[Federal Register Volume 69, Number 239 (Tuesday, December 14, 2004)]
[Notices]
[Pages 74548-74551]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3612]


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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 [email protected]. 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