Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order Granting Accelerated Approval of a Proposed Rule Change To Address Obvious and Catastrophic Options Errors in Response to the Regulation NMS Plan To Address Extraordinary Market Volatility, 22001-22004 [2013-08612]

Download as PDF Federal Register / Vol. 78, No. 71 / Friday, April 12, 2013 / Notices III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing rule change has become effective pursuant to Section 19(b)(3)(A)(ii) of the Act 13 and subparagraph (f)(2) of Rule 19b–4 thereunder,14 because it establishes a due, fee, or other charge imposed by ISE. At any time within 60 days of the filing of such 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: mstockstill on DSK6TPTVN1PROD with NOTICES Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rulecomments@sec.gov. Please include File Number SR–ISE–2013–29 on the subject line. Paper Comments • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–ISE–2013–29. 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 (https://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 13 15 14 17 U.S.C. 78s(b)(3)(A)(ii). CFR 240.19b–4(f)(2). VerDate Mar<15>2010 16:47 Apr 11, 2013 Jkt 229001 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 ISE. 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– 2013–29 and should be submitted on or before May 3, 2013. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.15 Kevin M. O’Neill, Deputy Secretary. [FR Doc. 2013–08608 Filed 4–11–13; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–69344; File No. SR–Phlx– 2013–29] Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order Granting Accelerated Approval of a Proposed Rule Change To Address Obvious and Catastrophic Options Errors in Response to the Regulation NMS Plan To Address Extraordinary Market Volatility April 8, 2013. I. Introduction On March 14, 2013, NASDAQ OMX PHLX LLC (‘‘Phlx’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change to provide for how the Exchange proposes to treat obvious and catastrophic options errors in response to the Regulation NMS Plan to Address Extraordinary Market Volatility (the ‘‘Plan’’). The proposed rule change was published for comment in the Federal Register on March 20, 2013.3 The Commission received one comment 15 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 Securities Exchange Act Release No. 69141 (March 15, 2013), 78 FR 17262 (‘‘Notice’’). 1 15 PO 00000 Frm 00097 Fmt 4703 Sfmt 4703 22001 letter on the proposal.4 This order approves the proposed rule change on an accelerated basis. II. Description of the Proposed Rule Change Since May 6, 2010, when the financial markets experienced a severe disruption, the equities exchanges and the Financial Industry Regulatory Authority have developed market-wide measures to help prevent a recurrence. In particular, on May 31, 2012, the Commission approved the Plan, as amended, on a one-year pilot basis.5 The Plan is designed to prevent trades in individual NMS stocks from occurring outside of specified Price Bands, creating a market-wide limit uplimit down mechanism that is intended to address extraordinary market volatility in NMS Stocks.6 In connection with the implementation of the Plan, the Exchange proposes to adopt new Rule 1047(f)(v) to exclude electronic trades that occur during a Limit State or Straddle State from the obvious error or catastrophic error review procedures pursuant to Rule 1092(a)(i) or (ii) and the nullification or adjustment provisions pursuant to Rule 1092(c)(ii)(E) or (F), for a one year pilot basis from the date of adoption of the proposed rule change.7 The Exchange proposes to retain the ability to review electronic trades that occur during a Limit State or Straddle State by Exchange motion pursuant to Rule 1092(e)(i)(B). Under Rule 1092(a)(i) and (ii), obvious and catastrophic errors are calculated by determining a theoretical price and applying such price to ascertain whether the trade should be nullified or adjusted. Pursuant to Rule 1092(a)(i) and (ii), obvious and catastrophic errors are determined by comparing the theoretical price of the option, calculated by one of the methods in Rule 1092(b), to an adjustment table in Rule 1092(a). Generally, the theoretical price of an 4 See Letter to Heather Seidel, Associate Director, Division of Trading and Markets, Commission, from Thomas A. Wittman, President, Phlx, dated April 5, 2013 (‘‘Phlx Letter’’). 5 Securities Exchange Act Release No. 67091 (May 31, 2012), 77 FR 33498. 6 Unless otherwise specified, capitalized terms used in this rule filing are based on the defined terms of the Plan. 7 The Exchange stated that various members of the Exchange staff have spoken to a number of member organizations about obvious and catastrophic errors during a Limit State or Straddle State and that a variety of viewpoints emerged, mostly focused on having many trades stand, on fairness and fair and orderly markets, and on being able to re-address the details during the course of the pilot, if needed. E:\FR\FM\12APN1.SGM 12APN1 22002 Federal Register / Vol. 78, No. 71 / Friday, April 12, 2013 / Notices mstockstill on DSK6TPTVN1PROD with NOTICES option is the National Best Bid and Offer (‘‘NBBO’’) of the option. In certain circumstances, Exchange officials have the discretion to determine the theoretical price.8 The Exchange believes that none of these methods is appropriate during a Limit State or Straddle State. Under Rule 1092(b)(i), the theoretical price is determined with respect to the NBBO for an option series just prior to the trade. According to the Exchange, during a Limit State or Straddle State, options prices may deviate substantially from those available prior to or following the state. The Exchange believes this provision would give rise to much uncertainty for market participants as there is no bright line definition of what the theoretical price should be for an option when the underlying NMS stock has an unexecutable bid or offer or both. Because the approach under Rule 1092(b)(i) by definition depends on a reliable NBBO, the Exchange does not believe that approach is appropriate during a Limit State or Straddle State. Additionally, because the Exchange system will only trade through the theoretical bid or offer if the Exchange or the participant (via an ISO order) has accessed all better priced interest away in accordance with the Options Order Protection and Locked/Crossed Markets Plan, the Exchange believes potential trade reviews of executions that occurred at the participant’s limit price and also in compliance with the aforementioned Plan could harm liquidity and also create an advantage to either side of an execution depending on the future movement of the underlying stock. With respect to Rule 1092(b)(ii) affording discretion to the Options Exchange Official to determine the theoretical price and thereby, ultimately, whether a trade is busted or adjusted and to what price, the Exchange notes that it would be difficult to exercise such discretion in periods of extraordinary market volatility and, in 8 Specifically, under Rule 1092(b), the theoretical price is determined in one of three ways: (i) If the series is traded on at least one other options exchange, the last National Best Bid price with respect to an erroneous sell transaction and the last National Best Offer price with respect to an erroneous buy transaction, just prior to the trade; (ii) as determined by an Options Exchange Official in its discretion, if there are no quotes for comparison purposes, or if the bid/ask differential of the NBBO for the affected series, just prior to the erroneous transaction, was at least two times the permitted bid/ask differential under the Exchange’s rules; or (iii) for transactions occurring as part of the Exchange’s automated opening system, the theoretical price shall be the first quote after the transaction(s) in question that does not reflect the erroneous transaction(s). VerDate Mar<15>2010 16:47 Apr 11, 2013 Jkt 229001 particular, when the price of the underlying security is unreliable. The Exchange again notes that the theoretical price in this context would be subjective.9 Ultimately, the Exchange believes that adding certainty to the execution of orders in these situations should encourage market participants to continue to provide liquidity to the Exchange, thus promoting fair and orderly markets. On balance, the Exchange believes that removing the potential inequity of nullifying or adjusting executions occurring during Limit States or Straddle States outweighs any potential benefits from applying these provisions during such unusual market conditions. Additionally, the Exchange proposes to provide that trades would not be subject to review under Rule 1092(c)(ii)(E) during a Limit or Straddle State. Under Rule 1092(c)(ii)(E), a trade may be nullified or adjusted where an execution occurred in a series quoted no bid. The Exchange believes that these situations are not appropriate for an error review because they are more likely to result in a windfall to one party at the expense of another in a Limit State or Straddle State, because the criteria for meeting the no-bid provision are more likely to be met in a Limit State or Straddle State, and unlike normal circumstances, may not be a true reflection of the value of the series being quoted. In response to these concerns, the Exchange proposes to adopt Rule 1047(f)(v) to provide that electronic trades are not subject to an obvious error or catastrophic error review pursuant to Rule 1092(a)(i) and (ii) and Rule 1092(c)(ii)(F) during a Limit State or Straddle State. In addition, the Exchange proposes to provide that electronic trades are not subject to review if, pursuant to Rule 1092(c)(ii)(E), the trade resulted in an execution in a series quoted no bid. Finally, proposed Rule 1047(f)(v) also will include a qualification that nothing in proposed Rule 1047(f)(v) will prevent electronic trades from being reviewed on Exchange motion pursuant to Rule 1092(e)(i)(B). According to the Exchange, this safeguard will provide the flexibility to act when necessary and appropriate, while also providing market participants with certainty that trades they effect with quotes and/or orders having limit prices will stand irrespective of subsequent moves in the 9 The Exchange also notes that the determination of theoretical price under Rule 1092(b)(iii) applies to trades executed during openings. Because the Exchange does not intend to open an option during a Limit State or Straddle State, this provision will not apply. PO 00000 Frm 00098 Fmt 4703 Sfmt 4703 underlying security. The right to review on Exchange motion electronic transactions that occur during a Limit State or Straddle State under this provision, according to the Exchange, would enable the Exchange to account for unforeseen circumstances that result in obvious or catastrophic errors for which a nullification or adjustment may be necessary in order to preserve the interest of maintaining a fair and orderly market and for the protection of investors. III. Discussion The Commission finds that the Exchange’s proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.10 Specifically, the Commission finds that the proposal is consistent with Section 6(b)(5) of the Act,11 in that it is designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, protect investors and the public interest. In the filing, the Exchange notes its belief that suspending certain aspects of Rule 1092 during a Limit State or Straddle State will ensure that limit orders that are filled during a Limit or Straddle State will have certainty of execution in a manner that promotes just and equitable principles of trade and removes impediments to, and perfects the mechanism of, a free and open market and a national market system. The Exchange believes the application of the current rule would be impracticable given what it perceives will be the lack of a reliable NBBO in the options market during Limit States and Straddle States, and that the resulting actions (i.e., nullified trades or adjusted prices) may not be appropriate given market conditions. In addition, given the Exchange’s view that options prices during Limit States or Straddle States may deviate substantially from those available shortly following the Limit State or Straddle State, the Exchange believes that providing market participants time to re-evaluate a transaction executed during a Limit or 10 In approving this proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 11 15 U.S.C. 78f(b)(5). E:\FR\FM\12APN1.SGM 12APN1 mstockstill on DSK6TPTVN1PROD with NOTICES Federal Register / Vol. 78, No. 71 / Friday, April 12, 2013 / Notices Straddle State will create an unreasonable adverse selection opportunity that will discourage participants from providing liquidity during Limit States or Straddle States. Ultimately, the Exchange believes that adding certainty to the execution of orders in these situations should encourage market participants to continue to provide liquidity to the Exchange during Limit States and Straddle States, thus promoting fair and orderly markets. The Exchange, however, has proposed this rule change based on its expectations about the quality of the options market during Limit States and Straddle States. The Exchange states, for example, that it believes that application of the obvious and catastrophic error rules would be impracticable given the potential for lack of a reliable NBBO in the options market during Limit States and Straddle States. Given the Exchange’s recognition of the potential for unreliable NBBOs in the options markets during Limit States and Straddle States, the Commission is concerned about the extent to which investors may rely to their detriment on the quality of quotations and price discovery in the options markets during these periods. This concern is heightened by the Exchange’s proposal to exclude electronic trades that occur during a Limit State or Straddle State from the obvious error or catastrophic error review procedures pursuant to Rule 1092(a)(i) or (ii) and the nullification or adjustment provisions pursuant to Rule 1092(c)(ii)(E) or (F). The Commission urges investors and market professionals to exercise caution when considering trading options under these circumstances. Broker-dealers also should be mindful of their obligations to customers that may or may not be aware of specific options market conditions or the underlying stock market conditions when placing their orders. While the Commission remains concerned about the quality of the options market during the Limit and Straddle States, and the potential impact on investors of executing in this market without the protections of the obvious or catastrophic error rules that are being suspended during the Limit and Straddle States, it believes that certain aspects of the proposal could help mitigate those concerns. First, despite the removal of obvious and catastrophic error protection during Limit States and Straddle States, the Exchange states that there are additional measures in place designed to protect investors. For example, the Exchange states that by rejecting market orders and stop orders, and cancelling pending VerDate Mar<15>2010 16:47 Apr 11, 2013 Jkt 229001 market orders and stop orders, only those orders with a limit price will be executed during a Limit State or Straddle State. Additionally, the Exchange notes the existence of SEC Rule 15c3–5 requiring broker-dealers to have controls and procedures in place that are reasonably designed to prevent the entry of erroneous orders. Finally, with respect to limit orders that will be executable during Limit States and Straddle States, the Exchange states that it applies price checks to limit orders that are priced sufficiently far through the NBBO. Therefore, on balance, the Exchange believes that removing the potential inequity of nullifying or adjusting executions occurring during Limit States or Straddle States outweighs any potential benefits from applying certain provisions during such unusual market conditions. The Exchange also believes that the aspect of proposed rule change that will continue to allow the Exchange to review on its own motion electronic trades that occur during a Limit State or a Straddle State is consistent with the Act because it would provide flexibility for the Exchange to act when necessary and appropriate to nullify or adjust a transaction and will enable the Exchange to account for unforeseen circumstances that result in obvious or catastrophic errors for which a nullification or adjustment may be necessary in order to preserve the interest of maintaining a fair and orderly market and for the protection of investors. The Exchange represents that it recognizes that this provision is limited and that it will administer the provision in a manner that is consistent with the principles of the Act. In addition, the Exchange represents that it will create and maintain records relating to the use of the authority to act on its own motion during a Limit State or Straddle State. Finally, the Exchange has proposed that the changes be implemented on a one year pilot basis. The Commission believes that it is important to implement the proposal as a pilot. The one year pilot period will allow the Exchange time to assess the impact of the Plan on the options marketplace and allow the Commission to further evaluate the effect of the proposal prior to any proposal or determination to make the changes permanent. To this end, the Exchange has committed to: (1) Evaluate the options market quality during Limit States and Straddle States; (2) assess the character of incoming order flow and transactions during Limit States and Straddle States; and (3) review any complaints from members and their customers concerning PO 00000 Frm 00099 Fmt 4703 Sfmt 4703 22003 executions during Limit States and Straddle States. Additionally, the Exchange has agreed to provide the Commission with data requested to evaluate the impact of the elimination of the obvious error rule, including data relevant to assessing the various analyses noted above. On April 5, 2013, the Exchange submitted a letter stating that it would provide specific data to the Commission and the public and certain analysis to the Commission to evaluate the impact of Limit States and Straddle States on liquidity and market quality in the options markets.12 This will allow the Commission, the Exchange, and other interested parties to evaluate the quality of the options markets during Limit States and Straddle States and to assess whether the additional protections noted by the Exchange are sufficient safeguards against the submission of erroneous trades, and whether the Exchange’s proposal appropriately balances the protection afforded to an erroneous order sender against the potential hazards associated with providing 12 In particular, the Exchange represented that, at least two months prior to the end of the one year pilot period of proposed Section 3(d)(iv), it would provide to the Commission an evaluation of (i) the statistical and economic impact of Straddle States on liquidity and market quality in the options market and (ii) whether the lack of obvious error rules in effect during the Limit States and Straddle States are problematic. In addition, the Exchange represented that each month following the adoption of the proposed rule change it would provide to the Commission and the public a dataset containing certain data elements for each Limit State and Straddle State in optionable stocks. The Exchange stated that the options included in the dataset will be those that meet the following conditions: (i) The options are more than 20% in the money (strike price remains greater than 80% of the last stock trade price for calls and strike price remains greater than 120% of the last stock trade price for puts when the Limit State or Straddle State is reached); (ii) the option has at least two trades during the Limit State or Straddle State; and (iii) the top ten options (as ranked by overall contract volume on that day) meeting the conditions listed above. For each of those options affected, each dataset will include, among other information: Stock symbol, option symbol, time at the start of the Limit State or Straddle State and an indicator for whether it is a Limit State or Straddle State. For activity on the Exchange in the relevant options, the Exchange has agreed to provide executed volume, time-weighted quoted bid-ask spread, time-weighted average quoted depth at the bid, time-weighted average quoted depth at the offer, high execution price, low execution price, number of trades for which a request for review for error was received during Limit States and Straddle States, an indicator variable for whether those options outlined above have a price change exceeding 30% during the underlying stock’s Limit State or Straddle State compared to the last available option price as reported by OPRA before the start of the Limit or Straddle State (1 if observe 30% and 0 otherwise), and another indicator variable for whether the option price within five minutes of the underlying stock leaving the Limit State or Straddle State (or halt if applicable) is 30% away from the price before the start of the Limit State or Straddle State. See Phlx Letter, supra note 4. E:\FR\FM\12APN1.SGM 12APN1 22004 Federal Register / Vol. 78, No. 71 / Friday, April 12, 2013 / Notices market participants additional time to review trades submitted during a Limit State or Straddle State. Finally, the Commission notes that the Plan, to which these rules relate, will be implemented on April 8, 2013. Accordingly, for the reasons stated above, and in consideration of the April 8, 2013 implementation date of the Plan, the Commission finds good cause, pursuant to Section 19(b)(2) of the Act,13 for approving the Exchange’s proposal prior to the 30th day after the publication of the notice in the Federal Register. IV. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,14 that the proposed rule change (SR–Phlx–2013– 29), be, and hereby is, approved on an accelerated basis. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.15 Kevin M. O’Neill, Deputy Secretary. [FR Doc. 2013–08612 Filed 4–11–13; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–69340; File No. SR– NYSEArca–2013–10] Self-Regulatory Organizations; NYSE Arca LLC; Order Approving, on an Accelerated Basis, Proposed Rule Change, as Modified by Amendment No. 1, Adopting New Exchange Rule 6.65A To Provide for How the Exchange Proposes To Treat Orders, Market-Making Quoting Obligations, and Errors in Response to the Regulation NMS Plan To Address Extraordinary Market Volatility; and Amending Exchange Rule 6.65 To Codify That the Exchange Shall Halt Trading in All Options Overlying NMS Stocks When the Equities Markets Initiate a Market-Wide Trading Halt Due to Extraordinary Market Volatility April 8, 2013. mstockstill on DSK6TPTVN1PROD with NOTICES I. Introduction On February 26, 2013, NYSE Arca, Inc. (the ‘‘Exchange’’ or ‘‘NYSE Arca’’) filed with the Securities and Exchange 13 15 U.S.C. 78s(b)(2). The Commission noticed substantially similar rules proposed by NYSE MKT LLC and NYSE Arca, Inc. with a full 21 day comment period. See Securities Exchange Act Release No. 69033, 78 FR 15067 (March 8, 2013) and Securities Exchange Act Release No. 69032, 78 FR 15080 (March 8, 2013). 14 15 U.S.C. 78s(b)(2). 15 17 CFR 200.30–3(a)(12). VerDate Mar<15>2010 16:47 Apr 11, 2013 Jkt 229001 Commission (‘‘Commission’’), pursuant to Section 19(b)(1) 1 of the Securities Exchange Act of 1934 (‘‘Act’’),2 and Rule 19b–4 thereunder,3 a proposed rule change to provide for how the Exchange proposes to treat orders, market-making quoting obligations, and errors in response to the Regulation NMS Plan to Address Extraordinary Market Volatility and to codify that the Exchange shall halt trading in all options overlying NMS stocks when the equities markets initiate a market-wide trading halt due to extraordinary market volatility. The proposed rule change was published for comment in the Federal Register on March 4, 2013.4 On April 1, 2013, the Exchange submitted Amendment No. 1 to the proposed rule change.5 The Commission received one comment letters on the proposal.6 This order approves the proposed rule change on an accelerated basis. II. Background On May 6, 2010, the U.S. equity markets experienced a severe disruption that, among other things, resulted in the prices of a large number of individual securities suddenly declining by significant amounts in a very short time period before suddenly reversing to prices consistent with their pre-decline levels.7 This severe price volatility led to a large number of trades being executed at temporarily depressed prices, including many that were more than 60% away from pre-decline prices. One response to the events of May 6, 2010, was the development of the single-stock circuit breaker pilot program, which was implemented 1 15 U.S.C. 78s(b)(1). U.S.C. 78a. 3 17 CFR 240.19b–4. 4 See Securities Exchange Act Release No. 69032, 78 FR 15080 (March 8, 2013). 5 In Amendment No. 1, the Exchange expanded upon its rationale for its proposed changes regarding the nullification and adjustment of options transactions, agreed to provide the Commission with relevant data to assess the impact of the proposal, and clarified the length of the pilot period related to such changes. Because the changes made in Amendment No. 1 do not materially alter the substance of the proposed rule change or raise any novel regulatory issues, Amendment No. 1 is not subject to notice and comment. 6 See Letter to Elizabeth M. Murphy, Secretary, Commission, from Janet McGinness, Executive Vice President and Corporate Secretary, General Counsel, NYSE Markets, dated April 5, 2013 (‘‘NYSE Letter’’). 7 The events of May 6 are described more fully in a joint report by the staffs of the Commodity Futures Trading Commission (‘‘CFTC’’) and the Commission. See Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues, ‘‘Findings Regarding the Market Events of May 6, 2010,’’ dated September 30, 2010, available at https:// www.sec.gov/news/studies/2010/marketeventsreport.pdf. 2 15 PO 00000 Frm 00100 Fmt 4703 Sfmt 4703 through a series of rule filings by the equity exchanges and by FINRA.8 The single-stock circuit breaker was designed to reduce extraordinary market volatility in NMS stocks by imposing a five-minute trading pause when a trade was executed at a price outside of a specified percentage threshold.9 To replace the single-stock circuit breaker pilot program, the equity exchanges filed a National Market System Plan 10 pursuant to Section 11A of the Act,11 and Rule 608 thereunder,12 which featured a ‘‘limit up-limit down’’ mechanism (as amended, the ‘‘Limit UpLimit Down Plan’’ or ‘‘Plan’’). The Plan sets forth requirements that are designed to prevent trades in individual NMS stocks from occurring outside of the specified price bands. The price bands consist of a lower price band and an upper price band for each NMS stock. When one side of the market for an individual security is outside the applicable price band, i.e., the National Best Bid is below the Lower Price Band, or the National Best Offer is above the Upper Price band, the Processors 13 are required to disseminate such National Best Bid or National Best Offer 14 with a flag identifying that quote as non-executable. When the other side of the market reaches the applicable 8 For further discussion on the development of the single-stock circuit breaker pilot program, see Securities Exchange Act Release No. 67091 (May 31, 2012), 77 FR 33498 (June 6, 2012) (‘‘Limit UpLimit Down Plan’’ or ‘‘Plan’’). 9 See Securities Exchange Act Release Nos. 62884 (September 10, 2010), 75 FR 56618 (September 16, 2010) and Securities Exchange Act Release No. 62883 (September 10, 2010), 75 FR 56608 (September 16, 2010) (SR–FINRA–2010–033) (describing the ‘‘second stage’’ of the single-stock circuit breaker pilot) and Securities Exchange Act Release No. 64735 (June 23, 2011), 76 FR 38243 (June 29, 2011) (describing the ‘‘third stage’’ of the single-stock circuit breaker pilot). 10 NYSE Euronext filed on behalf of New York Stock Exchange LLC (‘‘NYSE’’), NYSE Amex LLC (‘‘NYSE Amex’’), and NYSE Arca, Inc. (‘‘NYSE Arca’’), and the parties to the proposed National Market System Plan, BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Board Options Exchange, Incorporated (‘‘CBOE’’), Chicago Stock Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., Financial Industry Regulatory Authority, Inc., NASDAQ OMX BX, Inc., NASDAQ OMX PHLX LLC, the Nasdaq Stock Market LLC, and National Stock Exchange, Inc. (collectively with NYSE, NYSE MKT, and NYSE Arca, the ‘‘Participants’’). On May 14, 2012, NYSE Amex filed a proposed rule change on an immediately effective basis to change its name to NYSE MKT LLC (‘‘NYSE MKT’’). See Securities Exchange Act Release No. 67037 (May 21, 2012) (SR–NYSEAmex–2012–32). 11 15 U.S.C. 78k–1. 12 17 CFR 242.608. 13 As used in the Plan, the Processor refers to the single plan processor responsible for the consolidation of information for an NMS Stock pursuant to Rule 603(b) of Regulation NMS under the Exchange Act. See id. 14 ‘‘National Best Bid’’ and ‘‘National Best Offer’’ has the meaning provided in Rule 600(b)(42) of Regulation NMS under the Exchange Act. See id. E:\FR\FM\12APN1.SGM 12APN1

Agencies

[Federal Register Volume 78, Number 71 (Friday, April 12, 2013)]
[Notices]
[Pages 22001-22004]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08612]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69344; File No. SR-Phlx-2013-29]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Granting Accelerated Approval of a Proposed Rule Change To Address 
Obvious and Catastrophic Options Errors in Response to the Regulation 
NMS Plan To Address Extraordinary Market Volatility

April 8, 2013.

I. Introduction

    On March 14, 2013, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change 
to provide for how the Exchange proposes to treat obvious and 
catastrophic options errors in response to the Regulation NMS Plan to 
Address Extraordinary Market Volatility (the ``Plan''). The proposed 
rule change was published for comment in the Federal Register on March 
20, 2013.\3\ The Commission received one comment letter on the 
proposal.\4\ This order approves the proposed rule change on an 
accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 69141 (March 15, 2013), 
78 FR 17262 (``Notice'').
    \4\ See Letter to Heather Seidel, Associate Director, Division 
of Trading and Markets, Commission, from Thomas A. Wittman, 
President, Phlx, dated April 5, 2013 (``Phlx Letter'').
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    Since May 6, 2010, when the financial markets experienced a severe 
disruption, the equities exchanges and the Financial Industry 
Regulatory Authority have developed market-wide measures to help 
prevent a recurrence. In particular, on May 31, 2012, the Commission 
approved the Plan, as amended, on a one-year pilot basis.\5\ The Plan 
is designed to prevent trades in individual NMS stocks from occurring 
outside of specified Price Bands, creating a market-wide limit up-limit 
down mechanism that is intended to address extraordinary market 
volatility in NMS Stocks.\6\
---------------------------------------------------------------------------

    \5\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77 
FR 33498.
    \6\ Unless otherwise specified, capitalized terms used in this 
rule filing are based on the defined terms of the Plan.
---------------------------------------------------------------------------

    In connection with the implementation of the Plan, the Exchange 
proposes to adopt new Rule 1047(f)(v) to exclude electronic trades that 
occur during a Limit State or Straddle State from the obvious error or 
catastrophic error review procedures pursuant to Rule 1092(a)(i) or 
(ii) and the nullification or adjustment provisions pursuant to Rule 
1092(c)(ii)(E) or (F), for a one year pilot basis from the date of 
adoption of the proposed rule change.\7\ The Exchange proposes to 
retain the ability to review electronic trades that occur during a 
Limit State or Straddle State by Exchange motion pursuant to Rule 
1092(e)(i)(B).
---------------------------------------------------------------------------

    \7\ The Exchange stated that various members of the Exchange 
staff have spoken to a number of member organizations about obvious 
and catastrophic errors during a Limit State or Straddle State and 
that a variety of viewpoints emerged, mostly focused on having many 
trades stand, on fairness and fair and orderly markets, and on being 
able to re-address the details during the course of the pilot, if 
needed.
---------------------------------------------------------------------------

    Under Rule 1092(a)(i) and (ii), obvious and catastrophic errors are 
calculated by determining a theoretical price and applying such price 
to ascertain whether the trade should be nullified or adjusted. 
Pursuant to Rule 1092(a)(i) and (ii), obvious and catastrophic errors 
are determined by comparing the theoretical price of the option, 
calculated by one of the methods in Rule 1092(b), to an adjustment 
table in Rule 1092(a). Generally, the theoretical price of an

[[Page 22002]]

option is the National Best Bid and Offer (``NBBO'') of the option. In 
certain circumstances, Exchange officials have the discretion to 
determine the theoretical price.\8\
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    \8\ Specifically, under Rule 1092(b), the theoretical price is 
determined in one of three ways: (i) If the series is traded on at 
least one other options exchange, the last National Best Bid price 
with respect to an erroneous sell transaction and the last National 
Best Offer price with respect to an erroneous buy transaction, just 
prior to the trade; (ii) as determined by an Options Exchange 
Official in its discretion, if there are no quotes for comparison 
purposes, or if the bid/ask differential of the NBBO for the 
affected series, just prior to the erroneous transaction, was at 
least two times the permitted bid/ask differential under the 
Exchange's rules; or (iii) for transactions occurring as part of the 
Exchange's automated opening system, the theoretical price shall be 
the first quote after the transaction(s) in question that does not 
reflect the erroneous transaction(s).
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    The Exchange believes that none of these methods is appropriate 
during a Limit State or Straddle State. Under Rule 1092(b)(i), the 
theoretical price is determined with respect to the NBBO for an option 
series just prior to the trade. According to the Exchange, during a 
Limit State or Straddle State, options prices may deviate substantially 
from those available prior to or following the state. The Exchange 
believes this provision would give rise to much uncertainty for market 
participants as there is no bright line definition of what the 
theoretical price should be for an option when the underlying NMS stock 
has an unexecutable bid or offer or both. Because the approach under 
Rule 1092(b)(i) by definition depends on a reliable NBBO, the Exchange 
does not believe that approach is appropriate during a Limit State or 
Straddle State. Additionally, because the Exchange system will only 
trade through the theoretical bid or offer if the Exchange or the 
participant (via an ISO order) has accessed all better priced interest 
away in accordance with the Options Order Protection and Locked/Crossed 
Markets Plan, the Exchange believes potential trade reviews of 
executions that occurred at the participant's limit price and also in 
compliance with the aforementioned Plan could harm liquidity and also 
create an advantage to either side of an execution depending on the 
future movement of the underlying stock.
    With respect to Rule 1092(b)(ii) affording discretion to the 
Options Exchange Official to determine the theoretical price and 
thereby, ultimately, whether a trade is busted or adjusted and to what 
price, the Exchange notes that it would be difficult to exercise such 
discretion in periods of extraordinary market volatility and, in 
particular, when the price of the underlying security is unreliable. 
The Exchange again notes that the theoretical price in this context 
would be subjective.\9\ Ultimately, the Exchange believes that adding 
certainty to the execution of orders in these situations should 
encourage market participants to continue to provide liquidity to the 
Exchange, thus promoting fair and orderly markets. On balance, the 
Exchange believes that removing the potential inequity of nullifying or 
adjusting executions occurring during Limit States or Straddle States 
outweighs any potential benefits from applying these provisions during 
such unusual market conditions.
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    \9\ The Exchange also notes that the determination of 
theoretical price under Rule 1092(b)(iii) applies to trades executed 
during openings. Because the Exchange does not intend to open an 
option during a Limit State or Straddle State, this provision will 
not apply.
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    Additionally, the Exchange proposes to provide that trades would 
not be subject to review under Rule 1092(c)(ii)(E) during a Limit or 
Straddle State. Under Rule 1092(c)(ii)(E), a trade may be nullified or 
adjusted where an execution occurred in a series quoted no bid. The 
Exchange believes that these situations are not appropriate for an 
error review because they are more likely to result in a windfall to 
one party at the expense of another in a Limit State or Straddle State, 
because the criteria for meeting the no-bid provision are more likely 
to be met in a Limit State or Straddle State, and unlike normal 
circumstances, may not be a true reflection of the value of the series 
being quoted.
    In response to these concerns, the Exchange proposes to adopt Rule 
1047(f)(v) to provide that electronic trades are not subject to an 
obvious error or catastrophic error review pursuant to Rule 1092(a)(i) 
and (ii) and Rule 1092(c)(ii)(F) during a Limit State or Straddle 
State. In addition, the Exchange proposes to provide that electronic 
trades are not subject to review if, pursuant to Rule 1092(c)(ii)(E), 
the trade resulted in an execution in a series quoted no bid.
    Finally, proposed Rule 1047(f)(v) also will include a qualification 
that nothing in proposed Rule 1047(f)(v) will prevent electronic trades 
from being reviewed on Exchange motion pursuant to Rule 1092(e)(i)(B). 
According to the Exchange, this safeguard will provide the flexibility 
to act when necessary and appropriate, while also providing market 
participants with certainty that trades they effect with quotes and/or 
orders having limit prices will stand irrespective of subsequent moves 
in the underlying security. The right to review on Exchange motion 
electronic transactions that occur during a Limit State or Straddle 
State under this provision, according to the Exchange, would enable the 
Exchange to account for unforeseen circumstances that result in obvious 
or catastrophic errors for which a nullification or adjustment may be 
necessary in order to preserve the interest of maintaining a fair and 
orderly market and for the protection of investors.

III. Discussion

    The Commission finds that the Exchange's proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\10\ Specifically, the Commission finds that the proposal is 
consistent with Section 6(b)(5) of the Act,\11\ in that it is designed 
to prevent fraudulent and manipulative acts and practices, promote just 
and equitable principles of trade, foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, remove impediments to and perfect the mechanism of a free 
and open market and a national market system, and, in general, protect 
investors and the public interest.
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    \10\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78f(b)(5).
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    In the filing, the Exchange notes its belief that suspending 
certain aspects of Rule 1092 during a Limit State or Straddle State 
will ensure that limit orders that are filled during a Limit or 
Straddle State will have certainty of execution in a manner that 
promotes just and equitable principles of trade and removes impediments 
to, and perfects the mechanism of, a free and open market and a 
national market system. The Exchange believes the application of the 
current rule would be impracticable given what it perceives will be the 
lack of a reliable NBBO in the options market during Limit States and 
Straddle States, and that the resulting actions (i.e., nullified trades 
or adjusted prices) may not be appropriate given market conditions. In 
addition, given the Exchange's view that options prices during Limit 
States or Straddle States may deviate substantially from those 
available shortly following the Limit State or Straddle State, the 
Exchange believes that providing market participants time to re-
evaluate a transaction executed during a Limit or

[[Page 22003]]

Straddle State will create an unreasonable adverse selection 
opportunity that will discourage participants from providing liquidity 
during Limit States or Straddle States. Ultimately, the Exchange 
believes that adding certainty to the execution of orders in these 
situations should encourage market participants to continue to provide 
liquidity to the Exchange during Limit States and Straddle States, thus 
promoting fair and orderly markets.
    The Exchange, however, has proposed this rule change based on its 
expectations about the quality of the options market during Limit 
States and Straddle States. The Exchange states, for example, that it 
believes that application of the obvious and catastrophic error rules 
would be impracticable given the potential for lack of a reliable NBBO 
in the options market during Limit States and Straddle States. Given 
the Exchange's recognition of the potential for unreliable NBBOs in the 
options markets during Limit States and Straddle States, the Commission 
is concerned about the extent to which investors may rely to their 
detriment on the quality of quotations and price discovery in the 
options markets during these periods. This concern is heightened by the 
Exchange's proposal to exclude electronic trades that occur during a 
Limit State or Straddle State from the obvious error or catastrophic 
error review procedures pursuant to Rule 1092(a)(i) or (ii) and the 
nullification or adjustment provisions pursuant to Rule 1092(c)(ii)(E) 
or (F). The Commission urges investors and market professionals to 
exercise caution when considering trading options under these 
circumstances. Broker-dealers also should be mindful of their 
obligations to customers that may or may not be aware of specific 
options market conditions or the underlying stock market conditions 
when placing their orders.
    While the Commission remains concerned about the quality of the 
options market during the Limit and Straddle States, and the potential 
impact on investors of executing in this market without the protections 
of the obvious or catastrophic error rules that are being suspended 
during the Limit and Straddle States, it believes that certain aspects 
of the proposal could help mitigate those concerns.
    First, despite the removal of obvious and catastrophic error 
protection during Limit States and Straddle States, the Exchange states 
that there are additional measures in place designed to protect 
investors. For example, the Exchange states that by rejecting market 
orders and stop orders, and cancelling pending market orders and stop 
orders, only those orders with a limit price will be executed during a 
Limit State or Straddle State. Additionally, the Exchange notes the 
existence of SEC Rule 15c3-5 requiring broker-dealers to have controls 
and procedures in place that are reasonably designed to prevent the 
entry of erroneous orders. Finally, with respect to limit orders that 
will be executable during Limit States and Straddle States, the 
Exchange states that it applies price checks to limit orders that are 
priced sufficiently far through the NBBO. Therefore, on balance, the 
Exchange believes that removing the potential inequity of nullifying or 
adjusting executions occurring during Limit States or Straddle States 
outweighs any potential benefits from applying certain provisions 
during such unusual market conditions.
    The Exchange also believes that the aspect of proposed rule change 
that will continue to allow the Exchange to review on its own motion 
electronic trades that occur during a Limit State or a Straddle State 
is consistent with the Act because it would provide flexibility for the 
Exchange to act when necessary and appropriate to nullify or adjust a 
transaction and will enable the Exchange to account for unforeseen 
circumstances that result in obvious or catastrophic errors for which a 
nullification or adjustment may be necessary in order to preserve the 
interest of maintaining a fair and orderly market and for the 
protection of investors. The Exchange represents that it recognizes 
that this provision is limited and that it will administer the 
provision in a manner that is consistent with the principles of the 
Act. In addition, the Exchange represents that it will create and 
maintain records relating to the use of the authority to act on its own 
motion during a Limit State or Straddle State.
    Finally, the Exchange has proposed that the changes be implemented 
on a one year pilot basis. The Commission believes that it is important 
to implement the proposal as a pilot. The one year pilot period will 
allow the Exchange time to assess the impact of the Plan on the options 
marketplace and allow the Commission to further evaluate the effect of 
the proposal prior to any proposal or determination to make the changes 
permanent. To this end, the Exchange has committed to: (1) Evaluate the 
options market quality during Limit States and Straddle States; (2) 
assess the character of incoming order flow and transactions during 
Limit States and Straddle States; and (3) review any complaints from 
members and their customers concerning executions during Limit States 
and Straddle States. Additionally, the Exchange has agreed to provide 
the Commission with data requested to evaluate the impact of the 
elimination of the obvious error rule, including data relevant to 
assessing the various analyses noted above. On April 5, 2013, the 
Exchange submitted a letter stating that it would provide specific data 
to the Commission and the public and certain analysis to the Commission 
to evaluate the impact of Limit States and Straddle States on liquidity 
and market quality in the options markets.\12\ This will allow the 
Commission, the Exchange, and other interested parties to evaluate the 
quality of the options markets during Limit States and Straddle States 
and to assess whether the additional protections noted by the Exchange 
are sufficient safeguards against the submission of erroneous trades, 
and whether the Exchange's proposal appropriately balances the 
protection afforded to an erroneous order sender against the potential 
hazards associated with providing

[[Page 22004]]

market participants additional time to review trades submitted during a 
Limit State or Straddle State.
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    \12\ In particular, the Exchange represented that, at least two 
months prior to the end of the one year pilot period of proposed 
Section 3(d)(iv), it would provide to the Commission an evaluation 
of (i) the statistical and economic impact of Straddle States on 
liquidity and market quality in the options market and (ii) whether 
the lack of obvious error rules in effect during the Limit States 
and Straddle States are problematic. In addition, the Exchange 
represented that each month following the adoption of the proposed 
rule change it would provide to the Commission and the public a 
dataset containing certain data elements for each Limit State and 
Straddle State in optionable stocks. The Exchange stated that the 
options included in the dataset will be those that meet the 
following conditions: (i) The options are more than 20% in the money 
(strike price remains greater than 80% of the last stock trade price 
for calls and strike price remains greater than 120% of the last 
stock trade price for puts when the Limit State or Straddle State is 
reached); (ii) the option has at least two trades during the Limit 
State or Straddle State; and (iii) the top ten options (as ranked by 
overall contract volume on that day) meeting the conditions listed 
above. For each of those options affected, each dataset will 
include, among other information: Stock symbol, option symbol, time 
at the start of the Limit State or Straddle State and an indicator 
for whether it is a Limit State or Straddle State. For activity on 
the Exchange in the relevant options, the Exchange has agreed to 
provide executed volume, time-weighted quoted bid-ask spread, time-
weighted average quoted depth at the bid, time-weighted average 
quoted depth at the offer, high execution price, low execution 
price, number of trades for which a request for review for error was 
received during Limit States and Straddle States, an indicator 
variable for whether those options outlined above have a price 
change exceeding 30% during the underlying stock's Limit State or 
Straddle State compared to the last available option price as 
reported by OPRA before the start of the Limit or Straddle State (1 
if observe 30% and 0 otherwise), and another indicator variable for 
whether the option price within five minutes of the underlying stock 
leaving the Limit State or Straddle State (or halt if applicable) is 
30% away from the price before the start of the Limit State or 
Straddle State. See Phlx Letter, supra note 4.
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    Finally, the Commission notes that the Plan, to which these rules 
relate, will be implemented on April 8, 2013. Accordingly, for the 
reasons stated above, and in consideration of the April 8, 2013 
implementation date of the Plan, the Commission finds good cause, 
pursuant to Section 19(b)(2) of the Act,\13\ for approving the 
Exchange's proposal prior to the 30th day after the publication of the 
notice in the Federal Register.
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    \13\ 15 U.S.C. 78s(b)(2). The Commission noticed substantially 
similar rules proposed by NYSE MKT LLC and NYSE Arca, Inc. with a 
full 21 day comment period. See Securities Exchange Act Release No. 
69033, 78 FR 15067 (March 8, 2013) and Securities Exchange Act 
Release No. 69032, 78 FR 15080 (March 8, 2013).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-Phlx-2013-29), be, and 
hereby is, approved on an accelerated basis.
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    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
---------------------------------------------------------------------------

    \15\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08612 Filed 4-11-13; 8:45 am]
BILLING CODE 8011-01-P
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