
[Federal Register Volume 77, Number 95 (Wednesday, May 16, 2012)]
[Notices]
[Pages 28905-28909]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-11819]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66964; File No. SR-NASDAQ-2012-057]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of Proposed Rule Change With Respect to the Authority 
of NASDAQ or NASDAQ Execution Services To Cancel Orders When a 
Technical or System Issue Occurs and To Describe the Operation of an 
Error Account

May 10, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 30, 2012, The NASDAQ Stock Market LLC

[[Page 28906]]

(``NASDAQ'' or the ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') a proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASDAQ proposes a rule change with respect to the authority of the 
Exchange or NASDAQ Execution Services (``NES'') to cancel orders when a 
technical or system issue occurs and to describe the operation of an 
error account for NES. NASDAQ will implement the proposed change upon 
approval by the Commission. The text of the proposed rule change is 
available at http://nasdaq.cchwallstreet.com, at NASDAQ's principal 
office, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of, and basis for, the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of those statements may be examined at 
the places specified in Item IV below. The Exchange has prepared 
summaries, set forth in sections A, B, and C below, of the most 
significant parts of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to amend Rule 4758 by adding a new paragraph 
(d) that addresses the authority of the Exchange or NES to cancel 
orders when a technical or systems issue occurs and to describe the 
operation of an error account for NES.\3\
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    \3\ NES is a facility of the Exchange. Accordingly, under Rule 
4758, the Exchange is responsible for filing with the Commission 
rule changes and fees relating to NES's functions. In addition, the 
Exchange is using the phrase ``NES or the Exchange'' in this rule 
filing to reflect the fact that a decision to take action with 
respect to orders affected by a technical or systems issue may be 
made in the capacity of NES or the Exchange depending on where those 
orders are located at the time of that decision.
    From time to time, the Exchange also uses non-affiliate third-
party broker-dealers to provide outbound routing services (i.e., 
third-party Routing Brokers). In those cases, orders are submitted 
to the third-party Routing Broker through NES, the third-party 
Routing Broker routes the orders to the routing destination in its 
name, and any executions are submitted for clearance and settlement 
in the name of NES so that any resulting positions are delivered to 
NES upon settlement. As described above, NES normally arranges for 
any resulting securities positions to be delivered to the member 
that submitted the corresponding order to the Exchange. If error 
positions (as defined in proposed Rule 4758(d)(2)) result in 
connection with the Exchange's use of a third-party Routing Broker 
for outbound routing, and those positions are delivered to NES 
through the clearance and settlement process, NES would be permitted 
to resolve those positions in accordance with proposed Rule 4758(d). 
If the third-party Routing Broker received error positions in 
connection with its role as a routing broker for the Exchange, and 
the error positions were not delivered to NES through the clearance 
and settlement process, then the third-party Routing Broker would 
resolve the error positions itself, and NES would not be permitted 
to accept the error positions, as set forth in proposed Rule 
4758(d)(2)(B).
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    NES is the approved routing broker of the Exchange, subject to the 
conditions listed in Rule 4758. The Exchange relies on NES to provide 
outbound routing services from itself to routing destinations of NES 
(``routing destinations'').\4\ When NES routes orders to a routing 
destination, it does so by sending a corresponding order in its own 
name to the routing destination. In the normal course, routed orders 
that are executed at routing destinations are submitted for clearance 
and settlement in the name of NES, and NES arranges for any resulting 
securities positions to be delivered to the member that submitted the 
corresponding order to the Exchange. From time to time, however, the 
Exchange and NES encounter situations in which it becomes necessary to 
cancel orders and resolve error positions.\5\
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    \4\ The Exchange has authority to receive inbound routes of 
equities orders by NES from NASDAQ OMX BX (``BX'') and the NASDAQ 
OMX PSX (``PSX'') of NASDAQ OMX PHLX on a pilot basis. See 
Securities Exchange Act Release No. 65554 (October 13, 2011), 76 FR 
65311 (October 20, 2011) (SR-NASDAQ-2011-142).
    \5\ The examples described in this filing are not intended to be 
exclusive. Proposed Rule 4758(d) would provide general authority for 
the Exchange or NES to cancel orders in order to maintain fair and 
orderly markets when technical and systems issues are occurring, and 
Rule 4758(d) also would set forth the manner in which error 
positions may be handled by the Exchange or NES. The proposed rule 
change is not limited to addressing order cancellation or error 
positions resulting only from the specific examples described in 
this filing.
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Examples of Circumstances That May Lead to Canceled Orders
    A technical or systems issue may arise at NES, a routing 
destination, or the Exchange that may cause the Exchange or NES to take 
steps to cancel orders if the Exchange or NES determines that such 
action is necessary to maintain a fair and orderly market. The examples 
set forth below describe some of the circumstances in which the 
Exchange or NES may decide to cancel orders.

    Example 1. If NES or a routing destination experiences a 
technical or systems issue that results in NES not receiving 
responses to immediate or cancel (``IOC'') orders that it sent to 
the routing destination, and that issue is not resolved in a timely 
manner, NES or the Exchange would seek to cancel the routed orders 
affected by the issue.\6\ For instance, if NES experiences a 
connectivity issue affecting the manner in which it sends or 
receives order messages to or from routing destinations, it may be 
unable to receive timely execution or cancellation reports from the 
routing destinations, and NES or the Exchange may consequently seek 
to cancel the affected routed orders. Once the decision is made to 
cancel those routed orders, any cancellation that a member submitted 
to the Exchange on its initial order during such a situation would 
be honored.\7\
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    \6\ In a normal situation (i.e., one in which a technical or 
systems issue does not exist), NES should receive an immediate 
response to an IOC order from a routing destination, and would pass 
the resulting fill or cancellation on to the Exchange member. After 
submitting an order that is routed to a routing destination, if a 
member sends an instruction to cancel that order, the cancellation 
is held by the Exchange until a response is received from the 
routing destination. For instance, if the routing destination 
executes that order, the execution would be passed on to the member 
and the cancellation instruction would be disregarded.
    \7\ If a member did not submit a cancellation to the Exchange, 
however, that initial order would remain ``live'' and thus be 
eligible for execution or posting on the Exchange, and neither the 
Exchange nor NES would treat any execution of that initial order or 
any subsequent routed order related to that initial order as an 
error.
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    Example 2. If the Exchange experiences a systems issue, the 
Exchange may take steps to cancel all outstanding orders affected by 
that issue and notify affected members of the cancellations. In 
those cases, the Exchange would seek to cancel any routed orders 
related to the members' initial orders.
Examples of Circumstances That May Lead to Error Positions
    In some instances, the technical or systems issue at NES, a routing 
destination, the Exchange, or a non-affiliate third party Routing 
Broker may also result in NES acquiring an error position that it must 
resolve. The examples set forth below describe some of the 
circumstances in which error positions may arise.

    Example A. Error positions may result from routed orders that 
the Exchange or NES attempts to cancel but that are executed before 
the routing destination receives the cancellation message or that 
are executed because the routing destination is unable to process 
the cancellation message. Using the situation described in Example 1 
above, assume that the Exchange seeks to cancel orders routed to a 
routing destination because it is not receiving timely execution or 
cancellation reports from the routing destination. In such a 
situation, NES may

[[Page 28907]]

still receive executions from the routing destination after 
connectivity is restored, which it would not then allocate to 
members because of the earlier decision to cancel the affected 
routed orders. Instead, NES would post those positions into its 
error account and resolve the positions in the manner described 
below.
    Example B. Error positions may result from an order processing 
issue at a routing destination. For instance, if a routing 
destination experienced a systems problem that affects its order 
processing, it may transmit back a message purporting to cancel a 
routed order, but then subsequently submit an execution of that same 
order (i.e., a locked-in trade) to The Depository Trust & Clearing 
Corporation (``DTCC'') for clearance and settlement. In such a 
situation, the Exchange would not then allocate the execution to the 
member because of the earlier cancellation message from the routing 
destination. Instead, NES would post those positions into its error 
account and resolve the positions in the manner described below.
    Example C. Error positions may result if NES receives an 
execution report from a routing destination but does not receive 
clearing instructions for the execution from the routing 
destination. For instance, assume that a member sends the Exchange 
an order to buy 100 shares of ABC stock, which causes NES to send an 
order to a routing destination that is subsequently executed, 
cleared, and closed out by that routing destination, and the 
execution is ultimately communicated back to that member. On the 
next trading day (T+1), if the routing destination does not provide 
clearing instructions for that execution, NES would still be 
responsible for settling that member's purchase, but would be left 
with a short position in its error account.\8\ NES would resolve the 
position in the manner described below.
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    \8\ To the extent that NES incurred a loss in covering its short 
position, it would submit a reimbursement claim to that routing 
destination.
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    Example D. Error positions may result from a technical or 
systems issue that causes orders to be executed in the name of NES 
that are not related to NES's function as the Exchange's routing 
broker and are not related to any corresponding orders of members. 
As a result, NES would not be able to assign any positions resulting 
from such an issue to members. Instead, NES would post those 
positions into its error account and resolve the positions in the 
manner described below.
    Example E. Error positions may result from a technical or 
systems issue through which the Exchange does not receive sufficient 
notice that a member that has executed trades on the Exchange has 
lost the ability to clear trades through DTCC. In such a situation, 
the Exchange would not have valid clearing information, which would 
prevent the trade from being automatically processed for clearance 
and settlement on a locked-in basis. Accordingly, NES would assume 
that member's side of the trades so that the counterparties can 
settle the trades. NES would post those positions into its error 
account and resolve the positions in the manner described below.
    Example F. Error positions may result from a technical or 
systems issue at the Exchange that does not involve routing of 
orders through NES. For example, a situation may arise in which a 
posted quote/order was validly cancelled but the system erroneously 
matched that quote/order with an order that was seeking to access 
it. In such a situation, NES would have to assume the side of the 
trade opposite the order seeking to access the cancelled quote/
order. NES would post the position in its error account and resolve 
the position in the manner described below.

    In the circumstances described above, neither the Exchange nor NES 
may learn about an error position until T+1, either: (1) During the 
clearing process when a routing destination has submitted to DTCC a 
transaction for clearance and settlement for which NES never received 
an execution confirmation; or (2) when a routing destination does not 
recognize a transaction submitted by NES to DTCC for clearance and 
settlement. Moreover, the affected members' trade may not be nullified 
absent express authority under Exchange rules.\9\
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    \9\ See, e.g., Rule 11890 (regarding clearly erroneous 
executions).
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Proposed Amendments to Rule 4758
    The Exchange proposes to amend Rule 4758 to add new paragraph (d) 
to address the cancellation of orders due to technical or systems 
issues and the use of an error account by NES.
    Specifically, under paragraph (d)(1) of the proposed rule, the 
Exchange or NES would be expressly authorized to cancel orders as may 
be necessary to maintain fair and orderly markets if a technical or 
systems issue occurred at the Exchange, NES, or a routing 
destination.\10\ The Exchange or NES would be required to provide 
notice of the cancellation to affected members as soon as practicable.
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    \10\ Such a situation may not cause the Exchange to declare 
self-help against the routing destination pursuant to Rule 611 of 
Regulation NMS. If the Exchange or NES determines to cancel orders 
routed to a routing destination under proposed Rule 4758(d), but 
does not declare self-help against that routing destination, the 
Exchange would continue to be subject to the trade-through 
requirements in Rule 611 with respect to that routing destination.
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    Paragraph (d)(2) of the proposed rule would permit NES to maintain 
an error account for the purpose of addressing positions that result 
from a technical or systems issue at NES, the Exchange, a routing 
destination, or a non-affiliate third-party Routing Broker that affects 
one or more orders (``error positions''). By definition, an error 
position would not include any position that results from an order 
submitted by a member to the Exchange that is executed on the Exchange 
and automatically processed for clearance and settlement on a locked-in 
basis. NES also would not be permitted to accept any positions in its 
error account from an account of a member and could not permit any 
member to transfer any positions from the member's account to NES's 
error account under the proposed rule.\11\ However, if a technical or 
systems issue results in the Exchange not having valid clearing 
instructions for a member to a trade, NES may assume that member's side 
of the trade so that the trade can be processed for clearance and 
settlement on a locked-in basis.\12\
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    \11\ The purpose of this provision is to clarify that NES may 
address error positions under the proposed rule that are caused by a 
technical or systems issue, but that NES may not accept from a 
member positions that are delivered to the member through the 
clearance and settlement process, even if those positions may have 
been related to a technical or systems issue at NES, the Exchange, a 
routing destination of NES, or a non-affiliate third-party Routing 
Broker. This provision would not apply, however, to situations like 
the one described in Example C in which NES incurred a short 
position to settle a member's purchase, as the member did not yet 
have a position in its account as a result of the purchase at the 
time of NES's action (i.e., NES's action was necessary for the 
purchase to settle into the member's account). Similarly, the 
provision would not apply to situations like the one described in 
Example F, where a system issue caused one member to receive an 
execution for which there was not an available contraparty, in which 
case action by NES would be necessary for the position to settle 
into that member's account. Moreover, to the extent a member 
receives locked-in positions in connection with a technical or 
systems issue, that member may seek to rely on NASDAQ Rule 4626 if 
it experiences a loss. That rule provides members with the ability 
to file claims against the Exchange for ``losses directly resulting 
from the [NASDAQ] systems' actual failure to correctly process an 
order, Quote/Order, message, or other data, provided the Nasdaq 
Market Center has acknowledged receipt of the order, Quote/Order, 
message, or data.''
    \12\ See Example E above.
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    Under paragraph (d)(3), in connection with a particular technical 
or systems issue, NES or the Exchange would be permitted to either (i) 
assign all resulting error positions to members, or (ii) have all 
resulting error positions liquidated, as described below. Any 
determination to assign or liquidate error positions, as well as any 
resulting assignments, would be required to be made in a 
nondiscriminatory fashion.
    NES or the Exchange would be required to assign all error positions 
resulting from a particular technical or systems issue to the 
applicable members affected by that technical or systems issue if NES 
or the Exchange:
     Determined that it has accurate and sufficient information 
(including valid clearing information) to assign the positions to all 
of the applicable members affected by that technical or systems issue;
     Determined that it has sufficient time pursuant to normal 
clearance and settlement deadlines to evaluate the information 
necessary to assign the

[[Page 28908]]

positions to all of the applicable members affected by that technical 
or systems issue; and
     Had not determined to cancel all orders affected by that 
technical or systems issue.
    For example, a technical or systems issue of limited scope or 
duration may occur at a routing destination, and the resulting trades 
may be submitted for clearance and settlement by such routing 
destination to DTCC. If there were a small number of trades, there may 
be sufficient time to match positions with member orders and avoid 
using the error account.
    There may be scenarios, however, where NES determines that it is 
unable to assign all error positions resulting from a particular 
technical or systems issue to all of the affected members, or 
determines to cancel all affected routed orders. For example, in some 
cases, the volume of questionable executions and positions resulting 
from a technical or systems issue might be such that the research 
necessary to determine which members to assign those executions to 
could be expected to extend past the normal settlement cycle for such 
executions. Furthermore, if a routing destination experiences a 
technical or systems issue after NES has transmitted IOC orders to it 
that prevents NES from receiving responses to those orders, NES or the 
Exchange may determine to cancel all routed orders affected by that 
issue. In such a situation, NES or the Exchange would not pass on to 
the members any executions on the routed orders received from the 
routing destination.
    The proposed rule also would require NES to liquidate error 
positions as soon as practicable.\13\ In liquidating error positions, 
NES would be required to provide complete time and price discretion for 
the trading to liquidate the error positions to a third-party broker-
dealer and could not attempt to exercise any influence or control over 
the timing or methods of trading to liquidate the error positions.\14\ 
NES also would be required to establish and enforce policies and 
procedures reasonably designed to restrict the flow of confidential and 
proprietary information between the third-party broker-dealer and NES/
the Exchange associated with the liquidation of the error positions.
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    \13\ If NES determines in connection with a particular technical 
or systems issue that some error positions can be assigned to some 
affected members but other error positions cannot be assigned, NES 
would be required under the proposed rule to liquidate all such 
error positions (including those positions that could be assigned to 
the affected members).
    \14\ This provision is not intended to preclude NES from 
providing the third-party broker with standing instructions with 
respect to the manner in which it should handle all error account 
transactions. For example, NES might instruct the broker to treat 
all orders as ``not held'' and to attempt to minimize any market 
impact on the price of the stock being traded.
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    Under proposed paragraph (d)(4), NES and the Exchange would be 
required to make and keep records to document all determinations to 
treat positions as error positions and all determinations for the 
assignment of error positions to members or the liquidation of error 
positions, as well as records associated with the liquidation of error 
positions through the third-party broker-dealer.
2. Statutory Basis
    The proposed rule change is consistent with Section 6(b) \15\ of 
the Securities Exchange Act of 1934 (the ``Act''), in general, and 
furthers the objectives of Section 6(b)(5),\16\ in particular, in that 
it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities, 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, and it is not 
designed to permit unfair discrimination among customers, brokers, or 
dealers. The Exchange believes that this proposal is in keeping with 
those principles since NES's or the Exchange's ability to cancel orders 
during a technical and systems issue and to maintain an error account 
facilitates the smooth and efficient operations of the market. 
Specifically, the Exchange believes that allowing NES or the Exchange 
to cancel orders during a technical or systems issue would allow the 
Exchange to maintain fair and orderly markets. Moreover, the Exchange 
believes that allowing NES to assume error positions in an error 
account and to liquidate those positions, subject to the conditions set 
forth in the proposed amendments to Rule 4758, would be the least 
disruptive means to correct these errors, except in cases where NES can 
assign all such error positions to all affected members of the 
Exchange. Overall, the proposed amendments are designed to ensure full 
trade certainty for market participants and to avoid disrupting the 
clearance and settlement process. The proposed amendments are also 
designed to provide a consistent methodology for handling error 
positions in a manner that does not discriminate among members. The 
proposed amendments are also consistent with Section 6 of the Act 
insofar as they would require NES to establish controls to restrict the 
flow of any confidential information between the third-party broker and 
NES/the Exchange associated with the liquidation of error positions.
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    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASDAQ does not believe that the proposed rule change will impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml; or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NASDAQ-2012-057 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.


[[Page 28909]]


All submissions should refer to File Number SR-NASDAQ-2012-057. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASDAQ-2012-057, and should 
be submitted on or before June 6, 2012.
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    \17\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-11819 Filed 5-15-12; 8:45 am]
BILLING CODE 8011-01-P


