[Federal Register Volume 65, Number 221 (Wednesday, November 15, 2000)]
[Notices]
[Pages 69082-69084]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-29187]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43517; File No. SR-CBOE-99-51]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 1 by the Chicago Board Options 
Exchange, Inc. Relating to the Maximum Size of Option Orders Eligible 
for Automatic Execution

November 3, 2000.

I. Introduction

    On September 1, 1999, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with 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 amending its rules regarding the 
automatic execution of options orders to increase the maximum number of 
contracts eligible to be executed on the Exchange's Retail Automatic 
Execution System (``RAES'') from fifty contracts to seventy-five 
contracts. Notice of the proposal was published in the Federal Register 
on June 21, 2000.\3\ The Commission received no comments on the 
proposal. On October 3, 2000, the Exchange submitted Amendment No. 1 to 
the proposal.\4\ This order approves the proposal and grants 
accelerated approval of Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 42930 (June 13, 
2000), 65 FR 38618 (June 21, 2000).
    \4\ See letter from Timothy Thompson, Assistant General Counsel, 
Legal Department, CBOE, to Gordon Fuller, Special Counsel, Division 
of Market Regulation, Commission, dated September 29, 2000. 
(``Amendment No. 1'').
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II. Description of the Proposal

    RAES automatically executes public customer market and marketable 
limit orders that fall within designated order size parameters. 
Generally, the maximum size of public customer market and marketable 
limit orders eligible for automatic execution through the RAES is fifty 
contracts.\5\ The Exchange proposes to increase from fifty contracts to 
seventy-five contracts the maximum size of orders for equity options 
and certain classes of index options that are eligible to be executed 
through RAES.\6\ In addition, the Exchange seeks to make certain 
complementary changes to the Exchange's firm quote rule and 
Interpretation .03 thereunder.\7\
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    \5\ Options subject to the fifty contract maximum include all 
classes of equity options, all classes of sector index options and 
all other classes of index options, except options on the S&P 500 
Index, options on the Nasdaq 100 Index, options on the Dow Jones 
Industrial Average (``DJIA''), options on the High Yield Select Ten, 
and interest rate options. The RAES eligibility maximum is currently 
100 contracts for options on the S&P 500 Index, the Nasdaq 100 
Index, the DJIA, the High Yield Select Ten, and interest rate 
options. See Securities Exchange Act Release No. 41821 (September 1, 
19999), 64 FR 50313 (September 16, 1999).
    \6\ The proposed increase to seventy-five contracts will not 
apply to those classes of index options cited in footnote 5 above.
    \7\ See CBOE Rule 8.51.
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    The Exchange notes that increasing the maximum size of orders 
eligible for execution through RAES to seventy-five contracts will not 
permit orders up to this size to be entered into RAES unless, for a 
particular options class, the appropriate Floor Procedure Committee 
(``FPC'') of the Exchange has determined, in its discretion, not to 
restrict the size of eligible orders in that options class.\8\ In 
addition, the Exchange represents that increasing automatic execution 
levels should provide the benefits of automatic execution to a larger 
number of customer orders. Further, the Exchange represents that RAES 
affords prompt and efficient executions at the CBOE displayed price or, 
in most cases, at the National Best Bid or Offer (``NBBO'') if the NBBO 
is better than the CBOE's displayed bid or offer.\9\
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    \8\ See CBOE Rule 6.8(e).
    \7\ See CBOE Rule 6.8, Interpretation .02.
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    The Exchange notes that its rules contain several safeguards to 
ensure the proper handling of RAES orders, even as the maximum order 
size is increased. First, the Commission has approved the 
implementation of variable RAES on the CBOE.\10\ Variable RAES allows 
market makers to specify the maximum size of orders that they are 
willing to trade at any one time on RAES; however, this determination 
is subject to a minimum size that may be established by the appropriate 
FPC. Variable RAES was proposed to ensure that market makers are 
willing to continue participating on RAES even as the maximum contract 
size is increased. The Exchange represents that the appropriate FPC 
will likely implement Variable RAES in any options class that has a 
contract limit of seventy-five contracts to ensure that there is 
adequate market-maker participation in that class.
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    \10\ See supra note 5 (citing to the order implementing Variable 
RAES on the CBOE).
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    Second, the Exchange requires Designated Primary Market-Makers 
(``DPMs'') to participate in any automated execution system which may 
be open in appointed option classes.\11\ Further, Interpretation .07 to 
CBOE Rule 8.7 states that market makers are expected to participate in 
and support Exchange-sponsored automated programs, including but not 
limited to, RAES. The Exchange is in the process of assigning a large 
percentage of its option classes that were formerly traded in market-
maker crowds to DPMs.\12\
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    \11\ See CBOE Rule 8.85(a)(9).
    \12\ All equity options have now been assigned to DPMs. 
Telephone conversation between Timothy Thompson, Director-Regulatory 
Affairs, CBOE, and Gordon Fuller, Special Counsel, Commission, on 
March 9, 2000.
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    Third, the Exchange's rules allow for RAES to be suspended when a 
fast market has been declared in order to maintain a fair and orderly 
market.\13\ CBOE Rule 6.6(b)(vi) provides the Exchange with the 
flexibility to intervene if it determines that there is inadequate 
market maker participation or capital requirements. In addition, CBOE 
Rule 8.16(b) requires a market maker who has logged onto RAES at any 
time during an expiration month to log onto RAES in that option class 
whenever he is present in the trading crowd until the next expiration. 
Further, CBOE Rule 8.16(c) provides that Floor Officials of the 
appropriate Market Performance Committee may require market makers who 
are members of the trading crowd to log on to RAES absent reasonable 
justification or excuse for nonparticipation if there is inadequate 
participation on RAES. Alternatively, the Floor Officials may allow 
market makers in other classes of options to log on to RAES in such 
classes.
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    \13\ See CBOE Rule 6.6(b)(vi).
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    Finally, the Exchange notes that its rules provide a minimum net 
capital requirement regarding DPMs, which is currently set forth in 
CBOE Rule 8.86. Further, the clearing firms for market makers and DPMs 
perform risk management functions to ensure that the market makers have 
sufficient financial resources to cover their positions throughout the 
day.
    In addition to increasing the maximum size for RAES-eligible orders 
in certain classes of options, the Exchange proposes to amend its firm 
quote rule, CBOE Rule 8.51. Currently,

[[Page 69083]]

the firm quote requirement may not be less than the RAES contract limit 
applicable to that class of options. The Exchange proposes to amend 
CBOE Rule 8.51(a) to provide that if the RAES contract limit is 
established at a level of higher than fifty contracts, then the firm 
quote requirement will remain at fifty contracts. The Exchange believes 
that because, for the most part, the RAES contract limit and the firm 
quote limit are of comparable levels on the CBOE, a firm representing a 
customer will always receive firm quote protection to the extent of 
fifty contracts.\14\
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    \14\ For the remainder of the order in excess of fifty 
contracts, the trading crowd will attempt to fill the order at the 
same price as the first fifty contracts. Telephone conversation 
between Timothy Thompson, Assistant General Counsel, Legal 
Department, CBOE, and Gordon Fuller, Special Counsel, Division of 
Market Regulation, Commission, on October 30, 2000. An order entered 
into RAES can trade directly with an order on the Exchange's 
customer limit order book in those cases where the prevailing market 
bid or offer is equal to the best bid or offer on the Exchange's 
book. See Securities Exchange Act Release No. 41995 (October 8, 
1999), 64 FR 56547 (October 20, 1999).
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    The Exchange also proposes to change Interpretation .03 to CBOE 
Rule 8.51. Interpretation .03 to CBOE Rule 8.51 currently provides that 
orders for accounts exempted from the firm quote requirement should not 
be reflected in the displayed quote when those orders are for less than 
the firm quote requirement applicable for that class of options and are 
represented in the crowd by a Floor Broker or DPM.\15\ With respect to 
broad-based index option classes, the Exchange proposes to change this 
requirement such that orders represented in the crowd by a Floor Broker 
or DPM for less than the firm quote requirement need not be reflected 
in the displayed market quote.\16\ In addition, with respect to classes 
other than broad-based index options, orders for less than ten 
contracts need not be reflected in the displayed quote.\17\ Thus, the 
DPM or another member of the trading crowd may determine to reflect the 
price of a market-maker or proprietary broker-dealer order in the 
displayed market quote even if that order is for less than the firm 
quote requirement for broad-based index options, or if the order is for 
less than ten contracts for all other options classes.\18\ Once the 
price of such an order is reflected in the displayed market quote, the 
trading crowd would be subject to the firm quote obligations of CBOE 
8.52(a)(2) even though the firm quote limit may be greater than the 
size of the displayed market-maker or proprietary broker-dealer order. 
By reflecting the price of that order in the quote, the trading crowd 
will be obligated to sell (buy) at least the established firm quote 
limit for that option class at the approved offer (bid) which the crowd 
determined to display when a buy (sell) order reaches the trading 
station where the particular option class is located for trading (as 
long as the improved bid or offer remains displayed), even though the 
firm quote limit will be greater than the size of the market-maker 
order or other proprietary broker-dealer order.\19\ Furthermore, any 
RAES order that is entered while that improved price is displayed will 
be executed at that improved price even if that order is for more 
contracts than was the size of the displayed market-maker or 
proprietary broker-dealer order.\20\ The CBOE represents that this 
change should ensure that any broker-dealer order represented in the 
crowd will be represented in the Exchange's quote and thus may become 
the basis for a quote at which an order may be executed. The Exchange 
represents that it will conduct further review to determine whether to 
include broad-based index option classes under the proposed change in 
the future.
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    \15\ In Amendment No. 1, the Exchange made technical changes to 
the proposed rule text to conform with recent amendments to 
Interpretation .03. See Securities Exchange Act Release No. 42558 
(March 22, 2000), 65 FR 16676 (March 29, 2000).
    \16\ See Amendment No. 1, supra note 4.
    \17\ Id.
    \18\ Id.
    \19\ See CBOE Rule 8.51(a)(2).
    \20\ See CBOE Rule 6.8(a)(ii). Of course, pursuant to the terms 
of Interpretation .02 to Exchange Rule 6.8, the RAES order may 
instead be filled at the NBBO if the NBBO is no more than the 
designated number of ticks better than the CBOE best bid or offer, 
or the order may be rejected for manual handling if the NBBO is more 
than the designated number of ticks better than the CBOE best bid or 
offer. The appropriate FPC has determined that the designated number 
of ticks shall be one tick.
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    The Exchange represents that its systems capacity is sufficient to 
accommodate the increased number of automatic executions anticipated to 
result from the implementation of this proposal. The Exchange believes 
that automatic execution of orders for up to seventy-five contracts 
will provide customers with quicker executions for a larger number of 
orders, by providing automatic rather than manual executions, thereby 
reducing the amount of orders subject to manual processing.

III. 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 
and, in particular, the requirements of section 6 of the Act.\21\ Among 
other provisions, section 6(b)(5) of the Act requires that the rules of 
an exchange be designed to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating securities transactions; 
remove impediments to and perfect the mechanism of a free and open 
market and a national securities system; and protect investors and the 
public interest.\22\
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    \21\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \22\ 15 U.S.C. 78f(b)(5).
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    While increasing the maximum order size limit from fifty contracts 
to seventy-five contracts for RAES eligibility by itself does not raise 
concerns under the Act,\23\ the Commission believes that this increase 
raises collateral issues that the CBOE will need to monitor and 
address. Increasing the maximum order size for particular option 
classes will make a larger number of option orders eligible for the 
Exchange's automatic execution system. These orders may benefit from 
greater speed of execution, but at the same time create greater risks 
for market maker participants. Market makers signed onto the RAES 
system will be exposed to the financial risks associated with larger-
sized orders being routed through the system for automatic execution at 
the displayed price. When the market for the underlying security 
changes rapidly, it may take a few moments for the related option's 
price to reflect that change. In the interim, customers may submit 
orders that try to capture the price differential between the 
underlying security and the option. The larger the orders accepted 
through RAES, the greater the risk market makers must be willing to 
accept. The Commission does not believe that, because the Exchange's 
appropriate FPC determines to approve orders as large as seventy-five 
contracts as eligible for RAES, the FPC or any other CBOE committee or 
officials should disengage RAES more frequently by, for example, 
declaring a ``fast'' market. Disengaging RAES can negatively affect 
investors by making it slower and less efficient to execute their 
option orders. It is the Commission's view that the Exchange, when 
increasing the maximum size of orders that can be sent through RAES, 
should not disadvantage all customers--

[[Page 69084]]

the vast majority of which enter orders for less than seventy-five 
contracts--by making the RAES system less reliable.
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    \23\ The Commission notes that it is concurrently approving 
similar proposals filed by the American Stock Exchange, LLP 
(``Amex''), the Pacific Stock Exchange, Inc. (``PCX''), and the 
Philadelphia Stock Exchange, Inc. (``Phlx''). See Securities 
Exchange Act Release Nos. 43516 (November 3, 2000) (SR-Amex-99-45); 
43518 (November 3, 2000) (SR-PCX-00-32); and 43515 (November 3, 
2000) (SR-Phlx-99-32).
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    Finally, the Commission finds good cause for approving Amendment 
No. 1 prior to the 30th day after notice of the Amendment is published 
in the Federal Register pursuant to section 19(b)(2) of the Act.\24\ 
Amendment No. 1 makes technical changes to the proposed rule text to 
reflect changes to Interpretation .03 to Rule 8.51 made in the filing 
of the proposed change. In addition, Amendment No. 1 clarifies that the 
DPM or another member of the trading crowd may determine to reflect the 
price of a market maker or other proprietary broker-dealer order in the 
displayed quote, even if that order is for less than the firm quote 
requirement (in the case of broad-based index options) or if the order 
is for less than ten contracts (in the case of all other option 
contracts.) \25\ The Commission believes that the proposal may increase 
price transparency at the Exchange by expanding the kinds of orders 
eligible to be reflected in the Exchange's displayed quote. The 
Commission finds that accelerated approval of Amendment No. 1 is 
appropriate in order to permit the opportunity for increased 
transparency for market-maker orders or other proprietary broker-dealer 
orders.
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    \24\ 15 U.S.C. 78s(b)(2).
    \25\ See Amendment No. 1, supra note 4.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether it is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying 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-99-51 and should be 
submitted by December 6, 2000.

Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with section 6(b)(5). \26\
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    \26\ 15 U.S.C. 78f(b)(5).
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    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CBOE-51) is approved, and 
Amendment No. 1 is approved on an accelerated basis.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority. \28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-29187 Filed 11-14-00; 8:45 am]
BILLING CODE 8010-01-M