[Federal Register Volume 61, Number 2 (Wednesday, January 3, 1996)]
[Notices]
[Pages 199-202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-00020]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36635; File No. SR-CBOE-95-52]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Chicago Board Options Exchange, Incorporated Relating to 
the Suspension of the Ten Contract Firm Quote Requirement During Fast 
Markets

December 22, 1996.

I. Introduction

    On September 5, 1995, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed a proposed rule change 
with the Securities and Exchange Commission (``SEC'' or 
``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ to 
amend CBOE Rules 8.51, 6.6 and 6.20 Interpretation .09 to: (i) Remove 
the pilot status of Rule 8.51; (ii) conform Rule 8.51 to the existing 
practice of permitting, but not requiring, Floor Officials to suspend 
the ten contract firm quote requirement of Rule 8.51(a) during a fast 
market; (iii) expand the group of persons with authority to grant 
suspensions, exemptions or exceptions to Rule 8.51 (currently only the 
Market Performance Committee) to any two Floor Officials, (iv) specify 
that when a fast market is declared any two Floor Officials have the 
power to suspend the firm quote requirement of Rule 8.51 and turn off 
the Retail Automatic Execution System (``RAES''); (v) allow the senior 
person then in charge of the Exchange's Control Room to suspend the ten 
contract firm quote requirement under certain circumstances; and (vi) 
amend Rule 6.20 Interpretation .09 to clarify the instances 

[[Page 200]]
where a member of the Market Performance Committee may perform the 
functions of a Floor Official.

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19(b)-4.
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    Notice of the proposal was published for comment and appeared in 
the Federal Register on October 25, 1995.\3\ The Commission received 
one comment letter concerning the proposed rule change.\4\ This order 
approves the Exchange's proposal.

    \3\ See Securities Exchange Act Release No. 36391 (October 18, 
1995), 60 FR 54737.
    \4\ The Security Traders Association (``STA'') supports the 
proposal to codify the Exchange's authority to suspend the ten 
contract firm quote requirement during a fast market because it will 
permit the market to react promptly to systems malfunctions, events 
in the market, or other circumstances which interfere with the 
Exchange's ability to disseminate current and accurate quotes. The 
STA believes that a self-regulatory organization must have the power 
and authority to modify, within limits, any technological or 
operational procedure immediately upon determining that it does not 
fulfill its intended purpose. See Letter from William R. Rothe, 
Chairman, and John L. Watson, III, President, STA, to Jonathan G. 
Katz, Secretary, Commission; dated November 15, 1995 (``Comment 
Letter'').
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II. Description of the Proposal

    The purposes of the proposal are: (1) To approve Rule 8.51 (``ten 
contract firm quote requirement'') on a permanent basis, removing the 
current pilot program designation, (2) to conform Rule 8.51 to the 
existing practice of permitting, but not requiring, Floor Officials to 
suspend the ten contract firm quote requirement of Rule 8.15(a) during 
a fast market, (3) to expand the group of persons with authority to 
grant suspension, exemptions, or exceptions to the firm quote 
requirement from the Market Performance Committee members to any two 
Floor Officials, (4) to specify that when a fast market is declared 
pursuant to Rule 6.6, two Floor Officials have the power to suspend the 
firm quote requirement of Rule 8.51 and turn off RAES, (5) grant the 
senior person then in charge of the Exchange's Control Room the 
authority to suspend the ten contract firm quote requirement, if there 
is a system malfunction that affects the Exchange's ability to 
disseminate or update market quotes, and (6) to amend Rule 6.20 
Interpretation .09 to clarify that the instances where a member of the 
Market Performance Committee may perform the functions of a Floor 
Official include enforcing policies and acting pursuant to rules 
related to RAES, fast markets, and the ten contract firm quote 
requirement.
    Rule 8.51(a) requires a trading crowd to sell (buy) at least ten 
contracts at the offer (bid) which is displayed when a buy (sell) 
customer order reaches the trading crowd. Initially, this rule was 
adopted as an Exchange pilot program to be monitored and enforced by 
the Exchange's Market Performance Committee.\5\ The ten contract firm 
quote requirement has been in effect since 1989, and the Exchange 
believes it is now time to remove the designation as a pilot program. 
The Exchange believes that the ten contract firm quote requirement has 
been beneficial to investors and has provided greater liquidity to the 
markets by requiring that the orders of non-broker dealer customer be 
filled for at least ten contracts at the displayed quote price. The 
Exchange further represents that trading crowds are aware of the 
requirements of Rule 8.51 and have generally been able to meet its 
requirements.\6\

    \5\ See Securities Exchange Act Release No. 26924 (June 13, 
1989), 54 FR 26284 (June 22, 1989).
    \6\ See Letter from Michael Meyer, Attorney, Schiff Hardin & 
Waite, to John Ayanian, Attorney, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Market Regulation''), 
Commission, dated December 14, 1995 (``CBOE Letter'').
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    Rule 8.51(a)(2) currently provides that the ten contract firm quote 
requirement will be in effect unless a fast market has been declared. 
Although not presently explicit in the rules, it is current practice 
not to automatically suspend this requirement when a fast market has 
been declared. The Exchange proposes to amend Rule 8.51(a)(2) and add 
Interpretation .07 to clarify that the ten contract firm quote 
requirement in paragraph (a) of Rule 8.51 is not automatically 
suspended when a fast market is declared. Instead, Interpretation .07 
would provide that any two Floor Officials have the power, but are not 
required, to suspend this requirement when a fast market has been 
declared.
    CBOE believes the interests of a fair and orderly market are better 
served when the rules allow Exchange officials the discretion to 
evaluate market conditions and circumstances and to exercise their 
judgment as to whether the ten contract firm quote requirement should 
be suspended in a fast market. This permits the firm quote requirement 
to remain in place for the benefit of non-broker dealer customers even 
when a fast market has been declared, except in those specific 
instances where two Floor Officials have determined that the ten 
contract firm quote requirement should be suspended.
    As set forth in Interpretation .09 to Rule 6.20, members of the 
Market Performance Committee may perform the functions of Floor 
Officials for the purpose of enforcing trading conduct policies. As 
Rule 8.51 is presently written, only the Market Performance Committee 
or Market Performance Committee members acting as Floor Officials may 
grant exemptions from, or make exceptions to, Rule 8.51. CBOE believes 
Floor Officials from the Floor Officials Committee are also qualified 
to make decisions regarding exemptions from, and exceptions to Rule 
8.51. CBOE sees no reason to limit this power to members of the Market 
Performance Committee. CBOE also believes that the power to suspend 
Rule 8.51 once a fast market is declared should be granted to any two 
Floor Officials, whether they are members of the Market Performance 
Committee or members of the Floor Officials Committee.
    CBOE's proposal would grant equal power to members of the Floor 
Officials Committee and members of the Market Performance Committee to 
act under Rule 8.51 regarding suspensions, exceptions to or exemptions 
from the firm quote requirement. It is important for a timely decision 
to be made once a fast market has been declared or other situations 
have arisen which warrant the suspension of the firm quote requirement, 
or an exemption or exception to this requirement. CBOE believes that it 
could be detrimental to a fair and orderly market to delay action until 
a member of the Market Performance Committee could be found to make 
such a decision when members of the Floor Officials Committee might 
already be present at the trading post. To implement CBOE's intention 
that any two Floor Officials may make decisions under Rule 8.51, 
including members of the Market Performance Committee acting as Floor 
Officials and members of the Floor Officials Committee, the proposal 
would amend Rule 6.20, Interpretation .09, amend Rule 8.51(a)(3), and 
add Interpretation .06 to Rule 8.51. In addition, the proposal would 
amend Rule 8.51 to clarify that in deciding whether to grant a 
suspension, exception to or exemption from the firm quote requirement, 
Floor Officials consider whether to do so would be in the interest of a 
fair and orderly market.
    Because Rule 8.51 requires that Exchange market makers honor non-
broker dealer customer orders at the displayed quote for up to ten 
contracts, it is important that the displayed market quote be accurate. 
Otherwise, market makers would be forced to trade ten contracts at an 
inaccurate or ``stale'' quote price. Therefore, if there is a system 
malfunction or other circumstance which interferes with the Exchange's 
ability to disseminate the then current and accurate quote, it is 
important for the Exchange to be able to act quickly to suspend the 
market 

[[Page 201]]
maker's obligations under Rule 8.51 until the difficulty is resolved. 
To implement such a quick response, the proposal would further amend 
Rule 8.51 to grant to the senior person then in charge of the 
Exchange's Control Room the authority to suspend the ten contract firm 
quote requirement contained in Rule 8.51(a) if there is a system 
malfunction or other circumstance that affects the Exchange's ability 
to disseminate or update market quotes. After exercising such 
authority, the senior person would need to immediately seek approval of 
two Floor Officials, who would be empowered to confirm or overrule the 
suspension.
    It is important for the Control Room to have this power to suspend 
the firm quote requirement, since the Control Room would most likely 
learn of the system malfunction before Floor Officials or other 
Exchange staff. Consequently, the Control Room could act in a timely 
manner to prevent market makers from having to trade at ``stale'' 
market quotes. If the Control Room does invoke its power to suspend the 
firm quote requirement, then the Control Room would disseminate a 
message notifying the public that the displayed quotes are not firm 
because of a data dissemination problem. This would inform non-broker 
dealer customers that their orders would not necessarily be filled at 
that displayed bid or offer. Once the system malfunction has been 
corrected and the market quotes have been updated, either the senior 
person then in charge of the Exchange's Control Room or two Floor 
Officials would be required to end the suspension of the firm quote 
requirement.
    As it is presently written, Rule 6.6(b) provides that the two Floor 
Officials declaring a fast market have the power to take a number of 
specified actions and more generally to take such other actions as are 
deemed necessary in the interest of maintaining a fair and orderly 
market. When a fast market has been declared, pursuant to these general 
powers, Floor Officials will often, in the interest of maintaining a 
fair and orderly market, suspend the ten contract firm quote 
requirement of Rule 8.51. This decision to suspend the firm quote 
requirement is made often during a fast market because the displayed 
quote is not current or accurate due to the influx of orders or other 
unusual circumstances. Therefore, market makers should not be forced to 
trade ten contracts at an inaccurate quote. In order to notify members 
and the public that, during a fast market, Floor Officials may suspend 
the firm quote requirements, CBOE proposes to specify in Rule 6.6(b) 
that when a fast market is declared, Floor Officials have the power to 
suspend the ten contract firm quote requirement of Rule 8.51.
    For the same reasons, after a fast market declaration, another 
action Floor Officials may take in the interest of maintaining a fair 
and orderly market is to turn off RAES. When RAES receives an order, 
the system automatically will attach to the order its execution price, 
determined by the prevailing market quote at the time of the order's 
entry into the system. A buy order will pay the prevailing market quote 
for an offer and a sell order will sell at the prevailing market quote 
for the bid. A market maker who has signed on as a participant in RAES 
will be designated as a contra-broker on the trade. Trades are assigned 
to these participating market makers on a rotating basis. Therefore, by 
agreeing to participate in RAES, a market maker is automatically 
assigned trades based on the prevailing market quote that is then being 
disseminated. Consequently, it is important for the prevailing market 
quote to be accurate, because otherwise market makers participating in 
RAES may be assigned trades at prices other than the actual prevailing 
market quote. During a fast market, often the influx of orders is 
greatly increased or other unusual circumstances exist that affect the 
accuracy of the prevailing market quote. For this reason, Floor 
Officials, acting under the general powers of Rule 6.6(b), may turn off 
RAES to prevent market makers from being assigned trades based on 
inaccurate market quotes. In order to notify members and the public 
that such action may be taken in a fast market, CBOE proposes to amend 
Rule 6.6 to specify that Floor Officials have the power to turn off 
RAES after a fast market has been declared.
    If RAES is turned off because of the circumstances described above, 
the orders that would have been routed to RAES will be automatically 
re-outed to either the Public Automated Routing System (``PAR'') 
workstation \7\ or floor broker printer in the trading crowd, or to the 
appropriate member firm booth. Where the order is re-routed will depend 
upon parameters set by member firms for their customers' orders prior 
to entering the orders onto RAES.\8\

    \7\ A PAR workstation is an automated, computer-based 
workstation that provides users with the ability to execute trades, 
transmit trade reports, and enter other data and commands at the 
touch of a screen, thereby eliminating the delay inherent in a 
keyboard-based system. Telephone conversation between Anthony 
Montesano, Manager, Trading Operations, CBOE, and John Ayanian, 
Attorney, OMS, Market Regulation, Commission, on December 21, 1995.
    \8\ According to CBOE, when determining order parameters for 
routing purposes, the member firms look to (1) the size of the 
order, (2) whether the series is on RAES, and (3) whether it is a 
market order or an immediately executable limit order. Telephone 
conversation between Edward Joyce, CBOE, and John Ayanian, OMS, 
Market Regulation, Commission, on December 21, 1995.
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    Furthermore, as Rule 6.6(b) is presently written, it could be 
interpreted that only the same two Floor Officials who declared the 
fast market have the power to take the other actions specified in Rule 
6.6(b). CBOE's practice has been that any two Floor Officials have the 
powers specified in Rule 6.6(b), not just the specific two individuals 
who declared the fast market. Therefore, CBOE proposes an amendment to 
Rule 6.6(b) to clarify that any two Floor Officials have the powers 
specified in 6.6(b).
    CBOE believes that members of the Market Performance Committee, who 
perform Floor Officials functions, as well as Floor Officials who are 
members of the Floor Officials Committee, are equally qualified to make 
decisions regarding Rule 6.6. To clarify that members of the Market 
Performance Committee may also act pursuant to Rule 6.6, the proposal 
would amend Rule 6.20 Interpretation .09 to specify that the Floor 
Official functions that Market Performance Committee members may 
perform include acting pursuant to rules related to fast markets and 
RAES. Again, when circumstances arise which might require the 
declaration of a fast market, it is important for timely decisions to 
be made regarding the declaration of a fast market and other related 
decisions specified in Rule 6.6. CBOE believes that it would be 
detrimental to a fair and orderly market to delay action until a Floor 
Official from the Floor Officials Committee is found to make such 
decisions when members of the Market Performance Committee might 
already be present at the trading post.
    The Exchange believes that the proposal is consistent with and 
furthers the objectives of Section 6(b)(5) of the Act, in that the 
proposal is designed to perfect the mechanisms of a free and open 
market and to protect investors and the public interest by: (1) 
Enabling any two Floor Officials to evaluate and consider market 
conditions and circumstances in determining whether to suspend the firm 
quote requirement of Rule 8.51 during a fast market; (2) clarifying the 
powers of Market Performance Committee members and specifying the 
powers Floor Officials may invoke during a fast market; and (3) 

[[Page 202]]
granting certain authority to the senior person then in charge of the 
Control Room to suspend the firm quote requirement when there has been 
a system malfunction affecting the dissemination or updating of quotes.
    The Exchange also believes that the entire proposal is consistent 
with Section 6(b) of the Act in general and furthers the objectives of 
Section 6(b)(5) in particular in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of change, to foster cooperation and coordination 
with persons engaged in facilitating transactions in securities, and to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system.

III. Commission Finding and Conclusions

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of Section 6(b)(5) of the Act.\9\ 
Specifically, the Commission finds that the Exchange's proposal strikes 
a reasonable balance between the Commission's mandates under Section 
6(b)(5) to remove impediments to and perfect the mechanism of a free 
and open market and a national market system, while protecting 
investors and the public interest.

    \9\ 15 U.S.C. 78f(b)(5).
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    For purposes of the CBOE's proposal to permanently approve the ten 
contract firm quote pilot program, the Commission reasserts its initial 
position regarding the benefits of the rule on the CBOE.\10\ 
Specifically, the permanent approval of the ten contract firm quote 
requirement rule is consistent with Section 6(b)(5) of the Act in that 
the rule results in improved market quality and better market maker 
performance than would otherwise occur. The ten contract firm quote 
requirement should continue to result in better executions of small 
customer orders by ensuring greater depth of CBOE options markets.

    \10\ See Securities Exchange Act Release No. 26924 (June 13, 
1989), 54 FR 26284 (June 22, 1989).
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    The Commission also believes that the ten contract firm quote 
requirement encourages market makers to become more competitive in 
making size markets, thereby facilitating transactions in securities, 
contributing to a more free and open market, and improving the quality 
of the CBOE's public customers' options markets.
    The Commission also believes that it is appropriate for the 
Exchange to conform its rules to the current practice not to 
automatically suspend the ten contract firm quote requirement when a 
fast market has been declared.\11\ Accordingly, the Commission believes 
that it is appropriate to add Interpretation .07 to Rule 8.51 to grant 
any two Floor Officials the authority, but not require them, to suspend 
the ten contract firm quote requirement during a fast market. The 
Commission agrees with the CBOE that, during a fast market, Exchange 
officials should have the discretion to evaluate market conditions and 
circumstances and to exercise their judgment as to whether the ten 
contract firm quote requirement should be suspended. Both amended Rule 
8.51(a)(2) and proposed Interpretation .07 to Rule 8.51 adequately 
address these issues and should help minimize adverse impact on non-
broker dealer customers during a fast market when two Floor Officials 
determine that market conditions and circumstances do not warrant such 
action.

    \11\ See CBOE Rule 8.51(a)(2).
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    The Commission also believes it is appropriate to allow the 
Exchange to allow any two Floor Officials, including members of the 
Market Performance Committee acting as Floor Officials and members of 
the Floor Officials Committee, to grant suspensions, exemptions, or 
exceptions to the ten contract firm quote requirement under Rule 8.51. 
Specifically, proposed rule change will (i) allow members of the Market 
Performance Committee to retain authority to grant exemptions from, or 
to suspend, the ten contract firm quote requirement under Rule 8.51, 
and grant Floor Officials that same authority; and (ii) clarify that 
the authority of Market Performance Committee members under 
Interpretation .09 under Rule 6.20 includes enforcing policies and 
acting pursuant to rules related to RAES and fast markets.\12\ The 
Commission believes that the Exchange adequately addresses these issues 
by amending (1) Rule 8.51(a)(3), (2) Interpretation .06 to Rule 8.51, 
(3) Interpretation .09 to Rule 6.20, and (4) Rule 6.6(b)(iv) as set 
forth above in Section II.

    \12\ See CBOE Letter, supra note 6.
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    In regard to RAES orders during a fast market, the Commission 
believes that it is appropriate to grant any two Floor Officials, 
pursuant to proposed Rule 6.6(b) (v), the express authority to turn off 
RAES after a fast market declaration if in the interest of maintaining 
a fair and orderly market. Floor Officials have the general authority 
to turn off RAES during unusual market conditions pursuant to current 
Rule 6.6(b)(v). Current Rule 6.6 (b)(v) allows Floor Officials to 
``[t]ake such other actions as are deemed necessary in the interest of 
maintaining a fair and orderly market.'' The Commission agrees with the 
Exchange that by expressly granting its Floor Official the discretion 
to turn off RAES during a fast market, Exchange members and the public 
will be properly notified that such action may be taken when a fast 
market has been declared.
    The Commission also believes that it is appropriate to allow the 
senior person then in charge of the Exchange's Control Room the 
authority to suspend the ten contract firm quote requirement if there 
is a systems malfunction or other circumstance that affects the 
Exchange's ability to disseminate or update market quotes. The type of 
circumstances that might impair the Exchange's ability to disseminate 
or update market quotes in a timely and accurate manner, include, but 
are not limited to, outages of the Exchange's autoquote system, 
communication disruptions between the Exchange and the Processor for 
the Options Price Reporting Authority, and the unavailability of market 
data from the underlying market and the CBOE.\13\ The Commission notes 
that the proposed rule change requires the senior person in charge of 
the Exchange's Control Room to immediately seek approval from two Floor 
Officials after exercising such authority. The Commission believes that 
this proposed rule change provides a reasonable mechanism for the CBOE 
to suspend the market maker's obligations under Rule 8.51 when the 
Exchange is unable to disseminate the then current and accurate quote.

    \13\ See CBOE Letter, supra note 6.
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    It is therefore ordered, pursuant to section 19(b) (2) of the 
Act,\14\ that the proposed rule change (File No. SR-CBOE-95-52) is 
approved.

    \14\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\

    \15\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-00020 Filed 1-2-96; 8:45 am]
BILLING CODE 8010-01-M