[Federal Register Volume 68, Number 200 (Thursday, October 16, 2003)]
[Notices]
[Pages 59657-59659]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-26207]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48600, File No. SR-CBOE-2003-44]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change by the Chicago 
Board Options Exchange, Inc., To Amend a Rule Regarding Nullification 
and Adjustment of Transactions

October 7, 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 October 7, 2003, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II 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 and is granting 
accelerated approval of the proposed rule change, which will be in 
effect on a temporary basis.
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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 is proposing to amend its obvious error rule, CBOE 
Rule 6.25, on a pilot basis. Proposed new language is italicized.
* * * * *
Rule 6.25 Nullification and Adjustment of Electronic Transactions
    (a)-(e) No Change.
Interpretations and Policies.......
    .03 (a) Trades may be adjusted or nullified when the execution 
price of the trade is higher or lower than the Theoretical Price for 
the series by an amount equal to at least two times the maximum bid/ask 
spread allowed for the option under Rule 8.7(b)(4), so long as such 
amount is $0.50 or more or $0.25 or more for options priced under $3. 
For purposes of this subparagraph, the Theoretical Price of an option 
is the last bid (offer) price, just prior to the trade, from the 
exchange providing the most volume in the option with respect to an 
erroneous bid (offer) entered on the Exchange. If there are no quotes 
for comparison purposes, then the Theoretical Price of an option is as 
determined by two Trading Officials. CBOE will use the volume figures 
for

[[Page 59658]]

that day (up to the time of the transaction in question) to determine 
which exchange provides the most volume. If CBOE is the volume leader, 
it will use volume figures from the exchange with the next highest 
volume level.
    (b) This Interpretation expires upon final approval of SR-CBOE-
2001-04 or December 1, 2003, whichever occurs earlier.
* * * * *

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 III 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
    On September 29, 2003, the Commission granted partial accelerated 
approval on a pilot basis of a provision of CBOE's proposed obvious 
error rule that allows for the adjustment and nullification of trades 
resulting from verifiable disruptions or malfunctions of Exchange 
systems.\3\ According to CBOE, while approval of this section provides 
a degree of relief to market makers and Designate Primary Market Makers 
(``DPMs'') who, through no fault of their own, execute trades 
electronically based on erroneous prices, it does not provide any 
protection against transactions executed at obviously erroneous prices 
that are not the result of Exchange systems disruptions. The purpose of 
this proposal, therefore, is to request accelerated approval, of new 
temporary Interpretation .03 to CBOE Rule 6.25, which is substantially 
similar to the SBT trade nullification rule (CBOE Rule 43.5) provision 
relating to obvious pricing errors, as described below.\4\
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    \3\ See Securities Exchange Act Release No. 48556 (September 29, 
2003), 68 FR 57716 (October 6, 2003), (File No. SR-CBOE-2001-04). 
The Exchange's proposed obvious error rule, CBOE Rule 6.25, defines 
six instances that qualify as ``obvious errors'' and hence are 
subject to adjustment or nullification. The Commission approved on a 
temporary basis until December 1, 2003 the following sections of 
CBOE Rule 6.25: (a)(3) and (b)-(e). The following sections of CBOE 
Rule 6.25 have not yet been approved: (a)(1), (2), (4)-(6) and 
Interpretations .01 and .02.
    \4\ The Commission approved CBOE Rule 43.5 as part of the 
Exchange's screen-based trading (``SBT'') rules. See Securities 
Exchange Act Release No. 47628 (April 3, 2003), 68 FR 17697 (April 
10, 2003) (File No. SR-CBOE-2000-55). CBOE represents that SBT rules 
have no application to trading that is not effected through the SBT.
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    Proposed Interpretation .03 to CBOE Rule 6.25 will allow for the 
adjustment or nullification of trades when the execution price of the 
trade is higher or lower than the ``Theoretical Price'' for the series 
by an amount equal to at least two times the maximum bid/ask spread 
allowed for the option under CBOE Rule 8.7(b)(4), provided the amount 
is $0.50 or more or $0.25 or more for options priced under $3. For 
purposes of this Interpretation, the Theoretical Price of an option is 
defined as the last bid (offer) price, just prior to the trade, from 
the exchange providing the most volume in the option with respect to an 
erroneous bid (offer) entered on the Exchange. If there are no quotes 
for comparison purposes, then the Theoretical Price of an option is as 
determined by two Trading Officials. CBOE will look to the volume 
figures for that day, up to the time of the transaction in question, to 
determine which exchange provides the most volume. If CBOE is the 
volume leader, it will use volume figures from the exchange with the 
next highest volume level.
    The Exchange represents that approval is both necessary and 
justified for several reasons. First, as indicated above, the 
Commission has already approved a substantially similar rule provision 
in the context of CBOE's SBT. The SBT rules were published for comment 
and the Commission received no negative comments. Second, and most 
important, the rule is necessary from a protective standpoint: trades 
executed at obviously erroneous prices can have extreme financial 
ramifications on a market maker and the inability to seek relief for 
obvious errors imposes a form of strict liability trading upon 
participants. The Exchange is not requesting relief from errors that do 
not qualify as obvious, and readily accepts that in some instances the 
cost of doing business means that market makers must honor trades 
executed at inaccurate prices. CBOE believes that requiring a market 
maker to honor trades executed at prices that are not even remotely 
close to theoretical value, will have nothing but a chilling effect and 
cause those market participants to stop quoting or reduce their sizes. 
CBOE notes that both the International Securities Exchange (``ISE'') 
and Pacific Exchange (``PCX'') have ``clearly erroneous'' rules, and 
CBOE represents that the obvious pricing component that it proposes 
herein is much more restrictive than either of those Exchanges' rules. 
According to CBOE, this means that the same trade executed on CBOE and 
ISE or PCX could be nullified or adjusted on the PCX or ISE while it 
would stand on CBOE. Accordingly, CBOE believes that competitive forces 
necessitate this proposal.
    The Exchange requests approval of this Interpretation on a 
temporary basis until the earlier of final Commission approval of File 
No. SR-CBOE-2001-04 or December 1, 2003. The procedural requirements 
necessary for implementation of CBOE Rule 6.25 (i.e., Sections (b)-(e)) 
were approved by the Commission on a pilot basis on September 29, 2003 
and will be utilized to implement proposed Interpretation .03.
2. Statutory Basis
    By providing for the adjustment or nullification of trades executed 
at clearly erroneous prices, the Exchange believes the proposed rule 
change is consistent with the Act and the rules and regulations under 
the Act applicable to a national securities exchange and, in 
particular, the requirements of Section 6(b) of the Act.\5\ 
Specifically, the Exchange believes that the proposed rule change is 
consistent with the requirements of Section 6(b)(5) of the Act,\6\ 
which requires that the rules of an exchange be designed to promote 
just and equitable principles of trade, to prevent fraudulent and 
manipulative acts and, in general, to protect investors and the public 
interest.
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE 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

    CBOE did not solicit or receive written comments on the proposed 
rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and

[[Page 59659]]

arguments concerning the foregoing, including whether the proposed rule 
change 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-CBOE-2003-44 and 
should be submitted by November 6, 2003.

IV. Commission's Findings and Order Granting Accelerated Approval on a 
Pilot Basis

    After careful review, the Commission finds that proposed 
Interpretation .03 to CBOE Rule 6.25 is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\7\ In particular, the 
Commission finds that the proposed Interpretation is consistent with 
the requirements of Section 6(b)(5) \8\ of the Act, which requires, 
among other things, that the rules of an exchange be designed to 
promote just and equitable principals 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.
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    \7\ 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).
    \8\ 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 is such that execution of a trade at that 
particular price indicates that 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 
such an ``obvious error'' has occurred should be based on specific and 
objective criteria and subject to specific and objective procedures. 
The Commission believes that CBOE's proposed Interpretation .03 to CBOE 
Rule 6.25 establishes such specific and objective criteria for 
determining when a trade may involve an ``obvious price error,'' and 
thus may be adjusted or nullified in a fair and non-discriminatory 
manner. The Commission notes that if there are no quotes for 
comparison, CBOE has specified that trading officials may determine the 
Theoretical Price, which would then be used to adjust or nullify 
transactions resulting from an obvious price error.
    The Commission finds good cause, pursuant to Section 6(b)(5) \9\ 
and Section 19(b)\10 \ of the Act, to accelerate approval of 
Interpretation .03 to CBOE Rule 6.25 on a pilot basis, prior to the 
thirtieth day after the date of publication of notice thereof in the 
Federal Register. The Commission notes that the provisions of the 
proposal are substantially similar to CBOE's SBT obvious price error 
rule, CBOE Rule 43.5(b)(5), which the Commission has approved.\11\ The 
Commission also notes that it has recently approved ``obvious error'' 
rules for ISE and PCX that provide procedures for the nullification or 
adjustment of a trade.\12\ Furthermore, the provisions of the proposed 
rule change would be in effect on a temporary basis until the earlier 
of approval of File No. SR-CBOE-2001-04 or December 1, 2003, whichever 
occurs earlier. Finally, the Commission notes that the procedures to 
implement Interpretation .03 to CBOE Rule 6.25 were adopted on a pilot 
basis in Securities Exchange Act Release No. 48556.\13\ The Commission 
finds, therefore, that granting accelerated approval of the proposed 
rule change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register, is appropriate and consistent 
with Section 6(b)(5) \14\ of the Act.
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    \9\ 15 U.S.C. 78f(b)(5).
    \10\ 15 U.S.C. 78s(b).
    \11\ See Securities Exchange Act Release No. 47628 (April 3, 
2003), 68 FR 17697 (April 10, 2003) (File No. SR-CBOE-00-55).
    \12\ See Securities Exchange Act Release No. 48538 (September 
25, 2003), 68 FR 56858 (October 2, 2003) (File No. SR-PCX-2002-01); 
and Securities Exchange Act Release No. 48097 (June 26, 2003), 68 FR 
39604 (July 2, 2003) (File No. SR-ISE-2003-10).
    \13\ See supra note 3.
    \14\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that Interpretation .03 to CBOE Rule 6.25, as set forth in the 
proposed rule change be and hereby is approved on an accelerated basis. 
Interpretation .03 to CBOE Rule 6.25 specifies that the Interpretation 
will expire upon final Commission approval of File No. SR-CBOE-2001-04 
or December 1, 2003, whichever occurs earlier.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-26207 Filed 10-15-03; 8:45 am]
BILLING CODE 8010-01-P