FINRA Rules 11892 & 11893: Clearly Erroneous Transactions

Instructor: Byron Yee

Byron has over 5 years of experience in banking and investments and is currently a Candidate for the Chartered Financial Analyst (CFA) Institute. He also is registered with FINRA Series 7 and 66 and has his Life & Disability Insurance producers license for WA state. Previous to his career in banking, he spent 2 years in West Africa as a Peace Corps Volunteer and 4 years in China as an English teacher and financial analyst. Byron double majored in Theatre Arts and Business Administration at Western Washington University. In his free time he enjoys hiking, cycling, running, and being in the great outdoors with his family.

This lesson explains how FINRA defines a clearly erroneous error and the detailed pricing points for both exchange-traded and OTC-trade securities. Examples are included to further add to understanding of these definitions.

Sharp Price Increases Lead to a Pricing Discrepancy

Samantha placed an order to buy 1,000 shares of Stock ABC and her broker quoted her at $10 per share. However, when the broker completed the order in the open market, the actual price was $11 per share. This resulted in a difference of $1,000 - an amount for which Samantha demanded reimbursement because she claimed this was an error of her broker, not normal market supply and demand factors.

What Is a Clearly Erroneous Error?

The Financial Industry Regulatory Authority (FINRA) considers an error in trade processing as clearly erroneous if it falls under one of the following three areas:

  • Trading the incorrect security: For example, a client wants to purchase stock of Company ABC, but the broker ends up purchasing stock of Company XYZ.
  • Pricing error: An example of this type of error is a when broker places an order to buy stock at $10 per share, but due to system issues, ends up purchasing the stock at $11 per share.
  • Quantity of shares error: For example, a customer wants to buy 1,000 shares of a stock, however only 100 shares are purchased.

The details and required corrective actions for each of these errors is the focus of another lesson. This lesson, however, goes into more detail about how a clearly erroneous error is defined based on prices of securities traded on an exchange and in an over-the-counter market.

Pricing Errors for Exchanged Listed Securities

First, let's quickly clarify the difference between a trade completed through an exchange versus over-the-counter. An exchange trade is a stock or bond that is traded through a major exchange platform (such as the New York Stock Exchange or the NASDAQ) and the deal is facilitated by a broker or dealer. Exchange trades happen for large corporate securities and have the benefit of being standardized, efficient, and well monitored for security and legal reasons.

Conversely, an over-the-counter (OTC) trade is done outside of a traditional exchange and can take place directly between the buyer and seller. These trades are usually smaller companies or in customized amounts or special terms and typically have much more relaxed regulatory requirements. For an overly simplified example, consider snack time at an elementary school. A student buying candy from a vending machine would be considered an exchange transaction. On the other hand, if one student has chips, another student has candy, and they agree to swap snacks, this is more of an OTC style transaction.

FINRA Rule 11892 has specific guidelines for defining a pricing error as clearly erroneous for an exchanged listed trade. Under this rule, if the actual trade price is outside of the range of the price quoted in the trade agreement, it is considered clearly erroneous. Below is a reference table of the given price ranges.

Reference Price Difference from Reference Price (Normal Market Hours) Difference from Reference Price (Outside Normal Market Hours)
$0.00-$25.00 10% 20%
$25.01-$50.00 5% 10%
>$50.00 3% 6%

For example, if the price of a stock is quoted at $10 and the trade agreement is made during normal business hours, then any actual execution price below $9.00 or above $11.00 (10% times $10.00 = $1.00 'normal error' range) would be considered a clearly erroneous error in processing the trade at an accurate price. The FINRA rule continues to explain that certain additional factors may be considered when determining if the price difference is clearly erroneous or not:

  • Operating system issues: For example, network connectivity or power supply problems delay the trade execution. If a trade has significant price differences due to system issues, this is usually considered clearly erroneous.
  • Volume and volatility of the security: If a security is very infrequently traded (low volume) and tends to have a lot of price fluctuation (high volatility), then this range of error may increase for the clearly erroneous price definition.
  • Corporate actions or special news: For example, if a corporation announces a big merger, or very poor performance results, these may have significant and immediate impacts on the stock price. In these cases, a purchase price different than the quoted price may not be considered clearly erroneous, rather just a matter of chance and timing of the trade.

Pricing Errors for OTC Securities

FINRA Rule 11893 has specific guidelines for defining a pricing error as clearly erroneous for an OTC trade. An OTC trade error is considered clearly erroneous if it is outside of the ranges given by FINRA.

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