
[Federal Register Volume 78, Number 71 (Friday, April 12, 2013)]
[Notices]
[Pages 21985-21992]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08613]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69345; File No. SR-C2-2013-013]


Self-Regulatory Organizations; C2 Options Exchange, Incorporated; 
Notice of Filing of Amendment No. 1, and Order Granting Accelerated 
Approval to Proposed Rule Change, as Modified by Amendment Nos. 1 and 
2, Relating to the Regulation NMS Plan To Address Extraordinary Market 
Volatility

April 8, 2013.

I. Introduction

    On March 7, 2013, C2 Options Exchange, Incorporated (``C2'' 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 modify its rules to address certain option 
order types, order handling procedures, obvious error and market-maker 
quoting obligations on the Exchange after the implementation of the 
National Market System Plan to Address Extraordinary Market Volatility 
(``Limit up-Limit Down Plan''). The proposed rule change was published 
for comment in the Federal Register on March 14, 2013.\3\ On March 26, 
2013, C2 filed Amendment No. 1 to the proposed rule change.\4\ In 
Amendment No. 1, the Exchange, among other things, proposed to add rule 
text to give the Exchange authority to review transactions in certain 
limited circumstances.\5\ On April 4, C2 filed Amendment No. 2 to the 
proposed rule change.\6\ The Commission received one comment letter on 
the proposed rule change.\7\ The Commission is publishing this notice 
to solicit comments on Amendment No. 1 from interested persons and is 
approving the proposed rule change, as modified by Amendment Nos. 1 and 
2, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 69083 (March 8, 
2013), 78 FR 16320 (``Notice'').
    \4\ See Amendment No. 1 dated March 26, 2013 (``Amendment No. 
1'').
    \5\ Id. Additionally, the Exchange provided rationale for 
terminating the HAL auction early and cancelling of the market 
orders, discussed infra.
    \6\ See Amendment No. 2 dated April 4, 2013 (``Amendment No. 
2''). Amendment No. 2 expanded upon the Exchange's rationale for its 
proposal to accept certain types of market orders during a limit up-
limit down state, its proposal to cancel and replace limit orders 
with market orders during a limit up-limit down state, and its 
proposed treatment of stock-option orders in a limit up-limit down 
state. Because Amendment No. 2 is technical in nature, it is not 
subject to notice and comment.
    \7\ See Letter to Elizabeth M. Murphy, Secretary, Commission, 
from Angelo Evangelou, Associate General Counsel, C2, dated April 4, 
2013 (``C2 Letter'').
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II. Background

    On May 6, 2010, the U.S. equity markets experienced a severe 
disruption that, among other things, resulted in the prices of a large 
number of individual securities suddenly declining by significant 
amounts in a very short time period before suddenly reversing to prices 
consistent with their pre-decline levels.\8\ This severe price 
volatility led to a large number of trades being executed at 
temporarily depressed prices, including many that were more than 60% 
away from pre-decline prices. One response to the events of May 6, 
2010, was the development of the single-stock circuit breaker pilot 
program, which was implemented through a series of rule filings by the 
equity exchanges and by FINRA.\9\ The

[[Page 21986]]

single-stock circuit breaker was designed to reduce extraordinary 
market volatility in NMS stocks by imposing a five-minute trading pause 
when a trade was executed at a price outside of a specified percentage 
threshold.\10\
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    \8\ The events of May 6 are described more fully in a joint 
report by the staffs of the Commodity Futures Trading Commission 
(``CFTC'') and the Commission. See Report of the Staffs of the CFTC 
and SEC to the Joint Advisory Committee on Emerging Regulatory 
Issues, ``Findings Regarding the Market Events of May 6, 2010,'' 
dated September 30, 2010, available at http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
    \9\ For further discussion on the development of the single-
stock circuit breaker pilot program, see Securities Exchange Act 
Release No. 67091 (May 31, 2012), 77 FR 33498 (June 6, 2012) 
(``Limit Up-Limit Down Plan'' or ``Plan'').
    \10\ See Securities Exchange Act Release Nos. 62884 (September 
10, 2010), 75 FR 56618 (September 16, 2010) and Securities Exchange 
Act Release No. 62883 (September 10, 2010), 75 FR 56608 (September 
16, 2010) (SR-FINRA-2010-033) (describing the ``second stage'' of 
the single-stock circuit breaker pilot) and Securities Exchange Act 
Release No. 64735 (June 23, 2011), 76 FR 38243 (June 29, 2011) 
(describing the ``third stage'' of the single-stock circuit breaker 
pilot).
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    To replace the single-stock circuit breaker pilot program, the 
equity exchanges filed a National Market System Plan \11\ pursuant to 
Section 11A of the Act,\12\ and Rule 608 thereunder,\13\ which featured 
a ``limit up-limit down'' mechanism.
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    \11\ NYSE Euronext filed on behalf of New York Stock Exchange 
LLC (``NYSE''), NYSE Amex LLC (``NYSE Amex''), and NYSE Arca, Inc. 
(``NYSE Arca''), and the parties to the proposed National Market 
System Plan, BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago 
Board Options Exchange, Incorporated (``CBOE''), Chicago Stock 
Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., Financial 
Industry Regulatory Authority, Inc., NASDAQ OMX BX, Inc., NASDAQ OMX 
PHLX LLC, the Nasdaq Stock Market LLC, and National Stock Exchange, 
Inc. (collectively with NYSE, NYSE MKT, and NYSE Arca, the 
``Participants''). On May 14, 2012, NYSE Amex filed a proposed rule 
change on an immediately effective basis to change its name to NYSE 
MKT LLC (``NYSE MKT''). See Securities Exchange Act Release No. 
67037 (May 21, 2012) (SR-NYSEAmex-2012-32).
    \12\ 15 U.S.C. 78k-1.
    \13\ 17 CFR 242.608.
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    The Plan sets forth requirements that are designed to prevent 
trades in individual NMS stocks from occurring outside of the specified 
price bands. The price bands consist of a lower price band and an upper 
price band for each NMS stock. When one side of the market for an 
individual security is outside the applicable price band, i.e., the 
National Best Bid is below the Lower Price Band, or the National Best 
Offer is above the Upper Price band, the Processors \14\ are required 
to disseminate such National Best Bid or National Best Offer \15\ with 
a flag identifying that quote as non-executable. When the other side of 
the market reaches the applicable price band, i.e., the National Best 
Offer reaches the lower price band, or the National Best Bid reaches 
the upper price band, the market for an individual security enters a 
15-second Limit State, and the Processors are required disseminate such 
National Best Offer or National Best Bid with an appropriate flag 
identifying it as a Limit State Quotation. Trading in that stock would 
exit the Limit State if, within 15 seconds of entering the Limit State, 
all Limit State Quotations were executed or canceled in their entirety. 
If the market does not exit a Limit State within 15 seconds, then the 
Primary Listing Exchange will declare a five-minute trading pause, 
which is applicable to all markets trading the security.
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    \14\ As used in the Plan, the Processor refers to the single 
plan processor responsible for the consolidation of information for 
an NMS Stock pursuant to Rule 603(b) of Regulation NMS under the 
Exchange Act. See id.
    \15\ ``National Best Bid'' and ``National Best Offer'' has the 
meaning provided in Rule 600(b)(42) of Regulation NMS under the 
Exchange Act. See id.
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    The Primary Listing Exchange may also declare a trading pause when 
the stock is in a Straddle State, i.e., the National Best Bid (Offer) 
is below (above) the Lower (Upper) Price Band and the NMS Stock is not 
in a Limit State. In order to declare a trading pause in this scenario, 
the Primary Listing Exchange must determine that trading in that stock 
deviates from normal trading characteristics such that declaring a 
trading pause would support the Plan's goal to address extraordinary 
market volatility.\16\
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    \16\ As set forth in more detail in the Plan, all trading 
centers would be required to establish, maintain, and enforce 
written policies and procedures reasonably designed to prevent the 
display of offers below the Lower Price Band and bids above the 
Upper Price Band for an NMS Stock. The Processors would be able to 
disseminate an offer below the Lower Price Band or bid above the 
Upper Price Band that nevertheless may be inadvertently submitted 
despite such reasonable policies and procedures, but with an 
appropriate flag identifying it as non-executable; such bid or offer 
would not be included in National Best Bid or National Best Offer 
calculations. In addition, all trading centers would be required to 
develop, maintain, and enforce policies and procedures reasonably 
designed to prevent trades at prices outside the price bands, with 
the exception of single-priced opening, reopening, and closing 
transactions on the Primary Listing Exchange.
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    On May 31, 2012, the Commission approved the Plan as a one-year 
pilot, which shall be implemented in two phases.\17\ The first phase of 
the Plan shall be implemented beginning April 8, 2013.\18\
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    \17\ See ``Limit Up-Limit Down Plan,'' supra note 9. See also 
Securities Exchange Act Release No. 68953 (February 20, 2013), 78 FR 
13113 (February 26, 2013) (Second Amendment to Limit Up-Limit Down 
Plan by BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Board 
Options Exchange, Inc., et al.) and Securities Exchange Act Release 
No. 69062 (March 7, 2013), 78 FR 15757 (March 12, 2013) (Third 
Amendment to Limit Up-Limit Down Plan by BATS Exchange, Inc., BATS 
Y-Exchange, Inc., Chicago Board Options Exchange, Inc., et al.)
    \18\ See ``Second Amendment to Limit Up-Limit Down Plan,'' supra 
note 17.
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III. Description of the Proposed Rule Change, as Modified by Amendment 
Nos. 1 and 2

    In light of and in connection with the Plan, the Exchange proposes 
to amend its rules to address certain option order types, order 
handling procedures, obvious error and market-maker quoting 
obligations.\19\ The Exchange believes these modifications will protect 
investors because when an underlying security is in a limit or straddle 
state (collectively referred to as a ``limit up-limit down state''), 
there will not be a reliable price for the security to serve as a 
benchmark for the price of the option. In addition, the Exchange 
believes these changes are warranted because the width of the options 
markets might be compromised during the limit up-limit down states and, 
thus, the quality of execution may be adversely impacted.
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    \19\ Specifically, the Exchange proposes to make changes to 
Exchange Rules Rule 6.10, ``Order Types Defined,'' 6.11, ``Openings 
(and sometimes Closings),'' Rule 6.13, ``Complex Order Execution,'' 
Rule 6.15, ``Obvious Error and Catastrophic Errors,'' Rule 6.18, 
``HAL,'' Rule 6.39, ``Equity Market Plan to Address Extraordinary 
Market Volatility,'' Rule 8.5, ``Obligations of Market-Makers, Rule 
8.17, ``DPM Obligations,'' and Rule 8.19, ``DPM Participation 
Entitlements.'' See Notice and Amendment No. 1.
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A. Exchange Rule 6.39 and the Plan

    The Exchange proposes to add Exchange Rule 6.39 to codify the 
changes occurring throughout its rulebook in connection with the Plan. 
The Exchange proposes to name Rule 6.39 as ``Equity Market Plan to 
Address Extraordinary Market Volatility''. The Exchange also plans to 
add new rule text that will define the Plan as it applies to the 
Exchange, and will describe the location of the other rule changes 
associated with the Plan. The proposed changes to Rule 6.39 will 
essentially serve as a roadmap for the Exchange's universal changes due 
to the implementation of the Plan.

B. Order Handling During the Limit Up-Limit Down State

    The Exchange proposes to add Exchange Rule 6.39 and modify Exchange 
Rules 6.10, 6.11, 6.13 and 6.18 to address how certain Exchange order 
types will be handled when the underlying security of such orders is in 
a limit up-limit down state. The proposed rule change will address how 
market orders,\20\ market-on-close,\21\ stop orders,\22\ and stock 
option orders \23\ will

[[Page 21987]]

function on the Exchange upon the implementation of the Plan. The 
Exchange is proposing to add language to clarify that: (a) Any market 
order will be returned during limit up-limit down states unless it 
qualifies for a certain exception; \24\ (b) market-on-close orders will 
not be elected if the underlying security is in a limit up-limit down 
state; (c) stop orders will not be triggered if the underlying security 
is in a limit up-limit down state, but will be held until the end of 
that state, at which time they will become eligible to be triggered; 
(d) stock-option orders will only execute if the calculated stock price 
is within the permissible bands.\25\ In addition, if a message is sent 
to replace a limit order with a market order while the underlying is in 
a limit up-limit down state, the resting limit order will be cancelled 
and the replaced market order will also be cancelled. The Exchange 
represented that cancelling a market order in this scenario is 
consistent with its treatment of market orders that are received during 
a limit up-limit down state, and cancelling the original limit order 
would be consistent with the Exchange's current cancel and replace 
functionality.\26\
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    \20\ See Exchange Rule 6.10 which defines a market order as ``an 
order to buy or sell a stated number of options contracts at the 
best price available at the time of execution.''
    \21\ See Exchange Rule 6.10(c)(2) which defines a market-on-
close order designation as an order ``to be executed as close as 
possible to the closing bell, or during the closing rotation, and 
should be near to or at the closing price for the particular series 
of option contracts.''
    \22\ See Exchange Rule 6.10(c)(3), which defines a stop order as 
a market order ``to buy or sell when the market for a particular 
option contract reaches a specified price on the Exchange.''
    \23\ See Exchange Rule 6.13(a)(2) which defines a stock-option 
order as ``an order to buy or sell a stated number of units of an 
underlying stock or a security convertible into the underlying stock 
* * * coupled with the purchase or sale of options contract(s) on 
the opposite side of the market.''
    \24\ Specifically, a market order submitted to initiate an 
Automated Improvement Mechanism will be accepted. The Exchange 
represented that such orders are entered with a contra order, and 
are thus effectively stopped because they must execute at a price at 
or better than the contra order. See Amendment No. 2.
    \25\ If the calculated price is not within the permissible Price 
Bands, the entire Stock-option order will be cancelled. The Exchange 
believes this is consistent with the Plan because it ensures that 
stock orders are not being electronically routed to stock venues for 
executions outside of the permissible Price Bands. See id.
    \26\ See id.
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    The Exchange stated that, although it has determined to continue 
options trading when a stock is in a limit up-limit down state, there 
will not be a reliable price for the underlying security to serve as a 
benchmark for the price of the option. Without a reliable underlying 
stock price, the Exchange stated that there is an enhanced risk of 
errors and improper executions. The Exchange also stated that adding a 
level of certainty for TPHs by specifying the treatment of such orders 
will encourage participation on the Exchange while the underlying 
security is in limit up-limit down states. Accordingly, the Exchange 
believes these order handling changes will best protect market 
participants after the implementation of the Plan by not allowing 
execution at unreasonable prices due to the shift in the stock prices.
    The Exchange proposes to modify its opening procedures under 
Exchange Rule 6.11, ``Openings (and sometimes Closings).'' The Exchange 
proposes to add an Interpretation and Policy .03 to clarify that if the 
underlying security for a class of options enters into a limit up-limit 
down state when the class moves to opening rotation, any market orders 
entered that trading day currently opening, prior to the opening of 
that class, will be cancelled. The Exchange stated that this change is 
consistent with cancelling the market orders in general during a limit 
up-limit down state. The Exchange further believes this proposed change 
will help the Exchange to protect the TPHs from executing skewed orders 
during limit up-limit down states.
    Next, the Exchange proposes to modify Exchange Rule 6.18, ``HAL.'' 
This functionality provides automated order handling in designated 
classes trading on the System for qualifying orders that are not 
automatically executed by the System.\27\ When the Exchange receives a 
qualifying order that is marketable against the National Best Bid or 
Offer (``NBBO'') and/or the Exchange's best bid or offer (``BBO''),\28\ 
HAL electronically exposes the order \29\ at the NBBO price to allow 
Market-Makers appointed in that class, as well as all Trading Permit 
Holders (``TPHs'') acting as agent for orders, at the top of the 
Exchange's book in the relevant series (or all TPHs if allowed by the 
Exchange) to step up to the NBBO price.
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    \27\ Currently, the Exchange determines the eligible order size, 
eligible order types, eligible origin code (i.e., public customer 
orders, non-Market-Maker broker-dealer orders and Market-Maker 
broker-dealer orders), and classes in which HAL is activated. See 
Exchange Rule 6.18.
    \28\ HAL will not electronically expose the order if the 
Exchange's quotation contains resting orders and does not contain 
sufficient Market-Maker quotation interest to satisfy the entire 
order.
    \29\ The duration of the exposure period may not exceed one 
second. See Exchange Rule 6.18(c) (describing the manner in which an 
exposed order is allocated under HAL); see also Exchange Rule 
6.18(d) (listing the circumstances in which an exposure period would 
terminate early).
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    The Exchange proposes to amend Rule 6.18 to modify the functioning 
of HAL with respect to market orders when the underlying security of 
the option is in a limit up-limit down state. Under the proposal, if an 
underlying security enters a limit up-limit down state while a market 
order is being exposed through HAL, the auction will end early, i.e., 
upon the entering of the limit up-limit down state. Additionally, any 
unexecuted portion of the market order would be cancelled. The Exchange 
stated that because there is an uncertainty of market prices during a 
limit up-limit down state, terminating the HAL auction early and 
cancelling the market order will ensure that market orders do not 
receive an unanticipated price.\30\ As such, the proposed rule changes 
would protect market participants by ensuring that they do not receive 
an executed order with an unanticipated price due to the change in the 
underlying security.
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    \30\ See Amendment No. 1.
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    The Exchange also proposes to modify the treatment of complex 
orders on the Hybrid System and the Complex Order Auction (``COA'') 
process. Generally, on a class-by-class basis, the Exchange may 
activate COA, which is a process by which eligible complex orders \31\ 
are given an opportunity for price improvement before being booked in 
the electronic complex order book (``COB'') or on a PAR workstation. 
Upon receipt of a COA-eligible order and a request from a TPH 
representing the order that such order be subjected to a COA, the 
Exchange will send a request for responses (``RFR'') message to all 
TPHs who have elected to receive RFR messages.\32\ Each Market-Maker 
with an appointment in the relevant option class and each TPH acting as 
agent for orders resting at the top of the COB in the relevant options 
series may then submit responses to the RFR message during the Response 
Time Interval.\33\
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    \31\ An eligible complex order, referred to in Rule 6.13 as a 
``COA-eligible order,'' means a complex order that, as determined by 
the Exchange on a class-by-class basis, is eligible for a COA 
considering the order's marketability (defined as a number of ticks 
away from the current market), size, complex order type and complex 
order origin type (i.e., non-broker-dealer public customer, broker-
dealers that are not Market-Makers or specialists on an options 
exchange, and/or Market-Makers or specialists on an options 
exchange). All determinations by the Exchange on COA-eligible order 
parameters are announced to Trading Permit Holders by Regulatory 
Circular. See Rule 6.18(c)(1)(B) and Interpretation and Policy .01 
to Rule 6.18.
    \32\ See Exchange Rule 6.18(c)(3)(B). The RFR message will 
identify the component series, the size of the COA-eligible order 
and any contingencies, but will not identify the side of the market.
    \33\ See Exchange Rule 6.18(c)(3)(B). A ``Response Time 
Interval'' means the period of time during which responses to the 
RFR may be entered, the length of which is determined by the 
Exchange on a class-by-class basis but may not exceed three seconds. 
See Rule 6.18(c)(3)(B).
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    The Exchange proposes to add to the COA rule that if, during COA, 
the underlying security of a market order enters a limit up-limit down 
state, the COA will end upon the entering of that state and the 
remaining portion of the order will cancel.

[[Page 21988]]

C. Market Maker Obligations and Participation Entitlements

    The Exchange proposes to eliminate all market maker obligations for 
options in which the underlying security is in a limit up-limit down 
state. Currently, Exchange Rules 8.5 and 8.17 impose certain 
obligations on Market-Makers and DPMs, respectively, including 
obligations to provide continuous quotes.
    The Exchange proposes to eliminate all market maker quoting 
obligations \34\ in series of options when the underlying security is 
currently in a limit up-limit down state. According to the Exchange, 
eliminating all Market Maker obligations in connection with the 
implementation of the Plan is the most effective way to ensure the 
options markets will not be compromised when the underlying security 
enters a limit up-limit down state. Specifically, there may not be 
reliable prices for an underlying security during a limit up-limit down 
state. Additionally, it may be difficult or not possible for a market 
participant to hedge the purchase or sale of an option if the bid or 
offer of an underlying security may not be executable due to a limit 
up-limit down state. Given the possible effects of the limit up-limit 
down state, the Exchange anticipates that Exchange Market-Makers may be 
forced to change behaviors during these periods. In an effort to 
protect the investors in the options market while the underlying 
security is in a limit up-limit down state, the Exchange believes that 
eliminating quoting obligations is the more effective way for this 
protection.
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    \34\ See Notice, supra note 3.
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    Although the Exchange is proposing to relieve market makers of 
their quoting obligations when the underlying is in a limit up-limit 
down state, the Exchange is proposing that Market-Makers and DPMs may 
still receive participation entitlements pursuant to the proposed rules 
in all series in their assigned classes in which they are quoting, even 
in series in which they are not required to provide continuous 
electronic quotes under the Exchange Rules. The Exchange stated that 
market makers already receive participation entitlements in series in 
which they are not required to quote; thus, under the proposed rule 
change, the market would continue to function as it does now with 
respect to how entitlements are allocated to Market-Makers. The 
Exchange believes this benefit is appropriate, as it incentivizes 
Market-Makers to quote in as many series as possible in their appointed 
classes, even those series in which the underlying security has entered 
into a limit up-limit down state. The Exchange stated that it is 
attempting to better encourage Market-Makers to quote even though they 
will not have the obligation. If market makers do choose to quote, the 
Exchange believes they should be entitled to receive the entitlement 
for such quoting as appropriate.

D. Nullification and Adjustment of Options Transactions

    In connection with the implementation of the Plan, the Exchange 
proposes to adopt Interpretation and Policy .08 to Rule 6.15 to exclude 
transactions in options that overlay a security during a Limit State or 
Straddle State from the obvious error pricing provision in Rule 
6.15(a)(1) for a one year pilot basis from the date of adoption of the 
proposed rule change. Additionally, the Exchange proposes to add rule 
text to provide that transactions in options that overlay an NMS stock 
that occur during a Limit State or Straddle State may be reviewed on an 
Exchange motion. The Exchange also proposes to provide the Commission 
with data and analysis during the duration of the pilot as requested.
    Under Rule 6.15, an Obvious Error occurs when the execution price 
of an electronic transaction is above or below the theoretical price 
for the series by a specified amount. Pursuant to Rule 6.15(a)(3)(A), 
the theoretical price of an option series is currently defined, for 
series traded on at least one other options exchange, as 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. In certain circumstances, 
designated personnel in the Help Desk have the discretion to determine 
the theoretical price pursuant to Rule 6.15(a)(3)(B).\35\
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    \35\ Rule 6.15(a)(3)(B) provides that if there are no quotes for 
comparison purposes, designated personnel in the Help Desk will 
determine the theoretical price.
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    The Exchange believes that neither method is appropriate during a 
Limit State or Straddle State. In Amendment No. 1, the Exchange noted 
that 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 value should be for an option when the underlying NMS 
stock has an unexecutable bid or offer or both. The Exchange noted that 
determining theoretical value in such a situation would be often times 
very subjective rather than an objective determination and would give 
rise to additional uncertainty and confusion for investors. Similarly, 
the Exchange believes the application of the current rule would be 
impracticable given the lack of a reliable national best bid or offer 
in the options market during Limit States and Straddle States, and 
would produce undesirable effects.
    Ultimately, the Exchange believes that adding certainty to the 
execution of limit orders in these situations should encourage market 
participants to continue to provide liquidity to the Exchange, thus 
promoting a fair and orderly market. 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.
    Therefore, the Exchange proposes to adopt Interpretation and Policy 
.08 to Rule 6.15 to provide that transactions executed during a Limit 
State or Straddle State are not subject to review under Rule 6.15 for 
Obvious and Catastrophic Errors. In addition, in Amendment No. 1, the 
Exchange proposes to give Exchange Officers the authority to review 
transactions believed to be erroneous that occur during a Limit State 
or Straddle State, on its own motion.\36\ 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

[[Page 21989]]

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 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 also 
proposes to provide the Commission with data and analysis during the 
duration of the pilot as requested.
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    \36\ Specifically, the Exchange is proposing to add language 
that states that in the interest of maintaining a fair and orderly 
market and for the protection of investors during a limit up-limit 
down state, the President of the Exchange or his/her designee, who 
shall be an officer of the Exchange but may not be a Permit Holder 
(``Exchange Officer''), may, on his or her own motion or upon 
request, determine to review any transition occurring on the 
Exchange during a limit up-limit down state that is believed to be 
erroneous. A transaction reviewed pursuant to this right may be 
nullified or adjusted only if it is determined by the Exchange 
officer that the transaction is erroneous as provided in Rule 6.15 
(a)(1)-(3). A transaction would be adjusted or nullified in 
accordance with the provision under which it is deemed an erroneous 
transaction. The Exchange Officer may be assisted by the Help Desk 
in reviewing a transaction. In addition, the Exchange Officer shall 
act as soon as possible after receiving the notification of the 
transaction, and ordinarily would be expected to act on the same day 
as the transaction occurred. In no event shall the Exchange Officer 
act later than 8:30 a.m. (CT) on the next trading day following the 
date of the transaction at issue.
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IV. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and rules and 
regulations thereunder applicable to a national securities 
exchange.\37\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\38\ which, 
among other things, requires a national securities exchange to be so 
organized and have the capacity to be able to carry out the purposes of 
the Act and to enforce compliance by its members and persons associated 
with its members with the provisions of the Act, the rules and 
regulations thereunder, and the rules of the exchange, and is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in regulation, clearing, settling, 
processing information with respect to, and facilitating transactions 
in securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.
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    \37\ In approving the proposed rule changes, the Commission has 
considered their impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \38\ 15 U.S.C. 78f(b).
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A. Exchange Rule 6.39 and the Plan

    Exchange Rule 6.39 lists changes to Exchange order types, order 
handling, obvious error, and market-maker quoting obligations that the 
Exchange is making in connection with the implementation of the Plan. 
The Exchange believes that the proposed changes to Rule 6.39 will 
describe to TPHs and other market participants where to find the 
changes associated with the Plan's implementation. Accordingly, the 
Commission finds that this change promotes clarity in connection with 
C2's proposed changes in response to the Limit up-Limit Down Plan and 
is therefore consistent with the Act.

B. Order Handling During the Limit Up-Limit Down State

    As detailed above, the Exchange proposes to add language to clarify 
that: (a) Market orders, with a certain exception, will be returned 
during limit up-limit down states, (b) market-on-close orders will not 
be elected if the underlying security is in a limit up-limit down 
state, (c) stop orders will not be triggered while the underlying 
security is in a limit up-limit down state, and (d) stock-option orders 
will only execute if the calculated stock price is within the 
permissible bands. In addition, during a limit up-limit down state, if 
a message is sent to replace a limit order with a market order, the 
resting limit order will be cancelled and the replaced market order 
will also be cancelled.
    The Commission finds that the Exchange's proposed method of 
handling such orders is consistent with Section 6(b)(5) of the Act. 
When the underlying stock enters a limit up-limit down state, the lack 
of a reliable price in that market could affect the options markets in 
various ways, including wider spreads and less liquidity. This could 
potentially mean that market orders, which contain no restrictions on 
the price at which they may execute, could receive executions at 
unintended prices if executed during the limit up-limit down state. As 
such, the proposed changes to reject market orders and market-on-close 
orders if the underlying is in a limit up-limit down state, to not 
trigger stop orders if the underlying is in a limit up-limit down 
state, and to cancel market orders that replace limit orders when the 
underlying is in a limit up-limit down state, are reasonably designed 
to prevent such orders from being executed at potentially unexpected 
prices.
    At the same time, the proposed exception to the treatment of these 
orders--accepting market orders that are submitted to initiate an 
Automated Price Improvement Mechanism--is designed to take into account 
the fact that market orders submitted in this way may not be at the 
same risk as other market orders for executions at unexpected prices. 
Specifically, market orders submitted through the Automated Price 
Improvement Mechanism are submitted as pairs, and are effectively 
stopped because they must execute at a price at or better than the 
contra order.
    The Exchange proposes to add an Interpretation and Policy .03 to 
Rule 6.11, which states that if the underlying security for a class of 
options enters into a limit up-limit down state when the class moves to 
opening rotation, any market orders entered that trading day will be 
cancelled. The Commission finds that this change is consistent with the 
Act in that it is reasonably designed to counter potential price 
dislocations that may occur if the underlying enters a limit up-limit 
down state during the opening by preventing market orders, which 
contain no restrictions on the price at which they may execute, from 
being executed at potentially unintended prices.
    The Exchange also proposes that, if an underlying security enters a 
limit up-limit down state while a market order is being exposed through 
HAL, the auction will end early, and any unexecuted portion of the 
market order would be cancelled. The Commission believes that this 
provision will provide certainty to options market participants on how 
market orders submitted to HAL will be handled during limit up-limit 
down states. In addition, the Commission finds that this provision is 
consistent with the Act in that it is reasonably designed to counter 
potential price dislocations that may occur if the underlying enters a 
limit up-limit down state while the HAL functionality is underway by 
preventing market orders, which contain no restrictions on the price at 
which they may execute, from being executed at potentially unintended 
prices.
    The Exchange proposes to amend the COA rule so that, if during a 
COA of a market order, the underlying security of an option enters a 
limit up-limit down state, the COA will end and the remaining portion 
of the order, if a market order, will cancel. As with the proposed 
change to HAL, the Commission believes that this provision is 
consistent with the Act in that it will provide certainty to options 
market participants on how market orders submitted to COA will be 
handled during limit up-limit down states. In addition, the Commission 
finds that this provision is reasonably designed to counter potential 
price dislocations that may occur if the underlying enters a limit up-
limit down state while a COA is underway by preventing market orders, 
which contain no restrictions on the price at which they may execute, 
from being executed at potentially unintended prices.

C. Market Maker Obligations

    The Commission finds that the proposal to suspend a market maker's

[[Page 21990]]

obligations when the underlying security is in a limit up-limit down 
state is consistent with the Act. During a limit up-limit down state, 
there may not be a reliable price for the underlying security to serve 
as a benchmark for market makers to price options. In addition, the 
absence of an executable bid or offer for the underlying security will 
make it more difficult for market makers to hedge the purchase or sale 
of an option. Given these significant changes to the normal operating 
conditions of market makers, the Commission finds that the Exchange's 
decision to suspend a market maker's obligations in these limited 
circumstances is consistent with the Act. The Commission notes, 
however, that the Plan was approved on a pilot basis and its 
Participants will monitor how it is functioning in the equity markets 
during the pilot period. To this end, the Commission expects that, upon 
implementation of the Plan, the Exchange will continue monitoring the 
quoting requirements that are being amended in this proposed rule 
change and determine if any necessary adjustments are required to 
ensure that they remain consistent with the Act.
    The Commission also finds that the proposal to maintain 
participation entitlements for market makers in all series in their 
assigned classes in which they are quoting, including in series for 
which the underlying security is in a limit up-limit down state and for 
which they are not required to provide continuous electronic quotes 
under the Exchange Rules, is consistent with the Act. To the extent 
that market makers are only eligible for participation entitlements if 
they are quoting at the best price on the Exchange, this proposal is 
reasonably designed to incentivize Market-Makers to quote more 
aggressively when the underlying security has entered into a limit up-
limit down state than they might otherwise quote, potentially providing 
additional liquidity and price discovery. To the extent that, under 
this proposal, market makers would receive participation entitlements 
in series in which they are not required to quote, the Commission notes 
that this aspect of the proposal is consistent with the current 
application of participation entitlements.

D. Nullification and Adjustment of Options Transactions

    The Commission finds that the Exchange's proposed rule change to 
suspend certain aspects of Rule 6.15 during a Limit State or Straddle 
State is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange. 
Specifically, the Commission finds that the proposal is consistent with 
Section 6(b)(5) of the Act,\39\ 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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    \39\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    In Amendment No. 1, the Exchange notes its belief that suspending 
certain aspects of Rule 6.15 during a Limit State or Straddle State 
will ensure that limit orders that are filled during a Limit State 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 electronic trades that occur during a 
Limit State or Straddle State from the obvious and catastrophic pricing 
error provisions and the nullification or adjustment provisions of Rule 
6.15. 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 States 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 in Amendment No. 1 that by 
rejecting market orders and not electing 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. 
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 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

[[Page 21991]]

and appropriate to nullify or adjust a transaction and will enable the 
Exchange to account for unforeseen circumstances that result in obvious 
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 
will administer this 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 4, 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.\40\ 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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    \40\ In particular, the Exchange represented that, at least two 
months prior to the end of the one year pilot period of proposed 
Interpretation and Policy .08 to Rule 6.15, 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 Straddle States and 
Limit 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 C2 Letter, supra 
note 7.
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    In addition, the Commission finds good cause, pursuant to Section 
19(b)(2) of the Act \41\ for approving the proposed rule change on an 
accelerated basis. This proposal is related to the Plan, which will 
become operative on April 8, 2013, and aspects of the proposal, such as 
rejecting market orders and not electing stop orders during a limit up-
limit down state, are designed to prevent such orders from receiving 
poor executions during those times. In granting accelerated approval, 
the proposed rule change, and its corresponding protections, will take 
effect upon the Plan's implementation date. Accordingly, the Commission 
finds that good cause exists for approving the proposed rule change on 
an accelerated basis.
---------------------------------------------------------------------------

    \41\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 1 
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-C2-2013-013 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-C2-2013-013. 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 such 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 publicly available. All 
submissions should refer to File Number SR-C2-2013-013 and should be 
submitted on or before May 3, 2013.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\42\ that the proposed rule change (SR-C2-2013-013), as modified by 
Amendments Nos.

[[Page 21992]]

1 and 2, be, and it hereby is, approved on an accelerated basis.
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    \42\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
---------------------------------------------------------------------------

    \43\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08613 Filed 4-11-13; 8:45 am]
BILLING CODE 8011-01-P


