[Federal Register Volume 65, Number 114 (Tuesday, June 13, 2000)]
[Notices]
[Pages 37191-37196]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14850]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42870; File No. SR-CBOE-97-37]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving Proposed Rule Change and Notice of Filing and 
Order Granting Accelerated Approval of Amendment Nos. 1, 2, 3, 4 and 5 
to the Proposed Rule Change Relating to Eligibility Requirements for 
Participation on the RAES System

May 31, 2000.

I. Introduction

    On August 6, 1997, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend its Retail Automatic 
Execution System (``RAES'') eligibility requirements for market makers. 
The proposed rule change was published in the Federal Register on 
August 20, 1997.\3\ The Commission received three comment letters on 
the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Exchange Act Release No. 38928 (August 12, 1997), 62 FR 
44296.
    \4\ Letters from James I. Gelbort to the Commissioners, SEC, 
dated September 7, 1997 (``Gelbort Letter''); Scott Kilrea, 
President, Letco, Lee E. Tenzer Trading Company, to Jonathan G. 
Katz, Secretary, SEC, dated February 20, 1998 (``Letco Letter No. 
1''); and Scott Kilrea, President Letco, Lee E. Tenzer Trading 
Company, et al, to Heather Seidal, Division of Market Regulation 
(``Division''), SEC, dated August 7, 1998 (``Letco Letter No. 2'').
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    On July 23, 1998, the CBOE submitted Amendment No. 1 to the 
proposed rule change. \5\ On September 28, 1999, the CBOE submitted 
Amendment No. 2 to the proposed rule change.\6\ On December 8, 1999, 
the CBOE submitted Amendment No. 3 to the proposed rule change.\7\ On 
March 22, 2000, the CBOE submitted Amendment No. 4 to the proposed rule 
change.\8\ Finally, on May 19, 2000, the CBOE submitted

[[Page 37192]]

Amendment No. 5 to the proposed rule change.\9\
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    \5\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Heather Seidel, Division, SEC, 
dated July 22, 1998 (``Amendment No. 1''). In Amendment No. 1, the 
Exchange amended the proposal by establishing a floor percentage 
that may be set by the Market Performance Committee (``MPC'') that 
limits a market maker's total transactions and contract volume 
executed on RAES. The CBOE also proposed that the market maker 
percentages should be established and calculated on a quarterly 
basis. Amendment No. 1 contained guidelines to be used by the MPC 
when determining whether to exempt market maker activity on one or 
more trading days during the applicable calendar quarter and 
guidelines for the exercise of discretion by the MPC pursuant to 
Interpretation .01 of the proposed rule change, which permits the 
MPC to apply the eligibility requirements to fewer than all classes 
traded at a particular trading station. Finally, the CBOE responded 
to issues raised in Letco Letter No. 1 (see supra note 4).
    \6\ Letter from Timothy Thompson, Director, Regulatory Affairs, 
Legal Department, CBOE, to Richard Strasser, Division, SEC, dated 
September 23, 1999 (``Amendment No. 2''). In Amendment No. 2, the 
CBOE amended the proposal to limit its application to those options 
classes identified by the Exchange as having market makers that 
trade an inordinate percentage of their transactions on RAES. The 
Exchange also reiterated its belief that the proposed rule language 
afforded protections against potential discrimination by the MPC 
when it determines which trading days to exempt from the percentage 
calculations because the MPC will not know the identity of market 
makers from the data it reviews. Finally, the Exchange responded to 
issues raised in Letco Letter No. 2 (see supra note 4).
    \7\ Letter from Stephanie C. Mullins, Attorney, CBOE, to Kelly 
Riley, Division, SEC, dated December 7, 1999 (``Amendment No. 3''). 
In Amendment No. 3, the CBOE amended the proposed rule change to 
provide an exemption from the proposed RAES percentage requirements 
for designated primary market makers (``DPMs'') and their designees, 
when acting in the capacity as a DPM in an option class.
    \8\ Letter from Timothy Thompson, Director, Regulatory Affairs, 
Legal Department, CBOE, to Kelly Riley, Division, SEC, dated March 
21, 2000 (``Amendment No. 4''). In Amendment No. 4, the CBOE 
corrected rule language submitted in Amendment No. 3, which failed 
to reflect the revisions proposed in Amendment No. 2.
    \9\ Letter from Timothy Thompson, Director, Regulatory Affairs, 
Legal Department, CBOE to Kelly Riley, Division, SEC, dated May 18, 
2000 (``Amendment No. 5''). In Amendment No. 5, the CBOE amended the 
proposed language of Interpretation .01 of Rule 8.16. Specifically, 
Interpretation .01 is proposed to contain factors to be considered 
by the MPC when it determines whether to impose the percentage 
requirements on a particular options class. Further, the Exchange 
deleted factors proposed in Amendment No. 1, which were to be used 
by the MPC to determine whether to exempt an options class from the 
percentage requirements. However, because the proposal, as amended 
in Amendment No. 2, is no longer proposed to be implemented floor 
wide but only applied to specific options classes that have been 
identified by the MPC as having market makers that are not actively 
fulfilling their market making obligations, the deleted factors were 
no longer necessary.
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    This order approves the proposed rule change, as amended. The 
Commission is also soliciting comment on Amendment Nos. 1, 2, 3, 4 and 
5 to the proposed rule change from interested persons.

II. Description of the Proposal

    The CBOE proposes to establish two additional eligibility 
requirements that market makers must satisfy to be eligible to 
participate in the RAES system.\10\ The Exchange also proposes to 
clarify that CBOE Rule 8.16 applies to RAES eligibility in all CBOE 
options except options on the Standard & Poor's 100 Stock index 
(``OEX''), options on the Standard & Poor's 500 Stock Index (``SPX'') 
and options on the Dow Jones Industrial Average (``DJX''), which have 
separate RAES rules.
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    \10\ RAES is the Exchange's automatic execution system for small 
(generally less than 50 contracts) public customer market or 
marketable limit orders. When RAES receives an order, the system 
automatically will attach to the order its execution price, 
determined by the prevailing market quote at the time of the order's 
entry into the system. A buy order will pay the offer; a sell order 
will sell at the bid. An eligible market maker who is signed onto 
RAES at the time the order is received will be designated to trade 
with the public customer at the assigned price.
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    The Exchange proposes to implement a limit on the percentage of a 
market maker's overall trades, both in terms of total transactions and 
contract volume, that a market maker may transact on RAES during a 
quarterly period. The proposed eligibility requirements, however, will 
not apply to DPMs.\11\ The eligibility requirements have two distinct 
parts, both of which must be satisfied. First, a market maker's RAES 
transactions may not exceed a maximum percentage of his or her total 
transactions for a calendar quarter. Second, a market maker's contract 
volume resulting from his or her RAES transactions must not exceed a 
maximum percentage of his or her overall contract volume during a 
calendar quarter.
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    \11\ See Amendment No. 3.
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    These percentages will be determined by the MPC. The MPC's 
authority to determine the applicable percentages, however, will be 
limited so that neither of the percentages may be set at less than 
fifteen percent. In other words, the MPC may not establish a maximum 
RAES transaction or contact volume percentage under fifteen percent.
    Further, the MPC will only implement these eligibility requirements 
on those options classes that have been identified as having market 
makers that are not actively fulfilling their market making 
obligations.\12\ If the MPC determines to implement the eligibility 
requirements on an options class, a regulatory circular will be issued 
setting forth the applicable percentages and the effective date for the 
application of the percentages before the beginning of the quarterly 
period.
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    \12\ See Amendment No. 2.
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    The MPC will have the authority to implement the eligibility 
requirements on those options classes that it identifies as having 
market makers that are not actively fulfilling their market making 
obligations on the floor of the Exchange. The factors to be considered 
by the MPC when determining whether to apply the percentage 
requirements include complaints from floor brokers or other market 
makers; the results of routine market performance surveys; data 
concerning the percentage of RAES trades performed by a particular 
market maker or market maker trading crowd; or any other factor that 
the MPC deems relevant.\13\
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    \13\ See Amendment No. 5.
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    At the end of each quarter, the market maker transaction and volume 
percentages will be calculated. The MPC will have the authority to 
exempt from the percentage tabulations certain trading days. When 
determining which days to exempt, however, the MPC will not be privy to 
individual market maker identities. It will consider whether a 
particular day experienced an unusually high percentage of RAES trades 
compared to normal trading days and any other relevant factors. 
Generally, the MPC will exempt market maker activity for any option 
class on days where the percentage of RAES trades out of total trades 
exceeds the requirement set for the class by the MPC.
    If a market maker is found to be in violation of the eligibility 
requirements, he or she may be determined ineligible to participate on 
RAES. In addition, a market maker may be subject to disciplinary or 
other remedial action by the MPC under paragraph (d) of Rule 8.16. 
Market makers, pursuant to Chapters XIX and XVII, as applicable, may 
appeal such actions taken by the MPC.\14\
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    \14\ The Exchange also noted that the MPC might determine to 
require an ineligible market maker to participate in RAES if there 
is inadequate participation in a particular options class. See CBOE 
Rule 8.16(c).
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III. Summary of Comments

    The Commission received three comment letters from two commenters 
on the proposed rule change.\15\ One commenter stated that he believed 
that the proposed rule change was unnecessary.\16\ The other commenter, 
while generally supporting the underlying motivation of the proposed 
rule change, questioned its application on DPMs \17\ and requested that 
approval of the proposal be postponed until the ramifications on DPMs 
could be resolved.\18\ The Exchange submitted to the Commission a 
letter in response to the issues raised by one commenter.\19\ In 
addition, the Exchange addressed the issues raised in the comment 
letters in Amendment Nos. 1, 2, and 3. The following discussion 
summarizes the issues raised by the commenters and the Exchange's 
response.
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    \15\ See supra note 4.
    \16\ See Gelbort Letter.
    \17\ See Letco Letter No. 1.
    \18\ See Letco Letter No. 2.
    \19\ Letter from Charles J. Henry, President and Chief Operating 
Officer, CBOE to Jonathan G. Katz, Secretary, SEC, dated October 31, 
1997 (``Response Letter''). The Response Letter addressed the issues 
raised in the Gelbort Letter.
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1. Gelbort Letter

    In his comment letter, Mr. Gelbort questioned the appropriateness 
of the proposed rule change and suggested that current Exchange rules 
should be able to sufficiently address the concerns described by the 
Exchange relating to market makers who fail to adequately fulfill their 
market making obligations. Specifically, Mr. Gelbort suggested that by 
filing the proposal the Exchange implied that it had been unable to 
enforce the provisions of CBOE Rule 8.7.\20\ Mr. Gelbort stated that he 
believed that other current Exchange rules, if employed effectively, 
could adequately address the problems identified by the Exchange. For 
example, according to Mr. Gelbort, CBOE Rule 8.2(a) provides

[[Page 37193]]

the Exchange with the authority to deny market maker registration for 
insufficient ability. In addition, according to Mr. Gelbort, CBOE Rule 
8.2(b) permits the MPC to suspend or terminate market maker 
registrations for incompetence. Further, Mr. Gelbort stated, CBOE Rule 
8.3 permits the MPC to suspend or terminate market maker appointments 
when the interests of a fair and orderly market are served. Finally, 
Mr. Gelbort described the authority granted to the MPC in CBOE 8.60 to 
hold informal meetings or hearings that may result in remedial actions 
against market makers and the disciplinary proceedings that the 
Exchange may institute under Chapter XVII of its rules.
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    \20\ CBOE Rule 8.7 sets forth the obligations of market makers. 
Pursuant to CBOE Rule 8.7, market makers are required, among other 
things, to execute transactions that constitute a course of dealings 
that are reasonably calculated to contribute to the maintenance of a 
fair and orderly market. Specifically, market makers are required, 
among other things, to compete with other market makers to improve 
markets, to make markets, to update market quotations in response to 
changed market conditions and to price options contracts fairly.
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    Mr. Gelbort also suggested that the proposed rule change might 
create inequities associated with its administration. Specifically, Mr. 
Gelbort raised concerns about the broad authority sought by the 
Exchange and questioned the apparent lack of numerical limits. Mr. 
Gelbort pointed out that the broad authority could result in the 
proposed rule being applied to exclude certain market makers in an 
arbitrary manner. He also questioned whether the proposed rule could be 
applied differently to market makers and DPMs.\21\ In addition, Mr. 
Gelbort suggested that because the Exchange has the authority to compel 
market maker participation on RAES whenever a market maker is present 
in the crowd during an expiration cycle after the market maker has 
signed on to RAES once,\22\ that market makers would not be able to 
self-regulate his or her own RAES trading percentage. Further, Mr. 
Gelbort stated that the proposed rule would not encourage compliance 
with the marekt making obligations of CBOE Rule 8.7 in all classes 
allocated to a crowd.
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    \21\ As discussed above, DPMs have been specifically exempted 
from operation of the rule. See Amendment No. 3.
    \22\ See CBOE Rule 8.16(b).
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    Mr. Gelbort also questioned the effect of changing the phrase from 
``in that trading crowd'' to ``at the trading station'' in proposed 
Rule 8.16(a)(iv). Mr. Gelbort expressed concern that his change in 
language could allow a future MPC to interpret the phrase as 
prohibiting market makers standing in one part of the crowd from 
trading or participating on RAES in all classes allocated to the crowd. 
According to Mr. Gelbort, some DPMs arrange their stations to make it 
difficult for all market makers to trade in all of the classes 
allocated to the station and he questioned the significance of the 
language change.
    Finally, Mr. Gelbort stated that he believed that the proposed rule 
change is anticompetitive because he believes it condones disregard for 
the affirmative market making obligations and because it arbitrarily 
restricts the number of market makers who may choose to interact with 
RAES-eligible orders. Further, he believed that the Exchange should 
clarify the problems sought to be addressed by the proposal and to 
determine whether current Exchange rules adequately address these 
problems. If, however, the Exchange finds that the proposal is the best 
gauge for market maker performance, Mr. Gelbort believes that 
persistent non-compliance should be met with sanctions stronger than 
exclusion from RAES.
    The Exchange responded to Mr. Gelbort's comments in its Response 
Letter.\23\ The following summarizes the Response Letter.
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    \23\ See supra note 19.
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    The Exchange expressed its strong disagreement with Mr. Gelbort's 
suggestion that is proposal was an indication of its inability to 
enforce CBOE Rule 8.7. According to the Exchange, the proposal should 
not be read to suggest that it lacks the ability to enforce compliance 
with CBOE Rule 8.7, but should be considered as an additional incentive 
for market makers to meet their market making obligations. The Exchange 
explained that it utilizes a number of current rules to ensure 
compliance by its market makers. For example, the Exchange stated that 
it conducts semi-annual crowd evaluations pursuant to CBOE Rule 8.60 
during which the MPC speaks to each member of a trading crowd to 
explain the obligations of market makers. These reviews have led to 
some trading crowds being restricted in new product allocations and 
have led to referrals to the Department of Market Regulation for 
appropriate action when it appears that individual market makers are 
performing below standard.
    The Exchange also stated that it evaluates the performance of 
individual market makers. The Exchange reviews, on a quarterly basis, 
whether a market maker is complying with the trading volume 
requirements of Interpretation .03 of CBOE Rule 8.7.\24\ The Exchange 
stated that the MPC takes progressive remedial actions against market 
makers for violations of these provisions. In conjunction with the 
MPC's review, the Department of Market Regulation reviews the 80 
percent in-person requirement.\25\ According to the Exchange, these 
reviews seek to ensure that market makers trade in the appointed 
options. If a market maker is not performing, remedial actions may be 
taken.
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    \24\ Interpretation .03A of CBOE Rule 8.7 requires a market 
maker to transact 75 percent of his or her total contract volume in 
options classes to which he or she has been appointed. 
Interpretation .03B of CBOE Rule 8.7 requires a market maker to 
execute at least 25 percent of his or her total transactions in 
person, and not through the use of orders, provided, however, that 
for any calendar quarter in which a market maker receives market 
maker treatment of off-floor orders, the market maker must execute 
in person, and not through the use of orders, 80 percent of his or 
her total transactions.
    \25\ Id.
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    Moreover, according to the Exchange, applications of potential 
market makers are reviewed. The Exchange's Membership Committee reviews 
all market maker applications, pursuant to CBOE Rule 8.2(a) and Chapter 
III of the Exchange's rules. All market maker applicants must 
successfully complete an examination that measures competence and 
qualifications. Further, all applicants must attend educational 
training.
    In response to Mr. Gelbort's assertion that the proposal may be 
inequitably administered because of the broad authority of the MPC to 
set applicable percentages, the Exchange stated that this flexibility 
was necessary because the MPC does not yet have experience with setting 
such limitations. Further, the Exchange believes that the flexibility 
will enable the MPC to apply appropriate to each class and to exempt 
trading days as necessary. The Exchange stated that the administration 
of the rule would not be arbitrary because the same percentages for a 
particular class will apply to all market makers. Moreover, members 
economically aggrieved by any MPC decision will be able to appeal such 
decision pursuant to Chapter XIX of the Exchange's rules.
    The Exchange disagreed with Mr. Gelbort's assertion that market 
makers will be unable to effectively regulate their percentage of RAES 
trades. While it is true that a market maker is obligated to log on to 
RAES in specified circumstances, which prevents the market maker from 
regulating the number of his or her RAES trades, the Exchange believes 
that a market maker can regulate the number of non-RAES trades by 
making competitive markets and aggressively competing for order flow. 
Thus, the Exchange believes that market makers can regulate the 
percentage of his or her RAES trades by monitoring his or her non-RAES 
trades. Moreover, the Exchange states that the MPC's authority to 
exempt certain

[[Page 37194]]

trading days should prevent market makers from failing to satisfy the 
tests due to unusual market conditions.
    In response to Mr. Gelbort's assertion that the proposal would not 
encourage compliance with the obligation imposed on market makers to 
make markets in all series of options classes at the trading station, 
the Exchange states the proposal was not intended for such a purpose. 
According to the Exchange, the proposed rule change was not meant to 
encourage compliance with this market maker obligation and that other 
Exchange rule serve this purpose.
    Regarding the proposed change in language from ``in the trading 
crowd'' to ``at the trading station,'' the Exchange states the terms 
``station'' and ``trading crowd'' are synonymous, pursuant to 
Interpretation .01 to CBOE Rule 8.8. Thus, a future MPC could not 
change this Interpretation without first submitting a proposed rule 
change to the Commission for approval.
    The Exchange believes that the proposal should provide market 
makers with an incentive to compete when they are signed onto RAES 
because failure to actively fulfill their market obligations under CBOE 
Rule 8.7 could lead to sanctions. The Exchange believes that the 
proposal complements the other objectives tests to ensure that a market 
maker fulfills his Rule 8.7 obligations. Further, the Exchange does not 
believe that the proposal will limit the number of market makers who 
will be able to actively engage in making markets in their appointed 
classes. Rather, the Exchange believes that the proposal encourages 
compliance with CBOE Rule 8.7 and promotes active competition among 
market makers.
    Finally, the Exchange agrees with Mr. Gelbort's observation that 
persistent non-compliance with the proposal should be met with a 
stronger sanction than expulsion from RAES. According to the Exchange, 
suspension from RAES is only one of the alternative sanctions that may 
be imposed pursuant to proposed paragraph (d) of CBOE Rule 8.16. 
Specifically, if a member repeatedly violates the proposed rule, the 
MPC may refer the violations to the Department of Market Regulation for 
an investigation of the market maker's compliance with CBOE Rule 8.7 
generally.

2. Letco Letters

    Letco submitted two letters to the Commission in response to the 
proposed rule change.\26\ In both letters, Letco expressed concern 
about some of the administrative applications of the proposal. 
Specifically, the commenter questioned the application of the proposal 
with respect to DPMs. As discussed above, subsequent to these comment 
letters, the Exchange amended the proposal to exempt DPMs from the 
proposal rule.\27\ Thus, the commenter's concerns regarding DPMs are 
moot.
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    \26\ See Letco Letter Nos. 1 and 2, supra note 4.
    \27\ See Amendment No. 3.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\28\ In particular, the Commission finds that the proposal is 
consistent with the requirements of Section 6(b)(5) \29\ of the Act, 
which requires, among other things, that the rules of an exchange be 
designed to promote just and equitable principals of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and in general, to protect investors and the 
public interest.
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    \28\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \29\ 15 U.S.C. 78f(b)(5).
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    Currently, CBOE Rule 8.16 does not contain any eligibility 
requirements for participating on RAES that is related to a market 
maker's trading activity. The Exchange stated that it had learned that 
some market makers on the floor have relied on their RAES participation 
to derive a large percentage of their profits and have not been 
affirmatively fulfilling their market making obligations as set forth 
in CBOE Rule 8.7. The Exchange explained that RAES was never intended 
to be a substitute to the normal operation of a traditional market 
making business. However, it became apparent to the Exchange that 
participation on RAES had led some market makers to cease to perform 
their obligations under CBOE 8.7.
    To address these problems, the Exchange developed the proposed 
eligibility requirements. With these requirements, the Exchange seeks 
to ensure that market makers affirmatively make markets in their 
allocated classes. The proposal seeks to prevent market makers from 
relying on order flow from RAES without actively seeking order flow on 
the floor of the Exchange.
    Pursuant to CBOE Rule 8.7, market makers have specified obligations 
that must be fulfilled. Generally, market makers are required to enter 
into transactions that constitute a course of dealings ``reasonably 
calculated to contribute to the maintenance of a fair and orderly 
market.'' Further, market makers are obligated to continuously engage 
in dealing for their own accounts when a lack of price continuity 
exists or when there is a temporary disparity between supply and demand 
for a particular contract, or when a temporary distortion of the price 
relationships exists between options contracts of the same class. In 
addition, market makers are specifically required to: (i) complete with 
other market makers to improve markets; (ii) make markets, which will 
be honored to a reasonable number of contracts in all series of options 
classes at the trading post; (iii) update market quotations in response 
to changed market conditions; and (iv) price options contracts fairly, 
within certain perimeters.
    As described above, market makers have many important obligations 
that create a viable marketplace for options contracts, and perform 
functions that contribute to fair and orderly markets, as well as to 
liquidity. If market makers are not actively performing these 
obligations, the integrity of the marketplace is compromised. Customers 
expect that when they send an order to the CBOE floor that it will be 
treated in a manner consistent with the requirements of the CBOE rules, 
and when market makers fail to fulfill their obligations, customers can 
be negatively impacted.
    If market makers are failing to fulfill their obligations as the 
Exchange described, the market for those securities can be adversely 
affected because there is not competition from all of the market makers 
in the trading crowd. This lack of total involvement by the crowd could 
lead to inferior pricing of customer orders, and could affect 
liquidity. Moreover, customer orders may be executed in a less timely 
manner.
    Thus, the Commission is satisfied that the proposal addresses these 
concerns in a manner that is consistent with the Act. Under the 
proposal, in a particular calendar quarter market makers will be 
limited in the proportion of RAES transactions that may make up their 
total transactions and total contract volume. As proposed, the MPC may 
determine for a particular options class to limit each market maker's 
transactions and contract volume attributed to trades on RAES to a 
maximum percentage of each market maker's total transactions and 
contract volume. The MPC will determine two percentages, one will 
establish a maximum percentage of a market maker's total transactions 
for the quarter that may be derived from RAES transactions; the other 
will establish the

[[Page 37195]]

maximum contract volume that may be derived from a market maker's RAES 
transactions. Neither of these percentages may be less than 15 percent.
    The Commission believes that these percentages should encourage 
market makers to actively fulfill their market making obligations. A 
market maker allocated options that are subject to these percentages 
requirements is more likely to participate in the floor market because 
its passive participation by signing onto RAES will be limited based on 
the market maker's non-RAES transactions. In this way, the proposed 
rule should act as an incentive to market makers to fulfill their 
obligations because those who fail to keep their RAES percentage within 
the maximum percentages will be subject to sanctions, including 
suspension of RAES participation.
    The Commission is satisfied with the 15 percent floor that has been 
established in the rule. This provision limits the discretion of the 
MPC by preventing the MPC from establishing percentages that may be too 
low, and recognizes the importance of technology in Exchange 
operations. Today, a large amount of orders are routed to RAES for 
automatic execution.\30\ Thus, an unduly restrictive percentage may 
have unintended consequences that compromise order flow and trading 
operations. This floor percentage is intended to strike a balance 
between establishing reasonable percentages to encourage market-makers 
to fulfill their obligations on the floor while also recognizing the 
amount of order flow that is routed to the RAES system for execution. 
The Commission expects that the Exchange will monitor the percentages 
established by the MPC to ensure that this balance is preserved.
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    \30\ According to the Exchange, approximately 34% of its order 
executions take place in RAES.
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    The proposal will only be implemented in those options classes that 
the Exchange has identified as having market makers that are not 
actively fulfilling their market making obligations. The Commission 
believes that this limitation is appropriate and consistent with the 
Act. There would not be any reason to impose such limitations on market 
makers who are already actively making markets in their allocated 
options classes. This proposal provides the MPC with a remedial measure 
that can be imposed when a problem is identified.
    The MPC will have the authority to determine the options classes in 
which market makers will be subject to the percentage limitations. In 
determining whether to impose the percentage requirements on a 
particular options classes, the MPC will consider factors such as 
complaints from floor brokers or other market makers that certain 
market makers performance surveys, data concerning the percentage of 
RAES trades performed by particular market makers, and other relevant 
factors. The Commission believes that these factors provide the MPC 
with the appropriate amount of discretion. Because the MPC will 
consider only relevant data, the limitations on the proportion of RAES 
trades to a market maker's total trades should only be applied to those 
options classes that are experiencing market maker problems. The 
Commission believes that this discretion should provide the MPC with 
flexibility to implement the eligibility requirements where needed, 
while also preventing the implementation of these requirements in 
classes that do not have such a need.
    The MPC, at the end of each quarter, will have the authority to 
exclude from the percentage calculations trading days that may have 
experienced an unusually high percentage of RAES transactions when 
compared to normal trading days. In making this decision, the MPC, 
however, will not be able to identify individual market makers. Thus, 
the MPC will not be able to make these decisions based on any market 
maker's identity or volume. This anonymity should help to ensure that 
the process of excluding days is fair.
    As described above, the Commission received three comment letters 
from two commenters regarding the proposal. The Commission believes 
that the Exchange adequately addressed the commenters concerns. 
Specifically, the Commission believes that the proposal does not 
reflect upon the Exchange's ability to enforce its market making 
obligations. Rather, the Commission believes that the proposal should 
enhance the existing regulatory structure of the Exchange. In addition, 
the Commission is satisfied with the Exchange's assertion that its 
rules already specifically define the terms ``in that trading crowd'' 
and ``at the trading station'' as synonymous, and the Commission 
further agrees that such definitions could only be amended by a rule 
change approved by the Commission.
    The Commission disagrees with Mr. Gelbort's assertion that the 
proposal is anticompetitive because it condones disregard for 
affirmative market making obligations and because it arbitrarily 
restricts the number of market makers that may interact with RAES-
eligible orders. On the contrary, the Commission believes that the 
proposal should encourage market makers to vigorously make markets in 
their appointed classes. Moreover, the Commission does not believe that 
the proposal arbitrarily restricts the number of RAES-eligible market 
makers that may interact with RAES transactions because all market 
makers will be able to continue to interact with RAES orders so long as 
their businesses do not place an over-reliance on RAES transactions to 
the detriment of the business on the floor. Market makers that fulfill 
their market making obligations on the floor, as well as in RAES, 
should not be prevented from participating in either trading forum.
    Finally, as discussed above both commenters expressed concerns 
about how the proposal would apply to DPMs. The Exchange has addressed 
these concerns by exempting DPMs from operation of the rule. DPMs have 
additional responsibilities along with making markets, such as 
maintaining the book, participating at all times in automated execution 
and order handling systems, and responding to competitive developments 
in areas of market quality and customer service.\31\ Thus, a DPM is 
unable to rely primarily on RAES trades to operate profitably. 
Therefore, imposing the eligibility requirements on DPMs would be 
unwarranted.
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    \31\ See CBOE Rules 8.80 and 8.81.
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    The Commission finds good cause to accelerate approval of Amendment 
Nos. 1, 2, 3, 4 and 5 to the proposed rule change prior to the 
thirtieth day after the date of publication of notice thereof in the 
Federal Register.
    In Amendment No. 1, the Exchange proposed to prohibit the MPC from 
requiring that market makers' transaction or contract volume from RAES 
executions be less than 15 percent of their total transaction or 
contract volume. By placing a floor on the percentage of a market 
maker's total transaction and contract volume that it must execute 
otherwise than on RAES, the Commission believes that the changes 
proposed in Amendment No. 1 preclude the MPC from establishing 
eligibility requirements that could actually harm the operations of the 
floor and the business of the market makers. The Exchange also proposed 
to apply these market makers eligibility requirements on a quarterly 
basis. Finally, the Exchange proposed two sets of guidelines for the 
MPC. The first set of guidelines will be used by the MPC to determine 
which days to exclude from the eligibility calculations. The Commission 
believes that these proposed guidelines strengthen the proposal by 
preventing the MPC from

[[Page 37196]]

considering inappropriate information that could lead to uneven or 
potentially discriminatory application of the eligibility requirements. 
The second set of guidelines set forth the factors to be considered by 
the MPC, pursuant to Interpretation .01, in determining whether to 
apply the eligibility requirements to fewer than all the option classes 
traded at a trading station. The second set of guidelines was 
eliminated by the CBOE in a subsequent amendment.\32\
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    \32\ See Amendment No.5
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    The Commission believes that the proposals in Amendment No. 1 
enhance the proposed rule change. For these reasons the Commission 
believes that good cause exists, consistent with Section 6(b)(5) \33\ 
and Section 19(b) \34\ of the Act, to accelerate approval of Amendment 
No. 1 to the proposed rule change.
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    \33\ 15 U.S.C. 78f(b)(5).
    \34\ 15 U.S.C. 78s(b).
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    In Amendment No. 2, the Exchange proposed to limit the application 
of the proposed rule to options classes identified as having market 
makers that trade an inordinate percentage of their trades on RAES. The 
Commission believes that allowing the Exchange to limit application of 
the proposal to only certain options classes will reduce the potential 
for undue burdens to be placed on those options classes that are 
trading without problems and that have market makers that are actively 
fulfilling their market making obligations. In addition, the Exchange 
further explained why it believes that its proposal sufficiently 
protects against the MPC discriminating against or in favor of any 
parties when exercising its discretion to exclude certain days from the 
percentage calculations. The Commission is satisfied that the proposal 
prevents the MPC from applying the eligibility requirements in a 
discriminatory fashion. In particular, the Commission believes that, 
because the data upon which the MPC will base its decision to exclude 
certain days from the calculation of the eligibility requirement will 
not identify individual market makers, the MPC will not be able to make 
such decisions based upon the businesses of the individual market 
makers on those days. For these reasons, the Commission believes that 
Amendment No. 2 is consistent with the Act and that good cause exists 
to accelerate its approval.
    The Commission believes that good cause exists, pursuant to Section 
6(b)(5) \35\ and Section 19(b) \36\ of the Act, to accelerate approval 
of Amendment No. 3 to the proposed rule change. In Amendment No. 3, the 
Exchange proposed to exempt DPMs from the eligibility requirements. The 
Commission believes that in light of the additional responsibilities 
that DPMs must fulfill and due to the fact that these additional 
responsibilities are required by specific CBOE rules, that it is 
reasonable to exempt DPMs from the eligibility requirements.
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    \35\ 15 U.S.C. 78f(b)(5).
    \36\ 15 U.S.C. 78S(b).
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    The Commission believes that good cause exists, pursuant to Section 
6(b)(5) \37\ and Section 19(b) \38\ of the Act, to accelerate approval 
of Amendment No. 4 to the proposed rule change. Amendment No. 4 was 
technical in nature and only sought to correct the proposed rule 
language submitted in Amendment No. 3 to make it consistent with the 
proposed rule language submitted in Amendment No. 2.
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    \37\ 15 U.S.C 78f(b)(5).
    \38\ 15 U.S.C. 78s.
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    Finally, in Amendment No. 5, the Exchange deleted proposed factors 
that were no longer applicable after the submission of Amendment No. 2. 
Specifically, in Amendment No. 2, the Exchange proposed to only apply 
the percentage requirements to those options classes that had a 
demonstrated need for the limitations. The factors the Exchange 
proposes to delete in Amendment No. 5 were to be used by the MPC to 
determine if options classes should be exempt from the percentage 
requirements. Because the proposal now only applies the percentage 
requirements to those options classes with a demonstrated need, these 
factors are no longer appropriate. In addition, the Exchange proposed 
to add factors to be used by the MPC to determine which options classes 
should be subject to the percentage requirements. The Commission 
believes that the factors, as described above, provide the Exchange 
with appropriate discretion to determine which options should be 
subject to the limitations. Therefore, the Commission believes that 
good cause exists, pursuant to Section 6(b)(5) \39\ and Section 19(b) 
\40\ of the Act, to accelerate approval of Amendment No. 5.
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    \39\ 15 U.S.C. 78f(b)(5).
    \40\ 15 U.S.C. 78s(b).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 1, 2, 3, 4, and 5, including 
whether Amendment Nos. 1, 2, 3, 4 and 5 are 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 in the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-97-37 and should be 
submitted by July 5, 2000.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\41\ that the amended proposed rule change (SR-CBOE-97-37) is 
approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\42\
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    \41\ 15 U.S.C. 78s(b)(2)
    \42\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14850 Filed 6-12-00; 8:45 am]
BILLING CODE 8010-01-M