80 FR 27801 - Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Amend Chapter V, Section 6
SECURITIES AND EXCHANGE COMMISSION Federal Register Volume 80, Issue 93 (May 14, 2015)
Federal Register Volume 80, Issue 93 (May 14, 2015)
| Page Range | 27801-27816 | |
| FR Document | 2015-11593 |
[Federal Register Volume 80, Number 93 (Thursday, May 14, 2015)] [Notices] [Pages 27801-27816] From the Federal Register Online [www.thefederalregister.org] [FR Doc No: 2015-11593] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-74915; File No. SR-NASDAQ-2015-054] Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Amend Chapter V, Section 6 May 8, 2015. 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 May 7, 2015, The NASDAQ Stock Market LLC (``Nasdaq'' or ``Exchange'') filed with the Securities and Exchange Commission (``SEC'' or ``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. --------------------------------------------------------------------------- \1\ 15 U.S.C. 78s(b)(1). \2\ 17 CFR 240.19b-4. --------------------------------------------------------------------------- I. Self-Regulatory Organization's Statement of the Terms of the Substance of the Proposed Rule Change The Exchange proposes to amend Chapter V, Regulation of Trading on [[Page 27802]] NOM, Section 6, to replace current Section 6 (``Current Rule''), entitled ``Obvious and Catastrophic Errors,'' with new Section 6 (``Proposed Rule''), entitled ``Nullification and Adjustment of Options Transactions including Obvious Errors.'' Section 6 relates to the adjustment and nullification of options transactions that occur on The NASDAQ Options Market (``NOM''). The text of the proposed rule change is available on the Exchange's Web site at http://nasdaq.cchwallstreet.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 Background For several months the Exchange has been working with other options exchanges to identify ways to improve the process related to the adjustment and nullification of erroneous options transactions. The goal of the process that the options exchanges have undertaken is to adopt harmonized rules related to the adjustment and nullification of erroneous options transactions as well as a specific provision related to coordination in connection with large-scale events involving erroneous options transactions. As described below, the Exchange believes that the changes the options exchanges and the Exchange have agreed to propose will provide transparency and finality with respect to the adjustment and nullification of erroneous options transactions. Particularly, the proposed changes seek to achieve consistent results for participants across U.S. options exchanges while maintaining a fair and orderly market, protecting investors and protecting the public interest. The Proposed Rule is the culmination of this coordinated effort and reflects discussions by the options exchanges to universally adopt: (1) certain provisions already in place on one or more options exchanges; and (2) new provisions that the options exchanges collectively believe will improve the handling of erroneous options transactions. Thus, although the Proposed Rule is in many ways similar to and based on the Exchange's Current Rule, the Exchange is adopting various provisions to conform with existing rules of one or more options exchanges and also to adopt rules that are not currently in place on any options exchange. As noted above, in order to adopt a rule that is similar in most material respects to the rules adopted by other options exchanges, the Exchange proposes to delete the Current Rule in its entirety and to replace it with the Proposed Rule. The Exchange notes that it has proposed additional objective standards in the Proposed Rule as compared to the Current Rule. The Exchange also notes that the Proposed Rule will ensure that the Exchange will have the same standards as all other options exchanges. However, there are still areas under the Proposed Rule where subjective determinations need to be made by Exchange personnel with respect to the calculation of Theoretical Price. The Exchange notes that the Exchange and all other options exchanges have been working to further improve the review of potentially erroneous transactions as well as their subsequent adjustment by creating an objective and universal way to determine Theoretical Price in the event a reliable NBBO is not available. For instance, the Exchange and all other options exchanges may utilize an independent third party to calculate and disseminate or make available Theoretical Price. However, this initiative requires additional exchange and industry discussion as well as additional time for development and implementation. The Exchange will continue to work with other options exchanges and the options industry towards the goal of additional objectivity and uniformity with respect to the calculation of Theoretical Price. As additional background, the Exchange believes that the Proposed Rule supports an approach consistent with long-standing principles in the options industry under which the general policy is to adjust rather than nullify transactions. The Exchange acknowledges that adjustment of transactions is contrary to the operation of analogous rules applicable to the equities markets, where erroneous transactions are typically nullified rather than adjusted and where there is no distinction between the types of market participants involved in a transaction. For the reasons set forth below, the Exchange believes that the distinctions in market structure between equities and options markets continue to support these distinctions between the rules for handling obvious errors in the equities and options markets. The Exchange also believes that the Proposed Rule properly balances several competing concerns based on the structure of the options markets. Various general structural differences between the options and equities markets point toward the need for a different balancing of risks for options market participants and are reflected in the Proposed Rule. Option pricing is formulaic and is tied to the price of the underlying stock, the volatility of the underlying security and other factors. Because options market participants can generally create new open interest in response to trading demand, as new open interest is created, correlated trades in the underlying or related series are generally also executed to hedge a market participant's risk. This pairing of open interest with hedging interest differentiates the options market specifically (and the derivatives markets broadly) from the cash equities markets. In turn, the Exchange believes that the hedging transactions engaged in by market participants necessitates protection of transactions through adjustments rather than nullifications when possible and otherwise appropriate. The options markets are also quote driven markets dependent on liquidity providers to an even greater extent than equities markets. In contrast to the approximately 7,000 different securities traded in the U.S. equities markets each day, there are more than 500,000 unique, regularly quoted option series. Given this breadth in options series the options markets are more dependent on liquidity providers than equities markets; such liquidity is provided most commonly by registered market makers but also by other professional traders. With the number of instruments in which registered market makers must quote and the risk attendant with quoting so many products simultaneously, the Exchange believes that those liquidity providers should be afforded a greater level of protection. In particular, the Exchange believes that liquidity providers should be allowed protection of their trades given the fact that they typically engage in hedging activity to protect them from significant [[Page 27803]] financial risk to encourage continued liquidity provision and maintenance of the quote-driven options markets. In addition to the factors described above, there are other fundamental differences between options and equities markets which lend themselves to different treatment of different classes of participants that are reflected in the Proposed Rule. For example, there is no trade reporting facility in the options markets. Thus, all transactions must occur on an options exchange. This leads to significantly greater retail customer participation directly on exchanges than in the equities markets, where a significant amount of retail customer participation never reaches the Exchange but is instead executed in off-exchange venues such as alternative trading systems, broker-dealer market making desks and internalizers. In turn, because of such direct retail customer participation, the exchanges have taken steps to afford those retail customers--generally Priority Customers--more favorable treatment in some circumstances. Definitions The Exchange proposes to adopt various definitions that will be used in the Proposed Rule, as described below. First, the Exchange proposes to adopt a definition of ``Customer,'' to make clear that this term would not include any broker-dealer or Professional.\3\ Although other portions of the Exchange's rules address the capacity of market participants, including customers, the proposed definition is consistent with such rules and the Exchange believes it is important for all options exchanges to have the same definition of Customer in the context of nullifying and adjusting trades in order to have harmonized rules. As set forth in detail below, orders on behalf of a Customer are in many cases treated differently than non-Customer orders in light of the fact that Customers are not necessarily immersed in the day-to-day trading of the markets, are less likely to be watching trading activity in a particular option throughout the day, and may have limited funds in their trading accounts. --------------------------------------------------------------------------- \3\ The term ``Professional'' means any person or entity that (i) is not a broker or dealer in securities, and (ii) places more than 390 orders in listed options per day on average during a calendar month for its own beneficial account(s). See Chapter I, Section 1(a)(48). --------------------------------------------------------------------------- Second, the Exchange proposes to adopt definitions for both an ``erroneous sell transaction'' and an ``erroneous buy transaction.'' As proposed, an erroneous sell transaction is one in which the price received by the person selling the option is erroneously low, and an erroneous buy transaction is one in which the price paid by the person purchasing the option is erroneously high. This provision helps to reduce the possibility that a party can intentionally submit an order hoping for the market to move in their favor while knowing that the transaction will be nullified or adjusted if the market does not. For instance, when a market participant who is buying options in a particular series sees an aggressively priced sell order posted on the Exchange, and the buyer believes that the price of the options is such that it might qualify for obvious error, the option buyer can trade with the aggressively priced order, then wait to see which direction the market moves. If the market moves in their direction, the buyer keeps the trade and if it moves against them, the buyer calls the Exchange hoping to get the trade adjusted or busted. Third, the Exchange proposes to adopt a new term, ``Official,'' to apply only to Section 6. Specifically, the term ``Official'' shall mean an Exchange staff member or contract employee designated as such by the Chief Regulatory Officer. A list of individual Officials shall be displayed on the Exchange Web site. The Chief Regulatory Officer shall maintain the list of Officials and update the Web site each time a name is added to, or deleted from, the list of Officials. In the event no Official is available to rule on a particular matter, the Chief Regulatory Officer or his/her designee shall rule on such matter. Fourth, the Exchange proposes to adopt a new term, a ``Size Adjustment Modifier,'' which would apply to individual transactions and would modify the applicable adjustment for orders under certain circumstances, as discussed in further detail below. As proposed, the Size Adjustment Modifier will be applied to individual transactions as follows: ------------------------------------------------------------------------ Number of contracts per execution Adjustment--TP plus/minus ----------------------------------------------------------------------- 1-50..................................... N/A........................ 51-250................................... 2 times adjustment amount.. 251-1000................................. 2.5 times adjustment amount 1001 or more............................. 3 times adjustment amount.. ------------------------------------------------------------------------ The Size Adjustment Modifier attempts to account for the additional risk that the parties to the trade undertake for transactions that are larger in scope. The Exchange believes that the Size Adjustment Modifier creates additional incentives to prevent more impactful Obvious Errors and it lessens the impact on the contra-party to an adjusted trade. The Exchange notes that these contra-parties may have preferred to only trade the size involved in the transaction at the price at which such trade occurred, and in trading larger size has committed a greater level of capital and bears a larger hedge risk. When setting the proposed size adjustment modifier thresholds, the Exchange has tried to correlate the size breakpoints with typical small and larger ``block'' execution sizes of underlying stock. For instance, SEC Rule 10b-18(a)(5)(ii) defines a ``block'' as a quantity of stock that is at least 5,000 shares and a purchase price of at least $50,000, among others.\4\ Similarly, NYSE Rule 72 defines a ``block'' as an order to buy or sell ``at least 10,000 shares or a quantity of stock having a market value of $200,000 or more, whichever is less.'' Thus, executions of 51 to 100 option contracts, which are generally equivalent to executions of 5,100 and 10,000 shares of underlying stock, respectively, are proposed to be subject to the lowest size adjustment modifier. An execution of over 1,000 contracts is roughly equivalent to a block transaction of more than 100,000 shares of underlying stock, and is proposed to be subject to the highest size adjustment modifier. The Exchange has correlated the proposed size adjustment modifier thresholds to smaller and larger scale blocks because the Exchange believes that the execution cost associated with transacting in block sizes scales according to the size of the block. In other words, in the same way that executing a 100,000 share stock order will have a proportionately larger market impact and will have a higher overall execution cost than executing a 500, 1,000 or 5,000 share order in the same stock, all other market factors being equal, executing a 1,000 option contract order will have a larger market impact and higher overall execution cost than executing a 5, 10 or 50 contract option order. --------------------------------------------------------------------------- \4\ See 17 CFR 240.10b-18(a)(5)(ii). --------------------------------------------------------------------------- Calculation of Theoretical Price Theoretical Price in Normal Circumstances Under both the Current Rule and the Proposed Rule, when reviewing a transaction as potentially erroneous, the Exchange needs to first determine the ``Theoretical Price'' of the option, i.e., the Exchange's estimate of the correct market price for the option. Pursuant to the Proposed Rule, if the applicable option series is traded on at least one other options exchange, then the [[Page 27804]] Theoretical Price of an option series is the last national best bid (``NBB'') just prior to the trade in question with respect to an erroneous sell transaction or the last national best offer (``NBO'') just prior to the trade in question with respect to an erroneous buy transaction unless one of the exceptions described below exists. Thus, the Exchange proposes that whenever the Exchange has a reliable NBB or NBO, as applicable, just prior to the transaction, then the Exchange will use this NBB or NBO as the Theoretical Price. The Exchange also proposes to specify in the Proposed Rule that when a single order received by the Exchange is executed at multiple price levels, the last NBB and last NBO just prior to the trade in question would be the last NBB and last NBO just prior to the Exchange's receipt of the order. The Exchange also proposes to set forth in the Proposed Rule various provisions governing specific situations where the NBB or NBO is not available or may not be reliable. Specifically, the Exchange is proposing additional detail specifying situations in which there are no quotes or no valid quotes (as defined below), when the national best bid or offer (``NBBO'') is determined to be too wide to be reliable, and at the open of trading on each trading day. No Valid Quotes As is true under the Current Rule, pursuant to the Proposed Rule the Exchange will determine the Theoretical Price if there are no quotes or no valid quotes for comparison purposes. As proposed, quotes that are not valid are all quotes in the applicable option series published at a time where the last NBB is higher than the last NBO in such series (a ``crossed market''), quotes published by the Exchange that were submitted by either party to the transaction in question, and quotes published by another options exchange against which the Exchange has declared self-help. Thus, in addition to scenarios where there are literally no quotes to be used as Theoretical Price, the Exchange will exclude quotes in certain circumstances if such quotes are not deemed valid. The Proposed Rule is consistent with the Exchange's application of the Current Rule but the descriptions of the various scenarios where the Exchange considers quotes to be invalid represent additional detail that is not included in the Current Rule. The Exchange notes that Exchange personnel currently are required to determine Theoretical Price in certain circumstances. While the Exchange continues to pursue alternative solutions that might further enhance the objectivity and consistency of determining Theoretical Price, the Exchange believes that the discretion currently afforded to Officials is appropriate in the absence of a reliable NBBO that can be used to set the Theoretical Price. Under the current Rule, Exchange personnel will generally consult and refer to data such as the prices of related series, especially the closest strikes in the option in question. Exchange personnel may also take into account the price of the underlying security and the volatility characteristics of the option as well as historical pricing of the option and/or similar options. Wide Quotes Similarly, pursuant to the Proposed Rule the Exchange will determine the Theoretical Price if the bid/ask differential of the NBB and NBO for the affected series just prior to the erroneous transaction was equal to or greater than the Minimum Amount set forth below and there was a bid/ask differential less than the Minimum Amount during the 10 seconds prior to the transaction. If there was no bid/ask differential less than the Minimum Amount during the 10 seconds prior to the transaction then the Theoretical Price of an option series is the last NBB or NBO just prior to the transaction in question. The Exchange proposes to use the following chart to determine whether a quote is too wide to be reliable: ------------------------------------------------------------------------ Bid price at time of trade Minimum amount ------------------------------------------------------------------------ Below $2.00.......................................... $0.75 $2.00 to $5.00....................................... 1.25 Above $5.00 to $10.00................................ 1.50 Above $10.00 to $20.00............................... 2.50 Above $20.00 to $50.00............................... 3.00 Above $50.00 to $100.00.............................. 4.50 Above $100.00........................................ 6.00 ------------------------------------------------------------------------ The Exchange notes that the values set forth above generally represent a multiple of 3 times the bid/ask differential requirements of other options exchanges, with certain rounding applied (e.g., $1.25 as proposed rather than $1.20).\5\ The Exchange believes that basing the Wide Quote table on a multiple of the permissible bid/ask differential rule provides a reasonable baseline for quotations that are indeed so wide that they cannot be considered reliable for purposes of determining Theoretical Price unless they have been consistently wide. As described above, while the Exchange will determine Theoretical Price when the bid/ask differential equals or exceeds the amount set forth in the chart above and within the previous 10 seconds there was a bid/ask differential smaller than such amount, if a quote has been persistently wide for at least 10 seconds the Exchange will use such quote for purposes of Theoretical Price. The Exchange believes that there should be a greater level of protection afforded to market participants that enter the market when there are liquidity gaps and price fluctuations. The Exchange does not believe that a similar level of protection is warranted when market participants choose to enter a market that is wide and has been consistently wide for some time. The Exchange notes that it has previously determined that, given the largely electronic nature of today's markets, as little as one second (or less) is a long enough time for market participants to receive, process and account for and respond to new market information.\6\ While introducing this new provision the Exchange believes it is being appropriately cautious by selecting a time frame that is an order of magnitude above and beyond what the Exchange has previously determined is sufficient for information dissemination. The table above bases the wide quote provision off of bid price in order to provide a relatively straightforward beginning point for the analysis. --------------------------------------------------------------------------- \5\ See, e.g., NYSE Arca Options Rule 6.37(b)(1). \6\ See, e.g., Chapter VII, Section 12, which requires certain orders to be exposed for at least one second before they can be executed; see also Securities Exchange Act Release No. 66306 (February 2, 2012), 77 FR 6608 (February 8, 2012) (SR-BX-2011-084) (order granting approval of proposed rule change to reduce the duration of the PIP from one second to one hundred milliseconds). --------------------------------------------------------------------------- As an example, assume an option is quoted $3.00 by $6.00 with 50 contracts posted on each side of the market for an extended period of time. If a market participant were to enter a market order to buy 20 contracts the Exchange believes that the buyer should have a reasonable expectation of paying $6.00 for the contracts which they are buying. This should be the case even if immediately after the purchase of those options, the market conditions change and the same option is then quoted at $3.75 by $4.25. Although the quote was wide according to the table above at the time immediately prior to and the time of the execution of the market order, it was also well established and well known. The Exchange believes that an execution at the then prevailing market price should not in and of itself constitute an erroneous trade. [[Page 27805]] Transactions at the Open Under the Proposed Rule, for a transaction occurring as part of the opening \7\ the Exchange will determine the Theoretical Price where there is no NBB or NBO for the affected series just prior to the erroneous transaction or if the bid/ask differential of the NBBO just prior to the erroneous transaction is equal to or greater than the Minimum Amount set forth in the chart proposed for the wide quote provision described above. The Exchange believes that this discretion is necessary because it is consistent with other scenarios in which the Exchange will determine the Theoretical Price if there are no quotes or no valid quotes for comparison purposes, including the wide quote provision proposed by the Exchange as described above. If, however, there are valid quotes and the bid/ask differential of the NBBO is less than the Minimum Amount set forth in the chart proposed for the wide quote provision described above, then the Exchange will use the NBB or NBO just prior to the transaction as it would in any other normal review scenario. --------------------------------------------------------------------------- \7\ See Chapter VI, Section 8 for a description of the Exchange's opening process. --------------------------------------------------------------------------- As an example of an erroneous transaction for which the NBBO is wide at the open, assume the NBBO at the time of the opening transaction is $1.00 x $5.00 and the opening transaction takes place at $1.25. The Exchange would be responsible for determining the Theoretical Price because the NBBO was wider than the applicable minimum amount set forth in the wide quote provision as described above. The Exchange believes that it is necessary to determine theoretical price at the open in the event of a wide quote at the open for the same reason that the Exchange has proposed to determine theoretical price during the remainder of the trading day pursuant to the proposed wide quote provision, namely that a wide quote cannot be reliably used to determine Theoretical Price because the Exchange does not know which of the two quotes, the NBB or the NBO, is closer to the real value of the option. Obvious Errors The Exchange proposes to adopt numerical thresholds that would qualify transactions as ``Obvious Errors.'' These thresholds are similar to those in place under the Current Rule. As proposed, a transaction will qualify as an Obvious Error if the Exchange receives a properly submitted filing and the execution price of a transaction is higher or lower than the Theoretical Price for the series by an amount equal to at least the amount shown below: ------------------------------------------------------------------------ Minimum Theoretical price amount ------------------------------------------------------------------------ Below $2.00................................................ $0.25 $2.00 to $5.00............................................. 0.40 Above $5.00 to $10.00...................................... 0.50 Above $10.00 to $20.00..................................... 0.80 Above $20.00 to $50.00..................................... 1.00 Above $50.00 to $100.00.................................... 1.50 Above $100.00.............................................. 2.00 ------------------------------------------------------------------------ Applying the Theoretical Price, as described above, to determine the applicable threshold and comparing the Theoretical Price to the actual execution price provides the Exchange with an objective methodology to determine whether an Obvious Error occurred. The Exchange believes that the proposed amounts are reasonable as they are generally consistent with the standards of the Current Rule and reflect a significant disparity from Theoretical Price. The Exchange notes that the Minimum Amounts in the Proposed Rule and as set forth above are identical to the Current Rule except for the last two categories, for options where the Theoretical Price is above $50.00 to $100.00 and above $100.00. The Exchange believes that this additional granularity is reasonable because given the proliferation of additional strikes that have been created in the past several years there are many more high-priced options that are trading with open interest for extended periods. The Exchange believes that it is appropriate to account for these high- priced options with additional Minimum Amount levels for options with Theoretical Prices above $50.00. Under the Proposed Rule, a party that believes that it participated in a transaction that was the result of an Obvious Error must notify an Official in the manner specified from time to time by the Exchange in a notice distributed to Participants. The Exchange currently requires electronic notification through a web-based application but believes that maintaining flexibility in the Rule is important to allow for changes to the process. The Exchange also proposes to adopt notification timeframes that must be met in order for a transaction to qualify as an Obvious Error. Specifically, as proposed a filing must be received by the Exchange within thirty (30) minutes of the execution with respect to an execution of a Customer order and within fifteen (15) minutes of the execution for any other participant. The Exchange also proposes to provide additional time for trades that are routed through other options exchanges to the Exchange. Under the Proposed Rule, any other options exchange will have a total of forty-five (45) minutes for Customer orders and thirty (30) minutes for non-Customer orders, measured from the time of execution on the Exchange, to file with the Exchange for review of transactions routed to the Exchange from that options exchange and executed on the Exchange (``linkage trades''). This includes filings on behalf of another options exchange filed by a third-party routing broker if such third-party broker identifies the affected transactions as linkage trades. In order to facilitate timely reviews of linkage trades the Exchange will accept filings from either the other options exchange or, if applicable, the third-party routing broker that routed the applicable order(s). The additional fifteen (15) minutes provided with respect to linkage trades shall only apply to the extent the options exchange that originally received and routed the order to the Exchange itself received a timely filing from the entering participant (i.e., within 30 minutes if a Customer order or 15 minutes if a non-Customer order). The Exchange believes that additional time for filings related to Customer orders is appropriate in light of the fact that Customers are not necessarily immersed in the day-to-day trading of the markets and are less likely to be watching trading activity in a particular option throughout the day. The Exchange believes that the additional time afforded to linkage trades is appropriate given the interconnected nature of the markets today and the practical difficulty that an end user may face in getting requests for review filed in a timely fashion when the transaction originated at a different exchange than where the error took place. Without this additional time the Exchange believes it would be common for a market participant to satisfy the filing deadline at the original exchange to which an order was routed but that requests for review of executions from orders routed to other options exchanges would not qualify for review as potential Obvious Errors by the time filings were received by such other options exchanges, in turn leading to potentially disparate results under the applicable rules of options exchanges to which the orders were routed. Pursuant to the Proposed Rule, an Exchange Officer may review a transaction believed to be erroneous on his/her own motion in the interest of maintaining a fair and orderly market and for the protection of investors. This proposed provision is designed to give an Exchange Officer the ability to [[Page 27806]] provide parties relief in those situations where they have failed to report an apparent error within the established notification period. A transaction reviewed pursuant to the proposed provision may be nullified or adjusted only if it is determined by the Exchange Officer that the transaction is erroneous in accordance with the provisions of the Proposed Rule, provided that the time deadlines for filing a request for review described above shall not apply. The Proposed Rule would require the Exchange Officer to act as soon as possible after becoming aware of the transaction; action by the Exchange Officer would ordinarily be expected on the same day that the transaction occurred. However, because a transaction under review may have occurred near the close of trading or due to unusual circumstances, the Proposed Rule provides that the Exchange Officer shall act no later than 8:30 a.m. Eastern Time on the next trading day following the date of the transaction in question. The Exchange also proposes to state that a party affected by a determination to nullify or adjust a transaction after an Exchange Officer's review on his or her own motion may appeal such determination in accordance with paragraph (k), which is described below. The Proposed Rule would make clear that a determination by an Exchange Officer not to review a transaction or determination not to nullify or adjust a transaction for which a review was conducted on an Exchange Officer's own motion is not appealable and further that if a transaction is reviewed and a determination is rendered pursuant to another provision of the Proposed Rule, no additional relief may be granted by an Exchange Officer. If it is determined that an Obvious Error has occurred based on the objective numeric criteria and time deadlines described above, the Exchange will adjust or nullify the transaction as described below and promptly notify both parties to the trade electronically or via telephone. The Exchange proposes different adjustment and nullification criteria for Customers and non-Customers. As proposed, where neither party to the transaction is a Customer, the execution price of the transaction will be adjusted by the Official pursuant to the table below. ------------------------------------------------------------------------ Buy transaction Sell transaction Theoretical Price (TP) adjustment-- TP adjustment-- TP plus Minus ------------------------------------------------------------------------ Below $3.00....................... $0.15 $0.15 At or above $3.00................. 0.30 0.30 ------------------------------------------------------------------------ The Exchange believes that it is appropriate to adjust to prices a specified amount away from Theoretical Price rather than to adjust to Theoretical Price because even though the Exchange has determined a given trade to be erroneous in nature, the parties in question should have had some expectation of execution at the price or prices submitted. Also, it is common that by the time it is determined that an obvious error has occurred additional hedging and trading activity has already occurred based on the executions that previously happened. The Exchange is concerned that an adjustment to Theoretical Price in all cases would not appropriately incentivize market participants to maintain appropriate controls to avoid potential errors. Further, as proposed any non-Customer Obvious Error exceeding 50 contracts will be subject to the Size Adjustment Modifier described above. The Exchange believes that it is appropriate to apply the Size Adjustment Modifier to non-Customer orders because the hedging cost associated with trading larger sized options orders and the market impact of larger blocks of underlying can be significant. As an example of the application of the Size Adjustment Modifier, assume Exchange A has a quoted bid to buy 50 contracts at $2.50, Exchange B has a quoted bid to buy 100 contracts at $2.05 and there is no other options exchange quoting a bid priced higher than $2.00. Assume that the NBBO is $2.50 by $3.00. Finally, assume that all orders quoted and submitted to Exchange B in connection with this example are non-Customer orders.Assume Exchange A's quoted bid at $2.50 is either executed or cancelled. Assume Exchange B immediately thereafter receives an incoming market order to sell 100 contracts. The incoming order would be executed against Exchange B's resting bid at $2.05 for 100 contracts. Because the 100 contract execution of the incoming sell order was priced at $2.05, which is $0.45 below the Theoretical Price of $2.50, the 100 contract execution would qualify for adjustment as an Obvious Error. The normal adjustment process would adjust the execution of the 100 contracts to $2.35 per contract, which is the Theoretical Price minus $0.15. However, because the execution would qualify for the Size Adjustment Modifier of 2 times the adjustment price, the adjusted transaction would instead be to $2.20 per contract, which is the Theoretical Price minus $0.30. By reference to the example above, the Exchange reiterates that it believes that a Size Adjustment Modifier is appropriate, as the buyer in this example was originally willing to buy 100 contracts at $2.05 and ended up paying $2.20 per contract for such execution. Without the Size Adjustment Modifier the buyer would have paid $2.35 per contract. Such buyer may be advantaged by the trade if the Theoretical Price is indeed closer to $2.50 per contract, however the buyer may not have wanted to buy so many contracts at a higher price and does incur increasing cost and risk due to the additional size of their quote. Thus, the proposed rule is attempting to strike a balance between various competing objectives, including recognition of cost and risk incurred in quoting larger size and incentivizing market participants to maintain appropriate controls to avoid errors. In contrast to non-Customer orders, where trades will be adjusted if they qualify as Obvious Errors, pursuant the Proposed Rule a trade that qualifies as an Obvious Error will be nullified where at least one party to the Obvious Error is a Customer. The Exchange also proposes, however, that if any member [sic] submits requests to the Exchange for review of transactions pursuant to the Proposed Rule, and in aggregate that Participant has 200 or more Customer transactions under review concurrently and the orders resulting in such transactions were submitted during the course of 2 minutes or less, where at least one party to the Obvious Error is a non-Customer, the Exchange will apply the non-Customer adjustment criteria described above to such transactions. The Exchange based its proposal of 200 transactions on the fact that the proposed level is reasonable as it is representative of an extremely large number of orders submitted to the [[Page 27807]] Exchange that are, in turn, possibly erroneous. Similarly, the Exchange based its proposal of orders received in 2 minutes or less on the fact that this is a very short amount of time under which one Participant could generate multiple erroneous transactions. In order for a participant to have more than 200 transactions under review concurrently when the orders triggering such transactions were received in 2 minutes or less, the market participant will have far exceeded the normal behavior of customers deserving protected status.\8\ While the Exchange continues to believe that it is appropriate to nullify transactions in such a circumstance if both participants to a transaction are Customers, the Exchange does not believe it is appropriate to place the overall risk of a significant number of trade breaks on non-Customers that in the normal course of business may have engaged in additional hedging activity or trading activity based on such transactions. Thus, the Exchange believes it is necessary and appropriate to protect non-Customers in such a circumstance by applying the non-Customer adjustment criteria, and thus adjusting transactions as set forth above, in the event a Participant has more than 200 transactions under review concurrently. --------------------------------------------------------------------------- \8\ The Exchange notes that in the third quarter of this year across all options exchanges the average number of valid Customer orders received and executed was less than 38 valid orders every two minutes. The number of obvious errors resulting from valid orders is, of course, a very small fraction of such orders. --------------------------------------------------------------------------- Catastrophic Errors Consistent with the Current Rule, the Exchange proposes to adopt separate numerical thresholds for review of transactions for which the Exchange does not receive a filing requesting review within the Obvious Error timeframes set forth above. Based on this review these transactions may qualify as ``Catastrophic Errors.'' As proposed, a Catastrophic Error will be deemed to have occurred when the execution price of a transaction is higher or lower than the Theoretical Price for the series by an amount equal to at least the amount shown below: ------------------------------------------------------------------------ Minimum Theoretical price amount ------------------------------------------------------------------------ Below $2.00................................................ $0.50 $2.00 to $5.00............................................. 1.00 Above $5.00 to $10.00...................................... 1.50 Above $10.00 to $20.00..................................... 2.00 Above $20.00 to $50.00..................................... 2.50 Above $50.00 to $100.00.................................... 3.00 Above $100.00.............................................. 4.00 ------------------------------------------------------------------------ Based on industry feedback on the Catastrophic Error thresholds set forth under the Current Rule, the thresholds proposed as set forth above are more granular and lower (i.e., more likely to qualify) than the thresholds under the Current Rule. As noted above, under the Proposed Rule as well as the Current Rule, parties have additional time to submit transactions for review as Catastrophic Errors. As proposed, notification requesting review must be received by the Official by 8:30 a.m. Eastern Time on the first trading day following the execution. For transactions in an expiring options series that take place on an expiration day, a party must notify an Official within 45 minutes after the close of trading that same day. As is true for requests for review under the Obvious Error provision of the Proposed Rule, a party requesting review of a transaction as a Catastrophic Error must notify the Official in the manner specified from time to time by the Exchange in a notice distributed to Participants. By definition, any execution that qualifies as a Catastrophic Error is also an Obvious Error. However, the Exchange believes it is appropriate to maintain these two types of errors because the Catastrophic Error provisions provide market participants with a longer notification period under which they may file a request for review with the Exchange of a potential Catastrophic Error than a potential Obvious Error. This provides an additional level of protection for transactions that are severely erroneous even in the event a participant does not submit a request for review in a timely fashion. The Proposed Rule would specify the action to be taken by the Exchange if it is determined that a Catastrophic Error has occurred, as described below, and would require the Exchange to promptly notify both parties to the trade electronically or via telephone. In the event of a Catastrophic Error, the execution price of the transaction will be adjusted by the Official pursuant to the table below. ------------------------------------------------------------------------ Buy transaction Sell transaction Theoretical price (TP) adjustment-- TP adjustment-- TP plus minus ------------------------------------------------------------------------ Below $2.00....................... $0.50 $0.50 $2.00 to $5.00.................... 1.00 1.00 Above $5.00 to $10.00............. 1.50 1.50 Above $10.00 to $20.00............ 2.00 2.00 Above $20.00 to $50.00............ 2.50 2.50 Above $50.00 to $100.00........... 3.00 3.00 Above $100.00..................... 4.00 4.00 ------------------------------------------------------------------------ Although Customer orders would be adjusted in the same manner as non- Customer orders, any Customer order that qualifies as a Catastrophic Error will be nullified if the adjustment would result in an execution price higher (for buy transactions) or lower (for sell transactions) than the Customer's limit price. Based on industry feedback, the levels proposed above with respect to adjustment amounts are the same levels as the thresholds at which a transaction may be deemed a Catastrophic Error pursuant to the chart set forth above. As is true for Obvious Errors as described above, the Exchange believes that it is appropriate to adjust to prices a specified amount away from Theoretical Price rather than to adjust to Theoretical Price because even though the Exchange has determined a given trade to be erroneous in nature, the parties in question should have had some expectation of execution at the price or prices submitted. Also, it is common that by the time it is determined that a Catastrophic Error has occurred additional hedging and trading activity has already occurred based on the executions that previously happened. The Exchange is concerned that an adjustment to Theoretical Price in all cases would not appropriately incentivize market participants to maintain appropriate controls to avoid potential errors. Further, the Exchange believes it is appropriate to maintain a higher adjustment level for Catastrophic [[Page 27808]] Errors than Obvious Errors given the significant additional time that can potentially pass before an adjustment is requested and applied and the amount of hedging and trading activity that can occur based on the executions at issue during such time. For the same reasons, other than honoring the limit prices established for Customer orders, the Exchange has proposed to treat all market participants the same in the context of the Catastrophic Error provision. Specifically, the Exchange believes that treating market participants the same in this context will provide additional certainty to market participants with respect to their potential exposure and hedging activities, including comfort that even if a transaction is later adjusted (i.e., past the standard time limit for filing under the Obvious Error provision), such transaction will not be fully nullified. However, as noted above, under the Proposed Rule where at least one party to the transaction is a Customer, the trade will be nullified if the adjustment would result in an execution price higher (for buy transactions) or lower (for sell transactions) than the Customer's limit price. The Exchange has retained the protection of a Customer's limit price in order to avoid a situation where the adjustment could be to a price that the Customer could not afford, which is less likely to be an issue for a market professional. Significant Market Events In order to improve consistency for market participants in the case of a widespread market event and in light of the interconnected nature of the options exchanges, the Exchange proposes to adopt a new provision that calls for coordination between the options exchanges in certain circumstances and provides limited flexibility in the application of other provisions of the Proposed Rule in order to promptly respond to a widespread market event.\9\ The Exchange proposes to describe such an event as a Significant Market Event, and to set forth certain objective criteria that will determine whether such an event has occurred. The Exchange developed these objective criteria in consultation with the other options exchanges by reference to historical patterns and events with a goal of setting thresholds that very rarely will be triggered so as to limit the application of the provision to truly significant market events. As proposed, a Significant Market Event will be deemed to have occurred when proposed criterion (A) below is met or exceeded or the sum of all applicable event statistics, where each is expressed as a percentage of the relevant threshold in criteria (A) through (D) below, is greater than or equal to 150% and 75% or more of at least one category is reached, provided that no single category can contribute more than 100% to the sum. All criteria set forth below will be measured in aggregate across all exchanges. --------------------------------------------------------------------------- \9\ Although the Exchange has proposed a specific provision related to coordination amongst options exchanges in the context of a widespread event, the Exchange does not believe that the Significant Market Event provision or any other provision of the proposed rule alters the Exchange's ability to coordinate with other options exchanges in the normal course of business with respect to market events or activity. The Exchange does already coordinate with other options exchanges to the extent possible if such coordination is necessary to maintain a fair and orderly market and/or to fulfill the Exchange's duties as a self-regulatory organization. --------------------------------------------------------------------------- The proposed criteria for determining a Significant Market Event are as follows: (A) Transactions that are potentially erroneous would result in a total Worst-Case Adjustment Penalty of $30,000,000, where the Worst- Case Adjustment Penalty is computed as the sum, across all potentially erroneous trades, of: (i) $0.30 (i.e., the largest Transaction Adjustment value listed in sub-paragraph (e)(3)(A) below); times; (ii) the contract multiplier for each traded contract; times (iii) the number of contracts for each trade; times (iv) the appropriate Size Adjustment Modifier for each trade, if any, as defined in sub-paragraph (e)(3)(A) below; (B) Transactions involving 500,000 options contracts are potentially erroneous; (C) Transactions with a notional value (i.e., number of contracts traded multiplied by the option premium multiplied by the contract multiplier) of $100,000,000 are potentially erroneous; (D) 10,000 transactions are potentially erroneous. As described above, the Exchange proposes to adopt a the Worst Case Adjustment Penalty, proposed as criterion (A), which is the only criterion that can on its own result in an event being designated as a significant market event. The Worst Case Adjustment Penalty is intended to develop an objective criterion that can be quickly determined by the Exchange in consultation with other options exchanges that approximates the total overall exposure to market participants on the negatively impacted side of each transaction that occurs during an event. If the Worst Case Adjustment criterion equals or exceeds $30,000,000, then an event is a Significant Market Event. As an example of the Worst Case Adjustment Penalty, assume that a single potentially erroneous transaction in an event is as follows: Sale of 100 contracts of a standard option (i.e., an option with a 100 share multiplier). The highest potential adjustment penalty for this single transaction would be $6,000, which would be calculated as $0.30 times 100 (contract multiplier) times 100 (number of contracts) times 2 (applicable Size Adjustment Modifier). The Exchange would calculate the highest potential adjustment penalty for each of the potentially erroneous transactions in the event and the Worst Case Adjustment Penalty would be the sum of such penalties on the Exchange and all other options exchanges with affected transactions. As described above, under the Proposed Rule if the Worst Case Adjustment Penalty does not equal or exceed $30,000,000, then a Significant Market Event has occurred if the sum of all applicable event statistics (expressed as a percentage of the relevant thresholds), is greater than or equal to 150% and 75% or more of at least one category is reached. The Proposed Rule further provides that no single category can contribute more than 100% to the sum. As an example of the application of this provision, assume that in a given event across all options exchanges that: (A) The Worst Case Adjustment Penalty is $12,000,000 (40% of $30,000,000), (B) 300,000 options contracts are potentially erroneous (60% of 500,000), (C) the notional value of potentially erroneous transactions is $30,000,000 (30% of $100,000,000), and (D) 12,000 transactions are potentially erroneous (120% of 10,000). This event would qualify as a Significant Market Event because the sum of all applicable event statistics would be 230%, far exceeding the 150% threshold. The 230% sum is reached by adding 40%, 60%, 30% and last, 100% (i.e., rounded down from 120%) for the number of transactions. The Exchange notes that no single category can contribute more than 100% to the sum and any category contributing more than 100% will be rounded down to 100%. As an alternative example, assume a large-scale event occurs involving low-priced options with a small number of contracts in each execution. Assume in this event across all options exchanges that: (A) The Worst Case Adjustment Penalty is $600,000 (2% of $30,000,000), (B) 20,000 options contracts are potentially erroneous (4% of 500,000), (C) the notional value of potentially erroneous transactions is $20,000,000 (20% of $100,000,000), and (D) 20,000 transactions are potentially erroneous (200% of 10,000, but rounded [[Page 27809]] down to 100%). This event would not qualify as a Significant Market Event because the sum of all applicable event statistics would be 126%, below the 150% threshold. The Exchange reiterates that as proposed, even when a single category other than criterion (A) is fully met, that does not necessarily qualify an event as a Significant Market Event. The Exchange believes that the breadth and scope of the obvious error rules are appropriate and sufficient for handling of typical and common obvious errors. Coordination between and among the exchanges should generally not be necessary even when a Participant has an error that results in executions on more than one exchange. In setting the thresholds above the Exchange believes that the requirements will be met only when truly widespread and significant errors happen and the benefits of coordination and information sharing far outweigh the costs of the logistics of additional intra-exchange coordination. The Exchange notes that in addition to its belief that the proposed thresholds are sufficiently high, the Exchange has proposed the requirement that either criterion (A) is met or the sum of applicable event statistics for proposed (A) through (D) equals or exceeds 150% in order to ensure that an event is sufficiently large but also to avoid situations where an event is extremely large but just misses potential qualifying thresholds. For instance, the proposal is designed to help avoid a situation where the Worst Case Adjustment Penalty is $15,000,000, so the event does not qualify based on criterion (A) alone, but there are transactions in 490,000 options contracts that are potentially erroneous (missing criterion (B) by 10,000 contracts), there transactions with a notional value of $99,000,000 (missing criterion (C) by $1,000,000), and there are 9,000 potentially erroneous transactions overall (missing criterion (D) by 1,000 transactions). The Exchange believes that the proposed formula, while slightly more complicated than simply requiring a certain threshold to be met in each category, may help to avoid inapplicability of the proposed provisions in the context of an event that would be deemed significant by most subjective measures but that barely misses each of the objective criteria proposed by the Exchange. To ensure consistent application across options exchanges, in the event of a suspected Significant Market Event, the Exchange shall initiate a coordinated review of potentially erroneous transactions with all other affected options exchanges to determine the full scope of the event. Under the Proposed Rule, the Exchange will promptly coordinate with the other options exchanges to determine the appropriate review period as well as select one or more specific points in time prior to the transactions in question and use one or more specific points in time to determine Theoretical Price. Other than the selected points in time, if applicable, the Exchange will determine Theoretical Price as described above. For example, around the start of a Significant Market Event that is triggered by a large and aggressively priced buy order, three exchanges have multiple orders on the offer side of the market: Exchange A has offers priced at $2.20, $2.25, $2.30 and several other price levels to $3.00, Exchange B has offers at $2.45, $2.30 and several other price levels to $3.00, Exchange C has offers at price levels between $2.50 and $3.00. Assume an event occurs starting at 10:05:25 a.m. ET and in this particular series the executions begin on Exchange A and subsequently begin to occur on Exchanges B and C. Without coordination and information sharing between the exchanges, Exchange B and Exchange C cannot know with certainty that whether or not the execution at Exchange A that happened at $2.20 immediately prior to their executions at $2.45 and $2.50 is part of the same erroneous event or not. With proper coordination, the exchanges can determine that in this series, the proper point in time from which the event should be analyzed is 10:05:25 a.m. ET, and thus, the NBO of $2.20 should be used as the Theoretical Price for purposes of all buy transactions in such options series that occurred during the event. If it is determined that a Significant Market Event has occurred then, using the parameters agreed with respect to the times from which Theoretical Price will be calculated, if applicable, an Official will determine whether any or all transactions under review qualify as Obvious Errors. The Proposed Rule would require the Exchange to use the criteria in Proposed Section 6(c), as described above, to determine whether an Obvious Error has occurred for each transaction that was part of the Significant Market Event. Upon taking any final action, the Exchange would be required to promptly notify both parties to the trade electronically or via telephone. The execution price of each affected transaction will be adjusted by an Official to the price provided below, unless both parties agree to adjust the transaction to a different price or agree to bust the trade. ------------------------------------------------------------------------ Buy transaction Sell transaction Theoretical price (TP) adjustment-- TP adjustment-- TP plus minus ------------------------------------------------------------------------ Below $3.00....................... $0.15 $0.15 At or above $3.00................. 0.30 0.30 ------------------------------------------------------------------------ Thus, the proposed adjustment criteria for Significant Market Events are identical to the proposed adjustment levels for Obvious Errors generally. In addition, in the context of a Significant Market Event, any error exceeding 50 contracts will be subject to the Size Adjustment Modifier described above. Also, the adjustment criteria would apply equally to all market participants (i.e., Customers and non-Customers) in a Significant Market Event. However, as is true for the proposal with respect to Catastrophic Errors, under the Proposed Rule where at least one party to the transaction is a Customer, the trade will be nullified if the adjustment would result in an execution price higher (for buy transactions) or lower (for sell transactions) than the Customer's limit price. The Exchange has retained the protection of a Customer's limit price in order to avoid a situation where the adjustment could be to a price that the Customer could not afford, which is less likely to be an issue for a market professional. The Exchange has otherwise proposed to treat all market participants the same in the context of a Significant Market Event to provide additional certainty to market participants with respect to their potential exposure as soon as an event has occurred. Another significant distinction between the proposed Obvious Error provision and the proposed Significant Market Event provision is that if the Exchange, in consultation with other [[Page 27810]] options exchanges, determines that timely adjustment is not feasible due to the extraordinary nature of the situation, then the Exchange will nullify some or all transactions arising out of the Significant Market Event during the review period selected by the Exchange and other options exchanges. To the extent the Exchange, in consultation with other options exchanges, determines to nullify less than all transactions arising out of the Significant Market Event, those transactions subject to nullification will be selected based upon objective criteria with a view toward maintaining a fair and orderly market and the protection of investors and the public interest. For example, assume a Significant Market Event causes 25,000 potentially erroneous transactions and impacts 51 options classes. Of the 25,000 transactions, 24,000 of them are concentrated in a single options class. The exchanges may decide the most appropriate solution because it will provide the most certainty to participants and allow for the prompt resumption of regular trading is to bust all trades in the most heavily affected class between two specific points in time, while the other 1,000 trades across the other 50 classes are reviewed and adjusted as appropriate. A similar situation might arise directionally where a Customer submits both erroneous buy and sell orders and the number of errors that happened that were erroneously low priced (i.e., erroneous sell orders) were 50,000 in number but the number of errors that were erroneously high (i.e., erroneous buy orders) were only 500 in number. The most effective and efficient approach that provides the most certainty to the marketplace in a reasonable amount of time while most closely following the generally prescribed obvious error rules could be to bust all of the erroneous sell transactions but to adjust the erroneous buy transactions. With respect to rulings made pursuant to the proposed Significant Market Event provision the Exchange believes that the number of affected transactions is such that immediate finality is necessary to maintain a fair and orderly market and to protect investors and the public interest. Accordingly, rulings by the Exchange pursuant to the Significant Market Event provision would be non-appealable pursuant to the Proposed Rule. Additional Provisions Mutual Agreement In addition to the objective criteria described above, the Proposed Rule also proposes to make clear that the determination as to whether a trade was executed at an erroneous price may be made by mutual agreement of the affected parties to a particular transaction. The Proposed Rule would state that a trade may be nullified or adjusted on the terms that all parties to a particular transaction agree, provided, however, that such agreement to nullify or adjust must be conveyed to the Exchange in a manner prescribed by the Exchange prior to 8:30 a.m. Eastern Time on the first trading day following the execution. The Exchange also proposes to explicitly state that it is considered conduct inconsistent with just and equitable principles of trade for any Participant to use the mutual adjustment process to circumvent any applicable Exchange rule, the Act or any of the rules and regulations thereunder. Thus, for instance, a Participant is precluded from seeking to avoid applicable trade-through rules by executing a transaction and then adjusting such transaction to a price at which the Exchange would not have allowed it to execute at the time of the execution because it traded through the quotation of another options exchange. The Exchange notes that in connection with its obligations as a self-regulatory organization, the Exchange's Regulatory Department reviews adjustments to transactions to detect potential violations of Exchange rules or the Act and the rules and regulations thereunder. Trading Halts Chapter V, Section 3 describes the Exchange's authority to declare trading halts in one or more options traded on the Exchange. The Exchange proposes to make clear in the Proposed Rule that it will nullify any transaction that occurs during a trading halt in the affected option on the Exchange pursuant to Section 6. If any trades occur notwithstanding a trading halt then the Exchange believes it appropriate to nullify such transactions. While the Exchange may halt options trading for various reasons, such a scenario almost certainly is due to extraordinary circumstances and is potentially the result of market-wide coordination to halt options trading or trading generally. Accordingly, the Exchange does not believe it is appropriate to allow trades to stand if such trades should not have occurred in the first place. The Exchange proposes to adopt Commentary .03 to Section 6 to state that the Exchange will nullify any transaction that occurs: (a) During a trading halt in the affected option on the Exchange; (b) with respect to equity options (including options overlying ETFs), during a trading halt on the primary listing market for the underlying security; or (c) respecting index options, the trade occurred during a trading halt on the primary market in underlying securities representing more than 10 percent of the current index value for stock index options. Currently, the Exchange's rules do not directly address nullification during a trading halt. Accordingly, and for consistency with other exchanges' rules, the Exchange proposes to adopt this provision. Erroneous Print and Quotes in Underlying Security Market participants on the Exchange likely base the pricing of their orders submitted to the Exchange on the price of the underlying security for the option. Thus, the Exchange believes it is appropriate to adopt provisions that allow adjustment or nullification of transactions based on erroneous prints or erroneous quotes in the underlying security. The Exchange proposes to adopt language in the Proposed Rule stating that a trade resulting from an erroneous print(s) disseminated by the underlying market that is later nullified by that underlying market shall be adjusted or busted as set forth in the Obvious Error provisions of the Proposed Rule, provided a party notifies the Official in a timely manner, as further described below. The Exchange proposes to define a trade resulting from an erroneous print(s) as any options trade executed during a period of time for which one or more executions in the underlying security are nullified and for one second thereafter. The Exchange believes that one second is an appropriate amount of time in which an options trade would be directly based on executions in the underlying equity security. The Exchange also proposes to require that if a party believes that it participated in an erroneous transaction resulting from an erroneous print(s) pursuant to the proposed erroneous print provision it must notify the Official within the timeframes set forth in the Obvious Error provision described above. The Exchange has also proposed to state that the allowed notification timeframe commences at the time of notification by the underlying market(s) of nullification of transactions in the underlying security. Further, the [[Page 27811]] Exchange proposes that if multiple underlying markets nullify trades in the underlying security, the allowed notification timeframe will commence at the time of the first market's notification. As an example of a situation in which a trade results from an erroneous print disseminated by the underlying market that is later nullified by the underlying market, assume that a given underlying is trading in the $49.00-$50.00 price range then has an erroneous print at $5.00. Given that there is the potential perception that the underlying has gone through a dramatic price revaluation, numerous options trades could promptly trigger based off of this new price. However, because the price that triggered them was not a valid price it would be appropriate to review said option trades when the underlying print that triggered them is removed. The Exchange also proposes to add a provision stating that a trade resulting from an erroneous quote(s) in the underlying security shall be adjusted or busted as set forth in the Obvious Error provisions of the Proposed Rule, provided a party notifies the Official in a timely manner, as further described below. Pursuant to the Proposed Rule, an erroneous quote occurs when the underlying security has a width of at least $1.00 and has a width at least five times greater than the average quote width for such underlying security during the time period encompassing two minutes before and after the dissemination of such quote. For purposes of the Proposed Rule, the average quote width will be determined by adding the quote widths of sample quotations at regular 15-second intervals during the four-minute time period referenced above (excluding the quote(s) in question) and dividing by the number of quotes during such time period (excluding the quote(s) in question).\10\ Similar to the proposal with respect to erroneous prints described above, if a party believes that it participated in an erroneous transaction resulting from an erroneous quote(s) it must notify the Official in accordance with the notification provisions of the Obvious Error provision described above. The Proposed Rule, therefore, puts the onus on each Participant to notify the Exchange if such Participant believes that a trade should be reviewed pursuant to either of the proposed provisions, as the Exchange is not in position to determine the impact of erroneous prints or quotes on individual Participants. The Exchange notes that it does not believe that additional time is necessary with respect to a trade based on an erroneous quote because a Participant has all information necessary to detect the error at the time of an option transaction that was triggered by an erroneous quote, which is in contrast to the proposed erroneous print provision that includes a dependency on an action by the market where the underlying security traded. --------------------------------------------------------------------------- \10\ The Exchange has proposed the price and time parameters for quote width and average quote width used to determine whether an erroneous quote has occurred based on established rules of options exchanges that currently apply such parameters. See, e.g., CBOE Rule 6.25(a)(5); NYSE Arca Rule 6.87(a)(5). Based on discussions with these exchanges, the Exchange believes that the parameters are a reasonable approach to determine whether an erroneous quote has occurred for purposes of the proposed rule. --------------------------------------------------------------------------- As an example of a situation in which a trade results from an erroneous quote in the underlying security, assume again that a given underlying is quoting and trading in the $49.00-$50.00 price range then a liquidity gap occurs, with bidders not representing quotes in the market place and an offer quoted at $5.00. Quoting may quickly return to normal, again in the $49.00-$50.00 price range, but due to the potential perception that the underlying has gone through a dramatic price revaluation, numerous options trades could trigger based off of this new quoted price in the interim. Because the price that triggered such trades was not a valid price it would be appropriate to review said option trades. Linkage Trades The Exchange also proposes to adopt language that clearly provides the Exchange with authority to take necessary actions when another options exchange nullifies or adjusts a transaction pursuant to its respective rules and the transaction resulted from an order that has passed through the Exchange and been routed on to another options exchange on behalf of the Exchange. Specifically, if the Exchange routes an order pursuant to the Options Order Protection and Locked/ Crossed Market Plan \11\ that results in a transaction on another options exchange (a ``Linkage Trade'') and such options exchange subsequently nullifies or adjusts the Linkage Trade pursuant to its rules, the Exchange will perform all actions necessary to complete the nullification or adjustment of the Linkage Trade. Although the Exchange is not utilizing its own authority to nullify or adjust a transaction related to an action taken on a Linkage Trade by another options exchange, the Exchange does have to assist in the processing of the adjustment or nullification of the order, such as notification to the Participant and The Options Clearing Corporation (``OCC'') of the adjustment or nullification. Thus, the Exchange believes that the proposed provision adds additional transparency to the Proposed Rule. --------------------------------------------------------------------------- \11\ See Chapter XII, Section 1(17). --------------------------------------------------------------------------- Appeals The Exchange proposes to maintain its current appeals process in connection with the Proposed Rule. Specifically, a party to a transaction affected by a decision made under this section may appeal that decision to the Nasdaq Review Council. An appeal must be made in writing, and must be received by the Exchange within thirty (30) minutes after the person making the appeal is given the notification of the determination being appealed. The Nasdaq Review Council may review any decision appealed, including whether a complaint was timely, whether an Obvious Error or Catastrophic Error occurred, whether the correct Theoretical Price was used, and whether an adjustment was made at the correct price. In order to maintain a diverse group of participants, the Nasdaq Review Council panel will continue be comprised minimally of representatives of one (1) member engaged in Market Making and two (2) industry representatives not engaged in Market Making. At no time should a review panel have more than 50% members engaged in Market Making. To assure fairness, members of the Nasdaq Review Council, like all members of Board Committees, are subject to a conflict of interest prohibition.\12\ --------------------------------------------------------------------------- \12\ See By-Law Article III, Section 7. --------------------------------------------------------------------------- No Adjustments to a Worse Price Finally, the Exchange proposes to include Commentary .02 to the Proposed Rule, which would make clear that to the extent the provisions of the proposed Rule would result in the Exchange applying an adjustment of an erroneous sell transaction to a price lower than the execution price or an erroneous buy transaction to a price higher than the execution price, the Exchange will not adjust or nullify the transaction, but rather, the execution price will stand. Limit Up-Limit Down Plan The Exchange proposes to amend Section 3(d)(iv) to reflect the numbering and content of the Proposed Rule. It will then continue to cover how the Exchange will treat Obvious and Catastrophic Errors in response to the Regulation NMS Plan to Address Extraordinary Market Volatility [[Page 27812]] Pursuant to Rule 608 of Regulation NMS under the Act (the ``Limit Up- Limit Down Plan'' or the ``Plan),\13\ which is applicable to all NMS stocks, as defined in Regulation NMS Rule 600(b)(47).\14\ --------------------------------------------------------------------------- \13\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77 FR 33498 (June 6, 2012). \14\ 17 CFR 242.600(b)(47). --------------------------------------------------------------------------- Implementation Date In order to ensure that other options exchanges are able to adopt rules consistent with this proposal and to coordinate the effectiveness of such harmonized rules, the Exchange proposes to delay the operative date of this proposal to May 8, 2015. 2. Statutory Basis The Exchange believes that its proposal is consistent with the requirements of the Act and the rules and regulations thereunder that are applicable to a national securities exchange, and, in particular, with the requirements of Section 6(b) of the Act.\15\ Specifically, the proposal is consistent with Section 6(b)(5) of the Act \16\ because it would promote just and equitable principles of trade, remove impediments to, and perfect the mechanism of, a free and open market and a national market system, and, in general, protect investors and the public interest. --------------------------------------------------------------------------- \15\ 15 U.S.C. 78f(b). \16\ 15 U.S.C. 78f(b)(5). --------------------------------------------------------------------------- As described above, the Exchange and other options exchanges are seeking to adopt harmonized rules related to the adjustment and nullification of erroneous options transactions. The Exchange believes that the Proposed Rule will provide greater transparency and clarity with respect to the adjustment and nullification of erroneous options transactions. Particularly, the proposed changes seek to achieve consistent results for participants across U.S. options exchanges while maintaining a fair and orderly market, protecting investors and protecting the public interest. Based on the foregoing, the Exchange believes that the proposal is consistent with Section 6(b)(5) of the Act \17\ in that the Proposed Rule will foster cooperation and coordination with persons engaged in regulating and facilitating transactions. --------------------------------------------------------------------------- \17\ 15 U.S.C. 78f(b)(5). --------------------------------------------------------------------------- The Exchange believes the various provisions allowing or dictating adjustment rather than nullification of a trade are necessary given the benefits of adjusting a trade price rather than nullifying the trade completely. Because options trades are used to hedge, or are hedged by, transactions in other markets, including securities and futures, many Participants, and their customers, would rather adjust prices of executions rather than nullify the transactions and, thus, lose a hedge altogether. As such, the Exchange believes it is in the best interest of investors to allow for price adjustments as well as nullifications. The Exchange further discusses specific aspects of the Proposed Rule below. The Exchange does not believe that the proposal is unfairly discriminatory, even though it differentiates in many places between Customers and non-Customers. The rules of the options exchanges, including the Exchange's existing Obvious Error provision, often treat Customers differently, often affording them preferential treatment. This treatment is appropriate in light of the fact that Customers are not necessarily immersed in the day-to-day trading of the markets, are less likely to be watching trading activity in a particular option throughout the day, and may have limited funds in their trading accounts. At the same time, the Exchange reiterates that in the U.S. options markets generally there is significant retail customer participation that occurs directly on (and only on) options exchanges such as the Exchange. Accordingly, differentiating among market participants with respect to the adjustment and nullification of erroneous options transactions is not unfairly discriminatory because it is reasonable and fair to provide Customers with additional protections as compared to non-Customers. The Exchange believes that its proposal with respect to the allowance of mutual agreed upon adjustments or nullifications is appropriate and consistent with the Act, as such proposal removes impediments to and perfects the mechanism of a free and open market and a national market system, allowing participants to mutually agree to correct an erroneous transactions without the Exchange mandating the outcome. The Exchange also believes that its proposal with respect to mutual adjustments is consistent with the Act because it is designed to prevent fraudulent and manipulative acts and practices by explicitly stating that it is considered conduct inconsistent with just and equitable principles of trade for any Participant to use the mutual adjustment process to circumvent any applicable Exchange rule, the Act or any of the rules and regulations thereunder. The Exchange believes its proposal to provide within the Proposed Rule definitions of Customer, erroneous sell transaction and erroneous buy transaction, and Official is consistent with Section 6(b)(5) of the Act because such terms will provide more certainty to market participants as to the meaning of the Proposed Rule and reduce the possibility that a party can intentionally submit an order hoping for the market to move in their favor in reliance on the Rule as a safety mechanism, thereby promoting just and fair principles of trade. Similarly, the Exchange believes that proposed Commentary .02 is consistent with the Act as it would make clear that the Exchange will not adjust or nullify a transaction, but rather, the execution price will stand when the applicable adjustment criteria would actually adjust the price of the transaction to a worse price (i.e., higher for an erroneous buy or lower for an erroneous sell order). As set forth below, the Exchange believes it is consistent with Section 6(b)(5) of the Act for the Exchange to determine Theoretical Price when the NBBO cannot reasonably be relied upon because the alternative could result in transactions that cannot be adjusted or nullified even when they are otherwise clearly at a price that is significantly away from the appropriate market for the option. Similarly, reliance on an NBBO that is not reliable could result in adjustment to prices that are still significantly away from the appropriate market for the option. The Exchange believes that its proposal with respect to determining Theoretical Price is consistent with the Act in that it has retained the standard of the current rule, which is to rely on the NBBO to determine Theoretical Price if such NBBO can reasonably be relied upon. Because, however, there is not always an NBBO that can or should be used in order to administer the rule, the Exchange has proposed various provisions that provide the Exchange with the authority to determine a Theoretical Price. The Exchange believes that the Proposed Rule is transparent with respect to the circumstances under which the Exchange will determine Theoretical Price, and has sought to limit such circumstances as much as possible. The Exchange notes that Exchange personnel currently are required to determine Theoretical Price in certain circumstances. While the Exchange continues to pursue alternative solutions that might further enhance the objectivity and consistency of determining Theoretical Price, the Exchange believes that the discretion currently afforded to Officials is appropriate in the absence of a reliable NBBO that can be used to set the Theoretical Price. [[Page 27813]] With respect to the specific proposed provisions for determining Theoretical Price for transactions that occur as part of the Exchange's Opening Process and in situations where there is a wide quote, the Exchange believes both provisions are consistent with the Act because they provide objective criteria that will determine Theoretical Price with limited exceptions for situations where the Exchange does not believe the NBBO is a reasonable benchmark or there is no NBBO. The Exchange notes in particular with respect to the wide quote provision that the Proposed Rule will result in the Exchange determining Theoretical Price less frequently than it would pursuant to wide quote provisions that have previously been approved. The Exchange believes that it is appropriate and consistent with the Act to afford protections to market participants by not relying on the NBBO to determine Theoretical Price when the quote is extremely wide but had been, in the prior 10 seconds, at much more reasonable width. The Exchange also believes it is appropriate and consistent with the Act to use the NBBO to determine Theoretical Price when the quote has been wider than the applicable amount for more than 10 seconds, as the Exchange does not believe it is necessary to apply any other criteria in such a circumstance. The Exchange believes that market participants can easily use or adopt safeguards to prevent errors when such market conditions exist. When entering an order into a market with a persistently wide quote, the Exchange does not believe that the entering party should reasonably expect anything other than the quoted price of an option. The Exchange believes that its proposal to adopt clear but disparate standards with respect to the deadline for submitting a request for review of Customer and non-Customer transactions is consistent with the Act, particularly in that it creates a greater level of protection for Customers. As noted above, the Exchange believes that this is appropriate and not unfairly discriminatory in light of the fact that Customers are not necessarily immersed in the day-to-day trading of the markets and are less likely to be watching trading activity in a particular option throughout the day. Thus, Participants representing Customer orders reasonably may need additional time to submit a request for review. The Exchange also believes that its proposal to provide additional time for submission of requests for review of linkage trades is reasonable and consistent with the protection of investors and the public interest due to the time that it might take an options exchange or third-party routing broker to file a request for review with the Exchange if the initial notification of an error is received by the originating options exchange near the end of such options exchange's filing deadline. Without this additional time, there could be disparate results based purely on the existence of intermediaries and an interconnected market structure. In relation to the aspect of the proposal giving Officials the ability to review transactions for obvious errors on their own motion, the Exchange notes that an Official can adjust or nullify a transaction under the authority granted by this provision only if the transaction meets the specific and objective criteria for an Obvious Error under the Proposed Rule. As noted above, this is designed to give an Official the ability to provide parties relief in those situations where they have failed to report an apparent error within the established notification period. However, the Exchange will only grant relief if the transaction meets the requirements for an Obvious Error as described in the Proposed Rule. The Exchange believes that its proposal to adjust non-Customer transactions and to nullify Customer transactions that qualify as Obvious Errors is appropriate for reasons consistent with those described above. In particular, Customers are not necessarily immersed in the day-to-day trading of the markets, are less likely to be watching trading activity in a particular option throughout the day, and may have limited funds in their trading accounts. The Exchange acknowledges that the proposal contains some uncertainty regarding whether a trade will be adjusted or nullified, depending on whether one of the parties is a Customer, because a party may not know whether the other party to a transaction was a Customer at the time of entering into the transaction. However, the Exchange believes that the proposal nevertheless promotes just and equitable principles of trade and protects investors as well as the public interest because it eliminates the possibility that a Customer's order will be adjusted to a significantly different price. As noted above, the Exchange believes it is consistent with the Act to afford Customers greater protections under the Proposed Rule than are afforded to non- Customers. Thus, the Exchange believes that its proposal is consistent with the Act in that it protects investors and the public interest by providing additional protections to those that are less informed and potentially less able to afford an adjustment of a transaction that was executed in error. Customers are also less likely to have engaged in significant hedging or other trading activity based on earlier transactions, and thus, are less in need of maintaining a position at an adjusted price than non-Customers. If any Participant submits requests to the Exchange for review of transactions pursuant to the Proposed Rule, and in aggregate that Participant has 200 or more Customer transactions under review concurrently and the orders resulting in such transactions were submitted during the course of 2 minutes or less, the Exchange believes it is appropriate for the Exchange apply the non-Customer adjustment criteria described above to such transactions. The Exchange believes that the proposed aggregation is reasonable as it is representative of an extremely large number of orders submitted to the Exchange over a relatively short period of time that are, in turn, possibly erroneous (and within a time frame significantly less than an entire day), and thus is most likely to occur because of a systems issue experienced by a Participant representing Customer orders or a systems issue coupled with the erroneous marking of orders. The Exchange does not believe it is possible at a level of 200 Customer orders over a 2 minute period that are under review at one time that multiple, separate Customers were responsible for the errors in the ordinary course of trading. In the event of a large-scale issue caused by an Participant that has submitted orders over a 2 minute period marked as Customer that resulted in more than 200 transactions under review, the Exchange does not believe it is appropriate to nullify all such transactions because of the negative impact that nullification could have on the market participants on the contra-side of such transactions, who might have engaged in hedging and trading activity following such transactions. In order for a participant to have more than 200 transactions under review concurrently when the orders triggering such transactions were received in 2 minutes or less, the Exchange believes that a market participant will have far exceeded the normal behavior of customers deserving protected status. While the Exchange continues to believe that it is appropriate to nullify transactions in such a circumstance if both participants to a transaction are Customers, the Exchange does not believe it is appropriate to place the overall risk of [[Page 27814]] a significant number of trade breaks on non-Customers that in the normal course of business may have engaged in additional hedging activity or trading activity based on such transactions. Thus, the Exchange believes it is necessary and appropriate to protect non- Customers in such a circumstance by applying the non-Customer adjustment criteria, and thus adjusting transactions as set forth above, in the event a Participant has more than 200 transactions under review concurrently. In summary, due to the extreme level at which the proposal is set, the Exchange believes that the proposal is consistent with Section 6(b)(5) of the Act in that it promotes just and equitable principles of trade by encouraging market participants to retain appropriate controls over their systems to avoid submitting a large number of erroneous orders in a short period of time. Similarly, the Exchange believes that the proposed Size Adjustment Modifier, which would increase the adjustment amount for non-Customer transactions, is appropriate because it attempts to account for the additional risk that the parties to the trade undertake for transactions that are larger in scope. The Exchange believes that the Size Adjustment Modifier creates additional incentives to prevent more impactful Obvious Errors and it lessens the impact on the contra-party to an adjusted trade. The Exchange notes that these contra-parties may have preferred to only trade the size involved in the transaction at the price at which such trade occurred, and in trading larger size has committed a greater level of capital and bears a larger hedge risk. The Exchange similarly believes that its Proposed Rule with respect to Catastrophic Errors is consistent with the Act as it affords additional time for market participants to file for review of erroneous transactions that were further away from the Theoretical Price. At the same time, the Exchange believes that the Proposed Rule is consistent with the Act in that it generally would adjust transactions, including Customer transactions, because this will protect against hedge risk, particularly for transactions that may have occurred several hours earlier and thus, which all parties to the transaction might presume are protected from further modification. Similarly, by providing larger adjustment amounts away from Theoretical Price than are set forth under the Obvious Error provision, the Catastrophic Error provision also takes into account the possibility that the party that was advantaged by the erroneous transaction has already taken actions based on the assumption that the transaction would stand. The Exchange believes it is reasonable to specifically protect Customers from adjustments through their limit prices for the reasons stated above, including that Customers are less likely to be watching trading throughout the day and that they may have less capital to afford an adjustment price. The Exchange believes that the proposal provides a fair process that will ensure that Customers are not forced to accept a trade that was executed in violation of their limit order price. In contrast, market professionals are more likely to have engaged in hedging or other trading activity based on earlier trading activity, and thus, are more likely to be willing to accept an adjustment rather than a nullification to preserve their positions even if such adjustment is to a price through their limit price. The Exchange believes that proposed rule change to adopt the Significant Market Event provision is consistent with Section 6(b)(5) of the Act in that it will foster cooperation and coordination with persons engaged in regulating the options markets. In particular, the Exchange believes it is important for options exchanges to coordinate when there is a widespread and significant event, as commonly, multiple options exchanges are impacted in such an event. Further, while the Exchange recognizes that the Proposed Rule will not guarantee a consistent result for all market participants on every market, the Exchange does believe that it will assist in that outcome. For instance, if options exchanges are able to agree as to the time from which Theoretical Price should be determined and the period of time that should be reviewed, the likely disparity between the Theoretical Prices used by such exchanges should be very slight and, in turn, with otherwise consistent rules, the results should be similar. The Exchange also believes that the Proposed Rule is consistent with the Act in that it generally would adjust transactions, including Customer transactions, because this will protect against hedge risk, particularly for liquidity providers that might have been quoting in thousands or tens of thousands of different series and might have affected executions throughout such quoted series. The Exchange believes that when weighing the competing interests between preferring a nullification for a Customer transaction and an adjustment for a transaction of a market professional, while nullification is appropriate in a typical one-off situation that it is necessary to protect liquidity providers in a widespread market event because, presumably, they will be the most affected by such an event (in contrast to a Customer who, by virtue of their status as such, likely would not have more than a small number of affected transactions). The Exchange believes that the protection of liquidity providers by favoring adjustments in the context of Significant Market Events can also benefit Customers indirectly by better enabling liquidity providers, which provides a cumulative benefit to the market. Also, as stated above with respect to Catastrophic Errors, the Exchange believes it is reasonable to specifically protect Customers from adjustments through their limit prices for the reasons stated above, including that Customers are less likely to be watching trading throughout the day and that they may have less capital to afford an adjustment price. The Exchange believes that the proposal provides a fair process that will ensure that Customers are not forced to accept a trade that was executed in violation of their limit order price. In contrast, market professionals are more likely to have engaged in hedging or other trading activity based on earlier trading activity, and thus, are more likely to be willing to accept an adjustment rather than a nullification to preserve their positions even if such adjustment is to a price through their limit price. In addition, the Exchange believes it is important to have the ability to nullify some or all transactions arising out of a Significant Market Event in the event timely adjustment is not feasible due to the extraordinary nature of the situation. In particular, although the Exchange has worked to limit the circumstances in which it has to determine Theoretical Price, in a widespread event it is possible that hundreds if not thousands of series would require an Exchange determination of Theoretical Price. In turn, if there are hundreds or thousands of trades in such series, it may not be practicable for the Exchange to determine the adjustment levels for all non-Customer transactions in a timely fashion, and in turn, it would be in the public interest to instead more promptly deliver a simple, consistent result of nullification. The Exchange believes that proposed rule change related to an erroneous print in the underlying security or an erroneous quote in the underlying security is likewise consistent with Section 6(b)(5) of the Act because the proposal provides for the adjustment or nullification of trades executed at erroneous prices through no fault on the part of the trading participants. Allowing for Exchange review in such [[Page 27815]] situations will promote just and fair principles of trade by protecting investors from harm that is not of their own making. Specifically with respect to the proposed provisions governing erroneous prints and quotes in the underlying security, the Exchange notes that market participants on the Exchange base the value of their quotes and orders on the price of the underlying security. The provisions regarding errors in prints and quotes in the underlying security cover instances where the information market participants use to price options is erroneous through no fault of their own. In these instances, market participants have little, if any, chance of pricing options accurately. Thus, these provisions are designed to provide relief to market participants harmed by such errors in the prints or quotes of the underlying security. The Exchange believes that the proposed provision related to Linkage Trades is consistent with the Act because it adds additional transparency to the Proposed Rule and makes clear that when a Linkage Trade is adjusted or nullified by another options exchange, the Exchange will take necessary actions to complete the nullification or adjustment of the Linkage Trade. The Exchange believes that retaining the same appeals process as the Exchange maintains under the Current Rule is consistent with the Act because such process provides Participants with due process in connection with decisions made by Officials under the Proposed Rule. The Exchange believes that this process provides fair representation of members by ensuring diversity amongst the members of any Obvious Error Review Panel, which is consistent with Sections 6(b)(3) and 6(b)(7) of the Act. B. Self-Regulatory Organization's Statement on Burden on Competition NASDAQ believes the entire proposal is consistent with Section 6(b)(8) of the Act \18\ in that it does not impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act as explained below. --------------------------------------------------------------------------- \18\ 15 U.S.C. 78f(b)(8). --------------------------------------------------------------------------- Importantly, the Exchange believes the proposal will not impose a burden on intermarket competition but will rather alleviate any burden on competition because it is the result of a collaborative effort by all options exchanges to harmonize and improve the process related to the adjustment and nullification of erroneous options transactions. The Exchange does not believe that the rules applicable to such process is an area where options exchanges should compete, but rather, that all options exchanges should have consistent rules to the extent possible. Particularly where a market participant trades on several different exchanges and an erroneous trade may occur on multiple markets nearly simultaneously, the Exchange believes that a participant should have a consistent experience with respect to the nullification or adjustment of transactions. The Exchange understands that all other options exchanges intend to file proposals that are substantially similar to this proposal. The Exchange does not believe that the proposed rule change imposes a burden on intramarket competition because the provisions apply to all market participants equally within each participant category (i.e., Customers and non-Customers). With respect to competition between Customer and non-Customer market participants, the Exchange believes that the Proposed Rule acknowledges competing concerns and tries to strike the appropriate balance between such concerns. For instance, as noted above, the Exchange believes that protection of Customers is important due to their direct participation in the options markets as well as the fact that they are not, by definition, market professionals. At the same time, the Exchange believes due to the quote-driven nature of the options markets, the importance of liquidity provision in such markets and the risk that liquidity providers bear when quoting a large breadth of products that are derivative of underlying securities, that the protection of liquidity providers and the practice of adjusting transactions rather than nullifying them is of critical importance. As described above, the Exchange will apply specific and objective criteria to determine 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 proposed rule change does not (i) significantly affect the protection of investors or the public interest; (ii) impose any significant burden on competition; and (iii) become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate if consistent with the protection of investors and the public interest, the proposed rule change has become effective pursuant to Section 19(b)(3)(A) of the Act \19\ and Rule 19b-4(f)(6) thereunder.\20\ --------------------------------------------------------------------------- \19\ 15 U.S.C. 78s(b)(3)(A). \20\ 17 CFR 240.19b-4(f)(6). As required under Rule 19b- 4(f)(6)(iii), the Exchange provided the Commission with written notice of its intent to file the proposed rule change, along with a brief description and the text of the proposed rule change, at least five business days prior to the date of filing of the proposed rule change, or such shorter time as designated by the Commission. --------------------------------------------------------------------------- The Exchange has asked the Commission to waive the 30-day operative delay so that the proposal may become operative immediately upon filing. The Commission believes that waiving the 30-day operative delay is consistent with the protection of investors and the public interest, as it will enable the Exchange to meet its proposed implementation date of May 8, 2015, which will help facilitate the implementation of harmonized rules related to the adjustment and nullification of erroneous options transactions across the options exchanges. For this reason, the Commission designates the proposed rule change to be operative upon filing.\21\ --------------------------------------------------------------------------- \21\ 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 necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule should be approved or disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or [[Page 27816]] Send an email to rule-comments@sec.gov. Please include File Number SR-NASDAQ-2015-054 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-NASDAQ-2015-054. 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-NASDAQ-2015-054, and should be submitted on or before June 4, 2015. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.\22\ --------------------------------------------------------------------------- \22\ 17 CFR 200.30-3(a)(12). Robert W. Errett, Deputy Secretary. [FR Doc. 2015-11593 Filed 5-13-15; 8:45 am] BILLING CODE 8011-01-P
![Federal Register / Vol. 80, No. 93 / Thursday, May 14, 2015 / Notices 27801
IV. Discussion and Commission regulations thereunder applicable to to effect settlement in cash without
Findings ICC. having to acquire or dispose of the
The proposed rule change will underlying deliverable obligations,
Section 19(b)(2)(C) of the Act 11 provide greater certainty and timeliness consistent with the requirements of Rule
directs the Commission to approve a with respect to the clearance and 17Ad–22(d)(15).19
proposed rule change of a self- settlement of CDS transactions in
regulatory organization if the circumstances where physical V. Conclusion
Commission finds that such proposed settlement applies. Although physical On the basis of the foregoing, the
rule change is consistent with the settlement applies only rarely, and as a Commission finds that the proposal is
requirements of the Act and the rules fallback to the normal procedure for consistent with the requirements of the
and regulations thereunder applicable to cash settlement, the proposed rule Act and in particular with the
such self-regulatory organization. change will prevent Participants from requirements of Section 17A of the
Section 17A(b)(3)(F) of the Act 12 being exposed to the credit risk of other Act 20 and the rules and regulations
requires, among other things, that the Participants with respect to the financial thereunder.
rules of a clearing agency are designed performance of physical settlement by It is therefore ordered, pursuant to
to promote the prompt and accurate guaranteeing timely payment of Section 19(b)(2) of the Act,21 that the
clearance and settlement of securities settlement amounts that are due to a proposed rule change (SR–ICC–2015–
transactions and, to the extent non-defaulting party. As a result, the 004) be, and hereby is, approved.22
applicable, derivative agreements, Commission believes the proposed rule For the Commission, by the Division of
contracts, and transactions, to assure the change will promote the prompt and Trading and Markets, pursuant to delegated
safeguarding of securities and funds accurate clearing and settlement of CDS authority.23
which are in the custody or control of contracts, and, in general, protect Robert W. Errett,
the clearing agency or for which it is investors and the public interest Deputy Secretary.
responsible and, in general, to protect consistent with the requirements of [FR Doc. 2015–11595 Filed 5–13–15; 8:45 am]
investors and the public interest. Section 17A(b)(3)(F) of the Act.16 BILLING CODE 8011–01–P
Rules 17Ad–22(b)(2–3) 13 require each Moreover, the proposed rule change
registered clearing agency that performs will require ICC to collect Physical
central counterparty services to Settlement Margin 17 (in addition to SECURITIES AND EXCHANGE
establish, implement, maintain and initial and variation margin) to cover the COMMISSION
enforce written policies and procedures specific obligations of each Matched
Delivery Seller to the clearinghouse [Release No. 34–74915; File No. SR–
reasonably designed to use margin NASDAQ–2015–054]
requirements to limit its credit with respect to physical settlement.
exposures to participants under normal Therefore, the Commission believes ICC
Self-Regulatory Organizations; The
market conditions and use risk-based will be able to maintain financial
NASDAQ Stock Market LLC; Notice of
models and parameters to set margin resources sufficient to support its
Filing and Immediate Effectiveness of
requirements and review such margin clearing operations, including
Proposed Rule Change To Amend
operations under the amended physical
requirements and the related risk-based Chapter V, Section 6
settlement procedures, in a manner
models and parameters at least monthly,
consistent with the requirements of Rule May 8, 2015.
and maintain sufficient financial
17Ad–22(b)(2–3).18 Furthermore, ICC Pursuant to Section 19(b)(1) of the
resources to withstand, at a minimum,
proposes to amend text of ICC Rules Securities Exchange Act of 1934
a default by the two participant families
2203(a)—(g), to address the legal (‘‘Act’’),1 and Rule 19b–4 thereunder,2
to which it has the largest exposures in
obligations that arise between notice is hereby given that, on May 7,
extreme but plausible market
Participants when settling a CDS 2015, The NASDAQ Stock Market LLC
conditions, in its capacity as a central
Contract that is to be physically settled, (‘‘Nasdaq’’ or ‘‘Exchange’’) filed with the
counterparty for security based swaps.
with corresponding changes to its Securities and Exchange Commission
Rule 17Ad–22(d)(15) 14 requires each Delivery Procedures. The Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed
registered clearing agency to establish, believes that ICC’s Rules, as amended, rule change as described in Items I and
implement, maintain and enforce establish ICC’s and Participants’ II below, which Items have been
written policies and procedures obligations for performance (including prepared by the Exchange. The
reasonably designed to state to its financial performance) of physically Commission is publishing this notice to
participants the clearing agency’s settled contracts, the procedures for solicit comments on the proposed rule
obligations with respect to physical settlement and the mechanism for ICC change from interested persons.
deliveries and identify and manage the
risks from these obligations. 16 15 U.S.C. 78q–1(b)(3)(F). I. Self-Regulatory Organization’s
The Commission finds that the 17 The Physical Settlement Margin is calculated as Statement of the Terms of the Substance
modification of the terms and the notional value minus the estimated value of the of the Proposed Rule Change
deliverable obligation and collected from the
conditions for physical settlement of Matched Delivery Seller and held by ICC until such The Exchange proposes to amend
cleared CDS Contracts and the adoption time the Matched Delivery Buyer and the Matched Chapter V, Regulation of Trading on
of certain new delivery procedures Delivery Seller as a pair confirm that settlement has
been occurred. Physical Settlement Margin is not
relating to physical settlement is collected from the Matched Delivery Buyer. The
19 17 CFR 240.17Ad–22(d)(15).
20 15 U.S.C. 78q–1.
consistent with the requirements of estimated value of the deliverable obligation will be
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21 15 U.S.C. 78s(b)(2).
Section 17A of the Act 15 and the determined by ICC using a ‘‘haircut’’ approach. ICC
22 In approving the proposed rule change, the
will use the price of the cheapest-to-deliver bond
as the basis for the ‘‘haircut’’ estimation. However, Commission considered the proposal’s impact on
11 15 U.S.C. 78s(b)(2)(C). if reliable pricing is not available, ICC reserves the efficiency, competition and capital formation. 15
12 15 U.S.C. 78q–1(b)(3)(F). U.S.C. 78c(f).
right to determine a price of zero and therefore
13 17 CFR 240.17Ad–22(b)(2–3). 23 17 CFR 200.30–3(a)(12).
charge the full notional amount as the Physical
14 17 CFR 240.17Ad–22(d)(15). Settlement Margin to the seller. 1 15 U.S.C. 78s(b)(1).
15 15 U.S.C. 78q–1. 18 17 CFR 240.17Ad–22(b)(2–3). 2 17 CFR 240.19b–4.
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![27806 Federal Register / Vol. 80, No. 93 / Thursday, May 14, 2015 / Notices
provide parties relief in those situations to unusual circumstances, the Proposed pursuant to another provision of the
where they have failed to report an Rule provides that the Exchange Officer Proposed Rule, no additional relief may
apparent error within the established shall act no later than 8:30 a.m. Eastern be granted by an Exchange Officer.
notification period. A transaction Time on the next trading day following If it is determined that an Obvious
reviewed pursuant to the proposed the date of the transaction in question.
The Exchange also proposes to state Error has occurred based on the
provision may be nullified or adjusted
that a party affected by a determination objective numeric criteria and time
only if it is determined by the Exchange
Officer that the transaction is erroneous to nullify or adjust a transaction after an deadlines described above, the
in accordance with the provisions of the Exchange Officer’s review on his or her Exchange will adjust or nullify the
Proposed Rule, provided that the time own motion may appeal such transaction as described below and
deadlines for filing a request for review determination in accordance with promptly notify both parties to the trade
described above shall not apply. The paragraph (k), which is described below. electronically or via telephone. The
Proposed Rule would require the The Proposed Rule would make clear Exchange proposes different adjustment
Exchange Officer to act as soon as that a determination by an Exchange and nullification criteria for Customers
possible after becoming aware of the Officer not to review a transaction or and non-Customers.
transaction; action by the Exchange determination not to nullify or adjust a As proposed, where neither party to
Officer would ordinarily be expected on transaction for which a review was the transaction is a Customer, the
the same day that the transaction conducted on an Exchange Officer’s execution price of the transaction will
occurred. However, because a own motion is not appealable and be adjusted by the Official pursuant to
transaction under review may have further that if a transaction is reviewed
the table below.
occurred near the close of trading or due and a determination is rendered
Buy transaction Sell transaction
Theoretical Price (TP) adjustment— adjustment—
TP plus TP Minus
Below $3.00 ................................................................................................................................................. $0.15 $0.15
At or above $3.00 ........................................................................................................................................ 0.30 0.30
The Exchange believes that it is Assume that the NBBO is $2.50 by advantaged by the trade if the
appropriate to adjust to prices a $3.00. Finally, assume that all orders Theoretical Price is indeed closer to
specified amount away from Theoretical quoted and submitted to Exchange B in $2.50 per contract, however the buyer
Price rather than to adjust to Theoretical connection with this example are non- may not have wanted to buy so many
Price because even though the Exchange Customer orders. contracts at a higher price and does
has determined a given trade to be • Assume Exchange A’s quoted bid at incur increasing cost and risk due to the
erroneous in nature, the parties in $2.50 is either executed or cancelled. additional size of their quote. Thus, the
question should have had some • Assume Exchange B immediately proposed rule is attempting to strike a
expectation of execution at the price or thereafter receives an incoming market balance between various competing
prices submitted. Also, it is common order to sell 100 contracts. objectives, including recognition of cost
that by the time it is determined that an • The incoming order would be and risk incurred in quoting larger size
obvious error has occurred additional executed against Exchange B’s resting and incentivizing market participants to
hedging and trading activity has already bid at $2.05 for 100 contracts. maintain appropriate controls to avoid
occurred based on the executions that • Because the 100 contract execution errors.
previously happened. The Exchange is of the incoming sell order was priced at In contrast to non-Customer orders,
concerned that an adjustment to $2.05, which is $0.45 below the where trades will be adjusted if they
Theoretical Price in all cases would not Theoretical Price of $2.50, the 100 qualify as Obvious Errors, pursuant the
appropriately incentivize market contract execution would qualify for Proposed Rule a trade that qualifies as
participants to maintain appropriate adjustment as an Obvious Error. an Obvious Error will be nullified where
controls to avoid potential errors. • The normal adjustment process at least one party to the Obvious Error
Further, as proposed any non- would adjust the execution of the 100 is a Customer. The Exchange also
Customer Obvious Error exceeding 50 contracts to $2.35 per contract, which is proposes, however, that if any member
contracts will be subject to the Size the Theoretical Price minus $0.15. [sic] submits requests to the Exchange
Adjustment Modifier described above. • However, because the execution for review of transactions pursuant to
The Exchange believes that it is would qualify for the Size Adjustment the Proposed Rule, and in aggregate that
appropriate to apply the Size Modifier of 2 times the adjustment Participant has 200 or more Customer
Adjustment Modifier to non-Customer price, the adjusted transaction would transactions under review concurrently
orders because the hedging cost instead be to $2.20 per contract, which and the orders resulting in such
associated with trading larger sized is the Theoretical Price minus $0.30. transactions were submitted during the
options orders and the market impact of By reference to the example above, course of 2 minutes or less, where at
larger blocks of underlying can be the Exchange reiterates that it believes least one party to the Obvious Error is
significant. that a Size Adjustment Modifier is a non-Customer, the Exchange will
tkelley on DSK3SPTVN1PROD with NOTICES
As an example of the application of appropriate, as the buyer in this apply the non-Customer adjustment
the Size Adjustment Modifier, assume example was originally willing to buy criteria described above to such
Exchange A has a quoted bid to buy 50 100 contracts at $2.05 and ended up transactions. The Exchange based its
contracts at $2.50, Exchange B has a paying $2.20 per contract for such proposal of 200 transactions on the fact
quoted bid to buy 100 contracts at $2.05 execution. Without the Size Adjustment that the proposed level is reasonable as
and there is no other options exchange Modifier the buyer would have paid it is representative of an extremely large
quoting a bid priced higher than $2.00. $2.35 per contract. Such buyer may be number of orders submitted to the
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![27816 Federal Register / Vol. 80, No. 93 / Thursday, May 14, 2015 / Notices
• Send an email to rule-comments@ SECURITIES AND EXCHANGE set forth in sections A, B, and C below,
sec.gov. Please include File Number SR– COMMISSION of the most significant parts of such
NASDAQ–2015–054 on the subject line. statements.
[Release No. 34–74920; File No. SR–
Paper Comments NYSEMKT–2015–39) A. Self-Regulatory Organization’s
Statement of the Purpose of, and
• Send paper comments in triplicate Self-Regulatory Organizations; NYSE Statutory Basis for, the Proposed Rule
to Brent J. Fields, Secretary, Securities MKT LLC; Notice of Filing and Change
and Exchange Commission, 100 F Street Immediate Effectiveness of Proposed
Rule Change Amending Rule 975NY— 1. Purpose
NE., Washington, DC 20549–1090.
Obvious Errors and Catastrophic The Exchange proposes to amend
All submissions should refer to File Errors in Order To Harmonize Current Rule 975NY—Obvious Errors
Number SR–NASDAQ–2015–054. This Substantial Portions of the Rule With and Catastrophic Errors in order to
file number should be included on the Recently Adopted, and Proposed harmonize substantial portions of the
subject line if email is used. To help the Rules of Other Options Exchanges rule with recently adopted, and
Commission process and review your proposed, rules of other options
comments more efficiently, please use May 8, 2015. exchanges.5
only one method. The Commission will Pursuant to Section 19(b)(1) 1 of the
Securities Exchange Act of 1934 (the Background
post all comments on the Commission’s
‘‘Act’’) 2 and Rule 19b–4 thereunder,3 For several months the Exchange has
Internet Web site (http://www.sec.gov/
notice is hereby given that, on May 8, been working with other options
rules/sro.shtml). Copies of the
2015, NYSE MKT LLC (the ‘‘Exchange’’ exchanges to identify ways to improve
submission, all subsequent or ‘‘NYSE MKT’’) filed with the the process related to the adjustment
amendments, all written statements Securities and Exchange Commission and nullification of erroneous options
with respect to the proposed rule (the ‘‘Commission’’) the proposed rule transactions. The goal of the process
change that are filed with the change as described in Items I and II that the options exchanges have
Commission, and all written below, which Items have been prepared undertaken is to adopt harmonized rules
communications relating to the by the self-regulatory organization. The related to the adjustment and
proposed rule change between the Commission is publishing this notice to nullification of erroneous options
Commission and any person, other than solicit comments on the proposed rule transactions as well as a specific
those that may be withheld from the change from interested persons. provision related to coordination in
public in accordance with the connection with large-scale events
I. Self-Regulatory Organization’s
provisions of 5 U.S.C. 552, will be involving erroneous options
Statement of the Terms of the Substance
available for Web site viewing and transactions. As described below, the
of the Proposed Rule Change
printing in the Commission’s Public Exchange believes that the changes the
Reference Room, 100 F Street, NE., The Exchange proposes to amend options exchanges and the Exchange
Washington, DC 20549 on official Rule 975NY—Obvious Errors and have agreed to propose will provide
business days between the hours of Catastrophic Errors 4 in order to transparency and finality with respect to
10:00 a.m. and 3:00 p.m. Copies of such harmonize substantial portions of the the adjustment and nullification of
filing also will be available for rule with recently adopted, and erroneous options transactions.
inspection and copying at the principal proposed rules of other options Particularly, the proposed changes seek
exchanges. The text of the proposed rule to achieve consistent results for
office of the Exchange. All comments
change is available on the Exchange’s participants across U.S. options
received will be posted without change;
Web site at www.nyse.com, at the exchanges while maintaining a fair and
the Commission does not edit personal principal office of the Exchange, and at
identifying information from orderly market, protecting investors and
the Commission’s Public Reference protecting the public interest.
submissions. You should submit only Room. The Proposed Rule is the culmination
information that you wish to make
II. Self-Regulatory Organization’s of this coordinated effort and reflects
available publicly. All submissions discussions by the options exchanges to
should refer to File Number SR– Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule universally adopt: (1) Certain provisions
NASDAQ–2015–054, and should be already in place on one or more options
submitted on or before June 4, 2015. Change
exchanges; and (2) new provisions that
For the Commission, by the Division of In its filing with the Commission, the the options exchanges collectively
Trading and Markets, pursuant to delegated self-regulatory organization included believe will improve the handling of
authority.22 statements concerning the purpose of, erroneous options transactions. Thus,
and basis for, the proposed rule change although the Proposed Rule is in many
Robert W. Errett, and discussed any comments it received ways similar to and based on the
Deputy Secretary. on the proposed rule change. The text Exchange’s Current Rule, the Exchange
[FR Doc. 2015–11593 Filed 5–13–15; 8:45 am] of those statements may be examined at is adopting various provisions to
BILLING CODE 8011–01–P the places specified in Item IV below. conform with existing rules of one or
The Exchange has prepared summaries, more options exchanges and also to
adopt rules that are not currently in
1 15 U.S.C.78s(b)(1).
place on any options exchange. As
tkelley on DSK3SPTVN1PROD with NOTICES
2 15 U.S.C. 78a.
3 17 CFR 240.19b–4.
noted above, in order to adopt a rule
4 For the purposes of this filing, Rule 975NY— that is similar in most material respects
Obvious Errors and Catastrophic Errors, in its
current format is referred to as ‘‘Current Rule.’’ Rule 5 See, e.g., Securities Exchange Act Release No.
975NY—Obvious Errors and Catastrophic Errors, 74556 (March 20, 2015), 80 FR 16031 (March 26,
with proposed changes is referred to as ‘‘Proposed 2015) (SR–BATS–2014–067 as amended) (the
22 17 CFR 200.30–3(a)(12). Rule’’. ‘‘BATS Filing’’).
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Document Created: 2015-12-15 15:32:58
Document Modified: 2015-12-15 15:32:58
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| Collection | Federal Register | |
| sudoc Class | AE 2.7: GS 4.107: AE 2.106: | |
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| Section | Notices | |
| FR Citation | 80 FR 27801 |
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