
[Federal Register Volume 78, Number 50 (Thursday, March 14, 2013)]
[Notices]
[Pages 16338-16341]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-05889]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69085; File No. SR-ISE-2013-15]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Notice of Filing of Proposed Rule Change To Amend the Obvious and 
Catastrophic Errors Rule

March 8, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is 
hereby given that on February 26, 2013, the International Securities 
Exchange, LLC (the ``Exchange'' or the ``ISE'') filed with the 
Securities and Exchange Commission (``Commission'') the proposed rule 
change as described in Items I and II below, which items have been 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.

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[[Page 16339]]

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Rule 720, Obvious and Catastrophic 
Errors. The text of the proposed rule change is available on the 
Exchange's Web site www.ise.com, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The self-regulatory organization has prepared summaries, 
set forth in Sections A, B and C below, of the most significant aspects 
of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange is proposing two changes to ISE Rule 720 (Obvious and 
Catastrophic Errors) to harmonize the rule so that it is applied 
consistently for both obvious errors and catastrophic errors.
Erroneous Transactions Involving Priority Customers
    First, under the current rule, the Exchange nullifies obvious error 
transactions unless all parties to the trade are ISE market makers, in 
which case the Exchange adjusts the price of the transaction. With 
respect to catastrophic errors, the ISE currently adjusts all 
transactions even if they involve non-market makers. The Exchange notes 
that while market professionals would prefer that all transactions be 
adjusted rather than nullified, there is an equally valid opposing view 
because adjustments can result in retail customer orders being adjusted 
to prices that may exceed their limit order price, potentially by a 
large amount, which retail customers would not expect.
    Therefore, ISE proposes amend [sic] Rule 720(b) (Obvious Error 
Procedure) and 720(c) \3\ (Catastrophic Error Procedure) to harmonize 
the obvious error and catastrophic error procedures by nullifying 
trades in both cases for transactions involving Priority Customers and 
adjusting trades where none of the parties to the trade are Priority 
Customers (i.e., market makers, broker-dealers and professional 
customers). Specifically, the Exchange proposes to amend Rule 
720(b)(2)(ii) and adopt Rule 720(c)(2)(B) which states that where at 
least one party to the obvious or catastrophic error is a Priority 
Customer, the trade will be nullified by Market Control \4\ unless both 
parties agree to an adjustment price for the transaction within thirty 
(30) minutes of being notified by Market Control of its determination. 
If the customer is willing to accept the adjusted price, and the 
customer has thirty (30) minutes to make that determination and the 
trade will be adjusted. If the customer does not respond within the 
prescribed time period, the trade will be nullified.
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    \3\ This proposed rule change also realigns certain parts of 
Rule 720. The rule on Catastrophic Error Procedure rule was 
previously found in Rule 720(d) and with the proposed realignment, 
this rule now appears as Rule 720(c).
    \4\ Market Control consists of designated personnel in the 
Exchange's market control center. See ISE Rule 720(a)(3)(ii).
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    The Exchange believes that the proposal to limit obvious error 
trade nullification only to transactions involving Priority Customers, 
and allowing catastrophic error trade nullification for transactions 
involving Priority Customers appropriately limits the number of 
nullifications, while assuring that retail customer orders are not 
adjusted through their limit order price (in other words, the adjusted 
price is higher than the limit price if it is a buy and lower than the 
limit price if it is a sell order) and forced to spend additional money 
for a trade at a price the customer had no interest in trading.
    The Exchange believes that retail customers are less likely to be 
immersed in the day-to-day trading of the markets and are also less 
likely to be watching trading activity in a particular option 
throughout the day. The Exchange, therefore, believes that it is fair 
and reasonable, and consistent with statutory standards, to change the 
procedure for obvious and catastrophic errors involving Priority 
Customers, and not for other market participants, so as not to expose 
Priority Customers to additional risk.
    The Exchange believes that this proposed rule change is a fair way 
to address the issue of a trade executing through a customer's limit 
order price while balancing the competing interests of certainty that 
trades stand versus dealing with true errors. The proposed rule change 
would continue to entail specific and objective procedures. 
Furthermore, the proposed rule change more fairly balances the 
potential windfall to one market participant against the potential 
reconsideration of a trading decision under the guise of an error.
Determination of Erroneous Transactions
    Second, under the current rule, Market Control determines whether 
an obvious error has occurred and applies the rule for making 
adjustments or nullifying trades, with the ability for those affected 
to request that a panel of members review actions taken by Market 
Control. With respect to catastrophic errors, the rule currently 
requires that a panel of members make the initial determination rather 
than Market Control. In the Exchange's experience, this procedure of 
requiring a member panel to make the initial determination of whether 
or not a catastrophic error has occurred in all cases is inefficient 
and unnecessary.
    Therefore, ISE proposes to harmonize the procedures for making 
obvious error and catastrophic error determinations. Specifically, ISE 
proposes to amend the catastrophic error procedure to provide parties 
affected by an action taken by Market Control the ability to request 
that such actions be reviewed by a member panel rather than requiring 
that a member panel make the initial determination in all cases. 
Specifically, the Exchange proposes to adopt rule text allowing Market 
Control to make the determination of whether or not a Catastrophic 
Error has occurred and what steps it shall take in the event a 
determination has been made that a Catastrophic Error has occurred.\5\ 
The Exchange believes that this approach is similar to rules of other 
markets.\6\
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    \5\ See Proposed Rule 720(c)(2).
    \6\ See PHLX Rule 1092(e)(ii) and (f)(ii).
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    With this proposed rule change, the Exchange also proposes to 
rearrange parts of Rule 702. Specifically, the Exchange proposes to 
delete Rule 720(c) (Obvious Error Panel) and move the substance of that 
rule to new Rule 720(d), which is also renamed Review Panel, and which 
will now apply to both obvious and catastrophic errors. Proposed Rule 
720(d) provides the composition of the Review Panel,\7\ the scope of 
the Review Panel's review,\8\ the procedure for requesting review \9\ 
and the decisions of the Review Panel.\10\

[[Page 16340]]

Finally, the Exchange also proposes to make conforming changes to 
Supplementary Material .01, .02, .03 and .04 to Rule 720 to reflect the 
changes proposed herein.
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    \7\ See Proposed Rule 720(d)(1).
    \8\ See Proposed Rule 720(d)(2).
    \9\ See Proposed Rule 720(d)(3).
    \10\ See Proposed Rule 720(d)(4).
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2. Statutory Basis
    The basis under the Securities Exchange Act of 1934 (the ``Exchange 
Act'') for this proposed rule change is found in Section 6(b)(5), in 
that the proposed change is designed to promote just and equitable 
principles of trade, will serve to remove impediments to and perfect 
the mechanisms of a free and open market and a national market system 
and, in general, to protect investors and the public interest.
    In particular, the proposed rule change relating to nullifying 
trades involving Priority Customers and adjusting trades where none of 
the parties are Priority Customers will help market participants better 
manage risk associated with potential erroneous trades. The Exchange 
believes that the proposal provides a fair process that will ensure 
that customers are not forced to accept a trade that was executed in 
violation of the customer's limit order price. For two reasons, the 
Exchange does not believe that the proposal is unfairly discriminatory, 
even though it offers some market participants a choice as to whether a 
trade is nullified or adjusted, while other market participants will 
continue to have all of their obvious and catastrophic errors 
adjusted.\11\ First, the Exchange's current rule differentiates among 
market participants. The notification period to begin the obvious error 
process is different for Exchange market makers and non-market makers 
(i.e., Electronic Access Members),\12\ and whether a trade is adjusted 
or busted also differs.\13\ Second, options rules often treat Priority 
Customers in a special way,\14\ recognizing that Priority Customers are 
not necessarily immersed in the day-to-day trading of the markets, less 
likely to be watching trading activity in a particular option 
throughout the day and may have limited funds in their trading 
accounts. Accordingly, differentiating among market participants by 
permitting Priority Customers to have a choice as to whether to nullify 
a trade involving an obvious or a catastrophic error is not unfairly 
discriminatory, because it is reasonable and fair to provide Priority 
Customers with additional options to protect themselves against the 
consequences of obvious and catastrophic errors.
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    \11\ Another options exchange recently cited these reasons as 
the basis to amend its catastrophic error rule to treat customer 
orders differently than non-customer orders. See Securities Exchange 
Act Release No. 68907 (February 12, 2013), 78 FR 11705 (February 19, 
2013) (SR-PHLX-2013-05).
    \12\ See ISE Rule 720(b)(1).
    \13\ See ISE Rule 720(b)(2).
    \14\ For example, many options exchanges' priority rules treat 
Priority Customer orders differently and some options exchanges only 
accept certain types of orders from Priority Customers. Most options 
exchanges also charge different fees for Priority Customer orders.
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    The Exchange acknowledges that the proposal contains some 
uncertainty regarding whether a trade will be adjusted or nullified, 
depending on whether one of the parties is a Priority Customer, because 
a person would not know, when entering into the trade, whether the 
other party is or is not a Priority Customer. The Exchange believes 
that the proposal nevertheless promotes just and equitable principles 
of trade and protects investors and the public interest, because it 
eliminates a more serious uncertainty in the rule's operation today, 
which is price uncertainty. Today, a Priority Customer's order can be 
adjusted to a significantly different price, which is more impactful 
than the possibility of nullification.
    Furthermore, there is uncertainty in the current obvious error 
portion of Rule 720 (as well as the rules of other options exchanges), 
which market participants have dealt with for a number of years. 
Specifically, Rule 720(b)(2)(i) provides that if it is determined that 
an Obvious Error has occurred where each party to the transaction is a 
market maker on the Exchange, the execution price of the transaction 
will be adjusted by Market Control (in accordance with subsection (A) 
and (B) of the rule, unless both parties agree to adjust to a different 
price or to nullify the transaction within ten minutes of being 
notified by Market Control of the Obvious Error. Additionally, Rule 
720(b)(2)(ii) provides that if it is determined that an Obvious Error 
has occurred where at least one party to the transaction to the Obvious 
Error is not an Exchange market maker, the trade will be busted by 
Market Control, unless both parties agree to adjust the price of the 
transaction within 30 minutes of being notified by Market Control of 
the Obvious Error. Therefore, an Exchange market maker who prefers 
adjustments over nullification cannot guarantee that outcome, because, 
if he trades with a non-Exchange market maker, a resulting obvious 
error would only be adjusted if the party on the other side of the 
trade agrees to an adjustment. This uncertainty has been embedded in 
the rule and accepted by market participants. The Exchange believes 
that this proposal, despite the uncertainty based on whether a Priority 
Customer is involved in a trade, is nevertheless consistent with the 
Act, because the ability to nullify a Priority Customer's trade 
involving an obvious or a catastrophic error should prevent the price 
uncertainty that mandatory adjustment under the current rule creates, 
which should promote just and equitable principles of trade and protect 
investors and the public interest. The Exchange has also weighed 
carefully the need to assure that one market participant is not 
permitted to receive a windfall at the expense of another market 
participant that made an obvious or a catastrophic error, against the 
need to assure that market participants are not simply being given an 
opportunity to reconsider poor trading decisions.
    Further, the Exchange believes that the proposed rule change 
relating to Market Control making the determination of whether a 
catastrophic error has occurred will promote just and equitable 
principles of trade by adding certainty and more consistency to the 
current rule.
    The Exchange's obvious and catastrophic rule and the procedures 
that carry out the rule have consistently been based on specific and 
objective criteria. The Exchange believes this proposed rule change 
furthers that principle by adopting objective guidelines for the 
determination of which trades may be nullified or adjusted and for the 
determination of whether or not a trade is deemed to be a catastrophic 
error.

B. Self-Regulatory Organization's Statement on Burden on Competition

    This proposed rule change does not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Exchange Act. The proposed rule change is intended to help market 
participants better manage the risk associated with erroneous options 
trades and therefore does not impose any burden on competition. While 
most options exchanges have similar, though not identical, rules 
regarding obvious and catastrophic errors, this proposed rule change, 
which treats Priority Customer orders differently than other exchanges 
do, may result in market participants choosing to route such orders to 
ISE and therefore attract order flow to ISE instead to a competing 
exchange.

[[Page 16341]]

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange has not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any unsolicited written comments from members or other interested 
parties.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the publication date of this notice or within 
such longer period (1) as the Commission may designate up to 45 days of 
such date if it finds such longer period to be appropriate and 
publishes its reasons for so finding or (2) as to which the self-
regulatory organization consents, the Commission will:
    (a) By order approve or disapprove such Proposed Rule Change; or
    (b) institute proceedings to determine whether the Proposed Rule 
Change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-ISE-2013-15 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-ISE-2013-15. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-ISE-2013-15 and should be 
submitted on or before April 4, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-05889 Filed 3-13-13; 8:45 am]
BILLING CODE 8011-01-P


