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December 5, 2008

Erroneous Trades Policy in Works

By Peter Chapman

Also in this article

  • Erroneous Trades Policy in Works
  • Page 2

As Traders Magazine was going to press, a working group of exchange and ECN officials was trying to hammer out a uniform policy covering trades entered into by mistake or executed at the wrong price.

The effort was made necessary by a deluge of criticism from broker-dealers-the working group's customers-over their handling of "clearly erroneous trades" during the turbulent market period of late September.

Erroneous trades have been around as long as people have been trading and are busted or adjusted by the individual market centers every week. But in the wake of the Securities and Exchange Commission's emergency ban on short selling in September, the number of bad trades exploded.

On one particular day, tens of thousands of trades had to be canceled because they were filled at prices that bore no relationship to their fair market values. Inadequate liquidity, high volatility and the market centers' subsecond processing speeds all conspired to cause the bad prints.

The disaster exposed inconsistencies and inefficiencies in the erroneous trade policies and procedures of the individual market centers that drove brokerage executives to distraction. Much of the problem stems from the fact that a single order may get executed at more than one marketplace. That exposes brokers to differing policies if the trades are deemed erroneous.

The concern over inconsistent practices is not new, and movement toward a marketwide solution has been in progress for a year. The blowups of September have sped the pace of change.

Brokers are calling for consistent policies across market centers. They took their anger public at this year's national Security Traders Association conference in Boca Raton, Fla.

"The STA and the brokers sitting in this crowd urge you to work actively together to come up with a coordinated policy," STA board member and BNY ConvergEx managing director Joe Cangemi told a panel of exchange and ECN executives, "that makes it very clear for the participants what to expect in situations that fall out of place, that are not the norm. We've yet to see the norm established."

The exchange officials said they would. "We will collectively work together to make it better," Joe Mecane, an NYSE Euronext executive vice president and chief administrative officer for U.S. markets, told the crowd.

A uniform policy started to emerge in November, built around mathematical parameters expected to make it easy for brokers and trading venues alike to determine which trades are considered to be clearly erroneous. That is expected to eliminate time-consuming dithering over bad trades.

The policy is built on three planks. The first is based on Nasdaq's 10-5-3 criteria for determining whether or not a trade is clearly erroneous.

Nasdaq will bust or adjust trades if the transaction price falls too far outside the national best bid or offer. For executions over $1.75 and up to $25, Nasdaq will bust or adjust if that trade price is 10 percent away from the NBBO. For executions over $25, but less than $50, Nasdaq will bust or adjust if that trade price is 5 percent away from the NBBO. For executions over $50, Nasdaq will only bust or adjust if the trade price is 3 percent away from the NBBO.