

[Federal Register: July 6, 2006 (Volume 71, Number 129)]
[Notices]               
[Page 38441-38442]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06jy06-124]                         

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54070; File No. SR-Phlx-2005-73)]

 
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Granting Approval of a Proposed Rule Change and Amendment Nos. 1 
and 2 Thereto Relating to the Exchange's Obvious Error Rule

June 29, 2006.

I. Introduction

    On November 14, 2005, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Phlx Rule 1092 with 
respect to: (1) the definition of ``obvious error'' and (2) the 
definition of ``Theoretical Price.'' On November 18, 2005, the Phlx 
submitted Amendment No. 1 to the proposed rule change.\3\ On April 6, 
2006, the Phlx submitted Amendment No. 2 to the proposed rule 
change.\4\ The proposed rule change and Amendment Nos. 1 and 2 were 
published for comment in the Federal Register on May 15, 2006.\5\ The 
Commission received no comments on the proposal. This order approves 
the proposed rule change, as amended.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 corrected technical errors in the proposed 
rule text.
    \4\ Amendment No. 2 deleted the proposed revisions to Phlx Rule 
1092(c) that related to an erroneous print disseminated by the 
underlying market that is later cancelled or corrected by the 
underlying market and an erroneous quote in the underlying market. 
Thus, the Exchange does not propose to make any changes to Phlx Rule 
1092(c).
    \5\ Securities Exchange Act Release No. 53776 (May 9, 2006).
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    The Phlx proposes to amend its Obvious Error Rule, Phlx Rule 1092. 
Currently, Phlx Rule 1092(a) defines ``obvious error'' as the execution 
price of a transaction that is higher or lower than the Theoretical 
Price (if the Theoretical Price is less than $3.00) for the series by 
an amount of 35 cents or more, or, during unusual market conditions 
(i.e., the Exchange has declared an unusual market condition status for 
the option in question), by an amount of 50 cents or more. Where the 
Theoretical Price is $3.00 or more, ``obvious error'' is defined as the 
execution price of a transaction that is higher or lower than the 
Theoretical Price for the series by an amount equal to at least two 
times the allowable maximum bid/ask spread for the series, so long as 
the amount is 50 cents or more, and three times the allowable bid/ask 
spread during unusual market conditions.
    The proposed rule change would revise the definition of ``obvious 
error'' by deeming an ``obvious error'' to have occurred when the 
execution price of a transaction is higher or lower than the 
Theoretical Price for a series by an amount equal to at least the 
amount shown below:

------------------------------------------------------------------------
                                                                Minimum
                      Theoretical price                          amount
------------------------------------------------------------------------
Below $2.....................................................       $.25
$2 to $5.....................................................        .40
Above $5 to $10..............................................        .50
Above $10 to $20.............................................        .80
Above $20....................................................       1.00
------------------------------------------------------------------------

    The Exchange believes that the proposed new definition of ``obvious 
error'' would facilitate the efficient determination by Floor Officials 
regarding whether a trade resulted from an obvious error by setting 
minimum amounts by which the transaction price differs from the 
Theoretical Price without requiring such Floor Officials to conduct an 
inquiry into the volume of all exchanges each time they review a 
transaction under the rule. The proposed definition of ``obvious 
error'' would apply during both normal and unusual market conditions, 
which in the Exchange's view would further streamline the Floor 
Officials' process of determining whether an obvious error exists.\6\
---------------------------------------------------------------------------

    \6\ The Commission recently approved the Exchange's proposal to 
establish the position of neutral Referee who, among other things, 
would review Floor Officials' obvious error rulings. See Securities 
Exchange Act Release No. 53548 (March 24, 2006), 71 FR 16389 (March 
31, 2006) (SR-Phlx-2005-42).
---------------------------------------------------------------------------

    Phlx Rule 1092(b) defines ``Theoretical Price'' as the last bid or 
offer, just prior to the transaction, on the exchange that has the most 
total volume in that option over the most recent 60 calendar days; or, 
if there are no quotes for comparison purposes, as determined by two 
Floor Officials and designated personnel in the Exchange's Market 
Surveillance Department. The proposed rule change would revise the 
definition of ``Theoretical Price'' as, respecting series traded on at 
least one other options exchange, the mid-point of the National Best 
Bid and Offer (``NBBO'') just prior to the transaction.
    According to the Exchange, currently all options exchanges, 
including the Phlx, have rules permitting specialists and market makers 
to disseminate electronic quotations with a bid/ask differential of up 
to $5.00, regardless of the price of the bid.\7\ For the most part, the 
Phlx believes that such quotations do not reflect the NBBO. Under 
current Phlx Rule 1092, the Theoretical Price, defined as the last bid 
or offer just prior to the transaction on the market with the highest 
volume, could differ from the NBBO by a significant amount if the bid/
ask differential on such market in the series is $5.00 wide. To account 
for this potential discrepancy between the Theoretical Price as 
established by rule

[[Page 38442]]

and the actual NBBO, the proposal would revise the definition of the 
term ``Theoretical Price'' to mean the mid-point of the NBBO just prior 
to the transaction. The Exchange believes that this new definition 
should provide Exchange Floor Officials with a more accurate measure of 
the price on which to base their determination that a transaction 
resulted from an obvious error. The Exchange also proposes to delete 
Commentary .02 to Phlx Rule 1092 from the Rule.\8\ This Commentary sets 
forth how Theoretical Price would be determined under current Phlx Rule 
1092(c).
---------------------------------------------------------------------------

    \7\ See, e.g., Exchange Rule 1014(c)(i)(A)(2).
    \8\ Phlx Rule 1092(b) would retain the provision that if there 
are no quotes for comparison purposes, two Floor Officials and 
designated personnel in the Exchange's Market Surveillance 
Department would determine Theoretical Price.
---------------------------------------------------------------------------

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange \9\ and, in 
particular, the requirements of Section 6(b) of the Act \10\ and the 
rules and regulations thereunder. Specifically, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\11\ in 
that the proposal promotes just and equitable principles of trade, 
removes impediments to and perfects the mechanism of a free and open 
market and a national market system, and protects investors and the 
public interest.
---------------------------------------------------------------------------

    \9\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission considers that in most circumstances trades that are 
executed between parties should be honored. On rare occasions, the 
price of the executed trade indicates an ``obvious error'' may exist, 
suggesting that it is unrealistic to expect that the parties to the 
trade had come to a meeting of the minds regarding the terms of the 
transaction. In the Commission's view, the determination of whether an 
``obvious error'' has occurred should be based on specific and 
objective criteria and subject to specific and objective procedures. 
The Phlx's proposal would provide specific and objective numerical 
criteria to be used by Floor Officials to determine whether a 
particular transaction involved an obvious error. In addition, the 
Exchange's proposal to base the definition of Theoretical Price on the 
midpoint of the NBBO would ensure that the Phlx's obvious error rule is 
consistent with the Options Intermarket Linkage Plan, which requires 
exchanges to avoid trade-throughs. Accordingly, the Commission finds 
that the Exchange's proposal is consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-Phlx-2005-73), as amended, 
is approved.
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78f(b)(2).
    \13\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
Nancy M. Morris,
Secretary.
[FR Doc. E6-10532 Filed 7-5-06; 8:45 am]

BILLING CODE 8010-01-P
