In the jargon of our industry, when we enter a trade pursuant to a mistake it's called an "error." Firms typically transfer such goofs to an Error Account.   Accordingly, the losses and costs of such mistakes are often assessed in full or in part against the registered representative.  Because such policy is frequently the source of contention, many firms utilize a formula that permits a percentage of non-chargeable bad trades versus a twelve-month trail. 

A trade error typically results from a miscommunication between a registered representative and customer, or results from a processing failure between the taking of the order and its entry. Sometimes the scenario is simple: I thought you said to buy 100 XYZ, not 100 XYC.Other times the cause of the error may be inherent in the order's processing; for example, you review your trade confirmations and note that the trader mistakenly executed an order for account 1324 instead of 1234.

The NASD is scrutinizing the use of Error Accounts for trades that were executed in apparent violation of either the SOES rules, the affirmative determination provisions of NASD Rule 3370, or the short sale rule (NASD Rule 3350).

Assuming that a BD improperly places trades into the Error Account, the consequences could be disastrous. Assuming that the trade at issue is one-sided (a buy or a sell), the firm's capital would be subjected to market risk until such time as the Error Account position is offset and closed. Similarly, if a round trip is placed into the Error Account, the firm's capital would absorb the resulting loss (or profit). Such use of the Error Account subjects the firm's capital to market risk and concerns the NASD.

More pointedly, NASD member firms operating pursuant to minimum net capital requirements of less than $100,000, including members that are typically subject to a $5,000 requirement, may be engaging in activity that could cause them to be considered dealers under the Net Capital Rule and therefore be subject to a $100,000 minimum net capital requirement.

• Dealers include those firms that engage in more than 10 proprietary transactions in a calendar year. Bona fide corrections, cancellations, and errors are generally not included in the 10-transaction total
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• In addition, to the extent members carry any security position in the "error account" for any period of time, either overnight or intra-day, such transactions would be considered when determining if the firm transacted more than 10 trades and could cause the member to be subject to a $100,000 minimum net capital requirement.

WORD TO THE WISE: YOU'RE NOT THE FIRST TO THINK OF THIS

At times BDs misuse their Error Accounts as synthetic Trading Accounts. The dangerous game here seeks to avoid the higher net capital requirement by intentionally executing "flawed" orders so that they may be placed into the Error Account, with the firm keeping the resulting proprietary trading profit without  the onus of a $100,000 Net Captial requirement.  Unfortunately, I've defended many such cases and I've heard it all (as has the NASD): we mixed up the clients' names, we transposed the account numbers, we wrote a lot of tickets that day and must have mistakenly put an extra trade through. The consequences of such a violation may be the need to deposit additional net capital, and significant fines and suspensions. Worse, absent an ability to increase Net Capital to $100,000 the BD may need to close!

If you have any questions,contact your local NASD District Office or the NASD Member Regulation Department at (202) 728-8221.