[Federal Register: June 23, 2006 (Volume 71, Number 121)]
[Notices]
[Page 36139-36141]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23jn06-72]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-54004; File No. SR-CBOE-2005-63]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Granting Approval of a Proposed Rule Change and
Amendments Nos. 1 and 2 Thereto Relating to the Nullification and
Adjustment of Equity Options Transactions
June 16, 2006.
I. Introduction
On August 12, 2005, the Chicago Board Options Exchange,
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission''), pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for an adjustment
provision for transactions during opening rotation resulting from
obvious errors between a non-broker-dealer customer and CBOE Market-
Maker(s), as well as transactions during opening rotation between a
non-broker-dealer customer and at least one non-CBOE Market-Maker. On
October 28, 2005, the CBOE submitted Amendment No. 1 to the proposed
rule
[[Page 36140]]
change.\3\ On April 7, 2006, the CBOE submitted Amendment No. 2 to the
proposed rule change.\4\ The proposed rule change and Amendments No. 1
and 2 were published for comment in the Federal Register on April 26,
2006.\5\ The Commission received one comment letter on the proposal.\6\
This order approves the proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Amendment No. 1 replaced the original filing in its
entirety.
\4\ Amendment No. 2 clarified and revised the example set forth
in the purpose section of the filing.
\5\ Securities Exchange Act Release No. 53672 (April 18, 2006),
71 FR 24767 (April 26, 2006).
\6\ See letter to Jonathan G. Katz, Secretary, Commission, from
Matthew B. Hinerfeld, Managing Director and Deputy General Counsel,
Citadel Investment Group, L.L.C. on behalf of Citadel Derivatives
Group LLC (collectively ``Citadel'') dated May 17, 2006 (``Citadel
Letter'').
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II. Description of the Proposed Rule Change
The CBOE proposes to revise CBOE Rule 6.25, the Exchange's obvious
error rule. Under the proposal, non-broker-dealer customers would be
permitted to request review for adjustment of an opening rotation
transaction from Trading Officials until 3:30 p.m. Central Time
(``CT'') on the day that the transaction occurred.\7\ According to the
Exchange, the purpose of the proposal is to protect non-broker-dealer
customers from obvious errors during the opening rotation when they do
not discover the error within 15 minutes of the execution of the
transaction. The proposed rule change, however, would not affect the
procedure set forth in CBOE Rule 6.25(b)(1), which permits a non-
broker-dealer customer to request within 15 minutes of an obvious error
transaction to have the transaction nullified by Trading Officials,
unless both parties agree to an adjustment price within 30 minutes of
being notified by Trading Officials of the obvious error.
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\7\ The term ``Trading Officials'' means two Exchange members
designated as Floor Officials and one member of the Exchange's
trading floor liaison staff. See Interpretations and Policies .02 of
CBOE Rule 6.25.
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For transactions during opening rotation between a non-broker-
dealer customer and a CBOE Market-Maker, after 15 minutes have elapsed
since the trade involving the obvious error occurred, but before 3:30
p.m. CT on the same trading day, the non-broker-dealer customer would
be able to request an obvious error review. In determining the extent
of any adjustment of the transaction, the Trading Officials would look
to the competing exchange with the most liquidity in the option class
for the two preceding months. The transaction would be adjusted to the
competing exchange's disseminated price at the time the trade occurred
(provided the adjustment does not violate the non-broker-dealer
customer's limit price), but only up to the number of contracts that
the competing exchange was displaying as its disseminated size at the
time the trade occurred.
For transactions during opening rotation between a non-broker-
dealer and at least one non-CBOE Market-Maker, which could include (but
is not limited to) an away specialist, an upstairs firm, or another
non-broker-dealer customer, after the 15-minute notification period has
passed, but before 3:30 p.m. CT on the same trading day, the non-
broker-dealer customer would be able to request an obvious error
review. In determining the extent of any adjustment to the transaction,
the Trading Officials would look to the competing exchange with the
most liquidity in the options class for the two preceding calendar
months. The transaction would be adjusted to the competing exchange's
disseminated price at the time the trade occurred, but it would not be
adjusted beyond the non-CBOE Market-Maker's limit price, and not for a
size greater than the disseminated size of the competing exchange.
III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange \8\ and, in
particular, the requirements of section 6(b) of the Act \9\ and the
rules and regulations thereunder. Specifically, the Commission finds
that the proposal is consistent with section 6(b)(5) of the Act,\10\ in
that the proposal promotes just and equitable principles of trade,
removes impediments to and perfects the mechanism of a free and open
market and a national market system, and protects investors and the
public interest.
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\8\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\9\ 15 U.S.C. 78f(b).
\10\ 15 U.S.C. 78f(b)(5).
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The Commission considers that in most circumstances trades that are
executed between parties should be honored. On rare occasions, the
price of the executed trade indicates an ``obvious error'' may exist,
suggesting that it is unrealistic to expect that the parties to the
trade had come to a meeting of the minds regarding the terms of the
transaction. In the Commission's view, the determination of whether an
``obvious error'' has occurred should be based on specific and
objective criteria and subject to specific and objective procedures.
CBOE's proposal would permit a non-broker-dealer customer, whose order
was executed during CBOE's opening rotation but who did not discover
that its transaction may have involved an obvious error within 15
minutes of its execution, to request an obvious error review for
adjustment of the transaction from Trading Officials until 3:30 p.m. CT
on the date of the transaction. The Commission believes that permitting
non-broker-dealer customers to request an obvious error review until
3:30 p.m. CT on the day of the transaction would give those customers a
reasonable amount of time to discover an obvious error transaction that
occurred during an opening rotation and to request an obvious error
review.
The Commission also believes that CBOE's proposal with respect to
the price to which a transaction will be adjusted is consistent with
the Act. Under the Exchange's proposal, an obvious error transaction
during an opening rotation involving a non-broker-dealer customer would
be adjusted to the Theoretical Price (provided that it does not violate
the customer's limit price). The Theoretical Price of an option series
is, for securities traded on at least one other options exchange, the
last bid price with respect to an erroneous sell transaction and the
last offer price with respect to an erroneous buy transaction, just
prior to the trade, disseminated by the competing options exchange that
has the most liquidity in that option class in the previous two
calendar months. The Commission believes that this basis for
determining Theoretical Price is consistent with the Linkage Plan,
which requires the options exchanges to avoid trading through better
prices available on all exchanges, not just the exchange that has the
most liquidity, because the Linkage Plan does not apply to transactions
effected during opening rotations.
The Commission has carefully considered the comments raised in the
Citadel Letter.\11\ The Citadel Letter stated that the proposed rule
change effectively would require CBOE Market Makers retroactively to
trade during the opening rotation at prices at which they were not
quoting and at which they did not want to trade. Citadel indicated that
the price protections offered by the Linkage Plan do not apply to
transactions during opening rotation.
[[Page 36141]]
Citadel noted that, as a result, there is a risk that orders executed
on one exchange as part of the opening rotation could receive a
different price if executed as part of the opening rotation on another
exchange. Citadel asserted that no ``obvious error'' is involved and
that the proposal is an inappropriate punitive measure because the
market maker has not done anything wrong. Citadel also stated that the
proposal creates an irrational distinction between those customer
orders that get the benefit of the adjustment and those that do not.
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\11\ See Citadel Letter, supra note 6.
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The Exchange countered that its obvious error rule currently
applies to transactions occurring as part of the opening rotation and
provides for the adjustment of market maker to market maker
transactions to prices that the market maker may not have been quoting
at the opening.\12\ The Exchange also noted that its obvious error rule
currently provides for differing treatment with respect to obvious
errors depending on the nature of the order and the parties involved.
According to the Exchange, the proposed rule change is consonant with
its obvious error rule, which currently addresses an error at the
opening, adjustment of an opening transaction, and differing treatment
of customers and market makers.
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\12\ Telephone conference among Andrew Spiwak, Director, Legal
Division, and Chief Enforcement Attorney, Jennifer Lamie, Managing
Senior Attorney, and Nancy Sanow, Assistant Director, Division of
Market Regulation, Commission on June 13, 2006.
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The Commission believes that the Citadel Letter does not raise any
issues that would preclude approval of the proposed rule change. In the
Commission's view, the proposed rule change strikes a reasonable
balance by affording non-broker-dealer customers the opportunity to
seek review of an opening rotation transaction until 3:30 CT on the day
of the transaction, if the transaction occurred at a price that
satisfies the threshold set forth in the Exchange's obvious error rule,
while at the same time limiting the size and amount of any such
adjustment.
IV. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\13\ that the proposed rule change (SR-CBOE-2005-63), as amended,
is approved.
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\13\ 15 U.S.C. 78f(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\14\
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\14\ 17 CFR 200.30-3(a)(12).
Nancy M. Morris,
Secretary.
[FR Doc. E6-9935 Filed 6-22-06; 8:45 am]
BILLING CODE 8010-01-P