[Federal Register Volume 78, Number 150 (Monday, August 5, 2013)]
[Notices]
[Pages 47459-47463]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-18749]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70061; File No. SR-NASDAQ-2013-095]
Self-Regulatory Organizations; The NASDAQ Stock Market LLC;
Notice of Filing and Immediate Effectiveness of Proposed Rule Change To
Amend Chapter V, Section 6, Obvious Errors, of the Rules of the NASDAQ
Options Market (``NOM'')
July 30, 2013.
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 July 19, 2013, 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, 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 Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend Chapter V, Section 6, Obvious
Errors, of the Rules of the NASDAQ Options Market (``NOM'').
The text of the proposed rule change is below; proposed new
language is italicized; proposed deletions are in brackets.
* * * * *
NASDAQ Stock Market Rules
* * * * *
Options Rules
* * * * *
Chapter V Regulation of Trading on NOM
* * * * *
Sec. 6 Obvious and Catastrophic Errors
(a)-(e) No change.
(f) Catastrophic Errors
(i)-(ii) No change.
(iii) Adjust or Bust. A Nasdaq Official will determine whether
there was a Catastrophic Error as defined above. If it is determined
that a Catastrophic Error has occurred, whether or not each party to
the transaction is an Options Participant, MarketWatch shall adjust the
execution price of the transaction, unless both parties agree to adjust
the transaction to a different price, to the theoretical price (i) plus
the adjustment value provided below for erroneous buy transactions, and
(ii) minus the adjustment value provided for erroneous sell
transactions, pursuant to the following chart; provided that the
adjusted price would not exceed the limit price of a Public Customer's
limit order, in which case the Public Customer would have 20 minutes
from notification of the proposed adjusted price to accept it or else
the trade will be nullified:
------------------------------------------------------------------------
Minimum
Theoretical price amount
------------------------------------------------------------------------
Below $2..................................................... $1
$2 to $5..................................................... 2
Above $5 to $10.............................................. 3
Above $10 to $50............................................. 5
Above $50 to $100............................................ 7
Above $100................................................... 10
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Upon taking final action, MarketWatch shall promptly notify both
parties to the trade electronically or via telephone.
(g) No change.
* * * * *
(b) Not applicable.
(c) Not applicable.
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 purpose of the proposal is to help market participants better
manage their risk by addressing the situation where, under current
rules, a trade can be adjusted to a price outside of a Public
Customer's limit. Specifically, the Exchange proposes to amend Chapter
V, Section 6(f) to enable a Public Customer who is the contra-side to a
trade that is deemed to be a catastrophic error to have the trade
nullified in instances where the adjusted price would violate the
Public Customer's limit price. Only if the Public Customer, or his
agent, affirms the customer's willingness to accept the adjusted price
through the customer's limit price within 20 minutes of notification of
the catastrophic error ruling would the trade be adjusted; otherwise it
would be nullified. Today, all catastrophic error trades are adjusted,
not nullified, on all of the options exchanges, except on NASDAQ OMX
PHLX LLC (``PHLX''), on whose provision this proposal is modeled.\3\
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\3\ See PHLX Rule 1092(f)(ii). Securities Exchange Act Release
No. 69304 (April 4, 2013), 78 FR 21482 (April 10, 2013) (SR-Phlx-
2013-05).
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Background
Currently, Chapter V, Section 6 governs obvious and catastrophic
errors. Obvious errors are calculated under the rule by determining a
theoretical price and determining, based on objective standards,
whether the trade should be nullified or adjusted. The rule also
contains a process for requesting an obvious error review. Certain more
substantial errors may fall under the category of a catastrophic error,
for which a longer time period is permitted to request a review and for
which trades can only be adjusted (not nullified).
[[Page 47460]]
Trades are adjusted pursuant to an adjustment table that, in effect,
assesses an adjustment penalty. By adjusting trades above or below the
theoretical price plus or minus a certain amount, the rule assesses a
``penalty'' in that the adjustment price is not as favorable as the
amount the party making the error would have received had it not made
the error.
Proposal
At this time, the Exchange proposes to change the catastrophic
error process to permit certain trades to be nullified. The definition
and calculation of a catastrophic error would not change.\4\ Once a
catastrophic error is determined by a NASDAQ Official, then if both
parties to the trade are not a Public Customer,\5\ the trade would be
adjusted under the current rule. If one of the parties is a Public
Customer, then the adjusted price would be compared to the limit price
of the order. If the adjusted price would violate the limit price (in
other words, be higher than the limit price if it is a buy order and
lower than the limit price if it is a sell order), then the Public
Customer would be offered an opportunity to nullify the trade. If the
Public Customer (or the Public Customer's broker-dealer agent) does not
respond within 20 minutes, the trade would be nullified.
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\4\ Nor is the definition or process for obvious errors
changing. However, the Exchange proposes to add reference to
``catastrophic'' errors to the title of the provision to better
reflect its content and match that of other options exchanges.
\5\ Chapter I, Section 1(a)(49) defines a Public Customer as
person that is not a broker or dealer in securities. Professional
Customers are Public Customers, for purposes of Chapter V, Section
6. See Chapter I, Section 1(a)(48).
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These changes should ensure that a Public Customer is not forced
into a situation where the original limit price is violated and thereby
the Public Customer is forced to spend additional dollars for a trade
at a price the Public Customer had no interest in trading and may not
be able to afford.
EXAMPLE 1--Resting Public Customer forced to adjust through his limit
price and would prefer nullification
Day 1
8:00:00 a.m. (pre-market)
Public Customer A enters order on NOM to buy 10 GOOG May 750 puts
for $25 (cost of $25,000, Public Customer has $50,000 in his trading
account).
10:00:00 a.m.
GOOG trading at $750
May 750 puts $29.00-$31.00 (100x100) on all exchanges
10:04:00 a.m.
GOOG drops to $690
May 750 puts $25-$100 (10x10) NOM
May 750 puts $20-$125 (10x10) CBOE
May 750 puts $10-$200 (100x100) on all other exchanges
10:04:01 a.m.
Public Customer B enters order to sell 10 May 750 puts for $25
(credit of $25,000)
10:04:01 a.m.
10 May 750 puts execute at $25 ($35 under parity) \6\ with Public
Customer A buying and Public Customer B selling.
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\6\ Parity is the intrinsic value of an option when it is in-
the-money. With respect to puts, it is calculated by subtracting the
price of the underlying from the strike price of the put. With
respect to calls, it is calculated by subtracting the strike price
from the price of the underlying.
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10:04:02 a.m. (1 second later)
GOOG trading $690
May 750 puts $75-$78 (100x100) NOM
May 750 puts $75-$80 (10x10) CBOE
May 750 puts $70-$80 (100x100) All other exchanges
No obvious error is filed within 20 minute notification time
required by rule. If this had been an obvious error review, the trade
would have been nullified in accordance with Chapter V, Section 6
because one of the parties to the trade was not an Options Participant.
4:00:00 p.m. (the close)
GOOG trading $710
May 750 puts $60-$63 (100x100) NOM
May 750 puts $55-$70 (10x10) CBOE
May 750 puts $50-$70 (100x100) All other exchanges
Day 2
8:00:00 a.m. (pre-market)
Public Customer B, submits S10 GOOG May 750 puts at $25 under
Catastrophic Review.
Trade meets the criteria of Catastrophic Error and is adjusted to
$68 ($75 (the 10:04:02 a.m. price) less $7 adjustment penalty).
9:30:00 a.m. (the opening)
GOOG trading $725
May 750 puts open $48.00-$51.00 (100x100) on all exchanges
Under current rule:
Without a choice, Public Customer A is forced to spend $68 (for a
total cost of $68,000, with only $25,000 in his account)
Puts are now trading $48, so Public Customer A shows a loss of
$20,000 ($68 less $48x10 contracts x 100 multiplier)
Under proposed rule:
Public Customer A would be able to choose to have the B10 GOOG May
750 puts nullified avoiding both a loss, and an expenditure of capital
exceeding the amount in his account. Public Customer B would be
relieved of the obligation to sell the puts at 25 because the trade
would be nullified.
EXAMPLE 2--Resting Public Customer trades, sells out his position, and
chooses to keep the adjusted trade and avoid nullification
Day 1
8:00:00 a.m. (pre-market)
Public Customer A enters order on NOM to Buy 10 BAC April 7.00
calls for $.01 (cost of $10 total). (Customer has $3,000 in his
account).
10:00:00 a.m.
BAC trading $11
April 7 calls $4.50-$4.70 (100x100) on all exchanges
10:04:00 a.m.
BAC Trading $11
April 7 calls $.01-$4.70 (10x10) NOM
April 7 calls $4.50-$4.70 (10x10) CBOE
April 7 calls $4.50-$4.70 (10x10)) All other exchanges
10:04:01 a.m.
Public Customer B enters order to sell 10 April 7 calls at $.01 on
NOM with an ISO indicator (which allows trade through)
10:04:01 a.m.
10 April 7 calls execute at $.01 on NOM Public Customer A buying
and Public Customer B selling.
10:04:02 a.m. (1 second later)
BAC is $11
April 7 calls $4.50-$4.70 (10x10) NOM
April 7 calls $4.50-$4.70 (10x10) CBOE
April 7 calls $4.50-$4.70 (10x10) All other exchanges
No obvious error is filed within 20 minute notification time
required by rule. If this had been an obvious error review, the trade
would have qualified as an obvious error and been nullified or
adjusted.
11:00:00 a.m.
BAC trading $9.60
April 7 calls $3.00-$3.25 (10x10) NOM
April 7 calls $.3.00-$3.25 (10x10) CBOE
April 7 calls $3.00-$3.25 (10x10) All other exchanges
Public Customer A sells 10 April 7 calls at $3.00 (a total credit
of $3,000 for a $2,990 profit)
3:00:00 p.m.
BAC trading $12.80
April 7 calls $5.80-$6.00 (10x10) NOM
April 7 calls $5.80-$6.00 (10x10)
[[Page 47461]]
CBOE
April 7 calls $5.80-$6.00 (10x10) All other exchanges
Public Customer A has now no position and would be at risk of a loss if
nullified.
3:20:00 p.m.
Public Customer B submits S10 BAC April 7 calls at $.01 under
Catastrophic Error Review.
Trade meets the criteria of Catastrophic Error and is adjusted to
$2.50 ($4.50 (the 10:04:02 a.m. price) less $2 adjustment penalty).
Impact:
Under current Rule: Public Customer A would be adjusted to $2.50
($4.50 (the 10:04:02 a.m. price) less $2 adjustment penalty).
Under Proposed rule:
Illustrating the need for a choice, Public Customer A chooses
within 20 minutes to accept an adjustment to $2.50 instead of a
nullification, locking in a gain of $500 instead of $2.990 (B 10 at
$2.50 vs. S10 at $3.00).
If not given a choice, Public Customer A would be naked short 10
calls at $3.00 that are now offered at $6.00 (a $3,000 loss).
These examples illustrate the need for Public Customer to have a
choice in order to manage his risk. By applying a notification time
limit of 20 minutes, it lessens the likelihood that the customer will
try to let the direction of the market for that option dictate his
decision for a long period of time, thus exposing the contra side to
more risk. This 20 minute time period is akin to the notification
period currently used in the rule respecting obvious errors (as opposed
to catastrophic errors).\7\
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\7\ See Chapter V, Section 6(e)(i) [sic]. If a party believes
that it participated in a transaction that was the result of an
Obvious Error, it must notify MarketWatch via written or electronic
complaint within 20 minutes of the execution.
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For a market maker or a broker-dealer, the penalty that is part of
the price adjustment process is usually enough to offset the additional
dollars spent, and they can often trade out of the position with little
risk and a potential profit. For a customer who is not immersed in the
day-to-day trading of the markets, this risk may be unacceptable. A
customer is also less likely to be watching trading activity in a
particular option throughout the day and less likely to be closely
focused on the execution reports the customer receives after a trade is
executed. Accordingly, the Exchange believes that it is fair and
reasonable, and consistent with statutory standards, to change the
procedure for catastrophic errors for Public Customers and not for
other participants.
The Exchange believes that the proposal is a fair way to address
the issue of a customer's limit price, yet still balance the competing
interests of certainty that trades stand versus dealing with true
errors. Earlier this year, PHLX amended its Rule 1092(f) to adopt the
same catastrophic error process as proposed herein. In approving that
proposal, the Commission stated ``. . . the Exchange has weighed the
benefits of certainty to non-broker-dealer customers that their limit
price will not be violated against the costs of increased uncertainty
to market makers and broker-dealers that their trades may be nullified
instead of adjusted depending on whether the other party to the
transaction is or is not a customer. The proposed rule change strikes a
similar balance on this issue to the approach taken in the Exchange's
Obvious Error Rule, whereby transactions in which an Obvious Error
occurred with at least one party as a non-specialist are nullified
unless both parties agree to adjust the price of the transaction within
30 minutes of being notified of the Obvious Error.'' \8\
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\8\ See supra note 3.
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The Exchange is proposing to amend Chapter V, Section 6 to
eliminate the risk associated with Public Customers receiving an
adjustment to a trade that is outside of the limit price of their
order, when there is a catastrophic error ruling respecting their
trade. The new provision would continue to entail specific and
objective procedures. Furthermore, the new provision more fairly
balances the potential windfall to one market participant against the
potential reconsideration of a trading decision under the guise of an
error.
2. Statutory Basis
The Exchange believes that its proposal is consistent with Section
6(b) of the Act \9\ in general, and furthers the objectives of Section
6(b)(5) of the Act \10\ in particular, in that it is designed to
promote just and equitable principles of trade, to remove impediments
to and perfect the mechanism of a free and open market and a national
market system, and, in general to protect investors and the public
interest, by helping Exchange members better manage the risk associated
with potential erroneous trades. Specifically, the Exchange believes
that the proposal is consistent with these principles because it
provides a fair process for Public Customers to address catastrophic
errors involving a limit order. In particular, the proposal permits
nullification in certain situations. Further, it gives customers a
choice. For two reasons, the Exchange does not believe that the
proposal is unfairly discriminatory, even though it offers some
participants (Public Customers) a choice as to whether a trade is
nullified or adjusted, while other participants will continue to have
all of their catastrophic errors adjusted. First, with respect to
obvious errors (as opposed to catastrophic errors), the rule currently
differentiates among Participants and whether a trade is adjusted or
busted depends on whether an Options Participant is involved.\11\
Second, options rules often treat customers in a special way,\12\
recognizing that customers are not necessarily immersed in the day-to-
day trading of the markets, less likely to be watching trading activity
in a particular option throughout the day and may have limited funds in
their trading accounts. Accordingly, differentiating among Participant
types by permitting customers to have a choice as to whether to nullify
a trade involving a catastrophic error is not unfairly discriminatory,
because it is reasonable and fair to provide non-professional customers
with additional options to protect themselves against the consequences
of obvious errors.
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\9\ 15 U.S.C. 78f(b).
\10\ 15 U.S.C. 78f(b)(5).
\11\ See Chapter V, Section 6(e)(i).
\12\ For example, many options exchange priority rules treat
customer orders differently and some options exchanges only accept
certain types of orders from customers. Most options exchanges
charge different fees for customers.
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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 Public Customer, because a
person would not know, when entering into the trade, whether the other
party is or is not a Public Customer. The Exchange believes that the
proposal nevertheless promotes just and equitable principles of trade
and protects investors and the public interest, because it eliminates a
more serious uncertainty in the rule's operation today, which is price
uncertainty. Today, a customer's order can be adjusted to a
significantly different price, as the examples above illustrate, which
is more impactful than the possibility of nullification. Furthermore,
there is uncertainty in the current obvious error portion of Chapter V,
Section 6 (as well as the rules of other options exchanges), which
Participants have dealt with for a number of years. Specifically,
Chapter V, Section 6(e)(i) and (ii) provide: Where each party to the
transaction is an Options Participant, the execution
[[Page 47462]]
price of the transaction will be adjusted to the prices provided in
subparagraphs (A) and (B) below unless both parties agree to adjust the
transaction to a different price or agree to bust the trade within ten
(10) minutes of being notified by MarketWatch of the Obvious Error;
where at least one party to the Obvious Error is not an Options
Participant, the trade will be nullified unless both parties agree to
an adjustment price for the transaction within 30 minutes of being
notified by MarketWatch of the Obvious Error.
Therefore, a Participant who prefers adjustments over nullification
cannot guarantee that outcome, because, if he trades with a non-
Participant, a resulting obvious error would only be adjusted if such
non-Participant agreed to an adjustment. This uncertainty has been
embedded in the rule and accepted by market participants. The Exchange
believes that this proposal, despite the uncertainty based on whether a
Public Customer is involved in a trade, is nevertheless consistent with
the Act, because the ability to nullify a Public Customer's trade
involving a catastrophic error should prevent the price uncertainty
that mandatory adjustment under the current rule creates, which should
promote just and equitable principles of trade and protect investors
and the public interest.
The proposal sets forth an objective process based on specific and
objective criteria and subject to specific and objective procedures. In
addition, the Exchange has again weighed carefully the need to assure
that one market participant is not permitted to receive a windfall at
the expense of another market participant that made a catastrophic
error, against the need to assure that market participants are not
simply being given an opportunity to reconsider poor trading decisions.
Accordingly, the Exchange has determined that introducing a
nullification procedure for catastrophic errors is appropriate and
consistent with the Act.
Consistent with Section 6(b)(8),\13\ the Exchange also believes
that the proposal does not impose a burden on competition not necessary
or appropriate in furtherance of the purposes of the Act, as described
further below.
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\13\ 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 not necessary or appropriate in
furtherance of the purposes of the Act. Currently, most options
exchanges have similar, although not identical, rules regarding
catastrophic errors. To the extent that this proposal would result in
NOM's rule being different, market participants may choose to route
orders to NOM, helping NOM compete against other options exchanges for
order flow based on its customer service by having a process more
responsive to current market needs. Of course, other options exchanges
may choose to adopt similar rules. The proposal does not impose a
burden on intra-market competition not necessary or appropriate in
furtherance of the purposes of the Act, because, even though it treats
different market participants differently, the Obvious Errors rule has
always been structured that way and adding the ability for Public
Customers to choose whether a catastrophic error trade is nullified
does not materially alter the risks faced by other market participants
in managing the consequences of obvious errors. Overall, the proposal
is intended to help market participants better manage the risk
associated with potential erroneous options trades and does not impose
a burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Because the foregoing proposed rule change does not: (i)
Significantly affect the protection of investors or the public
interest; (ii) impose any significant burden on competition; and (iii)
become operative for 30 days from the date on which it was filed, or
such shorter time as the Commission may designate, it has become
effective pursuant to Section 19(b)(3)(A)(ii) of the Act\14\ and
subparagraph (f)(6) of Rule 19b-4 thereunder.\15\
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\14\ 15 U.S.C. 78s(b)(3)(a)(ii).
\15\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)
requires a self-regulatory organization to give the Commission
written notice of its intent to file the proposed rule change at
least five business days prior to the date of filing of the proposed
rule change, or such shorter time as designated by the Commission.
The Exchange has satisfied this requirement.
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At any time within 60 days of the filing of the proposed rule
change, the Commission summarily may temporarily suspend such rule
change if it appears to the Commission that such action is: (i)
Necessary or appropriate in the public interest; (ii) for the
protection of investors; or (iii) otherwise in furtherance of the
purposes of the Act. If the Commission takes such action, the
Commission shall institute proceedings to determine whether the
proposed rule should be approved or disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NASDAQ-2013-095 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-NASDAQ-2013-095. 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 the 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-
[[Page 47463]]
NASDAQ-2013-095 and should be submitted on or before August 26, 2013.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-18749 Filed 8-2-13; 8:45 am]
BILLING CODE 8011-01-P