[Federal Register Volume 68, Number 163 (Friday, August 22, 2003)]
[Notices]
[Pages 50820-50822]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-21540]



[[Page 50820]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48342; File No. SR-PCX-2002-01]


Self Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1 and 2 Thereto by the Pacific Exchange, 
Inc., Relating to Procedures for Obvious Errors in Options Transactions

August 14, 2003.
    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 January 3, 2002, the Pacific Exchange, Inc. (``PCX'' 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 July 
28, 2003, the Exchange submitted Amendment No. 1 to the proposed rule 
change.\3\ On August 8, 2003, the Exchange submitted Amendment No. 2 to 
the proposed rule change.\4\ 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\ See Letter from Mai S. Shiver, Senior Attorney, Regulatory 
Policy, Exchange, to Nancy J. Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated July 25, 2003 
(``Amendment No. 1''). Amendment No. 1 supersedes and replaces the 
proposed rule change in its entirety.
    \4\ See Letter from Mai S. Shiver, Senior Attorney, Regulatory 
Policy, Exchange, to Nancy J. Sanow, Assistant Director, Division, 
Commission, dated August 7, 2003 (``Amendment No. 2''). Amendment 
No. 2 supersedes and replaces the proposed rule change and Amendment 
No. 1 in their entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to define an ``obvious error'' for 
options transactions and establish a procedure to follow in the event 
of an obvious error. Proposed new language is italicized; proposed 
deletions are in brackets.
* * * * *
    Rule 6.87 (g) Trade Nullification and Price Adjustment Procedures 
[Price Adjustments. Due to instantaneous execution, an incorrect quote 
appearing on a screen may result in an Auto-Ex trade at an incorrect 
price. An Auto-Ex trade executed at an erroneous quote should be 
treated as a trade reported at an erroneous price. The price of the 
Auto-Ex trade should be adjusted to reflect accurately the market quote 
at the time of execution. This will result in public customers and 
market makers receiving correct fills at prevailing market quotes 
through Auto-Ex.]
    (1) Mutual Agreement: The determination as to whether an Auto-Ex 
trade was executed at an erroneous price may [is to] be made by mutual 
agreement of the affected parties to a particular transaction. A trade 
may be nullified or adjusted on the terms that all parties to a 
particular transaction agree. In the absence of mutual agreement by the 
parties, a particular trade may only be nullified or adjusted when the 
transaction results from an Obvious Error as provided in this Rule. 
[two Floor Officials. In making their determination, the Floor 
Officials should consider such factors as:
    (1) the length of time the allegedly incorrect quote was displayed;
    (2) whether any non-Auto-Ex tracks were effected at the same price 
as the Auto-Ex transaction; and
    (3) whether any members of the trading crowd were aware of orders 
actively being represented in the trading crowd that appear to have 
been ``printed through'' by the Auto-Ex trade.]
    (2) Obvious Error Subject to Trade Nullification or Price 
Adjustment: Absent mutual agreement as provided in Rule 6.87(g)(1), 
parties to a trade may have a trade nullified or its price adjusted if: 
(i) any such party makes a documented request within the time specified 
in Rule 6.87(g)(3); and (ii) one of the conditions below is met:
    A. The trade resulted from a verifiable disruption or malfunction 
of an Exchange execution, dissemination, or communication system that 
caused a quote/order to trade in excess of its disseminated size (e.g. 
a quote/order that is frozen, because of an Exchange system error, and 
repeatedly traded) in which case trades in excess of the disseminated 
size may be nullified; or
    B. The trade resulted from a verifiable disruption or malfunction 
of an Exchange dissemination or communication system that prevented a 
member from updating or canceling a quote/order for which the member is 
responsible where there is Exchange documentation providing that the 
member sought to update or cancel the quote/order; or
    C. The trade resulted from an erroneous print disseminated by the 
underlying market which is later cancelled or corrected by the 
underlying market where such erroneous print resulted in a trade higher 
or lower than the average trade in the underlying security during the 
time period encompassing two minutes before and after the erroneous 
print, by an amount at least five times greater than the average quote 
width for such underlying security during the time period encompassing 
two minutes before and after the erroneous print. For purposes of this 
Rule, the average trade in the underlying security shall be determined 
by adding the prices of each trade during the four minute time period 
referenced above (excluding the trade in question) and dividing by the 
number of trades during such time period (excluding the trade in 
question); or
    D. The trade resulted from an erroneous quote in the Primary Market 
(as defined in Rule 6.1(b)(27)) for the underlying security that has a 
width of at least $1.00 and that width is at least five times greater 
than the average quote width for such underlying security during the 
time period encompassing two minutes before and after the dissemination 
of such quote. For the purposes of this rule, the average quote width 
shall be determined by adding the quote widths of each separate quote 
during the four minute time period referenced above (excluding the 
quote in question) and dividing by the number of quotes during such 
time period (excluding the quote in question); or
    E. The execution price of the trade is higher or lower than the 
mid-point of the Best Bid and Offer (among all of the exchanges other 
than the PCX) by an amount equal to at least the bid/ask spread 
provided in Rule 6.37(b)(1), or, in the event where the bid/ask spread 
in the underlying is greater than the bid/ask spread set forth in Rule 
6.37(b)(1), by an amount as set forth in Rule 6.37 (b)(3). For the 
purpose of this calculation, the Exchange will not apply a wider bid/
ask spread as provided for LEAPS or for options subject to unusual 
market conditions;
    F. The trade resulted in an execution price in a series quoted no 
bid and at least one strike price below (for calls) or above (for puts) 
in the same class were quoted no bid at the time of the erroneous 
execution.
    G. The trade is automatically executed at a price where the Market 
Maker sells $0.10 or more below parity. Parity describes an option 
contract's total premium when that premium is equal to its intrinsic 
value. Parity for calls is measured by reference to the offer price of 
the underlying security in the primary market at the time of the 
transaction minus the strike price for the call. Parity for puts is 
measured by the strike price of an underlying security minus its bid 
price in the primary market at the time of the transaction.

[[Page 50821]]

    (3) Obvious Error Procedure. Two Floor Officials will administer 
the application of this Rule as follows:
    A. Notification. If a Member on the Exchange believes that it 
participated in a transaction that was the result of an Obvious Error, 
it must notify two Floor Officials within five (5) minutes of the 
execution. If an Order Entry Firm representing a public customer 
believes an order it executed on the Exchange was the result of an 
Obvious Error, it must notify the Exchange within twenty (20) minutes 
of the execution. Absent unusual circumstances, two Floor Officials 
will not grant relief under this Rule unless notification is made 
within the prescribed time periods.
    B. Adjust or Nullify. Two Floor Officials will determine whether 
the execution is subject to a trade nullification or price adjustment. 
If two Floor Officials determine that one of the conditions of Rule 
6.87(g)(2) has been met and that the complaining party has timely 
documented a request for relief, then a trade will be adjusted or 
nullified as follows:
    (1) Where each party to the transaction is a Market Maker on the 
Exchange, or the trade involves a limit order that may be adjusted to 
its limit, the Exchange will adjust the execution price of the 
transaction within ten (10) minutes of two Floor Officials making such 
determination. In such case, the adjusted price will be the last bid 
(offer) price, just prior to the trade, from the exchange providing the 
highest total contract volume in the option for the previous sixty (60) 
days with respect to an erroneous bid (offer) entered on the Exchange. 
If there is no quote for comparison purposes, then the adjusted price 
of an option will be determined by two Floor Officials; or
    (2) Where at least one party to the transaction is not a Market 
Maker on the Exchange or where the trade does not involve a limit order 
that may be adjusted to its limit, the Exchange will nullify the 
transaction within ten (10) minutes of two Floor Officials making such 
determination.
    (3) Upon taking final action, the two Floor Officials will promptly 
notify both parties to the trade.

Commentary

    .01 In no case will the two Floor Officials involved in an obvious 
error determination include a person related to a party to the trade in 
question.
    .02 All determinations made by the two Floor Officials under 
subsection (g)(2) will be rendered without prejudice as to the rights 
of the parties to the transaction to submit a dispute to arbitration.
    .03 Nothing in this rule prevents a potentially aggrieved party 
from appealing the decision of two Floor Officials pursuant to Rule 11 
of the Exchange rules.
* * * * *

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
    While the Exchange believes that it would be detrimental to allow 
market participants to adjust or nullify trades simply because they are 
based on poor trading decisions, it does believe that just and 
equitable principles of trade permit such adjustments or trade 
nullifications where one market participant would receive a windfall at 
the expense of another market participant that made an obvious error. 
In promulgating the basis for determining whether to adjust or nullify 
trades based upon obvious error, the Exchange believes that it must 
rely on objective standards to establish when a transaction was clearly 
the result of an obvious error, under what circumstances a trade will 
be adjusted or nullified, and to what price a trade will be adjusted if 
adjustment is appropriate under the circumstances.
    As proposed, the affected parties to a particular transaction may 
determine, by mutual agreement, that an electronic trade was executed 
at an erroneous price and they may adjust the terms or nullify the 
trade as they agree. In the absence of mutual agreement by the parties, 
the proposed rule provides that two trading officials may nullify or 
adjust a trade if an affected party provides a documented request for 
relief within five minutes of the execution (or 20 minutes if the 
request is on behalf of a public customer) of the trade so long as one 
of following conditions is met:
    [sbull] The trade resulted from a verifiable disruption or 
malfunction of an Exchange execution, dissemination, or communication 
system that caused a quote/order to trade in excess of its disseminated 
size (e.g., a quote/order that is frozen, because of an Exchange system 
error, and repeatedly traded) in which case trades in excess of the 
disseminated size may be nullified; or
    [sbull] The trade resulted from a verifiable disruption or 
malfunction of an Exchange dissemination or communication system that 
prevented a member from updating or canceling a quote/order for which 
the member is responsible where there is Exchange documentation 
providing that the member sought to update or cancel the quote/order; 
or
    [sbull] The trade resulted from an erroneous print disseminated by 
the underlying market which is later cancelled or corrected by the 
underlying market where such erroneous print resulted in a trade higher 
or lower than the average trade in the underlying security during the 
time period encompassing two minutes before and after the erroneous 
print, by an amount at least five times greater than the average quote 
width for such underlying security during the time period encompassing 
two minutes before and after the erroneous print. For purposes of the 
proposed rule, the average trade in the underlying security shall be 
determined by adding the prices of each trade during the four minute 
time period referenced above (excluding the trade in question) and 
dividing by the number of trades during such time period (excluding the 
trade in question); or
    [sbull] The trade resulted from an erroneous quote in the Primary 
Market (as defined in Rule 6.1(b)(27)) for the underlying security that 
has a width of at least $1.00 and that width is at least five times 
greater than the average quote width for such underlying security 
during the time period encompassing two minutes before and after the 
dissemination of such quote. For purposes of the proposed rule, the 
average quote width shall be determined by adding the quote widths of 
each separate quote during the four minute time period referenced above 
(excluding the quote in question) and dividing by the number of quotes 
during such time period (excluding the quote in question); or
    [sbull] The execution price of the trade is higher or lower than 
the mid-point of the Best Bid and Offer (among all of the exchanges 
other than the PCX) by an amount equal to at least the bid/ask spread 
provided in Rule 6.37(b)(1), or, in the event where the bid/ask spread 
in the underlying is greater than the bid/

[[Page 50822]]

ask spread set forth in Rule 6.37(b)(1), by an amount as set forth in 
Rule 6.37 (b)(3). For the purpose of this calculation, the Exchange 
will not apply a wider bid/ask spread as provided for LEAPS or for 
options subject to unusual market conditions; or
    [sbull] The trade resulted in an execution price in a series quoted 
no bid and at least one strike price below (for calls) or above (for 
puts) in the same class were quoted no bid at the time of the erroneous 
execution; or
    [sbull] The trade is automatically executed at a price where the 
Market Maker sells $0.10 or more below parity. Parity describes an 
option contract's total premium when that premium is equal to its 
intrinsic value. Parity for calls is measured by reference to the offer 
price of the underlying security in the primary market at the time of 
the transaction minus the strike price for the call. Parity for puts is 
measured by the strike price of an underlying security minus its bid 
price in the primary market at the time of the transaction.
    Under the proposed rule change, when a Market Maker on the Exchange 
believes that it participated in a transaction that was the result of 
an obvious error, it must notify two Floor Officials \5\ within five 
minutes of the execution. If an Order Entry Firm representing a public 
customer believes an order it executed on the Exchange was the result 
of an Obvious Error, it must notify the Exchange within twenty (20) 
minutes of the execution. Absent unusual circumstances, two Floor 
Officials will not grant relief under the proposed rule change unless 
notification is made within the prescribed time periods.
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    \5\ In no case will the two Floor Officials involved in an 
obvious error determination include a person related to a party to 
the trade in question.
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    As proposed, two Floor Officials will determine whether the 
execution is subject to a trade nullification or price adjustment. If 
two Floor Officials determine that one of the above-stated conditions 
has occurred, and the complaining party has timely documented a request 
for relief, then the Floor Officials will take one of the following 
actions:
    (1) Where each party to the transaction is a Market Maker on the 
Exchange or the trade involves a limit order than may be adjusted to 
its limit, the execution price of the transaction will be adjusted 
within ten minutes of the Floor Officials making such a determination. 
In such case, the adjusted price will be the last bid (offer) price 
just prior to trade from the exchange providing the highest total 
contract volume for the previous sixty (60) days in the option with 
respect to an erroneous bid (offer) entered on the Exchange. If there 
is no quote for comparison purposes, then the adjusted price of the 
option will be determined by two Floor Officials.
    (2) If at least one party to the transaction is not a Market Maker 
on the Exchange or where the trade does not involve a limit order that 
may be adjusted to its limit, the trade will be nullified within ten 
(10) minutes of two Floor Officials making such determination.
    All determinations made by the two Floor Officials under the 
proposed rule change will be rendered without prejudice as to the 
rights of the parties to the transaction to submit a dispute to 
arbitration. The Exchange believes that the rule proposal promotes fair 
and equitable resolutions of erroneous trades.

2. Statutory Basis

    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act \6\ in general, and furthers the 
objectives of Section 6(b)(5) \7\ in particular, in that it is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanism for a free and open market and a national market 
system, and, in general, to protect investors and the public interest.
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    \6\ 15 U.S.C. 78f(b).
    \7\ 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
    The Exchange did not solicit or receive written 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, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. 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 at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-PCX-2002-01 and should be submitted by September 12, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-21540 Filed 8-21-03; 8:45 am]
BILLING CODE 8010-01-P