[Federal Register Volume 78, Number 75 (Thursday, April 18, 2013)]
[Notices]
[Pages 23323-23327]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-09098]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69368; File No. SR-BOX-2013-20]


Self-Regulatory Organizations; BOX Options Exchange LLC; Notice 
of Filing and Immediate Effectiveness of Proposed Rule Change To 
Suspend Certain Provisions in Rule 7170 Regarding Obvious Errors During 
Limit Up-Limit Down States in Securities That Underlie Options Traded 
on the Exchange on a Pilot Basis

April 12, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on April 8, 2013, BOX Options Exchange LLC (the 
``Exchange'') filed with the Securities and Exchange

[[Page 23324]]

Commission (``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule 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 IM-7080-1 (Trading Conditions During 
Limit State or Straddle State) to permit the Exchange to suspend 
certain provisions in BOX Rule 7170 (Obvious and Catastrophic Errors) 
during limit up-limit down states in securities that underlie options 
traded on the Exchange on a pilot basis. The text of the proposed rule 
change is available from the principal office of the Exchange, at the 
Commission's Public Reference Room and also on the Exchange's Internet 
Web site at http://boxexchange.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 self-regulatory organization 
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 self-regulatory organization 
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 proposes to amend IM-7080-1 (Trading Conditions During 
Limit State or Straddle State) to permit the Exchange to suspend 
certain provisions in BOX Rule 7170 (Obvious and Catastrophic Errors) 
during limit up-limit down states in securities that underlie options 
traded on the Exchange on a pilot basis. This is a competitive filing 
that is based on a proposal recently submitted by International 
Securities Exchange, LLC (``ISE'') and approved by the Commission.\3\
---------------------------------------------------------------------------

    \3\ See Securities Exchange Act Release No. 69329 (April 5, 
2013) (SR-ISE-2013-22).
---------------------------------------------------------------------------

Background

    On May 31, 2012, the Commission approved the Plan to Address 
Extraordinary Market Volatility (the ``Plan''),\4\ which establishes 
procedures to address extraordinary volatility in NMS Stocks. The 
procedures provide for market-wide limit up-limit down requirements 
that prevent trades in individual NMS Stocks from occurring outside of 
specified Price Bands. These limit up-limit down requirements are 
coupled with Trading Pauses to accommodate more fundamental price 
moves. The Plan procedures are designed, among other things, to protect 
investors and promote fair and orderly markets.\5\
---------------------------------------------------------------------------

    \4\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77 
FR 33498 (June 6, 2012) (File No. 4-631) (``Plan Approval Order'').
    \5\ Id. at 33511 (Preamble to the Plan).
---------------------------------------------------------------------------

    BOX is not a participant in the Plan because it does not trade NMS 
Stocks. However, BOX trades options contracts overlying NMS Stocks. 
Because options pricing models are highly dependent on the price of the 
underlying security and the ability of options traders to effect 
hedging transactions in the underlying security, the implementation of 
the Plan will impact the trading of options classes traded on the 
Exchange. Specifically, under the Plan, upper and lower price bands 
will be calculated based on a reference price for each NMS Stock.\6\ 
When one side of the market for an individual security is outside the 
applicable price band, the national best bid or national best offer 
will be disseminated with a flag identifying it as non-executable 
(i.e., a ``Straddle State''). When the other side of the market reaches 
the applicable price band, such national best bid or offer will be 
disseminated with a flag identifying it as a Limit State Quotation.\7\ 
If trading for a security does not exit a Limit State within 15 
seconds, a Trading Pause will be declared by the Primary Listing 
Exchange.\8\ The Trading Pause will last at least five minutes\9\ and 
will end when the Primary Listing Exchange disseminates a Reopening 
Price.\10\
---------------------------------------------------------------------------

    \6\ The reference price equals the arithmetic mean price of 
eligible reported transactions for the NMS Stock over the 
immediately preceding five-minute period. See Section I(T) of the 
Plan.
    \7\ See Section I(D) of the Plan. The Limit State will end when 
the entire size of all Limit State Quotations are executed or 
cancelled.
    \8\ See Section VII(A) of the Plan. The Primary Listing Exchange 
is the market on which an NMS Stock is listed. If an NMS Stock is 
listed on more than one market, the Primary Listing Exchange is the 
market on which the security has been listed the longest. See 
Section I(O) of the Plan. A trading pause may also be declared when 
the national best bid (offer) is below (above) the lower (upper) 
price band and the security is not in a Limit State, and trading in 
that security deviates from normal trading characteristics. See 
Section VII(A)(2) of the Plan.
    \9\ A Trading Pause may last longer than 5 minutes if, for 
example, the Primary Market declares a Regulatory Halt, or if there 
is a significant order imbalance. See Section VII(B) of the Plan. If 
the Primary Listing Exchange does not report a Reopening Price 
within ten minutes after the declaration of a trading Pause and has 
not declared a Regulatory Halt, all trading centers may begin 
trading the security. Id.
    \10\ The Reopening Price is the price of a transaction that 
reopens trading on the Primary Listing Exchange following a Trading 
Pause or a Regulatory Halt, or, if the Primary Listing Exchange 
reopens with quotations, the midpoint of those quotations. The 
Exchange notes that under BOX Rule IM-7080-11 (IM-7080-12 as of 4/
7), trading on the Exchange is halted whenever trading in the 
underlying security has been paused by the primary listing market. 
Accordingly, the Exchange need not adopt any rule changes to address 
this aspect of the Plan.
---------------------------------------------------------------------------

Proposal

    When the national best bid (offer) for a security underlying an 
options class is non-executable, the ability for options market 
participants to purchase (sell) shares of the underlying security and 
the price at which they may be able to purchase (sell) shares will 
become uncertain, as there will be a lack of transparency regarding the 
availability of liquidity for the security.\11\ This uncertainty will 
be factored into the options pricing models of market professionals, 
such as options market makers, which will likely result in wider 
spreads and less liquidity at the best bid and offer for the options 
class. Accordingly, during a Limit State, the Exchange will 
automatically reject all incoming orders that do not contain a limit 
price to protect them from being executed at prices that may be vastly 
inferior to the prices available immediately prior to or following a 
Limit State or Straddle State.\12\ Such un-priced orders include Market 
Orders and BOX-Top Orders, which become market orders when the stop 
price is elected. The Exchange will also cancel any resting Market 
Orders and BOX-Top Orders.
---------------------------------------------------------------------------

    \11\ See Letter to Boris Ilyevsky, Managing Director, ISE, from 
Thomas Price, Managing Director, Securities Industry and Financial 
Markets Association, dated October 4, 2012 (``SIFMA Letter'').
    \12\ See Securities Exchange Act Release No. 69186 (March 20, 
2013), 78 FR 18413 (March 26, 2013) (SR-BOX-2013-12).
---------------------------------------------------------------------------

    The Exchange proposes to exclude transactions executed during a 
Limit State or Straddle State from certain provisions in BOX Rule 7170, 
on a one-year pilot basis. This will not include Rule 7170(e) and (f), 
which specify when a trade resulting from an erroneous print or quote 
in the underlying security may be adjusted or busted.
    The remaining provisions in BOX Rule 7170 provide a process by 
which a transaction may be busted or adjusted

[[Page 23325]]

when the execution price of a transaction deviates from the option's 
theoretical price by a certain amount. Under these provisions, the 
theoretical price is the national best bid price for the option with 
respect to a sell order and the national best offer for the option with 
respect to a buy order.\13\ As discussed above, during a Limit State or 
Straddle State, options prices may deviate substantially from those 
available prior to or following the limit state. The Exchange believes 
these provisions would give rise to much uncertainty for market 
participants as there is no bright line definition of what the 
``theoretical value'' should be for an option when the underlying NMS 
stock has an unexecutable bid or offer or both. Determining 
``theoretical value'' in such a situation would be often times very 
subjective as opposed to an objective determination, giving rise to 
additional uncertainty and confusion for investors. Accordingly, the 
Exchange does not believe that the approach employed under Rule 7170, 
which by definition depends upon a reliable national best bid and offer 
in the option, is appropriate during a Limit State or Straddle 
State.\14\
---------------------------------------------------------------------------

    \13\ Rule 7170 provides that if there are no quotes from other 
options exchanges for comparison purposes, the theoretical price 
will be determined by designated personnel in the MRC. However, 
given that options market makers and other industry professionals 
will have difficulty pricing options during Limit States and 
Straddle States, the Exchange does not believe it would be 
reasonable for BOX personnel to derive theoretical prices to be 
applied to transactions executed during such unusual market 
conditions.
    \14\ See SIFMA Letter, supra note 11 (requesting that exchange 
obvious error rules that reference theoretical prices be reviewed to 
ensure that options exchange officials do not have the discretion to 
cancel executions of limit orders and stop limit orders during a 
limit or straddle state).
---------------------------------------------------------------------------

    After careful consideration, the Exchange believes the application 
of the current provisions in Rule 7170 would be impracticable given the 
lack of a reliable national best bid or offer in the options market 
during Limit States and Straddle States, and produce undesirable 
effects. Pursuant to Rule 7170, market participants have five minutes 
(in the case of a Market Maker) and 20 minutes (in the case of a non-
Market Maker Options Participant) to notify the Exchange to review a 
transaction as an obvious error under 7170(g)(1) and Participants have 
until 8:30 a.m. the following day to request that the Exchange review a 
trade as a catastrophic error under Rule 7170(h)(1).\15\ The Exchange 
believes that during periods of extraordinary volatility, the review 
period for transactions under the obvious error and catastrophic error 
provisions would allow market participants to re-evaluate a transaction 
that occurred during a Limit State or Straddle State at a later time, 
which is potentially unfair to other market participants and would 
discourage market participants from providing liquidity during Limit 
States or Straddle States. For example, 20 minutes after a transaction 
that occurs during extraordinary volatility that triggers a Limit State 
or Straddle State the market could look drastically different from a 
price and liquidity level The Exchange believes that market 
participants should not be able to benefit from the time frame to 
review their transactions in these situations. Suspending application 
of certain provisions in Rule 7170 would mitigate two of the 
undesirable aspects described above--(i) the moral hazard associated 
with granting a second look to trades that went against the market 
participant after market conditions have changed and (ii) gaming the 
obvious error rule to retroactively adjust market maker quotes by 
adjusting the execution price at a later time.
---------------------------------------------------------------------------

    \15\ For transactions in expiring options series that take place 
on expiration Friday, a Participant must notify MOC by 5:00 p.m. 
Eastern Time on that same day. See Rule 7170(h)(1).
---------------------------------------------------------------------------

    The Exchange notes that there are additional protections in place 
outside of the Obvious and Catastrophic Error Rule that will continue 
to safeguard customers. First, SEC Rule 15c3-5 requires that, 
``financial risk management controls and supervisory procedures must be 
reasonably designed to prevent the entry of orders that exceed 
appropriate pre-set credit or capital thresholds, or that appear to be 
erroneous.''\16\ Secondly, the Exchange has price checks applicable to 
limit orders that reject limit orders that are priced sufficiently far 
through the NBBO that it seems likely an error occurred. The 
requirements placed upon broker dealers to adopt controls to prevent 
the entry of orders that appear to be erroneous, coupled with Exchange 
functionality that filters out orders that appear to be erroneous, 
serve to sharply reduce the incidence of errors arising from situations 
where, for example, a participant mistakenly enters an order to pay $20 
for an option offered at $2. The Exchange also notes that pursuant to 
BOX Rule 7230(e), the Exchange may compensate Options Participants for 
losses resulting directly from the malfunction of the Exchange's 
systems, and that this protection is independent from the provisions in 
BOX Rule 7170. Accordingly, the Exchange believes it is appropriate to 
eliminate any potential protection applying the obvious error rule 
might provide during Limit and Straddle States, as its application may 
produce inequitable results.
---------------------------------------------------------------------------

    \16\ See Securities and Exchange Act Release No. 63241, 75 FR 
69791 (November 15, 2010) (S7-03-10).
---------------------------------------------------------------------------

    The Exchange notes that Rule 15010 (Order Protection) will continue 
to apply during Limit and Straddle States. Accordingly, only orders 
identified as Intermarket Sweep Orders will trade through protected 
bids and offers during Limit and Straddle States, and as a result, the 
only trades that would potentially have been reviewed under Rule 7170 
during Limit and Straddle States are those involving Intermarket Sweep 
Orders. The Exchange believes that this is an additional factor that 
supports its proposal to suspend certain provisions in Rule 7170 during 
Limit and Straddle States.
    The Exchange proposes to review the operation of this proposal 
during the one-year pilot period from the operative date and analyze 
the impact of the Limit and Straddle States accordingly.\17\ In this 
respect, the Exchange notes that its current obvious error rule does 
not contain a provision that permits the Exchange to review trades on 
its own motion. The Exchange believes that in normal market conditions, 
such a provision is not necessary and undermines the objective nature 
of the rule. However, during the pilot period, the Exchange will 
evaluate whether adopting such a provision for reviewing trades during 
Limit and Straddle states is necessary and appropriate.
---------------------------------------------------------------------------

    \17\ During the pilot, the Exchange will provide the Commission 
with data regarding the how Limit and Straddle States affect the 
quality of the options market.
---------------------------------------------------------------------------

    Additionally, the Exchange represents that it will conduct its own 
analysis concerning the elimination of the obvious error rule during 
Limit and Straddle States and agrees to provide the Commission with 
relevant data to assess the impact of this proposed rule change. As 
part of its analysis, the Exchange will evaluate (1) the options market 
quality during Limit and Straddle States, (2) assess the character of 
incoming order flow and transactions during Limit and Straddle States, 
and (3) review any complaints from members and their customers 
concerning executions during Limit and Straddle States. The Exchange 
also agrees to provide to the Commission data requested to evaluate the 
impact of the elimination of the obvious error rule, including data 
relevant to assessing the various analyses noted above. The Exchange 
notes that these proposed changes are consistent with the views of the 
Securities Industry and

[[Page 23326]]

Financial Markets Association's (``SIFMA'') Listed Options Trading 
Committee.\18\
---------------------------------------------------------------------------

    \18\ Id.
---------------------------------------------------------------------------

    Specifically, the Exchange agrees to provide the following data to 
the Commission to help evaluate the impact of the proposal. At least 
two months prior to the end of the pilot period the Exchange shall 
provide an assessment that evaluates the statistical and economic 
impact of Straddle States on liquidity and market quality in the 
options markets; and assess whether the lack of obvious error rules in 
effect during the Straddle and Limit States is problematic. On a 
monthly basis, the Exchange shall provide both the Commission and 
public a dataset containing the data for each Straddle and Limit State 
in optionable stocks.\19\
---------------------------------------------------------------------------

    \19\ The dataset will include the options for each underlying 
security that reaches a straddle state and meets the following 
conditions: the option is more than 20% in the money (strike price 
remains < 80% of last stock trade price for calls and strike price 
remains > 120% of last stock trade price for puts when the straddle 
or limit state is reached); the option has at least 2 trades during 
the straddle or limit state; and any of the top 10 options (as 
ranked by overall contract volume on that day) that meet the 
conditions above. For each of those options affected the data record 
will contain the stock symbol, option symbol, time at the start of 
the straddle or limit state, an indicator for whether it is a 
straddle or limit state. For activity on the Exchange the data 
record will contain the executed volume, time-weighted quoted bid-
ask spread, time-weighted average quoted depth at the bid, time-
weighted average quoted depth at the offer, high execution price, 
low execution price, number of trades for which a request for review 
for error was received during straddle or limit states, an indicator 
variable for whether those options outlined above have a price 
change exceeding 30% during the underlying stock's straddle or limit 
state compared to the last available option price as reported by 
OPRA before the start of the straddle or limit state (1 if observe 
30% and 0 otherwise), and another indicator variable for whether the 
option price within five minutes of the underlying stock leaving 
straddle or limit state (or halt if applicable) is 30% away from the 
price before the start of the straddle or limit state.
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes that the proposal is consistent with the 
requirements of Section 6(b) of the Securities Exchange Act of 1934 
(the ``Act''),\20\ in general, and Section 6(b)(4) of the Act,\21\ in 
particular, in that it is designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in 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.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78f(b).
    \21\ 15 U.S.C. 78f(b)(4).
---------------------------------------------------------------------------

    The Exchange believes that it is necessary and appropriate in the 
interest of promoting fair and orderly markets to exclude transactions 
executed during a Limit State or Straddle State from the provision of 
BOX Rule 7170. The Exchange believes the application of the current 
rule will be impracticable given the lack of a reliable national best 
bid or offer in the options market during Limit States and Straddle 
States, and that the resulting actions (i.e., busted trades or adjusted 
prices) may not be appropriate given market conditions. This change 
would ensure that limit orders that are filled during a Limit State or 
Straddle State would have certainty of execution in a manner that 
promotes just and equitable principles of trade, removes impediments 
to, and perfects the mechanism of a free and open market and a national 
market system. Moreover, given that options prices during brief Limit 
States or Straddle States may deviate substantially from those 
available shortly following the Limit State or Straddle State, the 
Exchange believes giving market participants five minutes (in the case 
of a Market Maker) and 20 minutes (in the case of a non-Market Maker 
Options Participant) to re-evaluate a transaction would create an 
unreasonable adverse selection opportunity that would discourage 
participants from providing liquidity during Limit States or Straddle 
States. In this respect, the Exchange notes that by rejecting market 
orders and cancelling pending market orders, only those orders with a 
limit price will be executed during a Limit State or Straddle State. 
Therefore, on balance, the Exchange believes that removing the 
potential inequity of busting or adjusting executions occurring during 
Limit States or Straddle States outweighs any potential benefits from 
applying Rule 7170 during such unusual market conditions. Additionally, 
as discussed above, there are additional pre-trade protections in place 
outside of the Obvious and Catastrophic Error Rule that will continue 
to safeguard customers.

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. In this regard and as indicated 
above, the Exchange notes that the rule change is being proposed as a 
competitive response to a filing submitted by ISE that was recently 
approved by the Commission.\22\ The Exchange does not believe that the 
proposal will have any impact on competition among exchanges or market 
participants on the Exchange, as the proposal provides that 
transactions executed during such states will not be reviewed pursuant 
to provisions in Rule 7170.
---------------------------------------------------------------------------

    \22\ See supra note 3.
---------------------------------------------------------------------------

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

    Because the foregoing proposed rule change does not significantly 
affect the protection of investors or the public interest, does not 
impose any significant burden on competition, and, by its terms, does 
not become operative for 30 days from the date on which it was filed, 
or such shorter time as the Commission may designate, it has become 
effective pursuant to Section 19(b)(3)(A) of the Act \23\ and Rule 19b-
4(f)(6) thereunder.\24\
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78s(b)(3)(A).
    \24\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii) 
requires the Exchange to give the Commission written notice of the 
Exchange's intent to file the proposed rule change, along with a 
brief description and text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission. The 
Exchange has satisfied this requirement.
---------------------------------------------------------------------------

    The Exchange has requested that the Commission waive the 30-day 
operative delay. The Commission believes that waiver of the operative 
delay is consistent with the protection of investors and the public 
interest because the proposal is substantially similar to those of 
other exchanges that have been approved by the Commission to exclude 
transactions executed during a Limit State or Straddle State from 
certain provisions of the obvious error rules.\25\ Further, the 
Commission notes that the Plan, to which these rules relate, was 
implemented on April 8, 2013. Therefore, the Commission designates the 
proposal operative upon filing.\26\
---------------------------------------------------------------------------

    \25\ See, e.g., supra note 3.
    \26\ For purposes only of waiving the 30-day operative delay, 
the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
---------------------------------------------------------------------------

    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if

[[Page 23327]]

it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.

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 email to [email protected]. Please 
include File Number SR-BOX-2013-20 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
All submissions should refer to File Number SR-BOX-2013-20. This file 
number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the 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-BOX-2013-20 and should be 
submitted on or before May 9, 2013.
---------------------------------------------------------------------------

    \27\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\27\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-09098 Filed 4-17-13; 8:45 am]
BILLING CODE 8011-01-P