[Federal Register Volume 78, Number 71 (Friday, April 12, 2013)]
[Notices]
[Pages 22017-22020]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-08611]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69342; File No. SR-MIAX-2013-12]
Self-Regulatory Organizations; Miami International Securities
Exchange LLC; Order Granting Accelerated Approval of a Proposed Rule
Change Relating to Obvious Errors in Limit or Straddle States
April 8, 2013.
I. Introduction
On March 22, 2013, Miami International Securities Exchange LLC
(``MIAX'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the ``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for how the Exchange
proposes to treat erroneous options transactions in response to the
Regulation NMS Plan to Address Extraordinary Market Volatility (the
``Plan''). The proposed rule change was published for comment in the
Federal Register on March 27, 2013.\3\ The Commission received one
comment letter on the proposal.\4\ This order approves the proposed
rule change on an accelerated basis.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 69210 (March 22, 2013),
78 FR 18637 (``Notice'').
\4\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Douglas M. Schafer, Executive Vice President, Chief Information
Officer, MIAX, dated February [sic] 5, 2013 (``MIAX Letter'').
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II. Description of the Proposed Rule Change
Since May 6, 2010, when the financial markets experienced a severe
disruption, the equities exchanges and the Financial Industry
Regulatory Authority have developed market-wide measures to help
prevent a recurrence. In particular, on May 31, 2012, the Commission
approved the Plan, as amended, on a one-year pilot basis.\5\ The Plan
is designed to prevent trades in individual NMS stocks from occurring
outside of specified Price Bands, creating a market-wide limit up-limit
down mechanism that is intended to address extraordinary market
volatility in NMS Stocks.\6\
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\5\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77
FR 33498.
\6\ Unless otherwise specified, capitalized terms used in this
rule filing are based on the defined terms of the Plan.
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In connection with the implementation of the Plan, the Exchange
proposes to adopt Commentary .06 to Rule 521 to exclude trades that
occur during a Limit State or Straddle State from the obvious error or
catastrophic error review procedures pursuant to Rule 521 for a one
year pilot basis following the adoption of the proposed rule change.\7\
The Exchange proposes to adopt new Rule 530(j) to apply to erroneous
transactions in options when the underlying NMS Stock has entered
either a Limit or Straddle State. In addition, the Exchange proposes to
retain the ability to review all erroneous transactions that occur
during Limit States and Straddle
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States resulting only from a verifiable disruption or malfunction of an
Exchange execution, dissemination or communication system pursuant to
new Rule 530(j).
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\7\ The Exchange stated that members of the Exchange staff have
spoken to its member organizations about obvious and catastrophic
errors during a Limit State or Straddle State and that the Exchange
has received generally favorable feedback concerning its proposed
rule change, given the built-in customer protections in the Exchange
system.
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Rule 521 provides a process by which a transaction may be nullified
or adjusted when the execution price of a transaction deviates from the
option's theoretical price by a certain amount. Generally, the
theoretical price of an option is the National Best Bid and Offer
(``NBBO'') of the option. In certain circumstances, Exchange officials
have the discretion to determine the theoretical price.\8\
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\8\ Specifically, under Rule 521, the theoretical price is
determined in one of three ways: (i) If the series is traded on at
least one other options exchange the last National Best Bid price
with respect to an erroneous sell transaction and the last National
Best Offer price with respect to an erroneous buy transaction, just
prior to the trade; (ii) as determined by an Exchange Official, if
there are no quotes for comparison purposes, or if the bid/ask
differential of the NBBO for the affected series, just prior to the
erroneous transaction, was at least two times the standard bid/ask
differential as permitted for pre-opening quotes under Rule
603(b)(4); or (iii) for transactions occurring as part of the
Exchange's automated opening system, the Theoretical Price shall be
the first quote after the transaction(s) in question that does not
reflect the erroneous transaction(s).
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The Exchange believes that none of these methods is appropriate
during a Limit State or Straddle State. Under Rule 521(b)(1), the
theoretical price is determined with respect to the NBBO for an option
series just prior to the trade. According to the Exchange, during a
Limit State or Straddle State, options prices may deviate substantially
from those available prior to or following the state. The Exchange
believes this provision would give rise to much uncertainty for market
participants as there is no bright line definition of what the
theoretical price should be for an option when the underlying NMS stock
has an unexecutable bid or offer or both. Because the approach under
Rule 521(b)(1) by definition depends on a reliable NBBO, the Exchange
does not believe that approach is appropriate during a Limit State or
Straddle State. Additionally, because the Exchange system will only
trade through the theoretical bid or offer if the Exchange or the
participant (via an ISO order) has accessed all better priced interest
away in accordance with the Options Order Protection and Locked/Crossed
Markets Plan, the Exchange believes potential trade reviews of
executions that occurred at the participant's limit price and also in
compliance with the aforementioned Plan could harm liquidity and also
create an advantage to either side of an execution depending on the
future movement of the underlying stock.
With respect to Rule 521(b)(2), affording discretion to the
Exchange Official to determine the theoretical price and thereby,
ultimately, whether a trade is busted or adjusted and to what price,
the Exchange notes that it would be difficult to exercise such
discretion in periods of extraordinary market volatility and, in
particular, when the price of the underlying security is unreliable.
The Exchange again notes that the theoretical price in this context
would be subjective.\9\ Ultimately, the Exchange believes that adding
certainty to the execution of orders in these situations should
encourage market participants to continue to provide liquidity to the
Exchange, thus promoting fair and orderly markets. On balance, the
Exchange believes that removing the potential inequity of nullifying or
adjusting executions occurring during Limit States or Straddle States
outweighs any potential benefits from applying these provisions during
such unusual market conditions.
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\9\ The Exchange also notes that the determination of
theoretical price under Rule 521(b)(3) applies to trades executed
during openings. Because the Exchange does not intend to open an
option during a Limit State or Straddle State, this provision will
not apply.
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In response to these concerns, the Exchange proposes to adopt
Commentary .06 to Rule 521, which provides that transactions in MIAX
options that overly an NMS stock are not subject to obvious error or
catastrophic error review under Rule 521 during a Limit State or
Straddle State. In addition, the Exchange proposes to adopt new Rule
530(j) to allow the Exchange to review all erroneous transactions
occurring during Limit States and Straddle States that resulted only
from a verifiable disruption or malfunction of an Exchange execution,
dissemination or communication system. Accordingly, the Exchange is
proposing to incorporate the relevant portions of Rule 521 into
proposed Rule 530(j) to establish the process for such review. Proposed
Rule 530(j) also will include analogous language to that used in
current Rule 521 regarding mutual agreement by the parties to an
erroneous transaction during a trading halt (i.e., trades on the
Exchange will be nullified when (i) the trade occurred during a trading
halt in the affected option on the Exchange, or (ii) respecting equity
options, the trade occurred during a trading halt on the primary market
for the underlying security) and the relevant elements of Rule 521
regarding the review procedure, requests for review and appeals from
decisions to bust a trade.
III. Discussion
The Commission finds that the Exchange's proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
exchange.\10\ Specifically, the Commission finds that the proposal is
consistent with Section 6(b)(5) of the Act,\11\ in that it is designed
to prevent fraudulent and manipulative acts and practices, promote just
and equitable principles of trade, foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, remove impediments to and perfect the mechanism of a free
and open market and a national market system, and, in general, protect
investors and the public interest.
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\10\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\11\ 15 U.S.C. 78f(b)(5).
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In the filing, the Exchange notes its belief that suspending
certain aspects of Rule 521 during a Limit State or Straddle State will
ensure that limit orders that are filled during a Limit or Straddle
State will have certainty of execution in a manner that promotes just
and equitable principles of trade and removes impediments to, and
perfects the mechanism of, a free and open market and a national market
system. The Exchange believes the application of the current rule would
be impracticable given what it perceives will be the lack of a reliable
NBBO in the options market during Limit States and Straddle States, and
that the resulting actions (i.e., nullified trades or adjusted prices)
may not be appropriate given market conditions. In addition, given the
Exchange's view that options prices during Limit States or Straddle
States may deviate substantially from those available shortly following
the Limit State or Straddle State, the Exchange believes that providing
market participants time to re-evaluate a transaction executed during a
Limit or Straddle State will create an unreasonable adverse selection
opportunity that will discourage participants from providing liquidity
during Limit States or Straddle States. Ultimately, the Exchange
believes that adding certainty to the execution of orders in these
situations should encourage market participants to continue to provide
liquidity to the Exchange during Limit States and
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Straddle States, thus promoting fair and orderly markets.
The Exchange, however, has proposed this rule change based on its
expectations about the quality of the options market during Limit
States and Straddle States. The Exchange states, for example, that it
believes that application of the obvious and catastrophic error rules
would be impracticable given the potential for lack of a reliable NBBO
in the options market during Limit States and Straddle States. Given
the Exchange's recognition of the potential for unreliable NBBOs in the
options markets during Limit States and Straddle States, the Commission
is concerned about the extent to which investors may rely to their
detriment on the quality of quotations and price discovery in the
options markets during these periods. This concern is heightened by the
Exchange's proposal to exclude electronic trades that occur during a
Limit State or Straddle State from the obvious error or catastrophic
error review procedures pursuant to Rule 521. The Commission urges
investors and market professionals to exercise caution when considering
trading options under these circumstances. Broker-dealers also should
be mindful of their obligations to customers that may or may not be
aware of specific options market conditions or the underlying stock
market conditions when placing their orders.
While the Commission remains concerned about the quality of the
options market during the Limit and Straddle States, and the potential
impact on investors of executing in this market without the protections
of the obvious or catastrophic error rules that are being suspended
during the Limit and Straddle States, it believes that certain aspects
of the proposal could help mitigate those concerns.
First, despite the removal of obvious and catastrophic error
protection during Limit States and Straddle States, the Exchange states
that there are additional measures in place designed to protect
investors. For example, the Exchange states that by rejecting market
orders, and cancelling pending market orders, only those orders with a
limit price will be executed during a Limit State or Straddle State.
Additionally, the Exchange notes the existence of SEC Rule 15c3-5
requiring broker-dealers to have controls and procedures in place that
are reasonably designed to prevent the entry of erroneous orders. The
Exchange will also continue to review erroneous transactions occurring
during Limit or Straddle States that resulted from a verifiable
disruption or malfunction of an Exchange execution, dissemination or
communication system under proposed Rule 530(j). Finally, the Exchange
states that the MIAX System is designed with built-in protection
mechanisms to prevent trade through the NBBO price at the time of
receipt of an order by more than one Minimum Price Variation.
Therefore, on balance, the Exchange believes that removing the
potential inequity of nullifying or adjusting executions occurring
during Limit States or Straddle States outweighs any potential benefits
from applying certain provisions during such unusual market conditions.
Finally, the Exchange has proposed that the changes be implemented
on a one year pilot basis. The Commission believes that it is important
to implement the proposal as a pilot. The one year pilot period will
allow the Exchange time to assess the impact of the Plan on the options
marketplace and allow the Commission to further evaluate the effect of
the proposal prior to any proposal or determination to make the changes
permanent. To this end, the Exchange has committed to: (1) Evaluate the
options market quality during Limit States and Straddle States; (2)
assess the character of incoming order flow and transactions during
Limit States and Straddle States; and (3) review any complaints from
members and their customers concerning executions during Limit States
and Straddle States. Additionally, the Exchange has agreed to provide
the Commission with data requested to evaluate the impact of the
elimination of the obvious error rule, including data relevant to
assessing the various analyses noted above. On April 5, 2013, the
Exchange submitted a letter stating that it would provide specific data
to the Commission and the public and certain analysis to the Commission
to evaluate the impact of Limit States and Straddle States on liquidity
and market quality in the options markets.\12\ This will allow the
Commission, the Exchange, and other interested parties to evaluate the
quality of the options markets during Limit States and Straddle States
and to assess whether the additional protections noted by the Exchange
are sufficient safeguards against the submission of erroneous trades,
and whether the Exchange's proposal appropriately balances the
protection afforded to an erroneous order sender against the potential
hazards associated with providing market participants additional time
to review trades submitted during a Limit State or Straddle State.
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\12\ In particular, the Exchange represented that, at least two
months prior to the end of the one year pilot period of proposed
Rule 6.65A(c), it would provide to the Commission an evaluation of
(i) the statistical and economic impact of Straddle States on
liquidity and market quality in the options market and (ii) whether
the lack of obvious error rules in effect during the Limit States
and Straddle States are problematic. In addition, the Exchange
represented that each month following the adoption of the proposed
rule change it would provide to the Commission and the public a
dataset containing certain data elements for each Limit State and
Straddle State in optionable stocks. The Exchange stated that the
options included in the dataset will be those that meet the
following conditions: (i) The options are more than 20% in the money
(strike price remains greater than 80% of the last stock trade price
for calls and strike price remains greater than 120% of the last
stock trade price for puts when the Limit State or Straddle State is
reached); (ii) the option has at least two trades during the Limit
State or Straddle State; and (iii) the top ten options (as ranked by
overall contract volume on that day) meeting the conditions listed
above. For each of those options affected, each dataset will
include, among other information: stock symbol, option symbol, time
at the start of the Limit State or Straddle State and an indicator
for whether it is a Limit State or Straddle State. For activity on
the Exchange in the relevant options, the Exchange has agreed to
provide executed volume, time-weighted quoted bid-ask spread, time-
weighted average quoted depth at the bid, time-weighted average
quoted depth at the offer, high execution price, low execution
price, number of trades for which a request for review for error was
received during Limit States and Straddle States, an indicator
variable for whether those options outlined above have a price
change exceeding 30% during the underlying stock's Limit State or
Straddle State compared to the last available option price as
reported by OPRA before the start of the Limit or Straddle state (1
if observe 30% and 0 otherwise), and another indicator variable for
whether the option price within five minutes of the underlying stock
leaving the Limit State or Straddle State (or halt if applicable) is
30% away from the price before the start of the Limit State or
Straddle State. See MIAX Letter, supra note 4.
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Finally, the Commission notes that the Plan, to which these rules
relate, will be implemented on April 8, 2013. Accordingly, for the
reasons stated above, and in consideration of the April 8, 2013
implementation date of the Plan, the Commission finds good cause,
pursuant to Section 19(b)(2) of the Act,\13\ for approving the
Exchange's proposal prior to the 30th day after the publication of the
notice in the Federal Register.
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\13\ 15 U.S.C. 78s(b)(2). The Commission noticed substantially
similar rules proposed by NYSE MKT LLC and NYSE Arca, Inc. with a
full 21 day comment period. See Securities Exchange Act Release No.
69033, 78 FR 15067 (March 8, 2013) and Securities Exchange Act
Release No. 69032, 78 FR 15080 (March 8, 2013).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-MIAX-2013-12), be, and
hereby is, approved on an accelerated basis.
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\14\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08611 Filed 4-11-13; 8:45 am]
BILLING CODE 8011-01-P