[Federal Register Volume 63, Number 78 (Thursday, April 23, 1998)]
[Notices]
[Pages 20227-20230]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10752]



[[Page 20227]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39879; File No. SR-CBOE-98-03]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., Relating to 
Allocation Procedures

April 16, 1998.

I. Introduction

    On January 22, 1998, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 \2\ 
thereunder, a proposed rule change to codify the Exchange's process for 
allocating securities to market-maker trading crowds and designated 
primary market-makers (``DPMs'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change, as modified by amendments,\3\ was 
published for comment in the Federal Register on March 12, 1998.\4\ No 
comments were received on the proposal. This order approves the 
proposed rule change, as amended.
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    \3\ On January 23, 1998, the CBOE filed a technical amendment to 
the filing, clarifying that the Exchange's Board of Directors had 
approved the proposed rule change in February 1997 (Amendment No. 
1).
    On February 12, 1998, the CBOE filed Amendment No. 2 to the 
proposal. Amendment No. 2 deletes CBOE Rules 8.80(a) and 8.80(b)(7) 
and inserts an inadvertently omitted part of the Federal Register 
notice. See Letter from Arthur Reinstein, Assistant General Counsel, 
CBOE, to Joshua Kans, Attorney, Division of Market Regulation 
(``Division''), Commission, dated February 12, 1998 (Amendment No. 
2).
    On March 4, 1998, the CBOE filed Amendment No. 3 to the 
proposal. Amendment No.3 clarifies the basis for deleting CBOE Rule 
8.80(b)(7). Amendment No. 3 also notes that the CBOE is in the 
process of comprehensively amending CBOE Rule 8.80. See Letter from 
Arthur Reinstein, CBOE, to Joshua Kans, Division, Commission, dated 
March 4, 1998 (Amendment No. 3).
    \4\ Securities Exchange Act Release No. 39725 (March 5, 1998), 
63 FR 12119.
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II. Description

    The Exchange's Board of Directors has delegated to the Exchange's 
Allocation Committee and Special Product Assignment Committee the 
authority to allocate the securities traded on the Exchange. Each 
security traded on the Exchange is allocated either to a market-maker 
trading crowd or to a DPM.\5\ To codify the process the Exchange uses 
to make those allocations, the CBOE proposes to adopt new CBOE Rule 
8.95, ``Allocation of Securities and Location of Trading Crowds and 
DPMs.'' CBOE Rule 8.95 will consist of seven subparagraphs, (a) through 
(g), and contain two interpretations.
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    \5\ As part of this rule change, the Exchange is deleting 
existing CBOE Rules 8.80(a) and 8.80(b)(7). See Amendment Nos. 2 and 
3, supra note 3.
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    Proposed CBOE Rule 8.95(a) provides that the Allocation Committee 
shall be responsible for determining for each equity option class 
traded on the Exchange (i) whether the option class should be allocated 
to a trading crowd or to a DPM and (ii) to which trading crowd or DPM 
the option class should be allocated. Similarly, proposed CBOE Rule 
8.95(a) provides that the Special Product Assignment Committee shall be 
responsible for determining for each security traded on the Exchange 
other than an equity option (i) whether the security should be 
allocated to a trading crowd or to a DPM and (ii) to which trading 
crowd or DPM the security should be allocated. Securities other than 
equity options that are traded on the Exchange include index options 
and securities traded pursuant to Chapter XXX, ``Stocks, Warrants and 
Other Securities,'' of the Exchange's Rules, such as structured 
products.
    Proposed CBOE Rule 8.95(a) further provides that the Allocation 
Committee shall be responsible for determining the location on the 
Exchange's trading floor of each trading crowd, each DPM, and each 
security traded on the Exchange. For example, this provision permits 
the Allocation Committee to place a large trading crowd or DPM 
operation in a trading floor location that is large enough to 
accommodate the crowd or DPM. As another example, if a DPM operate as a 
DPM at more than one trading station, this provision permits the 
Allocation Committee to determine the station, and the location within 
each station, at which the securities allocated to the DPM will trade.
    Proposed CBOE Rule 8.95(b) describes the criteria that may be 
considered by the Allocation Committee and Special Product Assignment 
Committee in making security allocation determinations and by the 
Allocation Committee in making location determinations. The factors to 
be considered may include, but are not limited to, any one or more of 
the following: performance, volume, capacity, market performance 
commitments, operational factors, efficiency, competitiveness, 
environment in which the security will be traded, expressed preferences 
of issuers, and recommendations of other Exchange committees.
    The following are some examples of the many ways in which these 
criteria may be applied. For example, in considering performance, the 
appropriate Allocation Committee (i.e., the Allocation Committee or 
Special Product Assignment Committee, as applicable) might look at the 
market performance ranking of the applicable trading crowds or DPMs, as 
established by market performance reviews that are conducted by the 
Exchange's Market Performance Committees and Modified Trading System 
(``MTS'') Appointments Committee.\6\ In considering volume, the 
appropriate Allocation Committee might look at the anticipated trading 
volume of the security and the trading volume attributable to the 
applicable trading crowds or DPMs in determining which trading crowds 
or DPMs would be best able to handle the additional volume. Similarly, 
in considering capacity, operational factors, and efficiency, the 
appropriate Allocation Committee might look to criteria such as the 
number of market-makers or DPM personnel, the ability to process order 
flow, and the amount of trading crowd or DPM capital in determining 
which trading crowds or DPMs would be best able to handle additional 
securities. In considering market performance commitments, the 
appropriate Allocation Committee might look at the pledges a trading 
crowd or DPM has made with respect to how narrow its bid-ask spreads 
will be and the number of contracts for which it will honor its 
disseminated market quotations beyond what is required by the 
Exchange's Rules. In considering competitiveness, the appropriate 
Allocation Committee might look at percentage of volume attributable to 
a trading crowd or DPM in allocated securities that are traded on more 
than one exchange. In considering the environment in which the security 
will be traded, the appropriate Allocation Committee might seek a 
proportionate distribution of securities between the market-maker 
system and the DPM system and across individual trading crowds and 
DPMs. Also, in considering expressed preferences of issuers, the 
appropriate Allocation Committee might give consideration to the views 
of the issuer of a security traded pursuant to

[[Page 20228]]

Chapter XXX with respect to the allocation of that security or to the 
licenser of an index on which an index option is based with respect to 
the allocation of that index option. Similarly, the appropriate 
Allocation Committee might consider the recommendations of other 
Exchange committees, particularly those that evaluate trading crowd and 
DPM market performance.
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    \6\ The Exchange has three committees that perform market 
performance functions, including the evaluation of market 
performance. The Exchange's Market Performance Committee performs 
market performance functions with respect to all trading crowds, 
market-makers (other than DPMs), and floor brokers that trade in 
securities other than DJX, NDX, OEX, and SPX index options; the 
Index Market Performance Committee performs market performance 
functions with respect to the trading crowds, market-makers (other 
than DPMs), and floor brokers that trade DJX, NDX, OEX, and SPX 
index options; and the MTS Appointments Committee performs market 
performance functions with respect to all DPMs.
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    Proposed CBOE Rule 8.95(c) provides that the appropriate Allocation 
Committee may remove an allocation and reallocate the applicable 
security during the first six months following its allocation to a 
trading crowd or DPM if the trading crowd or DPM fails to adhere to any 
market performance commitments made by the trading crowd or DPM in 
connection with receiving the allocation. The Allocation Committees 
typically request that trading crowds and DPMs make market performance 
commitments as part of their applications to receive allocations of 
particular securities. As described above, these commitments may relate 
to pledges to keep bid-ask spreads within a particular width or to make 
disseminated quotations firm for a designated number of contracts 
beyond what is required by Exchange Rules. Proposed CBOE Rule 8.95(c) 
permits the appropriate Allocation Committee to remove an allocation if 
these commitments are not met and gives trading crowds and DPMs 
incentive to abide by these commitments. Following the initial six 
month period after an allocation is made, all the responsibility for 
monitoring market performance with respect to that security is vested 
in the appropriate Market Performance Committee or MTS Appointments 
Committee, which continually evaluate trading crowd and DPM market 
performance, as applicable, and are authorized pursuant to CBOE Rule 
8.60, CBOE Rule 8.80, and other Exchange rules to take remedial action 
for failure to satisfy minimum market performance standards.
    Proposed CBOE Rule 8.95(c) also provides that the appropriate 
Allocation Committee may change an allocation determination or change a 
location determination, if in concludes that doing so is in the best 
interest of the Exchange based on operational factors or efficiency. 
For example, if, due to market conditions, the trading volume in a 
security greatly increased over a short time frame and the trading 
crowd or DPM allocated the security could not handle the order flow, it 
may become necessary for the appropriate Allocation Committee to 
reallocate the security to a trading crowd of DPM with the capacity to 
do so. Similarly, if the trading volume at a trading crowd or DPM post 
greatly increased and the number of crowd members or DPM personnel grew 
along with the increase in volume, it may become necessary for the 
appropriate Allocation Committee to relocate the trading crowd of DPM 
to a larger trading post.\7\
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    \7\ Under the proposal, when CBOE Rule 8.95(c) becomes 
effective, the CBOE would delete existing CBOE Rule 8.80(b)(7).
    CBOE Rule 8.80(b)(7)(i) states that the MTS Appointments 
Committee may discontinue the use of a DPM in an option class if the 
trading activity in that class exceeds a predetermined volume. That 
provision is not superfluous because the CBOE membership voted in 
December 1993 to advise the MTS Appointments Committee not to 
exercise that authority. See Amendment 2, supra note 3.
    Existing CBOE Rule 8.80(b)(7)(ii) permits the MTS Appointments 
Committee to discontinue use of a DPM in an option class if it 
determines that trading would be better accommodated by using a 
market-maker system without a DPM. Proposed CBOE Rule 8.95(c) would 
give similar authority to the appropriate Allocation Committee. See 
Amendment Nos. 2 and 3, supra note 3.
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    Proposed CBOE Rule 8.95(d) provides that prior to taking any action 
to remove an allocation or to change a location, the appropriate 
Allocation Committee shall generally give the affected trading crowd or 
DPM prior notice of the contemplated action and an opportunity to be 
heard concerning the action. The only exception to this requirement 
would be in those unusual situations when expeditious action is 
required due to extreme market volatility or some other situation 
requiring emergency action. Specifically, except when expeditious 
action is required, proposed CBOE Rule 8.95(d) requires that prior to 
taking any action to remove an allocation or to change a location, the 
appropriate Allocation Committee shall notify the trading crowd or DPM 
involved of the reasons the committee is considering taking the 
contemplated action, and shall either convene or more informal meetings 
of the committee (or a committee panel) with the trading crowd or DPM 
to discuss the matter, or provide the trading crowd or DPM with the 
opportunity to submit a written statement to the committee concerning 
the matter. Due to the informal nature of the meetings provided for 
under proposed CBOE Rule 8.95(d) and to encourage constructive 
communication between the committee and the affected trading crowd or 
DPM at those meeting, ordinarily neither counsel for the committee nor 
counsel for the trading crowd or DPM shall be invited to attend these 
meetings and no verbatim record of the meetings shall be kept.
    As with any decision made by the Allocation Committee and the 
Special Product Assignment Committee, any person adversely affected by 
a decision made by the appropriate Allocation Committee to remove an 
allocation or change a location may appeal the decision to the 
Exchange's Appeals Committee under Chapter XIX, ``Hearing and Review,'' 
of the Exchange's Rules. The appeal procedures in Chapter XIX provide 
for the right to a formal hearing concerning any such decision and for 
the right to be accompanied, represented, and advised by counsel at the 
stages of the proceeding. In addition, any decision of the Appeals 
Committee may be appealed to the Exchange's Board of Directors pursuant 
to CBOE Rule 19.5, ``Review.''
    Proposed CBOE Rule 8.95(e) provides that the allocation of a 
security to a trading crowd or DPM and the location of a trading crowd 
or DPM on the Exchange's trading floor does not convey ownership rights 
in the allocation or in the order flow associated with the allocation 
or location. Proposed CBOE Rule 8.95(e) is intended to make clear the 
trading crowds and DPMs may not buy, sell, or otherwise transfer an 
allocation or location to another party, and that instead, it is the 
Exchange that has the sole authority to determine allocations and 
locations on the Exchange's trading floor. Notwithstanding proposed 
CBOE Rule 8.95(e), Exchange rules will continue to permit the transfer 
of DPM appointments pursuant to CBOE Rule 8.80(b)(3), which provides 
for the transfer of appointments with the approval of the MTS 
Appointments Committee.
    Proposed CBOE Rule 8.95(f) is intended to reflect the current 
restrictions that are in place with respect to the allocation of 
securities to DPMs. Proposed CBOE Rule 8.95(f) reiterates the provision 
currently contained in CBOE Rule 8.80(a) that no option classes opened 
for trading prior to May 1, 1987, shall be allocated to a DPM, except 
to the extent authorized by a membership vote.\8\ In addition, proposed 
CBOE Rule 8.95(f) modifies the foregoing provision, which was approved 
pursuant to an Exchange membership vote taken in November 1989. Under 
this modification, if a trading crowd indicates that it no longer 
wishes to trade an option class opened for trading prior to May 1, 
1987, the option class may be reallocated to another trading crowd or 
to a DPM giving priority to trading crowd applications over DPM 
applications,

[[Page 20229]]

provided that the trading crowd's commitment to market quality is 
competitive and that operational considerations are satisfied.
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    \8\ Proposed CBOE Rule 8.95(f) supersedes CBOE Rule 8.80(a). 
Accordingly, the CBOE proposes to delete CBOE Rule 8.80(a). See 
Amendment No. 2, supra note 3.
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    Proposed CBOE Rule 8.95(g) provides that in allocating and 
reallocating securities to trading crowds and DPMs, the appropriate 
Allocation Committee shall act in accordance with any limitation or 
restriction on the allocation of securities that is established 
pursuant to another Exchange rule. For example, the appropriate Market 
Performance Committee or the MTS Appointments Committee may take 
remedial action against a trading crowd or DPM pursuant to CBOE Rule 
8.60, ``Evaluation of Trading Crowd Performance,'' and CBOE Rule 
8.80(b)(10) for failing to satisfy minimum market performance 
standards, and such action may involve a restriction related to the 
allocation of securities to that trading crowd or DPM. Similarly, the 
MTS Appointments Committee may restrict a DPM's ability to receive or 
retain allocations of securities pursuant to various provisions of CBOE 
Rule 8.80, ``Modified Trading System,'' including as a condition of 
appointment as a DPM (CBOE Rule 8.80(b)(3)), due to failure to perform 
DPM functions (CBOE Rule 8.80(b)(4)(i)), or due to a material, 
financial, operational, or personnel change (CBOE Rule 8.80(b)(4)(ii)). 
Proposed CBOE Rule 8.95(g) is intended to clarify that the appropriate 
Allocation Committee must act in accordance with any such restrictions 
in making allocation and location determinations.
    Proposed CBOE Rule 8.95, Interpretation .01 generally provides that 
it shall be the responsibility of the appropriate Allocation Committee 
to reallocate a security if it is removed from a trading crowd or DPM 
pursuant to another Exchange rule or if for some other reason the 
trading crowd or DPM to which the security has been allocated no longer 
retains the allocation. For example, as described above, CBOE Rules 
8.60 and 8.80 authorize the Market Performance Committees and the MTS 
Appointments Committee to take remedial actions against trading crowds 
and DPMs in specified circumstances, including the removal of an 
allocation. Proposed CBOE Rule 8.95, Interpretation .01 is intended to 
clarify that if the appropriate Market Performance Committee or the MTS 
Appointments Committee removes an allocation pursuant to CBOE Rule 8.60 
or CBOE Rule 8.80, it is the responsibility of the appropriate 
Allocation Committee (and not the committee that took the action to 
remove the allocation) to reallocate the security pursuant to proposed 
CBOE Rule 8.95. The only exception to this provision is that the MTS 
Appointments Committee is authorized, pursuant to CBOE Rule 8.80(b)(6), 
to allocate to an interim DPM on a temporary basis a security that is 
removed from another DPM, until the appropriate Allocation Committee 
makes a final allocation of the security.
    Finally, proposed CBOE Rule 8.95, Interpretation. 02 provides that 
it shall be the responsibility of the Allocation Committee to relocate 
a trading crowd or DPM in the event that the trading crowd or DPM is 
required to be relocated pursuant to another Exchange rule. As has been 
discussed, CBOE Rule 8.60 and CBOE Rule 8.80(b)(10) permit the Market 
Performance Committees and the MTS Appointments Committee to take 
remedial actions against trading crowds and DPMs in specified 
circumstances, including requiring that a trading crowd or DPM be 
relocated. Like proposed Interpretation .01, proposed Interpretation 
.02 is intended to clarify that if the appropriate Market Performance 
Committee or the MTS Appointments Committee requires the relocation of 
a trading crowd or DPM pursuant to CBOE Rule 8.60 or CBOE Rule 
8.80(b)(10), it is the responsibility of the Allocation Committee (and 
not the Committee that took the action to require the relocation) to 
relocate the trading crowd or DPM.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Section 6(b) of the Act.\9\ 
Specifically, The Commission believes that the proposal is consistent 
with the Section 6(b)(5) \10\ requirements that the rules of an 
exchange be designed to remove impediments to and perfect the mechanism 
of a free and open market and to protect investors and the public 
interest. Moreover, the proposal is consistent with the requirement of 
section 6(b)(5) of the Act that the rules of an exchange not be 
designed to permit unfair discrimination between brokers or dealers or 
issuers.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change is 
appropriate because it codifies the Exchange's procedures for 
allocating securities between trading crowds and DPMs and determining 
where those trading crowds or DPMs should be located.\11\ Moreover, the 
Commission believes that the proposed provisions should help to ensure 
that securities traded by the Exchange are allocated in an equitable 
and fair manner, giving all trading crowds and DPMs a fair opportunity 
to obtain allocations.
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    \11\ Teleconference between Arthur Reinstein, CBOE, Yvonne 
Fraticelli, Attorney, Commission and Joshua Kans, Commission, 
January 29, 1998.
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    Specifically, the Commission believes that the CBOE's proposed Rule 
8.95(a)--which provides that the Exchange's Allocation Committee and 
the Special Product Assignment Committee are responsible for allocating 
option classes among trading crowds and DPMs, and which provides that 
the Allocation Committee is responsible for determining the location on 
the Exchange floor of each trading crowd, DPM and security--sets forth 
a fair and reasonable method of apportioning the responsibility for 
allocating securities and assigning space on the Exchange floor.
    The Commission further believes that the OBOE's proposed Rule 
8.95(b), which describes the information that the Allocation Committee 
and Special Product Assignment Committee may consider when making 
determinations under Rule 8.95(a), will give those committees the 
flexibility to consider all appropriate factors while putting the 
Exchange membership on notice of several of the important factors that 
may be considered in making such a determination.
    The Commission also believes that the CBOE's proposed Rule 8.95(c), 
regarding removing allocations made under proposed Rule 8.95(a), 
provide a reasonable means of ensuring that the Allocation Committee 
and the Special Product Assignment Committee retain the ability to take 
actions to promote fair and efficient trading of the securities at 
issue. This provision also appropriately allocates responsibility 
between those two committees and the appropriate Market Performance 
Committee of MTS Appointments Committee.
    The Commission believes that the CBOE's proposed Rule 8.95(d), 
which provides that, unless expeditious action is required, the 
affected trading crowd or DPM will receive notice of a potential action 
under proposed Rule 8.95(c), and will have the opportunity to 
participate in an informal meeting with the appropriate committee or 
submit a written statement concerning the matter, provides a fair and 
reasonable means of making expeditious decisions regarding allocation 
and location while protecting the interest of the affected trading 
crowd

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or DPM. In making this determination, the Commission notes that any 
person adversely affected by a decision made under proposed Rule 
8.95(c) has the right to a formal hearing, with the assistance of 
counsel, before the Exchange's Appeals Committee. Moreover, decisions 
of the Appeals Committee may be appealed to the Exchange's Board of 
Directors.
    The Commission believes that the CBOE's proposed Rule 8.95(e)--
which provides that the allocation of security to a trading crowd or a 
DPM, or the assignment of a trading crowd's or a DPM's location on the 
Exchange's floor, does not convey ownership rights in the allocation or 
location or associated order flow--merely reiterates the limited nature 
of those allocations, and highlights that the Exchange retains the 
authority to determine allocations and locations.
    The Commission believes that the CBOE's proposed Rule 8.95(f), 
which provides special rules for option classes opened for trading 
prior to May 1, 1987, merely reflects existing practices that are 
consistent with the will of the Exchange's membership.
    The Commission believes that the CBOE's proposed Rule 8.95(g), 
which states that in allocating and reallocating securities the 
Allocation Committee and the Special Products Assignment Committee 
shall act in accordance with restrictions and limitations established 
pursuant to other Exchange rules, ensures that proposed Rule 8.95 does 
not cause any inconsistencies with existing Exchange rules, and that 
other Exchange committees are not hindered in the exercise of their own 
responsibilities.
    The Commission believes that the CBOE's proposed Rule 8.95, 
Interpretation .01, which provides that the Allocation Committee and 
the Special Products Assignment Committee are responsible for 
reallocating securities that are removed from a trading crowd or DPM 
pursuant to another rule, or when the trading crowd or DPM for some 
other reason no longer retains the allocation, subject to Rule 
8.80(b)(6), clarifies in a reasonable and efficient way the respective 
responsibilities of those two committees and other Exchange committees 
such as the MTS Appointments Committee.
    The Commission believes that the CBOE's proposed Rule 8.95, 
Interpretation .02, which provides that the Allocation Committee is 
responsible for relocating a trading crowd or DPM which is required to 
be relocated pursuant to another Exchange rule, clarifies the 
respective responsibilities of the Allocation Committee and other 
Exchange committees.
    Finally, the Commission believes that eliminating CBOE Rules 
8.80(a) and 8.80(b)(7) current with the effectiveness of proposed CBOE 
Rule 8.95 will help avoid redundancies that may otherwise cause 
confusion. The Commission notes that Rule 8.80(b)(8) is made redundant 
by the elimination of Rule 8.80(b)(7), but the Exchange has stated that 
it is in the process of proposing to update and reorganize CBOE Rule 
8.80, a process which will include the deletion of CBOE Rule 
8.80(b)(8).\12\
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    \12\ See Amendment No. 3, supra note 3.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-CBOE-98-03), as amended, is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10752 Filed 4-22-98; 8:45 am]
BILLING CODE 8010-01-M