4880 Federal Register / Vol. 66, No. 12 / Thursday, January 18, 2001 / Notices

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3The ISE corrected a typographical error that

appeared in the proposed rule language. Telephone

conversation between Katherine Simmons, Vice

President and Associate General Counsel, ISE, and

Susie Cho, Attorney, Division of Market Regulation,

Commission, January 10,2 001.

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43830; File No. SR–ISE–

00–19]

Self Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

the International Securities Exchange

LLC Adopting an Obvious Error Rule

January 10, 2001.

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

20, 2000, 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 prepared by the Exchange.

The Commission is publishing this

notice to solicit comments on the

proposed rule change from interested

persons.

I. Self-Regulatory Organizations

Statement of the Terms of Substance of

the Proposed Rule Change

The Exchange is proposing to adopt

new ISE Rule 720, which gives the

Exchange the authority to bust or adjust

trades that result from clearly erroneous

orders or quotations. Proposed new

language is italicized.

* * * * *

Rule 720. Obvious Errors

The Exchange shall either bust a

transaction or adjust the execution price

of a transaction that results from an

Obvious Error as provided in this Rule.

(a) Definition of obvious Error. For

purposes of this Rule only, Obvious

Error will be deemed to have occurred

when:

(1) during regular market conditions

(including rotations), the execution

price of a transaction is higher or lower

than the Theoretical Price for the series

by an amount equal to at least two (2)

times the maximum bid/ask spread

allowed for the option, so long as such

amount is 50 cents or more; or

(2) during fast market conditions (i.e.,

the Exchange has declared a fast market

status for the option in question), the

execution price of a transaction is

higher or lower than the Theoretical

Price for the series by an amount equal

to at least three (3) times the maximum

bid/ask spread allowed for the option,

so long as such amount is 50 cents or

more.

(b) Definition of Theoretical Price. For

purposes of this Rule only, the

Theoretical Price of an option is:

(1) if the series is traded on at least

one other options exchange, the last bid

or offer, just prior to the trade, found on

the exchange that has the most liquidity

in that option as provided in

Supplementary Material .02 below; or 

(2) if there are no quotes for

comparison purposes,as determined by

the Obvious Error Panel.

(c) Adjustments. Where the execution

price of a transaction executed as the

result of an Obvious Error is adjusted,

the adjusted price will be:

(1) the Theoretical Price of the option

in the case where the erroneous price is

displayed in the market and

subsequently executed by quotes or

orders that did not exist in the System

at the time of the erroneous price was

entered; or

(2) the last bid or offer, just prior to

the trade, found on the exchange that

has the most liquidity in that option as

provided in Supplementary Material .03

below in the case where an erroneous

price executes against quotes or orders

already existing in the System at the

time the erroneous price was entered.

(d) Obvious Error Procedure.

Designated personnel in the Exchange’s

market control center (‘‘Market

Control’’) shall administer the

application of this Rule as follows.

(1) Notification. If a market maker on

the Exchange believes that it

participated in a transaction that was

the result of an Obvious Error, it must

notify Market Control within five (5)

minutes of the execution. If an

Electronic Access Member believes an

order it executed on the Exchange was

the result of an Obvious Error, it must

notify Market Control within twenty (20)

minutes of the execution. Except as

provided below, no relief under this

Rule will be provided unless notification

is made within the prescribed time

periods.

(2) Adjust or Bust. Market Control will

determine whether there was an

Obvious Error as defined above. If it is

determined that an Obvious Error has

occurred, Market Control shall take one

of the following actions: (i) where each

party to the transaction is a market

maker on the Exchange, the execution

price of the transaction will be adjusted

unless both parties agree to bust the

trade within ten (10 minutes of being

notified by Market Control of the

Obvious Error, or 3 (ii) where at least one

party to the Obvious Error is not a

market maker on the Exchange, the

trade will be busted unless both parties

agree to adjust the price of the

transaction within thirty (30) minutes of

being notified by Market Control of the

Obvious Error.

(e) Obvious Error Panel.

(1) Composition. An Obvious Error

Panel will be comprised of

representatives from three (3) Members

that are market makers on the

Exchange, at least one (1) of which shall

be a representative from a Member that

is a Competitive Market Maker and not

also a Primary market Maker.

(2) Request for Review. If a party

affected by a determination made under

this Rule so requests, the Obvious Error

Panel will review decisions made by

market Control under this Rule,

including whether an Obvious Error

occurred, whether the correct

Theoretical Price was used, and whether

an adjustment was made at the correct

price. A party may also request that the

Obvious Error Panel provide relief under

this Rule in cases where the party failed

to provide the notification required in

paragraph (d)(1), but unusual

circumstances must merit special

consideration. The Obvious Error Panel

shall review the facts and render a

decision on the day of the transaction.

All determinations by the Obvious Error

Panel shall be final.

Supplementary Material to Rule 720

.01 For purposes of paragraph (a) of

this Rule, the maximum bid/ask spread

shall be the maximum bid/ask spread

allowed under Rule 803(b), unless a

wider spread has been allowed by the

Exchange for the option because of

unusual market conditions, such as

high market volatility.

.02 The Theoretical Price will be

determined under paragraph (b)(1)

above as follows: (i) the bid price from

the exchange providing the most volume

will be used with respect to an

erroneous bid price entered on the

Exchange, and (ii) the offer price from

the exchange providing the most volume

will be used with respect to an

erroneous offer price entered on the

Exchange.

.03 The price to which a transaction

is adjusted under paragraph (c)(2) above

will be as follows: (i) the bid price from

the exchange providing the most volume

for the option will be used with respect

to an erroneous offer price entered on

the Exchange, and (ii) the offer price

from the exchange providing the most

volume for the option will be used with

Federal Register / Vol. 66, No. 12 / Thursday, January 18, 2001 / Notices 4881

4While current ISE Rule 804(d)(2) gives the

Exchange some flexibility with respect to customer

orders when a market maker’s quote is obviously an

error, it only states that an obviously erroneous

quote may not be ‘‘firm’’ for customer orders. ISE

Rule 804 does not expressly give the Exchange

authority to bust an executed transaction, nor does

it contain any guidelines for determining when a

quotation is obviously erroneous.

5The theoretical price of an option in the case of

an erroneous bid (offer) is the last bid (offer), just

prior to the trade, found on the exchange that has

the most liquidity in that option other than the ISE.

If there are no quotes for comparison purposes, the

theoretical price will be determined by an obvious

error panel.

6The reason for requiring a greater deviation from

the theoretical price during fast market conditions

is that when the price of an underlying is moving

rapidly, it is not as ‘‘obvious’’ that an option price

might be in error.

7A party to a transaction will be considered an

Exchange market maker under proposed ISE Rule

720 if the resulting position is booked in an ISE

market maker account. For example, under ISE Rule

803, a Competitive Market Maker (‘‘CMM’’) on the

ISE may execute up to 25 percent of its total volume

in securities to which it is not appointed. An

obvious error involving two CMMs will be adjusted

under proposed ISE Rule 720 unless both agree to

bust the trade.

respect to an erroneous bid price

entered on the Exchange. If there are no

quotes for comparison purposes, the

adjustment price will be determined by

the Obvious Error Panel.

.04 When Market Control determines

that an Obvious Error has occurred and

action is warranted under paragraph

(d)(2) above, the identity of the parties

to the trade will be disclosed to each

other in order to encourage conflict

resolution.

.05 Each market maker firm shall

designate at least one person that is

knowledgeable about options market

making on the ISE to be called upon by

the Exchange to participate on an

Obvious Error Panel. In no case shall an

Obvious Error Panel include a person

related to a party to the Obvious Error

in question. To the extent reasonably

possible, the Exchange shall call upon

representatives of each market maker to

participate on an Obvious Error Panel

on an equally frequent basis.

* * * * *

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 proposes to adopt new

ISE Rule 720 that would allow it to

either adjust or bust a transaction in

circumstances where a member or its

customer has made an error and the

price of the execution is ‘‘obviously’’

not correct.4 In such situations, the

Exchange does not believe it is

consistent with just and equitable

principles of trade to permit one market

participant to receive a wind-fall at the

expense of another market participant

that made an obvious error. Conversely,

the Exchange does not seek to permit

market participants to reconsider poor

trading decisions. The ISE believes that

the proposed rule contains objective

standards regarding when a transaction

was clearly the result of an ‘‘obvious

error,’’ under what circumstances a

trade will be adjusted or busted, and to

what price a trade will be adjusted if

adjustment is appropriate under the

circumstances.

Under proposed ISE Rule 720, when

a member believes that it has

participated in a transaction that was

the result of an obvious error, it must

notify ISE Market Control within a

specified time of the execution. The

proposed rule requires Exchange market

makers, who are continuously

monitoring their transactions on the ISE,

to notify ISE Market Control within five

minutes of an execution. The proposed

rule allows Electronic Access Members,

which may handle customer orders on

multiple exchanges simultaneously and

which may need to contact customers

for instruction, up to twenty minutes to

notify ISE Market Control.

ISE Market Control will determine

whether there was an obvious error

according to the following objective

criteria: (1) An obvious error will be

deemed to have occurred during normal

market conditions when the execution

price of a transaction is higher or lower

than the theoretical price 5 for the series

by an amount equal to at least two times

the maximum bid/ask spread allowed

for the option, so long as such amount

is 50 cents or more; and (2) an obvious

error will be deemed to have occurred

during fast market conditions when the

execution price of a transaction is

higher or lower than the theoretical

price for the series by an amount equal

to at least three times the maximum bid/

ask spread allowed for the option, so

long as such amount is 50 cents or

more.6 ISE Market Control is not given

any discretion under proposed ISE Rule

720 to take actions with respect to

transactions that do not come within the

objective obvious error criteria. In

situations where the theoretical price is

not objectively determinable, a panel of

member representatives will be

convened to determine the theoretical

price.

If it is determined that a transaction

is the result of an obvious error, ISE

Market Control will take one of the

following actions: (1) Where each party

to the transaction is an Exchange market

maker,7 the execution price of the

transaction will be adjusted unless both

parties agree to bust the trade; or (2)

where at least one party to the obvious

error is not a market maker on the

Exchange, the trade will be busted

unless both parties agree to adjust the

price of the transaction. In the first

instance, Exchange market makers, who

commonly hedge transactions

immediately, have indicated a

preference for adjusting the price of a

transaction rather than changing their

positions. Thus, the default action will

be to adjust the price of the execution

according to the objective criteria

discussed below. In the second instance,

where customer limit orders may be

involved, the Exchange does not believe

it appropriate to adjust the price of a

transaction without the consent of the

market participants. Accordingly, the

default will be to bust the trade unless

both sides agree to adjust the price. The

default action will be taken unless

agreement is reached within ten

minutes in the case where both parties

are Exchange market makers, and within

thirty minutes where at least one party

is not an Exchange market maker.

Where an adjustment is made to a

transaction price, the adjusted price will

be determined by objective criteria. The

adjusted price will be equal to the

theoretical price of the option in the

case where the erroneous price is

displayed in the market and

subsequently executed by quotes or

orders that did not exist in the system

at the time the price was entered. For

example, if an option had a bid of $5

and offer of $5.20 on the options

exchange with the most volume in that

option and due to an erroneous

quotation, the ISE displayed a bid of $7

that was executed against by an

incoming sell order or market maker

offer, the adjustment price would be $5,

which is the fair price at which a market

participant could have sold the option

at the time of the transaction. The ISE

would presume that, in this situation,

the seller knew that the price was

4882 Federal Register / Vol. 66, No. 12 / Thursday, January 18, 2001 / Notices

8 In no case shall an obvious error panel include

a person related to a party to the obvious error in

question. To the extent reasonably possible, the

Exchange shall call upon representatives of each

market maker to participate on an obvious error

panel on an equally frequent basis.

9 15 U.S.C. 78f(b). 10 15 U.S.C. 78f(b)(5).

1 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3 15 U.S.C. 78s(b)(3)(A)(ii).

obviously erroneous as compared to the

price being displayed by the primary

options exchange for the option.

Where a participant enters a quotation

or order in error that executes against

standing interest on the Exchange, the

contra side to the transaction had no

notice of an erroneous price and took no

action to execute at the erroneous price.

In this instance, the adjustment price

will be the bid (offer) price from the

exchange providing the most volume in

the case of an erroneous offer (bid) price

entered on the Exchange. The ISE

believes that this will result in a more

favorable adjustment price for the

participant with standing interest in the

book than the participant that made the

error. As a result, in the previous

example, if the erroneous bid of $7

executed against an offer in the system

at $6.50, the adjustment price would be

$5.20 (the offer price) instead of 5 (the

bid price). Again, the only time an

adjustment will be made to the price of

a transaction is in the case where both

parties were ISE market makers or

where both parties agree to the

adjustment.

Finally, proposed ISE Rule 720

specifies that each market maker firm

will designate at least one person that is

knowledgeable about options market

making on the ISE to be called upon by

the Exchange to participate on an

obvious error panel.8 Proposed ISE Rule

720 provides that an obvious error panel

will have the authority to: (1) Determine

a theoretical price when there is no

quote for an option on another options

exchanges; and (2) upon request by a

party to a potential obvious error,

review whether the correct theoretical

price was used and whether an

adjustment was made at the correct

price. A party to a potential obvious

error may also request that the obvious

error panel provide relief under the

proposed rule in cases where the party

failed to give notice within the required

time periods, but there must be unusual

circumstances to merit this special

consideration. All determinations by an

obvious error panel will be made on the

same day as the transaction in question

and shall be final.

2. Statutory Basis

The Exchange believes that the

proposed rule change is consistent with

Section 6(b) of the Act 9 in general, and

furthers the objectives of Section

6(b)(5) 10 in particular, in that it is

designed to prevent fraudulent and

manipulative acts and practices, to

promote just and equitable principles of

trade, to remove impediments to and

perfect the mechanism for a free an

open market and a national market

system, and, in general, to protect

investors and the public interest.

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

The Exchange did not solicit or

receive written comments on the

proposed rule change.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the Exchange consents,

the commission will:

(A) By order approve such proposed

rule change, or

(B) Institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing,

including whether the proposed rule

change is consistent with the Act.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, NW.,

Washington, DC 20549–0609. Copies of

the submission, all subsequent

amendments, all written statements

with respect to the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying at

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the Exchange. All

submissions should refer to File No.

SR–ISE–00–19 and should be submitted

by February 8, 2001.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.1

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–1409 Filed 1–17–01; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43831; File No. JR–NASA–

00–72]

Self-Regulatory Organizations; Notice

of Filing and Immediate Effectiveness

of Proposed Rule Change by the

National Association of Securities

Dealers, Inc. Relating to Nasdaq’s

Transaction Credit Pilot Program

January 10, 2001.

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 December

13, 2000, the National Association of

Securities Dealers, Inc. (‘‘NASD’’ or

‘‘Association’’), through its wholly

owned subsidiary The Nasdaq Stock

Market, Inc. (‘‘NASD’’), filed with the

Securities and Exchange Commission

(‘‘SEC’’ or ‘‘Commission’’) the proposed

rule change as described in Items I, II,

and III below, which Items have been

prepared by Nasdaq. Nasdaq has

designated this proposal as one

establishing or changing a due, fee, or

other charge imposed by the Association

under Section 19(b)(3)(A)(ii) of the Act,3

which renders the proposal effective

upon filing with the Commission. The

Commission is publishing this notice to

solicit comments on the proposed rule

change from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

Nasdaq proposes to amend NASD

Rule 7010, System Services, to extend

Nasdaq’s transaction credit pilot

program for an additional three months

for Tape A and B reports. The text of the

proposed rule change is below.

Proposed new language is in italics.

Proposed deletions are in brackets.