
[Federal Register Volume 78, Number 71 (Friday, April 12, 2013)]
[Notices]
[Pages 21982-21985]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08606]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69343; File No. SR-BX-2013-026]


Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Order 
Granting Accelerated Approval of a Proposed Rule Change To Adopt 
Chapter V, Section 3 Subparagraph (d)(iv) Regarding Obvious Error or 
Catastrophic Error Review

April 8, 2013.

I. Introduction

    On March 14, 2013, NASDAQ OMX BX, Inc. (``Exchange'') filed with 
the Securities and Exchange Commission (``Commission''), pursuant to 
Section

[[Page 21983]]

19(b)(1) of the Securities Exchange Act of 1934 (the ``Act'') \1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change to provide for how the 
Exchange proposes to treat obvious and catastrophic options errors in 
response to the Regulation NMS Plan to Address Extraordinary Market 
Volatility (the ``Plan''). The proposed rule change was published for 
comment in the Federal Register on March 20, 2013.\3\ The Commission 
received one comment letter on the proposal.\4\ This order approves the 
proposed rule change on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 69140 (March 15, 2013), 
78 FR 17255 (``Notice'').
    \4\ See Letter to Heather Seidel, Associate Director, Division 
of Trading and Markets, Commission, from Thomas A. Wittman, Senior 
Vice President, BX, dated April 5, 2013 (``BX Letter'').
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II. Description of the Proposed Rule Change

    Since May 6, 2010, when the financial markets experienced a severe 
disruption, the equities exchanges and the Financial Industry 
Regulatory Authority have developed market-wide measures to help 
prevent a recurrence. In particular, on May 31, 2012, the Commission 
approved the Plan, as amended, on a one-year pilot basis.\5\ The Plan 
is designed to prevent trades in individual NMS stocks from occurring 
outside of specified Price Bands, creating a market-wide limit up-limit 
down mechanism that is intended to address extraordinary market 
volatility in NMS Stocks.\6\
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    \5\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77 
FR 33498.
    \6\ Unless otherwise specified, capitalized terms used in this 
rule filing are based on the defined terms of the Plan.
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    In connection with the implementation of the Plan, the Exchange 
proposes to adopt new Chapter V, Section 3(d)(iv) to exclude trades 
that occur during a Limit State or Straddle State from the obvious 
error or catastrophic error review procedures pursuant to Chapter V, 
Sections 6(b) or 6(f), for a one year pilot basis from the date of 
adoption of the proposed rule change.\7\ The Exchange proposes to 
retain the ability to review trades that occur during a Limit State or 
Straddle State by Exchange motion pursuant to Chapter V, Section 
6(d)(i).
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    \7\ The Exchange stated that various members of the Exchange 
staff have spoken to a number of member organizations about obvious 
and catastrophic errors during a Limit State or Straddle State and 
that a variety of viewpoints emerged, mostly focused on having many 
trades stand, on fairness and fair and orderly markets, and on being 
able to re-address the details during the course of the pilot, if 
needed.
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    Under Sections 6(b)(i) and (f)(i), obvious and catastrophic errors 
are calculated by determining a theoretical price and applying such 
price to ascertain whether the trade should be nullified or adjusted. 
Obvious and catastrophic errors are determined by comparing the 
theoretical price of the option, calculated by one of the methods in 
Section 6(c), to an adjustment table in Section 6(b)(i) for obvious 
errors or Section 6(f)(i) for catastrophic errors. Generally, the 
theoretical price of an option is the National Best Bid and Offer 
(``NBBO'') of the option. In certain circumstances, Exchange officials 
have the discretion to determine the theoretical price.\8\
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    \8\ Specifically, under Section 6(c), the theoretical price is 
determined in one of two ways: (i) If the series is traded on at 
least one other options exchange, the last National Best Bid price 
with respect to an erroneous sell transaction and the last National 
Best Offer price with respect to an erroneous buy transaction, just 
prior to the transaction; or (ii) as determined by MarketWatch as 
defined in Chapter I, if there are no quotes for comparison 
purposes.
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    The Exchange believes that neither of these methods is appropriate 
during a Limit State or Straddle State. Under Section 6(c)(i), the 
theoretical price is determined with respect to the NBBO for an option 
series just prior to the trade. According to the Exchange, during a 
Limit State or Straddle State, options prices may deviate substantially 
from those available prior to or following the state. The Exchange 
believes this provision would give rise to much uncertainty for market 
participants as there is no bright line definition of what the 
theoretical price should be for an option when the underlying NMS stock 
has an unexecutable bid or offer or both. Because the approach under 
Section 6(c)(i) by definition depends on a reliable NBBO, the Exchange 
does not believe that approach is appropriate during a Limit State or 
Straddle State. Additionally, because the Exchange system will only 
trade through the theoretical bid or offer if the Exchange or the 
participant (via an ISO order) has accessed all better priced interest 
away in accordance with the Options Order Protection and Locked/Crossed 
Markets Plan, the Exchange believes potential trade reviews of 
executions that occurred at the participant's limit price and also in 
compliance with the aforementioned Plan could harm liquidity and also 
create an advantage to either side of an execution depending on the 
future movement of the underlying stock.
    With respect to Section 6(c)(ii), affording discretion to Exchange 
staff to determine the theoretical price and thereby, ultimately, 
whether a trade is busted or adjusted and to what price, the Exchange 
notes that it would be difficult to exercise such discretion in periods 
of extraordinary market volatility and, in particular, when the price 
of the underlying security is unreliable. The Exchange again notes that 
the theoretical price in this context would be subjective. Ultimately, 
the Exchange believes that adding certainty to the execution of orders 
in these situations should encourage market participants to continue to 
provide liquidity to the Exchange, thus promoting fair and orderly 
markets. On balance, the Exchange believes that removing the potential 
inequity of nullifying or adjusting executions occurring during Limit 
States or Straddle States outweighs any potential benefits from 
applying these provisions during such unusual market conditions.
    Additionally, the Exchange proposes to provide that trades would 
not be subject to review under Section 6(b)(ii) during a Limit or 
Straddle State. Under Section 6(b)(ii), a trade may be nullified or 
adjusted where an execution occurred in a series quoted no bid. The 
Exchange believes that these situations are not appropriate for an 
error review because they are more likely to result in a windfall to 
one party at the expense of another in a Limit State or Straddle State, 
because the criteria for meeting the no-bid provision are more likely 
to be met in a Limit State or Straddle State, and unlike normal 
circumstances, may not be a true reflection of the value of the series 
being quoted.
    In response to these concerns, the Exchange proposes to adopt 
Section 3(d)(iv) to provide that trades are not subject to an obvious 
error or catastrophic error review pursuant to Section 6(b) and 6(f) 
during a Limit State or Straddle State. In addition, proposed Section 
3(d)(iv) also will include a qualification that nothing in proposed 
Section 3(d)(iv) will prevent electronic trades from being reviewed on 
Exchange motion pursuant to Section 6(d)(i). According to the Exchange, 
this safeguard will provide the flexibility to act when necessary and 
appropriate, while also providing market participants with certainty 
that trades they effect with quotes and/or orders having limit prices 
will stand irrespective of subsequent moves in the underlying security. 
The right to review on Exchange motion electronic transactions that 
occur during a Limit State or Straddle State under this provision, 
according to the Exchange, would enable the Exchange to account for 
unforeseen circumstances that result in obvious or catastrophic errors 
for

[[Page 21984]]

which a nullification or adjustment may be necessary in order to 
preserve the interest of maintaining a fair and orderly market and for 
the protection of investors.

III. Discussion

    The Commission finds that the Exchange's proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange.\9\ 
Specifically, the Commission finds that the proposal is consistent with 
Section 6(b)(5) of the Act,\10\ in that it is designed to prevent 
fraudulent and manipulative acts and practices, promote just and 
equitable principles of trade, foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, remove impediments to and perfect the mechanism of a free 
and open market and a national market system, and, in general, protect 
investors and the public interest.
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    \9\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    In the filing, the Exchange notes its belief that suspending 
certain aspects of Chapter V, Section 6 during a Limit State or 
Straddle State will ensure that limit orders that are filled during a 
Limit or Straddle State will have certainty of execution in a manner 
that promotes just and equitable principles of trade and removes 
impediments to, and perfects the mechanism of, a free and open market 
and a national market system. The Exchange believes the application of 
the current rule would be impracticable given what it perceives will be 
the lack of a reliable NBBO in the options market during Limit States 
and Straddle States, and that the resulting actions (i.e., nullified 
trades or adjusted prices) may not be appropriate given market 
conditions. In addition, given the Exchange's view that options prices 
during Limit States or Straddle States may deviate substantially from 
those available shortly following the Limit State or Straddle State, 
the Exchange believes that providing market participants time to re-
evaluate a transaction executed during a Limit or Straddle State will 
create an unreasonable adverse selection opportunity that will 
discourage participants from providing liquidity during Limit States or 
Straddle States. Ultimately, the Exchange believes that adding 
certainty to the execution of orders in these situations should 
encourage market participants to continue to provide liquidity to the 
Exchange during Limit States and Straddle States, thus promoting fair 
and orderly markets.
    The Exchange, however, has proposed this rule change based on its 
expectations about the quality of the options market during Limit 
States and Straddle States. The Exchange states, for example, that it 
believes that application of the obvious and catastrophic error rules 
would be impracticable given the potential for lack of a reliable NBBO 
in the options market during Limit States and Straddle States. Given 
the Exchange's recognition of the potential for unreliable NBBOs in the 
options markets during Limit States and Straddle States, the Commission 
is concerned about the extent to which investors may rely to their 
detriment on the quality of quotations and price discovery in the 
options markets during these periods. This concern is heightened by the 
Exchange's proposal to exclude trades that occur during a Limit State 
or Straddle State from the obvious error or catastrophic error review 
procedures pursuant to Section 6(b) or 6(f). The Commission urges 
investors and market professionals to exercise caution when considering 
trading options under these circumstances. Broker-dealers also should 
be mindful of their obligations to customers that may or may not be 
aware of specific options market conditions or the underlying stock 
market conditions when placing their orders.
    While the Commission remains concerned about the quality of the 
options market during the Limit and Straddle States, and the potential 
impact on investors of executing in this market without the protections 
of the obvious or catastrophic error rules that are being suspended 
during the Limit and Straddle States, it believes that certain aspects 
of the proposal could help mitigate those concerns.
    First, despite the removal of obvious and catastrophic error 
protection during Limit States and Straddle States, the Exchange states 
that there are additional measures in place designed to protect 
investors. For example, the Exchange states that by rejecting market 
orders and stop orders, and cancelling pending market orders and stop 
orders, only those orders with a limit price will be executed during a 
Limit State or Straddle State. Additionally, the Exchange notes the 
existence of SEC Rule 15c3-5 requiring broker-dealers to have controls 
and procedures in place that are reasonably designed to prevent the 
entry of erroneous orders. Finally, with respect to limit orders that 
will be executable during Limit States and Straddle States, the 
Exchange states that it applies price checks to limit orders that are 
priced sufficiently far through the NBBO. Therefore, on balance, the 
Exchange believes that removing the potential inequity of nullifying or 
adjusting executions occurring during Limit States or Straddle States 
outweighs any potential benefits from applying certain provisions 
during such unusual market conditions.
    The Exchange also believes that the aspect of the proposed rule 
change that will continue to allow the Exchange to review on its own 
motion electronic trades that occur during a Limit State or a Straddle 
State is consistent with the Act because it would provide flexibility 
for the Exchange to act when necessary and appropriate to nullify or 
adjust a transaction and will enable the Exchange to account for 
unforeseen circumstances that result in obvious or catastrophic errors 
for which a nullification or adjustment may be necessary in order to 
preserve the interest of maintaining a fair and orderly market and for 
the protection of investors. The Exchange represents that it recognizes 
that this provision is limited and that it will administer the 
provision in a manner that is consistent with the principles of the 
Act. In addition, the Exchange represents that it will create and 
maintain records relating to the use of the authority to act on its own 
motion during a Limit State or Straddle State.
    Finally, the Exchange has proposed that the changes be implemented 
on a one year pilot basis. The Commission believes that it is important 
to implement the proposal as a pilot. The one year pilot period will 
allow the Exchange time to assess the impact of the Plan on the options 
marketplace and allow the Commission to further evaluate the effect of 
the proposal prior to any proposal or determination to make the changes 
permanent. To this end, the Exchange has committed to: (1) Evaluate the 
options market quality during Limit States and Straddle States; (2) 
assess the character of incoming order flow and transactions during 
Limit States and Straddle States; and (3) review any complaints from 
members and their customers concerning executions during Limit States 
and Straddle States. Additionally, the Exchange has agreed to provide 
the Commission with data requested to evaluate the impact of the 
elimination of the obvious error rule, including data relevant to 
assessing the various analyses noted above. On April 5, 2013, the 
Exchange submitted a letter stating that it would provide specific data 
to

[[Page 21985]]

the Commission and the public and certain analysis to the Commission to 
evaluate the impact of Limit States and Straddle States on liquidity 
and market quality in the options markets.\11\ This will allow the 
Commission, the Exchange, and other interested parties to evaluate the 
quality of the options markets during Limit States and Straddle States 
and to assess whether the additional protections noted by the Exchange 
are sufficient safeguards against the submission of erroneous trades, 
and whether the Exchange's proposal appropriately balances the 
protection afforded to an erroneous order sender against the potential 
hazards associated with providing market participants additional time 
to review trades submitted during a Limit State or Straddle State.
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    \11\ In particular, the Exchange represented that, at least two 
months prior to the end of the one year pilot period of proposed 
Section 3(d)(iv), it would provide to the Commission an evaluation 
of (i) the statistical and economic impact of Straddle States on 
liquidity and market quality in the options market and (ii) whether 
the lack of obvious error rules in effect during the Limit States 
and Straddle States are problematic. In addition, the Exchange 
represented that each month following the adoption of the proposed 
rule change it would provide to the Commission and the public a 
dataset containing certain data elements for each Limit State and 
Straddle State in optionable stocks. The Exchange stated that the 
options included in the dataset will be those that meet the 
following conditions: (i) The options are more than 20% in the money 
(strike price remains greater than 80% of the last stock trade price 
for calls and strike price remains greater than 120% of the last 
stock trade price for puts when the Limit State or Straddle State is 
reached); (ii) the option has at least two trades during the Limit 
State or Straddle State; and (iii) the top ten options (as ranked by 
overall contract volume on that day) meeting the conditions listed 
above. For each of those options affected, each dataset will 
include, among other information: stock symbol, option symbol, time 
at the start of the Limit State or Straddle State and an indicator 
for whether it is a Limit State or Straddle State. For activity on 
the Exchange in the relevant options, the Exchange has agreed to 
provide executed volume, time-weighted quoted bid-ask spread, time-
weighted average quoted depth at the bid, time-weighted average 
quoted depth at the offer, high execution price, low execution 
price, number of trades for which a request for review for error was 
received during Limit States and Straddle States, an indicator 
variable for whether those options outlined above have a price 
change exceeding 30% during the underlying stock's Limit State or 
Straddle State compared to the last available option price as 
reported by OPRA before the start of the Limit or Straddle state (1 
if observe 30% and 0 otherwise), and another indicator variable for 
whether the option price within five minutes of the underlying stock 
leaving the Limit State or Straddle State (or halt if applicable) is 
30% away from the price before the start of the Limit State or 
Straddle State. See BX Letter, supra note 4.
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    Finally, the Commission notes that the Plan, to which these rules 
relate, will be implemented on April 8, 2013. Accordingly, for the 
reasons stated above, and in consideration of the April 8, 2013 
implementation date of the Plan, the Commission finds good cause, 
pursuant to Section 19(b)(2) of the Act,\12\ for approving the 
Exchange's proposal prior to the 30th day after the publication of the 
notice in the Federal Register.
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    \12\ 15 U.S.C. 78s(b)(2). The Commission noticed substantially 
similar rules proposed by NYSE MKT LLC and NYSE Arca, Inc. with a 
full 21 day comment period. See Securities Exchange Act Release No. 
69033, 78 FR 15067 (March 8, 2013) and Securities Exchange Act 
Release No. 69032, 78 FR 15080 (March 8, 2013).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-BX-2013-026), be, and hereby 
is, approved on an accelerated basis.
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    \13\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08606 Filed 4-11-13; 8:45 am]
BILLING CODE 8011-01-P


