[Federal Register Volume 66, Number 12 (Thursday, January 18, 2001)]
[Notices]
[Pages 4880-4882]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 01-1409]
[[Page 4880]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-43830; File No. SR-ISE-00-19]
Self Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the International Securities Exchange LLC Adopting an Obvious
Error Rule
January 10, 2001.
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 November 20, 2000, the International Securities Exchange LLC
(``ISE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II, and III below which Items have been prepared by the
Exchange. The Commission is publishing this notice to solicit comments
on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organizations Statement of the Terms of
Substance of the Proposed Rule Change
The Exchange is proposing to adopt new ISE Rule 720, which gives
the Exchange the authority to bust or adjust trades that result from
clearly erroneous orders or quotations. Proposed new language is
italicized.
* * * * *
Rule 720. Obvious Errors
The Exchange shall either bust a transaction or adjust the
execution price of a transaction that results from an Obvious Error as
provided in this Rule.
(a) Definition of obvious Error. For purposes of this Rule only,
Obvious Error will be deemed to have occurred when:
(1) during regular market conditions (including rotations), the
execution price of a transaction is higher or lower than the
Theoretical Price for the series by an amount equal to at least two (2)
times the maximum bid/ask spread allowed for the option, so long as
such amount is 50 cents or more; or
(2) during fast market conditions (i.e., the Exchange has declared
a fast market status for the option in question), the execution price
of a transaction is higher or lower than the Theoretical Price for the
series by an amount equal to at least three (3) times the maximum bid/
ask spread allowed for the option, so long as such amount is 50 cents
or more.
(b) Definition of Theoretical Price. For purposes of this Rule
only, the Theoretical Price of an option is:
(1) if the series is traded on at least one other options exchange,
the last bid or offer, just prior to the trade, found on the exchange
that has the most liquidity in that option as provided in Supplementary
Material .02 below; or
(2) if there are no quotes for comparison purposes,as determined by
the Obvious Error Panel.
(c) Adjustments. Where the execution price of a transaction
executed as the result of an Obvious Error is adjusted, the adjusted
price will be:
(1) the Theoretical Price of the option in the case where the
erroneous price is displayed in the market and subsequently executed by
quotes or orders that did not exist in the System at the time of the
erroneous price was entered; or
(2) the last bid or offer, just prior to the trade, found on the
exchange that has the most liquidity in that option as provided in
Supplementary Material .03 below in the case where an erroneous price
executes against quotes or orders already existing in the System at the
time the erroneous price was entered.
(d) Obvious Error Procedure. Designated personnel in the Exchange's
market control center (``Market Control'') shall administer the
application of this Rule as follows.
(1) Notification. If a market maker on the Exchange believes that
it participated in a transaction that was the result of an Obvious
Error, it must notify Market Control within five (5) minutes of the
execution. If an Electronic Access Member believes an order it executed
on the Exchange was the result of an Obvious Error, it must notify
Market Control within twenty (20) minutes of the execution. Except as
provided below, no relief under this Rule will be provided unless
notification is made within the prescribed time periods.
(2) Adjust or Bust. Market Control will determine whether there was
an Obvious Error as defined above. If it is determined that an Obvious
Error has occurred, Market Control shall take one of the following
actions: (i) where each party to the transaction is a market maker on
the Exchange, the execution price of the transaction will be adjusted
unless both parties agree to bust the trade within ten (10 minutes of
being notified by Market Control of the Obvious Error, or \3\ (ii)
where at least one party to the Obvious Error is not a market maker on
the Exchange, the trade will be busted unless both parties agree to
adjust the price of the transaction within thirty (30) minutes of being
notified by Market Control of the Obvious Error.
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\3\ The ISE corrected a typographical error that appeared in the
proposed rule language. Telephone conversation between Katherine
Simmons, Vice President and Associate General Counsel, ISE, and
Susie Cho, Attorney, Division of Market Regulation, Commission,
January 10,2 001.
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(e) Obvious Error Panel.
(1) Composition. An Obvious Error Panel will be comprised of
representatives from three (3) Members that are market makers on the
Exchange, at least one (1) of which shall be a representative from a
Member that is a Competitive Market Maker and not also a Primary market
Maker.
(2) Request for Review. If a party affected by a determination made
under this Rule so requests, the Obvious Error Panel will review
decisions made by market Control under this Rule, including whether an
Obvious Error occurred, whether the correct Theoretical Price was used,
and whether an adjustment was made at the correct price. A party may
also request that the Obvious Error Panel provide relief under this
Rule in cases where the party failed to provide the notification
required in paragraph (d)(1), but unusual circumstances must merit
special consideration. The Obvious Error Panel shall review the facts
and render a decision on the day of the transaction. All determinations
by the Obvious Error Panel shall be final.
Supplementary Material to Rule 720
.01 For purposes of paragraph (a) of this Rule, the maximum bid/
ask spread shall be the maximum bid/ask spread allowed under Rule
803(b), unless a wider spread has been allowed by the Exchange for the
option because of unusual market conditions, such as high market
volatility.
.02 The Theoretical Price will be determined under paragraph
(b)(1) above as follows: (i) the bid price from the exchange providing
the most volume will be used with respect to an erroneous bid price
entered on the Exchange, and (ii) the offer price from the exchange
providing the most volume will be used with respect to an erroneous
offer price entered on the Exchange.
.03 The price to which a transaction is adjusted under paragraph
(c)(2) above will be as follows: (i) the bid price from the exchange
providing the most volume for the option will be used with respect to
an erroneous offer price entered on the Exchange, and (ii) the offer
price from the exchange providing the most volume for the option will
be used with
[[Page 4881]]
respect to an erroneous bid price entered on the Exchange. If there are
no quotes for comparison purposes, the adjustment price will be
determined by the Obvious Error Panel.
.04 When Market Control determines that an Obvious Error has
occurred and action is warranted under paragraph (d)(2) above, the
identity of the parties to the trade will be disclosed to each other in
order to encourage conflict resolution.
.05 Each market maker firm shall designate at least one person
that is knowledgeable about options market making on the ISE to be
called upon by the Exchange to participate on an Obvious Error Panel.
In no case shall an Obvious Error Panel include a person related to a
party to the Obvious Error in question. To the extent reasonably
possible, the Exchange shall call upon representatives of each market
maker to participate on an Obvious Error Panel on an equally frequent
basis.
* * * * *
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
The Exchange proposes to adopt new ISE Rule 720 that would allow it
to either adjust or bust a transaction in circumstances where a member
or its customer has made an error and the price of the execution is
``obviously'' not correct.\4\ In such situations, the Exchange does not
believe it is consistent with just and equitable principles of trade to
permit one market participant to receive a wind-fall at the expense of
another market participant that made an obvious error. Conversely, the
Exchange does not seek to permit market participants to reconsider poor
trading decisions. The ISE believes that the proposed rule contains
objective standards regarding when a transaction was clearly the result
of an ``obvious error,'' under what circumstances a trade will be
adjusted or busted, and to what price a trade will be adjusted if
adjustment is appropriate under the circumstances.
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\4\ While current ISE Rule 804(d)(2) gives the Exchange some
flexibility with respect to customer orders when a market maker's
quote is obviously an error, it only states that an obviously
erroneous quote may not be ``firm'' for customer orders. ISE Rule
804 does not expressly give the Exchange authority to bust an
executed transaction, nor does it contain any guidelines for
determining when a quotation is obviously erroneous.
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Under proposed ISE Rule 720, when a member believes that it has
participated in a transaction that was the result of an obvious error,
it must notify ISE Market Control within a specified time of the
execution. The proposed rule requires Exchange market makers, who are
continuously monitoring their transactions on the ISE, to notify ISE
Market Control within five minutes of an execution. The proposed rule
allows Electronic Access Members, which may handle customer orders on
multiple exchanges simultaneously and which may need to contact
customers for instruction, up to twenty minutes to notify ISE Market
Control.
ISE Market Control will determine whether there was an obvious
error according to the following objective criteria: (1) An obvious
error will be deemed to have occurred during normal market conditions
when the execution price of a transaction is higher or lower than the
theoretical price \5\ for the series by an amount equal to at least two
times the maximum bid/ask spread allowed for the option, so long as
such amount is 50 cents or more; and (2) an obvious error will be
deemed to have occurred during fast market conditions 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 three
times the maximum bid/ask spread allowed for the option, so long as
such amount is 50 cents or more.\6\ ISE Market Control is not given any
discretion under proposed ISE Rule 720 to take actions with respect to
transactions that do not come within the objective obvious error
criteria. In situations where the theoretical price is not objectively
determinable, a panel of member representatives will be convened to
determine the theoretical price.
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\5\ The theoretical price of an option in the case of an
erroneous bid (offer) is the last bid (offer), just prior to the
trade, found on the exchange that has the most liquidity in that
option other than the ISE. If there are no quotes for comparison
purposes, the theoretical price will be determined by an obvious
error panel.
\6\ The reason for requiring a greater deviation from the
theoretical price during fast market conditions is that when the
price of an underlying is moving rapidly, it is not as ``obvious''
that an option price might be in error.
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If it is determined that a transaction is the result of an obvious
error, ISE Market Control will take one of the following actions: (1)
Where each party to the transaction is an Exchange market maker,\7\ the
execution price of the transaction will be adjusted unless both parties
agree to bust the trade; or (2) where at least one party to the obvious
error is not a market maker on the Exchange, the trade will be busted
unless both parties agree to adjust the price of the transaction. In
the first instance, Exchange market makers, who commonly hedge
transactions immediately, have indicated a preference for adjusting the
price of a transaction rather than changing their positions. Thus, the
default action will be to adjust the price of the execution according
to the objective criteria discussed below. In the second instance,
where customer limit orders may be involved, the Exchange does not
believe it appropriate to adjust the price of a transaction without the
consent of the market participants. Accordingly, the default will be to
bust the trade unless both sides agree to adjust the price. The default
action will be taken unless agreement is reached within ten minutes in
the case where both parties are Exchange market makers, and within
thirty minutes where at least one party is not an Exchange market
maker.
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\7\ A party to a transaction will be considered an Exchange
market maker under proposed ISE Rule 720 if the resulting position
is booked in an ISE market maker account. For example, under ISE
Rule 803, a Competitive Market Maker (``CMM'') on the ISE may
execute up to 25 percent of its total volume in securities to which
it is not appointed. An obvious error involving two CMMs will be
adjusted under proposed ISE Rule 720 unless both agree to bust the
trade.
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Where an adjustment is made to a transaction price, the adjusted
price will be determined by objective criteria. The adjusted price will
be equal to the theoretical price of the option in the case where the
erroneous price is displayed in the market and subsequently executed by
quotes or orders that did not exist in the system at the time the price
was entered. For example, if an option had a bid of $5 and offer of
$5.20 on the options exchange with the most volume in that option and
due to an erroneous quotation, the ISE displayed a bid of $7 that was
executed against by an incoming sell order or market maker offer, the
adjustment price would be $5, which is the fair price at which a market
participant could have sold the option at the time of the transaction.
The ISE would presume that, in this situation, the seller knew that the
price was
[[Page 4882]]
obviously erroneous as compared to the price being displayed by the
primary options exchange for the option.
Where a participant enters a quotation or order in error that
executes against standing interest on the Exchange, the contra side to
the transaction had no notice of an erroneous price and took no action
to execute at the erroneous price. In this instance, the adjustment
price will be the bid (offer) price from the exchange providing the
most volume in the case of an erroneous offer (bid) price entered on
the Exchange. The ISE believes that this will result in a more
favorable adjustment price for the participant with standing interest
in the book than the participant that made the error. As a result, in
the previous example, if the erroneous bid of $7 executed against an
offer in the system at $6.50, the adjustment price would be $5.20 (the
offer price) instead of 5 (the bid price). Again, the only time an
adjustment will be made to the price of a transaction is in the case
where both parties were ISE market makers or where both parties agree
to the adjustment.
Finally, proposed ISE Rule 720 specifies that each market maker
firm will designate at least one person that is knowledgeable about
options market making on the ISE to be called upon by the Exchange to
participate on an obvious error panel.\8\ Proposed ISE Rule 720
provides that an obvious error panel will have the authority to: (1)
Determine a theoretical price when there is no quote for an option on
another options exchanges; and (2) upon request by a party to a
potential obvious error, review whether the correct theoretical price
was used and whether an adjustment was made at the correct price. A
party to a potential obvious error may also request that the obvious
error panel provide relief under the proposed rule in cases where the
party failed to give notice within the required time periods, but there
must be unusual circumstances to merit this special consideration. All
determinations by an obvious error panel will be made on the same day
as the transaction in question and shall be final.
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\8\ In no case shall an obvious error panel include a person
related to a party to the obvious error in question. To the extent
reasonably possible, the Exchange shall call upon representatives of
each market maker to participate on an obvious error panel on an
equally frequent basis.
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2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with Section 6(b) of the Act \9\ in general, and furthers the
objectives of Section 6(b)(5) \10\ in particular, in that it is
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to remove impediments
to and perfect the mechanism for a free an open market and a national
market system, and, in general, to protect investors and the public
interest.
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\9\ 15 U.S.C. 78f(b).
\10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange did not solicit or receive written comments on the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the commission will:
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be 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. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.
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 inspection and copying at the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
Exchange. All submissions should refer to File No. SR-ISE-00-19 and
should be submitted by February 8, 2001.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\1\
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\1\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-1409 Filed 1-17-01; 8:45 am]
BILLING CODE 8010-01-M