[Federal Register Volume 70, Number 148 (Wednesday, August 3, 2005)]
[Notices]
[Pages 44709-44711]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-4120]


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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:

------------------------------------------------------------------------
              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