Clearly Erroneous Transactions

Now that you understand how firms handle internal trade errors, let's look at what happens when a trade executes at a price that is wildly off from the prevailing market. These situations are handled not by the firm, but by the Financial Industry Regulatory Authority (FINRA) or the exchange.

What Makes a Transaction "Clearly Erroneous"?

A clearly erroneous transaction is one where the execution price is substantially away from the prevailing market price at the time of execution. Unlike a trade error (wrong order entry by a rep), this involves a trade that actually executed on the market at a price far removed from where the stock was trading.

Think of it this way: A stock is trading at $50, but due to a technical glitch or human error, a trade executes at $5. That is clearly erroneous; it should never have happened at that price.

Exchange-Listed Securities (FINRA Rule 11892)

For securities listed on an exchange, FINRA uses the reference price (typically the last sale price before the erroneous transaction) to determine whether a trade qualifies as clearly erroneous.

Numerical Thresholds (Normal Trading Hours)

• If the execution price deviates from the reference price by more than the applicable threshold, the trade may be declared clearly erroneous
• A FINRA officer reviews the transaction and determines whether to nullify (break) the trade

Who Can Request a Review?

• Either party to the transaction
• A FINRA officer acting on their own initiative

Multi-Stock Events

• When 20 or more securities are involved in a clearly erroneous event (such as a market-wide technical failure), FINRA coordinates with the exchanges
• In multi-stock events, all transactions at prices 30% or more away from the reference price are nullified

Exam Tip: Gotchas

Notice the inverse relationship: cheaper stocks get wider thresholds (10% for stocks under $25) while expensive stocks get tighter thresholds (3% for stocks over $50). This makes sense because a 3% move on a $100 stock is $3, which is significant. A 3% move on a $2 stock is only 6 cents, which could be normal volatility.

OTC Equity Securities (FINRA Rule 11893)

For OTC (over-the-counter) equity securities that are not listed on an exchange:

• Wider thresholds apply compared to exchange-listed securities, because OTC markets have lower liquidity and wider bid-ask spreads
• FINRA must act no later than the start of trading on the day following the transaction date
• A clearly erroneous determination renders the transaction null and void

Key Procedural Points

• Requests for review must be filed promptly after the transaction
• FINRA's decision to nullify or let a trade stand is generally final (subject to review by the Uniform Practice Code Committee under Rule 11894)
• Parties cannot unilaterally break a trade - only FINRA or the exchange can declare a transaction clearly erroneous

Exam Tip: Gotchas

Know the difference: a trade error (wrong order entry by a rep) is handled internally with a cancel/rebill. A clearly erroneous transaction (execution far from market price) is nullified by FINRA or the exchange. The firm cannot break a clearly erroneous trade on its own - it must go through the regulatory process.