[Federal Register: December 14, 2004 (Volume 69, Number 239)]
[Notices]
[Page 74548-74551]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14de04-107]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-50814; File No. SR-BSE-2004-52]
Self-Regulatory Organizations; Boston Stock Exchange, Inc.;
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto
Relating to Market Maker Quote Obligations Under the Rules of the
Boston Options Exchange Facility
December 7, 2004.
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 24, 2004, the Boston Stock Exchange,
[[Page 74549]]
Inc. (``BSE'' 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. On December 3, 2004, the BSE filed an Amendment No. 1 to the
proposed rule change.\3\ 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.
\3\ In Amendment No. 1, the BSE made technical, non-substantive
changes to the rule text.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to adopt a rule under the rules of the Boston
Options Exchange Facility (``BOX'') to provide BOX Market Makers
protection from the unreasonable risk associated with communication
failures and systemic errors. The text of the proposed rule change, as
amended, is below. Proposed new language is in italics.
Chapter VI.
* * * * *
Sec. 12 Standard Market Maker Protection Mechanism
(a) Trade Counter
The Trading Host will maintain a ``trade counter'' for each Market
Maker on each class to which the Market Maker is appointed. This trade
counter will be incremented by one every time the Market Maker executes
a trade of at least 10 contracts on any series in the appointed class.
Whenever the Trading Host receives from the Market Maker a message to
update or refresh any of his quotes on any of the options series in the
same class, the trade counter at the Trading Host for that class will
be reset to zero.
(b) Standard Market Maker Protection Mechanism
The Trading Host will implement the Standard Market Maker
Protection Mechanism on an appointed class whenever the following
conditions are met:
i. The trade counter has reached ``n'' executions against the
quotes of the Market Maker in the Market Maker's appointed class; and
ii. The Trading Host has not received from the Market Maker a
message to update or refresh any of his quotes on any of the options
series in the same class before the ``n'' executions have occurred.
When the above conditions are met, the Trading Host will
automatically cancel all quotes posted by the Market Maker on that
class by generating a ``bulk cancel'' message.
(c) The bulk cancel message will have the same time priority as any
other quote or order message received by BOX. Any orders or quotes that
matched with the Market Maker's quote and were received by the Trading
Host prior to the receipt of the bulk cancel message will be
automatically executed. Orders or quotes received by the Trading Host
after receipt of the bulk cancel message will not be executed against
the Market Maker. At any time the Market Maker may update or refresh
any of its quotes for any of the options series in the same class and
reset the trade counter to zero.
(d) The Board shall determine the appropriate trade counter
threshold of ``n'' executions required in paragraph (b) above to
implement the Standard Market Maker Protection Mechanism. In no case
will the threshold be lower than five.
Sec. 13 Advanced Market Maker Protection Mechanism
(a) The Advanced Market Maker Protection Mechanism is enabled (or
disabled ) for an options class when a Market Maker sends an Advanced
Market Maker Protection enabling (or disabling ) message to the Trading
Host. Unless enabled, the Advanced Market Maker Protection Mechanism is
disabled for all options classes.
(b) When the Advanced Market Maker Protection Mechanism is enabled
for a Market Maker's appointed options class, any ``bulk quote''
message sent by the Market Maker on that class is automatically
rejected as soon as one of the following activating events occurs:
i. The Market Maker's Standard Market Maker Protection Mechanism is
triggered for that class, pursuant to Section 12; or
ii. The Market Maker activates the Panic Quote function for that
class pursuant to Section 14.
(c) Once the Advanced Market Maker Protection Mechanism has been
activated for an options class, any bulk quote messages sent by the
Market Maker on that class will continue to be rejected until the
Market Maker sends an Advanced Market Maker Protection enabling or
disabling message to the Trading Host.
(d) For purposes of this Section 13, a ``bulk quote'' message is a
single message from a Market Maker that simultaneously updates all of
the Market Maker's quotes in multiple series in a class at the same
time.
Sec. 14. Panic Quote
A Market Maker may simultaneously cancel all its quotes in an
assigned class by sending a Panic Quote message to the Trading Host
through the Panic Quote channel, or otherwise requesting BOX operations
staff to manually generate the Panic Quote message to the Trading Host
in order to cancel all of the Market Maker's quotes in that class.
* * * * *
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 had 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 proposed rule change is to provide all BOX
Market Makers protection from the unreasonable risk of multiple nearly
simultaneous executions caused by communication failures or systemic
errors. Like auto-quote systems used on other options exchanges, the
primary method for Market Makers to update their quotes on BOX is to
post and update quotes on multiple series of options at the same time
through the use of ``bulk quotes''.\4\ Generally, these quotes are
based on the Market Maker's proprietary pricing models that rely on
various factors, including the price of the underlying security and
that security's market volatility. As these variables change, a Market-
Maker's pricing model and automated quote system will continuously
enter bulk quote updates for most or all series in the class.
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\4\ A ``bulk quote'' message is a single message from a Market
Maker that simultaneously updates all of the Market Maker's quotes
in multiple series in a class at the same time.
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In most instances a Market Maker sends a message to BOX to update
or refresh its quote on at least one series in its assigned class after
each execution by the Market Maker in that options series or any
movement in the
[[Page 74550]]
underlying security's price. Several executions in the class without
any message or quote update from the Market Maker would indicate some
type of technical breakdown in either the Market Maker's communication
link with BOX or the Market Maker's automated trading and quotation
system. If a Market Maker's communication link with BOX is lost or
delayed and the Market Maker cannot effectively update its quotes after
an execution or when the underlying security's price moves, then the
Market Maker's stale quotes are vulnerable to being hit and
automatically executed across all the series in the assigned class
nearly simultaneously. Similarly, if the Market Maker's pricing model
and automated quote update system malfunctions, the Market Maker's bulk
quote update could inadvertently automatically execute across all the
series in the assigned class.
These nearly simultaneous multiple executions can create huge
unintended principal positions for the Market Maker and expose the
Market Maker to unnecessary market risk. Firm risk management
procedures dictate that Market Makers must take into account the
possibility of such errors and the corresponding risk to the Market
Maker and the firm. As a result, the BSE believes that Market Makers
widen their quotes, quote less aggressively and limit their quote size
in order to avoid such unintended executions and the attendant risks
and costs, all to the detriment of customers and other market
participants. The proposed rule addresses these concerns.
Standard Market Maker Protection
The Standard Market Maker Protection feature on BOX would protect
all Market Makers from excessive multiple and unintended automatic
executions due to the following:
Communication problems preventing the Market Maker from
making intended quote updates.
Technical or systemic errors causing Market Maker quote
update errors.
Bulk quotes unintentionally ``sweeping the book'' or being
``swept''.
The Standard Market Maker Protection Mechanism would begin with a
``trade counter'' for each class where the Market Maker has a market
making appointment. This trade counter would be incremented by one
every time the Market Maker executes a trade of at least 10 contracts
on any series of the assigned class. The trade counter would reset
every time the Market Maker sends a quote update or refresh message to
BOX on any one of the series within the class. The Boston Options
Exchange Regulation LLC (``BOXR'') Board would define a threshold
number for the trade counter to reach (currently determined to be five)
\5\ to trigger the implementation of the Standard Market Maker
Protection Mechanism. This would limit the number of consecutive
executions a given Market Maker could have automatically executed on an
assigned class without BOX receiving any message from the Market Maker.
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\5\ In no case will the threshold be less than five.
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Once the trade counter has reached the defined threshold number of
five, the Trading Host would automatically cancel all quotes posted by
that Market Maker on that class by generating a bulk cancel message.
The bulk cancel message would have the same time priority as any other
quote update or order message the Trading Host receives, so that any
orders or quotes that matched with the Market Maker's quote and were
received by the Trading Host prior to the receipt of the cancel message
would be automatically executed pursuant to the BOX rules. Orders or
quotes received by the Trading Host after receipt of the cancel message
would not be executed against the Market Maker.
As soon as the Standard Market Maker Protection Mechanism is
triggered, the Market Maker would receive a message to confirm the
cancellation of the Market Maker's quotes on the given class. The
Market Maker could respond with a quote update or refresh, or no reply,
which BOX would assume means a communication or system problem with the
Market Maker. At any time the Market Maker may update or refresh any of
its quotes for any of the options series in the given class and reset
the trade counter to zero.
Advanced Market Maker Protection
The Advanced Market Maker Protection Mechanism would provide Market
Makers with an additional feature that may be enabled/disabled on
demand by the Market Makers using a special message sent to the Trading
Host. The Market Maker would enable the mechanism by sending BOX an
Advanced Market Maker Protection enabling message. When enabled, the
Advanced Market Maker Protection feature would cause BOX to
automatically reject any bulk quote message sent by the Market Maker on
a specific appointed class as soon as one of the following events
occurs:
The Market Maker's Standard Market Maker Protection
Mechanism is triggered for the given class.
The Panic Quote function is triggered by the Market Maker
for the given class.\6\
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\6\ See discussion of Panic Quote below.
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Quoting for the Market Maker on an options class would be disabled
once the Advanced Market Maker Protection Mechanism is triggered for
such class.\7\ Any subsequent bulk quote update message would be
rejected. Quoting for the Market Maker would only be reactivated by the
Market Maker sending to BOX a new Advanced Market Maker Protection
enabling message.
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\7\ No other options classes would be affected.
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Standard and Advanced Market Maker Protection
These mechanisms would protect both Market Maker quotes currently
posted and in the BOX book and those incoming bulk quotes that a Market
Maker may erroneously generate as part of an automatic update. For
example, this would mean that a new bulk quote message from a Market
Maker that is immediately executable across multiple series would not
generate a number of executions greater than the defined threshold
number (i.e. would not allow the Market Maker to unintentionally sweep
the book).
Without these protection mechanisms multiple unintentional trades
could automatically occur. These executions would not properly reflect
the true nature of the market and would subject Market Makers to
unreasonable market risk and multiple execution and clearing fees, with
no real economic justification behind the trades.\8\ The Exchange
believes the proposed rule change would reduce these inefficiencies and
risks by preventing a BOX Market Maker from erroneously trading
automatically multiple times. Under normal circumstances, BOX Market
Maker quotes do match and are automatically executed; however, these
are usually only on a few series in a class and involve immediate quote
updates after an execution. The trade counter would not reach the
threshold level under most circumstances.
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\8\ In many instances such trades qualify under the BOX obvious
error rule and are busted. However, not all trades created by these
circumstances technically qualify. The Market Maker Protection
Mechanism would also spare BOXR from expending considerable
resources to address obvious errors that arise in this manner.
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The Exchange believes these protection mechanisms would eliminate
trades that are involuntary, the result of technological error or
inaccuracy, and that impede certain liquidity providers'
[[Page 74551]]
ability to competitively quote. Also, the Exchange believes the
protection mechanisms would increase the liquidity available in the BOX
market and would enhance competition because Market-Makers would be
better able to quote larger size aggressively with fewer concerns over
technological breakdowns.
Panic Quote
A Market Maker may simultaneously cancel all its quotes in an
assigned class by triggering the Panic Quote function. The Panic Quote
function would be triggered by the Market Maker sending a Panic Quote
message to the BOX Trading Host through the Panic Quote channel, or
otherwise requesting BOX operations staff to manually generate the
Panic Quote message to the Trading Host in order to cancel all of the
Market Maker's quotes in that class.
Triggering the Panic Quote function would also trigger the Advanced
Market Maker Protection Mechanism, and all subsequent bulk quote
messages would be rejected by the BOX Trading Host until the Market
Maker sends a new Advanced Market Maker Protection enabling message.
These market maker protections do not relieve a Market Maker's
obligations pursuant to Chapter VI, Sections 5 and 6 of the BOX Rules;
in particular, Chapter VI, Section 6(d) of the BOX Rules which
addresses a Market Maker's obligation to enter continuous quotations
for the options classes to which it is appointed. After a market maker
protection has been utilized, Market Makers are expected to resume
entering continuous quotations for the options classes to which they
are appointed as soon as practicable.
2. Statutory Basis
The Exchange believes that the proposal is consistent with the
requirements of section 6(b) of the Act,\9\ in general, and 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 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 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 has neither solicited nor received 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. 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-BSE-2004-52 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549-0609.
All submissions should refer to File Number SR-BSE-2004-52. 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 in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Section, 450 Fifth
Street, NW., Washington, DC 20549. Copies of such filing also will be
available for inspection and copying at the principal office of the
BSE. 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
publicly available. All submissions should refer to File Number SR-BSE-
2004-52 and should be submitted on or before January 4, 2004.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
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\11\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E4-3612 Filed 12-13-04; 8:45 am]
BILLING CODE 8010-01-P