appeal a determination by Nasdaq 
must submit their appeal within the time parameters specified by the 
rule. Both parties are then given the opportunity to submit supporting 
arguments in writing, and the matter is submitted to the MORC for a 
determination. Nasdaq proposes, however, that an officer empowered to 
review transactions on Nasdaq's own motion (i.e., the President or an 
Executive Vice President) may determine that the number of transactions 
affected by a decision to break or modify trades on Nasdaq's own motion 
is such that the decision must be accorded immediate finality in order 
to maintain a fair and orderly market and to protect investors and the 
public interest.

d. Communications Between Nasdaq and Market Participants

    Amended NASD rule 11890 will describe in greater detail the 
parameters for communications between Nasdaq and market participants. 
Specifically, the proposal will provide that materials submitted to 
Nasdaq or the MORC must be submitted via facsimile machine and must be 
received within the time parameters specified by the rule. However, if 
requested, Nasdaq staff may authorize submission of materials via 
electronic mail on a case-by-case basis.\5\ Materials shall be deemed 
received at the time indicated by a facsimile machine or computer that 
receives the materials. Nasdaq reserves the right to reject or accept 
material that is not received within the time parameters specified by 
the rule.
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    \5\ For example, if a party wishes to submit, pursuant to 
subparagraph (a)(2)(A) of the amended rule, a large document 
containing supporting information, it may be preferable to submit 
the document via electronic mail. Electronic mail may be used only 
when specifically authorized by Nasdaq staff, however, because it is 
impossible to control the delivery time of electronic mail.
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    Nasdaq will provide notice of determinations under the rule via 
facsimile machine, electronic mail, or telephone (including voicemail). 
However, in cases where an officer nullifies or modifies a large number 
of transactions pursuant to Nasdaq's authority to act on its own 
motion, individual notice may not be practicable. In that case, Nasdaq 
may provide notice to market participants via the Nasdaq Workstation II 
Service, a press release, or any other method reasonably expected to 
provide rapid notice to many market participants.

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,\6\ and in particular, the requirements of section 
15A(b)(6) of the Act,\7\ which, among other things, requires that the 
association's rules be 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. Specifically, the Commission 
believes that Nasdaq's proposal may clarify the scope of Nasdaq's 
authority to review erroneous transactions and the procedural aspects 
of reviewing such transactions.
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    \6\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \7\ 15 U.S.C. 78o-3(b)(6).
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    Nasdaq proposes to delineate, in part, the conditions under which 
Nasdaq will consider petitions by market participants to review 
transactions. Proposed NASD rule 11890 explicitly

[[Page 4527]]

limits its purview to transactions arising out of the use or operation 
of Nasdaq execution or communication systems and explicitly requires 
that the parties to a reviewable transaction be readily identifiable by 
Nasdaq through its systems. The Commission believes that the amended 
rule better reflects Nasdaq's interpretation of the scope of its rule. 
Nasdaq has represented that in the past it has declined to adjudicate 
petitions on the grounds that the transaction would be more 
appropriately reviewed by the market center on which it was executed. 
Therefore, the Commission believes that the proposed rule change 
clarifies the application and operation of the rule for market 
participants.
    Nasdaq also proposes to amend NASD rule 11890 to state that 
Nasdaq's authority to review transactions based upon its own motion may 
be exercised in the event of extraordinary market conditions or other 
circumstances in which the nullification or modification of 
transactions may be necessary for the maintenance of a fair and orderly 
market or the protection of investors and the public interest. The 
Commission believes that the proposal clarifies Nasdaq's authority to 
nullify or modify transactions on its own motion and provides Nasdaq 
with the flexibility to address a variety of extraordinary market 
conditions expeditiously. The Commission notes that Nasdaq expects to 
assert its authority primarily in circumstances where the disruption or 
malfunction of a system resulted in the execution of trades with 
obvious errors, such as a price substantially unrelated to the inside 
market. Nasdaq has also represented that it will not attempt to break 
or modify trades entered into through, or reported to, a UTP exchange. 
Nasdaq will endeavor to coordinate its actions with other market 
centers to achieve consistent treatment of trades outside Nasdaq's 
jurisdiction.
    Regarding the review of Nasdaq determinations by the MORC, Nasdaq 
proposes that an officer empowered to review transactions on Nasdaq's 
own motion (i.e., the President or an Executive Vice President) may 
determine that the number of transactions affected by a decision to 
break or modify trades on Nasdaq's own motion is such that the decision 
must be accorded immediate finality in order to maintain a fair and 
orderly market and to protect investors and the public interest. The 
Commission believes that Nasdaq's proposal is reasonable and that the 
market may be well served by the finality it provides. Furthermore, 
Nasdaq has represented, and the Commission expects, that Nasdaq would 
use this authority only on rare occasions. For example, Nasdaq believes 
that there may be circumstances in which review by the MORC of a large 
number of trades would be impractical and could expose market 
participants to unacceptable levels of risk.\8\
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    \8\ For example, Nasdaq believes that if an erroneously priced 
order or quote causes a large number of transactions to occur at 
prices far in excess of a security's true value and if a decision is 
made to break all of the affected trades, some sellers may appeal 
the decision to break the trades. If a market participant is a party 
to trades on both sides of the market, and some remain broken while 
others are appealed and reinstated, it will suffer losses that arise 
solely from the inconsistent treatment of its trades.
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    Finally, Nasdaq proposes to describe in greater detail the 
parameters for communications between Nasdaq and market participants. 
The Commission believes that the proposal may clarify procedural 
aspects of the process of reviewing transactions and therefore promote 
the fair and efficient resolution of disputes.

IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal, as amended, is consistent with the Act and the rules and 
regulations thereunder. It is therefore ordered, pursuant to section 
19(b)(2) of the Act,\9\ that the proposed rule change (SR-NASD-2002-
127), as amended, be and hereby is approved.
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    \9\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-2017 Filed 1-28-03; 8:45 am]
BILLING CODE 8010-01-P