[Federal Register Volume 78, Number 7 (Thursday, January 10, 2013)]
[Notices]
[Pages 2308-2310]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-00308]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68585; File No. SR-CBOE-2012-108]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change To Address the 
Authority To Cancel Orders When a Technical or Systems Issue Occurs and 
To Describe the Operation of Routing Service Error Accounts

January 4, 2013.

I. Introduction

    On November 8, 2012, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to (i) address the authority of 
the Exchange to cancel orders (or release routing-related orders) when 
a technical or systems issue occurs; and (ii) describe the operation of 
an Exchange error account(s) and routing broker error account(s), which 
may be used to liquidate unmatched executions that may occur in the 
provision of the Exchange's routing service. The proposed rule change 
was published for comment in the Federal Register on November 26, 
2012.\3\ The Commission received no comment letters regarding the 
proposed rule change. This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 68262 (November 19, 
2012), 77 FR 70517 (November 26, 2012) (SR-CBOE-2012-108) 
(``Notice'').
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II. Description of the Proposal

    In its proposal, the Exchange states that it operates a ``hybrid'' 
style system of trading that allows automatic executions to occur 
electronically and open outcry trades to occur on the floor of the 
Exchange.\4\ As part of this infrastructure, the Exchange states that 
it automatically routes orders to other exchanges under certain 
circumstances. These routing services are provided in conjunction with 
one or more routing brokers that are not affiliated with the 
Exchange.\5\ Mechanically, when the Exchange receives an order from a 
Trading Permit Holder that is held in the Exchange system and 
determines to route an order to another exchange, the Exchange provides 
the routing broker with a corresponding order and instructions to route 
the order to another exchange. The routing broker then sends the 
corresponding order to the other exchange.
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    \4\ See Notice, 77 FR at 70518.
    \5\ See Notice, 77 FR at 70518 n.4, n.8, and accompanying text.
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    In its proposal, CBOE states that the Exchange may encounter 
situations that make it necessary to cancel orders (or release routing-
related orders),\6\ and to resolve error positions that result from 
errors of the Exchange, routing brokers, or another exchange.\7\
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    \6\ See Notice, 77 FR at 70518. For examples of some of the 
circumstances in which the Exchange may decide to cancel orders, see 
Notice, 77 FR at 70519.
    \7\ See Notice, 77 FR at 70518. Specifically, CBOE Rule 6.14C 
defines ``error positions'' as ``unmatched trade positions that may 
occur in connection with the routing service provided under Rule 
6.14B''.
    For examples of some of the circumstances that may lead to error 
positions, see Notice, 77 FR at 70520-21.
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Proposed Rule 6.6A (Order Cancellation/Release)

    New CBOE Rule 6.6A provides CBOE with general authority to cancel 
orders as it deems to be necessary to maintain fair and orderly markets 
if a technical or systems issue occurs at the Exchange, a routing 
broker in connection with the routing service provided under CBOE Rule 
6.14B, or another exchange to which an Exchange order has been routed. 
It also provides that a routing broker may only cancel orders being 
routed to another exchange based on the Exchange's standing or specific 
instructions or as otherwise provided in the Exchange Rules. CBOE will 
be required to provide notice of the cancellation to affected Trading 
Permit Holders as soon as practicable.\8\
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    \8\ See CBOE Rule 6.6A(a).
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    Paragraph (b) of the rule provides that the Exchange may also 
determine to release orders being held on the

[[Page 2309]]

Exchange awaiting an away exchange execution as it deems to be 
necessary to maintain fair and orderly markets if a technical or 
systems issues occurs at the Exchange, a routing broker, or another 
exchange to which an order has been routed. Paragraph (c) of the rule 
provides that, for purposes of Rule 6.6A, technical or system issues 
would include, without limitation, instances where the Exchange has not 
received confirmation of an execution (or cancellation) on another 
exchange from a routing broker within a response time interval 
designated by the Exchange, which interval may not be less than three 
(3) seconds.

Proposed Rule 6.14C (Routing Service Error Accounts)

    New CBOE Rule 6.14C provides that each routing broker shall 
maintain, in the name of the routing broker, one or more accounts for 
the purpose of liquidating error positions. In addition the Exchange 
may also maintain, in the name of the Exchange, one or more Exchange 
error accounts (``Exchange Error Account'') for the purposes of 
liquidating error positions, subject to the procedures prescribed in 
new CBOE Rule 6.14C.
    Paragraph (a) of the rule provides that errors to which the rule 
applies include any action or omission by the Exchange, a routing 
broker, or another exchange to which an Exchange order has been routed, 
that results in an unmatched trade position due to the execution of an 
order that is subject to the away market routing service and for which 
there is no corresponding order to pair with the execution (each a 
``routing error''); and that such routing errors would include, without 
limitation, positions resulting from determinations by the Exchange to 
cancel or release an order pursuant to CBOE Rule 6.6A.
    Paragraph (b) of the rule provides that, generally, each routing 
broker will use its own error account to liquidate error positions. In 
certain circumstances, however, the Exchange may use an Exchange Error 
Account. In particular, in instances where the routing broker is unable 
to use its own error account (e.g., due to a technical, systems, or 
other issue that prevents the routing broker from doing so) \9\ or 
where the error is due to a technical or systems issue at the Exchange, 
the Exchange may (but would not be required to) determine it is 
appropriate to use an Exchange Error Account. The Exchange states that 
in making such a determination to use an Exchange Error Account, the 
Exchange would consider whether it has sufficient time, information, 
and capabilities considering the market circumstances to determine that 
an error is due to such circumstances and whether the Exchange can 
address the error.\10\
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    \9\ See Notice, 77 FR at 70519.
    \10\ See Notice, 77 FR at 70520.
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    Pursuant to paragraph (c), the Exchange will not be permitted to 
accept any positions in an Exchange Error Account from an account of a 
Trading Permit Holder or permit any Trading Permit Holder to transfer 
any positions from the Trading Permit Holder's account to an Exchange 
Error Account. In other words, the Exchange may not accept from a 
Trading Permit Holder positions that are delivered to the Trading 
Permit Holder through the clearance and settlement process, even if 
those positions may have been the result of an error.\11\
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    \11\ See Notice, 77 FR at 70520 n.17. This provision would not 
apply if the Exchange incurred a position to settle a Trading Permit 
Holder purchase, as the Trading Permit Holder did not yet have a 
position in its account as a result of the purchase at the time of 
the Exchange's action. See id.
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    To the extent a routing broker uses its own account to liquidate 
error positions, paragraph (d) of new CBOE Rule 6.14 provides that the 
routing broker shall liquidate the error positions as soon as 
practicable. The routing broker could determine to liquidate the 
position itself or have a third-party broker-dealer liquidate the 
position on the routing broker's behalf. Paragraph (d) also provides 
that the routing broker shall establish and enforce policies and 
procedures reasonably designed to (i) adequately restrict the flow of 
confidential and proprietary information associated with the 
liquidation of the error position in accordance with Rule 6.14B,\12\ 
and (ii) prevent the use of information associated with other orders 
subject to the routing services when making determinations regarding 
the liquidation of error positions. In addition, paragraph (d) provides 
that the routing broker shall make and keep records associated with the 
liquidation of such routing broker error positions and shall maintain 
such records in accordance with Rule 17a-4 under the Act.\13\
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    \12\ Rule 6.14B(b) provides that the Exchange shall establish 
and maintain procedures and internal controls reasonably designed to 
adequately restrict the flow of confidential and proprietary 
information between the Exchange and the routing broker, and any 
other entity, including any affiliate of the routing broker, and, if 
the routing broker or any of its affiliates engages in any other 
business activities other than providing routing services to the 
Exchange, between the segment of the routing broker or affiliate 
that provides the other business activities and the segment of the 
routing broker that provides the routing services.
    \13\ 17 CFR 240.17a-4.
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    Paragraph (e) of the rule provides that, to the extent an Exchange 
Error Account is used to liquidate error positions, the Exchange shall 
liquidate the error positions as soon as practicable. In liquidating 
error positions in an Exchange Error Account, the Exchange shall 
provide complete time and price discretion for the trading to a third-
party broker-dealer and shall not attempt to exercise any influence or 
control over the timing or methods of such trading.\14\ Such a third-
party broker-dealer may include a routing broker not affiliated with 
the Exchange. Paragraph (e) also provides that the Exchange shall 
establish and enforce policies and procedures reasonably designed to 
adequately restrict the flow of confidential and proprietary 
information between the Exchange and the third-party broker-dealer 
associated with the liquidation of the error positions.
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    \14\ This provision is not intended to preclude the Exchange 
from providing the third-party broker-dealer with standing 
instructions with respect to the manner in which it should handle 
all error account transactions. For example, the Exchange might 
instruct the broker-dealer to treat all orders as ``not held'' and 
to attempt to minimize any market impact on the price of the option 
being traded.
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    Finally, paragraph (e) provides that the Exchange shall make and 
keep records to document all determinations to treat positions as error 
positions under the rule (whether or not an Exchange Error Account is 
used to liquidate such error positions), as well as records associated 
with the liquidation of Exchange Error Account error positions through 
a third-party broker-dealer, and shall maintain such records in 
accordance with Rule 17a-1 under the Act.\15\
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    \15\ 17 CFR 240.17a-1.
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III. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of Section 6(b) of the Act 
\16\ and the rules and regulations thereunder applicable to a national 
securities exchange.\17\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\18\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of

[[Page 2310]]

trade, to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, 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; and are not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. In addition, the Commission 
believes the proposed rule change is consistent with Section 
11A(a)(1)(C) of the Act \19\ in that it seeks to assure economically 
efficient execution of securities transactions.
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    \16\ 15 U.S.C. 78f(b).
    \17\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \18\ 15 U.S.C. 78f(b)(5).
    \19\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission recognizes that technical or systems issues may 
occur, and believes that CBOE Rule 6.6A, in allowing CBOE to cancel or 
release orders affected by technical or systems issues, should provide 
a reasonably efficient means for CBOE to handle such orders, and 
appears reasonably designed to permit CBOE to maintain fair and orderly 
markets.\20\
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    \20\ The Commission notes that CBOE states it believes that 
allowing the Exchange to cancel or release orders under such 
circumstances would allow the Exchange to maintain fair and orderly 
markets, and that CBOE Rule 6.14C is designed ensure full trade 
certainty for market participants and avoid disrupting the clearance 
and settlement process. See Notice, 77 FR at 70521. The Commission 
also notes that CBOE states that a decision to cancel or release 
orders due to a technical or systems issue is not equivalent to the 
Exchange declaring self-help against a routing destination pursuant 
to Rule 611 of Regulation NMS. See 17 CFR 242.611(b). See also 
Notice, 77 FR at 70519 n.9.
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    The Commission also believes that allowing the Exchange to resolve 
error positions through the use of error accounts maintained by its 
routing brokers or the Exchange itself pursuant to the procedures set 
forth in the rule, and as described above, is consistent with the Act. 
The Commission notes that the rule establishes criteria for determining 
which positions are error positions to which the rule applies, and the 
procedures for the handling of such positions. In particular, the 
Commission notes that CBOE Rule 6.14C only applies to error positions 
that result from the Exchange's routing service, and that such 
positions shall be liquidated by the routing broker or the Exchange, as 
applicable, as soon as practicable.\21\ In this regard, the Commission 
believes that the new rule appears reasonably designed to further just 
and equitable principles of trade and the protection of investors and 
the public interest, and to help prevent unfair discrimination, in that 
it should help assure the handling of error positions will be based on 
clear and objective criteria, and that the resolution of those 
positions will occur promptly through a transparent process.
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    \21\ See CBOE Rule 6.14C.
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    The Commission is also concerned about the potential for misuse of 
confidential and proprietary information. The Commission notes that 
CBOE or a routing broker, as applicable, will establish and enforce 
policies and procedures reasonably designed to (1) adequately restrict 
the flow of confidential and proprietary information associated with 
the liquidation of the error positions, and (2) in the case of 
liquidations by a routing broker, prevent the use of information 
associated with other orders subject to the routing services when 
making determinations regarding the liquidation of error positions.\22\ 
Furthermore, to the extent the Exchange uses an Exchange Error Account 
to liquidate error positions, the Exchange shall provide complete time 
and price discretion for the trading to liquidate error positions in an 
Exchange Error Account to a third-party broker-dealer and shall not 
attempt to exercise any influence or control over the timing or methods 
of such trading.\23\ The Commission believes that these requirements 
should help mitigate the Commission's concerns. In particular, the 
Commission believes that these requirements should help assure that 
none of CBOE, its routing brokers, or any third-party broker-dealer is 
able to misuse confidential or proprietary information obtained in 
connection with the liquidation of error positions for its own benefit. 
The Commission also notes that routing brokers would be required to 
make and keep records associated with the liquidation of routing broker 
error positions \24\ and CBOE would be required to make and keep 
records to document all determinations to treat positions as error 
positions under this Rule (whether or not an Exchange Error Account is 
used to liquidate such error positions), as well as records associated 
with the liquidation of Exchange Error Account error positions through 
a third-party broker-dealer.\25\
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    \22\ See CBOE Rules 6.14C(d)(i); 6.14C(e)(ii).
    \23\ See CBOE Rule 6.14C(e)(i).
    \24\ See CBOE Rule 6.14C(d)(ii).
    \25\ See CBOE Rule 6.14C(e)(iii).
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    Finally, the Commission notes that the proposed procedures for 
canceling orders and the handling of error positions are consistent 
with procedures the Commission has approved for other exchanges.\26\
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    \26\ See, e.g., Securities Exchange Act Release Nos. 67281 (June 
27, 2012), 77 FR 39543 (July 3, 2012) (SR-NASDAQ-2012-057); 66963 
(May 10, 2012), 77 FR 28919 (May 16, 2012) (SR-NYSEArca-2012-22); 
67010 (May 17, 2012), 77 FR 30564 (May 23, 2012) (SR-EDGX-2012-08); 
and 67011 (May 17, 2012), 77 FR 30562 (May 23, 2012) (SR-EDGA-2012-
09).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CBOE-2012-108) be, and it 
hereby is, approved.
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    \27\ 15 U.S.C. 78s(b)(2).
    \28\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-00308 Filed 1-9-13; 8:45 am]
BILLING CODE 8011-01-P