
[Federal Register Volume 82, Number 72 (Monday, April 17, 2017)]
[Notices]
[Pages 18173-18180]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-07635]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80429; File No. SR-ISE-2017-30]


Self-Regulatory Organizations; Nasdaq ISE, LLC; Notice of Filing 
and Immediate Effectiveness of Proposed Rule Change Relating to Obvious 
Errors

April 11, 2017.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 3, 2017, Nasdaq ISE, LLC (``ISE'' or ``Exchange'') \3\ filed 
with the Securities and Exchange Commission (``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.
    \3\ ISE was renamed Nasdaq ISE, LLC in a rule change that became 
operative on April 3, 2017. See Securities Exchange Act Release No. 
80325 (March 29, 2017) (SR-ISE-2017-25).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Rule 720 (``Current Rule''), 
entitled ``Nullification and Adjustment of Options Transactions 
including Obvious Errors'' by adding a new Supplementary Material .05 
to Rule 720.
    The text of the proposed rule change is available on the Exchange's 
Web site at www.ise.com, at the principal office of the Exchange, 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
    Last year, the Exchange and other options exchanges adopted a new, 
harmonized rule related to the adjustment and nullification of 
erroneous options transactions, including a specific provision related 
to coordination in connection with large-scale events involving 
erroneous options transactions.\4\ The Exchange believes that the 
changes the options exchanges implemented with the new, harmonized rule 
have led to increased transparency and finality with respect to the 
adjustment and nullification of erroneous options transactions. 
However, as part of the initial initiative, the Exchange and other 
options exchanges deferred a few specific matters for further 
discussion.
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    \4\ See Securities Exchange Act Release No. 76232 (October 22, 
2015), 80 FR 66063 (October 28, 2015) (SR-ISE-2015-34).
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    Specifically, the options exchanges have been working together to 
identify ways to improve the process related to the adjustment and 
nullification of erroneous options transactions as it relates to 
complex orders \5\ and stock-option orders. The goal of the process 
that the options exchanges have undertaken is to further harmonize 
rules related to the adjustment and nullification of erroneous options 
transactions. As described below, the

[[Page 18174]]

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 complex 
order and stock-option order 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.
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    \5\ See Rule 722(a)(1) defining a complex order and (a)(2) 
definition a stock-option order.
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    The Proposed Rule is the culmination of this coordinated effort and 
reflects discussions by the options exchanges whereby the exchanges 
that offer complex orders and/or stock-option orders will universally 
adopt new provisions that the options exchanges collectively believe 
will improve the handling of erroneous options transactions that result 
from the execution of complex orders and stock-option orders.\6\
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    \6\ An exchange that does not offer complex orders and stock-
option orders will not adopt these new provisions until such time as 
the exchange offers complex orders and/or stock-option orders. The 
Exchange currently trades complex orders and/or stock-option orders 
pursuant to ISE Rule 722.
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    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 option 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 this 
proposal. 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 necessitate 
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 this proposal. 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.
Complex Orders and Stock-Option Orders
    As more fully described below, the Proposed Rule applies much of 
the Current Rule to complex orders and stock-option orders.\7\ The 
Proposed Rule deviates from the Current Rule only to account for the 
unique qualities of complex orders and stock-option orders. The 
Proposed Rule reflects the fact that complex orders can execute against 
other complex orders or can execute against individual simple orders in 
the leg markets. When a complex order executes against the leg markets 
there may be different counterparties on each leg of the complex order, 
and not every leg will necessarily be executed at an erroneous price. 
With regards to stock-option orders, the Proposed Rule reflects the 
fact that stock-option orders contain a stock component that is 
executed on a stock trading venue, and the Exchange may not be able to 
ensure that the stock trading venue will adjust or nullify the stock 
execution in the event of an obvious or catastrophic error. In order to 
apply the Current Rule and account for the unique characteristics of 
complex orders and stock-option orders, proposed Supplementary Material 
.05 is split into three parts--paragraphs (a), (b), and (c).
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    \7\ In order for a complex order or stock-option order to 
qualify as an obvious or catastrophic error at least one of the legs 
must itself qualify as an obvious or catastrophic error under the 
Current Rule. See Proposed Rule 720.05(a)-(c).
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    First, proposed Supplementary Material .05(a) governs the review of 
complex orders that are executed against individual legs (as opposed to 
a complex order that executes against another complex order).\8\ 
Proposed Rule 720.05(a) provides:
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    \8\ The leg market consists of quotes and/or orders in single 
options series. A complex order may be received by the Exchange 
electronically, and the legs of the complex order may have different 
counterparties. For example, Market-Maker 1 may be quoting in ABC 
calls and Market-Maker 2 may be quoting in ABC puts. A complex order 
to buy the ABC calls and puts may execute against the quotes of 
Market-Maker 1 and Market-Maker 2.

    If a complex order executes against individual legs and at least 
one of the legs qualifies as an Obvious Error under paragraph (c)(1) 
or a Catastrophic Error under paragraph (d)(1), then the leg(s) that 
is an Obvious or Catastrophic Error will be adjusted in accordance 
with paragraphs (c)(4)(A) or (d)(3), respectively, regardless of 
whether one of the parties is a Customer. However, any Customer 
order subject to this paragraph (a) 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 on the complex order or individual leg(s). If any leg of 
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a complex order is nullified, the entire transaction is nullified.

    As previously noted, at least one of the legs of the complex order 
must qualify as an obvious or catastrophic

[[Page 18175]]

error under the Current Rule in order for the complex order to receive 
obvious or catastrophic error relief. Thus, when the Exchange is 
notified (within the timeframes set forth in paragraph (c)(2) or 
(d)(2)) of a complex order that is a possible obvious error or 
catastrophic error, the Exchange will first review the individual legs 
of the complex order to determine if one or more legs qualify as an 
obvious or catastrophic error.\9\ If no leg qualifies as an obvious or 
catastrophic error, the transaction stands--no adjustment and no 
nullification.
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    \9\ Because a complex order can execute against the leg market, 
the Exchange may also be notified of a possible obvious or 
catastrophic error by a counterparty that received an execution in 
an individual options series. If upon review of a potential obvious 
error the Exchange determines an individual options series was 
executed against the leg of a complex order or stock-option order, 
Proposed Rule 720.05 will govern.
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    Reviewing the legs to determine whether one or more legs qualify as 
an obvious or catastrophic error requires the Exchange to follow the 
Current Rule. In accordance with paragraphs (c)(1) and (d)(1) of the 
Current Rule, the Exchange compares the execution price of each 
individual leg to the Theoretical Price of each leg (as determined by 
paragraph (b) of the Current Rule). If the execution price of an 
individual leg is higher or lower than the Theoretical Price for the 
series by an amount equal to at least the amount shown in the obvious 
error table in paragraph (c)(1) of the Current Rule or the catastrophic 
error table in paragraph (d)(1) of the Current Rule, the individual leg 
qualifies as an obvious or catastrophic error, and the Exchange will 
take steps to adjust or nullify the transaction.\10\
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    \10\ Only the execution price on the leg (or legs) that 
qualifies as an obvious or catastrophic error pursuant to any 
portion of Proposed Rule 720.05 will be adjusted. The execution 
price of a leg (or legs) that does not qualify as an obvious or 
catastrophic error will not be adjusted.
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    To illustrate, consider a Customer submits a complex order to the 
Exchange consisting of leg 1 and leg 2--Leg 1 is to buy 100 ABC calls 
and leg 2 is to sell 100 ABC puts. Also, consider that Market-Maker 1 
is quoting the ABC calls $1.00-1.20 and Market-Maker 2 is quoting the 
ABC puts $2.00-2.20. If the complex order executes against the quotes 
of Market-Makers 1 and 2, the Customer buys the ABC calls for $1.20 and 
sells the ABC puts for $2.00. As with the obvious/catastrophic error 
reviews for simple orders, the execution price of leg 1 is compared to 
the Theoretical Price \11\ of Leg 1 in order to determine if Leg 1 is 
an obvious error under paragraph (c)(1) of the Current Rule or a 
catastrophic error under paragraph (d)(1) of the Current Rule. The same 
goes for Leg 2. The execution price of Leg 2 is compared to the 
Theoretical Price of Leg 2. If it is determined that one or both of the 
legs are an obvious or catastrophic error, then the leg (or legs) that 
is an obvious or catastrophic error will be adjusted in accordance with 
paragraphs (c)(4)(A) or (d)(3) of the Current Rule, regardless of 
whether one of the parties is a Customer.\12\ Although a single-legged 
execution that is deemed to be an obvious error under the Current Rule 
is nullified whenever a Customer is involved in the transaction, the 
Exchange believes adjusting execution prices is generally better for 
the marketplace than nullifying executions because liquidity providers 
often execute hedging transactions to offset options positions. When an 
options transaction is nullified the hedging position can adversely 
affect the liquidity provider. With regards to complex orders that 
execute against individual legs, the additional rationale for adjusting 
erroneous execution prices when possible is the fact that the 
counterparty on a leg that is not executed at an obvious or 
catastrophic error price cannot look at the execution price to 
determine whether the execution may later be nullified (as opposed to 
the counterparty on single-legged order that is executed at an obvious 
error or catastrophic error price).
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    \11\ See Rule 720(b) (defining the manner in which Theoretical 
Price is determined).
    \12\ See Rule 720(a)(1) (defining Customer for purposes of Rule 
720 as not including a broker-dealer, Professional Customer, or 
Voluntary Professional Customer).
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    Paragraph (c)(4)(A) of the Current Rule mandates that if it is 
determined that an obvious error has occurred, the execution price of 
the transaction will be adjusted pursuant to the table set forth in 
(c)(4)(A). Although for simple orders paragraph (c)(4)(A) is only 
applicable when no party to the transaction is a Customer, for the 
purposes of complex orders paragraph (a) of Supplementary Material .05 
will supersede that limitation; therefore, if it is determined that a 
leg (or legs) of a complex order is an obvious error, the leg (or legs) 
will be adjusted pursuant to (c)(4)(A), regardless of whether a party 
to the transaction is a Customer. The Size Adjustment Modifier defined 
in subparagraph (a)(4) will similarly apply (regardless of whether a 
Customer is on the transaction) by virtue of the application of 
paragraph (c)(4)(A).\13\ The Exchange notes that adjusting all market 
participants is not unique or novel. When the Exchange determines that 
a simple order execution is a Catastrophic Error pursuant to the 
Current Rule, paragraph (d)(3) already provides for adjusting the 
execution price for all market participants, including Customers.
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    \13\ See Rule 720(c)(4)(A) (stating that any non-Customer 
Obvious Error exceeding 50 contracts will be subject to the Size 
Adjustment Modifier defined in sub-paragraph (a)(4)). The Size 
Adjustment Modifier may also apply to the option leg of a stock-
option order that is adjusted pursuant to Proposed Rule 720.05(c).
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    Furthermore, as with the Current Rule, Proposed Rule 720.05(a) 
provides protection for Customer orders, stating that where at least 
one party to a complex order transaction is a Customer, the transaction 
will be nullified if adjustment would result in an execution price 
higher (for buy transactions) or lower (for sell transactions) than the 
Customer's limit price on the complex order or individual leg(s). For 
example, assume Customer enters a complex order to buy leg 1 and leg 2.
     Assume the NBBO for leg 1 is $0.20-1.00 and the NBBO for 
leg 2 is $0.50-1.00 and that these have been the NBBOs since the market 
opened.
     A split-second prior to the execution of the complex order 
a Customer enters a simple order to sell the leg 1 options series at 
$1.30, and the simple order enters the Exchange's book so that the BBO 
is $.20-$1.30. The limit price on the simple order is $1.30.
     The complex order executes leg 1 against the Exchange's 
best offer of $1.30 and leg 2 at $1.00 for a net execution price of 
$2.30.
     However, leg 1 executed on a wide quote (the NBBO for leg 
1 was $0.20-1.00 at the time of execution, which is wider than 
$0.75).\14\ Leg 2 was not executed on a wide quote (the market for leg 
2 was $0.50-1.00); thus, leg 2 execution price stands.
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    \14\ See Rule 720(b)(3).
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    The Exchange determines that the Theoretical Price for leg 
1 is $1.00, which was the best offer prior to the execution. Leg 1 
qualifies as an obvious error because the difference between the 
Theoretical Price ($1.00) and the execution price ($1.30) is larger 
than $0.25.\15\
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    \15\ See Rule 720(c)(1).
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     According to Proposed Rule 720.05(a) Customers will also 
be adjusted in accordance with Rule 720(c)(4)(A), which for a buy 
transaction under $3.00 calls for the Theoretical Price to by adjusted 
by adding $0.15 \16\ to the Theoretical Price of $1.00. Thus, adjust 
execution price for leg 1 would be $1.15.
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    \16\ See Rule 720(c)(4)(A).

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[[Page 18176]]

     However, adjusting the execution price of leg 1 to $1.15 
violates the limit price of the Customer's sell order on the simple 
order book for leg 1, which was $1.30.
     Thus, the entire complex order transaction will be 
nullified \17\ because the limit price of a Customer's sell order would 
be violated by the adjustment.\18\
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    \17\ If any leg of a complex order is nullified, the entire 
transaction is nullified. See Proposed Rule 720.05(a).
    \18\ The simple order in this example is not an erroneous sell 
transaction because the execution price was not erroneously low. See 
Rule 720(a)(2).
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    As the above example demonstrates, incoming complex orders may 
execute against resting simple orders in the leg market. If a complex 
order leg is deemed to be an obvious error, adjusting the execution 
price of the leg may violate the limit price of the resting order, 
which will result in nullification if the resting order is for a 
Customer. In contrast, Rule 720(d)(1) provides that if an adjustment 
would result in an execution price that is higher than an erroneous buy 
transaction or lower than an erroneous sell transaction the execution 
will not be adjusted or nullified.\19\ If the adjustment of a complex 
order would violate the complex order Customer's limit price, the 
transaction will be nullified.
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    \19\ See Rule 720(d)(1).
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    As previously noted, paragraph (d)(3) of the Current Rule already 
mandates that if it is determined that a catastrophic error has 
occurred, the execution price of the transaction will be adjusted 
pursuant to the table set forth in (d)(3). For purposes of complex 
orders under Proposed Rule .05(a), if one of the legs of a complex 
orders is determined to be a Catastrophic Error under paragraph (d)(3), 
all market participants will be adjusted in accordance with the table 
set forth in (d)(3). Again, however, where at least one party to a 
complex order transaction is a Customer, the transaction will be 
nullified if adjustment would result in an execution price higher (for 
buy transactions) or lower (for sell transactions) than the Customer's 
limit price on the complex order or individual leg(s). Again, if any 
leg of a complex order is nullified, the entire transaction is 
nullified. Additionally, as is the case today, if it is determined that 
a Catastrophic Error has not occurred, the Exchange shall take action 
as set forth in ISE Rule 720(e). A Member that submits an appeal 
seeking the review of the Obvious Error Panel will be assessed a fee of 
$5,000 for each ruling that is overturned. In addition, in instances 
where the Exchange, on behalf of a Member requests a determination by 
another market center that a transaction is clearly erroneous, the 
Exchange will pass any resulting charges through to the relevant 
Member.
    Other than honoring the limit prices established for Customer 
orders, the Exchange has proposed to treat Customers and non-Customers 
the same in the context of the complex orders that trade against the 
leg market. When complex orders trade against the leg market, it is 
possible that at least some of the legs will execute at prices that 
would not be deemed obvious or catastrophic errors, which gives the 
counterparty in such situations no indication that the execution will 
later by adjusted or nullified. The Exchange believes that treating 
Customers and non-Customers the same in this context will provide 
additional certainty to non-Customers (especially Market-Makers) with 
respect to their potential exposure and hedging activities, including 
comfort that even if a transaction is later adjusted, 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 on the complex order or 
individual leg(s). 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 a Customer would not have expected, 
and market professionals such as non-Customers would be better prepared 
to recover in such situations. Therefore, adjustment for non-Customers 
is more appropriate.
    Second, proposed Supplementary Material .05(b) governs the review 
of complex orders that are executed against other complex orders. 
Proposed Rule 720.05(b) provides:

    If a complex order executes against another complex order and at 
least one of the legs qualifies as an Obvious Error under paragraph 
(c)(1) or a Catastrophic Error under paragraph (d)(1), then the 
leg(s) that is an Obvious or Catastrophic Error will be adjusted or 
busted in accordance with paragraph (c)(4) or (d)(3), respectively, 
so long as either: (i) The width of the National Spread Market for 
the complex order strategy just prior to the erroneous transaction 
was equal to or greater than the amount set forth in the wide quote 
table of paragraph (b)(3) or (ii) the net execution price of the 
complex order is higher (lower) than the offer (bid) of the National 
Spread Market for the complex order strategy just prior to the 
erroneous transaction by an amount equal to at least the amount 
shown in the table in paragraph (c)(1). If any leg of a complex 
order is nullified, the entire transaction is nullified. For 
purposes of Rule 720, the National Spread Market for a complex order 
strategy is determined by the National Best Bid/Offer of the 
individual legs of the strategy.

    As described above in relation to Proposed Rule 720.05(a), the 
first step is for the Exchange to review (upon receipt of a timely 
notification in accordance with paragraphs (c)(2) or (d)(2) of the 
Current Rule) the individual legs to determine whether a leg or legs 
qualifies as an obvious or catastrophic error. If no leg qualifies as 
an obvious or catastrophic error, the transaction stands--no adjustment 
and no nullification.
    Unlike Proposed Rule 720.05(a), the Exchange is also proposing to 
compare the net execution price of the entire complex order package to 
the National Spread Market (``NSM'') for the complex order 
strategy.\20\ Complex orders are exempt from the order protection rules 
of the options exchanges.\21\ Thus, depending on the manner in which 
the systems of an options exchange are calibrated, a complex order can 
execute without regard to the prices offered in the complex order books 
or the leg markets of other options exchanges. In certain situations, 
reviewing the execution prices of the legs in a vacuum would make the 
leg appear to be an obvious or catastrophic error, even though the net 
execution price on the complex order is not an erroneous price. For 
example, assume the Exchange receives a complex order to buy ABC calls 
and sell ABC puts.
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    \20\ For example, if the NBBO of Leg 1 is $1.00-2.00 and the 
NBBO of Leg 2 is $5.00-7.00, then the NSM for a complex order to buy 
Leg 1 and buy Leg 2 is $6.00-9.00. See ISE Rule 722. NSM is the 
derived net market for a complex order package.
    \21\ See Rule 1901(b)(7). All options exchanges have the same 
order protection rule.
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     If the BBO for the ABC calls is $5.50-7.50 and the BBO for 
ABC puts is $3.00-4.50, then the Exchange's spread market is $1.00-
4.50.\22\
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    \22\ The complex order is to buy ABC calls and sell ABC puts. 
The Exchange's best offer for ABC puts is $7.50 and Exchange's best 
bid for is $3.00. If the Customer were to buy the complex order 
strategy, the Customer would receive a debit of $4.50 (buy ABC calls 
for $7.50 minus selling ABC puts for $3.00). If the Customer were to 
sell the complex order strategy the Customer would receive a credit 
of $1.00 (selling the ABC calls for $5.50 minus buying the ABC puts 
for $4.50). Thus, the Exchange's spread market is $1.00-4.50.
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     If the NBBO for the ABC calls is $6.00-6.50 and the NBBO 
for the ABC puts is $3.50-4.00, then the NSM is $2.00-3.00.
     If the Customer buys the calls at $7.50 and sells the puts 
at $4.50, the complex order Customer receives a net execution price of 
$3.00 (debit), which

[[Page 18177]]

is the expected net execution price as indicated by the NSM offer of 
$3.00.
    If the exchange were to solely focus on the $7.50 execution price 
of the ABC calls or the $4.50 execution price of the ABC puts, the 
execution would qualify as an obvious or catastrophic error because the 
execution price on the legs was outside the NBBO, even though the net 
execution price is accurate. Thus, the additional review of the NSM to 
determine if the complex order was executed at a truly erroneous price 
is necessary. The same concern is not present when a complex order 
executes against the leg market under Proposed Rule 720.03(a). The ISE 
System permits a given leg of a complex order to trade through the NBBO 
provided the complex order trades no more than a configurable amount 
outside of the NBBO.\23\
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    \23\ See Supplementary Material .07 to Rule 722, which states, 
``[p]rice limits for complex orders and quotes. (a) As provided in 
paragraph (b)(3) above, the legs of a complex order may be executed 
at prices that are inferior to the prices available on other 
exchanges trading the same options series. Notwithstanding, the 
System will not permit any leg of a complex order to trade through 
the NBBO for the series by a configurable amount calculated as the 
lesser of (i) an absolute amount not to exceed $0.10, and (ii) a 
percentage of the NBBO not to exceed 500%, as determined by the 
Exchange on a class or series basis. A Member can also include an 
instruction on a complex order entered on the complex order book 
that each leg of the complex order is to be executed only at a price 
that is equal to or better than the national best bid or offer for 
the options series or any stock component, as applicable.''
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    In order to incorporate NSM, Rule 720.05(b) provides that if the 
Exchange determines that a leg or legs does qualify as on obvious or 
catastrophic error, the leg or legs will be adjusted or busted in 
accordance with paragraph (c)(4) or (d)(3) of the Current Rule, so long 
as either: (i) The width of the NSM for the complex order strategy just 
prior to the erroneous transaction was equal to or greater than the 
amount set forth in the wide quote table of paragraph (b)(3) of the 
Current Rule or (ii) the net execution price of the complex order is 
higher (lower) than the offer (bid) of the NSM for the complex order 
strategy just prior to the erroneous transaction by an amount equal to 
at least the amount shown in the table in paragraph (c)(1) of the 
Current Rule.
    For example, assume an individual leg or legs qualifies as an 
obvious or catastrophic error and the width of the NSM of the complex 
order strategy just prior to the erroneous transaction is $6.00-9.00. 
The complex order will qualify to be adjusted or busted in accordance 
with paragraph (c)(4) of the Current Rule because the wide quote table 
of paragraph (b)(3) of the Current Rule indicates that the minimum 
amount is $1.50 for a bid price between $5.00 to $10.00. If the NSM 
were instead $6.00-7.00 the complex order strategy would not qualify to 
be adjusted or busted pursuant to .05(b)(i) because the width of the 
NSM is $1.00, which is less than the required $1.50. However, the 
execution may still qualify to be adjusted or busted in accordance with 
paragraph (c)(4) or (d)(3) of the Current Rule pursuant to .05(b)(ii). 
Focusing on the NSM in this manner will ensure that the obvious/
catastrophic error review process focuses on the net execution price 
instead of the execution prices of the individual legs, which may have 
execution prices outside of the NBBO of the leg markets.
    Again, assume an individual leg or legs qualifies as an obvious or 
catastrophic error as described above. If the NSM is $6.00-7.00 (not a 
wide quote pursuant to the wide quote table in paragraph (b)(3) of the 
Current Rule) but the execution price of the entire complex order 
package (i.e., the net execution price) is higher (lower) than the 
offer (bid) of the NSM for the complex order strategy just prior to the 
erroneous transaction by an amount equal to at least the amount in the 
table in paragraph (c)(1) of the Current Rule, then the complex order 
qualifies to be adjusted or busted in accordance with paragraph (c)(4) 
or (d)(3) of the Current Rule. For example, if the NSM for the complex 
order strategy just prior to the erroneous transaction is $6.00-7.00 
and the net execution price of the complex order transaction is $7.75, 
the complex order qualifies to be adjusted or busted in accordance with 
paragraph (c)(4) of the Current Rule because the execution price of 
$7.75 is more than $0.50 (i.e., the minimum amount according to the 
table in paragraph (c)(1) when the price is above $5.00 but less than 
$10.01) from the NSM offer of $7.00. Focusing on the NSM in this manner 
will ensure that the obvious/catastrophic error review process focuses 
on the net execution price instead of the execution prices of the 
individual legs, which may have execution prices outside of the NBBO of 
the leg markets.
    Although the Exchange believes adjusting execution prices is 
generally better for the marketplace than nullifying executions because 
liquidity providers often execute hedging transactions to offset 
options positions, the Exchange recognizes that complex orders 
executing against other complex orders is similar to simple orders 
executing against other simple orders because both parties are able to 
review the execution price to determine whether the transaction may 
have been executed at an erroneous price. Thus, for purposes of complex 
orders that meet the requirements of Rule 720.05(b), the Exchange 
proposes to apply the Current Rule and adjust or bust obvious errors in 
accordance with paragraph (c)(4) (as opposed to applying paragraph 
(c)(4)(A) as is the case under .05(a)) and catastrophic errors in 
accordance with (d)(3).
    Therefore, for purposes of complex orders under Proposed Rule 
720.05(b), if one of the legs is determined to be an obvious error 
under paragraph (c)(1), all Customer transactions will be nullified, 
unless a Member submits 200 or more Customer transactions for review in 
accordance with (c)(4)(C).\24\ For purposes of complex orders under 
Proposed Rule 720.05(b), if one of the legs is determined to be a 
catastrophic error under paragraph (d)(3) and all of the other 
requirements of Rule 720.05(b) are met, all market participants will be 
adjusted in accordance with the table set forth in (d)(3). Again, 
however, pursuant to paragraph (d)(3) where at least one party to a 
complex order transaction is a Customer, the transaction will be 
nullified if adjustment would result in an execution price higher (for 
buy transactions) or lower (for sell transactions) than the Customer's 
limit price on the complex order or individual leg(s). Also, if any leg 
of a complex order is nullified, the entire transaction is nullified.
---------------------------------------------------------------------------

    \24\ Rule 720(c)(4)(C) also requires the orders resulting in 200 
or more Customer transactions to have been submitted during the 
course of 2 minutes or less.
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    Third, proposed Supplementary Material .05(c) governs stock-option 
orders.
    Proposed Rule 720.05(c) provides:

    If the option leg of a stock-option order qualifies as an 
Obvious Error under paragraph (c)(1) or a Catastrophic Error under 
paragraph (d)(1), then the option leg that is an Obvious or 
Catastrophic Error will be adjusted in accordance with paragraph 
(c)(4)(A) or (d)(3), respectively, regardless of whether one of the 
parties is a Customer. However, the option leg of any Customer order 
subject to this paragraph (c) 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 on the 
stock-option order, and the Exchange will attempt to nullify the 
stock leg. Whenever a stock trading venue nullifies the stock leg of 
a stock-option order or whenever the stock leg cannot be executed, 
the Exchange will nullify the option leg upon request of one of the 
parties to the transaction or in accordance with paragraph (c)(3).

    Similar to proposed Supplementary Material .05(a), an options leg 
(or legs) of a stock-option order must qualify as

[[Page 18178]]

an obvious or catastrophic error under the Current Rule in order for 
the stock-option order to qualify as an obvious or catastrophic error. 
Also similar to Proposed Rule 720.05(a), if an options leg (or legs) 
does qualify as an obvious or catastrophic error, the option leg (or 
legs) will be adjusted in accordance with paragraph (c)(4)(A) or 
(d)(3), respectively, regardless of whether one of the parties is a 
Customer. Again, as with Proposed Rule 720.05(a), where at least one 
party to a complex order transaction is a Customer, the Exchange will 
nullify the option leg and attempt to nullify the stock leg if 
adjustment would result in an execution price higher (for buy 
transactions) or lower (for sell transactions) than the Customer's 
limit price on the complex order or individual leg(s).
    The stock leg of a stock-option order is not executed on the 
Exchange; rather, the stock leg is sent to a stock trading venue for 
execution. The Exchange is unaware of a mechanism by which the Exchange 
can guarantee that the stock leg will be nullified by the stock trading 
venue in the event of an obvious or catastrophic error on the Exchange. 
Thus, in the event of the nullification of the option leg pursuant to 
Proposed Rule 720.05(c), the Exchange will attempt to have the stock 
leg nullified by the stock trading venue by either contacting the stock 
trading venue or notifying the parties to the transaction that the 
option leg is being nullified. The party or parties to the transaction 
may ultimately need to contact the stock trading venue to have the 
stock portion nullified. Finally, the Exchange proposes to provide 
guidance that whenever the stock trading venue nullifies the stock leg 
of a stock-option order, the option will be nullified upon request of 
one of the parties to the transaction or by an Official acting on their 
own motion in accordance with paragraph (c)(3). There are situations in 
which buyer and seller agree to trade a stock-option order, but the 
stock leg cannot be executed. The Exchange proposes to provide guidance 
that whenever the stock portion of a stock-option order cannot be 
executed, the Exchange will nullify the option leg upon request of one 
of the parties to the transaction or on an Official's own motion.
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 April 17, 2017.
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.\25\ Specifically, the 
proposal is consistent with Section 6(b)(5) of the Act \26\ 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.
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    \25\ 15 U.S.C. 78f(b).
    \26\ 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 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 \27\ in that the Proposed Rule will foster cooperation and 
coordination with persons engaged in regulating and facilitating 
transactions.
---------------------------------------------------------------------------

    \27\ 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 
Members, 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 does not believe that the proposal is unfairly 
discriminatory, even though it differentiates in many places between 
Customers and non-Customers. As with the Current Rule, Customers are 
treated 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 to adopt the ability to 
adjust a Customer's execution price when a complex order is deemed to 
be an Obvious or Catastrophic Error is consistent with the Act. A 
complex order that executes against individual leg markets may receive 
an execution price on an individual leg that is not an Obvious or 
Catastrophic error but another leg of the transaction is an Obvious or 
Catastrophic Error. In such situations where the complex order is 
executing against at least one individual or firm that is not aware of 
the fact that they have executed against a complex order or that the 
complex order has been executed at an erroneous price, the Exchange 
believes it is more appropriate to adjust execution prices if possible 
because the derivative transactions are often hedged with other 
securities. Allowing adjustments instead of nullifying transactions in 
these limited situations will help to ensure that market participants 
are not left with a hedge that has no position to hedge against.
    The Exchange also believes its proposal related to stock-option 
orders is consistent with the Act. Stock-option orders consist of an 
option component and a stock component. Due to the fact that the 
Exchange has no control over the venues on which the stock is executed 
the proposal focuses on the option component of the stock-option order 
by adjusting or nullifying the option in accordance with paragraph 
(c)(4)(A) or (d)(3). Also, nullifying the option component if the stock 
component cannot be executed ensures that market participants receive 
the execution for which they bargained. Stock-option orders are 
negotiated and agreed to as a package; thus, if for any reason the 
stock portion of a stock-option order cannot ultimately be executed, 
the parties should not be

[[Page 18179]]

saddled with an options position sans stock.

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

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition 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 inter-market 
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 that trade complex orders and/or stock-option orders 
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 intra-market 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, 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 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

    No written comments were either solicited or received.

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

    Because the foregoing 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, it has become 
effective pursuant to Section 19(b)(3)(A)(iii) of the Act \28\ and 
subparagraph (f)(6) of Rule 19b-4 thereunder.\29\
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    \28\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \29\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6) 
requires a self-regulatory organization to give the Commission 
written notice of its intent to file 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. 
The Exchange has satisfied this requirement.
---------------------------------------------------------------------------

    A proposed rule change filed pursuant to Rule 19b-4(f)(6) under the 
Act \30\ normally does not become operative for 30 days after the date 
of its filing. However, Rule 19b-4(f)(6)(iii) \31\ permits the 
Commission to designate a shorter time if such action is consistent 
with the protection of investors and the public interest. 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 allow the Exchange to implement the proposed rule change by 
April 17, 2017 in coordination with the other options exchanges. 
Accordingly, the Commission hereby waives the operative delay and 
designates the proposal operative upon filing.\32\
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    \30\ 17 CFR 240.19b-4(f)(6).
    \31\ 17 CFR 240.19b-4(f)(6)(iii).
    \32\ 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).
---------------------------------------------------------------------------

    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: (i) 
Necessary or appropriate in the public interest; (ii) for the 
protection of investors; or (iii) 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-ISE-2017-30 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-ISE-2017-30. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-ISE-

[[Page 18180]]

2017-30, and should be submitted on or before May 8, 2017.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\33\
---------------------------------------------------------------------------

    \33\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-07635 Filed 4-14-17; 8:45 am]
BILLING CODE 8011-01-P


