[Federal Register Volume 65, Number 28 (Thursday, February 10, 2000)]
[Notices]
[Pages 6665-6668]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3033]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42379; File No. SR-CBOE-98-27]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 6 to the Proposed Rule Change by the Chicago Board 
Options Exchange, Inc. Relating to Enhancements to the Exchange's 
Processing of Live Ammo Orders

February 2, 2000.

I. Introduction

    On June 16, 1998, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending its rule governing the 
execution of orders on the ``live ammo'' screen. On June 23, 1998, the 
CBOE submitted Amendment No. 1 to the proposed rule change to the 
Commission.\3\ On July 15, 1998, the CBOE submitted Amendment No. 2 to 
the proposed rule change to the

[[Page 6666]]

Commission.\4\ On July 21, 1998, the CBOE submitted Amendment No. 3 to 
the proposed rule change to the Commission.\5\ On August 6, 1998, the 
proposal was published in the Federal Register.\6\ On August 11, 1998, 
the CBOE submitted Amendment No. 4 to the proposed rule change to the 
Commission.\7\ On August 18, 1998, the CBOE submitted Amendment No. 5 
to the proposed rule change to the Commission.\8\ On January 21, 2000, 
the CBOE submitted Amendment No. 6 to the proposed rule change to the 
Commission.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Richard Strasser, Assistant 
Director, Division of Market Regulation (``Division''), SEC, dated 
June 23, 1998 (``Amendment No. 1'').
    \4\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Richard Strasser, Assistant 
Director, Division, SEC, dated July 10, 1998 (``Amendment No. 2'').
    \5\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Richard Strasser, Assistant 
Director, Division, SEC, dated July 20, 1998 (``Amendment No. 3'').
    \6\ Exchange Act Release No. 40283 (July 30, 1998), 63 FR 42085.
    \7\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Michael Walinskas, Associate 
Director, Division, SEC, dated August 7, 1998 (``Amendment No. 4''). 
In Amendment No. 4, the Exchange proposed to implement the proposed 
rule change on a pilot basis for 90 days and requested accelerated 
approval of the proposed rule change, as amended. In addition, the 
Exchange supplemented the record with data to demonstrate the 
purpose of the proposed rule change.
    \8\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Michael Walinskas, Associate 
Director, Division, SEC, dated August 17, 1998 (``Amendment No. 
5''). In Amendment No. 5, the Exchange proposed that the proposed 
rule change be approved on a pilot basis for six months during which 
time the Exchange would submit a monthly report on the progress of 
the implementation of the proposal. The Exchange further proposed to 
distribute a Regulatory Circular to its members describing the 
parameters of the live ammo to Retail Automatic Execution System 
(``RAES'') system.
    \9\ Letter from Timothy H. Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Richard Strasser, Assistant 
Director, Division, SEC, dated January 20, 2000 (``Amendment No. 
6''). In Amendment No. 6, the CBOE proposed a nine-month pilot. In 
addition, the CBOE committed to submit a report to the SEC by August 
31, 2000, analyzing the degree to which orders accumulate on the 
live ammo screen during the pilot period. During the pilot period, 
the Exchange will work on a further systems change that will route 
live ammo orders directly to RAES without manual intervention. The 
CBOE further committed to distribute a Regulatory Circular to its 
members describing the parameters of the ``Live Ammo to RAES'' 
system and how the proposed changes will be implemented on the 
floor. The Exchange amended the proposed rule by deleting the phrase 
that stated that the system may only be used ``when the OBO or the 
DPM believes that there are unusual market conditions or when there 
is a large influx of orders to the electronic book screen'' and 
replaced it with the statement that the system should be used ``when 
the OBO or the DPM believes there are more orders on the live ammo 
screen than can be expeditiously handled in open outcry.'' In 
Amendment No. 6, the Exchange also described its plan to roll out 
the proposed change over a period of a few weeks to ensure that 
there are no unforeseen capacity or operational problems. Finally, 
the CBOE withdrew Amendment Nos. 4 and 5 to the proposed rule 
change.
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    The Commission received two comments on the proposed rule 
change.\10\ This notice and order solicits comments from interested 
persons on Amendment No. 6 and approves the proposal, as amended, on a 
pilot basis until October 31, 2000.
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    \10\ Letter from David Miller, Managing Director, Salomon Smith 
Barney, Chairman, CBOE Member Firm Committee, to Michael Walinskas, 
Associate Director, Division, SEC, dated August 7, 1998; and letter 
from Jim Brophy, A.G. Edwards, et al. to Michael Walinskas, 
Associate Director, Division, SEC, dated August 13, 1998.
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II. Description of the Proposal

    The CBOE proposes to amend its rule governing the execution of 
orders by order book officials (``OBO'') or designated primary market 
makers' (``DPM'') book staff to provide for the electronic execution of 
certain orders on the ``live ammo'' screen. The proposal will allow an 
OBO or a DPM to designate orders to be electronically executed against 
market makers standing in the crowd.
    Currently, an OBO or a DPM, acting in his or her capacity as an 
OBO,\11\ represents in the trading crowd the orders that have been 
placed in the customer limit order book (also known as the Electronic 
Book or the EBook), which displays all pre-open market orders \12\ and 
customer limit orders. Orders placed in the EBook are represented 
individually when they become marketable and are traded with the market 
makers standing in the crowd.
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    \11\ Pursuant to CBOE Rule 8.80, a DPM acts as a market maker, 
floor broker and OBO in its allocated options classes. Currently, 
equity options on the CBOE floor have been allocated to DPMs. Index 
options still utilize OBOs.
    \12\ After the Exchange opens, the EBook does not display market 
orders.
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    The ``live ammo'' screen, which is an undisplayed portion of the 
EBook, receives for further processing orders that are market orders or 
limit orders that improve the market. An order may be routed to the 
live ammo screen under a number of circumstances. First, if a customer 
submits a cancel/replace market order to cancel and replace an order 
already displayed by the Book, the replacement market order will 
automatically be routed to the live ammo screen rather than returning 
directly to the displayed portion of the EBook. Second, if a customer 
submits a cancel/replace limit order and the replacement order has a 
limit price that betters the same-side market quote for an order 
displayed on the EBook, the replacement order will automatically be 
routed to the live ammo screen. Third, market orders received through 
the Exchange's ``order shoe'' that are manually booked are 
automatically routed to the live ammo screen. Fourth, limit orders that 
better the same-side market quote that are received through the order 
shoe and that are manually booked are automatically routed to the live 
ammo screen. Fifth, limit orders that better the same-side market quote 
and that are routed directly to the book when the routing parameters 
have been set at ``O'' are automatically sent to the live ammo screen. 
\13\ Finally, marketable limit order that are electronically booked 
from a floor broker's PAR workstation are automatically routed to the 
live ammo screen. \14\
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    \13\ The ``O'' parameter is an order routing parameter that may 
be implemented under high volume situations to route all limit 
orders to the EBook.
    \14\ According to the Exchange, approximately 90 percent of 
orders routed to the live ammo screen are cancel/replacement orders.
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    Orders sent to the live ammo screen are either traded manually in 
open outcry or sent to the EBook if book eligible, by either the OBO or 
the DPM, as the case may be. \15\ When the live ammo screen experiences 
a large influx of orders it becomes difficult. according to the 
Exchange, for the OBO (or the DPM) to represent and execute these 
orders in a timely fashion, which can cause orders on the live ammo 
screen to queue. According to the Exchange, these backlogs usually had 
occurred during the opening rotations when a large number of orders can 
build up on the live ammo screen, \16\ but they also can occur 
throughout the day during busy trading times.
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    \15\ A ``book all'' button is currently available to send book 
eligible orders on the live ammo screen to the EBook.
    \16\ Since submitting this filing, the Exchange has implemented 
the Rapid Opening System (``ROS''), which has significantly reduced 
the opening rotation time period.
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    To address this problem and accelerate the process of executing 
orders that are on the live ammo screen, the Exchange proposes to 
implement a new feature created for the live ammo screen, which will 
allow the OBO (or DPM) to send RAES-eligible orders on the live ammo 
screen to RAES for automatic execution. Under the proposal, the OBO (or 
DPM) may select all or any portion of the orders displayed on a live 
ammo page to be routed to RAES. \17\ If fewer than all orders are 
selected, those orders will be routed based on time priority, pursuant 
to CBOE Rule 6.45. Orders selected for automatic execution must satisfy 
RAES requirements. Currently, RAES accepts market and marketable limit 
orders that meet the applicable size

[[Page 6667]]

requirements. \18\ Any market maker who is signed on to RAES at the 
time the OBO (or DPM) routes the order or orders to RAES for automatic 
execution will be eligible to be electronically assigned as the contra-
party on the trade. Orders on the live ammo screen that are not RAES-
eligible will be manually represented.
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    \17\ A live ammo screen page may contain up to thirteen orders.
    \18\ Most equity option classes have an eligible order size for 
RAES of 50 contracts. See Exchange Act Release No. 41821 (September 
1, 1999), 64 FR 50313 (September 16, 1999).
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    As proposed, there may be instances when a RAES-eligible live ammo 
order may be executed before a non-RAES-eligible live ammo order that 
was received earlier. Therefore, the Exchange proposes to implement 
this live ammo to RAES feature notwithstanding the provisions of CBOE 
Rule 6.45. CBOE Rule 6.45 gives priority to some bids and offers, 
because they were made earlier in time, over other bids and offers. 
\19\ In addition, if CBOE's best bid or offer on the limit order book 
equals the prevailing market quote, orders on the live ammo screen will 
be crossed with the orders in the Ebook. \20\
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    \19\ For the reasons discussed below, the Exchange believes that 
instances where the priority of orders would be executed out of 
sequence would be infrequent. First, the non-RAES-eligible order 
must be for the same series as the RAES-eligible order that is 
traded for there to be an interruption of the normal priority 
principles. Second, for the RAES-eligible order to trade ahead of 
the non-RAES-eligible order, the limit price of the non-RAES-
eligible order must be at the CBOE's quoted market because that is 
the price at which the RAES-eligible order will be executed. When 
the limit price for the larger non-RAES-eligible order is at the 
market, the CBOE book staff will act to execute the order promptly. 
See Amendment No. 3.
    \20\ The CBOE's Automated Book Priority (``ABP'') system allows 
orders in live ammo to cross with orders held in the EBook. If the 
live ammo order is for a size greater than the limit order size 
displayed on the EBook, the ABP will cross the live ammo order with 
the EBook and any balance will be routed to RAES (provided it is 
RAES-eligible) for execution against the market makers signed on to 
RAES at the book price. Telephone call between Timonthy Thompson and 
Anthony Montesano, CBOE and Kelly Riley and Heather Traeger, SEC, 
dated January 14, 2000.
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III. Summary of Comments

    The Commission received two comments on the proposal both of which 
expressed their support. \21\ The comment letter from the CBOE Member 
Firm Committee described the problems caused by backlogs of orders 
accumulating on the live ammo screen. The comment letter described how 
it could take the book staff up to 30 minutes to trade orders on the 
live ammo screen. The commenter detailed how many live ammo backlogs 
occur during the opening rotation and their belief that the ROS would 
alleviate some of the problems. \22\ The commenter believed that the 
proposal would be an interim fix until the implementation of ROS. The 
comment letter from the CBOE member firm community also expressed its 
strong support for the proposal. The commenter believed that the 
proposal would be in their best interests as well as the best interests 
of their customers, who they believed, would receive better service 
than was currently available.
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    \21\ See note 10.
    \22\ The Commission notes that since this proposal was filed the 
ROS has been implemented on the Exchange. ROS provides for the 
automated opening of options classes on the Exchange and has 
significantly shortened the length of time needed for opening each 
option class. While ROS has mitigated the problems during the 
opening rotations, it has not had an impact on intraday trading 
volatility. See Exchange Act Release No. 41033 (February 9, 1999), 
64 FR 8156 (February 18, 1999.) Telephone call between Timothy 
Thompson and Anthony Montesano, CBOE and Kelly Riley and Heather 
Traeger, SEC, on January 14, 2000.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\23\ In particular, the Commission finds that the 
proposed rule change is consistent with the requirements of Section 
6(b)(5) of the Act,\24\ which provides, among other things, that the 
rules of an exchange be designed to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, and processing 
information with respect to, and facilitating transactions in 
securities, and to remove impediments to and perfect the mechanism of a 
free and open market, and in general to protect investors and the 
public interest.
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    \23\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \24\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change should help 
in providing timely executions of orders on the live ammo screens of 
the CBOE's EBook. Currently, the OBO (or DPM) must individually 
represent orders that are displayed on the live ammo screen in the 
crowd. In periods of high volume or volatility, the OBO (or DPM) may 
not be able to manually represent these live ammo orders in a timely 
fashion. According to the Exchange, these marketable orders may stay on 
the live ammo screen for up to 30 minutes, during which time the market 
could move significantly away from the market that was quoted at the 
time the order was routed to the live ammo screen. Thus, investors 
currently may not be receiving the best price on the CBOE floor when 
their orders are placed on the live ammo screen.\25\
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    \25\ Delayed execution of customer orders could implicate a 
broker-dealer's best execution responsibilities. See letter from 
Chairman Arthur Levitt to Michael Kelly, President, First Options of 
Chicago, Inc., dated April 13, 1999 (``While price is certainly a 
key element in a quality execution, other factors, such as the 
ability to obtain a complete and timely fill * * * may also be 
considered in determining whether a customer is receiving best 
execution.'')
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    To address this problem, the Exchange is proposed to implement a 
new mechanism of the live ammo screen, which will allow the OBO (or 
DPM) to send RAES-eligible orders to RAES for automatic execution. This 
feature should help to address the problem of orders being left on the 
live ammo screen for long periods of time when the OBO (or DPM) is 
unable to manually represent the live ammo orders in a timely fashion. 
As a result, customer orders routed to the live ammo screen should 
receive more timely executions during periods of high volume or 
volatility on the Exchange. Although non-RAES eligible orders may be 
executed out of time priority under the proposal, the Commission is 
hopeful that the proposed rule change will enhance the timely 
processing of all live ammo orders. That having been said, however, the 
Commission is concerned that the continued use of the live ammo screen 
may unfairly disadvantage customer orders. As a result, the Commission 
is approving this proposal as an interim measure to provide the 
Exchange with the time to make modifications to its order processing 
systems to improve the handling of customer orders that currently are 
routed to the live ammo screen. In particular, the Commission expects 
that the Exchange will make the necessary systems enhancements to 
ensure that a maximum number of customer orders in the CBOE system are 
matched against one another.
    Moreover, the Commission expects that the Exchange will develop the 
necessary systems enhancements to ensure that when there are no 
opportunities for matching customer orders in the CBOE system, RAES-
eligible orders will be routed directly to RAES without the interim 
step of appearing first on the live ammo screen. The Commission 
requests that the Exchange submit any proposed rule changes to 
implement these enhancements by August 31, 2000. The Commission also 
notes that the Exchange has agreed to provide the Commission with an 
analysis of the

[[Page 6668]]

degree to which live ammo orders accumulate on the live ammo screens 
during the pilot period.
    The Commission finds good cause for approving Amendment No. 6 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice in the Federal Register. In Amendment No. 6, CBOE 
requests that the proposal be approved on a pilot basis for a nine-
month period. Amendment No. 6 also would remove the requirement that 
the live ammo to RAES feature may only be used in unusual market 
conditions or when there is a large influx of orders to the Book. As 
amended, the proposal would permit the OBO (or DPM) to employ the live 
ammo to RAES feature at any time when the OBO (or DPM) determines that 
there are more orders on the live ammo screen than can be expeditiously 
handled in open outcry.\26\ The Commission finds good cause for 
accelerating approval of Amendment No.6 to allow the Exchange to 
address immediately the order processing problems caused by the live 
ammo system while developing the needed systems enhancements to 
eliminate these problems in the future.
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    \26\ In Amendment No. 6, the Exchange committed to distribute a 
Regulatory Circular to announce the changes to its members. The 
Regulatory Circular will also remind members of the priority 
principles under CBOE Rule 6.45(a) and (b).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 6, including whether Amendment No. 6 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. Copies 
of the submission, all subsequent amendments, all written statements 
with respect to the proposed rule change that are filed with the 
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CBOE. All submissions should refer to File No. SR-CBOE-98-27 and should 
be submitted by March 2, 2000.

VI. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change, as amended, (SR-CBOE-98-27) is 
approved on a pilot basis until October 31, 2000.

    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-3033 Filed 2-9-00; 8:45 am]
BILLING CODE 8010-01-M