
[Federal Register Volume 80, Number 92 (Wednesday, May 13, 2015)]
[Notices]
[Pages 27392-27408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-11485]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74900; File No. SR-C2-2015-012]


Self-Regulatory Organizations; C2 Options Exchange, Incorporated; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
Relating to the Nullification and Adjustment of Options Transactions 
Including Obvious Errors

May 7, 2015.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b 4 thereunder,\2\ notice is hereby given 
that on May 6, 2015, C2 Options Exchange, Incorporated (the 
``Exchange'' or ``C2'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I and II below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange seeks to amend Exchange rules related to the 
nullification and adjustment of options transactions including obvious 
errors. The text of the proposed rule change is available on the 
Exchange's Web site (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the 
Secretary, and at the Commission's Public Reference Room.

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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
Background
    For several months the Exchange has been working with other options 
exchanges to identify ways to improve the process related to the 
adjustment and nullification of erroneous options transactions. The 
goal of the process that the options exchanges have undertaken is to 
adopt harmonized rules related to the adjustment and nullification of 
erroneous options transactions as well as a specific provision related 
to coordination in connection with large-scale events involving 
erroneous options transactions. As described below, the Exchange 
believes that the changes the options exchanges and the Exchange have 
agreed to propose will provide transparency and finality with respect 
to the adjustment and nullification of erroneous options transactions. 
Particularly, the proposed changes seek to achieve consistent results 
for participants across U.S. options exchanges while maintaining a fair 
and orderly market, protecting investors and protecting the public 
interest.
    The Proposed Rule is the culmination of this coordinated effort and 
reflects discussions by the options exchanges to universally adopt: (1) 
Certain provisions already in place on one or more options exchanges; 
and (2) new provisions that the options exchanges collectively believe 
will improve the handling of erroneous options transactions. Thus, 
although the Proposed Rule is in many ways similar to and based on the 
Exchange's Current Rule, the Exchange is adopting various provisions to 
conform with existing rules of one or more options exchanges and also 
to adopt rules that are not currently in place on any options exchange. 
As noted above, in order to adopt a rule that is similar in most 
material respects to the rules adopted by other options exchanges, the 
Exchange proposes to delete the Current Rule in its entirety and to 
replace it with the Proposed Rule.
    The Exchange notes that it has proposed additional objective 
standards

[[Page 27393]]

in the Proposed Rule as compared to the Current Rule. The Exchange also 
notes that the Proposed Rule will ensure that the Exchange will have 
the same standards as all other options exchanges. However, there are 
still areas under the Proposed Rule where subjective determinations 
need to be made by Exchange personnel with respect to the calculation 
of Theoretical Price. The Exchange notes that the Exchange and all 
other options exchanges have been working to further improve the review 
of potentially erroneous transactions as well as their subsequent 
adjustment by creating an objective and universal way to determine 
Theoretical Price in the event a reliable NBBO is not available. For 
instance, the Exchange and all other options exchanges may utilize an 
independent third party to calculate and disseminate or make available 
Theoretical Price. However, this initiative requires additional 
exchange and industry discussion as well as additional time for 
development and implementation. The Exchange will continue to work with 
other options exchanges and the options industry towards the goal of 
additional objectivity and uniformity with respect to the calculation 
of Theoretical Price.
    As additional background, the Exchange believes that the Proposed 
Rule supports an approach consistent with long-standing principles in 
the options industry under which the general policy is to adjust rather 
than nullify transactions. The Exchange acknowledges that adjustment of 
transactions is contrary to the operation of analogous rules applicable 
to the equities markets, where erroneous transactions are typically 
nullified rather than adjusted and where there is no distinction 
between the types of market participants involved in a transaction. For 
the reasons set forth below, the Exchange believes that the 
distinctions in market structure between equities and options markets 
continue to support these distinctions between the rules for handling 
obvious errors in the equities and options markets. The Exchange also 
believes that the Proposed Rule properly balances several competing 
concerns based on the structure of the options markets.
    Various general structural differences between the options and 
equities markets point toward the need for a different balancing of 
risks for options market participants and are reflected in the Proposed 
Rule. Option pricing is formulaic and is tied to the price of the 
underlying stock, the volatility of the underlying security and other 
factors. Because options market participants can generally create new 
open interest in response to trading demand, as new open interest is 
created, correlated trades in the underlying or related series are 
generally also executed to hedge a market participant's risk. This 
pairing of open interest with hedging interest differentiates the 
options market specifically (and the derivatives markets broadly) from 
the cash equities markets. In turn, the Exchange believes that the 
hedging transactions engaged in by market participants necessitates 
protection of transactions through adjustments rather than 
nullifications when possible and otherwise appropriate.
    The options markets are also quote driven markets dependent on 
liquidity providers to an even greater extent than equities markets. In 
contrast to the approximately 7,000 different securities traded in the 
U.S. equities markets each day, there are more than 500,000 unique, 
regularly quoted option series. Given this breadth in options series 
the options markets are more dependent on liquidity providers than 
equities markets; such liquidity is provided most commonly by 
registered market makers but also by other professional traders. With 
the number of instruments in which registered market makers must quote 
and the risk attendant with quoting so many products simultaneously, 
the Exchange believes that those liquidity providers should be afforded 
a greater level of protection. In particular, the Exchange believes 
that liquidity providers should be allowed protection of their trades 
given the fact that they typically engage in hedging activity to 
protect them from significant financial risk to encourage continued 
liquidity provision and maintenance of the quote-driven options 
markets.
    In addition to the factors described above, there are other 
fundamental differences between options and equities markets which lend 
themselves to different treatment of different classes of participants 
that are reflected in the Proposed Rule. For example, there is no trade 
reporting facility in the options markets. Thus, all transactions must 
occur on an options exchange. This leads to significantly greater 
retail customer participation directly on exchanges than in the 
equities markets, where a significant amount of retail customer 
participation never reaches the Exchange but is instead executed in 
off-exchange venues such as alternative trading systems, broker-dealer 
market making desks and internalizers. In turn, because of such direct 
retail customer participation, the exchanges have taken steps to afford 
those retail customers--generally Priority Customers--more favorable 
treatment in some circumstances.
Definitions
    The Exchange proposes to adopt various definitions that will be 
used in the Proposed Rule, as described below.
    First, the Exchange proposes to adopt a definition of ``Customer,'' 
to make clear that this term would not include any broker-dealer, 
Professional Customer, or Voluntary Professional Customer.\3\ Although 
other portions of the Exchange's rules address the capacity of market 
participants, including customers, the proposed definition is 
consistent with such rules and the Exchange believes it is important 
for all options exchanges to have the same definition of Customer in 
the context of nullifying and adjusting trades in order to have 
harmonized rules. As set forth in detail below, orders on behalf of a 
Customer are in many cases treated differently than non-Customer orders 
in light of the fact that Customers are not necessarily immersed in the 
day-to-day trading of the markets, are less likely to be watching 
trading activity in a particular option throughout the day, and may 
have limited funds in their trading accounts.
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    \3\ A ``Professional'' is any person or entity that (i) is not a 
broker or dealer in securities; and (ii) places more than 390 orders 
in listed options per day on average during a calendar month for its 
own beneficial account(s). See Rule 1.1. A ``Voluntary 
Professional'' is any person or entity that is not a broker or 
dealer in securities that elects, in writing, to be treated in the 
same manner as a broker or dealer in securities for purposes of 
various C2 rules. See Rule 1.1.
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    Second, the Exchange proposes to adopt definitions for both an 
``erroneous sell transaction'' and an ``erroneous buy transaction.'' As 
proposed, an erroneous sell transaction is one in which the price 
received by the person selling the option is erroneously low, and an 
erroneous buy transaction is one in which the price paid by the person 
purchasing the option is erroneously high. This provision helps to 
reduce the possibility that a party can intentionally submit an order 
hoping for the market to move in their favor while knowing that the 
transaction will be nullified or adjusted if the market does not. For 
instance, when a market participant who is buying options in a 
particular series sees an aggressively priced sell order posted on the 
Exchange, and the buyer believes that the price of the options is such 
that it might qualify for obvious error, the option buyer can trade 
with the aggressively priced order, then wait to see which direction 
the market moves. If the market moves in their direction, the buyer 
keeps the trade and if it moves against them, the

[[Page 27394]]

buyer calls the Exchange hoping to get the trade adjusted or busted.
    Third, the Exchange proposes to adopt a definition of ``Official,'' 
which would mean an Officer of the Exchange or such other employee 
designee of the Exchange that is trained in the application of the 
Proposed Rule.
    Fourth, the Exchange proposes to adopt a new term, a ``Size 
Adjustment Modifier,'' which would apply to individual transactions and 
would modify the applicable adjustment for orders under certain 
circumstances, as discussed in further detail below. As proposed, the 
Size Adjustment Modifier will be applied to individual transactions as 
follows:

------------------------------------------------------------------------
   Number of contracts per execution        Adjustment--TP Plus/Minus
------------------------------------------------------------------------
1-50...................................  N/A.
51-250.................................  2 times adjustment amount.
251-1000...............................  2.5 times adjustment amount.
1001 or more...........................  3 times adjustment amount.
------------------------------------------------------------------------

    The Size Adjustment Modifier attempts to account for the additional 
risk that the parties to the trade undertake for transactions that are 
larger in scope. The Exchange believes that the Size Adjustment 
Modifier creates additional incentives to prevent more impactful 
Obvious Errors and it lessens the impact on the contra-party to an 
adjusted trade. The Exchange notes that these contra-parties may have 
preferred to only trade the size involved in the transaction at the 
price at which such trade occurred, and in trading larger size has 
committed a greater level of capital and bears a larger hedge risk.
    When setting the proposed size adjustment modifier thresholds the 
Exchange has tried to correlate the size breakpoints with typical small 
and larger ``block'' execution sizes of underlying stock. For instance, 
SEC Rule 10b-18(a)(5)(ii) defines a ``block'' as a quantity of stock 
that is at least 5,000 shares and a purchase price of at least $50,000, 
among others.\4\ Similarly, NYSE Rule 72 defines a ``block'' as an 
order to buy or sell ``at least 10,000 shares or a quantity of stock 
having a market value of $200,000 or more, whichever is less.'' Thus, 
executions of 51 to 100 option contracts, which are generally 
equivalent to executions of 5,100 and 10,000 shares of underlying 
stock, respectively, are proposed to be subject to the lowest size 
adjustment modifier. An execution of over 1,000 contracts is roughly 
equivalent to a block transaction of more than 100,000 shares of 
underlying stock, and is proposed to be subject to the highest size 
adjustment modifier. The Exchange has correlated the proposed size 
adjustment modifier thresholds to smaller and larger scale blocks 
because the Exchange believes that the execution cost associated with 
transacting in block sizes scales according to the size of the block. 
In other words, in the same way that executing a 100,000 share stock 
order will have a proportionately larger market impact and will have a 
higher overall execution cost than executing a 500, 1,000 or 5,000 
share order in the same stock, all other market factors being equal, 
executing a 1,000 option contract order will have a larger market 
impact and higher overall execution cost than executing a 5, 10 or 50 
contract option order.
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    \4\ See 17 CFR 240.10b-18(a)(5)(ii).
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Calculation of Theoretical Price
Theoretical Price in Normal Circumstances
    Under both the Current Rule and the Proposed Rule, when reviewing a 
transaction as potentially erroneous, the Exchange needs to first 
determine the ``Theoretical Price'' of the option, i.e., the Exchange's 
estimate of the correct market price for the option. Pursuant to the 
Proposed Rule, if the applicable option series is traded on at least 
one other options exchange, then the Theoretical Price of an option 
series is the last national best bid (``NBB'') just prior to the trade 
in question with respect to an erroneous sell transaction or the last 
national best offer (``NBO'') just prior to the trade in question with 
respect to an erroneous buy transaction unless one of the exceptions 
described below exists. Thus, the Exchange proposes that whenever the 
Exchange has a reliable NBB or NBO, as applicable, just prior to the 
transaction, then the Exchange will use this NBB or NBO as the 
Theoretical Price.
    The Exchange also proposes to specify in the Proposed Rule that 
when a single order received by the Exchange is executed at multiple 
price levels, the last NBB and last NBO just prior to the trade in 
question would be the last NBB and last NBO just prior to the 
Exchange's receipt of the order.
    The Exchange also proposes to set forth in the Proposed Rule 
various provisions governing specific situations where the NBB or NBO 
is not available or may not be reliable. Specifically, the Exchange is 
proposing additional detail specifying situations in which there are no 
quotes or no valid quotes (as defined below), when the national best 
bid or offer (``NBBO'') is determined to be too wide to be reliable, 
and at the open of trading on each trading day.
No Valid Quotes
    As is true under the Current Rule, pursuant to the Proposed Rule 
the Exchange will determine the Theoretical Price if there are no 
quotes or no valid quotes for comparison purposes. As proposed, quotes 
that are not valid are all quotes in the applicable option series 
published at a time where the last NBB is higher than the last NBO in 
such series (a ``crossed market''), quotes published by the Exchange 
that were submitted by either party to the transaction in question, and 
quotes published by another options exchange against which the Exchange 
has declared self-help. Thus, in addition to scenarios where there are 
literally no quotes to be used as Theoretical Price, the Exchange will 
exclude quotes in certain circumstances if such quotes are not deemed 
valid. The Proposed Rule is consistent with the Exchange's application 
of the Current Rule but the descriptions of the various scenarios where 
the Exchange considers quotes to be invalid represent additional detail 
that is not included in the Current Rule.
    The Exchange notes that Exchange personnel currently are required 
to determine Theoretical Price in certain circumstances. While the 
Exchange continues to pursue alternative solutions that might further 
enhance the objectivity and consistency of determining Theoretical 
Price, the Exchange believes that the discretion currently afforded to 
Exchange Officials is appropriate in the absence of a reliable NBBO 
that can be used to set the Theoretical Price. Under the Current Rule, 
Exchange personnel will generally consult and refer to data such as the 
prices of related series, especially the closest strikes in the option 
in question. Exchange personnel may also take into account the price of 
the underlying security and the volatility characteristics of the 
option as well as historical pricing of the option and/or similar 
options.
Wide Quotes
    Similarly, pursuant to the Proposed Rule the Exchange will 
determine the Theoretical Price if the bid/ask differential of the NBB 
and NBO for the affected series just prior to the erroneous transaction 
was equal to or greater than the Minimum Amount set forth below and 
there was a bid/ask differential less than the Minimum Amount during 
the 10 seconds prior to the transaction. If there was no bid/ask 
differential less than the Minimum Amount during the 10 seconds prior 
to

[[Page 27395]]

the transaction then the Theoretical Price of an option series is the 
last NBB or NBO just prior to the transaction in question. The Exchange 
proposes to use the following chart to determine whether a quote is too 
wide to be reliable:

------------------------------------------------------------------------
                                                               Minimum
                 Bid price at time of trade                     amount
------------------------------------------------------------------------
Below $2.00................................................        $0.75
$2.00 to $5.00.............................................         1.25
Above $5.00 to $10.00......................................         1.50
Above $10.00 to $20.00.....................................         2.50
Above $20.00 to $50.00.....................................         3.00
Above $50.00 to $100.00....................................         4.50
Above $100.00..............................................         6.00
------------------------------------------------------------------------

    The Exchange notes that the values set forth above generally 
represent a multiple of 3 times the bid/ask differential requirements 
of other options exchanges, with certain rounding applied (e.g., $1.25 
as proposed rather than $1.20).\5\ The Exchange believes that basing 
the Wide Quote table on a multiple of the permissible bid/ask 
differential rule provides a reasonable baseline for quotations that 
are indeed so wide that they cannot be considered reliable for purposes 
of determining Theoretical Price unless they have been consistently 
wide. As described above, while the Exchange will determine Theoretical 
Price when the bid/ask differential equals or exceeds the amount set 
forth in the chart above and within the previous 10 seconds there was a 
bid/ask differential smaller than such amount, if a quote has been 
persistently wide for at least 10 seconds the Exchange will use such 
quote for purposes of Theoretical Price. The Exchange believes that 
there should be a greater level of protection afforded to market 
participants that enter the market when there are liquidity gaps and 
price fluctuations. The Exchange does not believe that a similar level 
of protection is warranted when market participants choose to enter a 
market that is wide and has been consistently wide for some time. Given 
the largely electronic nature of today's markets, the Exchange believes 
the designated time frame is appropriate and is long enough for market 
participants to receive, process, and account for and respond to new 
market information. The table above bases the wide quote provision off 
of bid price in order to provide a relatively straightforward beginning 
point for the analysis.
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    \5\ See, e.g., NYSE Arca Options Rule 6.37(b)(1).
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    As an example, assume an option is quoted $3.00 by $6.00 with 50 
contracts posted on each side of the market for an extended period of 
time. If a market participant were to enter a market order to buy 20 
contracts the Exchange believes that the buyer should have a reasonable 
expectation of paying $6.00 for the contracts which they are buying. 
This should be the case even if immediately after the purchase of those 
options, the market conditions change and the same option is then 
quoted at $3.75 by $4.25. Although the quote was wide according to the 
table above at the time immediately prior to and the time of the 
execution of the market order, it was also well established and well 
known. The Exchange believes that an execution at the then prevailing 
market price should not in and of itself constitute an erroneous trade.
Transactions at the Open
    Under the Proposed Rule, for a transaction occurring as part of the 
Opening Process \6\ the Exchange will determine the Theoretical Price 
where there is no NBB or NBO for the affected series just prior to the 
erroneous transaction or if the bid/ask differential of the NBBO just 
prior to the erroneous transaction is equal to or greater than the 
Minimum Amount set forth in the chart proposed for the wide quote 
provision described above. The Exchange believes that this discretion 
is necessary because it is consistent with other scenarios in which the 
Exchange will determine the Theoretical Price if there are no quotes or 
no valid quotes for comparison purposes, including the wide quote 
provision proposed by the Exchange as described above. If, however, 
there are valid quotes and the bid/ask differential of the NBBO is less 
than the Minimum Amount set forth in the chart proposed for the wide 
quote provision described above, then the Exchange will use the NBB or 
NBO just prior to the transaction as it would in any other normal 
review scenario.
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    \6\ See Exchange Rule 6.11--Openings (and sometimes Closing) for 
a description of the Exchange's Opening Process.
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    As an example of an erroneous transaction for which the NBBO is 
wide at the open, assume the NBBO at the time of the opening 
transaction is $1.00 x $5.00 and the opening transaction takes place at 
$1.25. The Exchange would be responsible for determining the 
Theoretical Price because the NBBO was wider than the applicable 
minimum amount set forth in the wide quote provision as described 
above. The Exchange believes that it is necessary to determine 
Theoretical Price at the open in the event of a wide quote at the open 
for the same reason that the Exchange has proposed to determine 
Theoretical Price during the remainder of the trading day pursuant to 
the proposed wide quote provision, namely that a wide quote cannot be 
reliably used to determine Theoretical Price because the Exchange does 
not know which of the two quotes, the NBB or the NBO, is closer to the 
real value of the option.
Obvious Errors
    The Exchange proposes to adopt numerical thresholds that would 
qualify transactions as ``Obvious Errors.'' These thresholds are 
similar to those in place under the Current Rule. As proposed, a 
transaction will qualify as an Obvious Error if the Exchange receives a 
properly submitted filing and the execution price of a transaction is 
higher or lower than the Theoretical Price for the series by an amount 
equal to at least the amount shown below:

------------------------------------------------------------------------
                                                               Minimum
                     Theoretical price                          amount
------------------------------------------------------------------------
Below $2.00................................................        $0.25
$2.00 to $5.00.............................................         0.40
Above $5.00 to $10.00......................................         0.50
Above $10.00 to $20.00.....................................         0.80
Above $20.00 to $50.00.....................................         1.00
Above $50.00 to $100.00....................................         1.50
Above $100.00..............................................         2.00
------------------------------------------------------------------------

Applying the Theoretical Price, as described above, to determine the 
applicable threshold and comparing the Theoretical Price to the actual 
execution price provides the Exchange with an objective methodology to 
determine whether an Obvious Error occurred. The Exchange believes that 
the proposed amounts are reasonable as they are generally consistent 
with the standards of the Current Rule and reflect a significant 
disparity from Theoretical Price. The Exchange notes that the Minimum 
Amounts in the Proposed Rule and as set forth above are identical to 
the Current Rule except for the last two categories, for options where 
the Theoretical Price is above $50.00 to $100.00 and above $100.00. The 
Exchange believes that this additional granularity is reasonable 
because given the proliferation of additional strikes that have been 
created in the past several years there are many more high-priced 
options that are trading with open interest for extended periods. The 
Exchange believes that it is appropriate to account for these high-
priced options with additional Minimum Amount levels for options with 
Theoretical Prices above $50.00.
    Under the Proposed Rule, a party that believes that it participated 
in a transaction that was the result of an Obvious Error must notify 
the Exchange's Help Desk in the manner

[[Page 27396]]

specified from time to time by the Exchange in a circular distributed 
to Participants.
    The Exchange also proposes to adopt notification timeframes that 
must be met in order for a transaction to qualify as an Obvious Error. 
Specifically, as proposed a filing must be received by the Exchange 
within thirty (30) minutes of the execution with respect to an 
execution of a Customer order and within fifteen (15) minutes of the 
execution for any other participant. The Exchange also proposes to 
provide additional time for trades that are routed through other 
options exchanges to the Exchange. Under the Proposed Rule, any other 
options exchange will have a total of forty-five (45) minutes for 
Customer orders and thirty (30) minutes for non-Customer orders, 
measured from the time of execution on the Exchange, to file with the 
Exchange for review of transactions routed to the Exchange from that 
options exchange and executed on the Exchange (``linkage trades''). 
This includes filings on behalf of another options exchange filed by a 
third-party routing broker if such third-party broker identifies the 
affected transactions as linkage trades. In order to facilitate timely 
reviews of linkage trades the Exchange will accept filings from either 
the other options exchange or, if applicable, the third-party routing 
broker that routed the applicable order(s). The additional fifteen (15) 
minutes provided with respect to linkage trades shall only apply to the 
extent the options exchange that originally received and routed the 
order to the Exchange itself received a timely filing from the entering 
participant (i.e., within 30 minutes if a Customer order or 15 minutes 
if a non-Customer order). The Exchange believes that additional time 
for filings related to Customer orders is appropriate in light of the 
fact that Customers are not necessarily immersed in the day-to-day 
trading of the markets and are less likely to be watching trading 
activity in a particular option throughout the day. The Exchange 
believes that the additional time afforded to linkage trades is 
appropriate given the interconnected nature of the markets today and 
the practical difficulty that an end user may face in getting requests 
for review filed in a timely fashion when the transaction originated at 
a different exchange than where the error took place. Without this 
additional time the Exchange believes it would be common for a market 
participant to satisfy the filing deadline at the original exchange to 
which an order was routed but that requests for review of executions 
from orders routed to other options exchanges would not qualify for 
review as potential Obvious Errors by the time filings were received by 
such other options exchanges, in turn leading to potentially disparate 
results under the applicable rules of options exchanges to which the 
orders were routed.
    Pursuant to the Proposed Rule, an Official may review a transaction 
believed to be erroneous on his/her own motion in the interest of 
maintaining a fair and orderly market and for the protection of 
investors. This proposed provision is designed to give an Official the 
ability to provide parties relief in those situations where they have 
failed to report an apparent error within the established notification 
period. A transaction reviewed pursuant to the proposed provision may 
be nullified or adjusted only if it is determined by the Official that 
the transaction is erroneous in accordance with the provisions of the 
Proposed Rule, provided that the time deadlines for filing a request 
for review described above shall not apply. The Proposed Rule would 
require the Official to act as soon as possible after becoming aware of 
the transaction; action by the Official would ordinarily be expected on 
the same day that the transaction occurred. However, because a 
transaction under review may have occurred near the close of trading or 
due to unusual circumstances, the Proposed Rule provides that the 
Official shall act no later than 7:30 a.m. Central Time on the next 
trading day following the date of the transaction in question.
    The Exchange also proposes to state that a party affected by a 
determination to nullify or adjust a transaction after an Official's 
review on his or her own motion may appeal such determination in 
accordance with paragraph (m), which is described below, but may not 
seek a review by an Obvious Error Panel under paragraph (k). The 
Proposed Rule would make clear that a determination by an Official not 
to review a transaction or determination not to nullify or adjust a 
transaction for which a review was conducted on an Official's own 
motion is not appealable and further that if a transaction is reviewed 
and a determination is rendered pursuant to another provision of the 
Proposed Rule, no additional relief may be granted by an Official.
    If it is determined that an Obvious Error has occurred based on the 
objective numeric criteria and time deadlines described above, the 
Exchange will adjust or nullify the transaction as described below and 
promptly notify both parties to the trade electronically or via 
telephone. The Exchange proposes different adjustment and nullification 
criteria for Customers and non-Customers.
    As proposed, where neither party to the transaction is a Customer, 
the execution price of the transaction will be adjusted by the Official 
pursuant to the table below.

------------------------------------------------------------------------
                                     Buy transaction    Sell transaction
      Theoretical price  (TP)        adjustment-- TP    adjustment-- TP
                                           Plus              Minus
------------------------------------------------------------------------
Below $3.00.......................              $0.15              $0.15
At or above $3.00.................              $0.30              $0.30
------------------------------------------------------------------------

    The Exchange believes that it is appropriate to adjust to prices a 
specified amount away from Theoretical Price rather than to adjust to 
Theoretical Price because even though the Exchange has determined a 
given trade to be erroneous in nature, the parties in question should 
have had some expectation of execution at the price or prices 
submitted. Also, it is common that by the time it is determined that an 
obvious error has occurred additional hedging and trading activity has 
already occurred based on the executions that previously happened. The 
Exchange is concerned that an adjustment to Theoretical Price in all 
cases would not appropriately incentivize market participants to 
maintain appropriate controls to avoid potential errors.
    Further, as proposed any non-Customer Obvious Error exceeding 50 
contracts will be subject to the Size Adjustment Modifier described 
above. The Exchange believes that it is appropriate to apply the Size 
Adjustment Modifier to non-Customer orders because the hedging cost 
associated with trading larger sized options orders and the market 
impact of larger blocks of underlying can be significant.

[[Page 27397]]

    As an example of the application of the Size Adjustment Modifier, 
assume Exchange A has a quoted bid to buy 50 contracts at $2.50, 
Exchange B has a quoted bid to buy 100 contracts at $2.05 and there is 
no other options exchange quoting a bid priced higher than $2.00. 
Assume that the NBBO is $2.50 by $3.00. Finally, assume that all orders 
quoted and submitted to Exchange B in connection with this example are 
non-Customer orders.
     Assume Exchange A's quoted bid at $2.50 is either executed 
or cancelled.
     Assume Exchange B immediately thereafter receives an 
incoming market order to sell 100 contracts.
     The incoming order would be executed against Exchange B's 
resting bid at $2.05 for 100 contracts.
     Because the 100 contract execution of the incoming sell 
order was priced at $2.05, which is $0.45 below the Theoretical Price 
of $2.50, the 100 contract execution would qualify for adjustment as an 
Obvious Error.
     The normal adjustment process would adjust the execution 
of the 100 contracts to $2.35 per contract, which is the Theoretical 
Price minus $0.15.
     However, because the execution would qualify for the Size 
Adjustment Modifier of 2 times the adjustment price, the adjusted 
transaction would instead be to $2.20 per contract, which is the 
Theoretical Price minus $0.30.
    By reference to the example above, the Exchange reiterates that it 
believes that a Size Adjustment Modifier is appropriate, as the buyer 
in this example was originally willing to buy 100 contracts at $2.05 
and ended up paying $2.20 per contract for such execution. Without the 
Size Adjustment Modifier the buyer would have paid $2.35 per contract. 
Such buyer may be advantaged by the trade if the Theoretical Price is 
indeed closer to $2.50 per contract, however the buyer may not have 
wanted to buy so many contracts at a higher price and does incur 
increasing cost and risk due to the additional size of their quote. 
Thus, the proposed rule is attempting to strike a balance between 
various competing objectives, including recognition of cost and risk 
incurred in quoting larger size and incentivizing market participants 
to maintain appropriate controls to avoid errors.
    In contrast to non-Customer orders, where trades will be adjusted 
if they qualify as Obvious Errors, pursuant the Proposed Rule a trade 
that qualifies as an Obvious Error will be nullified where at least one 
party to the Obvious Error is a Customer. The Exchange also proposes, 
however, that if any Participant submits requests to the Exchange for 
review of transactions pursuant to the Proposed Rule, and in aggregate 
that Participant has 200 or more Customer transactions under review 
concurrently and the orders resulting in such transactions were 
submitted during the course of 2 minutes or less, where at least one 
party to the Obvious Error is a non-Customer, the Exchange will apply 
the non-Customer adjustment criteria described above to such 
transactions. The Exchange based its proposal of 200 transactions on 
the fact that the proposed level is reasonable as it is representative 
of an extremely large number of orders submitted to the Exchange that 
are, in turn, possibly erroneous. Similarly, the Exchange based its 
proposal of orders received in 2 minutes or less on the fact that this 
is a very short amount of time under which one Participant could 
generate multiple erroneous transactions. In order for a participant to 
have more than 200 transactions under review concurrently when the 
orders triggering such transactions were received in 2 minutes or less, 
the market participant will have far exceeded the normal behavior of 
customers deserving protected status.\7\ While the Exchange continues 
to believe that it is appropriate to nullify transactions in such a 
circumstance if both participants to a transaction are Customers, the 
Exchange does not believe it is appropriate to place the overall risk 
of a significant number of trade breaks on non-Customers that in the 
normal course of business may have engaged in additional hedging 
activity or trading activity based on such transactions. Thus, the 
Exchange believes it is necessary and appropriate to protect non-
Customers in such a circumstance by applying the non-Customer 
adjustment criteria, and thus adjusting transactions as set forth 
above, in the event a Participant has more than 200 transactions under 
review concurrently.
---------------------------------------------------------------------------

    \7\ The Exchange notes that in the third quarter of this year 
across all options exchanges the average number of valid Customer 
orders received and executed was less than 38 valid orders every two 
minutes. The number of obvious errors resulting from valid orders 
is, of course, a very small fraction of such orders.
---------------------------------------------------------------------------

Catastrophic Errors
    Consistent with the Current Rule, the Exchange proposes to adopt 
separate numerical thresholds for review of transactions for which the 
Exchange does not receive a filing requesting review within the Obvious 
Error timeframes set forth above. Based on this review these 
transactions may qualify as ``Catastrophic Errors.'' As proposed, a 
Catastrophic Error will be deemed to have occurred when the execution 
price of a transaction is higher or lower than the Theoretical Price 
for the series by an amount equal to at least the amount shown below:

------------------------------------------------------------------------
                                                               Minimum
                     Theoretical price                          amount
------------------------------------------------------------------------
Below $2.00................................................        $0.50
$2.00 to $5.00.............................................         1.00
Above $5.00 to $10.00......................................         1.50
Above $10.00 to $20.00.....................................         2.00
Above $20.00 to $50.00.....................................         2.50
Above $50.00 to $100.00....................................         3.00
Above $100.00..............................................         4.00
------------------------------------------------------------------------

    Based on industry feedback on the Catastrophic Error thresholds set 
forth under the Current Rule, the thresholds proposed as set forth 
above are more granular and lower (i.e., more likely to qualify) than 
the thresholds under the Current Rule. As noted above, under the 
Proposed Rule as well as the Current Rule, parties have additional time 
to submit transactions for review as Catastrophic Errors. As proposed, 
notification requesting review must be received by the Exchange's Help 
Desk by 7:30 a.m. Central Time on the first trading day following the 
execution. For transactions in an expiring options series that take 
place on an expiration day, a party must notify the Exchange's Help 
Desk within 45 minutes after the close of trading that same day. As is 
true for requests for review under the Obvious Error provision of the 
Proposed Rule, a party requesting review of a transaction as a 
Catastrophic Error must notify the Exchange's Help Desk in the manner 
specified from time to time by the Exchange in a circular distributed 
to Participants. By definition, any execution that qualifies as a 
Catastrophic Error is also an Obvious Error. However, the Exchange 
believes it is appropriate to maintain these two types of errors 
because the Catastrophic Error provisions provide market participants 
with a longer notification period under which they may file a request 
for review with the Exchange of a potential Catastrophic Error than a 
potential Obvious Error. This provides an additional level of 
protection for transactions that are severely erroneous even in the 
event a participant does not submit a request for review in a timely 
fashion.
    The Proposed Rule would specify that relief under the catastrophic 
error provision would not be granted under paragraph (d) if an Obvious 
Error Panel has previously rendered a decision with respect to the 
transaction(s) in question. In addition, if it is determined that a 
Catastrophic Error has not occurred, the

[[Page 27398]]

Participant will be subject to a charge of $5,000. The Proposed Rule 
also specifies the action to be taken by the Exchange if it is 
determined that a Catastrophic Error has occurred, as described below, 
and would require the Exchange to promptly notify both parties to the 
trade electronically or via telephone. In the event of a Catastrophic 
Error, the execution price of the transaction will be adjusted by the 
Official pursuant to the table below.

------------------------------------------------------------------------
                                     Buy transaction    Sell transaction
      Theoretical price  (TP)        adjustment-- TP    adjustment-- TP
                                           Plus              Minus
------------------------------------------------------------------------
Below $2.00.......................              $0.50              $0.50
$2.00 to $5.00....................               1.00               1.00
Above $5.00 to $10.00.............               1.50               1.50
Above $10.00 to $20.00............               2.00               2.00
Above $20.00 to $50.00............               2.50               2.50
Above $50.00 to $100.00...........               3.00               3.00
Above $100.00.....................               4.00               4.00
------------------------------------------------------------------------

    Although Customer orders would be adjusted in the same manner as 
non-Customer orders, any Customer order that qualifies as a 
Catastrophic Error will be nullified if the adjustment would result in 
an execution price higher (for buy transactions) or lower (for sell 
transactions) than the Customer's limit price. Based on industry 
feedback, the levels proposed above with respect to adjustment amounts 
are the same levels as the thresholds at which a transaction may be 
deemed a Catastrophic Error pursuant to the chart set forth above.
    As is true for Obvious Errors as described above, the Exchange 
believes that it is appropriate to adjust to prices a specified amount 
away from Theoretical Price rather than to adjust to Theoretical Price 
because even though the Exchange has determined a given trade to be 
erroneous in nature, the parties in question should have had some 
expectation of execution at the price or prices submitted. Also, it is 
common that by the time it is determined that a Catastrophic Error has 
occurred additional hedging and trading activity has already occurred 
based on the executions that previously happened. The Exchange is 
concerned that an adjustment to Theoretical Price in all cases would 
not appropriately incentivize market participants to maintain 
appropriate controls to avoid potential errors. Further, the Exchange 
believes it is appropriate to maintain a higher adjustment level for 
Catastrophic Errors than Obvious Errors given the significant 
additional time that can potentially pass before an adjustment is 
requested and applied and the amount of hedging and trading activity 
that can occur based on the executions at issue during such time. For 
the same reasons, other than honoring the limit prices established for 
Customer orders, the Exchange has proposed to treat all market 
participants the same in the context of the Catastrophic Error 
provision. Specifically, the Exchange believes that treating market 
participants the same in this context will provide additional certainty 
to market participants with respect to their potential exposure and 
hedging activities, including comfort that even if a transaction is 
later adjusted (i.e., past the standard time limit for filing under the 
Obvious Error provision), such transaction will not be fully nullified. 
However, as noted above, under the Proposed Rule where at least one 
party to the transaction is a Customer, the trade will be nullified if 
the adjustment would result in an execution price higher (for buy 
transactions) or lower (for sell transactions) than the Customer's 
limit price. The Exchange has retained the protection of a Customer's 
limit price in order to avoid a situation where the adjustment could be 
to a price that the Customer could not afford, which is less likely to 
be an issue for a market professional.
Significant Market Events
    In order to improve consistency for market participants in the case 
of a widespread market event and in light of the interconnected nature 
of the options exchanges, the Exchange proposes to adopt a new 
provision that calls for coordination between the options exchanges in 
certain circumstances and provides limited flexibility in the 
application of other provisions of the Proposed Rule in order to 
promptly respond to a widespread market event.\8\ The Exchange proposes 
to describe such an event as a Significant Market Event, and to set 
forth certain objective criteria that will determine whether such an 
event has occurred. The Exchange developed these objective criteria in 
consultation with the other options exchanges by reference to 
historical patterns and events with a goal of setting thresholds that 
very rarely will be triggered so as to limit the application of the 
provision to truly significant market events. As proposed, a 
Significant Market Event will be deemed to have occurred when proposed 
criterion (A) below is met or exceeded or the sum of all applicable 
event statistics, where each is expressed as a percentage of the 
relevant threshold in criteria (A) through (D) below, is greater than 
or equal to 150% and 75% or more of at least one category is reached, 
provided that no single category can contribute more than 100% to the 
sum. All criteria set forth below will be measured in aggregate across 
all exchanges.
---------------------------------------------------------------------------

    \8\ Although the Exchange has proposed a specific provision 
related to coordination amongst options exchanges in the context of 
a widespread event, the Exchange does not believe that the 
Significant Market Event provision or any other provision of the 
proposed rule alters the Exchange's ability to coordinate with other 
options exchanges in the normal course of business with respect to 
market events or activity. The Exchange does already coordinate with 
other options exchanges to the extent possible if such coordination 
is necessary to maintain a fair and orderly market and/or to fulfill 
the Exchange's duties as a self-regulatory organization.
---------------------------------------------------------------------------

    The proposed criteria for determining a Significant Market Event 
are as follows:
    (A) Transactions that are potentially erroneous would result in a 
total Worst-Case Adjustment Penalty of $30,000,000, where the Worst-
Case Adjustment Penalty is computed as the sum, across all potentially 
erroneous trades, of: (i) $0.30 (i.e., the largest Transaction 
Adjustment value listed in sub-paragraph (e)(3)(A) below); times; (ii) 
the contract multiplier for each traded contract; times (iii) the 
number of contracts for each trade; times (iv) the appropriate Size 
Adjustment Modifier for each trade, if any, as defined in sub-paragraph 
(e)(3)(A) below;
    (B) Transactions involving 500,000 options contracts are 
potentially erroneous;
    (C) Transactions with a notional value (i.e., number of contracts 
traded multiplied by the option premium

[[Page 27399]]

multiplied by the contract multiplier) of $100,000,000 are potentially 
erroneous;
    (D) 10,000 transactions are potentially erroneous.
    As described above, the Exchange proposes to adopt a the Worst Case 
Adjustment Penalty, proposed as criterion (A), which is the only 
criterion that can on its own result in an event being designated as a 
significant market event. The Worst Case Adjustment Penalty is intended 
to develop an objective criterion that can be quickly determined by the 
Exchange in consultation with other options exchanges that approximates 
the total overall exposure to market participants on the negatively 
impacted side of each transaction that occurs during an event. If the 
Worst Case Adjustment criterion is equal to or exceeds $30,000,000, 
then an event is a Significant Market Event. As an example of the Worst 
Case Adjustment Penalty, assume that a single potentially erroneous 
transaction in an event is as follows: sale of 100 contracts of a 
standard option (i.e., an option with a 100 share multiplier). The 
highest potential adjustment penalty for this single transaction would 
be $6,000, which would be calculated as $0.30 times 100 (contract 
multiplier) times 100 (number of contracts) times 2 (applicable Size 
Adjustment Modifier). The Exchange would calculate the highest 
potential adjustment penalty for each of the potentially erroneous 
transactions in the event and the Worst Case Adjustment Penalty would 
be the sum of such penalties on the Exchange and all other options 
exchanges with affected transactions.
    As described above, under the Proposed Rule if the Worst Case 
Adjustment Penalty does not equal or exceed $30,000,000, then a 
Significant Market Event has occurred if the sum of all applicable 
event statistics (expressed as a percentage of the relevant 
thresholds), is greater than or equal to 150% and 75% or more of at 
least one category is reached. The Proposed Rule further provides that 
no single category can contribute more than 100% to the sum. As an 
example of the application of this provision, assume that in a given 
event across all options exchanges that: (A) The Worst Case Adjustment 
Penalty is $12,000,000 (40% of $30,000,000), (B) 300,000 options 
contracts are potentially erroneous (60% of 500,000), (C) the notional 
value of potentially erroneous transactions is $30,000,000 (30% of 
$100,000,000), and (D) 12,000 transactions are potentially erroneous 
(120% of 10,000). This event would qualify as a Significant Market 
Event because the sum of all applicable event statistics would be 230%, 
far exceeding the 150% threshold. The 230% sum is reached by adding 
40%, 60%, 30% and last, 100% (i.e., rounded down from 120%) for the 
number of transactions. The Exchange notes that no single category can 
contribute more than 100% to the sum and any category contributing more 
than 100% will be rounded down to 100%.
    As an alternative example, assume a large-scale event occurs 
involving low-priced options with a small number of contracts in each 
execution. Assume in this event across all options exchanges that: (A) 
The Worst Case Adjustment Penalty is $600,000 (2% of $30,000,000), (B) 
20,000 options contracts are potentially erroneous (4% of 500,000), (C) 
the notional value of potentially erroneous transactions is $20,000,000 
(20% of $100,000,000), and (D) 20,000 transactions are potentially 
erroneous (200% of 10,000, but rounded down to 100%). This event would 
not qualify as a Significant Market Event because the sum of all 
applicable event statistics would be 126%, below the 150% threshold. 
The Exchange reiterates that as proposed, even when a single category 
other than criterion (A) is fully met, that does not necessarily 
qualify an event as a Significant Market Event.
    The Exchange believes that the breadth and scope of the obvious 
error rules are appropriate and sufficient for handling of typical and 
common obvious errors. Coordination between and among the exchanges 
should generally not be necessary even when a Participant has an error 
that results in executions on more than one exchange. In setting the 
thresholds above the Exchange believes that the requirements will be 
met only when truly widespread and significant errors happen and the 
benefits of coordination and information sharing far outweigh the costs 
of the logistics of additional intra-exchange coordination. The 
Exchange notes that in addition to its belief that the proposed 
thresholds are sufficiently high, the Exchange has proposed the 
requirement that either criterion (A) is met or the sum of applicable 
event statistics for proposed (A) through (D) equals or exceeds 150% in 
order to ensure that an event is sufficiently large but also to avoid 
situations where an event is extremely large but just misses potential 
qualifying thresholds. For instance, the proposal is designed to help 
avoid a situation where the Worst Case Adjustment Penalty is 
$15,000,000, so the event does not qualify based on criterion (A) 
alone, but there are transactions in 490,000 options contracts that are 
potentially erroneous (missing criterion (B) by 10,000 contracts), 
there transactions with a notional value of $99,000,000 (missing 
criterion (C) by $1,000,000), and there are 9,000 potentially erroneous 
transactions overall (missing criterion (D) by 1,000 transactions). The 
Exchange believes that the proposed formula, while slightly more 
complicated than simply requiring a certain threshold to be met in each 
category, may help to avoid inapplicability of the proposed provisions 
in the context of an event that would be deemed significant by most 
subjective measures but that barely misses each of the objective 
criteria proposed by the Exchange.
    To ensure consistent application across options exchanges, in the 
event of a suspected Significant Market Event, the Exchange shall 
initiate a coordinated review of potentially erroneous transactions 
with all other affected options exchanges to determine the full scope 
of the event. Under the Proposed Rule, the Exchange will promptly 
coordinate with the other options exchanges to determine the 
appropriate review period as well as select one or more specific points 
in time prior to the transactions in question and use one or more 
specific points in time to determine Theoretical Price. Other than the 
selected points in time, if applicable, the Exchange will determine 
Theoretical Price as described above. For example, around the start of 
a SME that is triggered by a large and aggressively priced buy order, 
three exchanges have multiple orders on the offer side of the market: 
Exchange A has offers priced at $2.20, $2.25, $2.30 and several other 
price levels to $3.00, Exchange B has offers at $2.45, $2.30 and 
several other price levels to $3.00, Exchange C has offers at price 
levels between $2.50 and $3.00. Assume an event occurs starting at 
9:05:25 a.m. CT and in this particular series the executions begin on 
Exchange A and subsequently begin to occur on Exchanges B and C. 
Without coordination and information sharing between the exchanges, 
Exchange B and Exchange C cannot know with certainty that whether or 
not the execution at Exchange A that happened at $2.20 immediately 
prior to their executions at $2.45 and $2.50 is part of the same 
erroneous event or not. With proper coordination, the exchanges can 
determine that in this series, the proper point in time from which the 
event should be analyzed is 9:05:25 a.m. CT, and thus, the NBO of $2.20 
should be used as the Theoretical Price for purposes of all buy 
transactions in such

[[Page 27400]]

options series that occurred during the event.
    If it is determined that a Significant Market Event has occurred 
then, using the parameters agreed with respect to the times from which 
Theoretical Price will be calculated, if applicable, an Official will 
determine whether any or all transactions under review qualify as 
Obvious Errors. The Proposed Rule would require the Exchange to use the 
criteria in Proposed Rule 6.15(c), as described above, to determine 
whether an Obvious Error has occurred for each transaction that was 
part of the Significant Market Event. Upon taking any final action, the 
Exchange would be required to promptly notify both parties to the trade 
electronically or via telephone.
    The execution price of each affected transaction will be adjusted 
by an Official to the price provided below, unless both parties agree 
to adjust the transaction to a different price or agree to bust the 
trade.

------------------------------------------------------------------------
                                     Buy transaction    Sell transaction
      Theoretical price  (TP)        adjustment-- TP    adjustment-- TP
                                           Plus              Minus
------------------------------------------------------------------------
Below $3.00.......................              $0.15              $0.15
At or above $3.00.................              $0.30              $0.30
------------------------------------------------------------------------

    Thus, the proposed adjustment criteria for Significant Market 
Events are identical to the proposed adjustment levels for Obvious 
Errors generally. In addition, in the context of a Significant Market 
Event, any error exceeding 50 contracts will be subject to the Size 
Adjustment Modifier described above. Also, the adjustment criteria 
would apply equally to all market participants (i.e., Customers and 
non-Customers) in a Significant Market Event. However, as is true for 
the proposal with respect to Catastrophic Errors, under the Proposed 
Rule where at least one party to the transaction is a Customer, the 
trade will be nullified if the adjustment would result in an execution 
price higher (for buy transactions) or lower (for sell transactions) 
than the Customer's limit price. The Exchange has retained the 
protection of a Customer's limit price in order to avoid a situation 
where the adjustment could be to a price that the Customer could not 
afford, which is less likely to be an issue for a market professional. 
The Exchange has otherwise proposed to treat all market participants 
the same in the context of a Significant Market Event to provide 
additional certainty to market participants with respect to their 
potential exposure as soon as an event has occurred.
    Another significant distinction between the proposed Obvious Error 
provision and the proposed Significant Market Event provision is that 
if the Exchange, in consultation with other options exchanges, 
determines that timely adjustment is not feasible due to the 
extraordinary nature of the situation, then the Exchange will nullify 
some or all transactions arising out of the Significant Market Event 
during the review period selected by the Exchange and other options 
exchanges. To the extent the Exchange, in consultation with other 
options exchanges, determines to nullify less than all transactions 
arising out of the Significant Market Event, those transactions subject 
to nullification will be selected based upon objective criteria with a 
view toward maintaining a fair and orderly market and the protection of 
investors and the public interest. For example, assume a Significant 
Market Event causes 25,000 potentially erroneous transactions and 
impacts 51 options classes. Of the 25,000 transactions, 24,000 of them 
are concentrated in a single options class. The exchanges may decide 
the most appropriate solution because it will provide the most 
certainty to participants and allow for the prompt resumption of 
regular trading is to bust all trades in the most heavily affected 
class between two specific points in time, while the other 1,000 trades 
across the other 50 classes are reviewed and adjusted as appropriate. A 
similar situation might arise directionally where a Customer submits 
both erroneous buy and sell orders and the number of errors that 
happened that were erroneously low priced (i.e., erroneous sell orders) 
were 50,000 in number but the number of errors that were erroneously 
high (i.e., erroneous buy orders) were only 500 in number. The most 
effective and efficient approach that provides the most certainty to 
the marketplace in a reasonable amount of time while most closely 
following the generally prescribed obvious error rules could be to bust 
all of the erroneous sell transactions but to adjust the erroneous buy 
transactions.
    With respect to rulings made pursuant to the proposed Significant 
Market Event provision the Exchange believes that the number of 
affected transactions is such that immediate finality is necessary to 
maintain a fair and orderly market and to protect investors and the 
public interest. Accordingly, rulings by the Exchange pursuant to the 
Significant Market Event provision would be non-appealable pursuant to 
the Proposed Rule.
Additional Provisions
Mutual Agreement
    In addition to the objective criteria described above, the Proposed 
Rule also proposes to make clear that the determination as to whether a 
trade was executed at an erroneous price may be made by mutual 
agreement of the affected parties to a particular transaction. The 
Proposed Rule would state that a trade may be nullified or adjusted on 
the terms that all parties to a particular transaction agree, provided, 
however, that such agreement to nullify or adjust must be conveyed to 
the Exchange in a manner prescribed by the Exchange prior to 7:30 a.m. 
Central Time on the first trading day following the execution.
    The Exchange also proposes to explicitly state that it is 
considered conduct inconsistent with just and equitable principles of 
trade for any Participant to use the mutual adjustment process to 
circumvent any applicable Exchange rule, the Act or any of the rules 
and regulations thereunder. Thus, for instance, a Participant is 
precluded from seeking to avoid applicable trade-through rules by 
executing a transaction and then adjusting such transaction to a price 
at which the Exchange would not have allowed it to execute at the time 
of the execution because it traded through the quotation of another 
options exchange. The Exchange notes that in connection with its 
obligations as a self-regulatory organization, the Exchange's 
Regulatory Department reviews adjustments to transactions to detect 
potential violations of Exchange rules or the Act and the rules and 
regulations thereunder.
Trading Halts
    Exchange Rule 6.32 describes the Exchange's authority to declare 
trading

[[Page 27401]]

halts in one or more options traded on the Exchange. The Exchange 
proposes to make clear in the Proposed Rule that it will nullify any 
transaction that occurs during a trading halt in the affected option on 
the Exchange pursuant to Rule 6.32. If any trades occur notwithstanding 
a trading halt then the Exchange believes it appropriate to nullify 
such transactions. While the Exchange may halt options trading for 
various reasons, such a scenario almost certainly is due to 
extraordinary circumstances and is potentially the result of market-
wide coordination to halt options trading or trading generally. 
Accordingly, the Exchange does not believe it is appropriate to allow 
trades to stand if such trades should not have occurred in the first 
place.
    The Exchange proposes to add Interpretation and Policy .05 to Rule 
6.32. The Interpretation and Policy will also state that the Exchange 
shall nullify any transaction that occurs: (a) During a trading halt in 
the affected option on the Exchange; or (b) with respect to equity 
options (including options overlying ETFs), during a regulatory halt as 
declared by the primary listing market for the underlying security.
Erroneous Print and Quotes in Underlying Security
    Market participants on the Exchange likely base the pricing of 
their orders submitted to the Exchange on the price of the underlying 
security for the option. Thus, the Exchange believes it is appropriate 
to adopt provisions that allow adjustment or nullification of 
transactions based on erroneous prints or erroneous quotes in the 
underlying security.
    The Exchange proposes to adopt language in the Proposed Rule 
stating that a trade resulting from an erroneous print(s) disseminated 
by the underlying market that is later nullified by that underlying 
market shall be adjusted or busted as set forth in the Obvious Error 
provisions of the Proposed Rule, provided a party notifies the 
Exchange's Help Desk in a timely manner, as further described below. 
The Exchange proposes to define a trade resulting from an erroneous 
print(s) as any options trade executed during a period of time for 
which one or more executions in the underlying security are nullified 
and for one second thereafter. The Exchange believes that one second is 
an appropriate amount of time in which an options trade would be 
directly based on executions in the underlying equity security. The 
Exchange also proposes to require that if a party believes that it 
participated in an erroneous transaction resulting from an erroneous 
print(s) pursuant to the proposed erroneous print provision it must 
notify the Exchange's Help Desk within the timeframes set forth in the 
Obvious Error provision described above. The Exchange has also proposed 
to state that the allowed notification timeframe commences at the time 
of notification by the underlying market(s) of nullification of 
transactions in the underlying security. Further, the Exchange proposes 
that if multiple underlying markets nullify trades in the underlying 
security, the allowed notification timeframe will commence at the time 
of the first market's notification.
    As an example of a situation in which a trade results from an 
erroneous print disseminated by the underlying market that is later 
nullified by the underlying market, assume that a given underlying is 
trading in the $49.00-$50.00 price range then has an erroneous print at 
$5.00. Given that there is the potential perception that the underlying 
has gone through a dramatic price revaluation, numerous options trades 
could promptly trigger based off of this new price. However, because 
the price that triggered them was not a valid price it would be 
appropriate to review said option trades when the underlying print that 
triggered them is removed.
    The Exchange also proposes to add a provision stating that a trade 
resulting from an erroneous quote(s) in the underlying security shall 
be adjusted or busted as set forth in the Obvious Error provisions of 
the Proposed Rule, provided a party notifies the Exchange's Help Desk 
in a timely manner, as further described below. Pursuant to the 
Proposed Rule, an erroneous quote occurs when the underlying security 
has a width of at least $1.00 and has a width at least five times 
greater than the average quote width for such underlying security 
during the time period encompassing two minutes before and after the 
dissemination of such quote. For purposes of the Proposed Rule, the 
average quote width will be determined by adding the quote widths of 
sample quotations at regular 15-second intervals during the four-minute 
time period referenced above (excluding the quote(s) in question) and 
dividing by the number of quotes during such time period (excluding the 
quote(s) in question).\9\ Similar to the proposal with respect to 
erroneous prints described above, if a party believes that it 
participated in an erroneous transaction resulting from an erroneous 
quote(s) it must notify the Exchange's Help Desk in accordance with the 
notification provisions of the Obvious Error provision described above. 
The Proposed Rule, therefore, puts the onus on each Participant to 
notify the Exchange if such Participant believes that a trade should be 
reviewed pursuant to either of the proposed provisions, as the Exchange 
is not in position to determine the impact of erroneous prints or 
quotes on individual Participants. The Exchange notes that it does not 
believe that additional time is necessary with respect to a trade based 
on an erroneous quote because a Participant has all information 
necessary to detect the error at the time of an option transaction that 
was triggered by an erroneous quote, which is in contrast to the 
proposed erroneous print provision that includes a dependency on an 
action by the market where the underlying security traded.
---------------------------------------------------------------------------

    \9\ The Exchange has proposed the price and time parameters for 
quote width and average quote width used to determine whether an 
erroneous quote has occurred based on established rules of options 
exchanges that currently apply such parameters. See, e.g., CBOE Rule 
6.25(a)(5); NYSE Arca Rule 6.87(a)(5). Based on discussions with 
these exchanges, the Exchange believes that the parameters are a 
reasonable approach to determine whether an erroneous quote has 
occurred for purposes of the proposed rule.
---------------------------------------------------------------------------

    As an example of a situation in which a trade results from an 
erroneous quote in the underlying security, assume again that a given 
underlying is quoting and trading in the $49.00-$50.00 price range then 
a liquidity gap occurs, with bidders not representing quotes in the 
market place and an offer quoted at $5.00. Quoting may quickly return 
to normal, again in the $49.00-$50.00 price range, but due to the 
potential perception that the underlying has gone through a dramatic 
price revaluation, numerous options trades could trigger based off of 
this new quoted price in the interim. Because the price that triggered 
such trades was not a valid price it would be appropriate to review 
said option trades.
Stop (and Stop-Limit) Order Trades Triggered by Erroneous Trades
    The Exchange notes that certain market participants and their 
customers enter stop or stop limit orders that are triggered based on 
executions in the marketplace. As proposed, transactions resulting from 
the triggering of a stop or stop-limit order by an erroneous trade in 
an option contract shall be nullified by the Exchange, provided a party 
notifies the Exchange's Help Desk in a timely manner as set forth 
below. The Exchange believes it is appropriate to nullify executions of 
stop or stop-limit orders that were wrongly triggered because such 
transactions should not have occurred. If a party believes that it 
participated in an erroneous transaction

[[Page 27402]]

pursuant to the Proposed Rule it must notify the Exchange's Help Desk 
within the timeframes set forth in the Obvious Error Rule above, with 
the allowed notification timeframe commencing at the time of 
notification of the nullification of transaction(s) that triggered the 
stop or stop-limit order.
Linkage Trades
    The Exchange also proposes to adopt language that clearly provides 
the Exchange with authority to take necessary actions when another 
options exchange nullifies or adjusts a transaction pursuant to its 
respective rules and the transaction resulted from an order that has 
passed through the Exchange and been routed on to another options 
exchange on behalf of the Exchange. Specifically, if the Exchange 
routes an order pursuant to the Intermarket Options Linkage Plan \10\ 
that results in a transaction on another options exchange (a ``Linkage 
Trade'') and such options exchange subsequently nullifies or adjusts 
the Linkage Trade pursuant to its rules, the Exchange will perform all 
actions necessary to complete the nullification or adjustment of the 
Linkage Trade. Although the Exchange is not utilizing its own authority 
to nullify or adjust a transaction related to an action taken on a 
Linkage Trade by another options exchange, the Exchange does have to 
assist in the processing of the adjustment or nullification of the 
order, such as notification to the Participant and the OCC of the 
adjustment or nullification. Thus, the Exchange believes that the 
proposed provision adds additional transparency to the Proposed Rule.
---------------------------------------------------------------------------

    \10\ See Securities Exchange Act Release No. 34-54551 (September 
29, 2006), 71 FR 194 (October 6, 2006).
---------------------------------------------------------------------------

Obvious Error Panel
    The Exchange proposes to maintain its current appeals process in 
connection with obvious errors. Specifically, if a party affected by a 
determination made under paragraph (c) so requests within the time 
permitted in paragraph (k)(3) below, an Obvious Error Panel will review 
decisions made under this Rule, including whether an obvious error 
occurred, whether the correct Theoretical Price was used, and whether 
the correct adjustment was made at the correct price. A party may also 
request that the Obvious Error Panel provide relief as required in this 
Rule in cases where the party failed to provide the notification 
required in paragraph (c)(2) and an extension was not granted, but 
unusual circumstances must merit special consideration. A party cannot 
request review by an Obvious Error Panel of determinations by a C2 
Official made pursuant to paragraph (c)(3) of this Rule.
    The Obvious Error Panel will be comprised of representatives from 
four (4) Participants. Two (2) of the representatives must be directly 
engaged in market making activity and two (2) of the representatives 
must be employed by non-Market-Maker Participants.\11\
---------------------------------------------------------------------------

    \11\ The Exchange notes that the Proposed Rule also includes 
Interpretation and Policy .03 and .04, which are being carried over 
from the Current Rule and describes qualification requirements for 
panelists. See Rule 6.15.02 and .03. The same provisions are 
applicable to the Catastrophic Error Panel.
---------------------------------------------------------------------------

    Under Proposed Rule (k)(3) a request for review must be made in 
writing within thirty (30) minutes after a party receives notification 
of the determination being appealed, except that if notification is 
made after 2:30 p.m. Central Time (``CT''), either party has until 8:30 
a.m. CT the next trading day to request review. The Obvious Error Panel 
shall review the facts and render a decision on the day of the 
transaction, or the next trade day in the case where a request is 
properly made the next trade day.
    The Obvious Error Panel may overturn or modify an action taken 
under this Rule upon agreement by a majority of the Panel 
representatives. All determinations by the Obvious Error Panel may be 
appealed in accordance with paragraph (m) of this Rule.
Catastrophic Error Panel
    The Exchange proposes to modify the procedure and function of the 
Catastrophic Error Panel in the Current Rule to conform the appeals 
process for catastrophic errors to the appeals process for obvious 
errors. Under the Current Rule, the Catastrophic Error Panel does not 
review initial determinations regarding catastrophic errors; rather, 
the Catastrophic Error Panel makes initial determinations with regards 
to whether a catastrophic error has occurred. In order to conform to 
the Proposed Rule, which provides that initial determinations regarding 
potential catastrophic errors are made by C2 Officials, the Exchange is 
proposing to adopt procedures similar to the Obvious Error Panel for 
the proposed Catastrophic Error Panel. Specifically, if a party 
affected by a determination made under paragraph (d) so requests within 
the time permitted in paragraph (l)(3), a Catastrophic Error Panel will 
review decisions made under this Rule, including whether a catastrophic 
error occurred, whether the correct Theoretical Price was used, and 
whether the correct adjustment was made at the correct price. The 
composition of the Catastrophic Error Panel will be the same as the 
Obvious Error Panel.
    Additionally, under paragraph (l)(3), a request for review must be 
made in writing within thirty (30) minutes after a party receives 
notification of a determination under paragraph (d), except that if 
notification is made after 2:30 p.m. Central Time (``CT''), either 
party has until 8:30 a.m. CT the next trading day to request review. 
The Catastrophic Error Panel shall review the facts and render a 
decision on the day of the transaction, or the next trade day in the 
case where a request is properly made the next trade day.
    Finally, as with the Obvious Error Panel, the Catastrophic Error 
Panel may overturn or modify an action taken under this Rule upon 
agreement by a majority of the Panel representatives. All 
determinations by the Catastrophic Error Panel may be appealed in 
accordance with paragraph (m) of this Rule.
Review
    Determinations made by an Obvious Error Panel or Catastrophic Error 
Panel can be appealed in accordance with paragraph (m) of the Proposed 
Rule. Paragraph (m) provides that, subject to the limitations contained 
in (c)(3),\12\ a Participant affected by a determination made under 
this Rule may appeal such determination, in accordance with chapter XIX 
of the Exchange's rules. For purposes of this Rule, a Participant must 
be aggrieved as described in Rule 19.1. Notwithstanding any provision 
in Rule 19.2 to the contrary, a request for review must be made in 
writing (in a form and manner prescribed by the Exchange) no later than 
the close of trading on the next trade date after the Participant 
receives notification of such determination from the Exchange.
---------------------------------------------------------------------------

    \12\ Transactions adjusted or nullified under (c)(3) cannot be 
reviewed by an Obvious Error Panel under paragraph (k) but can be 
appealed in accordance with paragraph (m).
---------------------------------------------------------------------------

Limit Up-Limit Down Plan
    The Exchange is proposing to adopt Interpretation and Policy .01 to 
the Proposed Rule to provide for how the Exchange will treat Obvious 
and Catastrophic Errors in response to the Regulation NMS Plan to 
Address Extraordinary Market Volatility Pursuant to Rule 608 of 
Regulation NMS under the Act (the ``Limit Up-Limit

[[Page 27403]]

Down Plan'' or the ``Plan),\13\ which is applicable to all NMS stocks, 
as defined in Regulation NMS Rule 600(b)(47).\14\ Under the Proposed 
Rule, during a pilot period to coincide with the pilot period for the 
Plan, including any extensions to the pilot period for the Plan, an 
execution will not be subject to review as an Obvious Error or 
Catastrophic Error pursuant to paragraph (c) or (d) of the Proposed 
Rule if it occurred while the underlying security was in a ``Limit 
State'' or ``Straddle State,'' as defined in the Plan. The Exchange, 
however, proposes to retain authority to review transactions on an 
Official's own motion pursuant to sub-paragraph (c)(3) of the Proposed 
Rule and to bust or adjust transactions pursuant to the proposed 
Significant Market Event provision, the proposed trading halts 
provision, the proposed provisions with respect to erroneous prints and 
quotes in the underlying security, or the proposed provision related to 
stop and stop limit orders that have been triggered by an erroneous 
execution. The Exchange believes that these safeguards will provide the 
Exchange with the flexibility to act when necessary and appropriate to 
nullify or adjust a transaction, while also providing market 
participants with certainty that, under normal circumstances, the 
trades they affect with quotes and/or orders having limit prices will 
stand irrespective of subsequent moves in the underlying security.
---------------------------------------------------------------------------

    \13\ Securities Exchange Act Release No. 67091 (May 31, 2012), 
77 FR 33498 (June 6, 2012) (order approving the Plan on a pilot 
basis).
    \14\ 17 CFR 242.600(b)(47).
---------------------------------------------------------------------------

    During a Limit or Straddle State, options prices may deviate 
substantially from those available immediately prior to or following 
such States. Thus, determining a Theoretical Price in such situations 
would often be very subjective, creating unnecessary uncertainty and 
confusion for investors. Because of this uncertainty, and consistent 
with the Current Rule, the Exchange proposes to provide that the 
Exchange will not review transactions as Obvious Errors or Catastrophic 
Errors when the underlying security is in a Limit or Straddle State.
    The Exchange represents that it will conduct its own analysis 
concerning the elimination of the Obvious Error and Catastrophic Error 
provisions during Limit and Straddle States and agrees to provide the 
Commission with relevant data to assess the impact of this proposed 
rule change. As part of its analysis, the Exchange will evaluate (1) 
the options market quality during Limit and Straddle States, (2) assess 
the character of incoming order flow and transactions during Limit and 
Straddle States, and (3) review any complaints from Participants and 
their customers concerning executions during Limit and Straddle States. 
The Exchange also agrees to provide to the Commission data requested to 
evaluate the impact of the inapplicability of the Obvious Error and 
Catastrophic Error provisions, including data relevant to assessing the 
various analyses noted above.
    In connection with this proposal, the Exchange will provide to the 
Commission and the public a dataset containing the data for each 
Straddle State and Limit State in NMS Stocks underlying options traded 
on the Exchange beginning in the month during which the proposal is 
approved, limited to those option classes that have at least one (1) 
trade on the Exchange during a Straddle State or Limit State. For each 
of those option classes affected, each data record will contain the 
following information:
     Stock symbol, option symbol, time at the start of the 
Straddle or Limit State, an indicator for whether it is a Straddle or 
Limit State.
     For activity on the Exchange:
    [cir] executed volume, time-weighted quoted bid-ask spread, time-
weighted average quoted depth at the bid, time-weighted average quoted 
depth at the offer;
    [cir] high execution price, low execution price;
    [cir] number of trades for which a request for review for error was 
received during Straddle and Limit States;
    [cir] an indicator variable for whether those options outlined 
above have a price change exceeding 30% during the underlying stock's 
Limit 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). Another indicator variable for whether 
the option price within five minutes of the underlying stock leaving 
the Limit or Straddle state (or halt if applicable) is 30% away from 
the price before the start of the Limit or Straddle State.
    In addition, by May 29, 2015, the Exchange shall provide to the 
Commission and the public assessments relating to the impact of the 
operation of the Obvious Error rules during Limit and Straddle States 
as follows: (1) Evaluate the statistical and economic impact of Limit 
and Straddle States on liquidity and market quality in the options 
markets; and (2) Assess whether the lack of Obvious Error rules in 
effect during the Straddle and Limit States are problematic. The timing 
of this submission would coordinate with Participants' proposed time 
frame to submit to the Commission assessments as required under 
Appendix B of the Plan. The Exchange notes that the pilot program is 
intended to run concurrent with the pilot period of the Plan, which has 
been extended to October 23, 2015. The Exchange proposes to reflect 
this date in the Proposed Rule.
No Adjustments to a Worse Price
    The Exchange also proposes to include Interpretation and Policy .02 
to the Proposed Rule, which would make clear that to the extent the 
provisions of the proposed Rule would result in the Exchange applying 
an adjustment of an erroneous sell transaction to a price lower than 
the execution price or an erroneous buy transaction to a price higher 
than the execution price, the Exchange will not adjust or nullify the 
transaction, but rather, the execution price will stand.
Arbitration
    Additionally, the Exchange proposes to adopt Interpretation and 
Policy .05, which provides that any determination made by an Official, 
an Obvious Error Panel, or a Catastrophic Error Panel under Proposed 
Rule shall be rendered without prejudice as to the rights of the 
parties to the transaction to submit a dispute to arbitration.
Implementation Date
    In order to ensure that other options exchanges are able to adopt 
rules consistent with this proposal and to coordinate the effectiveness 
of such harmonized rules, the Exchange proposes to delay the operative 
date of this proposal to May 8, 2015.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with the 
requirements of the Act and the rules and regulations thereunder that 
are applicable to a national securities exchange, and, in particular, 
with the requirements of section 6(b) of the Act.\15\ Specifically, the 
proposal is consistent with section 6(b)(5) of the Act \16\ because it 
would promote just and equitable principles of trade, 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.
---------------------------------------------------------------------------

    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As described above, the Exchange and other options exchanges are 
seeking to adopt harmonized rules related to the adjustment and 
nullification of

[[Page 27404]]

erroneous options transactions. The Exchange believes that the Proposed 
Rule will provide greater transparency and clarity with respect to the 
adjustment and nullification of erroneous options transactions. 
Particularly, the proposed changes seek to achieve consistent results 
for participants across U.S. options exchanges while maintaining a fair 
and orderly market, protecting investors and protecting the public 
interest. Based on the foregoing, the Exchange believes that the 
proposal is consistent with section 6(b)(5) of the Act \17\ in that the 
Proposed Rule will foster cooperation and coordination with persons 
engaged in regulating and facilitating transactions.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Exchange believes the various provisions allowing or dictating 
adjustment rather than nullification of a trade are necessary given the 
benefits of adjusting a trade price rather than nullifying the trade 
completely. Because options trades are used to hedge, or are hedged by, 
transactions in other markets, including securities and futures, many 
Participants, and their customers, would rather adjust prices of 
executions rather than nullify the transactions and, thus, lose a hedge 
altogether. As such, the Exchange believes it is in the best interest 
of investors to allow for price adjustments as well as nullifications. 
The Exchange further discusses specific aspects of the Proposed Rule 
below.
    The Exchange does not believe that the proposal is unfairly 
discriminatory, even though it differentiates in many places between 
Customers and non-Customers. The rules of the options exchanges, 
including the Exchange's existing Obvious Error provision, often treat 
Customers differently, often affording them preferential treatment. 
This treatment is appropriate in light of the fact that Customers are 
not necessarily immersed in the day-to-day trading of the markets, are 
less likely to be watching trading activity in a particular option 
throughout the day, and may have limited funds in their trading 
accounts. At the same time, the Exchange reiterates that in the U.S. 
options markets generally there is significant retail customer 
participation that occurs directly on (and only on) options exchanges 
such as the Exchange. Accordingly, differentiating among market 
participants with respect to the adjustment and nullification of 
erroneous options transactions is not unfairly discriminatory because 
it is reasonable and fair to provide Customers with additional 
protections as compared to non-Customers.
    The Exchange believes that its proposal with respect to the 
allowance of mutual agreed upon adjustments or nullifications is 
appropriate and consistent with the Act, as such proposal removes 
impediments to and perfects the mechanism of a free and open market and 
a national market system, allowing participants to mutually agree to 
correct an erroneous transactions without the Exchange mandating the 
outcome. The Exchange also believes that its proposal with respect to 
mutual adjustments is consistent with the Act because it is designed to 
prevent fraudulent and manipulative acts and practices by explicitly 
stating that it is considered conduct inconsistent with just and 
equitable principles of trade for any Participant to use the mutual 
adjustment process to circumvent any applicable Exchange rule, the Act 
or any of the rules and regulations thereunder.
    The Exchange believes its proposal to provide within the Proposed 
Rule definitions of Customer, erroneous sell transaction and erroneous 
buy transaction, and Official is consistent with section 6(b)(5) of the 
Act because such terms will provide more certainty to market 
participants as to the meaning of the Proposed Rule and reduce the 
possibility that a party can intentionally submit an order hoping for 
the market to move in their favor in reliance on the Rule as a safety 
mechanism, thereby promoting just and fair principles of trade. 
Similarly, the Exchange believes that proposed Interpretation and 
Policy .02 is consistent with the Act as it would make clear that the 
Exchange will not adjust or nullify a transaction, but rather, the 
execution price will stand when the applicable adjustment criteria 
would actually adjust the price of the transaction to a worse price 
(i.e., higher for an erroneous buy or lower for an erroneous sell 
order).
    As set forth below, the Exchange believes it is consistent with 
section 6(b)(5) of the Act for the Exchange to determine Theoretical 
Price when the NBBO cannot reasonably be relied upon because the 
alternative could result in transactions that cannot be adjusted or 
nullified even when they are otherwise clearly at a price that is 
significantly away from the appropriate market for the option. 
Similarly, reliance on an NBBO that is not reliable could result in 
adjustment to prices that are still significantly away from the 
appropriate market for the option.
    The Exchange believes that its proposal with respect to determining 
Theoretical Price is consistent with the Act in that it has retained 
the standard of the current rule, which is to rely on the NBBO to 
determine Theoretical Price if such NBBO can reasonably be relied upon. 
Because, however, there is not always an NBBO that can or should be 
used in order to administer the rule, the Exchange has proposed various 
provisions that provide the Exchange with the authority to determine a 
Theoretical Price. The Exchange believes that the Proposed Rule is 
transparent with respect to the circumstances under which the Exchange 
will determine Theoretical Price, and has sought to limit such 
circumstances as much as possible. The Exchange notes that Exchange 
personnel currently are required to determine Theoretical Price in 
certain circumstances. While the Exchange continues to pursue 
alternative solutions that might further enhance the objectivity and 
consistency of determining Theoretical Price, the Exchange believes 
that the discretion currently afforded to Exchange Officials is 
appropriate in the absence of a reliable NBBO that can be used to set 
the Theoretical Price.
    With respect to the specific proposed provisions for determining 
Theoretical Price for transactions that occur as part of the Exchange's 
Opening Process and in situations where there is a wide quote, the 
Exchange believes both provisions are consistent with the Act because 
they provide objective criteria that will determine Theoretical Price 
with limited exceptions for situations where the Exchange does not 
believe the NBBO is a reasonable benchmark or there is no NBBO. The 
Exchange notes in particular with respect to the wide quote provision 
that the Proposed Rule will result in the Exchange determining 
Theoretical Price less frequently than it would pursuant to wide quote 
provisions that have previously been approved. The Exchange believes 
that it is appropriate and consistent with the Act to afford 
protections to market participants by not relying on the NBBO to 
determine Theoretical Price when the quote is extremely wide but had 
been, in the prior 10 seconds, at much more reasonable width. The 
Exchange also believes it is appropriate and consistent with the Act to 
use the NBBO to determine Theoretical Price when the quote has been 
wider than the applicable amount for more than 10 seconds, as the 
Exchange does not believe it is necessary to apply any other criteria 
in such a circumstance. The Exchange believes that market participants 
can easily use or adopt safeguards to prevent errors when such

[[Page 27405]]

market conditions exist. When entering an order into a market with a 
persistently wide quote, the Exchange does not believe that the 
entering party should reasonably expect anything other than the quoted 
price of an option.
    The Exchange believes that its proposal to adopt clear but 
disparate standards with respect to the deadline for submitting a 
request for review of Customer and non-Customer transactions is 
consistent with the Act, particularly in that it creates a greater 
level of protection for Customers. As noted above, the Exchange 
believes that this is appropriate and not unfairly discriminatory in 
light of the fact that Customers are not necessarily immersed in the 
day-to-day trading of the markets and are less likely to be watching 
trading activity in a particular option throughout the day. Thus, 
Participants representing Customer orders reasonably may need 
additional time to submit a request for review. The Exchange also 
believes that its proposal to provide additional time for submission of 
requests for review of linkage trades is reasonable and consistent with 
the protection of investors and the public interest due to the time 
that it might take an options exchange or third-party routing broker to 
file a request for review with the Exchange if the initial notification 
of an error is received by the originating options exchange near the 
end of such options exchange's filing deadline. Without this additional 
time, there could be disparate results based purely on the existence of 
intermediaries and an interconnected market structure.
    In relation to the aspect of the proposal giving Officials the 
ability to review transactions for obvious errors on their own motion, 
the Exchange notes that an Official can adjust or nullify a transaction 
under the authority granted by this provision only if the transaction 
meets the specific and objective criteria for an Obvious Error under 
the Proposed Rule. As noted above, this is designed to give an Official 
the ability to provide parties relief in those situations where they 
have failed to report an apparent error within the established 
notification period. However, the Exchange will only grant relief if 
the transaction meets the requirements for an Obvious Error as 
described in the Proposed Rule.
    The Exchange believes that its proposal to adjust non-Customer 
transactions and to nullify Customer transactions that qualify as 
Obvious Errors is appropriate for reasons consistent with those 
described above. In particular, Customers are not necessarily immersed 
in the day-to-day trading of the markets, are less likely to be 
watching trading activity in a particular option throughout the day, 
and may have limited funds in their trading accounts.
    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 Customer, because a party 
may not know whether the other party to a transaction was a Customer at 
the time of entering into the transaction. However, the Exchange 
believes that the proposal nevertheless promotes just and equitable 
principles of trade and protects investors as well as the public 
interest because it eliminates the possibility that a Customer's order 
will be adjusted to a significantly different price. As noted above, 
the Exchange believes it is consistent with the Act to afford Customers 
greater protections under the Proposed Rule than are afforded to non-
Customers. Thus, the Exchange believes that its proposal is consistent 
with the Act in that it protects investors and the public interest by 
providing additional protections to those that are less informed and 
potentially less able to afford an adjustment of a transaction that was 
executed in error. Customers are also less likely to have engaged in 
significant hedging or other trading activity based on earlier 
transactions, and thus, are less in need of maintaining a position at 
an adjusted price than non-Customers.
    If any Participant submits requests to the Exchange for review of 
transactions pursuant to the Proposed Rule, and in aggregate that 
Participant has 200 or more Customer transactions under review 
concurrently and the orders resulting in such transactions were 
submitted during the course of 2 minutes or less, the Exchange believes 
it is appropriate for the Exchange apply the non-Customer adjustment 
criteria described above to such transactions. The Exchange believes 
that the proposed aggregation is reasonable as it is representative of 
an extremely large number of orders submitted to the Exchange over a 
relatively short period of time that are, in turn, possibly erroneous 
(and within a time frame significantly less than an entire day), and 
thus is most likely to occur because of a systems issue experienced by 
a Participant representing Customer orders or a systems issue coupled 
with the erroneous marking of orders. The Exchange does not believe it 
is possible at a level of 200 Customer orders over a 2 minute period 
that are under review at one time that multiple, separate Customers 
were responsible for the errors in the ordinary course of trading. In 
the event of a large-scale issue caused by a Participant that has 
submitted orders over a 2 minute period marked as Customer that 
resulted in more than 200 transactions under review, the Exchange does 
not believe it is appropriate to nullify all such transactions because 
of the negative impact that nullification could have on the market 
participants on the contra-side of such transactions, who might have 
engaged in hedging and trading activity following such transactions. In 
order for a participant to have more than 200 transactions under review 
concurrently when the orders triggering such transactions were received 
in 2 minutes or less, the Exchange believes that a market participant 
will have far exceeded the normal behavior of customers deserving 
protected status. While the Exchange continues to believe that it is 
appropriate to nullify transactions in such a circumstance if both 
participants to a transaction are Customers, the Exchange does not 
believe it is appropriate to place the overall risk of a significant 
number of trade breaks on non-Customers that in the normal course of 
business may have engaged in additional hedging activity or trading 
activity based on such transactions. Thus, the Exchange believes it is 
necessary and appropriate to protect non-Customers in such a 
circumstance by applying the non-Customer adjustment criteria, and thus 
adjusting transactions as set forth above, in the event a Participant 
has more than 200 transactions under review concurrently. In summary, 
due to the extreme level at which the proposal is set, the Exchange 
believes that the proposal is consistent with section 6(b)(5) of the 
Act in that it promotes just and equitable principles of trade by 
encouraging market participants to retain appropriate controls over 
their systems to avoid submitting a large number of erroneous orders in 
a short period of time.
    Similarly, the Exchange believes that the proposed Size Adjustment 
Modifier, which would increase the adjustment amount for non-Customer 
transactions, is appropriate because it attempts to account for the 
additional risk that the parties to the trade undertake for 
transactions that are larger in scope. The Exchange believes that the 
Size Adjustment Modifier creates additional incentives to prevent more 
impactful Obvious Errors and it lessens the impact on the contra-party 
to an adjusted trade. The Exchange notes that these contra-parties may 
have preferred to only trade the size involved in the transaction at

[[Page 27406]]

the price at which such trade occurred, and in trading larger size has 
committed a greater level of capital and bears a larger hedge risk.
    The Exchange similarly believes that its Proposed Rule with respect 
to Catastrophic Errors is consistent with the Act as it affords 
additional time for market participants to file for review of erroneous 
transactions that were further away from the Theoretical Price. At the 
same time, the Exchange believes that the Proposed Rule is consistent 
with the Act in that it generally would adjust transactions, including 
Customer transactions, because this will protect against hedge risk, 
particularly for transactions that may have occurred several hours 
earlier and thus, which all parties to the transaction might presume 
are protected from further modification. Similarly, by providing larger 
adjustment amounts away from Theoretical Price than are set forth under 
the Obvious Error provision, the Catastrophic Error provision also 
takes into account the possibility that the party that was advantaged 
by the erroneous transaction has already taken actions based on the 
assumption that the transaction would stand. The Exchange believes it 
is reasonable to specifically protect Customers from adjustments 
through their limit prices for the reasons stated above, including that 
Customers are less likely to be watching trading throughout the day and 
that they may have less capital to afford an adjustment price. The 
Exchange believes that the proposal provides a fair process that will 
ensure that Customers are not forced to accept a trade that was 
executed in violation of their limit order price. In contrast, market 
professionals are more likely to have engaged in hedging or other 
trading activity based on earlier trading activity, and thus, are more 
likely to be willing to accept an adjustment rather than a 
nullification to preserve their positions even if such adjustment is to 
a price through their limit price.
    The Exchange believes that proposed rule change to adopt the 
Significant Market Event provision is consistent with section 6(b)(5) 
of the Act in that it will foster cooperation and coordination with 
persons engaged in regulating the options markets. In particular, the 
Exchange believes it is important for options exchanges to coordinate 
when there is a widespread and significant event, as commonly, multiple 
options exchanges are impacted in such an event. Further, while the 
Exchange recognizes that the Proposed Rule will not guarantee a 
consistent result for all market participants on every market, the 
Exchange does believe that it will assist in that outcome. For 
instance, if options exchanges are able to agree as to the time from 
which Theoretical Price should be determined and the period of time 
that should be reviewed, the likely disparity between the Theoretical 
Prices used by such exchanges should be very slight and, in turn, with 
otherwise consistent rules, the results should be similar. The Exchange 
also believes that the Proposed Rule is consistent with the Act in that 
it generally would adjust transactions, including Customer 
transactions, because this will protect against hedge risk, 
particularly for liquidity providers that might have been quoting in 
thousands or tens of thousands of different series and might have 
affected executions throughout such quoted series. The Exchange 
believes that when weighing the competing interests between preferring 
a nullification for a Customer transaction and an adjustment for a 
transaction of a market professional, while nullification is 
appropriate in a typical one-off situation that it is necessary to 
protect liquidity providers in a widespread market event because, 
presumably, they will be the most affected by such an event (in 
contrast to a Customer who, by virtue of their status as such, likely 
would not have more than a small number of affected transactions). The 
Exchange believes that the protection of liquidity providers by 
favoring adjustments in the context of Significant Market Events can 
also benefit Customers indirectly by better enabling liquidity 
providers, which provides a cumulative benefit to the market. Also, as 
stated above with respect to Catastrophic Errors, the Exchange believes 
it is reasonable to specifically protect Customers from adjustments 
through their limit prices for the reasons stated above, including that 
Customers are less likely to be watching trading throughout the day and 
that they may have less capital to afford an adjustment price. The 
Exchange believes that the proposal provides a fair process that will 
ensure that Customers are not forced to accept a trade that was 
executed in violation of their limit order price. In contrast, market 
professionals are more likely to have engaged in hedging or other 
trading activity based on earlier trading activity, and thus, are more 
likely to be willing to accept an adjustment rather than a 
nullification to preserve their positions even if such adjustment is to 
a price through their limit price. In addition, the Exchange believes 
it is important to have the ability to nullify some or all transactions 
arising out of a Significant Market Event in the event timely 
adjustment is not feasible due to the extraordinary nature of the 
situation. In particular, although the Exchange has worked to limit the 
circumstances in which it has to determine Theoretical Price, in a 
widespread event it is possible that hundreds if not thousands of 
series would require an Exchange determination of Theoretical Price. In 
turn, if there are hundreds or thousands of trades in such series, it 
may not be practicable for the Exchange to determine the adjustment 
levels for all non-Customer transactions in a timely fashion, and in 
turn, it would be in the public interest to instead more promptly 
deliver a simple, consistent result of nullification.
    The Exchange believes that proposed rule change related to review, 
nullification and/or adjustment of erroneous transactions during a 
trading halt, an erroneous print in the underlying security, an 
erroneous quote in the underlying security, or an erroneous transaction 
in the option with respect to stop and stop limit orders is likewise 
consistent with section 6(b)(5) of the Act because the proposal 
provides for the adjustment or nullification of trades executed at 
erroneous prices through no fault on the part of the trading 
participants. Allowing for Exchange review in such situations will 
promote just and fair principles of trade by protecting investors from 
harm that is not of their own making. Specifically with respect to the 
proposed provisions governing erroneous prints and quotes in the 
underlying security, the Exchange notes that market participants on the 
Exchange base the value of their quotes and orders on the price of the 
underlying security. The provisions regarding errors in prints and 
quotes in the underlying security cover instances where the information 
market participants use to price options is erroneous through no fault 
of their own. In these instances, market participants have little, if 
any, chance of pricing options accurately. Thus, these provisions are 
designed to provide relief to market participants harmed by such errors 
in the prints or quotes of the underlying security.
    The Exchange believes that the proposed provision related to 
Linkage Trades is consistent with the Act because it adds additional 
transparency to the Proposed Rule and makes clear that when a Linkage 
Trade is adjusted or nullified by another options exchange, the 
Exchange will take necessary actions to complete the nullification or 
adjustment of the Linkage Trade.
    The Exchange believes that retaining the same appeals process for 
obvious

[[Page 27407]]

errors as the Exchange maintains under the Current Rule is consistent 
with the Act because such process provides Participants with due 
process in connection with decisions made by Exchange Officials under 
the Proposed Rule. The Exchange believes that this process provides 
fair representation of Participants by ensuring multiple Participants 
are members of any Obvious Error Review Panel, which is consistent with 
sections 6(b)(3) and 6(b)(7) of the Act. The Exchange believes adopting 
a similar appeals process for catastrophic errors is consistent with 
the Act for the same reasons noted above.
    With regard to the portion of the Exchange's proposal related to 
the applicability of the Obvious Error Rule when the underlying 
security is in a Limit or Straddle State, the Exchange believes that 
the proposed rule change is consistent with section 6(b)(5) of the Act 
because it will provide certainty about how errors involving options 
orders and trades will be handled during periods of extraordinary 
volatility in the underlying security. Further, the Exchange believes 
that it is necessary and appropriate in the interest of promoting fair 
and orderly markets to exclude from Rule 6.15 those transactions 
executed during a Limit or Straddle State.
    The Exchange believes the application of the Proposed Rule without 
the proposed provision would be impracticable given the lack of 
reliable NBBO in the options market during Limit and Straddle States, 
and that the resulting actions (i.e., nullified trades or adjusted 
prices) may not be appropriate given market conditions. The Proposed 
Rule change would ensure that limit orders that are filled during a 
Limit State or Straddle State would have certainty of execution in a 
manner that promotes just and equitable principles of trade, removes 
impediments to, and perfects the mechanism of a free and open market 
and a national market system.
    Moreover, given the fact that options prices during brief Limit or 
Straddle States may deviate substantially from those available shortly 
following the Limit or Straddle State, the Exchange believes giving 
market participants time to re-evaluate a transaction would create an 
unreasonable adverse selection opportunity that would discourage 
participants from providing liquidity during Limit or Straddle States. 
In this respect, the Exchange notes that only those orders with a limit 
price will be executed during a Limit or Straddle State. Therefore, on 
balance, the Exchange believes that removing the potential inequity of 
nullifying or adjusting executions occurring during Limit or Straddle 
States outweighs any potential benefits from applying certain 
provisions during such unusual market conditions. Additionally, as 
discussed above, there are additional pre-trade protections in place 
outside of the Obvious and Catastrophic Error Rule that will continue 
to safeguard customers.
    The Exchange notes that under certain limited circumstances the 
Proposed Rule will permit the Exchange to review transactions in 
options that overlay a security that is in a Limit or Straddle State. 
Specifically, an Official will have authority to review a transaction 
on his or her own motion in the interest of maintaining a fair and 
orderly market and for the protection of investors. Furthermore, the 
Exchange will have the authority to adjust or nullify transactions in 
the event of a Significant Market Event, a trading halt in the affected 
option, an erroneous print or quote in the underlying security, or with 
respect to stop and stop limit orders that have been triggered based on 
erroneous trades. The Exchange believes that the safeguards described 
above will protect market participants and will provide the Exchange 
with the flexibility to act when necessary and appropriate to nullify 
or adjust a transaction, while also providing market participants with 
certainty that, under normal circumstances, the trades they effect with 
quotes and/or orders having limit prices will stand irrespective of 
subsequent moves in the underlying security. The right to review those 
transactions that occur during a Limit or Straddle State would allow 
the Exchange to account for unforeseen circumstances that result in 
Obvious or Catastrophic Errors for which a nullification or adjustment 
may be necessary in the interest of maintaining a fair and orderly 
market and for the protection of investors. Similarly, the ability to 
nullify or adjust transactions that occur during a Significant Market 
Event or trading halt, erroneous print or quote in the underlying 
security, or erroneous trade in the option (i.e., stop and stop limit 
orders) may also be necessary in the interest of maintaining a fair and 
orderly market and for the protection of investors. Furthermore, the 
Exchange will administer this provision in a manner that is consistent 
with the principles of the Act and will create and maintain records 
relating to the use of the authority to act on its own motion during a 
Limit or Straddle State or any adjustments or trade breaks based on 
other proposed provisions under the Rule.

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

    C2 does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. Importantly, the Exchange 
believes the proposal will not impose a burden on intermarket 
competition but will rather alleviate any burden on competition because 
it is the result of a collaborative effort by all options exchanges to 
harmonize and improve the process related to the adjustment and 
nullification of erroneous options transactions. The Exchange does not 
believe that the rules applicable to such process is an area where 
options exchanges should compete, but rather, that all options 
exchanges should have consistent rules to the extent possible. 
Particularly where a market participant trades on several different 
exchanges and an erroneous trade may occur on multiple markets nearly 
simultaneously, the Exchange believes that a participant should have a 
consistent experience with respect to the nullification or adjustment 
of transactions. The Exchange understands that all other options 
exchanges intend to file proposals that are substantially similar to 
this proposal.
    The Exchange does not believe that the proposed rule change imposes 
a burden on intramarket competition because the provisions apply to all 
market participants equally within each participant category (i.e., 
Customers and non-Customers). With respect to competition between 
Customer and non-Customer market participants, the Exchange believes 
that the Proposed Rule acknowledges competing concerns and tries to 
strike the appropriate balance between such concerns. For instance, as 
noted above, the Exchange believes that protection of Customers is 
important due to their direct participation in the options markets as 
well as the fact that they are not, by definition, market 
professionals. At the same time, the Exchange believes due to the 
quote-driven nature of the options markets, the importance of liquidity 
provision in such markets and the risk that liquidity providers bear 
when quoting a large breadth of products that are derivative of 
underlying securities, that the protection of liquidity providers and 
the practice of adjusting transactions rather than nullifying them is 
of critical importance. As described above, the Exchange will apply 
specific and objective criteria to determine

[[Page 27408]]

whether an erroneous transaction has occurred and, if so, how to adjust 
or nullify a transaction.

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

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

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

    Because the proposed rule change does not (i) significantly affect 
the protection of investors or the public interest; (ii) impose any 
significant burden on competition; and (iii) become operative for 30 
days from the date on which it was filed, or such shorter time as the 
Commission may designate if consistent with the protection of investors 
and the public interest, the proposed rule change has become effective 
pursuant to section 19(b)(3)(A) of the Act \18\ and Rule 19b-4(f)(6) 
thereunder.\19\
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    \18\ 15 U.S.C. 78s(b)(3)(A).
    \19\ 17 CFR 240.19b-4(f)(6). As required under Rule 19b-
4(f)(6)(iii), the Exchange provided the Commission with written 
notice of its intent to file the proposed rule change, along with a 
brief description and the text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission.
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    The Exchange has asked the Commission to waive the 30-day operative 
delay so that the proposal may become operative immediately upon 
filing. The Commission believes that waiving the 30-day operative delay 
is consistent with the protection of investors and the public interest, 
as it will enable the Exchange to meet its proposed implementation date 
of May 8, 2015, which will help facilitate the implementation of 
harmonized rules related to the adjustment and nullification of 
erroneous options transactions across the options exchanges. For this 
reason, the Commission designates the proposed rule change to be 
operative upon filing.\20\
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    \20\ For purposes only of waiving the 30-day operative delay, 
the Commission has also considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act. If the Commission 
takes such action, the Commission shall institute proceedings to 
determine whether the proposed rule should be approved or disapproved.

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-C2-2015-012 on the subject line.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-C2-2015-012. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-C2-2015-012 and should be 
submitted on or before June 3, 2015.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-11485 Filed 5-12-15; 8:45 am]
 BILLING CODE 8011-01-P


