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.
The final policy may not adopt the NBBO as the exclusive reference price. The last sale, a volume-weighted average price or some other reference price may be used. The individual exchange would have the final say as to which reference price it wants to apply to a particular bad trade.
The second plank takes into account volatile market conditions by relaxing the above-mentioned parameters. One idea is to increase the above-mentioned percentages if the S&P 500 Index opens significantly higher or lower than the previous day’s close.
For example, if the S&P 500 opens 3 percent higher or lower, the above-mentioned percentages would double. If the index opens 6 percent higher or lower, the above-mentioned percentages would triple.
The third plank deals with brokers who report bad trades late. Now, under the rules of some exchanges, brokers must report a bad trade within 30 minutes. If they are even a minute late, the exchange does nothing and the trade stands.
Under the new policy, these rules are relaxed but the broker might still be penalized. If the broker reports after 30 minutes, the bar for declaring a trade “erroneous” would be higher. The exchanges might decide that a trade would have had to have occurred a relatively large percentage away from the reference price to be considered erroneous. The amount away could be a flat 30 percent.
For their part, brokers are pleased with the efforts of the working group and are optimistic that a uniform policy will produce fairness and operational efficiencies and lead to happier clients.
“We believe that if all markets are subject to a similar, if not exactly the same, policy, and are working in the spirit of cooperation, then all investors will be treated fairly because each would be subject to the same rule set,” Cangemi told Traders Magazine.
Once agreement is reached, the exchanges will have to make rule filings with the SEC before any changes can go into effect. The SEC is said to be waiting impatiently for the filings.
(c) 2008 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/
