
[Federal Register Volume 78, Number 71 (Friday, April 12, 2013)]
[Notices]
[Pages 22017-22020]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08611]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69342; File No. SR-MIAX-2013-12]


Self-Regulatory Organizations; Miami International Securities 
Exchange LLC; Order Granting Accelerated Approval of a Proposed Rule 
Change Relating to Obvious Errors in Limit or Straddle States

April 8, 2013.

I. Introduction

    On March 22, 2013, Miami International Securities Exchange LLC 
(``MIAX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 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 erroneous options transactions 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 27, 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. 69210 (March 22, 2013), 
78 FR 18637 (``Notice'').
    \4\ See Letter to Elizabeth M. Murphy, Secretary, Commission, 
from Douglas M. Schafer, Executive Vice President, Chief Information 
Officer, MIAX, dated February [sic] 5, 2013 (``MIAX 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 Commentary .06 to Rule 521 to exclude trades that 
occur during a Limit State or Straddle State from the obvious error or 
catastrophic error review procedures pursuant to Rule 521 for a one 
year pilot basis following the adoption of the proposed rule change.\7\ 
The Exchange proposes to adopt new Rule 530(j) to apply to erroneous 
transactions in options when the underlying NMS Stock has entered 
either a Limit or Straddle State. In addition, the Exchange proposes to 
retain the ability to review all erroneous transactions that occur 
during Limit States and Straddle

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States resulting only from a verifiable disruption or malfunction of an 
Exchange execution, dissemination or communication system pursuant to 
new Rule 530(j).
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    \7\ The Exchange stated that members of the Exchange staff have 
spoken to its member organizations about obvious and catastrophic 
errors during a Limit State or Straddle State and that the Exchange 
has received generally favorable feedback concerning its proposed 
rule change, given the built-in customer protections in the Exchange 
system.
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    Rule 521 provides a process by which a transaction may be nullified 
or adjusted when the execution price of a transaction deviates from the 
option's theoretical price by a certain amount. 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 Rule 521, the theoretical price is 
determined in one of three 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 trade; (ii) as determined by an Exchange Official, if 
there are no quotes for comparison purposes, or if the bid/ask 
differential of the NBBO for the affected series, just prior to the 
erroneous transaction, was at least two times the standard bid/ask 
differential as permitted for pre-opening quotes under Rule 
603(b)(4); or (iii) for transactions occurring as part of the 
Exchange's automated opening system, the Theoretical Price shall be 
the first quote after the transaction(s) in question that does not 
reflect the erroneous transaction(s).
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    The Exchange believes that none of these methods is appropriate 
during a Limit State or Straddle State. Under Rule 521(b)(1), 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 
Rule 521(b)(1) 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 Rule 521(b)(2), affording discretion to the 
Exchange Official 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.\9\ 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.
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    \9\ The Exchange also notes that the determination of 
theoretical price under Rule 521(b)(3) applies to trades executed 
during openings. Because the Exchange does not intend to open an 
option during a Limit State or Straddle State, this provision will 
not apply.
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    In response to these concerns, the Exchange proposes to adopt 
Commentary .06 to Rule 521, which provides that transactions in MIAX 
options that overly an NMS stock are not subject to obvious error or 
catastrophic error review under Rule 521 during a Limit State or 
Straddle State. In addition, the Exchange proposes to adopt new Rule 
530(j) to allow the Exchange to review all erroneous transactions 
occurring during Limit States and Straddle States that resulted only 
from a verifiable disruption or malfunction of an Exchange execution, 
dissemination or communication system. Accordingly, the Exchange is 
proposing to incorporate the relevant portions of Rule 521 into 
proposed Rule 530(j) to establish the process for such review. Proposed 
Rule 530(j) also will include analogous language to that used in 
current Rule 521 regarding mutual agreement by the parties to an 
erroneous transaction during a trading halt (i.e., trades on the 
Exchange will be nullified when (i) the trade occurred during a trading 
halt in the affected option on the Exchange, or (ii) respecting equity 
options, the trade occurred during a trading halt on the primary market 
for the underlying security) and the relevant elements of Rule 521 
regarding the review procedure, requests for review and appeals from 
decisions to bust a trade.

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.\10\ Specifically, the Commission finds that the proposal is 
consistent with Section 6(b)(5) of the Act,\11\ 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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    \10\ 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).
    \11\ 15 U.S.C. 78f(b)(5).
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    In the filing, the Exchange notes its belief that suspending 
certain aspects of Rule 521 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

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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 electronic trades that occur during a 
Limit State or Straddle State from the obvious error or catastrophic 
error review procedures pursuant to Rule 521. 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 cancelling pending market 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. The 
Exchange will also continue to review erroneous transactions occurring 
during Limit or Straddle States that resulted from a verifiable 
disruption or malfunction of an Exchange execution, dissemination or 
communication system under proposed Rule 530(j). Finally, the Exchange 
states that the MIAX System is designed with built-in protection 
mechanisms to prevent trade through the NBBO price at the time of 
receipt of an order by more than one Minimum Price Variation. 
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.
    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 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.\12\ 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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    \12\ In particular, the Exchange represented that, at least two 
months prior to the end of the one year pilot period of proposed 
Rule 6.65A(c), 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 MIAX 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,\13\ 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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    \13\ 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,\14\ that the proposed rule change (SR-MIAX-2013-12), be, and 
hereby is, approved on an accelerated basis.
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    \14\ 15 U.S.C. 78s(b)(2).


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    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. 2013-08611 Filed 4-11-13; 8:45 am]
BILLING CODE 8011-01-P


