[Federal Register Volume 79, Number 21 (Friday, January 31, 2014)]
[Notices]
[Pages 5491-5495]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-01965]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71405; File No. SR-Topaz-2014-05]


Self-Regulatory Organizations; Topaz Exchange, LLC; Notice of 
Filing and Immediate Effectiveness of Proposed Rule Change Regarding 
System Protections

January 27, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that, on January 17, 2014, the Topaz Exchange, LLC (d/b/a ISE Gemini) 
(the ``Exchange'' or ``Topaz'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which items

[[Page 5492]]

have been prepared by the Exchange. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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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 proposes to specify in its rules certain system 
protections contained in the trading system.
    The text of the proposed rule change is available on the Exchange's 
Internet Web site at http://www.ise.com, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

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 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 purpose of the proposal is to specify in the Exchange's rules 
certain existing trading system protections that prevent the entry and/
or execution of orders in certain circumstances. These protections are 
in addition to the system protection currently described in Rule 714 
that prevents orders from being automatically executed at prices that 
are inferior to a protected bid or offer on another exchange (``trade 
through protection'') pursuant to the requirements of the Intermarket 
Linkage Plan (the ``Plan'') and rules adopted by the Exchange to 
implement the Plan (the ``Linkage Rules'').\3\
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    \3\ Linkage Rules of the International Securities Exchange, LLC 
(``ISE'') are incorporated by reference into the Topaz rulebook. The 
ISE Linkage Rules are provided in Chapter 19 of the ISE rulebook.
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    Specifically, Topaz Rule 714 provides that incoming orders will not 
be automatically executed at prices that are inferior to the national 
best bid or offer (``NBBO''). Thus, the language currently contained in 
Rule 714 reflects how the trading system assures compliance with the 
prohibition on trading through the NBBO contained in Topaz Rule 1901. 
Rule 714 also indicates that the prohibition on trade-throughs does not 
apply with respect to non-firm quotations as provided in Topaz Rule 
1900(k). The Exchange proposes to make several non-substantive changes 
to the text and format of Topaz Rule 714 with respect to these linkage-
related provisions for clarity,\4\ and to add a reference to 
intermarket sweep orders (``ISOs''). Pursuant to Topaz Rule 1901, ISOs 
are eligible to be executed at a price that is inferior to the NBBO. 
For clarity, the Exchange believes it is appropriate to specify in Rule 
714 that the system does not prevent the automatic execution of an ISO 
at a price that is inferior to the NBBO.
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    \4\ The current text of Rule 714 references non-firm quotations 
on the Exchange. This language preceded the adoption of the Linkage 
Rules and is no longer applicable. Accordingly, the Exchange 
proposes to delete this language.
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    The Exchange also is proposing to amend Rule 714 to add additional 
circumstances in which the trading system does not provide automatic 
executions as follows:
     Price Level Protection. There is a limit on the number of 
price levels at which an incoming order to sell (buy) will be executed 
automatically when there are no bids (offers) from other exchanges at 
any price for the options series. In such a circumstance, incoming 
orders are automatically executed at each successive price level until 
the maximum number of price levels is reached,\5\ and any balance is 
either handled by the primary market maker (``PMM'') (in the case of 
Priority Customer Orders) \6\ or canceled (in the case of Professional 
Orders).\7\ The number of price levels, which may be between 1 and 10, 
is determined by the Exchange from time-to-time on a class-by-class 
basis. Currently, this limit is set to three price levels.\8\
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    \5\ For example, assume the parameter is set to three tick 
levels, the best bid on Topaz in an options series that is traded in 
penny increments is $1.50, and there are no bids in the series from 
any other exchanges. If a Priority Customer market order to sell is 
received, the system will not automatically execute the incoming 
order at a price below $1.48. Therefore, such an order will execute 
the full size available at $1.50, $1.49 and $1.48, and any 
unexecuted balance will be handled by the PMM. In this respect, the 
PMM has the obligation under existing Exchange rules to engage in 
dealings for his own account when, among other things, there is a 
temporary disparity between the supply of and demand for a 
particular options contract, and to act with due diligence in 
handling orders. See infra, notes 13 and 14 and accompanying text.
    \6\ Pursuant to Topaz Rule 100(a)(37A) and (37B), a Priority 
Customer Order is an order for the account of a person or entity 
that (i) is not a broker or dealer in securities, and (ii) does not 
place more than 390 orders in listed options per day on average 
during a calendar month for its own beneficial account(s).
    \7\ Pursuant to Topaz Rule 100(a)(37C), a Professional Order is 
an order that is for the account of a person or entity that is not a 
Priority Customer.
    \8\ The Exchange will provide at least a two week notice to 
members via an exchange circular prior to changing the price level 
limit to allow members the opportunity to perform any system 
changes. Any change to the price level limit would be subject to 
consultations with members.
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     Limit Order Price Protection. There is a limit on the 
amount by which incoming limit orders to buy may be priced above the 
Exchange's best offer and by which incoming limit orders to sell may be 
priced below the Exchange's best bid. Limit orders that exceed the 
pricing limit are rejected upon entry. The limit is established by the 
Exchange from time-to-time, on a class-by-class basis, as the greater 
of: (i) an absolute amount not to exceed $2.00, or (ii) a percentage of 
the Exchange's best bid/offer not to exceed 10 percent.\9\ The Exchange 
currently has these limits set to $1.00 and 1 percent respectively.\10\
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    \9\ For example, if the Topaz best bid is $3.00 and the limits 
are set to the greater of $1.00 or 1% (which equals $0.03 in this 
example), a limit order to sell that is entered with a limit price 
below $2.00 will be rejected.
    \10\ The Exchange will provide at least a two week notice to 
members via an exchange circular prior to changing the limit order 
price check to allow members the opportunity to perform any system 
changes. Any change to the limit order price check would be subject 
to consultations with members.
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     Size Limitation. There is a limit on the number of 
contracts an incoming order may specify. Orders or quotes that exceed 
the maximum number of contracts are rejected upon entry.\11\ The 
maximum number of contracts, which shall not be less than 10,000, is 
established by the Exchange from time-to-time on a class-by-class 
basis. Currently, this limit is set to 999,999 contracts.\12\
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    \11\ For example, if the limit is set to 800,000 contracts, an 
order with a size of 800,001 or greater would be rejected by the 
system.
    \12\ The Exchange will provide at least a two week notice to 
members via an exchange circular prior to changing the size limit to 
allow members the opportunity to perform any system changes. Any 
change to the size limit would be subject to consultations with 
members.
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    The Exchange further proposes that, in the event of unusual market 
conditions and in the interest of a fair and orderly market, the 
Exchange may temporarily establish the levels at which the order 
protections are triggered as necessary and appropriate.
    When the PMM handles Priority Customer orders that are not 
automatically executed or canceled pursuant to the price level 
protection described above, they must do so pursuant to their 
obligations under Topaz Rule 803 and consistent with Rule 400 (Just and 
Equitable Principles

[[Page 5493]]

of Trade). Rule 803 states, among other things, that market makers have 
a continuous obligation to engage, to a reasonable degree under the 
existing circumstances, in dealings for his own account when there 
exists, or it is reasonably anticipated that there will exist, a lack 
of price continuity, a temporary disparity between the supply of and 
demand for a particular options contract, or a temporary distortion of 
the price relationships between options contracts of the same 
class.\13\ The Rule also specifies that a PMM must act with due 
diligence in handling orders and must accord priority to such orders 
over the PMM's principal orders.\14\ In addition to these existing 
provisions, the Exchange proposes to specify in Rule 803(c) that PMMs 
are required to address orders they handle as soon as practical by 
either (i) executing all or a portion of the orders at a price that at 
least matches the NBBO and that improves upon the Exchange's best bid 
(in the case of a sell order) or the Exchange's best offer (in the case 
of a buy order); \15\ or (ii) releasing all or a portion of the order 
for execution against bids and offers on the Exchange.
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    \13\ Rule 803(b).
    \14\ Rule 803, Supplementary Material .01. The Exchange 
currently conducts surveillance of PMMs to assure that orders are 
handled timely, that such orders are executed at appropriate prices, 
and that such orders are afforded priority over the PMM's principal 
orders. This surveillance includes all orders handled by the PMM 
regardless of whether they are handling them via operation of the 
NBBO trade through protection and price level protection.
    \15\ A PMM cannot provide an execution at the same price as the 
Exchange's best bid or offer (as applicable) because that would 
allow the PMM to by-pass the execution priority rules contained in 
Rule 713. The Exchange conducts surveillance to detect instances 
when the PMM executes an order it is handling at the same price as 
the Topaz best bid or offer (as applicable). It is not a violation 
for the PMM to execute an order at the same price as the Topaz best 
bid or offer when the PMM is the only market participant at that 
price.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Securities Exchange Act of 1934 (the ``Act'') \16\ in 
general, and furthers the objectives of Section 6(b)(5) of the Act \17\ 
in particular, in that it is designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
for a free and open market and a national market system, and, in 
general, to protect investors and the public interest. The system 
protections described above were implemented in the interest of 
protecting investors and to assure fair and orderly markets on the 
Exchange.
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    \16\ 15 U.S.C. 78f(b).
    \17\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Exchange operates an electronic marketplace in 
which orders are processed and executed in less than one second. 
Without any safeguards, orders that outsize the liquidity available at 
the displayed best bid or offer on the Exchange could potentially trade 
at prices far below the best bid and far above the best offer, creating 
extreme volatility in the marketplace and poor executions for 
investors. The primary safeguard in the national market system that 
protects against such occurrences is the prohibition against trading 
through protected bids and offers on other options exchanges, as this 
links the liquidity available across markets and in most circumstances, 
provides a stop-gap on each individual exchange. However, not all 
products are multiply traded, and even in multiply-traded options 
series, it is possible that Topaz could be the only exchange 
disseminating a protected bid and/or offer in a particular options 
series at any given sub-second during the trading day.
    Accordingly, the Exchange designed its system to provide the price 
level protection described above when there are no other protected bids 
and offers in the national market system. The Exchange believes that 
limiting the number of price levels at which an incoming order will 
execute in these circumstances appropriately balances the interests of 
investors seeking execution of their orders and the Exchange's 
obligations to provide a fair and orderly market. While Professional 
Orders are canceled in these circumstances, the Exchange seeks to 
provide a higher level of service for Priority Customer orders by 
having them handled by the PMM, which has an affirmative obligation to 
provide liquidity and price continuity. This procedure also provides an 
opportunity for liquidity to refresh in the market, further providing 
better execution potential for Priority Customer orders. The Exchange 
believes that providing this service for Priority Customer orders is 
appropriate and consistent with feedback from members that enter 
Priority Customer orders on the Exchange, who prefer that Priority 
Customer orders not be canceled in this circumstance.
    Similarly, the Exchange's experience and member feedback indicates 
that the current limit of three price levels has worked well to balance 
the interests of investors receiving execution of their orders while 
protecting them from being executed at unreasonable prices. 
Nevertheless, the Exchange believes it is appropriate to maintain some 
flexibility to adjust the number of price level so that it can 
continually evaluate market conditions and investor needs. In this 
respect, under the proposal, the Exchange has the flexibility to adjust 
the number of price levels up to ten. The Exchange believes this limit 
is sufficient to give it the ability to make appropriate adjustments as 
necessary and appropriate to maintain fair and orderly markets.
    The Exchange also represents that the proposal merely clarifies the 
existing PMM obligations by specifying that the PMM must address orders 
it handles by either providing an execution or releasing orders for 
execution against bids and offers on the Exchange. The proposal further 
specifies that the price at which a PMM may execute an order must be at 
least equal to the NBBO and improve upon the best bid (offer) on the 
Exchange.\18\ While this was not previously stated explicitly in the 
Rules for this specific circumstance, the Exchange has always applied 
the obligations contained in Topaz Rule 803(b) and Supplementary 
Material .01 thereto, as well as Rule 400 and Rule 713, consistent with 
the additional proposed language and has enforced compliance 
accordingly.\19\ Moreover, the Exchange believes the specified order 
handling provisions are appropriate to assure compliance with all 
applicable Exchange Rules with respect to the handling of orders by the 
PMM.\20\
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    \18\ See supra, note 15.
    \19\ See supra, notes 14 and 15.
    \20\ Id.
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    The limit order price protection and size limitation for regular 
orders were designed to reject orders upon entry that were likely 
submitted in error. Limit orders that are entered with prices that 
cross the market by a large amount are likely to have been entered in 
the wrong options series, on the wrong side of the market, or with an 
erroneous price (e.g., a bid of $15 rather than $1.50). Similarly, 
orders entered with an unreasonably large size (e.g., 1 million 
contracts or more) are likely to have been entered in error. The 
Exchange believes that it is in the interest of fair and orderly 
markets and the protection of investors to reject these orders upon 
entry, and thereby prevent erroneous transactions from occurring.
    The Exchange further believes that the Exchange's experience and 
member feedback indicates that the current limits of $1.00 and 1 
percent for the limit order price protection, and 999,999 contracts for 
the size limitation, has worked well to provide the protection of 
rejecting orders that have been entered in error while assuring that 
valid orders are not rejected. In this

[[Page 5494]]

respect, the Exchange notes that orders below the established limits 
may well have been entered in error, but that it is highly unlikely 
that orders entered above the current limits were not entered in error. 
The Exchange believes it is appropriate to maintain some flexibility to 
adjust the limits so that it can continually evaluate the extent to 
which such limits could be reduced to prevent the entry of additional 
erroneous orders without rejecting legitimate orders. In this respect, 
under the proposal, the Exchange has specified that the limit order 
price protection limits shall not exceed $2.00 and 10 percent 
respectively. The Exchange believes that these limits provide 
sufficient flexibility for the Exchange to make appropriate adjustments 
in the interest of maintaining fair and orderly markets. The Exchange 
also notes that it has specified that the order size limitation shall 
not be less than 10,000 contracts. The Exchange notes in this respect 
that a block-size options order is defined as an order of at least 50 
contracts,\21\ and that an order of 500 contracts is considered a very 
large institutional-size order (a block-size order in the equities 
market is an order of at least 10,000 shares).\22\ Accordingly, the 
Exchange believes that it would not be unreasonable to set a size limit 
as low as 10,000 contracts should the Exchange determine that it was 
necessary to maintain fair and orderly markets and to protect investors 
from executing orders entered with an erroneously large size.
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    \21\ Rule 716(a).
    \22\ See, e.g., Rule 716(e) (providing that the minimum size of 
an order entered into the Solicited Order Mechanism is 500 
contracts); and Rule 715(j) (providing that a qualified Contingent 
Cross Order must be for at least 1,000 contracts).
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    Finally, the Exchange notes that it will give members at least a 
two week notice prior to changing the level at which the system 
protections are triggered to allow members to perform any system 
changes, and that the Exchange provides these protections for the 
benefit of, and in consultation with, its members. Notwithstanding, the 
Exchange also recognizes that the applicable protections may not be 
appropriate in unusual market conditions. In this respect, the Exchange 
has included in the proposal a provision providing that, in the event 
of unusual market conditions and in the interest of a fair and orderly 
market, the Exchange may temporarily establish the levels at which the 
system protections are triggered that are beyond those specified in the 
rule. The Exchange believes this is consistent with its obligation to 
assure a fair and orderly market, and that the need for such 
flexibility is recognized in other Exchange rules, such as those 
related to position limits, quote-width differentials and market maker 
risk parameters.\23\ In the event that the Exchange temporarily revises 
the levels at which the protections are triggered, it will immediately 
notify all members.
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    \23\ See Rule 412 (regarding position limits), Rule 803 
(regarding maximum quotation spreads) and Rule 804 (regarding market 
maker risk parameters).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change specifies circumstances in which the 
trading system does not provide an automatic execution in the interest 
of protecting investors against the execution of erroneous orders or 
the execution of orders at erroneous prices. As such, the proposal does 
not impose any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange has not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any unsolicited written comments from members or other interested 
parties.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The Exchange believes that the foregoing proposed rule change may 
take effect upon filing with the Commission pursuant to 
Section19(b)(3)(A) \24\ of the Act and Rule 19b-4(f)(6) thereunder \25\ 
because the foregoing proposed rule change does not (i) significantly 
affect the protection of investors or the public interest, (ii) impose 
any significant burden on competition, and (iii) become operative for 
30 days after its filing date, or such shorter time as the Commission 
may designate.
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    \24\ 15 U.S.C. 78s(b)(3)(A).
    \25\ 17 CFR 240.19b-4(f)(6).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is: (i) 
necessary or appropriate in the public interest; (ii) for the 
protection of investors; or (iii) otherwise in furtherance of the 
purposes of the Act. If the Commission takes such action, the 
Commission shall institute proceedings to determine whether the 
proposed rule should be approved or 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 email to [email protected]. Please include 
File Number SR-Topaz-2014-05 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-Topaz-2014-05. 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-Topaz-2014-05 and should be 
submitted on or before February 21, 2014.


[[Page 5495]]


    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-01965 Filed 1-30-14; 8:45 am]
BILLING CODE 8011-01-P