
[Federal Register Volume 78, Number 91 (Friday, May 10, 2013)]
[Notices]
[Pages 27453-27457]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-11140]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69517; File No. SR-BOX-2013-22]


Self-Regulatory Organizations; BOX Options Exchange LLC; Notice 
of Filing and Immediate Effectiveness of Proposed Rule Change To Amend 
Rule 7170 (Obvious and Catastrophic Errors)

May 6, 2013.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 
1934 (the ``Act'') \2\ and Rule 19b-4 thereunder,\3\ notice is hereby 
given that, on April 26, 2013, BOX Options Exchange LLC (the 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the self-regulatory 
organization. The Commission is publishing this notice to solicit 
comments on the proposed rule from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 15 U.S.C. 78a.
    \3\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Rule 7170 (Obvious and Catastrophic 
Errors). Specifically, the Exchange proposes to amend Rule 7170(h)(2) 
to permit the nullification of trades involving catastrophic errors in 
certain situations specified below. The text of the proposed rule 
change is available from the principal office of the Exchange, at the 
Commission's Public Reference Room and also on the Exchange's Internet 
Web site at http://boxexchange.com.

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

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

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

1. Purpose
    The purpose of the proposal is to help market participants better 
manage their risk by addressing the situation where, under current 
rules, a trade can be adjusted to a price outside of a customer's 
limit. Specifically, the Exchange proposes to amend Rule 7170(h) to 
enable a Public Customer \4\

[[Page 27454]]

who is the contra-side to a trade that is deemed to be a catastrophic 
error to have the trade nullified in instances where the adjusted price 
would violate the Public Customer's limit price. Only if the Public 
Customer, or his agent, affirms the Public Customer's willingness to 
accept the adjusted price through the Public Customer's limit price 
within 20 minutes of notification of the catastrophic error ruling 
would the trade be adjusted; otherwise it would be nullified. Today, 
all catastrophic error trades are adjusted, not nullified, on all of 
the options exchanges. This is a competitive filing that is based on a 
proposal recently submitted by NASDAQ OMX PHLX LLC (``PHLX'') and 
approved by the Commission.\5\
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    \4\ Under BOX Rule 100(a)(51) the term ``Public Customer'' means 
a person that is not a broker or dealer in securities. This includes 
Professionals under BOX Rule 100(a)(50), but not broker-dealers or 
Market Makers.
    \5\ See Securities Exchange Act Release No. 69304 (April 4, 
2013), 78 FR 21482 (April 10, 2013) (Order Approving SR-Phlx-2013-
005).
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Background
    Currently, Rule 7170 governs obvious and catastrophic errors. 
Obvious errors are calculated under the rule by determining a 
theoretical price and determining, based on objective standards, 
whether the trade should be nullified or adjusted. The rule also 
contains a process for requesting an obvious error review. Certain more 
substantial errors may fall under the category of a catastrophic error, 
for which a longer time period is permitted to request a review and for 
which trades can only be adjusted (not nullified). Trades are adjusted 
pursuant to an adjustment table that, in effect, assesses an adjustment 
penalty. By adjusting trades above or below the theoretical price, the 
Rule assesses a ``penalty'' in that the adjustment price is not as 
favorable as the amount the party making the error would have received 
had it not made the error.
Proposal
    At this time, the Exchange proposes to change the catastrophic 
error process to permit certain trades to be nullified. The definition 
and calculation of a catastrophic error would not change.\6\ First 
whether a transaction is a catastrophic error is determined by the 
Exchange's MRC,\7\ if both parties to the trade are Public Customers 
then the trade would be adjusted under the current rule. However, if 
only one of the parties is a Public Customer, then the adjusted price 
would be compared to the limit price of the order. If the adjusted 
price would violate the limit price (in other words, be higher than the 
limit price if it is a buy and lower than the limit price if it is a 
sell order), then the Public Customer would be offered an opportunity 
to nullify the trade. If the Public Customer (or the Public Customer's 
broker-dealer agent) does not respond within 20 minutes, the trade 
would be adjusted under the current rule.
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    \6\ Nor is the definition or process for obvious errors 
changing.
    \7\ The MRC is the BOX Market Regulation Center.
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    These changes should ensure that a Public Customer is not forced 
into a situation where the original limit price is violated and thereby 
the Public Customer is forced to spend additional dollars for a trade 
at a price the customer had no interest in trading and may not be able 
to afford.

    EXAMPLE 1--Resting Public Customer forced to adjust through his 
limit price and would prefer nullification.

Day 1

8:00:00 a.m. (pre-market)

Customer A enters order on BOX to buy 10 GOOG May 750 puts for $25 
(cost of $25,000, Customer has $50,000 in his trading account).

10:00:00 a.m.

GOOG trading at $750
May 750 puts $29.00-$31.00 (100x100) on all exchanges

10:04:00 a.m.

GOOG drops to $690
May 750 puts $25-$100 (10x10) BOX May 750 puts $20-$125 (10x10) CBOE
May 750 puts $10-$200 (100x100) on all other exchanges

10:04:01 a.m.

Customer B enters order to sell 10 May 750 puts for $25 (credit of 
$25,000)

10:04:01 a.m.

    10 May 750 puts execute at $25 ($35 under parity) \8\ with Customer 
A buying and Customer B selling.
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    \8\ Parity is the intrinsic value of an option when it is in-
the-money. With respect to puts, it is calculated by subtracting the 
price of the underlying from the strike price of the put. With 
respect to calls, it is calculated by subtracting the strike price 
from the price of the underlying.

10:04:02 a.m. (1 second later)

GOOG trading $690
May 750 puts $75-$78 (100x100) BOX May 750 puts $75-$80 (10x10) CBOEMay 
750 puts $70-$80 (100x100) All other exchanges

    No obvious error is filed within 20 minute notification time 
required by rule. If this had been an obvious error review, the trade 
would have been nullified in accordance with Rule 7170 because one of 
the parties to the trade was a non-market maker.

4:00:00 p.m. (the close)

GOOG trading $710
May 750 puts $60-$63 (100x100) BOX May 750 puts $55-$70 (10x10) CBOE
May 750 puts $50-$70 (100x100) All other exchanges

Day 2

8:00:00 a.m. (pre-market)

    Customer B, submits S10 GOOG May 750 puts at $25 under Catastrophic 
Review. Trade meets the criteria of Catastrophic Error and is adjusted 
to $68 ($75 (the 10:04:02 a.m. price less $7 adjustment penalty).

9:30:00 a.m. (the opening)

GOOG trading $725
May 750 puts open $48.00-$51.00 (100x100) on all exchanges

    Under current rule:

Without a choice, Customer A is forced to spend $68 (cost of $68,000, 
with only $25,000 in his account)
Puts are now trading $48, so Customer A shows a loss of $20,000 ($68 
less $48x10 contracts x 100 multiplier)

    Under proposed rule:

Customer A would be able to choose to have the B10 GOOG May 750 puts 
nullified avoiding both a loss, and an expenditure of capital exceeding 
the amount in his account.
Customer B would be relieved of the obligation to sell the puts at 25 
because the trade would be nullified.

    EXAMPLE 2--Resting Public Customer trades, sells out his position, 
thus would choose to keep the adjusted trade and avoid nullification.

Day 1

8:00:00 a.m. (pre-market)

Customer A enters order on BOX to Buy 10 BAC April 7.00 calls for $.01 
(cost of $10 total. (Customer has $3,000 in his account).

10:00:00 a.m.

BAC trading $11
April 7 calls $4.50-$4.70 (100x100) on all exchanges

10:04:00 a.m.

BAC Trading $11
April 7 calls $.01-$4.70 (10x10) BOX April 7 calls
$4.50-$4.70 (10x10) CBOE
April 7 calls $4.50-$4.70 (10x10)) All other exchanges

10:04:01 a.m.

Customer B enters order to sell 10 April 7 calls at $.01 on BOX with an 
ISO indicator (which allows trade through)

[[Page 27455]]

10:04:01 a.m.

10 April 7 calls execute at $.01 on BOX Customer A buying and Customer 
B selling.

10:04:02 a.m. (1 second later)

BAC is $11
April 7 calls $4.50-$4.70 (10x10) BOX April 7 calls
$4.50-$4.70 (10x10) CBOE
April 7 calls $4.50-$4.70 (10x10)) All other exchanges

    No obvious error is filed within 20 minute notification time 
required by rule. If this had been an obvious error review, the trade 
would have been nullified.

11:00:00 a.m.

BAC trading $9.60
April 7 calls $3.00-$3.25 (10x10) BOX April 7 calls
$3.00-$3.25 (10x10) CBOE
April 7 calls $3.00-$3.25 (10x10)) All other exchanges
Customer A sells 10 April 7 calls at $3.00 (a total credit of $3,000 
for a $2,990 profit)

3:00:00 p.m.

BAC trading $12.80
April 7 calls $5.80-$6.00 (10x10) BOX April 7 calls
$5.80-$6.00 (10x10) CBOE
April 7 calls $5.80-$6.00 (10x10)) All other exchanges
Customer A has now no position and would be at risk of a loss if 
nullified.

3:20:00 p.m.

Customer B submits S10 BAC April 7 calls at $.01 under Catastrophic 
Error Review. Trade meets the criteria of Catastrophic Error and is 
adjusted to $2.50 ($4.50 (the 10:04:02 a.m. price) less $2 adjustment 
penalty).

    Impact:

Under current Rule: Customer A would be adjusted to $2.50 ($4.50 (the 
10:04:02 a.m. price) less $2 adjustment penalty).

    Under Proposed rule:

Illustrating the need for a choice, Customer A chooses within 20 
minutes to accept an adjustment to $2.50 instead of a nullification, 
locking in a gain of $500 instead of $2.990 (B 10 at $2.50 vs. S10 at 
$3.00).
If not given a choice, Customer A would be naked short 10 calls at 
$3.00 that are now offered at $6.00 (a $3,000 loss).
    These examples illustrate the need for the Public Customer to have 
a choice in order to manage his risk. By applying a notification time 
limit of 20 minutes, it lessens the likelihood that the Public Customer 
will try to let the direction of the market for that option dictate his 
decision for a long period of time, thus exposing the contra side to 
more risk. This 20 minute time period is akin to the notification 
period currently used in the rule respecting the notification period 
for starting the obvious error process for non-Market Maker Options 
Participants.\9\
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    \9\ See BOX Rule 7170(g)(1).
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    For a market maker or a broker-dealer, the penalty that is part of 
the price adjustment process is usually enough to offset the additional 
dollars spent, and they can often trade out of the position with little 
risk and a potential profit. For a Public Customer who is not immersed 
in the day-to-day trading of the markets, this risk may be 
unacceptable. A Public Customer is also less likely to be watching 
trading activity in a particular option throughout the day and less 
likely to be closely focused on the execution reports the Public 
Customer receives after a trade is executed. Accordingly, the Exchange 
believes that it is fair and reasonable, and consistent with statutory 
standards, to change the procedure for catastrophic errors for Public 
Customers and not for other Participants.
    The Exchange believes that the proposal is a fair way to address 
the issue of a Public Customer's limit price, yet still balance the 
competing interests of certainty that trades stand versus dealing with 
true errors. In 2009, the Exchange amended Rule 7170 to adopt the 
catastrophic error provision. In doing so, the Exchange stated that it 
had ``weighed carefully the need to assure that one market participant 
is not permitted to receive a windfall at the expense of another market 
participant that made an Obvious Error, against the need to assure that 
market participants are not simply being given an opportunity to 
reconsider poor trading decisions. The Exchange stated that, while it 
believed that the Obvious Error Rule strikes the correct balance in 
most situations, in some extreme situations, Participants may not be 
aware of errors that result in very large losses within the time 
periods currently required under the rule. In this type of extreme 
situation, the Exchange believes Participants should be given more time 
to seek relief so that there is a greater opportunity to mitigate very 
large losses and reduce the corresponding large wind-falls. However, to 
maintain the appropriate balance, the Exchange believes Participants 
should only be given more time when the execution price is much further 
away from the theoretical price than is required for Obvious Errors so 
that relief is only provided in extreme circumstances.'' \10\
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    \10\ See Securities Exchange Act Release No. 59197 (January 5, 
2009), 74 FR 969 (January 9, 2009)(SR-BSE-2008-52)(Notice of Filing 
and Immediate Effectiveness of a Proposed Rule Change Relating to 
Catastrophic Errors).
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    The Exchange believes that this proposal is consistent with those 
principles because it strikes the aforementioned balance. The Exchange 
is proposing to amend Rule 7170 to eliminate the risk associated with 
Public Customers receiving an adjustment to a trade that is outside of 
the limit price of their order, when there is a catastrophic error 
ruling respecting their trade. The new provision would continue to 
entail specific and objective procedures. Furthermore, the new 
provision more fairly balances the potential windfall to one market 
participant against the potential reconsideration of a trading decision 
under the guise of an error.
    The obvious and catastrophic error rules of the options exchanges 
are similar, especially with respect to only adjusting trades that 
result in a catastrophic error. Nevertheless, the Exchange believes, 
based on the aforementioned example, the recently approved Phlx filing, 
and Participant requests that this aspect of the catastrophic error 
process should change, as explained above. Relatedly, members of 
SIFMA's Options Committee also expressed concern during a recent 
meeting that this particular outcome may not be appropriate. 
Accordingly, the Exchange has determined to amend the rule.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \11\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \12\ in particular, in that it is designed to 
promote just and equitable principles of trade, 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, by helping Participants better manage the risk associated 
with potential erroneous trades. Specifically, the Exchange believes 
that the proposal is consistent with these principles because it 
provides a fair process for Public Customers to address catastrophic 
errors involving a limit order. In particular, the proposal still 
permits nullification in certain situations. Further, it gives Public 
Customers a choice. For two reasons, the Exchange does not believe that 
the proposal is unfairly

[[Page 27456]]

discriminatory, even though it offers some Participants (Public 
Customers) a choice as to whether a trade is nullified or adjusted, 
while other Participants (Broker-Dealers and Market Makers) will 
continue to have all of their catastrophic errors adjusted. First, the 
rule currently differentiates among Participants: the notification 
period to begin the obvious error process is different for Market 
Makers and non-Market Maker Options Participants, and whether a trade 
is adjusted or busted also differs.\13\ Second, options rules often 
treat Public Customers in a special way,\14\ recognizing that Public 
Customers are not necessarily immersed in the day-to-day trading of the 
markets, less likely to be watching trading activity in a particular 
option throughout the day and may have limited funds in their trading 
accounts. Accordingly, differentiating among Participant types by 
permitting Public Customers to have a choice as to whether to nullify a 
trade involving a catastrophic error is not unfairly discriminatory, 
because it is reasonable and fair to provide Public Customers with 
additional options to protect themselves against the consequences of 
obvious errors.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
    \13\ See Rule 7170(g)(1).
    \14\ For example, many options exchange priority rules treat 
Public Customers orders differently and some options exchanges only 
accept certain types of orders from Public Customers. Most options 
exchanges charge different fees for Public Customers.
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    The Exchange acknowledges that the proposal contains some 
uncertainty regarding whether a trade will be adjusted or nullified, 
depending on whether one of the parties is a Public Customer, because a 
person would not know, when entering into the trade, whether the other 
party is or is not a Public Customer. The Exchange believes that the 
proposal nevertheless promotes just and equitable principles of trade 
and protects investors and the public interest, because it eliminates a 
more serious uncertainty in the rule's operation today, which is price 
uncertainty. Today, a Public Customer's order can be adjusted to a 
significantly different price, as the examples above illustrate, which 
is more impactful than the possibility of nullification. Furthermore, 
there is uncertainty in the current obvious error portion of Rule 7170 
(as well as the rules of other options exchanges), which Participants 
have dealt with for a number of years. Specifically, Rule 7170(g)(2) 
provides that if it is determined that an Obvious Error has occurred: 
(A) where each party to the transaction is either a market maker on the 
Exchange, the execution price of the transaction will be adjusted by 
the MRC, unless both parties agree to nullify the transaction within 
ten minutes of being notified by the MRC of the Obvious Error; or (B) 
where at least one party to the transaction in which an Obvious Error 
occurred is not a market maker on the Exchange, the MRC will nullify 
the transaction, unless both parties agree to adjust the price of the 
transaction within 30 minutes of being notified by the MRC of the 
Obvious Error. Therefore, a market maker who prefers adjustments over 
nullification cannot guarantee that outcome, because, if he trades with 
a Public Customer, a resulting obvious error would only be adjusted if 
the Public Customer agreed to an adjustment. This uncertainty has been 
embedded in the rule and accepted by market participants. The Exchange 
believes that this proposal, despite the uncertainty based on whether a 
Public Customer is involved in a trade, is nevertheless consistent with 
the Act, because the ability to nullify a Public Customer's trade 
involving a catastrophic error should prevent the price uncertainty 
that mandatory adjustment under the current rule creates, which should 
promote just and equitable principles of trade and protect investors 
and the public interest.
    The proposal sets forth an objective process based on specific and 
objective criteria and subject to specific and objective procedures. In 
addition, the Exchange has again weighed carefully the need to assure 
that one market participant is not permitted to receive a windfall at 
the expense of another market participant that made a catastrophic 
error, against the need to assure that market participants are not 
simply being given an opportunity to reconsider poor trading decisions. 
Accordingly, the Exchange has determined that introducing a 
nullification procedure for catastrophic errors is appropriate and 
consistent with the Act.
    Consistent with Section 6(b)(8),\15\ the Exchange also believes 
that the proposal does not impose a burden on competition not necessary 
or appropriate in furtherance of the purposes of the Act, as described 
further below.
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    \15\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. In this regard and as indicated 
above, the Exchange notes that the rule change is being proposed as a 
competitive response to the filing submitted by Phlx.\16\ The Exchange 
believes this proposed rule change is necessary to permit fair 
competition among the options exchanges and to establish uniform rules 
regarding catastrophic errors. Currently, most options exchanges have 
similar, although not identical, rules regarding catastrophic errors. 
To the extent that this proposal would result in the Exchange's rule 
being different, market participants may choose to route orders to the 
Exchange, helping the Exchange compete against other options exchanges 
for order flow based on its Public Customers service by having a 
process more responsive to current market needs. The proposal does not 
impose a burden on intra-market competition not necessary or 
appropriate in furtherance of the purposes of the Act, because, even 
though it treats different market participants differently, the Obvious 
and Catastrophic Errors rule has always been structured that way and 
adding the ability for Public Customers to choose whether a 
catastrophic error trade is nullified does not materially alter the 
risks faced by other market participants in managing the consequences 
of obvious errors. Overall, the proposal is intended to help market 
participants better manage the risk associated with potential erroneous 
options trades and does not impose a burden on competition.
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    \16\ See supra, note 4.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange has neither solicited nor received comments on the 
proposed rule change.

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

    This proposed rule change does not significantly affect the 
protection of investors or the public interest, does not impose any 
significant burden on competition, and, by its terms, does not become 
operative for 30 days after the date of the filing, or such shorter 
time as the Commission may designate if consistent with the protection 
of investors and the public interest. The Exchange provided the 
Commission with written notice of its intent to file the proposed rule 
change, along with a brief description and text of the proposed rule 
change, prior to the date of filing the proposed rule change as

[[Page 27457]]

required by Rule 19b-4(f)(6).\17\ The proposed rule change is 
substantially similar in all material respects to a proposal submitted 
by Phlx that was recently approved by the Commission.\18\ The Exchange 
believes that this proposed rule change, which is essential for 
competitive purposes and to promote a free and open market for the 
benefit of investors, does not raise any new, unique or substantive 
issues from those raised in the Phlx filing.
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    \17\ 17 CFR 240.19b-4(f)(6).
    \18\ See supra, note 4.
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IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-BOX-2013-22 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-BOX-2013-22. 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-BOX-2013-22 and should be 
submitted on or before May 31, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
Kevin M. O'Neill,
Deputy Secretary.
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    \19\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2013-11140 Filed 5-9-13; 8:45 am]
BILLING CODE 8011-01-P


