
[Federal Register: June 2, 2009 (Volume 74, Number 104)]
[Notices]               
[Page 26447-26449]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02jn09-114]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59981; File No. SR-CBOE-2009-024]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of a Proposed Rule Change Related 
to Its Obvious Error Rules

May 27, 2009.

I. Introduction

    On April 8, 2009, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' 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 CBOE Rules 6.25 and 
24.16 (collectively, the ``Obvious Error Rules'') pertaining to the 
nullification and adjustment of options transactions. The proposed rule 
change was published for comment in the Federal Register on April 24, 
2009.\3\ The Commission received no comment letters on the proposal. 
This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 59793 (April 20, 2009), 
74 FR 18762.
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II. Discussion

A. Merging Rules

    The Exchange proposes to merge Rule 24.16 (which currently relates 
to only index, ETF and HOLDRS options) into Rule 6.25 (which currently 
relates to only equity options) to form a single obvious error rule.

B. Obvious Pricing Errors

1. Definition of Theoretical Price
    The Exchange proposes to amend Rule 6.25's definition of 
``Theoretical Price'' to base it on the national best bid or offer 
(``NBBO'') instead of the market with the most liquidity. Using the 
NBBO to define Theoretical Price is similar to how ``fair market 
value'' is currently defined for obvious pricing errors under Rule 
24.16. The Exchange also proposes to permit Trading Officials to 
establish the Theoretical Price when the NBBO for the affected series, 
just prior to the erroneous transaction, is at least two times the 
permitted bid/ask differential under subparagraph (b)(iv)(A) of Rule 
8.7.
2. Non-CBOE Market Makers
    The Exchange proposes to provide for the adjustment of Obvious 
Pricing Error transactions involving non-CBOE Market-Makers, provided 
the adjusted price does not violate the non-CBOE Market-Maker's limit 
price.
3. ROS and HOSS Rotations
    The Exchange proposes to revise the Obvious Pricing Error provision 
as it pertains to transactions occurring as part of the Rule 6.2A, 
Rapid Opening System (``ROS''), or Rule 6.2B, Hybrid Opening System 
(``HOSS''), rotations. With respect to regular ROS and HOSS rotations, 
the Exchange is proposing to add a condition that the option contract 
quantity subject to nullification or adjustment would not exceed the 
size of the first quote after the transaction(s) in question that does 
not reflect the erroneous transaction(s). Any nullifications or 
adjustments would occur on a pro rata basis considering the overall 
size of the ROS or HOSS opening trade. With respect to HOSS rotations 
in index options series being used to calculate the final settlement 
price of a volatility index, the Exchange proposes to carryover a 
condition from Rule 24.16 that the first quote after the transaction(s) 
in question that does not reflect the erroneous transaction(s) must be 
for at least the size of the HOSS opening transaction(s). If the size 
of the quote is less than the size of the opening transaction(s), then 
the Obvious Pricing Error provision shall not apply.
4. Non-Broker-Dealer Customer Orders Entered Before the Opening 
Rotation
    The Exchange proposes to extend the expanded notification period 
applicable to transactions during opening rotations involving non-
broker-dealer Customers to include certain orders entered before the 
opening that are executed immediately following the opening rotation. 
Specifically, Rule 6.25 currently requires that members notify CBOE 
Trading Officials or designated personnel in the control room within a 
short time period following the execution of a trade (generally 15 
minutes) if they believe the trade qualifies as an Obvious Pricing 
Error. However, an expanded notification period is available for 
transactions during option rotation occurring as part of ROS or HOSS 
where at least one party to the transaction is a non-broker-dealer 
Customer. The Exchange proposes to make the expanded notification 
period applicable to transactions involving non-broker-dealer 
Customers' marketable orders that are entered before the opening 
rotation and that are executed as part of the Hybrid Agency Liaison 
(``HAL'') on the opening process and certain transactions involving 
non-broker-dealer Customers' complex orders that are entered before the 
opening rotation and that are executed immediately following the 
opening rotation through the Exchange's electronic Complex Order Book.
5. Binary Options
    The Exchange proposes to provide that any price adjustment for a 
binary option series (including any adjustment penalty that may be 
applicable to transactions between CBOE Market-Makers) shall not exceed 
the applicable exercise settlement amount for the binary option.

C. Catastrophic Pricing Errors

    The Exchange proposes to amend Rule 6.25 to add criteria for 
identifying ``Catastrophic Errors'' and making adjustments when 
Catastrophic Errors occur, as well as a streamlined procedure for 
reviewing actions taken in these extreme circumstances. Under Rule 
6.25, trades that result from an Obvious Pricing Error may be adjusted 
or busted according to objective standards. Under the Rule, whether an 
Obvious Pricing error has occurred is determined by comparing the 
execution price to the Theoretical Price of the option. The rule 
requires that members notify CBOE Trading Officials or designated 
personnel in the control room within a short time period following the 
execution of a trade (generally 15 minutes) if they believe the trade 
qualifies as an Obvious Pricing Error. Trades that qualify for 
adjustment or are nullified under the Rule are compared to a price that 
matches the theoretical price plus or minus an adjustment value for 
transactions between CBOE Market Makers, which is $0.15 if the 
Theoretical Value is under $3 and $0.30 if the Theoretical Value is at 
or above $3. By adjusting trades above or below the Theoretical Price, 
the rule assesses a ``penalty'' in that the adjustment price is not as 
favorable as the amount the party making the error

[[Page 26448]]

would have received had it not made the error.
    In some extreme situations, members may not be aware of errors that 
result in very large losses within the time periods required under the 
Rule. In this type of extreme situation, CBOE proposes to give members 
more time to seek relief so that there is a greater opportunity to 
mitigate very large losses and reduce the corresponding large 
windfalls. In such cases, the proposal sets forth the minimum amount by 
which the options execution price must differ from the Theoretical 
Price for a Catastrophic Error to occur. The proposal also sets forth 
the adjustment value to be used by CBOE when it makes a Catastrophic 
Error determination. A Catastrophic Error would be deemed to have 
occurred when the execution price of a transaction is higher or lower 
than the Theoretical Price for the option by an amount equal to at 
least the ``Minimum Amount,'' and the adjustment would be made plus or 
minus the ``Adjustment Value.'' At all price levels, the Minimum Amount 
and the Adjustment Value for Catastrophic Errors would be significantly 
higher than for Obvious Pricing Errors, which the Exchange believes 
would limit the application of the proposed rule to situations where 
the losses are very large.
    Under the new provision, generally, members will have until 7:30 
a.m. Central Time on the day following the trade to notify Trading 
Officials or designated personnel in the control room of a potential 
Catastrophic Error. Once notification has been received within the 
required time period, a panel comprised of at least one member of the 
Exchange's staff designated to perform Catastrophic Error Panel 
functions and four Exchange members (the ``Panel'') will review the 
claim. Fifty percent of the number of Exchange members on the Panel 
must be directly engaged in market making activity and fifty percent of 
the number of Exchange members on the Panel must act in the capacity of 
a floor broker. In the event the Panel determines that a Catastrophic 
Error did not occur, the member that initiated the review will be 
charged $5,000.

D. Erroneous Prints & Quotes in the Underlying

1. Adjustments
    For consistency, the Exchange proposes to amend Rule 6.25 to allow 
for adjustments and nullifications of erroneous prints in the 
underlying (currently the provision calls for nullifications only).
2. Average Quote Width
    The Exchange is also proposing to revise the provisions to 
determine the ``average quote width'' in the underlying by adding the 
quote widths of sample quotations at regular 15-second intervals during 
the two minutes preceding and following an erroneous transaction.
3. Designation of Underlying
    The Exchange proposes to modify the erroneous trade and quote 
provisions to allow the Exchange to designate the applicable underlying 
security(ies) or related instruments for any option. Under the revised 
rule, the Exchange would identify particular underlying or, with 
respect to ETF(s), HOLDRS(s), and index options, related instrument(s) 
that would be used to determine an erroneous print or quote and would 
also identify the relevant market(s) trading the underlying or related 
instrument to which the Exchange would look for purposes of applying 
the obvious error analysis. The underlying or related instrument(s) and 
relevant market(s) will be designated by the Exchange and announced via 
Regulatory Circular. For a particular ETF, HOLDRS, index value and/or 
futures product to qualify for consideration as a ``related 
instrument,'' the revised rule requires that: (i) The option class and 
related instrument must be derived from or designed to track the same 
underlying index; or (ii) in the case of S&P 100-related options, the 
options class and related instrument must be derived from or designed 
to track the S&P 100 Index or the S&P 500 Index.

E. Trading Officials

    The Exchange is proposing to change the definition of the term 
Trading Officials to mean three Exchange officials designated to 
perform Trading Official functions, at least one of which is an 
Exchange member designated as a Floor Official and at least one of 
which is a member of the Exchange's staff designated to perform Trading 
Official functions. The term is currently defined to mean two Exchange 
members designated as Floor Officials and one member of the Exchange's 
staff designated to perform Trading Official functions.

F. Obvious Error Panel

    The Exchange is proposing to change a reference from ``non-DPM 
floor brokers'' to simply ``floor brokers'' in the composition 
requirements for Obvious Error Panels, which review certain 
determinations rendered by Trading Officials and the senior official in 
the Exchange's control room under Rule 6.25(b).

III. Commission Findings

    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\4\ and, in 
particular, the requirements of Section 6(b) of the Act \5\ and the 
rules and regulations thereunder. Specifically, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\6\ in 
that the proposal is designed to promote just and equitable principles 
of trade, to prevent fraudulent and manipulative acts, to remove 
impediments and to perfect the mechanism for a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest.
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    \4\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
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    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 approving proposals relating to adjustment or 
nullification of trades involving obvious errors, the Commission has 
stated that the determination of whether an obvious error has occurred 
and the process for reviewing such a determination should be based on 
specific and objective criteria and subject to specific and objective 
procedures.\7\ The Commission believes that the rule changes proposed 
by the CBOE are clear, specific, and objective.
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    \7\ See, e.g., Securities Exchange Act Release Nos. 58778 
(October 14, 2008), 73 FR 62577 (October 21, 2008) and 58460 
(September 4, 2008), 73 FR 53060 (September 12, 2008) (approving 
revisions to CBOE's Obvious Error Rules).
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Merging Rules

    Merging CBOE Rules 6.25 and 24.16 improves clarity and efficiency 
by harmonizing the obvious error provision across all equity option 
transactions into one rule.

Obvious Pricing Errors

    The modifications to CBOE's pricing error provision clarify the 
objective standards that are to be applied in determining whether an 
obvious error has occurred. Utilizing the NBBO as a reference point for 
theoretical price is in

[[Page 26449]]

conformity with other obvious error provisions previously approved by 
the Commission.\8\ The amendments relating to non-CBOE market-makers 
and ROS and HOSS rotations also conform CBOE's rule to rules already 
approved by the Commission.\9\ The Commission believes that expanding 
the applicability of the extended customer obvious error notification 
provision for transactions involving certain non-broker-dealer customer 
orders that are entered before the opening rotation and that are 
executed as part of HAL on the opening process or that are executed 
immediately following the opening rotation through the Complex Order 
Book would give those customers a reasonable amount of time to discover 
an obvious error transaction and to request an obvious error review. 
The Commission believes that limiting the price adjustment for binary 
options is reasonable and objective in light of the payout structure of 
those options.
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    \8\ See, e.g., Securities Exchange Act Release No. 57712 (April 
24, 2008), 73 FR 24100 (May 1, 2008) (approving revisions to the 
Philadelphia Stock Exchange's Obvious Error Rule).
    \9\ See, e.g., CBOE Rule 24.16.
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Catastrophic Error

    The Commission believes that the proposed catastrophic error 
provision balances the need for certainty of trades and mitigating 
large losses due to errors in extreme circumstances through clear and 
objective procedures.\10\ Moreover, the Commission believes that the 
proposed Catastrophic Error Panel, the streamlined review process, and 
the proposed fee for unsuccessful claims are appropriate to accomplish 
this balance.
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    \10\ See Securities Exchange Act Release No. 57398 (February 28, 
2008), 73 FR 12240 (March 6, 2008).
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Erroneous Prints and Quotes in the Underlying

    The Commission deems that the provision allowing CBOE to designate 
the applicable underlying securities (or related instruments) and 
relevant markets for any option is beneficial to members in determining 
whether an erroneous print or quote has occurred. The provision takes 
into account the fact that members often base their options prices on 
various products in various markets and that erroneous options 
transactions may be a result of erroneous prints or quotes in markets 
other than the primary market for an underlying security. The changes 
to the calculation of average quote width and allowing adjustments in 
addition to nullifications are appropriate and consistent with other 
rules previously approved by the Commission.\11\
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    \11\ See supra, note 8, and Rule 6.25(a)(5) (relating to an 
erroneous quote in the underlying).
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Trading Officials and Obvious Error Panel

    The Commission believes that the change to the definition of 
``Trading Officials'' is appropriate and does not negatively impact the 
objectiveness or fairness of CBOE's obvious error provisions. Lastly, 
the Commission notes that deleting ``non-DPM'' from the definition of 
floor brokers is a non-substantive technical change and is appropriate.
    IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-CBOE-2009-024) is hereby 
approved.
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    \12\ 15 U.S.C. 78s(b)(2).
    \13\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-12717 Filed 6-1-09; 8:45 am]

BILLING CODE 8010-01-P
