Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, October 5, 2009

SEC Approves Consistent Exchange Rules on Breaking "Clearly Erroneous" Trades

The SEC announced that it has approved new exchange rules for breaking stock trades that deviate so substantially from current market prices that they are considered “clearly erroneous.” The rules would for the first time provide a consistent standard across stock exchanges and reduce uncertainty about what happens to a trade depending on where it is executed.  Clearly erroneous trades can result from a variety of causes, including human error or computer malfunction. Because the markets today are so fast, automated and interconnected, an erroneous trade on one market can very rapidly trigger a wave of similarly erroneous trades on other markets.

Historically, the clearly erroneous execution rules varied from exchange to exchange, with some breaking trades only if the price exceeded an objective threshold based on the preceding market price, and others relying more heavily on the subjective judgment of exchange officials. In addition, there were variations in the time periods within which exchanges required the clearly erroneous review process to be triggered and completed. The problems with inconsistent exchange rules became particularly evident last fall when the extraordinary market volatility led to a substantial increase in the number of erroneous trades.

To better assure consistent results across the equities markets, the exchanges — led by NYSE Arca — worked together with Commission staff to develop “model” rules with more objective standards for breaking trades. These new rules, filed by BATS Exchange, Chicago Board Options Exchange, Chicago Stock Exchange, International Securities Exchange, NASDAQ Stock Market, NASDAQ OMX BX, National Stock Exchange, New York Stock Exchange, NYSE Amex, and NYSE Arca, become effective today.

In general, the new rules allow an exchange to consider breaking a trade only if the price exceeds the consolidated last sale price by more than a specified percentage amount: 10% for stocks priced under $25; 5% for stocks priced between $25 and $50; and 3% for stocks priced over $50. In addition, the erroneous trade review process generally must commence within 30 minutes of the trade, and be resolved within 30 minutes thereafter.

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