[Federal Register: January 16, 2008 (Volume 73, Number 11)]
[Notices]
[Page 2967-2969]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16ja08-111]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-57127; File No. SR-ISE-2007-112]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of a Proposed Rule Change, as Modified by
Amendment No. 1 Thereto, Relating to Obvious Errors
January 10, 2008.
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 29, 2007, 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 substantially
prepared by the Exchange. On January 4, 2008, the ISE submitted
Amendment No. 1 to the proposed rule change. The Commission is
publishing this notice to solicit comments on the proposed rule change,
as amended, 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 its Obvious Error rule to address
``Catastrophic Errors.'' The text of the proposed rule change is
available at the Exchange, the Commission's Public Reference Room, and
http://www.ise.com.
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 states that the purpose of the proposed rule change is
to amend ISE Rule 720 (the ``Obvious Error Rule'') to address certain
extreme circumstances. In particular, the Exchange proposes to add
criteria for identifying ``Catastrophic Errors'' and making adjustments
when Catastrophic Errors occur, as well as a streamlined procedure for
reviewing actions taken in these extreme circumstances.
The Exchange notes that, currently under the Obvious Error Rule,
trades that result from an Obvious Error may be adjusted or busted
according to objective standards. Under the rule, whether an Obvious
Error has occurred is determined by comparing the execution price to
the theoretical price of the option. The rule requires that members
notify ISE Market Control within a short time period following the
execution of a trade (five minutes for market makers and 20 minutes for
Electronic Access Members (``EAMs'')) if they believe the trade
qualifies as an Obvious Error. Trades that qualify for adjustment are
adjusted under the rule to a price that matches the theoretical price
plus or minus an adjustment value, which is $.15 if the theoretical
value is under $3 and $.30 if the theoretical value is at or above $3.
By adjusting trades above or below the theoretical price, the rule
assesses a ``penalty'' in that the adjustment price is not as favorable
as what the party making the error would have received had it not made
the error.
In formulating the Obvious Error Rule, the Exchange has weighed
carefully the need to assure that one market participant is not
permitted to receive a wind-fall at the expense of another market
participant that made an Obvious Error, against the need to assure that
market participants are not simply being given an opportunity to
reconsider poor trading decisions. The Exchange states that, while it
believes that the Obvious Error Rule strikes the correct balance in
most situations, in some extreme situations, members may not be aware
of errors that result in very large losses within the time periods
required under the rule. In this type of extreme situation, ISE
believes members should be given more time to seek relief so that there
is a greater opportunity to mitigate very large losses and reduce the
corresponding large wind-falls. However, to maintain the appropriate
balance, the Exchange believes members should only be given more time
when the execution price is much further away from the theoretical
price than is required for Obvious Errors, and that the adjustment
``penalty'' should be much greater, so that relief is only provided in
extreme circumstances.\3\
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\3\ The Exchange does not believe the type of extreme situation
that is covered by the proposed rule would occur in the normal
course of trading. Rather, this type of situation could potentially
occur as a result of, for example, an error in a member's quotation
system that causes a market maker to severely misprice an option.
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Accordingly, the Exchange proposes to amend the Obvious Error Rule
to address ``Catastrophic Errors.'' Under the proposed rule, Members
will have until 8:30 a.m. Eastern Time on the day following the trade
to notify Market Control of a potential Catastrophic Error. For trades
that take place in an expiring series on expiration Friday, Members
must notify Market Control of a potential Catastrophic Error by 5 p.m.
Eastern Time that same day. Once a
[[Page 2968]]
member has notified Market Control of a Catastrophic Error within the
required time period, a tribunal comprised of two representatives from
market makers and two representatives from EAMs that are unrelated to
the transaction in question (the ``Tribunal'') will review the
Catastrophic Error claim. In the event the Tribunal determines that a
Catastrophic Error did not occur, the member that initiated the review
will be charged $5,000 to reimburse the Exchange for the costs
associated with reviewing the claim.
A Catastrophic Error would be deemed to have occurred when the
execution price of a transaction is higher or lower than the
theoretical price for the option by an amount equal to at least the
amount shown in the second column of the chart below (the ``Minimum
Amount''), and the adjustment would be made plus or minus the amount
shown in column three of the chart below (the ``Adjustment Value''). At
all price levels, the Minimum Amount and the Adjustment Value for
Catastrophic Errors would be significantly higher than for Obvious
Errors, which the Exchange believes, would limit the application of the
proposed rule to situations where the losses are very large.
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Minimum Adjustment
Theoretical price amount value
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Below $2....................................... $1 $1
$2 to $5....................................... $2 $2
Above $5 to $10................................ $5 $3
Above $10 to $50............................... $10 $5
Above $50 to $100.............................. $20 $7
Above $100..................................... $30 $10
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The following example demonstrates how the proposed Catastrophic
Error provisions would operate within the Obvious Error framework.
Assume a member notifies ISE Market Control within 2 minutes of a trade
where 100 contracts of an option with a theoretical price of $9 were
purchased for $17, resulting in an $80,000 error.\4\ The trade would
qualify as an Obvious Error because the purchase price is more than
$.50 above the theoretical price and the member notified ISE Market
Control within the required time period. Market Control would review
the trade and either bust it or adjust it to a purchase price of
$9.30,\5\ which reduces the cost of the error to $3,000.\6\ If,
however, the member failed to identify the same error and notify Market
Control until four hours after the trade, it could not be reviewed
under the current Obvious Error Rule. Under the proposal, this trade
would qualify as a Catastrophic Error because the purchase price is
more than $5 above the theoretical price. Under the proposal, the
Tribunal would review the trade and adjust the purchase price to $12,
which reduces the cost of the error to $30,000.\7\
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\4\ One hundred contracts equal 10,000 shares, and the purchase
price is $8 per share above the theoretical price. Therefore, the
purchaser paid $80,000 over the theoretical value.
\5\ ISE Rule 720(c)(2).
\6\ 10,000 shares at $.30 per share over the theoretical value.
\7\ 10,000 shares at $3.00 per share over the theoretical value.
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The Exchange believes that the proposed longer time period is
appropriate to allow members to discover, and seek relief from, trading
errors that result in extreme losses. At the same time, the Exchange
believes that the proposed Minimum Amounts required for a trade to
qualify as a Catastrophic Error, in combination with the large
Adjustment Values, assures that only those transactions where the price
of the execution results in very high losses will be eligible for
adjustment under the new provisions. While the Exchange believes it is
important to identify and resolve trading errors quickly, it also
believes it is important to the integrity of the marketplace to have
the authority to mitigate extreme losses resulting from errors. In this
respect, the Exchange believes that the above example illustrates how
market participants would continue to be encouraged to identify errors
quickly, as losses will be significantly lower if the erroneous trades
are busted or adjusted under the Obvious Error provisions of the rule.
In consideration of the extreme nature of situations that will be
addressed under the proposed Catastrophic Error provisions, the
Exchange proposes a streamlined procedure for making determinations and
adjustments. Under the current rule for Obvious Errors, ISE Market
Control makes determinations that can then be appealed to a panel of
member representatives. For Catastrophic Errors, the Exchange proposes
to have a one-step process where the Tribunal makes determinations and
adjustments. Additionally, given the burden that reviews under the
Catastrophic Error provisions of the rule will have on exchange staff
and member representatives, the Exchange proposes to include a $5000
fee in the event that the Tribunal determines that a Catastrophic Error
did not occur. The Exchange believes that this is reasonable to
encourage Members to requests reviews only in appropriate situations,
particularly given the objective criteria used to determine whether a
Catastrophic Error occurred and the considerable amount of time members
are given under the proposal to assess whether a trade falls within
that criteria.
The Exchange also amended Supplementary Material .02, .03, and .04
to ISE Rule 720 to reflect the proposed creation of the Tribunal.
2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
Section 6(b) of the Act,\8\ in general, and furthers the objectives of
Section 6(b)(5) of the Act,\9\ in particular, in that it is designed to
prevent fraudulent and manipulative acts, 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.
In particular, the proposal will allow members a longer opportunity to
seek relief from errors that result in large losses.
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\8\ 15 U.S.C. 78f(b).
\9\ 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
No written comments were solicited or received by the Exchange with
respect to the proposed rule change.
[[Page 2969]]
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 the 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. 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 e-mail to rule-comments@sec.gov. Please include
File Number SR-ISE-2007-112 on the subject line.
Paper Comments
Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-ISE-2007-112. This file
number should be included on the subject line if e-mail 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 Accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 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-ISE-2007-112 and should be
submitted on or before February 6, 2008.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\10\
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\10\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-647 Filed 1-15-08; 8:45 am]
BILLING CODE 8011-01-P