Document ID: SEC-2013-0234-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: C2 Options Exchange, Inc.
Posted Date: 2013-02-06T05:00Z

[Federal Register Volume 78, Number 25 (Wednesday, February 6, 2013)]
[Notices]
[Pages 8621-8628]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-02630]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68792; File No. SR-C2-2013-004]

Self-Regulatory Organizations; C2 Options Exchange, Incorporated; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
To Amend the Fees Schedule

January 31, 2013.
    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 24, 2013, C2 Options Exchange, Incorporated (the 
``Exchange'' or ``C2'') filed with the Securities and Exchange 
Commission (the ``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.
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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 amend the Fees Schedule. The text of the 
proposed rule change is available on the Exchange's Web site (http://www.c2exchange.com/Legal/), at the Exchange's Office of the Secretary, 
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 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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to amend its transaction fees for simple, 
non-complex orders in equity options classes (all of which may be 
listed on other exchanges as well as C2). Going forward, fees will be 
calculated based on the following formula (fees are calculated on a 
per-contract basis): Fee = (C2 BBO Market Width at time of execution) x 
(Market Participant Rate) x 50. The C2 BBO Market Width is the 
difference between the quoted best offer and best bid in each class on 
C2 (the displayed C2 ask price minus the displayed C2 bid price). The 
Market Participant Rates are different rates for different types of 
market participants, as follows:

------------------------------------------------------------------------
                                                                 Rate
                     Market Participant                        (percent)
------------------------------------------------------------------------
C2 Market-Maker.............................................          30
Public Customer (Maker).....................................          40
All other origins...........................................          50
------------------------------------------------------------------------

    The Exchange multiplies the C2 BBO Market Width and the Market 
Participant Rate by 50 because this allows C2 to reach a per-contract 
amount that takes into account half of the C2 BBO Market Width. The use 
of 50 as a multiplier is mathematically equivalent to the nominal C2 
BBO Market Width divided by two, academically making the assumption 
that the theoretical value of the difference between the ask price and 
the bid price is the midpoint between the two. For purposes of this fee 
structure, the Exchange will be using the BBO as calculated by C2. The 
fee does not apply to Public Customer Takers because they will be 
receiving a rebate for such transactions (to be described later in this 
proposed rule change).
    The Exchange uses different Market Participant Rates for different 
market participants as a function of each market participant's 
obligations and responsibilities in the relevant class, as well as to 
provide incentives for Market-Makers to quote in a manner that narrows 
bid-ask spreads, which promotes market liquidity and therefore enhances 
market quality. C2 Market-Makers purchase permits and have quoting 
obligations, thereby justifying a lower Market Participant Rate. Public 
Customers have a lower Market Participant Rate than orders originating 
from other origins (other than C2 Market-Makers) because Public 
Customer order flow is a desirable commodity for all options exchanges 
and the Exchange seeks to attract such order flow. Further, Public 
Customers do not have access to many of the resources (such as 
technology, capital treatment, etc.) that other market participants may 
more easily access. Moreover, assessing different fee rates to 
different types of market participants is a common practice within the 
options industry, and many options exchanges, including C2, currently 
do so.\3\
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    \3\ See current C2 Fees Schedule, Section 1, which lists lower 
transaction fees for Public Customers than other market 
participants. See also Chicago Board Options Exchange, Incorporated 
(``CBOE'') Fees Schedule, Rate Tables on pages 1-2, which list lower 
transaction fees for Customers and CBOE Market-Makers than other 
market participants. See also International Securities Exchange, LLC 
(``ISE'') Schedule of Fees, Section 1, which lists lower transaction 
fees for Customers and ISE Market-Makers than other market 
participants.
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    The maximum fee for simple, non-complex orders in all equity 
options classes will be $0.85 per contract because, notwithstanding the 
tenets of the overall proposal, the Exchange does not want to have fees 
and rebates match or exceed the minimum trading increment ($0.01 x the 
100 multiplier, or $1.00 per contract). This maximum fee amount is 
reasonable because, among other things, the fee will not always be 
assessed for the maximum amount. The fee will only be for the maximum 
amount when the BBO Market Width is wide. Otherwise, the fee will be 
smaller. Indeed, the purpose of the proposed new fees structure is to 
encourage tighter quoting by linking lower fees to such tighter 
quoting. A maximum fee amount is necessary to prevent fees from 
becoming prohibitively high in the event of a wide BBO Market Width. A 
maximum fee amount of $0.85 per contract is reasonable because it is 
lower than the minimum trading increment. The Commission has, in the 
past, noted the argument that a maximum fee of $0.99 per contract or 
lower may be viable

[[Page 8622]]

because any maximum fee of $0.99 per contract or lower still allows for 
price improvement.\4\ Purchasing an options contract at $2.00 with an 
execution fee of $0.99 is a better all-inclusive price than purchasing 
the same options contract at $2.01 with no execution fees. Simply put, 
the execution of an order at a $0.01 better price will bring a better 
all-inclusive price as long as the fee is $0.99 per contract or lower. 
The proposed maximum fee here is not even $0.99 per contract, but only 
$0.85 per contract. And, as stated above, $0.85 will not be assessed on 
all transactions, but is merely a maximum fee amount based on the 
formula described above for determining fees under the proposed fees 
structure. Indeed, the Exchange anticipates that the vast majority of 
transactions will be assessed a significantly lower per-contract fee 
than $0.85.
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    \4\ See Securities Exchange Act Release No. 61902 (April 14, 
2010), 75 FR 20738 (April 20, 2010) (File No. S7-09-10) at 20750 
(``It could be argued that because investors will not be worse off 
accessing a price that is better by $1 per contract as long as the 
fee to access that quotation is not more than $0.99 per contract, 
any fee cap should not be lower than $0.99 per contract * * *'').
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    In conjunction with this new fee calculation for simple, non-
complex orders in all equity options classes, the Exchange proposes to 
adopt a rebate (in lieu of a fee) for simple, non-complex Public 
Customer orders in all equity options classes that remove liquidity 
(i.e. takers) based upon the following formula (rebates are calculated 
on a per-contract basis):
    Rebate = (C2 BBO Market Width at time of execution) x (Order Size 
Multiplier) x 50
    The Order Size Multiplier is a different multiplier based upon the 
size of the order:

------------------------------------------------------------------------
                                                              Multiplier
                Number of contracts in order                   (percent)
------------------------------------------------------------------------
1-10........................................................          36
11-99.......................................................          30
100-250.....................................................          20
251+........................................................           0
------------------------------------------------------------------------

    The rebate is limited to Public Customer taker orders because, at 
this time, C2 seeks to provide extra incentives for Public Customer 
order flow to route to the Exchange. Further, providing rebates 
targeted towards Public Customers is a common practice within the 
options industry, and many options exchanges, including C2, currently 
do so.\5\ The Exchange applies different Order Size Multipliers for 
different size orders because the Exchange desires to attract smaller 
orders, and on related note, because of different hedging 
considerations associated with these smaller orders. Smaller orders are 
more attractive to Market-Makers because they are easier to hedge than 
large orders. For example, imagine a situation in which a Public 
Customer executes a 5-contract trade of at-the-money calls against a 
counterparty. In a practical delta hedge, the counterparty would 
execute a stock trade for 250 shares of the underlying stock (5 
contracts X 50 delta). In contemporary stock markets, this size share 
block is relatively easy to execute. Had the transaction been for 500 
contracts, the counterparty would have had to trade 25,000 shares of 
the underlying stock, which would be much more difficult. C2 will be 
most able to incent counterparties to participate in trades if they 
have a reasonable assumption that a meaningful amount of incoming 
orders will be for smaller quantities. This can be achieved by 
incentivizing order flow providers to direct small Public Customer 
``taker'' orders to C2.
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    \5\ See current C2 Fees Schedule, Section 1, and NASDAQ Stock 
Market LLC Options Market (``NOM'') Chapter XV (Options Pricing), 
Section 2.
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    The proposed maximum rebate will be $0.75 per contract for the same 
reasons described above for limiting the maximum per-contract fee. It 
is necessary to maintain a spread between the maximum fee of $0.85 per 
contract and the maximum rebate, because, in the event that the maximum 
fee and rebate both apply, the $0.10 per-contract difference will allow 
the Exchange to maintain a minimum level of profit potential. Rebate 
amounts are often generally lower than fee amounts on the Exchange, as 
well as on other exchanges,\6\ for this reason (among others).
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    \6\ See current C2 Fees Schedule, Section 1, and NOM Chapter XV 
(Options Pricing), Section 2.
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    With respect to the rebate, in order to prevent order flow 
providers from ``shredding'' large Public Customer orders into smaller 
orders in order to take advantage of the higher rebates offered to such 
smaller Public Customer taker orders, multiple orders from the same 
executing firm for itself or for a Clearing Member Trading Agreement 
(``CMTA'') or correspondent firm in the same series on the same side of 
the market that are received by the Exchange within 500 milliseconds 
will be aggregated for purposes of determining the order quantity. 500 
milliseconds is the proper amount of time to discourage shredding to 
take advantage of quantity-based fees. Such a time interval is lengthy 
enough to discourage ``shredding'' due to the market risk the sender 
would realize in trying to game this interval. This time interval also 
matches that used by the Chicago Board Options Exchange, Incorporated 
(``CBOE'') to prevent ``shredding.''\7\
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    \7\ See CBOE Fees Schedule Table on ``Linkage Fees''.
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    To illustrate how the new fee and rebate structure would operate, 
consider the following examples. First, consider a situation in which 
the C2 market in an equity options class is 1.00-1.03, with the offer 
comprised of a resting C2 Market-Maker quote to sell 10 contracts. A 
Public Customer order to buy 10 contracts comes in and executes against 
that C2 Market-Maker quote at 1.03. At the time of the execution, the 
BBO Market Width is 0.03 (the difference between the C2 offer and the 
C2 bid). The fee for the C2 Market-Maker would be calculated by 
multiplying 0.03 by 30% (the Market Participant Rate for C2 Market-
Makers), and then multiplying that by 50. As such, the fee for the C2 
Market-Maker would be $0.45 per contract. Because the Public Customer 
order is a ``taker'' order, the Public Customer would receive a rebate. 
This rebate would be calculated by multiplying the BBO Market Width of 
0.03 by the Order Size Multiplier of 36% (because the Public Customer 
order is for 10 contracts), and then multiplying that by 50. As such, 
the Public Customer would receive a rebate of $0.54 per contract.
    Now, consider a situation in which the C2 market in an equity 
options class is 3.50--3.52. The resting offer on the C2 Book is a C2 
Market-Maker quote for 10 contracts, and next on the C2 Book sits a 
broker-dealer sell order at the same price for 15 contracts. Following 
that is a C2 Market-Maker quote for 25 contracts at 3.53 and a broker-
dealer order for 20 contracts at 3.55. The best offer on another 
exchange is 3.54 for 25 contracts. A Public Customer (``taker'') market 
order to buy 60 contracts at the market is received by C2.
    The Public Customer buy order would trade with all interest at 
3.52. The BBO Market Width here is 0.02. Therefore, the fees for 
execution of the C2 Market-Maker quote resting at 3.52 and the broker-
dealer behind the C2 Market-Maker (but also at 3.52) would be 
calculated by multiplying 0.02 by the Market Participant Rate, which 
for a C2 Market-Maker is 30% and for a broker-dealer is 50%, and then 
multiplying each of those amounts by 50. The C2 Market-Maker sell 
quote's execution fee for those first 10 contracts would therefore be 
$0.30 per contract (0.02 x 30% x 50), and the broker-dealer sell 
order's fee for the next 15 contracts

[[Page 8623]]

would be $0.50 per contract (0.02 x 50% x 50). The rebate for the 
Public Customer buy order would be calculated by multiplying the BBO 
Market Width (0.02) by the Order Size Multiplier (30%, because the size 
of the total order sent in by the Public Customer was 60 contracts), 
and then multiplying that amount by 50. Therefore, the Public Customer 
rebate would be $0.30 per contract for these first 25 contracts that 
traded at 3.52.
    With 35 contracts remaining in the Public Customer buy order, it 
would then interact with the resting C2 Market-Maker quote to sell 25 
contracts at 3.53. The fee for execution of this C2 Market-Maker quote 
would be calculated by multiplying the new BBO Market Width (now 0.03) 
by the C2 Market-Maker Market Participant Rate of 30%, and then 
multiplying that amount by 50. Therefore, the C2 Market-Maker's fee for 
these 25 contracts would be $0.45 per contract. The rebate for the 
Public Customer buy order (for these next 25 contracts) would be 
calculated by multiplying this new BBO Market Width of 0.03 by the 
Order Size Multiplier of 30%, and then multiplying that by 50. 
Therefore, the Public Customer rebate for these 25 contracts would be 
$0.45 per contracts.
    There remain 10 contracts on Public Customer's buy order. However, 
because another exchange is now quoting a resting order for 25 
contracts at 3.54, and this quote is now the National Best Offer, the 
remaining 10 contracts on the buy order would be routed to that 
exchange rather than trading with the resting broker-dealer order on 
the C2 Book that is priced at 3.55.
    Finally, consider a situation in which the C2 market in an equity 
options class is 1.00-1.05. A C2 Market-Maker quote to buy 5 contracts 
for at 1.00 sits on the C2 Book, with a broker-dealer order to buy 
another 5 contracts at the same price resting behind it. A Public 
Customer (``taker'') order to sell 10 contracts at the market comes in 
and executes against the C2 Market-Maker quote and the broker-dealer 
buy order. The fee for the C2 Market-Maker would be calculated by 
multiplying the BBO Market Width of .05 by the C2 Market-Maker Market 
Participant Rate of 30%, and then multiplying that by 50. The fee for 
the C2 Market-Maker would be $0.75 per contract. The fee for the 
broker-dealer would be calculated by multiplying the BBO Market Width 
of .05 by the broker-dealer Market Participant Rate of 50%, and then 
multiplying that by 50. This comes out to $1.25 per contract. However, 
because this amount is higher than the maximum per-contract fee of 
$0.85 per contract, the broker-dealer's fee would be brought down to 
$0.85 per contract. The Public Customer's rebate would be calculated by 
multiplying the BBO Market Width of 0.05 by the Order Size Multiplier 
of 36% (since the order is for 10 contracts) and then multiplying that 
by 50. This comes out to $0.90 per contract. However, because this 
amount is higher than the maximum per-contract rebate of $0.75 per 
contract, the Public Customer's rebate would be $0.75 per contract.
    As with the current fee structure, there will be no fees or rebates 
for trades on the open. Because orders would have been received before 
the Exchange was disseminating a market, it would not be appropriate to 
assess fees (or provide rebates) based on an unknown BBO Market Width.
    The Exchange proposes to adopt this new method of calculating fees 
and rebates because BBO Market Width is an important component of 
market quality and of the cost of using an exchange market. In 
addition, the structure of the Market Participant Rate, which is a 
component of the proposed fees structure, is designed to provide 
incentives for Market-Makers to quote in a manner that narrows bid-ask 
spreads, promotes market liquidity, and enhances market quality. 
Moreover, C2 believes that the proposed fee and rebate structure 
addresses issues with respect to maker-taker pricing that have been 
identified in academic studies. These studies find that although maker-
taker pricing has led to a reduction in quoted spreads, it has not led 
to a decline in true economic spreads once access fees and liquidity 
rebates are accounted for.\8\ C2 believes that, calibrated correctly, a 
fee formula for transaction fees and rebates based on BBO Market Width, 
Market Participant Rate, and order size harnesses the incentives of 
different market participants that leads them to behave in a way that 
narrows bid-ask spreads, promotes market liquidity, and thereby 
enhances overall market quality. C2 believes that its competitive 
position for order flow relative to other option exchanges is improved 
through rules and policies that help promote high-quality markets.
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    \8\ See James Angel, Lawrence Harris, and Chester S. Spatt, 
``Equity Trading in the 21st Century,'' USC Marshall School of 
Business, May 18, 2010, page 42. See also Katya Malinova and Andreas 
Park, ``Subsidizing Liquidity: The Impact of Make/Take Fees on 
Market Quality,'' available at: http://ssrn.com/abstract=1823600.
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    The proposed new fee and rebate structure will potentially 
compliment brokers' best-execution obligations towards their customers. 
First, the proposed fee structure provides a generous ``taker'' rebate 
for public customers. The concept of ``best execution'' is primarily 
geared towards the treatment of retail order flow by brokers, and, on 
C2, the majority of public retail customer orders take liquidity, as 
opposed to make liquidity. Further, the amount of the fee or rebate for 
a transaction is easily determinable by applying the simple formulas 
described above. Order routers and other market participants have 
complex options pricing and routing software that should easily handle 
C2's proposed formula for fees or rebates. Moreover, even if it were 
difficult for brokers to determine the fee amounts, they could always 
assume the fee would equal the $0.85 per contract cap and route orders 
accordingly (even though the Exchange expects that fees for most 
transactions will fall short of that cap). Importantly, the $0.85 per 
contract cap is less than $1.00 per contract, which means that, in any 
situation in which C2 had even a one-cent better price than any other 
exchange, a market participant will be getting the best all-inclusive 
price by routing an order to C2. In situations in which C2 as well as 
another exchange(s) is at the NBBO, the market participant or order 
router can determine the exchange to which to send the order; there are 
multiple factors along with fees, including systems speed, service, 
etc., that are taken into account to determine ``best execution'', and 
since trade-throughs are of course prevented, the market participant 
will still be getting the best price. Finally, it will not be difficult 
to verify the BBO Market Width at the time of execution, as it could be 
deduced from the fee (which will be listed on the market participant's 
billing reports). Additionally, the Exchange is currently developing 
the system functionality to list the BBO Market Width at the time of 
execution on the trade fill report.
    The proposed new fee and rebate structure will benefit all market 
participants and the markets in general. A fee structure that is based 
upon BBO Market Width, in which fees are lower when such BBO Market 
Width is smaller, will encourage tighter quoting (which in turn means 
better prices). The rebates for Public Customers will bring greater 
Public Customer order flow to the Exchange, and this increased volume 
and liquidity will benefit all market participants. On a broader level, 
a new, original, different fee structure benefits investors and the 
market in general by providing a new and different option for investors 
to consider when they decide which exchange

[[Page 8624]]

provides the most attractive option for directing order flow.
    The proposed changes are to take effect on February 1, 2013.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Act and the rules and regulations thereunder applicable to the 
Exchange and, in particular, the requirements of Section 6(b) of the 
Act.\9\ Specifically, the Exchange believes the proposed rule change is 
consistent with Section 6(b)(4) of the Act\10\, which provides that 
Exchange rules may provide for the equitable allocation of reasonable 
dues, fees, and other charges among its Trading Permit Holders and 
other persons using its facilities. The proposed fee formula for 
simple, non-complex orders in all equity options classes is reasonable 
because it takes into account BBO Market Width, which is a factor in 
determining the liquidity associated with any potential options trade. 
Offering a different fee based on BBO Market Width is equitable and not 
unfairly discriminatory because assessing a lower fee for narrower 
spreads will provide incentives to quote more narrowly, which thereby 
results in better prices for all market participants.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 15 U.S.C. 78f(b)(4).
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    Offering a lower Market Participant Rate for C2 Market-Makers than 
for other market participants is equitable and not unfairly 
discriminatory because C2 Market-Makers take on a number of 
obligations, including quoting obligations and the need to purchase 
permits, that some other market participants do not have. Further, a 
fees structure that includes a lower Market Participant Rate for C2 
Market-Makers, who are the market participants that do the vast 
majority of quoting, incentivizes more and narrower quoting, thereby 
encouraging liquidity provision, which is vital to the marketplace and 
benefits all market participants. Offering a lower Market Participant 
Rate for Public Customers than for orders originating from other market 
participants (except C2 Market-Makers) is equitable and not unfairly 
discriminatory because those other market participants do not have the 
obligations of C2 Market-Makers yet have access to many of the 
resources (technology, capital treatment, etc.) that Public Customers 
do not.
    Not assessing fees or providing rebates for trades on the open is 
reasonable because it allows market participants to avoid having to pay 
fees for such trades. This is equitable and not unfairly discriminatory 
because orders would have been received before the Exchange was 
disseminating a market, and therefore it would not be appropriate to 
assess fees (or provide rebates) based on an unknown BBO Market Width.
    In the past, in the context of market data fees, the Commission has 
acknowledged that exchanges can offer different prices to ``particular 
classes of subscribers'' based on market conditions such as ``their 
economic circumstances and their need for and use of'' a particular 
product or service.\11\ For example, the Commission has previously 
approved or cited favorably to differential pricing between retail and 
non-retail investors.\12\ Further, assessing different fee rates to 
different types of market participants is a common practice within the 
options industry, and many options exchanges, including C2, currently 
do so.\13\ Far from undermining the purposes of the Exchange Act, the 
Commission has found that such differential pricing ``provide[s] an 
opportunity for many investors to have access to'' products and 
services that they otherwise might choose to forego.\14\ Indeed, in the 
past, the Commission has disapproved fees when such fees would 
interfere with the operation of the national market system--for 
example, by providing market participants with quicker access to ``top 
of book'' data that broker dealers are required by law to access 
pursuant to their duty of best execution.\15\ The current proposal does 
not present any such concerns.
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    \11\ See Securities Exchange Act No. 42208 (December 9, 1999), 
64 FR 70613 (December 17, 1999) at 70630 (Concept Release, 
Regulation of Market Information Fees and Revenues) (File No. S7-28-
99).
    \12\ See id. at 70630-31; see also Securities Exchange Act 
Release No. 46843 (November 18, 2002), 67 FR 70471 (November 22, 
2002) at 70472 (Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment No. 5 to 
the Proposed Rule Change by the National Association of Securities 
Dealers, Inc., Relating to Fees for Nasdaq Data Entitlement 
Packages) (SR-NASD-2002-33).
    \13\ See current C2 Fees Schedule, Section 1, which lists lower 
transaction fees for Public Customers than other market 
participants. See also CBOE Fees Schedule, Rate Tables on pages 1-2, 
which list lower transaction fees for Customers and CBOE Market-
Makers than other market participants. See also ISE Schedule of 
Fees, Section 1, which lists lower transaction fees for Customers 
and ISE Market-Makers than other market participants.
    \14\ See Securities Exchange Act Release No. 46843 (November 18, 
2002), 67 FR 70471 (November 22, 2002) at 70472 (Order Approving 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval to Amendment No. 5 to the Proposed Rule Change 
by the National Association of Securities Dealers, Inc., Relating to 
Fees for Nasdaq Data Entitlement Packages) (SR-NASD-2002-33).
    \15\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005) at 37569 (Final Rules and 
Amendments to Joint Industry Plans (``Regulation NMS'')) (File No. 
S7-10-04).
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    Having a maximum per-contract fee amount under the proposed new 
formula is reasonable because it will limit the amount that market 
participants can pay. This maximum fee amount is reasonable because the 
fee will not always be for the maximum amount. The fee will only be for 
the maximum amount when the BBO Market Width is wide. Otherwise, the 
fee will be smaller. Indeed, the purpose of the proposed new fees 
structure is to encourage tighter quoting by linking lower fees to such 
tighter quoting. A maximum fee amount is necessary to prevent fees from 
becoming prohibitively high in the event of a wide BBO Market Width. A 
maximum fee amount of $0.85 per contract is reasonable because it is 
lower than the minimum trading increment. The Commission has, in the 
past, noted the argument that a maximum fee of $0.99 per contract or 
lower may be viable because any maximum fee of $0.99 per contract or 
lower still allows for price improvement.\16\ Purchasing an options 
contract at $2.00 with an execution fee of $0.99 is a better all-
inclusive price than purchasing the same options contract at $2.01 with 
no execution fees. Simply put, the execution of an order at a $0.01 
better price will bring a better all-inclusive price as long as the fee 
is $0.99 per contract or lower. The proposed maximum fee here is not 
even $0.99 per contract, but only $0.85 per contract. And, as stated 
above, $0.85 will not be assessed on all transactions, but is merely a 
maximum fee amount based on the formula described above for determining 
fees under the proposed fees structure. The maximum per-contract fee is 
equitable and not unfairly discriminatory because this limit will apply 
to all market participants.
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    \16\ See Securities Exchange Act Release No. 61902 (April 14, 
2010), 75 FR 20738 (April 20, 2010) (File No. S7-09-10) at 20750 
(``It could be argued that because investors will not be worse off 
accessing a price that is better by $1 per contract as long as the 
fee to access that quotation is not more than $0.99 per contract, 
any fee cap should not be lower than $0.99 per contract * * *'').
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    Providing a rebate for Public Customer orders in all equity options 
classes that remove liquidity (i.e. takers) is reasonable because it 
will allow Public Customer takers to receive a rebate, as opposed to 
pay a fee, for the execution of orders. Providing this rebate to Public 
Customer takers only is equitable and not unfairly discriminatory 
because the increased volume and liquidity that the rebate will 
incentivize will benefit all other market participants. The rebate for 
``take''

[[Page 8625]]

orders will incentivize Public Customers to ``take'' orders from all 
market participants, thereby providing a counterparty for resting 
``make'' orders from all market participants. Further, providing 
rebates targeted towards Public Customers is a common practice within 
the options industry.\17\
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    \17\ See current C2 Fees Schedule, Section 1, and NOM Chapter XV 
(Options Pricing), Section 2.
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    Offering different Order Size Multipliers for different-sized 
orders is equitable and not unfairly discriminatory because the highest 
profit opportunity exists for the lowest-size orders since the profit 
potential is not captured until after the counter-party has executed 
its hedging transaction. Smaller orders are much easier to hedge than 
large orders, which makes smaller orders more attractive to Market-
Makers. C2 will be most able to incent counterparties to participate in 
trades if they have a reasonable assumption that a meaningful amount of 
incoming orders will be for smaller quantities. This can be achieved by 
incentivizing order flow providers to direct small Public Customer 
``taker'' orders to C2. This will benefit all market participants with 
the improved liquidity and trading opportunities. Market-Makers, who 
have greater obligations (including quoting), will be able to engage in 
more trades (especially hedging) due to the incenting of the direction 
of small Public Customer ``taker'' orders to C2.
    Having a maximum rebate of $0.75 is reasonable because it is 
necessary to maintain a spread between the maximum fee of $0.85 per 
contract and the maximum rebate in order for the Exchange to maintain a 
minimum level of profit potential, and the $0.10 per contract 
difference allows the Exchange to do so. Currently, rebates are lower 
than fee amounts on the Exchange, as well as on other exchanges, for 
this reason. Moreover, the amount of the maximum rebate is higher than 
the maximum rebate currently offered on the Exchange \18\ and is either 
higher than or within the range of rebates offered on other 
exchanges.\19\ The maximum rebate is equitable and not unfairly 
discriminatory because it will be applied to all Public Customers 
equally. Further, providing this rebate to Public Customer takers only 
is equitable and not unfairly discriminatory because the increased 
volume and liquidity that the rebate will incentivize will benefit all 
other market participants. The rebate for ``take'' orders will 
incentivize Public Customers to ``take'' orders from all market 
participants, thereby providing a counterparty for resting ``make'' 
orders from all market participants. Further, providing rebates 
targeted towards Public Customers is a common practice within the 
options industry.\20\
---------------------------------------------------------------------------

    \18\ See Exchange Fees Schedule, Section 1.
    \19\ See and NOM Chapter XV (Options Pricing), Section 2.
    \20\ See current C2 Fees Schedule, Section 1, and NOM Chapter XV 
(Options Pricing), Section 2.
---------------------------------------------------------------------------

    Aggregating, for the purposes of determining the order quantity, 
multiple orders from the same executing firm for itself or for a CMTA 
or correspondent firm in the same series on the same side of the market 
that are received by the Exchange within 500 milliseconds is consistent 
with the Section 6(b)(5) \21\ requirements that the rules of an 
exchange be designed to promote just and equitable principles of trade, 
to prevent fraudulent and manipulative acts, to remove impediments to 
and to perfect the mechanism for a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest by preventing the ``shredding'' of large orders into multiple 
smaller ones in order to accrue a larger rebate. 500 milliseconds is 
the proper amount of time to discourage shredding to take advantage of 
quantity-based fees. Such a time interval is lengthy enough to 
discourage ``shredding'' due to the market risk the sender would 
realize in trying to game this interval. This time interval also 
matches that used by CBOE to prevent ``shredding.'' \22\
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78f(b)(5).
    \22\ See CBOE Fees Schedule Table on ``Linkage Fees''.
---------------------------------------------------------------------------

    Finally, the Exchange believes the proposed rule change is 
consistent with the Section 6(b)(5)\23\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, to prevent fraudulent and manipulative acts, to remove 
impediments to and to perfect the mechanism for a free and open market 
and a national market system, and, in general, to protect investors and 
the public interest. Offering the proposed fee structure based on BBO 
Market Width provides a new and different option for investors looking 
to determine to which exchange to route orders, one that encourages 
tighter quoting and better prices, all of which perfects the mechanism 
for a free and open market and national market system.
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Given the robust competition for order flow that exists in the 
options market, new, innovative price schedules like the one being 
proposed here are consistent with the above-mentioned goals of the 
Exchange Act. Indeed, by and large, the Commission historically has 
permitted exchanges to set their own fees absent some evidence that 
market forces were insufficient to constrain prices. There is no such 
evidence here.
    When Congress charged the Commission with supervising the 
development of a ``national market system'' for securities, a premise 
of its action was that prices ordinarily would be determined by market 
forces. See, e.g., H.R. Rep. No. 94-229, at 92 (1975) (Conf. Rep.) 
(stating Congress's intent that the ``national market system evolve 
through the interplay of competitive forces as unnecessary regulatory 
restrictions are removed''). Consistent with this purpose, Congress and 
the Commission have repeatedly stated their preference for competition, 
rather than regulatory intervention, to determine prices, products, and 
services in the securities markets. See S. Rep. No. 94-75, 94th Cong., 
1st Sess. 8 (1975) (``The objective [in enacting the 1975 amendments to 
the Exchange Act] would be to enhance competition and to allow economic 
forces, interacting within a fair regulatory field, to arrive at 
appropriate variations in practices and services.''); Order Approving 
Proposed Rule Change Relating to NYSE Arca Data, Securities Exchange 
Act Release No. 59039 (December 2, 2008), 73 FR 74770 (Dec. 9, 2008) at 
74781 (``The Exchange Act and its legislative history strongly support 
the Commission's reliance on competition, whenever possible, in meeting 
its regulatory responsibilities for overseeing the SROs and the 
national market system. Indeed, competition among multiple markets and 
market participants trading the same products is the hallmark of the 
national market system.'') (SR-NYSEArca-2006-21); Regulation NMS, 70 FR 
at 37499 (observing that NMS regulation ``has been remarkably 
successful in promoting market competition in [the] forms that are most 
important to investors and listed companies'').
    In NetCoalition v. Securities and Exchange Commission, 615 F.3d 525 
(D.C. Cir. 2010), the D.C. Circuit approved the Commission's practice 
of relying on ``competitive forces'' in determining whether an 
exchange's proposed data fees were consistent with the purposes of the 
Exchange Act--as long as it had a ``reasoned basis'' for doing so. Id. 
at 544. Around the same time, Congress reaffirmed the primary role that 
exchanges have in setting prices when it enacted the Dodd-Frank 
amendments to the Exchange Act, which expanded the authorization of

[[Page 8626]]

exchanges to file immediately effective fee schedules, subject only to 
limited post-effectiveness review by the Commission. 15 U.S.C. 
78s(b)(3)(A).
    This consistent and considered judgment of Congress and the 
Commission is correct, particularly in light of evidence of robust 
competition in the options market for orders and liquidity. There are 
more options exchanges now than ever before, with no single exchange 
commanding at a given time more than 35% of listed options market 
share, a very different picture than 10 or 20 years ago. As the 
Commission recently estimated, order volume is fairly evenly 
distributed between the four largest entities that own options 
exchanges.\24\ Indeed, recent data demonstrates this distribution of 
market share: The CBOE Holdings entities (CBOE and C2) have combined a 
market share of 26.40%, the International Securities Exchange has a 
market share of 15.85%, the NYSE Euronext entities (NYSE Amex and NYSE 
Arca) have a combined market share of 25.59%, and The NASDAQ OMX Group, 
Inc. entities (NASDAQ OMX BX, NASDAQ OMX Phlx, and NASDAQ Options 
Market) have a combined market share of 25.55%.\25\ None of these four 
entities (which control over 93% of the market) could afford to charge 
opportunistic fees that resulted in being placed at the bottom of an 
order routing table and losing market share to competitors.
---------------------------------------------------------------------------

    \24\ See Securities Exchange Act Release No. 61902 (April 14, 
2010), 75 FR. 20738 (April 20, 2010) at 20759 (Proposed Amendments 
to Rule 610 of Regulation NMS) (File No. S7-09-10).
    \25\ Market share for November 2012, as provided by the Options 
Clearing Corporation (available at http://www.optionsclearing.com/webapps/exchange-volume).
---------------------------------------------------------------------------

    In the case of C2, it is particularly unlikely that an innovative 
pricing approach could cause competitive harm to the options market or 
to market participants. C2 is a new market participant that currently 
handles only about 1.45% percent of total market share in options 
trading.\26\ Thus, the proposed rule is a modest attempt by a new 
market entrant to attract order volume away from more established 
competitors by adopting an innovative pricing strategy. C2 believes 
that this new pricing strategy will benefit the options markets and 
public consumers in particular. Indeed, it is well-established that new 
market entrants and new business models have procompetitive effects, 
and that innovations like the proposed rule can incentivize competitors 
to develop their own innovations in response. See, e.g., Leegin 
Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 891 (2007) (``New 
products and new brands are essential to a dynamic economy''); Brooke 
Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 243 (1993) 
(noting that ``sound antitrust policy'' encouraged ``maverick'' pricing 
strategies because of their procompetitive effects); U.S. Dep't of 
Justice & Fed. Trade Comm'n, Horizontal Merger Guidelines ] 2.1.5 
(expressing view of DOJ and FTC that ``maverick'' firms benefit 
consumers by ``threaten[ing] to disrupt market conditions with a new 
technology or business model,'' ``tak[ing] the lead in price cutting or 
other competitive conduct,'' and ``resist[ing] otherwise prevailing 
industry norms''). The fact that an exchange proposes something new is 
a reason to be receptive, not skeptical--innovation is the life-blood 
of a vibrant competitive market--and that is particularly so in the 
case of a new market entrant of relatively small size like C2 that can 
cause no widespread competitive harm if the proposed fees structure 
fails to attract significant order volume.
---------------------------------------------------------------------------

    \26\ Id.
---------------------------------------------------------------------------

    Access to exchange quotes is also more efficient than ever and 
helps to promote price transparency and competition among exchanges for 
order flow. Orders are processed and executed electronically in 
milliseconds (also very different than 10 years ago) and markets are 
more open to new users than ever before. Under the NMS plan for order 
protection in listed options (``Options Linkage Plan''), each 
participating options exchange is required ``to establish, maintain, 
and enforce written policies and procedures as approved by the 
Commission that are reasonably designed to prevent Trade-Throughs'' in 
each exchange's listed options contracts.\27\ When more than one 
exchange is displaying the NBBO (which is overwhelmingly the case), 
brokers often assign lowest priority in their order routing tables to 
the exchange with the highest transaction fees. This means that if an 
exchange sets high fees, it risks losing business to exchanges with 
lower fees--the same competitive pressure used by our free markets 
every day to constrain price.
---------------------------------------------------------------------------

    \27\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) at 39264-65 (Joint Industry 
Plan; Order Approving the National Market System Plan Relating to 
Options Order Protection and Locked/Crossed Markets Submitted by the 
Chicago Board Options Exchange, Incorporated, International 
Securities Exchange, LLC, The NASDAQ Stock Market LLC, NASDAQ OMX 
BX, Inc., NASDAQ OMS PHLX, Inc., NYSE Amex LLC, and NYSE Arca, 
Inc.).
---------------------------------------------------------------------------

    Indeed, order routers' ability to effectively view all exchanges' 
displayed prices simultaneously and execute at the exchange that 
charges the lowest fees is more disciplining than the market forces 
that operate in many other industries. A customer in the market for a 
new television, for instance, cannot simultaneously know the price of 
every television at every retail store. And even if all those prices 
were known, transaction costs often would prevent the customer from 
buying at the lowest price--perhaps the cheapest television is twenty 
miles away, for example. In the options markets, by contrast, order 
routers can simultaneously view and execute orders at the exchange with 
the lowest transaction fees when more than one exchange has, or may 
match, the NBBO. Plus, broker-dealers, who have accepted responsibility 
for handling orders on behalf of customers, are monitoring displayed 
quotes. They are typically more sophisticated and better-informed 
market participants than customers in non-financial markets, and 
therefore are better able to make the types of decisions that will 
produce efficient markets and constrain prices.
    Options exchanges have adopted different pricing models (``Make or 
Take'' or ``Broker Payment'') based on their competitive assessment of 
the incentives that will best attract order flow and liquidity. This 
competition has helped to exert competitive pressure on the exchanges' 
transaction fees. The Exchange believes that its proposed model will 
help further competition by providing market participants with yet 
another option in determining where to execute orders and post 
liquidity. By expanding the universe of pricing models, the Exchange's 
proposal will help competition to achieve one of its signature 
benefits, i.e., allowing the marketplace to determine which pricing 
model best serves consumer needs.

B. Self-Regulatory Organization's Statement on Burden on Competition

    C2 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. On the contrary, C2 believes 
that the proposed rule change will promote competition. A new, 
original, different fee structure benefits investors and the market in 
general by providing a new and different option for investors to 
consider when they decide which exchange provides the most attractive 
option for directing order flow.
    In the case of C2, it is particularly unlikely that an innovative 
pricing approach could cause competitive harm to the options market or 
to market participants. C2 is a new market participant that currently 
handles only

[[Page 8627]]

about 1.45% percent of total market share in options trading.\28\ Thus, 
the proposed rule is a modest attempt by a new market entrant to 
attract order volume away from more established competitors by adopting 
an innovative pricing strategy. C2 believes that this new pricing 
strategy will benefit the options markets and public consumers in 
particular. Indeed, it is well-established that new market entrants and 
new business models have procompetitive effects, and that innovations 
like the proposed rule can incentivize competitors to develop their own 
innovations in response. See, e.g., Leegin Creative Leather Prods. v. 
PSKS, Inc., 551 U.S. 877, 891 (2007) (``New products and new brands are 
essential to a dynamic economy''); Brooke Group v. Brown & Williamson 
Tobacco Corp., 509 U.S. 209, 243 (1993) (noting that ``sound antitrust 
policy'' encouraged ``maverick'' pricing strategies because of their 
procompetitive effects); U.S. Dep't of Justice & Fed. Trade Comm'n, 
Horizontal Merger Guidelines ] 2.1.5 (expressing view of DOJ and FTC 
that ``maverick'' firms benefit consumers by ``threaten[ing] to disrupt 
market conditions with a new technology or business model,'' ``tak[ing] 
the lead in price cutting or other competitive conduct,'' and 
``resist[ing] otherwise prevailing industry norms''). The fact that an 
exchange proposes something new is a reason to be receptive, not 
skeptical--innovation is the life-blood of a vibrant competitive 
market--and that is particularly so in the case of a new market entrant 
of relatively small size like C2 that can cause no widespread 
competitive harm if the proposed fees structure fails to attract 
significant order volume.
---------------------------------------------------------------------------

    \28\ Market share for November 2012, as provided by the Options 
Clearing Corporation (available at http://www.optionsclearing.com/webapps/exchange-volume).
---------------------------------------------------------------------------

    Access to exchange quotes is also more efficient than ever and 
helps to promote price transparency and competition among exchanges for 
order flow. Orders are processed and executed electronically in 
milliseconds (also very different than 10 years ago) and markets are 
more open to new users than ever before. Under the Options Linkage 
Plan, each participating options exchange is required ``to establish, 
maintain, and enforce written policies and procedures as approved by 
the Commission that are reasonably designed to prevent Trade-Throughs'' 
in each exchange's listed options contracts.\29\ When more than one 
exchange is displaying the NBBO (which is overwhelmingly the case), 
brokers often assign lowest priority in their order routing tables to 
the exchange with the highest transaction fees. This means that if an 
exchange sets high fees, it risks losing business to exchanges with 
lower fees--the same competitive pressure used by our free markets 
every day to constrain price.
---------------------------------------------------------------------------

    \29\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) at 39264-65 (Joint Industry 
Plan; Order Approving the National Market System Plan Relating to 
Options Order Protection and Locked/Crossed Markets Submitted by the 
Chicago Board Options Exchange, Incorporated, International 
Securities Exchange, LLC, The NASDAQ Stock Market LLC, NASDAQ OMX 
BX, Inc., NASDAQ OMS PHLX, Inc., NYSE Amex LLC, and NYSE Arca, 
Inc.).
---------------------------------------------------------------------------

    Indeed, order routers' ability to effectively view all exchanges' 
displayed prices simultaneously and execute at the exchange that 
charges the lowest fees is more disciplining than the market forces 
that operate in many other industries. A customer in the market for a 
new television, for instance, cannot simultaneously know the price of 
every television at every retail store. And even if all those prices 
were known, transaction costs often would prevent the customer from 
buying at the lowest price--perhaps the cheapest television is twenty 
miles away, for example. In the options markets, by contrast, order 
routers can simultaneously view and execute orders at the exchange with 
the lowest transaction fees when more than one exchange has, or may 
match, the NBBO. Plus, broker-dealers, who have accepted responsibility 
for handling orders on behalf of customers, are monitoring displayed 
quotes. They are typically more sophisticated and better-informed 
market participants than customers in non-financial markets, and 
therefore are better able to make the types of decisions that will 
produce efficient markets and constrain prices.
    Options exchanges have adopted different pricing models (``Make or 
Take'' or ``Broker Payment'') based on their competitive assessment of 
the incentives that will best attract order flow and liquidity. This 
competition has helped to exert competitive pressure on the exchanges' 
transaction fees. The Exchange believes that its proposed model will 
help further competition by providing market participants with yet 
another option in determining where to execute orders and post 
liquidity. By expanding the universe of pricing models, the Exchange's 
proposal will help competition to achieve one of its signature 
benefits, i.e., allowing the marketplace to determine which pricing 
model best serves consumer needs.

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

    The Exchange neither solicited nor received comments on the 
proposed rule change.

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

    The foregoing rule change has become effective pursuant to Section 
19(b)(3)(A) \30\ of the Act and paragraph (f) of Rule 19b-4 \31\ 
thereunder. 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 necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78s(b)(3)(A).
    \31\ 17 CFR 240.19b-4(f).
---------------------------------------------------------------------------

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 rule-comments@sec.gov. Please include 
File Number SR-C2-2013-004 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-C2-2013-004. 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

[[Page 8628]]

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 
such filing also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-C2-2013-004 and should be submitted by February 27, 
2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
---------------------------------------------------------------------------

    \32\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-02630 Filed 2-5-13; 8:45 am]
BILLING CODE 8011-01-P