[Federal Register Volume 73, Number 11 (Wednesday, January 16, 2008)]
[Notices]
[Pages 2967-2969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-647]


-----------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.

------------------------------------------------------------------------
                                                  Minimum    Adjustment
               Theoretical price                   amount       value
------------------------------------------------------------------------
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
------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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 [email protected]. 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\
---------------------------------------------------------------------------

    \10\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-647 Filed 1-15-08; 8:45 am]
BILLING CODE 8011-01-P