Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75439

1For example, in August 1999, only 32% of

equity options classes were traded on more than

one exchange. By the end of September 2000, the

number of equity options classes that were

multiply-traded had risen to 45%. In addition,

aggregate options volume traded only on a single

exchange fell from 61% to 15% over this same

period.

2 In accepting orders and routing them to an

exchange for execution, brokers act as agents for

their customers and owe them a duty of best

execution. A broker’s duty of best execution is

derived from common law agency principles and

fiduciary obligations. It is incorporated both in selfregulatory organizations’ rules and in the antifraud

provisions of the federal securities laws through

judicial and Commission decisions. This duty

requires a broker to seek the most favorable terms

reasonably available under the circumstances for a

customer’s transaction. As a result, brokers must

periodically assess the quality of competing

markets. See Securities Exchange Act Release No.

37619A (September 6, 1996), 61 FR 48290

(September 12, 1996).

(2) A broker or dealer shall make the

report required by paragraph (b)(1) of

this section publicly available within

one month after the end of the quarter

addressed in the report.

(c) Customer requests for information

on order routing. (1) Every broker or

dealer shall, on request of a customer,

disclose to its customer the identity of

the venue to which the customer’s

orders were routed for execution in the

six months prior to the request, whether

the orders were directed orders or nondirected orders, and the time of the

transactions, if any, that resulted from

such orders.

(2) A broker or dealer shall notify

customers in writing at least annually of

the availability on request of the

information specified in paragraph (c)(1)

of this section.

(d) Exemptions. The Commission

may, by order upon application,

conditionally or unconditionally

exempt any person, security, or

transaction, or any class or classes of

persons, securities, or transactions, from

any provision or provisions of this

section, if the Commission determines

that such exemption is necessary or

appropriate in the public interest, and is

consistent with the protection of

investors.

Dated: November 17, 2000.

By the Commission.

Jonathan G. Katz,

Secretary.

[FR Doc. 00–30131 Filed 11–30–00; 8:45 am]

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 240

[Release No. 34–43591; File No. S7–17–00]

RIN 3235–AH96

Firm Quote and Trade-Through

Disclosure Rules for Options

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘SEC’’ or ‘‘Commission’’)

is adopting an amendment to Rule

11Ac1–1 under the Securities Exchange

Act of 1934 (‘‘Exchange Act’’) to require

options exchanges and options market

makers to publish firm quotes. The

Commission also is adopting new Rule

11Ac1–7 under the Exchange Act to

require a broker-dealer to disclose to its

customer when its customer’s order for

listed options is executed at a price

inferior to a better published quote and

what that better quote was, unless the

transaction was effected on a market

that is a participant in an intermarket

options linkage plan approved by the

Commission. These rules will facilitate

the ability of market participants to

obtain the best price for customer

orders.

EFFECTIVE DATE: February 1, 2001.

FOR FURTHER INFORMATION CONTACT:

Deborah Flynn, Senior Special Counsel,

at (202) 942–0075, Kelly Riley, Special

Counsel, at (202) 942–0752, John

Roeser, Attorney, at (202) 942–0762,

Terri Evans, Special Counsel, at (202)

942–4162, and Heather Traeger,

Attorney, at (202) 942–0763, Division of

Market Regulation, Securities and

Exchange Commission, 450 Fifth Street,

NW., Washington, DC 20549–1001.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Executive Summary

II. Background

A. Prior Attempts to Limit Intermarket

Trade-Throughs

B. Application of the Quote Rule in the

Options Market

III. Description of Proposed Rulemaking

A. Proposed Trade-Through Disclosure

Rule

B. Proposed Amendments to the Quote

Rule

IV. Discussion

A. Trade-Through Disclosure Rule

1. Minimum Requirements for Linkage

Plans

2. Mandatory Participation in a Linkage

Plan

3. Exception from Disclosure Requirement

for Block Trades

4. Definition of Trade-Through

a. OPRA Delays

b. Systems Malfunctions

c. Relief from Firm Quote Obligation

d. Thirty-Second Delay

e. Trades Not Excluded from the Definition

of Trade-Through

5. Compliance Date

B. Amendments to the Quote Rule

1. Collecting and Making Available

Quotation Sizes

2. Firm Quote Sizes for Customer and

Broker-Dealer Orders

3. Minimum Quote Size

4. Automatic Execution Systems

5. Exception During Trading Rotations

6. Thirty-Second Response

7. One-Percent Exception

8. Amendments to Defined Terms

9. Compliance Date

V. Paperwork Reduction Act

A. Use and Disclosure of the Information

Collected

B. Trade-Through Disclosure Rule

1. Capital Costs

2. Burden Hours

C. Amendments to the Quote Rule

1. Capital Costs

2. Burden Hours

VI. Costs and Benefits of Final Rules

A. Costs and Benefits of the Trade-Through

Disclosure Rule

1. Comments

2. Benefits

3. Costs

B. Costs and Benefits of Amendments to

the Quote Rule

1. Comments

2. Benefits

1. Costs

C. Conclusion

VII. Effects on Competition, Efficiency, and

Capital Formation

VIII. Final Regulatory Flexibility Analysis

A. Need for, and Objectives of, the Rules

B. Significant Issues Raised by Public

Comment

C. Small Entities Subject to the Rules

D. Projected Reporting, Recordkeeping, and

Other Compliance Requirements

E. Agency Action to Minimize Effect on

Small Entities

IX. Statutory Authority

I. Executive Summary

Recent increases in the multiple

listing of options classes previously

listed on a single exchange have

intensified the competition among the

option exchanges and heightened the

need to further integrate the options

markets into the national market system.

The marked increase in multiple trading

is indicative of the dynamic

environment in which the options

markets currently operate.1 While the

growth in multiple trading has

increased the competition between

markets, it also has dramatically altered

the environment in which options

market participants conduct their

trading. In particular, multiple trading

raises new best execution challenges for

brokers.2 When an option is listed on

only one exchange, brokers do not have

to decide where to route an order, and

consequently, satisfying their best

execution obligations is simpler than

when they must consider the relative

merits of routing an order to two or

more market centers. With as many as

five options exchanges currently trading

75440 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

3See Securities Exchange Act Release No. 42029,

64 FR 57674 (October 26, 1999) (‘‘October 19, 1999

Order’’). The October 19, 1999 Order directed the

American Stock Exchange LLC (‘‘Amex’’), Chicago

Board Options Exchange, Inc. (‘‘CBOE’’), Pacific

Exchange, Inc. (‘‘PCX’’), and Philadelphia Stock

Exchange, Inc. (‘‘Phlx’’) to act jointly in discussing,

developing, and submitting for Commission

approval an intermarket linkage plan. The

Commission’s Order also requested the

International Securities Exchange LLC (‘‘ISE’’) to

participate with the options exchanges in the

development of an intermarket linkage plan. The

ISE was subsequently registered as a national

securities exchange for options trading on February

24, 2000. See Securities Exchange Act Release No.

42455, 65 FR 11387 (March 2, 2000).

4See Securities Exchange Act Release No. 43086,

65 FR 48023 (August 4, 2000). As originally

approved, the Amex, CBOE, and ISE were the only

participants in the Linkage Plan.

5See Securities Exchange Act Release Nos. 43573

(November 16, 2000); and 43574 (November 16,

2000). The Commission issued orders to permit

Phlx and PCX to participate in the Linkage Plan.

6Exchange Act Rule 11Ac1–7, 17 CFR

240.11Ac1–7.

7See Securities Exchange Act Release No. 43085

(July 28, 2000), 65 FR 47918 (August 4, 2000)

(‘‘Proposing Release’’).

8Exchange Act Rule 11Ac1–1, 17 CFR

240.11Ac1–1.

9See Proposing Release, supra note 7.

10Exchange Act Rule 11Ac1–7, 17 CFR

240.11Ac1–7.

11Exchange Act Rule 11Ac1–1, 17 CFR

240.11Ac1–1.

12 15 U.S.C. 78k–1.;

13Pub. L. No. 94–29, 89 Stat. 97 (1975) (‘‘1975

Amendments’’). In the 1975 Amendments, Congress

directed the Commission to oversee the

development of a national market system. Congress

granted the Commission broad, discretionary

powers to oversee the development of a fully

integrated national market system for the processing

and settlement of securities transactions. See also

infra note 16.

14Section 11A(a)(1)(C) of the Exchange Act, 15

U.S.C. 78k–1(a)(1)(C).

15Section 11A(a)(1)(D) of the Exchange Act, 15

U.S.C. 78k–1(a)(1)(D).

16Senate Committee on Banking, Housing, and

Urban Affairs, Report to Accompany S. 249, S. Rep.

94–75, 94th Cong., 1st Sess. 7 (1975) (‘‘Senate

Report’’). See also Committee of Conference, Report

to Accompany S. 249, H.R. Rep. No. 94–229, 94th

Cong., 1st Sess. 2 (1975) (‘‘Conference Report’’).

17 Id.

18See Senate Report. See also Conference Report.

In the Conference Report, the Committee stated that

the unique characteristics of securities other than

common stocks may require different treatment in

a national market system.

19The two primary objectives of the 1975

Amendments were (1) ‘‘the maintenance of stable

and orderly markets with maximum capacity for

absorbing trading imbalances without undue price

movements,’’ and (2) ‘‘the centralization of all

buying and selling interest so that each investor

will have the opportunity for the best execution of

his order, regardless of where in the system it

originates.’’ See Senate Report.

20Section 11A(a)(2) of the Exchange Act

authorizes the Commission to designate, by rule,

securities qualified for trading in the national

market system. 15 U.S.C. 78k–1(a)(2).

certain options classes, brokers are

required to regularly and rigorously

evaluate the execution quality available

at each options exchange.

Directly relevant to a broker’s ability

to obtain best execution for its

customers is the ability to get the best

price available. The considerable growth

in the number of options classes traded

on more than one exchange has

significantly increased the likelihood

that an order may be executed at a price

that is inferior to a quoted price

available on another exchange

(‘‘intermarket trade-through’’).

According to preliminary data analyzed

by the Commission’s Office of Economic

Analysis, during the week of June 26,

2000, 5 percent of all trades in the 50

most active multiply-traded equity

options were executed at prices inferior

to the best price quoted on a competing

market. Currently, it is difficult to

ensure that a customer order sent to one

exchange will receive the best available

price because of the absence of fair

access and an efficient mechanism

allowing a market participant at one

exchange to reach a better price

published by another exchange. As a

result, better prices quoted on another

exchange do not always receive price

priority, and customer orders may

receive inferior executions.

Because of our concerns about the

increasing likelihood of intermarket

trade-throughs in the options markets,

on October 19, 1999, the Commission

issued an Order directing the options

exchanges to act jointly to file a national

market system plan for linking the

options markets.3 On July 28, 2000, the

Commission approved an intermarket

linkage plan proposed by three of the

options exchanges (‘‘Linkage Plan’’) 4

and subsequently, the other two

exchanges filed with the Commission

amendments to permit their

participation in the Linkage Plan. 5

In conjunction with its approval of

the Linkage Plan, the Commission

proposed a new rule, Exchange Act Rule

11Ac1–7 (‘‘Trade-Through Disclosure

Rule’’),6 to require a broker-dealer to

disclose to its customer when the

customer’s order for a listed option is

executed at a price inferior to a better

published quote and that better quote,

unless the transaction was effected on a

market that participates in an

intermarket linkage plan approved by

the Commission.7 In addition, the

Commission proposed to amend

Exchange Act Rule 11Ac1–1 (‘‘Quote

Rule’’) 8 to require options exchanges

and options market makers to publish

firm quotes. 9 These proposed rules

were intended to facilitate the ability of

market participants to obtain the best

price for customer orders without

mandating a specific linkage.

With the current expansion of

multiple trading in options, the

Commission is increasingly concerned

about intermarket trade-throughs of

customer orders. The Commission

believes that adoption of the new rule

and amendment to the Quote Rule are

necessary at this time to encourage the

removal of barriers to access to, and the

use of efficient vehicles to reach, better

prices on another market. Consequently,

as discussed below, the Commission

today is adopting the Trade-Through

Disclosure Rule 10 and amending the

Quote Rule,11 substantially as proposed,

with certain modifications

recommended by commenters.

II. Background

Section 11A of the Exchange Act,12

enacted as part of the Securities Acts

Amendments of 1975,13 sets forth

Congress’ findings concerning the

establishment of a national market

system. Congress found, among other

things, that it was in the public interest

and appropriate for the protection of

investors and the maintenance of fair

and orderly markets to assure the

availability to brokers, dealers, and

investors of quote and transaction

information.14 Congress also found that

linking all of the markets for qualified

securities would ‘‘foster efficiency,

enhance competition, increase the

information available to brokers,

dealers, and investors, facilitate the

offsetting of investors’ orders, and

contribute to best execution of such

orders.’’ 15

The national market system was

intended by Congress to potentially

encompass ‘‘all segments of corporate

securities including all types of

common and preferred stocks, bonds,

debentures, warrants, and options.’’ 16

Congress included all types of securities

because it believed that many of the

goals of a national market system, such

as the availability of information with

respect to price, volume, and

quotations, would be universally

beneficial.17

Congress did, however, recognize the

differences between the markets and

granted the Commission broad powers

to implement a national market system

without forcing all securities markets

into a single mold.18 Accordingly,

Congress granted the Commission the

authority to implement the objectives of

the 1975 Amendments,19 while

allowing the Commission to recognize

and classify markets, firms, and

securities in any manner appropriate or

necessary in the public interest or for

the protection of investors.20

Many of the national market system

initiatives were implemented in the

equities markets at a time when

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75441

21The trading of standardized options on

securities exchanges began in 1973 with the

organization of the CBOE as a national securities

exchange. See Securities Exchange Act Release No.

9985 (February 1, 1973) 1 S.E.C. Doc. 11 (February

13, 1973). Currently, Amex, CBOE, ISE, PCX, and

Phlx are the only national securities exchanges that

trade standardized options.

22 In October 1977, in response to allegations of

widespread manipulation in the market for

exchange-traded options, the Commission initiated

an investigation and special study of the options

markets. The result of the Commission’s

investigation was The Report of the Special Study

of the Options Markets, issued on December 22,

1978 (‘‘Options Study’’). Report of the Special

Study of the Options Markets to the Securities and

Exchange Commission, 96th Cong., 1st Sess.

(Comm. Print No. 96–IFC3, December 22, 1978)

(examining the major issues of market structure in

standardized options markets, including multiple

trading). In the Options Study, the Commission

acknowledged that Congress had intended to

include options in a national market system, and set

forth a number of issues to be explored before the

options markets could be fully integrated into the

national market system. Options Study at 1029–

1030. The Options Study delineated the following

as among the issues to be explored in the options

market: (1) A comprehensive quotation system for

the dissemination of firm quotes; (2) market linkage

and order routing systems to enable the best

execution of orders; (3) nationwide limit order

protection to ensure that agency orders receive

auction-type trading protections; and (4) off-board

trading restrictions. Subsequently, the Commission

approved, pursuant to Section 11A of the Exchange

Act and Rule 11Aa3–2 thereunder, a national

market system plan that collects and disseminates

consolidated quotes and trades for the options

markets, the Options Price Reporting Authority

(‘‘OPRA’’) Plan for Reporting of Consolidated

Options Last Sale Reports and Quotation

Information (‘‘OPRA Plan’’). See Securities

Exchange Act Release No. 17638 (March 18, 1981).

23The Commission has repeatedly called for

increased national market system initiatives in the

options markets. See Securities Exchange Act

Release No. 16701 (March 26, 1980), 45 FR 21426

(April 1, 1980) (deferring expansion of multiple

trading to afford the options exchanges an

opportunity to consider the development of market

integration facilities); Securities Exchange Act

Release No 22026 (May 8, 1985), 50 FR 20310 (May

15, 1985) (urging options market participants to

consider the development of market integration

facilities); Directorate of Economic and Policy

Analysis, ‘‘The Effects of Multiple Trading on the

Market for OTC Options’’ (November 1986); Office

of the Chief Economist, ‘‘Potential Competition and

Actual Competition in the Options Market’’

(November 1986); and Securities Exchange Act

Release No. 26871 (May 26, 1989), 54 FR 24058

(June 5, 1989) (requesting comment on three

measures, including an intermarket linkage). In

1989, the Commission adopted Exchange Act Rule

19c-5, which generally prohibits any exchange from

adopting rules limiting its ability to list any stock

options class because that options class is listed on

another exchange. See Securities Exchange Act

Release No. 26870 (May 26, 1989), 54 FR 23963

(June 5, 1989). In 1990, then Chairman Breeden

requested that the options exchanges develop an

intermarket linkage plan. See letter from Chairman

Breeden to the Registered Options Exchanges dated

January 9, 1990.

24 Id.

25 In the equity markets, the ITS Plan includes a

trade-through rule protecting displayed bids and

offers for ITS-eligible exchange-listed securities. See

Securities Exchange Act Release No. 17703 (April

9, 1981), 22 S.E.C. Doc. 707. In conformance with

the ITS Plan, each participating exchange and the

National Association of Securities Dealers

(‘‘NASD’’) has adopted rules that limit tradethroughs in exchange-listed securities. See

Securities Exchange Act Release No. 17704 (April

9, 1981), 46 FR 22520 (April 17, 1981). The NASD

submitted a proposed trade-through rule for

exchange-listed stocks, which the Commission

approved on May 6, 1982. See Securities Exchange

Act Release No. 18714, 47 FR 20429 (May 12, 1982).

On June 21, 1985, the Commission requested

comment on, among other things, the extent to

which securities listed on The Nasdaq Stock

Market, Inc. (‘‘Nasdaq’’) should be subject to tradethrough rules. See Securities Exchange Act Release

No. 22127 (June 21, 1985), 50 FR 26584 (June 27,

1985). In addition, in recently adopting

amendments to the ITS Plan to expand the linkage

to all listed securities, the Commission concluded

that the NASD should continue to consider

modifications to its existing trade-through rule to

cover non-ITS participants, but that such

modifications were not a precondition to approval

of the expanded linkage. See Securities Exchange

Act Release No. 42212 (December 9, 1999), 64 FR

70297 (December 16, 1999).

26See Securities Exchange Act Release No. 16701

(March 26, 1980), 45 FR 21426 (April 1, 1980)

(‘‘Moratorium Termination Release’’).

27Exchange Act Rule 19c–5, 17 CFR 240.19c–5.

See Securities Exchange Act Release No. 26870,

supra note 23.

28The NYSE has since sold its options business

to the CBOE. See Securities Exchange Act Release

No. 38542 (April 23, 1997), 62 FR 23521 (April 30,

1997).

29The filing was amended on April 29, 1991,

when the signatories to the Proposed Plan

submitted a Model Option Trade-Through Rule as

Exhibit A to the Proposed Plan (‘‘Model TradeThrough Rule’’). The Model Trade-Through Rule

would have been incorporated into each of the

options exchanges’ rules. The Model TradeThrough Rule provided that, absent reasonable

justification or excuse, a member in a participant

market should avoid initiating a trade-through

when purchasing or selling an options contract

permitted to be transmitted through the proposed

linkage.

30See Securities Exchange Act Release No. 30187

(January 14, 1992), 57 FR 2612 (January 22, 1992).

31The Phase-In Plan was put forth by the

Securities Industry Association (‘‘SIA’’) and

endorsed by the Committee on Options Proposals

(‘‘COOP’’). See letters to Jonathan G. Katz,

Secretary, SEC, from Thomas P. Hart, Chairman,

SIA Options and Derivative Products Committee,

dated March 10, 1992; and Michael Schwartz,

Chairman, COOP, dated March 11, 1992.

32 Id. See also letter from Richard C. Breeden,

Chairman, SEC, to Alger B. Chapman, Chairman &

CEO, CBOE, dated June 30, 1992 (setting forth the

Commission’s understanding of the elements of the

Phase-In Plan).

33See Securities Exchange Act Release Nos.

34431, 34432, 34444, 34434, and 34435 (July 22,

1994), 59 FR 38994 (August 1, 1994) (orders

approving proposed rule changes filed by Amex,

CBOE, NYSE, Phlx, and PCX, respectively). See also

Amex Rule 958A, Commentary 01; CBOE Rule

8.51(b); PCX Rule 6.37(d); Phlx Rule 1015(b); and

ISE Rule 804.

standardized options trading was

relatively new.21 Therefore, even though

Congress had intended to include

options in a national market system, the

Commission deferred applying many of

the national market system initiatives to

options to give options trading an

opportunity to develop.22 Today, the

options markets continue to operate

with limited market integration

facilities.23

A. Prior Attempts To Limit Intermarket

Trade-Throughs

To address the limited market

integration facilities in the options

market, the Commission has repeatedly

encouraged the exchanges to implement

mechanisms to limit trade-throughs.24

For example, in 1980, at the time the

Commission ended the voluntary

moratorium on expansion of

standardized options trading, it asked

for comment on several approaches to

more fully integrate the options markets

into the national market system,

including a market linkage system

similar to the Intermarket Trading

System (‘‘ITS’’),25 requiring brokerage

firms to route retail orders on an orderby-order basis to the market center

showing the best quotation, and an

order exposure system for options

public limit orders.26

Subsequently, the Commission’s

adoption of Exchange Act Rule 19c-5 in

1989 27 created the need for some

mechanism to ensure that customers’

orders for multiply-traded options could

be executed at the best available price.

Accordingly, in 1990, the Amex, CBOE,

New York Stock Exchange (‘‘NYSE’’),28

and PCX filed with the Commission a

proposed Joint Industry Plan providing

for the creation and operation of an

Options Intermarket Communications

Linkage (‘‘Proposed Plan’’).29 The

Commission sought comment on the

Proposed Plan,30 but neither the

Proposed Plan nor its Model TradeThrough Rule was adopted, in part,

because the options exchanges could

not reach a consensus on several critical

elements.

During the comment period on the

Proposed Plan, an alternative plan was

considered that involved the gradual

phase-in of multiple trading, along with

the adoption of exchange rules and

operational enhancements linking the

markets non-electronically (‘‘Phase-In

Plan’’).31 Specifically, the Phase-In Plan

would have provided for the re-routing

of orders received through automated

systems to other execution facilities, in

conjunction with a trade-or-fade rule.32

Again, however, the exchanges did not

agree to the Phase-In Plan and it was not

adopted.

In 1994, the markets adopted trade-orfade rules, which require a market

maker to revise its quote if it is

unwilling to trade at its published quote

with an order sent to it by a market

maker from another exchange.33 The

trade-or-fade rules do not provide

efficient means of access between the

markets. They also provide little

incentive to try to reach a better quote

75442 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

34Exchange Act Rule 11Ac1–1, 17 CFR

240.11Ac1–1. The reliability and availability of

quotation information are basic components of a

national market system and are needed so that

broker-dealers are able to make best execution

decisions for their customers’ orders, and customers

are able to make order entry decisions. See

Securities Exchange Act Release No. 12670 (July 29,

1976), 41 FR 32856 (August 5, 1976) (proposing

Exchange Act Rule 11Ac1–1).

35See Securities Exchange Act Release No. 14415

(January 26, 1978), 43 FR 4342 (February 1, 1978),

as amended in Securities Exchange Act Release

Nos. 37619A (September 6, 1996), 61 FR 48290

(September 12, 1996); and 40760 (December 8,

1998), 63 FR 70844 (December 22, 1998).

36See supra notes 21 and 22 and accompanying

text.

37See Moratorium Termination Release, supra

note 26.

38 In 1980, quotes were updated manually; thus,

the options exchanges argued that it would be

virtually impossible for a market maker to update

its quotes in a timely fashion each time the

underlying stock price moved.

39See Securities Exchange Act Release No. 26870,

supra note 23.

40See Securities Exchange Act Release No. 26871,

supra note 23.

41One major concern of market participants was

that due to the derivative nature of options, and the

need to adjust quotes in numerous series in

response to a single price change in the underlying

security, it would be impossible, or at least

impractical, to require options market makers to

honor their disseminated quotes. Further, it was

thought to be difficult for an exchange to identify

which member of a trading crowd was responsible

for a quote and to provide a mechanism for quotes

to be modified or withdrawn.

42Autoquote systems enable options market

professionals to update their quotes in numerous

options series simultaneously.

43Automatic execution systems provide, in effect,

firm quotes for public customer orders.

44See Securities Exchange Act Release No. 26871,

supra note 23.

45See generally Amex Rule 958A (requiring a

specialist to sell/buy at least 10 contracts at the

offer/bid displayed when the order reaches the

trading post); CBOE Rule 8.51 (generally requiring

a trading crowd to sell/buy at least the RAES

contract limit applicable to a particular options

class at the offer/bid displayed when a customer

order reaches the trading station); PCX Rule 6.86

(generally requiring a trading crowd to provide a

depth of 20 contracts for all non-broker-dealer

orders at the bid/offer disseminated at the time an

order is announced at the trading post); Phlx Rule

1015 (requiring that public customer orders be

filled at the best market for a minimum of 10

contracts); and ISE Rule 804 (requiring a market

maker to enter the number of contracts it is willing

to buy or sell at its quote and prohibiting a market

maker from entering a bid or offer for less than 10

contracts). 46 In response to the Proposing Release, the

Commission received comment letters from

fourteen commenters representing the views of four

exchanges, seven firms, and four other interested

parties. See letters to Jonathan G. Katz, Secretary,

SEC, from Samuel F. Lek, Chief Executive Officer,

Lek Securities Corporation, dated September 20,

2000 (‘‘Lek Letter’’); Michael J. Simon, Senior Vice

President and Secretary, ISE, dated September 18,

2000 (‘‘ISE Letter’’); George Brunelle, Brunelle &

Hadjikow, dated September 15, 2000 (‘‘Brunelle

Letter’’); Juan Carlos Pinilla, Managing Director, J.P.

Morgan Securities, Inc. (‘‘JPMorgan Letter’’);

Thomas A. Bond, CBOE, dated October 9, 2000

(‘‘CBOE Letter’’); Phillip D. DeFeo, Chairman and

Chief Executive Officer, PCX, dated October 10,

2000 (‘‘PCX Letter’’); Michael G. Vitek, President,

Botta, dated September 29, 2000 (‘‘Botta Letter’’);

Joel Greenberg, Managing Director, Susquehanna

Investment Group, dated September 22, 2000

(‘‘Susquehanna Letter’’); Chris Delzio, Amex

Member, dated August 15, 2000 (‘‘Delzio Letter’’);

Lewis Singletary, Journeyman Holdings

Corporation, dated September 30, 2000 (‘‘Singletary

Letter’’); Meyer S. Frucher, Phlx, dated September

18, 2000 (‘‘Phlx Letter’’); Edward Provost, Executive

Vice President, Business Development Division,

CBOE, dated September 13, 2000 (asking for an

extension of the comment period); Robert Bellick,

Co-Managing Partner, Wolverine Trading, L.L.P.,

dated October 25, 2000 (‘‘Wolverine Letter’’); Robin

Roger, Managing Director and Counsel, Morgan

Stanley Dean Witter, dated October 25, 2000

(‘‘Morgan Stanley Letter’’); and William McGowen,

Chairman, Options Committee, SIA, dated October

31, 2000 (‘‘SIA Letter’’).

47See Proposing Release, supra note.

in another market, because that quote

need not be firm when reached. Thus,

the trade-or-fade rules have done little

to promote price priority or discourage

intermarket trade-throughs. As

described below, the rules adopted by

the Commission today respond to

changes in the options markets and

reflect a different approach to limiting

intermarket trade-throughs and

promoting price priority.

B. Application of the Quote Rule in the

Options Market

As a testament to the importance of

firm quotes in the securities markets,

one of the first national market system

initiatives implemented by the

Commission in the equity markets was

the Quote Rule.34 The Quote Rule

requires all national securities

exchanges and associations to establish

procedures for collecting from their

members bids, offers, and quotation

sizes with respect to reported securities,

and for making such bids, offers, and

sizes available to quotation vendors. It

also requires that quotation information

made available to vendors be ‘‘firm,’’

subject to certain exceptions.

By its terms, the Quote Rule currently

does not apply to options. At the time

the Quote Rule was adopted in 1978,35

standardized options had been listed

and traded on the options exchanges for

only a few years, and the Commission

had imposed a moratorium that

restricted the expansion of options

trading.36 For example, in 1980, when

the Commission lifted the moratorium

on options listings, it also set forth its

vision on the future of options multiple

trading, including the feasibility of firm

quotes.37 Successful implementation of

a linkage among the markets was

thought to depend upon the quality and

reliability of quotation information

disseminated by each market center. At

that time, however, the Commission

believed that the imposition of a firm

quote requirement on the options

markets and market participants was

unworkable.38

In conjunction with the Commission’s

adoption in 1989 of Rule 19c-5 39

relating to multiple trading of options,

the Commission published a staff

concept release that discussed options

market structure issues associated with

multiple trading, and outlined

suggestions for possible market

structure enhancements.40 The release

emphasized that the availability and

reliability of comprehensive quotation

information for options are important

elements in considering the concerns

traditionally associated with multiple

trading.

The release discussed whether the

then-existing quote and trade reporting

mechanism for options needed to be

adapted for multiple trading by

requiring that equity options quotes be

firm. Market participants had, in the

past, argued against a firm quote

requirement in the options markets for

a number of reasons.41 These concerns,

however, were recognized as largely

moot due to the development of

autoquote 42 and automatic execution 43

systems, which indicated that firm

quotes were, at the very least,

possible.44

Today, each options market requires

its market makers to have firm quotes

for some types of orders. 45Therefore,

the Commission believes that imposing

a market-wide firm quote obligation on

options market participants should not

be unduly burdensome. While the

exchanges’ firm quote rules and

automatic execution systems provide

their public customers with firm quote

guarantees, these rules currently do not

extend to other market participants. As

described below, the amendments to the

Quote Rule adopted by the Commission

today require that options quotes be

firm for broker-dealer orders for at least

one contract.

III. Description of Proposed

Rulemaking 46

A. Proposed Trade-Through Disclosure

Rule

In the Proposing Release, the

Commission proposed new Rule 11Ac1–

7 under the Exchange Act 47 to require

a broker-dealer to disclose to a customer

when the customer’s order to buy or sell

a listed option is executed at a price

inferior to the best quote published at

the time of execution of the customer’s

order. The proposal identified seven

circumstances in which a trade

executed at a price inferior to a

published price on another market

would, nevertheless, not be considered

a trade-through for purposes of the

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75443

48The seven exceptions to the proposed

definition of a trade-through included when: (1)

The market publishing the better price was

experiencing systems problems, which made the

quote inaccessible; (2) OPRA was experiencing

queuing; (3) the market publishing the better price

was experiencing unusual market conditions; (4)

the market showing the better price was in a trading

rotation; (5) the customer order was executed as

part of a trading rotation in that options class; (6)

the customer order was executed as part of a

complex trade; or (7) the market publishing the

better quote fails to respond to an order routed to

it within 30 seconds of receiving the order. See

Proposing Release, supra note.

49See Proposing Release, supra note.

50As noted above, OPRA does not have the

capability to collect size information from the

options exchanges, but it anticipates implementing

systems changes to accommodate quotes with size

in January 2001.

51Exchange Act Rule 11Ac1–7(b)(1), 17 CFR

240.11Ac1–7(b)(1). The Commission believes that a

broker-dealer should be allowed to rely on the

market of execution to notify the broker-dealer

when a trade-through has occurred and the best

quote available at that time. One commenter

suggested that the Trade-Through Disclosure Rule

require that exchanges provide all relevant

information to the broker-dealers, including a

determination of whether a trade-through has

occurred. See Morgan Stanley Letter. The

Commission does not believe it is necessary at this

time to impose such a requirement and expects that

an exchange that does not participate in a linkage

plan will have strong incentives to provide a

broker-dealer executing orders on its market with

any information the broker-dealer needs to comply

with disclosure obligations.

52The term ‘‘completion of the transaction’’ in the

Trade-Through Disclosure Rule shall have the

meaning provided in Exchange Act Rule 15c1–

1(b)(1), 17 CFR 240.15c1–1(b)(1). Exchange Act

Rule 11Ac1–7(b), 17 CFR 11Ac1–7(b).

53Exchange Act Rule 11Ac1–7(b)(2)(i), 17 CFR

240.11Ac1–7(b)(2)(i). The Trade-Through

Disclosure Rule also provides the Commission with

the authority to exempt any broker or dealer from

the requirements of the rule. Exchange Act Rule

11Ac1–7(c), 17 CFR 240.11Ac1–7(c).

54Exchange Act Rule 11Ac1–7(b)(2)(ii), 17 CFR

240.11Ac1–7(b)(2)(ii). The Commission sought

comment on whether broker-dealers should be

excepted from the trade-through disclosure

requirement if they systematically route customer

orders on an order-by-order basis to the exchange

with the best price at the time the order is routed.

Only one commenter addressed this issue, noting

that simply routing orders to an exchange

displaying the best price at the time the order is

routed is not sufficient because of variances in the

national best bid and offer (‘‘NBBO’’), the

possibility that the receiving market does not offer

trade-through protection, or the possibility of price

improvement. At this time, the Commission has

decided not to provide broker-dealers with an

exemption from the disclosure requirements of the

Trade-Through Disclosure Rule on this basis.

55See Lek Letter; PCX Letter; JPMorgan Letter;

and ISE Letter.

56See Lek Letter.

57See CBOE Letter.

58See JPMorgan Letter; ISE Letter; CBOE Letter;

Phlx Letter; and Wolverine Letter. Another

commenter argued that the focus of the Commission

and the options industry should be on preventing

the occurrence of intermarket trade-throughs by

moving ahead aggressively on implementing the

Linkage Plan, rather than by disclosing intermarket

trade-throughs to investors after the fact. See SIA

Letter.

59See Linkage Plan, Section 12.

rule.48 In addition, as an incentive for

markets to cooperate in developing

effective means to access the quotes of

other markets to avoid intermarket

trade-throughs, the Commission’s

proposal excepted broker-dealers from

the proposed disclosure requirements if

they effected their customer orders on

options markets that participated in an

intermarket linkage plan approved by

the Commission that had provisions

reasonably designed to limit intermarket

trade-throughs.

B. Proposed Amendments to the Quote

Rule

The Commission also proposed to

amend Exchange Act Rule 11Ac1–1 to

require options exchanges and options

market makers to publish firm quotes.49

Because OPRA currently does not have

the ability to collect from the exchanges

and disseminate to quotation vendors

size information, the Commission

proposed to amend the Quote Rule so

that broker-dealers would not be

required to communicate, and options

exchanges would not be required to

collect and make available on a quoteby-quote basis, the size associated with

each quotation in listed options.

Instead, an options exchange would be

required to establish by rule and

periodically publish the size for which

its best bid or offer in each options

series that is listed on the exchange is

firm. If, however, an exchange does

collect quotations with size from its

broker-dealers, it would have to make

such information available as currently

required under the rule.50

In addition, the Commission proposed

two alternatives relating to the

flexibility an exchange would have to

establish the size for which its quotes

were firm for different types of orders.

Specifically, under proposed

Alternative A, the size for which an

exchange’s best bid or offer is firm

would have to be the same for orders

received from customers as for orders

received from broker-dealers. Under

proposed Alternative B, however, an

exchange could allow market makers to

establish different firm quote sizes for

broker-dealer orders and for customer

orders.

Finally, the Commission proposed to

require a responsible broker or dealer to

respond to an order within 30 seconds

by either executing the entire order or

executing at least that portion of the

order equal to its applicable firm quote

size and revising its quote.

IV. Discussion

A.Trade-Through Disclosure Rule

After carefully reviewing the

comment letters, the Commission has

decided to adopt the Trade-Through

Disclosure Rule, with several

modifications from the proposal. Under

this rule, a broker is required to disclose

to its customer when the customer’s

order for listed options is executed at a

price inferior to a better published

quote, and to disclose the better

published quote available at that time.51

This disclosure must be made to the

customer in writing at or before the

completion of the transaction,52 and

may be provided in conjunction with

the confirmation statement routinely

sent to investors. Such disclosure must

be displayed as prominently as the

transaction price disclosed to the

customer.

The Trade-Through Disclosure Rule

provides, however, that a broker-dealer

is not required to disclose to its

customer an intermarket trade-through

if the broker-dealer effects the

transaction on an exchange that

participates in an approved linkage plan

that includes provisions reasonably

designed to limit customers’ orders from

being executed at prices that trade

through a better published price.53 In

addition, broker-dealers will not be

required to provide the disclosure

required by the Trade-Through

Disclosure Rule if the order is executed

as part of a block trade.54

A number of commenters supported

the Commission’s proposal to require

broker-dealers to disclose tradethroughs.55 In particular, one

commenter believed that intermarket

trade-throughs virtually would be

eliminated if a broker-dealer were

required to disclose to a customer that

an order was executed at a price that

was inferior to the best-published

quote.56 Another commenter disagreed

with this view, however, stating that the

imposition of a disclosure requirement

would not have a significant impact on

the frequency of intermarket tradethroughs.57

In addition, several commenters noted

that the disclosure required by the

Trade-Through Disclosure Rule would

never need to be made by broker-dealers

if all exchanges join the Linkage Plan.58

The Commission notes, however, that

under the current terms of the Linkage

Plan, any participant may withdraw

from the plan with 30 days prior written

notice to each of the other plan

participants and the facilities manager,

if any.59 In addition, there may be new

options exchanges entering the market

in the future and those exchanges may

decide not to participate in the Linkage

Plan or any other intermarket linkage

plan approved by

75444 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

60One commenter contended that the proposal

would do nothing to improve the transparency of

execution quality. See Wolverine Letter. The

Commission disagrees with this assertion. Although

the disclosures about execution quality adopted

today for the equity markets provides much more

information to investors than the Trade-Through

Disclosure Rule does, the Commission believes that,

before execution quality disclosures could be

required for options trading, potentially difficult

issues, such as the absence of a consolidated NBBO

in the options market, would have to be resolved.

See Securities Exchange Act Release No. 43590

(November 17, 2000).

61The Commission notes, however, that the

Trade-Through Disclosure Rule does not replace the

well-established duty that brokers provide best

execution to their customers. To the contrary,

brokers remain obligated to seek the most favorable

terms possible under the circumstances for their

customers. See supra note.

62 In addition, to comply with these standards, an

exchange participating in a linkage would have to

adopt rules to allow the exchange to sanction

specialists or market makers that trade through

better prices of other exchanges, maintain policies

and procedures that would limit the occurrence of

intermarket trade-throughs, and maintain records

that would identify intermarket trade-throughs and

any review or remedial action taken by the

exchange in response to such intermarket tradethroughs.

63See JPMorgan Letter.

64See CBOE Letter.

65See ISE Letter and Phlx Letter.

66See ISE Letter.

67See Phlx Letter.

the Commission. Moreover, as discussed

further below, the Linkage Plan

approved by the Commission must still

be amended before the Commission

would consider it to be reasonably

designed to limit intermarket tradethroughs and, therefore, satisfy the

exception from trade-through

disclosure. Therefore, the Commission

continues to believe that the TradeThrough Disclosure Rule is needed to

ensure that, if the exchange on which

their orders are executed does not

belong to an approved linkage plan

designed to limit intermarket tradethroughs, investors receive disclosure

when their orders are not executed at

the best price.

It is an important feature of the TradeThrough Disclosure Rule adopted today

that it does not prohibit intermarket

trade-throughs. At times, investors may

value speed, size, or liquidity over

price. By not prohibiting intermarket

trade-throughs, the rule permits

investors to achieve their goals and

provides them with information that

will facilitate their ability to actively

monitor whether the quality of

executions they receive is satisfactory.60

Therefore, the Commission believes that

the rule will help to ensure that the

decision not to pursue publiclydisplayed, superior prices is rooted in

the interests of customers, not that of

intermediaries. In addition, the

Commission believes that in the absence

of direct linkages, the rule will

encourage broker-dealers to develop

effective means of accessing better

quotes published by other markets and

thereby, avoid intermarket tradethroughs.61

1. Minimum Requirements for

Linkage Plans

The Trade-Through Disclosure Rule

excepts from its requirements any

broker-dealer that executes customer

orders on exchanges that participate in

an intermarket linkage plan that is

reasonably designed to limit intermarket

trade-throughs. The Commission

believes that to be reasonably designed

to limit intermarket trade-throughs, a

plan should contain, at a minimum,

provisions to: (1) Limit participants

from trading through, not only the

quotes of other linkage plan

participants, but also, the quotes of

exchanges that are not participants in an

approved linkage plan; (2) require plan

participants to actively surveil their

markets for trades executed at prices

inferior to those publicly quoted on

other exchanges; and (3) make clear that

the failure of a market with a better

quote to complain within a specified

period of time that its quote was tradedthrough may affect potential liability,

but does not signify that a trade-through

has not occurred. Accordingly, the

Linkage Plan must be amended before

broker-dealers effecting transactions on

exchanges participating in the plan

would be excepted from the disclosure

requirements of the Trade-Through

Disclosure Rule.62 The Commission

does not agree that these modifications

to the Linkage Plan would add

significant costs without adding

significant additional deterrence to

intermarket trade-throughs, as stated by

one commenter,63 and believes that the

minimum requirements are important

factors to consider in assessing whether

a linkage plan is ‘‘reasonably designed

to limit trade-throughs’’ and therefore,

vitiate the need for broker-dealers to

provide disclosure to their customers.

The Commission requested comment

on what provisions a linkage plan

should include and whether the

minimum factors set forth above are

sufficient. In particular, the Commission

asked for comment on whether, instead

of requiring that a linkage plan limit

intermarket trade-throughs of the quotes

disseminated by markets that do not

participate in an approved linkage plan,

a linkage should only be required to

limit intermarket trade-throughs of

markets that participate in an approved

linkage plan. In this regard, one

commenter asserted that the

Commission should not require a

linkage plan to protect against trading

through those markets that are not

participants of the same linkage plan

because those markets would be

difficult to access effectively. This

commenter noted that a linkage plan

provides an efficient and almost

instantaneous means by which one

exchange participating in the plan can

access another exchange participating in

the plan, as well as minimum size

guarantees for orders routed through the

linkage, and therefore, assures

customers and dealers access to the best

bid or offer. In contrast, for markets that

do not participate in the linkage plan,

the lack of effective access simply

increases the time needed to execute a

customer order without any

corresponding guarantee of execution.64

Other commenters, however,

supported the notion that a linkage plan

must provide some form of protection

against trading through any exchanges

that do not participate in the linkage

plan.65 One of the commenters stated

that options exchanges should adopt

reasonable rules and procedures to

address trade-throughs of markets that

do not participate in an approved

linkage plan because, to instill investor

confidence in the options market, there

must be the same basic protections

against trade-throughs as are available

in the equity market.66 Another

commenter argued that firms that do not

execute transactions on an exchange

that participates in a linkage plan

should be required to disclose

intermarket trade-throughs of both

participant and non-participant markets,

particularly in light of the possibility

that a market could opt out of the

plan.67

In proposing this rule, the

Commission recognized that, by

providing an incentive for markets to

cooperate in developing effective means

to access other markets, intermarket

trade-throughs would be minimized.

However, the value of the TradeThrough Disclosure Rule would be

greatly diminished to the extent that: (1)

One or more options exchanges decide

not to participate in an approved

linkage plan; (2) intermarket tradethroughs were not minimized by the

implementation of a linkage plan

because the plan fails to provide

protection across all markets, including

markets that do not participate in the

linkage plan; (3) away markets fail to

complain about intermarket tradethroughs; or (4) market makers or

specialists were not subject to potential

sanctions for intermarket tradethroughs. Accordingly, the Commission

believes that to provide sufficient

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75445

68See ISE Letter; Phlx Letter; and CBOE Letter.

69See CBOE Letter.

70See PCX Letter. On the other hand, another

commenter expressed concern that a disclosurebased approach to creating incentives for markets

to link will not be as effective in fostering quote and

order competition and interaction as a direct

Commission role in mandating a universal linkage.

See Morgan Stanley Letter. The Commission is not,

however, attempting to foster quote and order

interaction by adopting the Trade-Through

Disclosure Rule, but is, instead, trying to achieve

the more limited goal of reducing the possibility for

investors’ orders to be executed at a price inferior

to the best available price.

71See supra notes 4 and 5.

72Exchange Act Rule 11Ac1–7(b)(2)(ii), 17 CFR

240.11Ac1–7(b)(2)(ii). The term ‘‘block trade’’ is

defined as a transaction in an options series that is

for 500 or more contracts and has a premium value

of at least $150,000. Exchange Act Rule 11Ac1–

7(a)(1), 17 CFR 240.11Ac1–7(a)(1).

73See JPMorgan Letter and SIA Letter.

74See Linkage Plan, Section 2 (3).

75See JPMorgan Letter and SIA Letter. One of

these commenters noted that with respect to blocksized orders, the quote bears ‘‘little relationship to

the average price that the customer could get for the

entire order.’’ See JPMorgan Letter. The other of

these commenters argued that ‘‘because large orders

are far more dependent on liquidity than smaller

orders, the ability to get a block off on a timely,

efficient basis may be severely impacted by strict

adherence to a trade-through rule.’’ See SIA Letter.

76Exchange Act Rule 11Ac1–7(b)(3), 17 CFR

240.11Ac1–7(b)(3).

77Exchange Act Rule 11Ac1–7(b)(4), 17 CFR

240.11Ac1–7(b)(4).

78Exchange Act Rule 11Ac1–7(b)(4)(ii), 17 CFR

240.11Ac1–7(b)(4)(ii).

79Exchange Act Rule 11Ac1–7(b)(4)(i), 17 CFR

240.11Ac1–7(b)(4)(i).

incentives to markets to avoid

intermarket trade-throughs under the

Trade-Through Disclosure Rule, an

intermarket linkage plan must contain

the provisions described above provide

broker-dealers executing orders on

markets participating in the plan with

an exception to the disclosure

requirements of the rule. Specifically,

the Commission believes that to

maintain the integrity and value of a

Trade-Through Disclosure Rule, a

linkage plan must provide protection

against orders trading through the

quotes of all markets, regardless of

whether that market participates in the

plan. However, to allow the options

exchanges to retain greater flexibility,

the Commission is not mandating

participation in a particular intermarket

linkage plan.

2. Mandatory Participation in a Linkage

Plan

The Commission also sought

comment on whether it should order the

options exchanges to become

participants in the Linkage Plan or any

other intermarket linkage plan. In

response, several commenters expressed

their view that the proposed TradeThrough Disclosure Rule was a vehicle

to compel options exchanges to join an

intermarket linkage plan,68 and one

argued that the Commission should

directly require all options exchanges to

become participants in a qualified

linkage plan rather than ‘‘creating a

disclosure-based exception that

accomplishes de facto the same

result.’’ 69 Another commenter,

however, expressly stated that it did not

believe that participation in a single

linkage plan should be mandatory. This

commenter concurred with the

Commission’s contention in the

Proposing Release that a single linkage

may fail to adapt over time and may

impede the entry of new market

participants.70

The Commission intends for the

intermarket linkage plan exception to

the Trade-Through Disclosure Rule to

encourage options markets to participate

in a Commission-approved intermarket

linkage plan. In fact, all five options

exchanges are now participants in the

Linkage Plan.71 However, at this time,

the Commission continues to be

reluctant to force, by government

mandate, all options exchanges to

participate in a single linkage system

that may, for example, fail to maintain

up-to-date technology. The Commission

believes that, in the absence of barriers

to access, the growth of electronic orderrouting systems may enable the options

exchanges to access one another’s

markets directly through agreed-upon

methods, or indirectly through brokerdealers. As a result, the Commission

continues to believe that, given effective

access, there may well be a variety of

equally effective, or more effective,

ways in which technology may be

employed by the markets to encourage

price priority and decrease the

likelihood of intermarket trade-throughs

in the options markets. Consequently,

rather than mandating exchange

participation in any one linkage plan,

the Commission is adopting the more

flexible approach, as proposed, that

provides incentives for the markets and

their members to develop mechanisms

to reduce the frequency of intermarket

trade-throughs, while allowing market

participants to choose the form of

mechanism employed.

3. Exception From Disclosure

Requirement for Block Trades

Finally, in response to comments, the

Commission is adopting an exclusion

from the trade-through disclosure

requirement for block trades.72 The

Commission sought comment on

whether to except block trades from the

trade-through definition because of their

size in relation to the quote, their

special handling needs, and the greater

resources of customers placing block

orders to monitor the quality of

executions they receive. Two

commenters specifically supported such

an exception.73

For ease of administration, the

Commission has adopted, in part, the

definition of ‘‘block trade’’ used in the

Linkage Plan,74 which was developed

by the options exchanges. Because a

block trade would involve 500 contracts

or more and a premium value of at least

$150,000, the Commission anticipates

that only highly sophisticated investors

will place such trades. Moreover, as

noted by commenters, because of the

size of these block orders, market

participants placing such orders do not

necessarily expect execution of the full

order at the best-quoted price.75 As a

result, the Commission believes that the

value of a trade-through disclosure for

market participants placing such orders

likely would be minimal.

4. Definition of Trade-Through

The Commission is adopting the

definition of a trade-through and the

exceptions to the definition of a tradethrough, substantially as proposed.

Specifically, a trade-through occurs

when a customer order is executed at a

price inferior to a quote published by

another market at the time of

execution.76 The rule also identifies four

circumstances in which a trade

executed at a price inferior to a

published price on another market

would, nevertheless, not be considered

a trade-through for purposes of the

rule.77

a. OPRA Delays. Because a brokerdealer should not be required to

disclose to its customer that its order

was executed at a price inferior to a

‘‘stale’’ quote, a trade will not be

considered a trade-through if it occurs

while OPRA is experiencing queuing.78

In the past, the aggregate message traffic

generated by the options exchanges has,

at times, surpassed OPRA systems

capacity, which could result in the

dissemination of quotes that are no

longer accurate or accessible.

b. Systems Malfunctions. Similarly,

the Commission believes that it is

appropriate to exclude from the

definition of trade-through trades that

are executed at a time when an

exchange has verified that the market

publishing the better price was

experiencing systems malfunctions,

thus resulting in inaccessible quotes.79

For example, this may occur when a

broker-dealer has attempted to access

the superior published quote and has

been unsuccessful because of systems

75446 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

80Exchange Act Rule 11Ac1–1(b)(3), 17 CFR

240.11Ac1–1(b)(3). Currently, each options

exchange has rules that allow the exchange to

suspend its firm quote requirements if, for example,

a systems malfunction or other circumstance

impairs the exchange’s ability to disseminate or

update market quotes in a timely and accurate

manner. See Amex Rule 958A; CBOE Rule 8.51(a);

PCX Rule 6.86(d); Phlx Rule 1015(a)(ix); and ISE

Rule 804(d). The options exchanges may have to

amend these rules to conform to the Quote Rule’s

exception for unusual market conditions.

81Exchange Act Rule 11Ac1–7(b)(4)(iii), 17 CFR

240.11Ac1–7(b)(4)(iii).

82See JPMorgan Letter.

83See supra note 2. One commenter asserted that

under the Commission’s proposal, brokers would

no longer have to make best execution evaluations.

See Wolverine Letter. The Commission strongly

disagrees with this view and expects brokers to

continue to fulfill their obligations to seek the most

favorable terms reasonably available under the

circumstances for a customer’s order.

84Exchange Act Rule 11Ac1–7(b)(4)(iv), 17 CFR

240.11Ac1–7(b)(4)(iv).

85See Brunelle Letter. Another commenter,

however, supported this proposed exception. See

ISE Letter.

86See JPMorgan Letter; CBOE Letter; and PCX

Letter.

87See JPMorgan Letter.

88See PCX Letter.

89See CBOE Letter.

problems in the quoting market. The

Commission believes that there is no

value in requiring a broker-dealer to

disclose an inability to access a market’s

quote that has been verified as

inaccessible.

c. Relief from Firm Quote Obligation.

The definition of trade-through also

excludes a trade executed at a price

inferior to a price published by another

exchange if the other exchange or its

members were relieved of their

obligations under the Quote Rule

because the exchange has determined,

for example, that, as a result of unusual

market conditions,80 it is incapable of

accurately collecting and disseminating

quotes.81

One commenter recommended that

the Commission provide brokers with

discretion to interpret the exceptions

broadly in light of their duty of best

execution, instead of forcing a broker to

incur the risk of subsequently providing

an inferior price to a public customer

against its better judgment. This

commenter argued that a broker should

have discretion to ‘‘use the ‘unusual

market circumstances’ exception to

refuse to route a trade to an exchange

that has a history of disseminating

‘flickering’ quotes, rather than being

forced to disclose to the customer a

trade-through of a phantom ‘better’ price

that, in all likelihood, never existed.’’ 82

The Commission agrees that brokers

must always consider their best

execution obligations to their

customers.83 The Trade-Through

Disclosure Rule does not prohibit

intermarket trade-throughs; it merely

requires a firm to provide information to

its customer about the market at the

time of execution. Therefore, the

Commission does not agree that brokerdealers should be granted discretion to

avoid disclosure if they trade through

another market quote because of their

discomfort with the quality of that

market’s quote. While the Commission

appreciates the commenter’s concerns

regarding ‘‘flickering quotes,’’ the Quote

Rule amendments adopted today are

designed to address this issue by

requiring that disseminated quotes be

firm up to the applicable firm quote

size.

d. Thirty-Second Delay. In addition,

the Trade-Through Disclosure Rule

excludes from the definition of tradethrough a trade that occurs after an

exchange member attempts to access a

better-published quote for a customer

order and the market publishing the

better quote fails to respond to the order

routed to it in a timely fashion.84

Although one commenter contended

that the Commission should not adopt

this exception to the definition of a

trade-through because it condones the

actions of a market maker who simply

ignores an incoming customer order that

is unfavorable or inconvenient,85 the

Commission believes that a brokerdealer should not be obligated to

disclose a trade-through in the event

that an exchange member attempted to

access a better published quote for a

customer order, but the market

publishing the better quote failed to

respond to the order routed to it within

30 seconds of receiving the order. In this

instance, the exchange member has

attempted to access the superior

published quote and has been

unsuccessful. The Commission believes

that the originating broker-dealer should

not be obligated to provide the

disclosure when the member of another

exchange has failed to satisfy its

obligations under the Quote Rule. In

addition, the Commission believes that

there is no value in requiring an

exchange member to repeatedly attempt

to access an inaccessible quote,

especially in a volatile market where

substantial delays may result in far

inferior executions for the investor.

Further, the Commission believes that

the amendments to the Quote Rule

adopted today will ensure that

responsible broker-dealers honor their

quotes up to the size for which they are

required to be firm, and expects

exchanges to surveil their members to

ensure compliance with the amended

Quote Rule.

e. Trades Not Excluded from the

Definition of Trade-Through. In the

Proposing Release, the Commission

sought comment on whether a tradethrough disclosure requirement should

apply to all trade-throughs, or only

when an order is executed at a price that

trades through a better price by a certain

price increment or amount. The

Commission noted that this question is

particularly important in a decimals

trading environment, where quotes may

be for a smaller size and the tradethrough price for smaller increments,

and with respect to large orders, where

the quote size may be small in relation

to the order size.

Several commenters supported such a

‘‘materiality’’ standard.86 For example,

one commenter argued that all orders

would benefit, regardless of size, from

an exception to the disclosure

requirement for trade-throughs of price

increments immaterial in relation to the

spread. This commenter believed that

any trade-though disclosure should

include the size of the traded-through

quote, but that a materiality exception

would be preferable to disclosure of the

size of the quote, because such size

disclosure would be more costly for

market participants, including

customers.87 Another of these

commenters believed the disclosure

requirement should not apply if the

price and size of the trade-through was

de minimus. Although this commenter

did not define de minimus, the

commenter argued that given the

imminent conversion to decimal

pricing, the burdens of disclosing when

an order trades through a quote that is

better by a very small amount or is only

for a small size would not be justified.88

On the other hand, one commenter

opposed adopting a de minimus

exception to the trade-through

definition due to the inherent difficulty

in defining what constitutes de

minimus, and the possibility that

opportunities for the unbundling of

orders to avoid trade-though liability

would be created.89

The Commission believes that it is

inappropriate at this time to attempt to

establish a materiality standard. The

Commission notes that, as of September

25, 2000, only 36 options are trading in

decimals. As a result, the Commission

does not believe that it, the options

exchanges, or other market participants

has had sufficient experience with a

decimals environment. The Commission

notes, however, that it will continue to

evaluate this issue as decimal pricing is

expanded to all options classes and the

markets adapt to the decimals

environment.

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75447

90See PCX Letter and Brunelle Letter. 91See PCX Letter 92See PCX Letter. 93See Brunelle Letter. 94Payment for order flow and other similar

arrangements increase the likelihood that such

contracts could become commonplace.

95See Proposing Release, supra note 7. 96One commenter recommended narrowing the

proposed definition of complex trades to exclude

certain investment strategies that include stock

trades, such as ‘‘buy-writes,’’ in which an investor

buys stock and writes a call on that stock. See ISE

Letter. The Commission believes, however, that

other strategies, such as spreads (the simultaneous

purchase or sale of options on the same underlying

stock with different strike prices or expiration dates

or both) and straddles (simultaneous purchase and

sale of an equal number of calls and puts on the

same underlying security with identical strike

prices and expiration dates), are sufficiently similar

to buy-writes to warrant similar treatment.

97See PCX Letter.

98Exchange Act Rule 11Ac1–1, 17 CFR

240.11Ac1–1.

99See JPMorgan Letter; ISE Letter; PCX Letter;

Lek Letter; Wolverine Letter; and SIA Letter.

100See Lek Letter and PCX Letter.

101See JPMorgan Letter.

102See Botta Letter; Susquehanna Letter; Brunelle

Letter; and Phlx Letter.

103See Botta Letter and Susquehanna Letter.

In addition, a few commenters

recommended that the trade-through

disclosure requirement not be applied to

orders from upstairs broker-dealers and

orders of customers who consent to the

potential for an execution at an inferior

price.90

Because upstairs broker-dealers’

orders are not eligible to be transmitted

through the linkage pursuant to the

Linkage Plan, one commenter argued

that broker-dealers should not be

required to disclose an execution at a

price inferior to the best price. 91 The

Commission notes that the tradethrough disclosure requirement would

not require disclosure to upstairs

broker-dealers because it only applies

when a broker-dealer executes a nonbroker-dealer order.

A commenter also recommended

including an exception for trades of

customers who request that their orders

be executed on a particular market,

regardless of whether a better price is

available on another market. This

commenter contended that a customer

may give such consent because of its

greater interest, for example, in the

speed of execution. 92 Another

commenter suggested an exception for

when customers provide instructions to

route, or avoid routing, their orders to

a particular exchange, irrespective of

price. 93

The Commission does not believe that

it is appropriate to except broker-dealers

from the requirement to disclose a tradethrough to its customer even when a

customer requests that its order be

executed on a particular market,

regardless of price. While one

commenter suggested that a tradethrough disclosure to a customer that

has explicitly requested an execution at

an inferior price may be superfluous,

the Commission is concerned that the

adoption of such an exception may

result in broker-dealers entering into

blanket adhesion contracts with

customers, solely to allow the brokerdealer to execute order flow on a

particular options exchange even

though that exchange does not provide

the best price. 94 The Commission

believes that such an exception would

raise investor protection concerns,

particularly with respect to

unsophisticated investors who may not

fully appreciate the impact of the

agreement and may lack the ability to

negotiate preferable terms. In addition,

the Commission believes that in those

instances where a customer has

expressed a desire to have its order

executed on a particular exchange

regardless of a better published price

available on another market, the

customer will not perceive the

disclosure of a trade-through as

problematic.

Finally, the Commission’s definition

of a trade-through also includes

transactions executed as part of a

complex trade. Although the

Commission proposed to exclude

complex trades, which were defined as

transactions in an option series that are

executed in conjunction with related

transactions occurring at or near the

same time for the purpose of executing

a particular investment strategy, 95 the

Commission now believes that such an

exclusion is not appropriate. 96 On

further consideration, the Commission

has determined that such disclosure is

important, even to customers executing

more complex trades. Because retail

customers use these types of investment

strategies, information about the

execution price relative to other prices

may be invaluable to their

understanding and decision-making.

Even the most sophisticated investors

may find this information useful.

5. Compliance Date

The Trade-Through Disclosure Rule

will become effective on February 1,

2001, and its compliance date is April

1, 2001. On April 1, 2000, brokerdealers will be required to make the

required disclosures unless their

transactions are effected on markets that

are participants in an effective national

market system options linkage plan that

includes provisions reasonably designed

to limit intermarket trade-throughs. The

Commission believes that a linkage plan

is not reasonably designed to limit

intermarket trade-throughs unless it has

been implemented and is operating.

While one commenter expressed its

view that the Commission should not

require compliance with the TradeThrough Disclosure Rule until the

Linkage Plan has been implemented, 97

the Commission is concerned that tying

the compliance date to this event may

provide a disincentive for the options

markets to fully implement the Linkage

Plan. Accordingly, the Commission does

not, at this time, believe that it is

necessary to delay the compliance date

of this rule until the linkage is fully

implemented and operating. The

Commission will consider granting

temporary exemptive relief to brokerdealers from the requirements of the

rule if the markets continue to make

substantial progress towards

implementing the Linkage Plan.

B. Amendments to the Quote Rule

As discussed above, the Commission

is adopting amendments to the Quote

Rule to extend its application to options

traded on national securities exchanges.

Generally, the Quote Rule requires

exchanges to collect quotations, and

sizes associated with those quotations,

from their members who are responsible

broker-dealers and make those

quotations and sizes available to

quotation vendors for each subject

security listed and admitted to unlisted

trading privileges on the exchange. 98

The Commission received several

comment letters addressing the

proposed Quote Rule amendments. A

number of commenters voiced their

support for amending the Quote Rule to

include listed options, 99 stating, for

example, that firm quotes will promote

efficiency and increase customer

confidence in the markets. 100 One

commenter noted that the lack of such

a rule in the options markets impeded

firms’ ability to execute customer orders

in an efficient manner because they

have to explore posted quotes to

determine if a quote is firm for an entire

order or only for an order of minimal

size. 101

Other commenters, however, opposed

the proposed amendments to the Quote

Rule. 102 Two of these commenters

argued that the current exchange rules

and exchange automatic execution

systems sufficiently guarantee firm

quotes to public customers. Thus, they

contended that amending the Quote

Rule would simply extend its

application to broker-dealer orders, a

result they opposed. 103 One commenter

noted that current competition among

market makers for public customer

75448 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

104See Susquehanna Letter.

105 15 U.S.C. 78k–1.

106See supra note and accompanying text. The

Commission expects the options exchanges will

seek approval from the Commission to amend their

existing rules to conform to the Quote Rule.

107See Brunelle Letter. This commenter believes

that because options trades are broken so

frequently, public investors, who are required to

honor all of their commitments, are held to a much

higher standard than exchange market makers. This

commenter recommends that in addition to the

rules proposed, the Commission require market

makers to disclose their failures to honor quotes

and completed transactions.

108Currently, OPRA does not have the systems

capability to collect and disseminate quotes with

size. OPRA is, however, scheduled to have this

capability by January 2001. Some options markets

may, however, choose to continue not to

disseminate quote size.

109The Commission is including the definition of

the term ‘‘option series’’ in the Quote Rule. Under

Exchange Act Rule 11Ac1–1(a)(29), the term

‘‘option series’’ means contracts in an options class

that have the same unit of trade, expiration date,

and exercise price, and other terms or conditions.

17 CFR 240.11Ac1–1(a)(29). 110Exchange Act Rule 11Ac1–1(d)(2), 17 CFR

11Ac1–1(d)(2). 111Exchange Act Rule 11Ac1–1(d)(2), 17 CFR

11Ac1–1(d)(2). 112 In this regard, several commenters suggested

that the Commission wait until OPRA is able to

disseminate size before proceeding with the

amendments. See Susquehanna Letter; Botta Letter;

PCX Letter; Phlx Letter; and JPMorgan Letter. One

commenter suggested that the Commission adopt

this approach to quote size only temporarily. See

Morgan Stanley Letter. Another commenter

characterized the Commission’s approach as an

‘‘appropriate solution,’’ arguing that the

Commission should refrain from mandating that

size be disseminated with each quotation until the

existing limitations on OPRA systems capacity have

been remedied. See SIA Letter. 113See ISE Letter. 114See Phlx Letter.

orders is intense, and believed that the

proposed amendments would force

allocation of capital into areas of

unacceptable risk, such as trading

against other broker-dealers, and away

from the facilitation of public customer

orders. 104

The Commission has carefully

considered the issues raised by

commenters and believes it is

appropriate to adopt amendments to the

Quote Rule to extend its application to

the options markets. The Commission,

however, has made accommodations for

the way in which the options markets

operate. The Commission believes that

the amendments will provide significant

and immediate benefits to investors. In

particular, market participants,

including customers and broker-dealers,

will be able to rely on quotes up to their

published size in routing orders that are

not eligible for execution in the

automatic execution systems. The

Commission believes that this result

should lead to increased competition on

the basis of size among the options

exchanges, which should enable

investors to receive better executions for

their orders. It will also enable market

makers and other broker-dealers to more

easily trade with displayed quotes,

increasing the accuracy and efficiency

of displayed quotes.

As noted above, the availability of

quotation information is one of the key

components of a national market

system. While options quotation

information is provided to market

participants today through OPRA, the

Commission believes that this

information will be substantially

enhanced by the amendments to the

Quote Rule. Quotes are not useful to

market participants if they are not

honored. Further, because market

participants will be required to disclose

trade-throughs of superior quotes

(unless an exception applies), these

superior quotes must be firm for all

market participants, including brokerdealers. Otherwise, the Trade-through

Disclosure Rule would be unworkable,

and market makers would be forced to

either route customers’ orders to

anomalous quotes, or unwillingly match

that quote to avoid trade-through

disclosure. The Commission believes

that requiring options quotes to be firm

furthers the national market system

goals of Section 11A 105 and will benefit

all options market participants.

Because of developments in

technology and changes in the options

markets, the Commission also believes

that the current exchange rules and

automatic execution systems alone are

no longer sufficient to provide adequate

investor protections. Currently, the

options markets are permitted to fade

from their quotes without consequence,

pursuant to their trade-or-fade rules.106

In addition, as noted by one commenter,

options market makers frequently

change the terms of trades or ‘‘break’’

trades subsequent to execution, without

prior notice to the customer.107 Thus,

options investors and their brokers

cannot fully rely on the disseminated

quotation information on which they

base their order routing decisions. The

Commission believes that options

investors deserve the same protections

as equity investors and therefore, the

Commission is adopting amendments to

extend the coverage of the Quote Rule

to the options market with

modifications to accommodate certain

unique aspects of the options market.

The Commission also believes that a

market maker that executes a trade at its

disseminated quote and then changes

the terms or ‘‘breaks’’ the trade may

well, absent exceptional circumstances,

be in violation of the firm quote

obligation adopted today.

1. Collecting and Making Available

Quotation Sizes

Because the options markets currently

do not disseminate to quotation vendors

the size associated with their bids and

offers 108 and due to the existing

limitations on OPRA system capacity,

the Commission is adopting

amendments to the Quote Rule so that

options exchanges may decide not to

collect from their members and make

available to vendors the size associated

with each quotation in listed options.

Instead, exchanges may choose to

establish by rule and periodically

publish the size for which their best bid

and offer in each options series 109 that

is listed on the exchange is firm. 110 If

the rules of an exchange do not require

its members to communicate to it

quotation sizes for listed options, then

responsible brokers or dealers that are

members of that exchange will be

relieved of their obligations under the

Quote Rule to communicate to such

exchange their quotation sizes. Instead,

each such responsible broker or dealer

may satisfy its firm quote obligation by

executing any order to buy or sell a

listed option that is a subject security,

in an amount up to the size established

by the exchange’s rules. 111 An options

exchange may, of course, choose to

establish procedures for collecting from

its members, and making available to

vendors, the sizes of such members’

quotes.

The Commission is not adopting the

recommendation of a few commenters

that exchanges be required to

disseminate quotation sizes as soon as

OPRA is capable of doing so. 112 One

commenter raised the concern that the

proposed amendments to the Quote

Rule would result in each exchange

using its portion of OPRA bandwidth

differently, which could benefit

exchanges that show relatively limited

size information, and have a significant

adverse effect on exchanges that collect

and disseminate the ‘‘real’’ size of their

trading interest. 113 This commenter

suggested that the Commission use its

exemptive authority under the Quote

Rule to require all exchanges to

disseminate size with their quotations,

even if an exchange determines to

establish by rule and periodically

publish its firm quote size.

Another commenter, while also

acknowledging OPRA capacity

constraints, argued that the concept of

the periodic publication of firm quote

sizes is contrary to OPRA’s plan to

require the dissemination of size with

every options quote by January 2001. 114

Thus, this commenter believed that the

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75449

115See Brunelle Letter.

116See JPMorgan Letter; ISE Letter; Lek Letter;

Wolverine Letter; and Morgan Stanley Letter.

117See Lek Letter.

118See ISE Letter.

119See Botta Letter; CBOE Letter; PCX Letter;

Susquehanna Letter; and SIA Letter.

120See Botta Letter; CBOE Letter; PCX Letter; ISE

Letter; Susquehanna Letter; and SIA Letter.

121See PCX Letter; CBOE Letter; and ISE Letter.

122See Susquehanna Letter and Botta Letter.

123See Botta Letter.

124See Susquehanna Letter.

125See Lek Letter.

126Exchange Act Rule 11Ac1–1(d)(1), 17 CFR

240.11Ac1–1(d)(1). Exchange rules must require

responsible broker-dealers to be firm for orders for

the accounts of broker-dealers for at least one

contract.

127Exchange Act Rule 11Ac1–1(d)(1)(ii), 17 CFR

240.11Ac1–1(d)(1)(ii).

proposed amendments to the Quote

Rule appeared to be unnecessary.

Finally, one commenter recommended

that any amendment to the Quote Rule

require on-floor specialists and market

makers, as well as the options

exchanges, to publish on a quote-byquote basis the size associated with each

quote. 115

The Commission has decided, at this

time, not to require the options

exchanges to disseminate quotes with

size. Currently, OPRA does not have the

capability to accept size with options

quotes, although it does anticipate

disseminating quotes with size in

January 2001. The Commission notes

that the options exchanges generate

significantly more quotes than the

equity exchanges. Adding size to quote

messages will increase the bandwidth

necessary to disseminate options market

data, and possibly, increase the number

of messages if a new quote is required

every time its associated size is

modified. As discussed above, over the

past year, OPRA has suffered serious

capacity constraints due to the

tremendous amount of quote message

traffic generated by the exchanges. Due

to the limitations on OPRA systems

capacity, the Commission, while

supporting OPRA’s efforts to modify its

systems to accommodate size, does not

believe that it is appropriate to mandate

further burdens on OPRA systems

capacity at this time.

Pursuant to the amendments to the

Quote Rule adopted by the Commission

today, the options exchanges will be

required to publicize the size for which

its quotes will be firm either on a quoteby-quote basis or by publicizing its rule

establishing its firm quote sizes. The

Commission believes that periodic

publication will be sufficient to inform

options market participants of the

relevant size information they need to

make informed order routing decisions.

Although the Commission recognizes

one commenter’s concerns that

disseminating quotes with size may

require more OPRA systems capacity,

the Commission believes that this is a

competitive issue and consequently, so

long as investors have access to the size

information that they require, it is not

necessary for the Commission to require

the dissemination of quotes with size at

this time.

2. Firm Quote Sizes for Customer and

Broker-Dealer Orders

The Commission proposed two

alternatives regarding the size for which

responsible broker-dealers’ quotes for

listed options would be required to be

firm. Under proposed Alternative A, the

size for which a responsible brokerdealer’s best bid or offer is firm would

be required to be the same for orders

received from customers and for orders

received from broker-dealers. Proposed

Alternative B would permit an exchange

to establish different firm quote sizes for

broker-dealer orders than for customer

orders. The Commission requested

commenters’ views on these two

alternatives.

Several commenters supported

Alternative A under which the

Commission proposed that the firm

quote size be the same for both customer

and broker-dealer proprietary orders. 116

One of these commenters argued that

providing the same firm quote size to all

market participants emboldens investor

confidence in fair pricing because if the

price of a security is too low, then

another professional will be ready and

able to bring the price in line by

entering buy orders, and vice versa for

sell orders. This commenter opposed a

different firm quote sizes because it

believed that this would permit a twotiered market — one consisting of

displayed quotes for non-professionals

only, and another, ‘‘shadow’’ market for

professionals. Further, the commenter

argued that the supposition that market

makers would widen their spreads if

their quotes were exposed to other

market professionals is unjustified and

unsupported by empirical data, and in

any case, the public is more harmed by

non-competitive, un-real quotes than by

wider spreads. 117 Another of these

commenters, however, believed that

applying the Quote Rule equally to all

market participants would prove

unworkable at this time because of the

structure of the options market. 118

On the other hand, several

commenters preferred allowing

responsible broker-dealers to be firm for

different sizes for customers and brokerdealers, as proposed in Alternative B.119

Some commenters argued that if market

makers were required to establish a

single quotation size for all market

participants, they would likely decrease

the disseminated size of their quotes

and their execution guarantees, limiting

liquidity available to customers.120 They

argued that the ability to establish

differing quote sizes for broker-dealer

and customer orders would allow

market makers to provide customers

with greater liquidity, while limiting

their exposure to non-customers.121

Other commenters argued that market

makers, not the Commission, should

determine how much liquidity they

want to guarantee to professionals.122

One commenter explained that market

makers provide different liquidity

guarantees to professional orders to

protect against being ‘‘picked off,’’ and

noted that if market makers quote less

aggressively, public customers whose

orders are generally automatically

executed at the NBBO could be

adversely affected.123 This commenter

noted that market makers compete

against each other by guaranteeing

different sizes, which would be

eliminated if only one quote size

applied to all types of orders. Another

commenter argued that options market

makers are at far greater risk than stock

specialists of being picked off by

professionals and that it would be

exponentially more difficult for an

options market maker than for a stock

specialist to provide continuously

updated quotes that would be firm

against professional interest.124

However, another commenter noted that

the equity market does not exempt

traders and market makers from the

Quote Rule when dealing with other

broker-dealers.125

After careful review of the

commenters’ observations and

suggestions, the Commission is adopting

amendments to the Quote Rule that

allow the options exchanges to establish

different firm quote sizes for brokerdealer orders than for customer

orders.126 An exchange that chooses not

to collect from their members and make

available to vendors the size associated

with each quotation in listed options

may establish by rule and periodically

publish the size at which its best bid or

offer in each options series listed on the

exchange is firm for orders from

customers and orders from brokerdealers.127 An exchange would also

have the flexibility to collect from its

members and make available to

quotation vendors the quotation sizes at

which such members are firm for

customer orders and, at the same time,

to establish by rule and periodically

75450 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

128Exchange Act Rule 11Ac1–1(d)(1)(iii), 17 CFR

240.11Ac1–1(d)(1)(iii).

129See PCX Letter; Phlx Letter; JPMorgan Letter;

ISE Letter; CBOE Letter; and Susquehanna Letter.

130See PCX Letter and SIA Letter.

131See PCX Letter.

132See Phlx Letter and Morgan Stanley Letter.

133See Phlx Letter.

134For customer orders, each responsible brokerdealer will be firm for its published size.

135 In comparison, exchanges that disseminate

one quote for a trading crowd, based on a single,

automatically generated quote would be required to

be firm only for a minimum of one contract.

136Exchange Act Rule 11Ac1–1(d)(4)(ii), 17 CFR

240.11Ac1–1(d)(4)(ii).

137The Commission did not propose in the

Proposing Release to include a definition of the

term ‘‘trading rotation’’ in the Quote Rule.

138Exchange Act Rule 11Ac1–1(a)(30), 17 CFR

240.11Ac1–1(a)(30).

139Exchange Act Rule 11Ac1–7(b)(4)(iv), 17 CFR

240.11Ac1–7(b)(4)(iv).

140Exchange Act Rule 11Ac1–1(d)(3), 17 CFR

240.11Ac1–1(d)(3). A responsible broker’s or

dealer’s applicable firm quote size would be its

published quote size or, if a responsible broker or

dealer has been relieved of the obligation to

communicate its quotation sizes, the minimum firm

quote size established by its exchange’s rules. One

commenter noted that the proposed amendments to

the Quote Rule failed to incorporate the use of a

defined term, ‘‘published quotation size,’’ where

applicable. See ISE Letter. In response to the

comment, the Commission is adopting technical

amendments to the Quote Rule to more uniformly

apply the defined term, published quotation size.

141When a responsible broker-dealer chooses to

respond to an order in an amount greater than the

firm quote size by executing only that portion of the

publish a different size for which their

members’ quotes must be firm for

broker-dealer orders.128

The Commission believes that the

unique structure of the options markets,

specifically, the tremendous number of

products that must be continuously

quoted by options market makers or

specialists, warrants this specific

accommodation. Currently, there are

approximately 178,000 options series

for which options market makers and

specialists continuously provide twosided quotations. Consequently, the

Commission believes that permitting

different quote size guarantees is the

best course of action at this time to help

ensure the continued availability of

liquidity, which facilitates the

maintenance of fair and orderly markets.

The Commission will, however,

continue to evaluate the markets to

determine if, in fact, this provision is

warranted.

3. Minimum Quote Size

In the Proposing Release, the

Commission requested commenters’

views on whether the Commission

should establish a minimum number of

contracts for which quotes should be

firm. The Commission received no

comments in support of mandating a

minimum firm quote size.129

Two commenters did suggest that in

absence of a mandated minimum firm

quote size, quotes should be firm for at

least one contract, which has the

economic equivalent of 100 shares of

stock, the minimum quote size in the

equities markets.130 One of these

commenters believed that the minimum

firm quote size should be viewed as a

competitive, rather than a regulatory,

issue.131 Other commenters argued

against a minimum firm quote size

because any such minimum would

facilitate and encourage wide-scale

proprietary trading by broker-dealers on

markets in which they are not

members.132 One of these commenters

believed that non-members of an

exchange should not be allowed to gain

free access to the exchange, because

such access could dilute the value of

exchange memberships.133

The Commission agrees that quote

size is a competitive issue and should

not be dictated by regulation. Under the

Quote Rule adopted today, each options

exchange will be required to publicize

the size at which their market makers or

specialists are firm. The Commission

believes that competitive market forces

will dictate appropriate firm quote sizes

for customer and broker-dealer orders in

the options markets.

Nevertheless, the Commission

believes that each disseminated quote

must represent at least one contract —

any less would mean that a quote was

not actually firm. For this reason, the

Commission is adopting a requirement

that if an exchange allows quotes to be

firm in different sizes for broker-dealer

orders than for customer orders, its rules

must require its market makers to be

firm for a minimum of one contract. As

noted by one of the commenters, one

contract is the economic equivalent of

100 shares of stock and therefore, this

requirement establishes in the options

market a standard equivalent to that

applied in the equities market.

On a related note, the Commission

believes that in those instances in which

a quote is disseminated by an exchange

that collects and aggregates quotation

sizes from several responsible brokerdealers, each responsible broker-dealer

would be required to be firm for at least

one contract for broker-dealer orders.134

Therefore, for example, if an exchange

collects and disseminates a quote, the

size of which reflects the aggregate size

of three competing responsible brokerdealers, the exchange quote must be

firm to orders from broker-dealers for at

least three contracts, one for each

responsible broker-dealer.135

4. Automatic Execution Systems

The amendments to the Quote Rule

adopted today do not affect the ability

of the options exchanges to provide

execution guarantees through their

automatic execution systems. The

exchanges’ automatic execution systems

are generally used for small, public

customer market and marketable limit

orders. Options exchanges will continue

to have the flexibility to publish a

different firm quote size for a particular

options class than its automatic

execution guarantee size. The

Commission, however, may reevaluate

this approach if it results in a decrease

in liquidity available for customer

orders.

5. Exception During Trading Rotations

Under the Quote Rule, responsible

brokers or dealers are relieved of their

obligations if, for example, the

responsible broker or dealer is in the

process of effecting a transaction and

immediately thereafter, communicates a

revised quotation. The amendments to

the Quote Rule being adopted today also

relieve responsible brokers or dealers

from their firm quote obligations when

an order for listed options is presented

during a trading rotation in that listed

option.136 During trading rotations,

market makers may be unable to

generate quotes in a timely fashion. The

Commission is adopting as part of the

Quote Rule the definition of ‘‘trading

rotation’’ proposed in the TradeThrough Disclosure Rule, with a slight

modification.137 Specifically, the

definition of trading rotation has been

modified to include references to

reopening and closing rotations, as well

as to opening rotations as proposed,

because the same difficulties in

providing firm quotes during opening

rotations apply during those other types

of trading rotations.138

6. Thirty-Second Response

As discussed above, if a responsible

broker or dealer fails to respond to an

incoming order within the 30 seconds,

the Trade-Through Disclosure Rule

permits the routing broker or dealer to

execute its customer’s order at an

inferior quote without being required to

disclose the better, but unresponsive,

quote to its customer.139 The

Commission is adopting an amendment

to the Quote Rule 140 to require a

responsible broker or dealer to respond

to an order to buy or sell a listed option

in an amount greater than the firm quote

size within 30 seconds by either: (i)

executing the entire order; or (ii)

executing at least that portion of the

order equal to the applicable firm quote

size and revising its bid or offer.141 The

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75451

order equal to the firm quote size, and thereafter,

revising its bid or offer to an inferior price, the

Commission expects that, in the absence of a price

movement in the underlying security, the

responsible broker-dealer will not reinstate its

original bid or offer for at least thirty seconds. A

responsible broker-dealer may not reinstate its bid

or offer for at least thirty seconds even if a

competing market maker independently quotes at

the original price during the thirty second period. 142Exchange Act Rule 11Ac1–1(c)(2), 17 CFR

240.11Ac1–1(c)(2). 143See Morgan Stanley Letter.

144See Phlx Letter; ISE Letter; and Brunelle

Letter.

145See ISE Letter.

146See Brunelle Letter.

147See CBOE Letter.

148See JPMorgan Letter.

149See Exchange Act Rule 11Ac1–1(a)(25), 17

CFR 240.11Ac1–1(a)(25).

150See JPMorgan Letter.

151The Commission defines the term ‘‘listed

option’’ in the Quote Rule as any option traded on

a registered national securities exchange or

automated facility of a registered national securities

association. See Exchange Act Rule 11Ac1–1(a)(27),

17 CFR 240.11Ac1–1(a)(27).

152One commenter noted that by changing the

definition of reported security in the Quote Rule,

options would be subject to the Limit Order Display

Rule, Exchange Act Rule 11Ac1–4, 17 CFR

240.11Ac1–4, which incorporates by reference the

definition of reported security in the Quote Rule.

See JPMorgan Letter. As the Commission did not

intend to amend the Limit Order Display Rule in

this manner, the Commission is adopting a

conforming amendment to the definition of

reported security in the Limit Order Display Rule,

to retain the existing definition in that rule.

153All national securities exchanges and national

securities associations must file with the

Commission a transaction reporting plan regarding

transactions in listed equity and Nasdaq securities.

See Exchange Act Rule 11Aa3–1(b)(1), 17 CFR

240.11Aa3–1(b)(1).

154Currently, the OPRA Plan is the only effective

national market system plan that collects,

processes, and makes available transaction reports

for listed options.

155The term ‘‘covered security’’ is defined as any

reported security and any other security for which

a transaction report, last sale data or quotation

information is disseminated through an automated

quotation system as described in Section

3(a)(51)(A)(ii) of the Exchange Act, 15 U.S.C.

78c(a)(51)(A)(ii). See Exchange Act Rule 11Ac1–

1(a)(6), 17 CFR 240.11Ac1–1(a)(6).

Quote Rule requires responsible brokers

and dealers to immediately execute an

order to buy or sell listed options in an

amount equal to or less than its firm

quote size.142

The Commission requested comment

on its proposal to require responsible

broker-dealers, within 30-seconds, to

either execute an entire order or execute

that portion of an order that is equal to

its firm quote size, and thereafter revise

its bid or offer. One commenter stated

that, ultimately, the Commission should

require that quotes be subject to

automatic or nearly automatic

executions.143 Similarly, several other

commenters considered 30 seconds too

long because it imposed unnecessary

market risk on customers and could

result in market makers abusing the

time period by holding orders until the

last second in an attempt to gain an

advantage.144 One commenter suggested

that market makers be required to

immediately respond to orders that are

not larger than the disseminated quote

size and respond within 15 seconds,

which is the turnaround time in the

Linkage Plan, to orders of greater

size.145 Another commenter suggested a

10-second response time would be more

appropriate.146

Further, because different types of

orders require different handling

procedures, which means that execution

times will be different, one commenter

opposed any requirement that would

institute an across-the-board 30-second

reporting requirement for all orders.147

This commenter suggested that the

Commission defer any decision on this

issue until the Linkage Plan has been

implemented and the exchanges have

gained some experience and data

regarding turnaround times. In addition,

this commenter suggested that if the

Commission extends trade-through

protection to markets that do not

participate in any approved linkage

plan, 30 seconds may be too long a time

period for those instances in which an

order is routed to a market that does not

participate in any approved linkage

plan, because there may not be a

guarantee of an execution in the event

that such market backs away from its

quote or is not firm for the entire order.

Finally, another commenter believed

that the 30-second response time would

not delay trades but suggested that the

Commission make an exception for fast

market conditions, and remain open to

changing the response time as

technology improves.148

For orders greater than an exchange’s

firm quote size, the Commission is

adopting the 30-second response

requirement, as proposed. The

Commission believes that the Quote

Rule currently requires responsible

broker-dealers to immediately execute

orders in a size up to its firm quote size

and is not amending that requirement as

applied to options. Accordingly, orders

equal to or smaller than a responsible

broker-dealers’ firm quote size must be

immediately executed.

The Commission believes that it is

appropriate to establish a time limit by

which a recipient market maker must

execute an order larger than its quote, or

change its quote. The Commission

believes that a time period must be set

forth in the rule to prevent brokerdealers from waiting an inordinate

amount of time before executing an

order or changing their quote. In this

regard, the Commission is concerned

that in the absence of a set time frame,

the execution of orders may be unduly

delayed. Therefore, at this time, the

Commission believes that the 30-second

time limit appropriately balances the

need for price priority against the need

for efficient execution of orders. The

Commission will, however, evaluate

this time frame as the exchanges

implement these amendments and as

technology progresses to determine if

another time frame is more appropriate.

7. One-Percent Exception

Under the Quote Rule exchanges are

required to collect and make available

the quotes communicated to them by

responsible broker-dealers for subject

securities. A subject security is any

exchange-traded security except a

security for which an exchange’s

executed volume during the most recent

calendar quarter comprised one percent

or less of the aggregate trading volume

for such security as reported to OPRA,

and any security actually quoted by an

exchange.149 One commenter believed

that this exception was not necessary for

listed options.150 This commenter

argued that the possibility of a chilling

effect on the liquidity of inactivelytraded securities would not justify the

monitoring burden that the exception

would impose on brokers, who would

be forced to keep track of which quotes

were firm and which, due to the one

percent exception, were not.

The Commission believes that the

options markets and options market

makers should be permitted to make use

of the one percent exception. The

Commission is not persuaded that this

exception, applied for years in the

equity markets, will impose significant

compliance burdens on market

participants. Any quote actually

published by the exchange must be firm.

8. Amendments to Defined Terms

To effectuate the application of the

Quote Rule to listed options, the

Commission is amending several

defined terms used in that rule. In

particular, the Commission is expanding

application of the Quote Rule to include

transactions in listed options 151 by

amending the definition of the term

‘‘reported security,’’ 152 to include any

security or class of securities for which

transaction reports are collected,

processed, and made available pursuant

to an effective transaction reporting

plan 153 or an effective national market

system plan for reporting transactions in

listed options.154 Consequently, listed

options are now also included within

the definitions of ‘‘covered security,’’ 155

75452 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

156The term ‘‘exchange-traded security’’ is

defined as any covered security or class of covered

securities listed and registered, or admitted to

unlisted trading privileges, on an exchange. See

Exchange Act Rule 11Ac1–1(a)(10), 17 CFR

240.11Ac1–1(a)(10).

157The term ‘‘subject security’’ is defined to

include any exchange-traded security other than a

security for which the executed volume of such

exchange, during the most recent calendar quarter,

comprised one percent or less of the aggregate

trading volume for such security as reported in the

consolidated system. See Exchange Act Rule

11Ac1–1(a)(25), 17 CFR 240.11Ac1–1(a)(25).

158Exchange Act Rule 11Ac1–1(a)(5), 17 CFR

240.11Ac1–1(a)(5).

159See Susquehanna Letter; Botta Letter; PCX

Letter; Phlx Letter; and JPMorgan Letter.

160 44 U.S.C. 3501 et seq. 161See Proposing Release, supra note . 162See Linkage Plan, supra note 4.

‘‘exchange-traded security,’’ 156 and

‘‘subject security.’’ 157 Thus, options

exchanges and market makers are

obligated to publish their quotes and, as

importantly, be firm for those quotes.

In addition, the Commission is

amending the definition of

‘‘consolidated system’’ under Rule

11Ac1–1(a)(5) 158 to include a

transaction reporting system operating

pursuant to an effective national market

system plan, as proposed. The effect of

this amendment is to make clear that

listed options would be ‘‘subject

securities’’ with respect to an exchange

or association only if, during the most

recent calendar quarter, the exchange or

association chooses to publish quotes or

the aggregate trading volume on such

exchange or association is more than

one percent of the aggregate trading

volume as reported by OPRA.

9. Compliance Date

The amendments to the Quote Rule

become effective on February 1, 2001,

and have a compliance date of April 1,

2001. Although several commenters

recommended that market makers and

exchanges not be required to comply

with the amendments to the Quote Rule

until OPRA is able to disseminate

quotes with size,159 the Commission

believes that these amendments will

provide significant benefits to options

market participants and does not believe

that they should be delayed while

OPRA develops new systems changes.

Further, because the options exchanges

will not be required to disseminate size

on a quote-by-quote basis, market

makers and exchanges can comply with

the amendments to the Quote Rule even

if OPRA is unable to accept quotes with

size by April 1, 2001.

V. Paperwork Reduction Act

Certain provisions of the new rules

contain ‘‘collection of information’’

requirements within the meaning of the

Paperwork Reduction Act of 1995

(‘‘PRA’’).160 Accordingly, the

Commission submitted them to the

Office of Management and Budget

(‘‘OMB’’) for review in accordance with

44 U.S.C. 3507(d) and 5 CFR 1320.11.

The Commission proposed, and OMB

approved, amendments to the collection

of information titled ‘‘Rule 11Ac1–1,

Dissemination of Quotations’’ (OMB

Control Number 3235–0461). The

Commission also proposed to create a

new information collection entitled

‘‘Rule 11Ac1–7, Trade-Through

Disclosure Rule.’’ OMB has approved

the new collection, and has assigned it

OMB Control Number 3235–0543, with

an expiration date of November 30,

2003. An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information,

unless it displays a currently valid OMB

control number.

The Proposing Release solicited

comments on these collection of

information requirements.161 No

comments were received that addressed

the PRA portion of the Proposing

Release. The Commission believes that

its previously published estimates of the

information collection burdens

associated with the new rule and rule

amendments are appropriate.

Any collection of information

pursuant to the new rules would be

mandatory. Market centers that are

national securities exchanges or

national securities associations would

be required to retain the required

collections of information for not less

than five years, the first two years in an

easily accessible place. Broker-dealers

would be required to retain the

collections of information for not less

than three years, the first two years in

an easily accessible place.

A. Use and Disclosure of the

Information Collected

The information collected pursuant to

the Trade-Through Disclosure Rule

would be sent to customers and retained

by broker-dealers. No information,

however, will be collected or retained

under this rule if all of the options

exchanges participate in an effective

national market system options linkage

plan that is reasonably designed to limit

intermarket trade-throughs. This

information would be used by

customers to evaluate the quality of the

executions they receive. It would also be

used by broker-dealers to evaluate and

make determinations related to their

best execution obligations. The

Commission and the options markets

would use the information collected

pursuant to the rule for inspections,

examinations, trading reconstructions,

enforcement inquiries or investigations.

The information collected pursuant to

the Quote Rule would be held by

broker-dealers and markets. Customers

of broker-dealers, as well as other

market participants, would use this

information to determine the sizes

associated with the best prices available

for listed options. The Commission and

self-regulatory organizations (‘‘SROs’’)

would use the information collected

pursuant to the rule for inspections,

examinations, trading reconstructions,

enforcement inquiries or investigations.

The Commission and other securities

regulatory authorities would obtain

possession of the information only upon

request. Any collection of information

received by the Commission, SROs, and

other securities regulatory authorities

would not be disclosed under the terms

of the proposal, subject to the provisions

of the Freedom of Information Act, 5

U.S.C. 552.

B. Trade-Through Disclosure Rule

1. Capital Costs

As the Commission noted in the

Proposing Release, if a broker-dealer

effects trades on a market that

participates in an approved linkage plan

with provisions reasonably designed to

limit intermarket trade-throughs,

including trade-throughs of prices on

markets not participating in a linkage

plan, the broker-dealer will have no

paperwork capital costs or paperwork

burdens under the Trade-Through

Disclosure Rule. The same will hold

true if all options markets participate in

such a linkage plan. As noted above, all

five options exchanges are currently

participants in the Linkage Plan

approved by the Commission on July 28,

2000.162 Only minor modifications to

the Linkage Plan are necessary for it to

be considered reasonably designed to

limit intermarket trade-throughs.

The Trade-Through Disclosure Rule

would require broker-dealers to make

certain disclosures to customers if the

broker-dealer effects trades on markets

that do not participate in an approved

linkage plan. Broker-dealers would

incur paperwork costs to modify

systems to permit them to: (1) Receive

information about when a trade-through

has occurred and the price that was

traded through; (2) match information

about trade-throughs with customer

accounts; and (3) disclose to customers

when trade-throughs occur. The

Commission has estimated that it would

take a computer programmer at an

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75453

163The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See Report on Management

and Professional Earnings in the Securities Industry

1999, published by the SIA (‘‘SIA Report’’).

164The Commission estimates that none of the 41

small broker-dealers who do not have a relationship

with a clearing firm regularly represent customer

options orders.

165 17 CFR 240.15c3–3.

166The Commission’s adoption of an exception to

the disclosure requirement of the Trade-Through

Disclosure Rule for block orders would only reduce

this burden. Because this burden was already

determined to be nominal, this change does not

affect the Commission’s initial burden estimate. See

Proposing Release, supra note 6.

167The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See SIA Report supra note

163.

168The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See Report on Office Salaries

in the Securities Industry 1999.

169The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See SIA Report supra note

163.

170The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See SIA Report supra note

163.

171The hourly rate contains 35% overhead,

which includes, among other costs, telephone,

postage and copying. See Report on Office Salaries

in the Securities Industry 1999.

hourly rate of approximately $50 163

between 500 and 1,000 hours to modify

the average broker-dealer’s systems to

receive trade-through information, at a

cost of between $25,000 and $50,000 for

each broker-dealer. Approximately

7,500 broker-dealers were registered

with the Commission as of December

31, 1999. Of those, approximately 3,800

conduct business with the general

public. Most introducing firms,

however, rely on their clearing firms to

generate confirmation statements for

customers.164 As a result, fewer than

330 broker-dealers would actually have

to modify their systems, should any

modifications be necessary. However, if

all 330 registered broker-dealers that

clear customer accounts pursuant to

Exchange Act Rule 15c3–3 165 were

required to make these systems

modifications, the one-time paperwork

cost would be between $8,250,000 and

$16,500,000.

2. Burden Hours

If a broker-dealer effects trades on

markets that do not participate in an

approved linkage plan with provisions

reasonably designed to limit intermarket

trade-throughs, including tradethroughs of prices on markets not

participating in an approved linkage

plan, the broker-dealer would be

required to disclose trade-throughs to its

customers. However, because brokerdealers’ systems would have already

been reprogrammed to receive

information about trade-throughs and to

appropriately disclose such tradethroughs to customers, the Commission

has estimated that the paperwork

burden of the disclosure for brokerdealers would be nominal, since it

would merely require a small amount of

additional information to be provided to

customers at or before the completion of

the transaction on confirmation

statements, or in some equivalent

fashion.166

C. Amendments to the Quote Rule

1. Capital Costs

In the Proposing Release, the

Commission noted that options

exchanges are obligated already,

pursuant to their participation in the

OPRA Plan, to collect bids and offers,

and send them to OPRA for

dissemination. However, under the

amended Quote Rule, the options

exchanges will be required to either

collect and make available to vendors

quotation sizes associated with such

bids and offers, or to establish by rule

and periodically publish the sizes for

which a quote must be firm, and to file

proposed rule changes to identify

unusual market conditions.

If an exchange chooses not to collect

and make available to vendors quotation

sizes associated with its members’ bids

and offers, but instead chooses to

implement rules and periodically

publish such rules establishing the sizes

for which its quotes will be firm, it

would incur one-time costs to file and

obtain approval of these rule changes, as

well as other related rules. The

Commission estimated that each of the

five options exchanges would need to

file two rule changes to comply with the

proposed amendments to the Quote

Rule, for a total of 10 rule changes. The

Commission has estimated that a

routine rule change requires

approximately 25 hours of legal review

at an hourly cost of $98.25,167 plus one

hour of secretarial time at an hourly cost

of $30.40,168 for a total cost of $2,487

per proposed rule change submitted for

Commission approval. Therefore, the

Commission has estimated that the

aggregate cost of two proposed rule

changes filed by each of the five options

exchanges would total approximately

$24,867.

Also, as noted in the Proposing

Release, broker-dealers that are market

makers or specialists have existing

obligations under exchange rules to

communicate their bids and offers to

their exchanges, and already do so.

Therefore, they would incur no

additional paperwork costs from the

amended Quote Rule beyond those

related to systems changes, discussed

below, to comply with the amended

Quote Rule. Market makers and

specialists may, to comply with the

amended Quote Rule, change their

quote-setting practices by changing the

factors used to establish quotes through

automated quoting systems (i.e.,

resetting the parameters). The

Commission notes that almost all option

quotes are currently set by automated

quoting systems. The Commission

estimated broker-dealer systems changes

made to comply with the amended

Quote Rule would require changes

estimated to take approximately three to

five minutes per options class. As there

are approximately 3,000 options classes

eligible for multiple listing, the

Commission estimated that the total

burden for one market could range from

180 to 250 hours. For all five markets,

the total burden could range from 900

to 1,255 hours. The hourly rate of an

exchange clerk that would make the

required system changes is $32.50;169

therefore, the total cost for these

changes could range from $29,250 to

$40,787.

2. Burden Hours

The Commission estimated that the

five options exchanges may, to comply

with the Quote Rule, amend their rules

at most once per year, for a total of five

proposed rule changes. The Commission

estimated that a routine proposed rule

change takes 25 hours of legal review at

an hourly cost of $98.25 170 plus one

hour of secretarial time at an hourly cost

of $30.40,171 for a total cost of $2,487

per proposed rule change. Therefore, the

total annual cost of five exchanges’

proposed rule changes would impose a

burden of $12,433.

Broker-dealers would not incur any

additional paperwork cost from the

amended Quote Rule beyond the

systems changes discussed above.

Market makers and specialists already

are required to make and provide quotes

in options to their exchanges. As a

result, the amendments to the Quote

Rule to include options would require

only that market makers and specialists

be firm for their quotes, which would

impose no additional paperwork burden

on them.

VI. Costs and Benefits of Final Rules

Recent increases in the multiple

listing of options classes previously

listed on a single exchange have

75454 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

172Exchange Act Rule 11Ac1–7(b)(1), 17 CFR

240.11Ac1–7(b)(1). The Commission believes that a

broker-dealer should be allowed to rely on the

market of execution to notify the broker-dealer of

when a trade-through has occurred and the best

quote at that time.

173Exchange Act Rule 11Ac1–7(b)(2), 17 CFR

240.11Ac1–7(b)(2).

174See Lek Letter.

175See ISE Letter.

176See CBOE Letter.

177See supra notes 4 and 5 and accompanying

text.

178See JPMorgan Letter.

179See JPMorgan Letter.

180See CBOE Letter.

181 It is possible that an order may not be routed

to the market publishing the best quote, if the

original market matches the better quote. However,

the Commission believes that the Trade-Through

Disclosure Rule may ensure that the customer

submitting the order will at least receive an

execution at the better published price.

intensified the competition among the

option exchanges and heightened the

need to further integrate the options

markets into the national market system.

While the growth in multiple trading

has increased the competition between

markets, it also has dramatically altered

the environment in which options

market participants conduct their

trading. In particular, multiple trading

raises new best execution challenges for

brokers. When an option is listed on

only one exchange, brokers do not have

to decide where to route an order, and

consequently, satisfying their best

execution obligations is less complex

than when they must consider the

relative merits of routing orders to two

or more market centers. With as many

as five options exchanges currently

trading certain options classes, brokers

are required to regularly and rigorously

evaluate on a more frequent basis the

execution quality available at each

options exchange.

Directly relevant to a broker’s ability

to obtain best execution for its

customers is the ability to get the best

price available. The considerable growth

in the number of options classes traded

on more than one exchange has

significantly increased the likelihood of

intermarket trade-throughs. With the

current expansion of multiple trading in

options, the Commission is increasingly

concerned about customer orders,

which are sent to one exchange, and

executed at prices that are inferior to

quotes published by another market. As

a result, the Commission believes that

adoption of the Trade-Through

Disclosure Rule and amendments to the

Quote Rule are necessary at this time to

encourage the removal of barriers to

access to, and the use of efficient

vehicles to reach, better prices on

another market.

A. Costs and Benefits of the TradeThrough Disclosure Rule

Under the Trade-Through Disclosure

Rule, a broker generally will be required

to disclose to its customer, in writing at

or before the completion of the

transaction, when the customer’s order

for listed options was executed at a

price inferior to a better published quote

and the better published quote available

at that time.172 A broker-dealer will not

be required to make this disclosure if

any of the four exceptions to the

definition of a trade-through apply,

which include when: (1) The market on

which the order is executed has verified

that the market publishing the better

price is experiencing systems problems,

which make the quote inaccessible, (2)

OPRA is experiencing queuing, (3) the

market publishing the better price is

relieved of its obligations to publish

firm quotes, or (4) the market publishing

the better quote fails to respond to an

order routed to it within 30 seconds.

A broker-dealer also will not be

required to provide such disclosure to

its customer if it effects the transaction

on an exchange that participates in an

approved linkage plan that includes

provisions reasonably designed to limit

customers’ orders from being executed

at prices that trade through a better

published price or the customer order

was executed as part of a block trade.173

Exchanges also will be required to

surveil and sanction specialists or

market makers that trade through better

prices published by other exchanges,

particularly because under the

intermarket linkage plan exception,

broker-dealers need not disclose to their

customers if their orders are executed at

a price inferior to a quote published by

another market.

1. Comments

In the Proposing Release, the

Commission requested comments on all

aspects of the costs and benefits of the

rule, including identification of

additional costs or benefits of the new

rule. In addition, the Commission

encouraged commenters to identify or

supply any relevant data concerning the

costs or benefits of the new rule.

None of the commenters specifically

addressed the costs or benefits of the

proposed Trade-Through Disclosure

Rule. However, several commenters

discussed certain aspects of the

Commission’s proposal, which

implicitly addressed the costs or

benefits of the proposal, such as the

likelihood that the rule would help to

prevent trade-throughs and therefore,

implicitly the associated costs of tradethroughs to investors. For example, one

commenter believed that trade-throughs

would be virtually eliminated if a

broker-dealer were required to disclose

to a customer that an order was

executed at a price that was inferior to

the best-published quote.174 In addition,

another commenter believed that a

linkage plan must provide some form of

protection against trading through

exchanges that do not participate in an

approved linkage plan to instill investor

confidence in the options markets.175

One commenter, however, did not

believe that the imposition of a

disclosure requirement would have a

significant impact on the frequency of

trade-throughs.176 In addition, another

commenter believed that the

Commission should modify the

provisions it requires for a linkage plan

to satisfy the exception to the disclosure

rule so that the recently approved

Linkage Plan 177 qualified as reasonable

without further amendment.178 The

commenter believed that the additional

factors proposed as elements of a plan

reasonably designed to limit tradethroughs would add significant costs to

the Linkage Plan without adding

significant additional deterrence.179 In

addition, this commenter believed that

if all or almost all of the options

exchanges are expected to join the

Linkage Plan, the Commission should

delay the adoption of the rule, because

it would not be cost-effective to require

firms to re-design their confirmation

systems to comply with such a rule if

the rule then became obsolete because

all of the exchanges were members of an

approved linkage that meets the rule’s

requirements. Another commenter

believed that the Commission should

not extend trade-through protection to

those markets that are not members of

the same linkage plan because they

would be difficult to access

effectively.180

2. Benefits

An intermarket trade-through may be

costly to an investor primarily because

the investor receives an execution at a

price that is not the best price available.

An intermarket trade-through also has

potential costs for the broker-dealer or

customer responsible for the best quote

because that quote or customer order

does not receive the execution it would

have if the order that was executed at

the inferior price were instead routed to

it.181 Consequently, intermarket tradethroughs may increase the incidence of

unexecuted customer limit orders not

being executed in a timely manner.

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75455

182The staff relied on data from OPRA for this

analysis. All trades marked as spreads, straddles,

late, or stopped were excluded from the sample. To

determine the quote in effect at the time of the

trade, the highest offer and lowest bid on each

competing exchange for a period of one minute

prior and two minutes after the reported execution

were identified. Quotes from an exchange that

indicated it was experiencing fast market

conditions during the time when the trade was

executed were not included. Quotes that indicated

that an option class was in rotation were also

excluded. The staff recognizes that not all these

trades in the sample could be fully executed at the

best available quoted price because of size or other

factors.

183Trades executed through automatic execution

systems account for about 36% of all trades and

about 12% of all contracts traded in the 50 most

active multiple-traded options classes during the

week of June 26, 2000. The procedure used for the

analysis of automatic execution trades is similar to

that described for all trades, except only trades

executed through the exchanges’ automatic

execution systems are included.

184The annual benefit estimate is obtained by

applying the staff’s trade-through findings for

automatic execution trades in the 50 most active

multiple-traded options classes to all multiplelisted classes and extending the results from one

week to a full year. In the options market, market

makers are almost always on the other side of the

transaction and therefore, investors benefit from

avoiding trade-throughs. If investors were on both

sides of the transactions, any savings for avoiding

trade-throughs would be offset by losses to

investors on the opposite side of the transactions.

185The staff estimates the benefits of executing a

maximum of 20 contracts at the best-quoted price

for those trades identified as trade-throughs could

total several hundred million dollars per year.

186See Securities Exchange Act Release No.

37182 (May 9, 1996), 61 FR 24644 (May 15, 1996).

187The Commission notes that Trade-Through

Disclosure Rule creates strong incentives for the

options exchanges to participate in an approved

intermarket linkage plan to attract order flow from

broker-dealers wishing to avoid the disclosure

requirement.

188The Commission published these numbers in

the Proposing Release and specifically solicited

comment on the costs of developing a linkage

between the markets, as well as the costs for

individual markets to integrate their systems into

such a plan. The Commission did not receive any

comments on the above data.

189See JPMorgan Letter.

190See Linkage Plan, Section 12.

To attempt to gauge the incidence of

intermarket trade-throughs, the staff

looked at trading involving the 50 most

active, multiple-listed options classes,

in which there is a great deal of investor

interest. The staff’s review of these

trades showed that approximately 5% of

all trades (or 7,964 trades for a total of

156,403 contracts) in the 50 most active

multiple-listed option classes took place

at prices inferior to the best price quoted

on a competing exchange during the

week of June 26, 2000.182 To better

evaluate the execution quality of small

customer orders, the staff also examined

automatic execution trades in the 50

most active multiple-listed options

classes. The staff also found that

approximately 1% of all automatic

execution trades (or 464 automatic

execution trades for a total of 2,336

contracts) in the 50 most active

multiple-listed option classes took place

at prices inferior to the best price quoted

on a competing exchange during the

week of June 26, 2000.183

Investors would benefit from the

Trade-Through Disclosure Rule because

they would be informed when their

orders are executed at a price inferior to

the best available price. With that

information, investors would have the

opportunity to reduce the likelihood

that their orders would be executed at

a price inferior to a price displayed by

another market by selecting brokerdealers that effect their transactions on

markets that are participants in an

approved linkage plan with provisions

reasonably designed to limit tradethroughs. Even if only one-half of all

orders executed through automatic

execution systems were executed at the

best-published quote (i.e., tradethroughs of automatic execution trades

were eliminated), the estimated annual

savings to investors trading through

exchanges’ automatic execution systems

would be approximately $5,500,000

each year.184 If all trades were

considered, the elimination of tradethroughs would result in substantially

higher annual savings to investors.185

3. Costs

The Trade-Through Disclosure Rule

may require broker-dealers and markets

to incur capital costs, such as one-time

costs to modify existing systems. For

example, the new rule could impose

one-time costs on markets and brokerdealers that must modify systems to

determine when trade-throughs have

occurred and to issue notifications to

customers of trade-throughs. Further, to

identify when an order trades through a

posted quote, information systems

would need to be developed that could

identify the displayed quotes at the time

of execution. Because the Commission

would allow broker-dealers to rely on

notifications from the markets when

trade-throughs occur and the better

available quote at that time, the costs of

such information systems may be borne

by the options markets.

In addition, implementing the rule

could require broker-dealers to provide

customer notifications at or before the

completion of the transaction. A brokerdealer may provide this disclosure to its

customers in conjunction with the

confirmation statements routinely sent

to customers and could be issued in

either electronic or paper form.186 An

alternative to changing confirmation

statements would be for broker-dealers

to route orders to exchanges

participating in an approved linkage

plan.187 Although the new rule does not

require the implementation of such a

plan, it does envision that an approved

plan could be implemented. Thus, one

possible cost to the options markets of

the Trade-Through Disclosure Rule

could be the capital investment to

establish a linkage. In addition to the

capital costs of establishing the linkage,

costs could include regulatory costs,

such as obtaining Commission approval

of a linkage and of SRO rule changes

necessary to implement a linkage.

Further, there may be economic

implications if a market chooses to

participate in an approved linkage plan,

because members may then be more

likely to use the linkage to route orders

to other exchanges that are quoting a

better price. The Commission estimates

that capital costs for a linkage plan

range from $1,000,000 to $1,500,000

initially, and yearly costs could range

from $300,000 to $1,000,000.188

The Commission recognizes that

broker-dealers may incur certain capital

costs to implement the Trade-Through

Disclosure Rule. While the Commission

recognizes that these costs cannot be

avoided, the Commission believes that

most of these costs will be one-time

costs for broker-dealers with continuing

savings to investors through the

elimination of trade-throughs. Also, as

members of the options exchanges,

broker-dealers may have input into a

decision by an exchange to participate

in an options linkage plan and therefore,

influence decisions that will impact

their costs, including potential exchange

fees.

The Commission is also sympathetic

to the comment that the rule may

become obsolete if all the options

exchanges participate in an approved

intermarket linkage plan.189 The

Commission is not mandating

participation in a particular intermarket

linkage plan to allow the options

exchanges to retain greater flexibility.

Because participation in an options

linkage plan is voluntary and because,

under the current terms of the Linkage

Plan, any participant may withdraw

from the plan at any time with 30 days

prior written notice to each of the other

plan participants and the facilities

manager, if any,190 the Commission

continues to believe that the TradeThrough Disclosure Rule is needed to

ensure that, if the exchange on which

their orders are executed do not belong

to an approved linkage plan with

provisions designed to limit tradethroughs, investors at least receive

75456 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

191Exchange Act Rule 11Ac1–1(d)(2), 17 CFR

240.11Ac1–1(d)(2).

192Exchange Act Rule 11Ac1–1(d)(1), 17 CFR

240.11Ac1–1(d)(1). Exchange rules must require

responsible broker-dealers to be firm for orders for

the account of broker-dealers for at least one

contract.

193Exchange Act Rule 11Ac1–1(d)(1)(iii), 17 CFR

240.11Ac1–1(d)(1)(iii).

194Exchange Act Rule 11Ac1–1(d)(3)(i), 17 CFR

240.11Ac1–1(d)(3)(i). A responsible broker’s or

dealer’s applicable firm quote size would be its

published quote size or, if a responsible broker or

dealer has been relieved of the obligation to

communicate its quotation sizes, the minimum firm

quote size established by its exchange’s rules.

195Exchange Act Rule 11Ac1–1(c)(2), 17 CFR

240.11Ac1–1(c)(2).

196See JPMorgan Letter.

197See Lek Letter.

198See Lek Letter and PCX Letter.

199See Lek Letter.

200See Brunelle Letter. This commenter noted

that subsequent to execution, specialists or market

makers frequently change the terms of the

transaction or ‘‘break’’ the trade.

201See Susquehanna Letter.

202See Susquehanna Letter and Botta Letter.

203See JPMorgan Letter.

disclosure if their orders are not

executed at the best price.

The Commission recognizes that by

providing an incentive for markets to

cooperate in developing effective means

to access other markets, trade-throughs

will be minimized. However, to the

extent that: (1) One or more options

exchanges decide not to participate in a

linkage plan; (2) trade-throughs are not

minimized by the implementation of an

intermarket linkage plan because the

plan fails to provide protection across

all markets, including markets that do

not participate in a linkage plan; (3)

away markets fail to complain about

trade-throughs; or (4) broker-dealers are

not subject to potential sanctions for

trade-throughs, the value of the TradeThrough Disclosure Rule would be

greatly diminished. Therefore, the

Commission believes that despite the

existing exchanges’ participation in the

Linkage Plan, the Trade-Through

Disclosure Rule adopted by the

Commission is also needed for the

protection of investors. The Commission

believes that the rule can only be

effective if trade-throughs of any market

are disclosed to investors, or effectively

limited by an approved linkage plan.

B. Costs and Benefits of Amendments to

the Quote Rule

The Commission is adopting

amendments to the Quote Rule to

extend its application to options traded

on national securities exchanges.

Generally, the Quote Rule requires

exchanges to collect quotations and

sizes from its responsible broker-dealers

and make those quotations and sizes

available to quotation vendors for each

subject security listed and admitted to

unlisted trading privileges on the

exchange.

The Commission is adopting

amendments to the Quote Rule to

accommodate the unique structure of

the options market to permit options

exchanges to decide whether or not to

collect from their members and make

available to vendors the size associated

with each quotation in listed options.

Instead, exchanges may choose to

establish by rule and periodically

publish the size for which its best bid

or offer in each options series that is

listed on the exchange is firm. If the

rules of the exchange do not require its

members to communicate quotation

sizes for listed options, responsible

broker-dealers that are members of that

exchange will be relieved of their

obligations under the Quote Rule to

communicate to that exchange their

quotation sizes. Instead, each

responsible broker-dealer may satisfy its

firm quote obligation by executing any

order to buy or sell a listed option that

is a subject security, in an amount up to

the size established by the exchange’s

rules.191 An exchange may establish in

its rules different firm quote sizes for

broker-dealer orders than for customer

orders.192

If, on the other hand, an options

exchange chooses to establish

procedures for collecting from its

members, and making available to

vendors, the sizes of its members’

quotes, the exchange may permit its

members’ quotes to be firm for different

sizes for customer orders than for

broker-dealer orders.193 In addition, an

exchange will have the flexibility to

collect and disseminate quote sizes for

customer orders and establish by rule

quote sizes for broker-dealer orders.

As discussed above, under the TradeThrough Disclosure Rule, if a

responsible broker-dealer fails to

respond to an incoming order within the

30 seconds, the routing broker-dealer

may execute its customer’s order at its

own inferior quote and would not be

required to disclose the trade-through to

its customer because the quote traded

through was unavailable. The

Commission also is adopting an

amendment to the Quote Rule to require

a responsible broker-dealer to respond

to an order to buy or sell a listed option

in an amount greater than its firm quote

size within 30 seconds by either: (1)

executing the entire order; or (2)

executing at least that portion of the

order equal to the applicable firm quote

size and revising its bid or offer.194 The

Quote Rule requires responsible brokers

and dealers to immediately execute an

order to buy or sell listed options in an

amount equal to or less than its firm

quote size.195

1. Comments

One commenter stated that the lack of

a Quote Rule in the options markets has

impeded firms’ ability to execute

customer orders in an efficient manner

while they explore posted quotes to see

whether they are firm for the entire

order or only for an order of minimal

size.196 Another commenter suggested

that a true linkage cannot occur so long

as market makers are permitted to refuse

to honor displayed quotes.197 Two

commenters also believe that the Quote

Rule will promote efficiency and

increase customer confidence in our

markets.198 In addition, another

commenter argued that the supposition

that market makers would widen their

spreads if their quotes were exposed to

other market professionals is unjustified

and unsupported by empirical data, and

in any case, the public is more harmed

by non-competitive un-real quotes than

by wider spreads.199

Alternatively, one commenter stated

that extending the Quote Rule to options

will not significantly improve the

current situation because the options

markets are already subject to exchangecreated firm quote rules, and despite

such rules, public investors have often

found that quotations in these markets

are not firm, and neither are many of

their transactions.200 In addition, one

commenter suggested that current

competition among market makers for

public customer orders is intense, but

the proposed amendments will force the

allocation of capital into areas of

unacceptable risk, such as trading

against other broker-dealers, and away

from the facilitation of public customer

orders.201 Two commenters believed

that to compensate for the increased

exposure to broker-dealers the

amendments will cause market makers

to be less aggressive, widen spreads,

limit quote size, and reduce overall

liquidity to public customers, despite

the fact that the proposal is suppose to

draw more liquidity into the market by

requiring market makers to be firm to

broker-dealers.202

One commenter also believed there is

no need for an exception to the Quote

Rule for exchanges whose aggregate

trading volume in a listed option is less

than or equal to one percent of the total

trading volume reported by OPRA.203

This commenter argues that the

possibility of a chilling effect on the

liquidity of inactively traded securities

does not justify the monitoring burden

that the exception would impose on

brokers, who would be forced to keep

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75457

204The equities markets have been subject to a

firm quote requirement since 1978. See Securities

Exchange Act Release No. 14415, supra note and

accompanying text.

205 In the Proposing Release, the Commission

stated that it was unable to quantify these costs and

further solicited comments on these costs. See

Proposing Release, supra note 7. No commenters

explicitly addressed this issue.

206See supra note 33.

track of which quotes were firm and

which, because of the one percent

exception, were not.

2. Benefits

Amending the Quote Rule would

reduce discrepancies between the

treatment of quotes in the options

markets and the equity markets.204

Although options trading is not

currently covered by the Commission’s

Quote Rule, each exchange’s rules

require their members’ quotes to be firm

up to a certain minimum size and

establish the process for handling orders

in excess of the exchange’s firm quote

size. Exchange rules also establish

whether members’ quotes must be firm

for all orders or only some orders, such

as only for public customer orders.

The Commission believes that

applying the Quote Rule to the options

market would provide a number of

benefits. Firm quotes reduce uncertainty

surrounding order routing decisions for

broker-dealers that are seeking to fill

customer orders at the best available

price. If broker-dealers are confident

that quotes are firm, investor orders may

be routed to the market with the best

price and receive an execution at that

price. Under current practices, because

broker-dealers cannot be confident that

a price on another market is firm (due

to existing market rules, including

trade-or-fade rules), orders do not

always receive the best available price.

As discussed above, the staff estimates

that five percent of all trades in the 50

most active multiply-listed classes took

place at prices inferior to the best price

quoted on a competing market during a

one-week period in June 2000. Brokerdealers often state that such tradethroughs occur when market makers

believe the better price on the other

market may not be firm and the quote

may ‘‘fade’’ if the broker-dealer were to

attempt to execute against it. By

requiring that posted prices be firm up

to a published size, a great deal of

uncertainty about order execution

quality could be reduced. This would be

true even if the quote were permitted to

be firm for different sizes for customer

orders than for broker-dealer orders.

In addition to providing certainty to

broker-dealers making order routing

decisions and seeking to fill orders at

the best available price, extending the

Quote Rule to the options markets may

benefit broker-dealers by enhancing

their ability to satisfy their regulatory

obligations, including best execution.

The Commission believes that the Quote

Rule may help broker-dealers to satisfy

their best execution obligations by

providing firm quote information and

reducing concerns about ‘‘fading’’

quotes. In addition, the Commission

believes that enhancing the ability of

broker-dealers to satisfy their best

execution obligations may reduce the

liability exposure faced by brokerdealers as to their best execution

obligations.

The Commission also believes that the

proposed amendments to the Quote

Rule would bolster investor confidence

in the options markets by ensuring that

quotes made by market makers or

specialists are available for a specified

number of options contracts, thus

providing greater certainty for investors.

The Commission believes that as a

result of increased investor confidence,

more investors may trade options and

thereby, increase volume and reduce

spreads on the options exchanges. In

addition, by requiring the quotations in

listed options to be firm, the

amendments may also lead to betterinformed investors, which should

increase investor confidence in the

market.

Another benefit of applying the Quote

Rule to options trading is that it would

likely increase competition between

markets. Because all quotes would be

firm, a market participant would know

that a posted quote would be recognized

as firm. Therefore, the posted quote may

attract order flow. The ability to attract

order flow with a market-improving

quote encourages intermarket price

competition, which benefits investors.

In addition, the Commission believes

that its proposal would result in (1)

fewer unexecuted investor orders due to

quote changes after order arrival, or (2)

fewer orders executed at prices less

favorable to the investor than those

prevailing at the time of order arrival.

3. Costs

Applying the Quote Rule to the

options market would require exchanges

to collect bids and offers from their

members. This would not impose a

significant burden on the exchanges

because bids and offers generally are

collected already by the markets and

sent to (and disseminated through)

OPRA. Currently, each of the options

markets has rules that establish the

maximum size of orders that its

automatic execution system will

execute. The exchanges would,

however, be required to publish the size

(or sizes, if different categories are used)

for which their quotes must generally be

firm. There are likely to be expenses

incurred by the markets related to

collecting and making available to

quotation venders or periodically

publishing their firm quote sizes.

Amendment of the Quote Rule to

include options may require markets to

incur one-time costs. For example,

options markets may need to enhance

surveillance and enforcement

mechanisms to ensure that its members

are complying with the Quote Rule.

Further, options market makers and

specialists may need to reevaluate and

change their quotes in light of the

obligation to be firm that would be

imposed by the amendment to the

Quote Rule.205

The Commission recognizes that these

costs cannot be avoided, although the

impact of the costs may be minimized

to the extent that a market already has

surveillance and enforcement

procedures in place to monitor its

members for compliance with the

existing rules of the Commission and

the exchange. However, the Commission

believes that the current situation,

wherein the options markets are

permitted to fade from their quotes

without consequence, pursuant to their

trade-or-fade rules,206 is no longer

acceptable. Currently, options investors

cannot fully rely on the disseminated

quotation information on which they

base their order routing decisions. The

Commission believes that options

investors deserve the same protections

as equity investors and therefore, the

Commission is adopting amendments to

extend the coverage of the Quote Rule

to the options market.

In addition, with respect to the

concern raised by two commenters

regarding the increased financial

exposure of broker-dealers under the

Quote Rule, the Commission notes that

under the rule being adopted today, the

options exchanges may establish

different quote sizes for broker-dealers’

orders than for customer orders. The

Commission also believes that the

options markets and options market

makers should be permitted to make use

of the one percent exception. The

Commission is not persuaded that this

exception, applied for years in the

equity markets, will impose significant

compliance burdens on market

participants.

C. Conclusion

With the current expansion of

multiple trading in options, the

Commission is increasingly concerned

75458 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

207 15 U.S.C. 78c(f).

208See Proposing Release, supra note 7.

209See Lek Letter; PCX Letter; and CBOE Letter.

210See JPMorgan Letter.

211See PCX Letter. See also ISE Letter.

212 15 U.S.C. 78w(a)(2).

213See Proposing Release, supra note 7.

214See Botta Letter; CBOE Letter; PCX Letter; and

Susquehanna Letter.

215See ISE Letter.

216See CBOE Letter and Botta Letter.

217See CBOE Letter.

218See Botta Letter.

about customer orders, which are sent to

one exchange, and executed at prices

that are inferior to quotes published by

another market. The Commission,

therefore, believes that adoption of the

Trade-Through Disclosure Rule and

amendments to the Quote Rule are

necessary at this time to encourage the

removal of barriers to access to, and the

use of efficient vehicles to reach, better

prices on other markets. The

Commission recognizes that there may

be some costs associated with the

implementation of these rules, however,

the Commission believes that the likely

benefits justify the possible costs.

VII. Effects on Competition, Efficiency,

and Capital Formation

Section 3(f) of the Exchange Act 207

requires the Commission, when

engaging in rulemaking that requires it

to consider or determine whether an

action is necessary or appropriate in the

public interest, to consider whether the

action will promote efficiency,

competition, and capital formation. In

the Proposing Release, the Commission

requested comment on these issues.208

With regards to the amendments to

the Quote Rule, several commenters

supported the Commission’s proposals

because they believed that the

amendments would promote efficiency

and enhance public confidence in the

options markets.209 Another commenter

that argued that the current lack of a

Quote Rule in the options markets

impeded firms’ ability to execute

customer orders in an efficient manner

because firms are forced to explore

quotes to determine the size for which

the quotes represent.210

The Commission believes that the

amendments to the Quote Rule are

necessary and appropriate in the public

interest. The amendments to the Quote

Rule should bolster investor confidence

in the options markets by ensuring that

quotes made by market participants are

available for a specified number of

contracts, thus providing greater

certainty for investors. Similarly, the

increased investor confidence should

promote market efficiency and capital

formation.

The amendments to the Quote Rule

should also assist broker-dealers in

making their best execution

determinations. Further, the amendment

to the Quote Rule will help to ensure

that important information relating to

the size associated with disseminated

quotes is available to all market

participants. This should promote

market efficiency, competition, and

capital formation.

With regards to the Trade-Through

Disclosure Rule, the Commission

believes that it will bolster confidence

in the options markets by better

informing investors about the quality of

their executions and the implications of

their broker-dealers’ execution

decisions. This increased investor

confidence should promote market

efficiency and capital formation. The

Trade-Through Disclosure Rule also

should help to minimize the number of

customer orders that do not receive an

execution at the best available quote.

The Commission also believes that the

Trade-Through Disclosure Rule will

assist broker-dealers in evaluating and

complying with their best execution

obligations. Moreover, the TradeThrough Disclosure Rule will provide

an incentive to develop effective means

of access between the markets to avoid

trade-throughs. One commenter agreed,

stating that the Trade-Through

Disclosure Rule should assure that the

options markets participate in either the

Linkage Plan or that they will develop

alternative plans that will effectively

address and limit trade-throughs.211 The

Commission believes that this will

result in the more efficient execution of

orders in the options markets.

Section 23(a)(2) of the Exchange

Act 212 requires that the Commission,

when promulgating rules under the

Exchange Act, to consider the impact

any rule would have on competition

and not to adopt any rule that would

impose a burden on competition that is

not necessary or appropriate in the

public interest. In the Proposing

Release, the Commission noted that

because both the proposed amendments

to the Quote Rule and the proposed

Trade-Through Disclosure Rule would

apply equally to all relevant market

participants, the Commission believed

the proposals would not have any anticompetitive impact.213 The

Commission, however, requested

comment on any anti-competitive

effects of the proposals. The

Commission did not receive any

comments regarding the competitive

impact of the Trade-Through Disclosure

Rule. Thus, the Commission continues

to believe that the Trade-Through

Disclosure Rule adopted today will not

have an anti-competitive impact on the

options markets because the rules apply

equally to each options market and

other relevant options market

participants.

The Commission did, however,

receive comments on the potential

competitive impact of the amendments

to the Quote Rule. Several commenters

that addressed the potential competitive

impact of a Commission-mandated firm

quote size believed that the Commission

should not mandate a firm quote size

because they argued that competitive

market forces should dictate an

appropriate firm quote size

minimum.214 Another commenter,

however, argued that the Commission

should mandate that the exchanges be

firm for one contract for non-customer

orders, which would permit the

exchanges to compete by providing

greater than the one contract minimum

to attract non-customer order flow.215

While agreeing that the Commission

should not dictate a firm quote size

minimum, two commenters disagreed

on whether the options exchanges or

options market makers should be

permitted to establish firm quote

minimums.216 For example, one

commenter noted that the options

exchanges compete for order flow by

establishing firm quote guarantees.217

Another commenter, however, argued

that it is the options market makers that

compete for order flow by establishing

quote sizes for which they are willing to

guarantee and that requiring the

exchanges to set minimum quote sizes

would eliminate this competition.218

As discussed above, the Commission

agrees that the minimum firm quote size

for each exchange should be determined

independently by each exchange as a

competitive issue and should not be

dictated by government regulation.

Further, the Commission also agrees

that each disseminated quote must be

firm for at least one contract. The

Commission believes that this approach

will encourage competition among the

exchanges, which should benefit all

investors.

The amendments to the Quote Rule

adopted by the Commission today

permit the options exchanges to

establish by rule and periodically

publish the sizes for which quotes will

be firm for listed options. While one

commenter argued that options market

makers should be able to compete on

this basis, the Commission believes, at

this time, that it is appropriate to permit

the exchanges to determine firm quote

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75459

219See PCX Letter.

220See Lek Letter.

221Of course, Exchange Act Rule 11Ac1–1(d)(1)

requires that exchange rules must require

responsible broker-dealers to be firm for orders for

the accounts of broker-dealers for at least one

contract. 17 CFR 240.11Ac1–1(d)(1).

222 5 U.S.C. 604.

223See Proposing Release supra note 7.

224See Exchange Act Rule 11Ac1–7, 17 CFR

240.11Ac1–7.

225See Exchange Act Rule 11Ac1–1, 17 CFR

240.11Ac1–1.

sizes. Currently, the options exchanges,

other than the ISE, do not accept quotes

from each competing market maker on

their floors. Further, OPRA does not, at

this time, have the capability to accept

and disseminate to vendors quotes with

size, although it plans to have such

capability early next year. Thus, the

Commission believes that, at this time,

it is appropriate for the exchanges to

establish by rule and periodically

publish the size associated with quotes

in listed options. The Commission will

continue to consider this issue as

technology advances because the

Commission believes that permitting

individual market makers to compete on

the basis of size on each exchange floor

as well as among competing exchanges

could further enhance the

competitiveness of the options markets.

Finally, the Commission received two

comments on the potential competitive

impact of the two alternative proposals

regarding establishing firm quote sizes

for broker-dealer orders and customer

orders. As discussed above, proposed

Alternative A would have required that

firm quote size minimums be the same

for all orders, while proposed

Alternative B would have permitted the

options exchanges to establish different

firm quote size minimums for brokerdealer and customer orders. One

commenter, while supporting proposed

Alternative A, suggested that it believed

that distinctions between broker-dealer

and customer orders would ultimately

be eliminated through competitive

measures of the exchanges.219 Another

commenter, who supported Alternative

A, argued that broker-dealers play an

important role in keeping prices fair and

should be permitted to participate in the

competitive pricing process.220

As noted above, the amendments to

the Quote Rule adopted today permit

the exchanges to establish different firm

quote sizes for broker-dealer orders than

for customer orders. Due to the

tremendous number of options products

that must be continuously quoted by

options market makers and specialists,

the Commission believes that this

distinction is appropriate at this time.

The Commission will continue to

consider whether this distinction is

appropriate. The Commission notes,

however, that the amendments to the

Quote Rule do not mandate that the

exchanges establish different quote sizes

for broker-dealer orders and customer

orders, it only permits the distinction.

Thus, the options exchanges are free to

establish their individual firm quotes

sizes for broker-dealer and customer

orders as they deem appropriate.221 The

Commission thinks that it is likely that

the options exchanges will compete on

this basis.

VIII. Final Regulatory Flexibility

Analysis

This Final Regulatory Flexibility

Analysis (‘‘FRFA’’) has been prepared in

accordance with the Regulatory

Flexibility Act.222 It relates to the

adoption of the Trade-Through

Disclosure Rule and amendments to the

Quote Rule. An Initial Regulatory

Flexibility Analysis (‘‘IRFA’’) was

prepared in accordance with 5 U.S.C.

603 and was made available to the

public.223 The Commission is adopting

the Trade-Through Disclosure Rule and

the amendments to the Quote Rule

substantially as proposed.

The Trade-Through Disclosure Rule,

Exchange Act Rule 11Ac1–7,224 will

require a broker-dealer to disclose to its

customer when the customer’s order is

executed at a price inferior to a price

published by another market. However,

a broker-dealer will not be required to

provide such disclosure to its customer

if it effects the customer’s transaction on

a market that participates in an

approved linkage plan that includes

provisions reasonably designed to limit

customers’ orders from being executed

at prices that trade through a better

published price, even if the better price

is on a market that is not part of the

linkage plan.

The Quote Rule, Exchange Act Rule

11Ac1–1,225 currently requires

exchanges to establish procedures for

collecting from their members bids,

offers, and quotation sizes for certain

equity securities available to quotation

venders. It also requires that the

quotation information made available to

vendors be firm, subject to certain

exceptions. The amendments to the

Quote Rule adopted by the Commission

today apply the Quote Rule to options

traded on a national securities exchange

or an automated facility of a national

securities association.

A. Need for, and Objectives of, the Rules

The significant increase in multiple

trading that has occurred during the

past year has dramatically altered the

options trading environment and raised

a number of issues, including new best

execution challenges for broker-dealers.

When an option is listed on only one

market, broker-dealers do not have to

decide where to route the order, and,

consequently, satisfying their best

execution obligations with respect to

such options orders is less complex than

when they must consider the relative

merits of executing orders on several

markets. Directly relevant to a broker’s

ability to get best execution for its

customers is the ability to get the best

price available. Currently, it is difficult

to ensure that a customer order sent to

one market will receive the best

available price because there is no

effective mechanism that allows brokerdealers on one market to access a better

price displayed on another.

The Commission is adopting the

Trade-Through Disclosure Rule and the

amendments to the Quote Rule to help

address this situation. The TradeThrough Disclosure Rule and the

amendments to the Quote Rule are

intended to bolster investor confidence

in the options markets by better

informing customers about the quality

of their executions and the implications

of their broker-dealers’ execution

decisions. The Trade-Through

Disclosure Rule will require a brokerdealer to disclose to its customer when

the customer’s order is executed at a

price inferior to the best-published

quote. A broker-dealer will not be

required to make this disclosure if the

broker-dealer transacts the customer

order on a market that participates in a

Commission-approved intermarket

linkage plan that has rules reasonably

designed to limit trade-throughs, even

when the better price is displayed by a

market that is not a participant in the

linkage plan. Amending the Quote Rule

to apply it to the options markets should

provide greater certainty about both

options quotes and pricing generally in

the options markets. The amendments

to the Quote Rule, along with the TradeThrough Disclosure Rule, should assist

broker-dealers in making their best

execution evaluations.

The Trade-Through Disclosure Rule

should help minimize the number of

customer orders that do not receive an

execution at the best available

published quote. Further, the TradeThrough Disclosure Rule will assist

broker-dealers in evaluating and

complying with their best execution

obligations. Finally, it will provide an

incentive for options markets to develop

effective means to access quotes on

other markets to avoid trade-throughs.

The amendments to the Quote Rule

also should bolster investor confidence

75460 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

226See 5 U.S.C. 604(a)(2).

227 17 CFR 240.0–10(c).

228The Commission’s estimate of 41 small

entities includes all of the registered broker-dealers

that do not have relationships with clearing firms.

229 17 CFR 240.0–10(e).

230Exchange Act Rule 11Aa3–1, 17 CFR

240.11Aa3–1.

in the options markets by ensuring that

quotes made by market participants are

available for a specified number of

options contracts, thus providing greater

certainty for investors. The amendments

to the Quote Rule also will assist brokerdealers in making their best execution

determinations. Further, the

amendments will provide information

to the market as a whole as to the

various factors affecting the market,

including the current levels of buying

and selling interest.

B. Significant Issues Raised by Public

Comment

As required by the Regulatory

Flexibility Act, this section (i)

summarizes the significant issues raised

by public comments in response to the

IRFA, (ii) summarizes the Commission’s

assessment of such issues, and (iii)

states any changes made in the

proposed rules as a result of such

comments.226

No comments were received in

response to the IRFA.

C. Small Entities Subject to the Rules

Commission rules generally define a

broker-dealer as a small entity for

purposes of the Exchange Act and the

Regulatory Flexibility Act if the brokerdealer had a total capital (net worth plus

subordinated liabilities) of less than

$500,000 on the date in the prior fiscal

year as of which its audited financial

statements were prepared, and it is not

affiliated with any person (other than a

natural person) that is not a small

entity.227 The Commission estimates

that as of December 31, 1999,

approximately 41 Commissionregistered broker-dealers were small

entities that would be subject to the

Trade-Through Disclosure Rule.228

However, the Commission estimates

that none of the 41 registered brokerdealers that would be considered small

entities for purposes of the statute

regularly represent options orders on

behalf of their customers. In addition,

the Commission notes that only those

broker-dealers that are also options

specialists or market makers will be

required to comply with the

amendments to the Quote Rule. As of

December 31, 1999, our data indicates

that only one broker-dealer that was a

small entity was an options specialist or

market maker.

The amendments to the Quote Rule

also will directly affect the national

securities exchanges that trade listed

options, none of which is a small entity

as defined by Commission rules.

Paragraph (e) of Exchange Act Rule 0–

10 229 states that the term ‘‘small

business,’’ when referring to an

exchange, means any exchange that has

been exempted from the reporting

requirements of Exchange Act Rule

11Aa3–1.230 The amendments to the

Quote Rule also will directly affect

national securities associations. There is

one national securities association,

which is not a small entity, as defined

by 13 CFR 121.201.

D. Projected Reporting, Recordkeeping,

and Other Compliance Requirements

The Trade-Through Disclosure Rule

will require a broker-dealer to disclose

to its customer at or before the

completion of the transaction when an

options trade executed for the customer

was made at a price inferior to a price

published by another exchange. The

broker-dealer will not be required to

provide such disclosure to its customer

if the options trade was executed on an

exchange that participates in an

approved linkage plan that has rules

reasonably designed to limit customers’

orders from being executed at prices

that are inferior to a published price,

even if that better published price is on

a market that is not part of the linkage

plan.

The amendments to the Quote Rule

will require a broker-dealer that is either

a specialist or market maker to honor its

quote for a size determined and

published by the options exchange

where the specialist or market maker is

quoting. The amendments also will

require national securities exchanges

and national securities associations

either to collect from their members the

size associated with their quotes and

disseminate that information to

quotation venders, or to establish by

rule and periodically publish such

information.

E. Agency Action To Minimize Effect on

Small Entities

The Regulatory Flexibility Act directs

the Commission to consider significant

alternatives that would accomplish the

stated objective, while minimizing any

significant adverse impact on small

entity issuers. In connection with

adopting the Trade-Through Disclosure

Rule and the amendments to the Quote

Rule, the Commission considered the

following alternatives: (1) The

establishment of differing compliance or

reporting requirements or timetables

that take into account the resources

available to small entities; (2) the

clarification, consolidation, or

simplification of compliance and

reporting requirements under the rules

for small entities; (3) the use of

performance rather than design

standards; and (4) an exemption from

coverage of the rules, or any part

thereof, for small entities.

The Commission believes that

different compliance or reporting

requirements or timetables for small

entities would interfere with achieving

the primary goals of bolstering investor

confidence, assisting broker-dealers in

best execution determinations, and

providing information as to the various

factors affecting the market, including

the current levels of buying and selling

interest. For example, if all brokerdealers quoting prices in options are not

required to comply with the

amendments to the Quote Rule,

investors and market participants would

be unable to determine true buying and

selling interest, undermining investor

confidence and the ability of a brokerdealer to make best execution decisions.

Further, broker-dealers would not be

certain that a quote was firm without

knowing whether the broker-dealer

making the quote is a small brokerdealer. In addition, if all broker-dealers

were not obligated to comply with the

Trade-Through Disclosure Rule, all

investors (those that are customers of

small broker-dealers) would not benefit

fully from the rule, potentially reducing

the benefits of the rule.

For the same reasons, the Commission

believes that exempting small entities

from the rules, in whole or in part, is not

appropriate. In addition, the

Commission has concluded that it is not

feasible to further clarify, consolidate, or

simplify the rules for small entities. The

Commission has used performance

elements in the rules. Specifically, the

rules do not require a broker-dealer to

satisfy its obligations in accordance

with any specific design, but rather

provide each broker-dealer, including

small entities, with the flexibility to

select the method of compliance that is

most efficient and appropriate for its

business operations. The Commission

does not believe different performance

standards for small entities would be

consistent with the purpose of the

Trade-Through Disclosure Rule and the

amendments to the Quote Rule.

Further, the Commission believes that

none of the above alternatives is

applicable to the amendment with

regard to national securities exchanges

or national securities associations. The

markets are directly subject to the

requirements of the rules and are not

Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations 75461

‘‘small entities’’ because they are all

national securities exchanges or

national securities associations that do

not meet the definition of small entity.

Therefore, the Commission does not

believe the alternatives to the rules are

applicable to the markets.

IX. Statutory Authority

The Commission is adopting the

Trade-Through Disclosure Rule and

amendments to the Quote Rule pursuant

to its authority under Exchange Act

Sections 3(b), 5, 6, 15, 11A, 17 (a) and

(b), 19, and 23(a).

List of Subjects in 17 CFR Part 240

Brokers-dealers, Fraud, Issuers,

Reporting and recordkeeping

requirements, Securities.

Text of the Final Rules

For the reasons set out in the

preamble, Title 17, Chapter II of the

Code of Federal Regulations is amended

as follows:

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934

1. The authority citation for Part 240

continues to read in part as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,

78c, 78d, 78f, 78i, 78j, 78j–1, 78k, 78k–1, 78l,

78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w,

78x, 78ll(d), 78mm, 79q, 79t, 80a–20, 80a–23,

80a–29, 80a–37, 80b–3, 80b–4 and 80b–11,

unless otherwise noted.

* * * * *

2. Section 240.11Ac1–1 is amended

by revising paragraphs (a)(5), (a)(20) and

(d); in the second sentence of paragraph

(b)(3)(i) by revising the phrase ‘‘under

paragraph (c)(2)’’ to read ‘‘under

paragraphs (c)(2) and (d)(3)’’, and

adding paragraphs (a)(26), (a)(27),

(a)(28), (a)(29), and (a)(30), and (e) to

read as follows:

§ 240.11Ac1–1 Dissemination of

quotations.

(a) Definitions. * * *

(5) The term consolidated system

means the consolidated transaction

reporting system, including a

transaction reporting system operating

pursuant to an effective national market

system plan.

* * * * *

(20) The term reported security means

any security or class of securities for

which transaction reports are collected,

processed and made available pursuant

to an effective transaction reporting

plan, or an effective national market

system plan for reporting transactions in

listed options.

* * * * *

(26) The term customer means any

person that is not a registered brokerdealer.

(27) The term listed option means any

option traded on a registered national

securities exchange or automated

facility of a national securities

association.

(28) The term options class means all

of the put option or call option series

overlying a security, as defined in

Section 3(a)(10) of the Act (15 U.S.C.

78c(a)(10)).

(29) The term options series means

the contracts in an options class that

have the same unit of trade, expiration

date, and exercise price, and other terms

or conditions.

(30) The term trading rotation means,

with respect to an options class, the

time period on an exchange during

which:

(i) Opening, re-opening, or closing

transactions in options series in such

options class are not yet completed; and

(ii) Continuous trading has not yet

commenced or has not yet ended for the

day in options series in such options

class.

* * * * *

(d) Transactions in listed options.

(1) An exchange or association:

(i) Shall not be required, under

paragraph (b) of this section, to collect

from responsible brokers or dealers who

are members of such exchange or

association, or to make available to

quotation vendors, the quotation sizes

and aggregate quotation sizes for listed

options, if such exchange or association

establishes by rule and periodically

publishes the quotation size for which

such responsible brokers or dealers are

obligated to execute an order to buy or

sell an options series that is a subject

security at its published bid or offer

under paragraph (c)(2) of this section;

(ii) May establish by rule and

periodically publish a quotation size,

which shall not be for less than one

contract, for which responsible brokers

or dealers who are members of such

exchange or association are obligated

under paragraph (c)(2) of this section to

execute an order to buy or sell a listed

option for the account of a broker or

dealer that is in an amount different

from the quotation size for which it is

obligated to execute an order for the

account of a customer; and

(iii) May establish and maintain

procedures and mechanisms for

collecting from responsible brokers and

dealers who are members of such

exchange or association, and making

available to quotation vendors, the

quotation sizes and aggregate quotation

sizes in listed options for which such

responsible broker or dealer will be

obligated under paragraph (c)(2) of this

section to execute an order from a

customer to buy or sell a listed option

and establish by rule and periodically

publish the size, which shall not be less

than one contract, for which such

responsible brokers or dealers are

obligated to execute an order for the

account of a broker or dealer.

(2) If, pursuant to paragraph (d)(1) of

this section, the rules of an exchange or

association do not require its members

to communicate to it their quotation

sizes for listed options, a responsible

broker or dealer that is a member of

such exchange or association shall:

(i) Be relieved of its obligations under

paragraph (c)(1) of this section to

communicate to such exchange or

association its quotation sizes for any

listed option; and

(ii) Comply with its obligations under

paragraph (c)(2) of this section by

executing any order to buy or sell a

listed option, in an amount up to the

size established by such exchange’s or

association’s rules under paragraph

(d)(1) of this section.

(3) Thirty second response. Each

responsible broker or dealer, within

thirty seconds of receiving an order to

buy or sell a listed option in an amount

greater than the quotation size

established by an exchange’s or

association’s rules pursuant to

paragraph (d)(1) of this section, or its

published quotation size must:

(i) Execute the entire order; or

(ii)(A) Execute that portion of the

order equal to at least:

(1) The quotation size established by

an exchange’s or association’s rules,

pursuant to paragraph (d)(1) of this

section, to the extent that such exchange

or association does not collect and make

available to quotation vendors quotation

size and aggregate quotation size under

paragraph (b) of this section; or

(2) Its published quotation size; and

(B) Revise its bid or offer.

(4) Notwithstanding paragraph (d)(3)

of this section, no responsible broker or

dealer shall be obligated to execute a

transaction for any listed option as

provided in paragraph (c)(2) of this

section if:

(i) Any of the circumstances in

paragraph (c)(3) of this section exist; or

(ii) The order for the purchase or sale

of a listed option is presented during a

trading rotation in that listed option.

(e) Exemptions. The Commission may

exempt from the provisions of this

section, either unconditionally or on

specified terms and conditions, any

responsible broker or dealer, electronic

communications network, exchange, or

association if the Commission

75462 Federal Register / Vol. 65, No. 232 / Friday, December 1, 2000 / Rules and Regulations

determines that such exemption is

consistent with the public interest, the

protection of investors and the removal

of impediments to and perfection of the

mechanism of a national market system.

3. Section 240.11Ac1–4 is amended

by revising paragraph (a)(10) to read as

follows:

§ 240.11Ac1–4 Display of customer limit

orders.

(a) Definitions. * * *

(10) The term reported security means

any security or class of securities for

which transaction reports are collected,

processed, and made available pursuant

to an effective transaction reporting

plan.

* * * * *

4. Section 240. 11Ac1–7 is added to

read as follows:

§ 240.11Ac1–7 Trade-through disclosure

rule.

(a) Definitions. For purposes of this

section:

(1) The term block trade means a

transaction in an option series that is for

500 or more contracts and has a

premium value of at least $150,000.

(2) The term customer means any

person that is not a registered brokerdealer.

(3) The term effective national market

system plan shall have the meaning

provided in § 240.11Aa3–2.

(4) The term listed option means any

option traded on a registered national

securities exchange or automated

facility of a national securities

association.

(5) The term options class means all

of the put option or call option series

overlying a security, as defined in

Section 3(a)(10) of the Act (15 U.S.C.

78c(a)(10)).

(6) The term options series means the

contracts in an options class that have

the same unit of trade, expiration date,

and exercise price, and other terms or

conditions.

(7) The term receipt means, with

respect to an order sent to an away

market displaying a superior price, the

time at which the order is either

represented in the trading crowd or

received by the specialist.

(b) Broker-dealer disclosure

requirements. (1) Any broker or dealer

that effects a transaction in a listed

option for the account of its customer

must disclose in writing to such

customer, at or before completion of

such transaction, as defined in

§ 240.15c1–1:

(i) When such transaction is effected

at a price that trades through a better

price published at the time of execution;

and

(ii) That better published price.

(2) A broker-dealer shall not be

required to provide the disclosure set

forth in paragraph (b)(1) of this section

if:

(i) It effects such transaction on a

market that is a sponsor or participant

in an effective national market system

options linkage plan that includes

provisions reasonably designed to limit

the incidence of customer orders being

executed at prices that trade through a

better published price, including prices

published other than by a linkage plan

sponsor or participant, or

(ii) The customer order is executed as

part of a block trade.

(3) A customer order is executed at a

price that trades through a better

published price if:

(i) The price at which an order to

purchase a listed option is executed is

higher than the lowest offer, at the time

the order was executed, published

pursuant to a national market system

plan for reporting quotations in listed

options; or

(ii) The price at which an order to sell

a listed option is executed is lower than

the highest bid, at the time the order

was executed, published pursuant to a

national market system plan for

reporting quotations in listed options.

(4) Notwithstanding paragraph (b)(3)

of this section, a customer order is not

considered to be executed at a price that

trades through a better published price

if:

(i) The market on which the order is

executed has verified that the market

publishing such better price is

experiencing a failure, material delay, or

malfunction of its systems;

(ii) The quotations disseminated

pursuant to the national market system

plan for reporting quotations indicates

that it is experiencing delays in

transmitting such quotations;

(iii) Such better published price was

published by an exchange whose

members are relieved of their

obligations under paragraph (c)(2) of

§ 240.11Ac1–1 because, pursuant to

paragraphs (b)(3) or (d)(4) of

§ 240.11Ac1–1, such exchange is not

required to meet its obligations under

paragraph (b)(1) of § 240.11Ac1–1; or

(iv) The customer order is executed

only after the market publishing the

better price fails to respond to an order

routed to it within 30 seconds of the

order’s receipt by that market.

(c) Exemptions. The Commission may

exempt from the provisions of this

section, either unconditionally or on

specified terms and conditions, any

broker or dealer if the Commission

determines that such exemption is

consistent with the public interest, the

protection of investors, the maintenance

of fair and orderly markets, or the

removal of impediments to and

perfection of the mechanism of a

national market system.

Dated: November 17, 2000.

By the Commission.

Jonathan G. Katz,

Secretary.

[FR Doc. 00–30132 Filed 11–30–00; 8:45 am]

BILLING CODE 8010–01–P