Document ID: SEC-2007-0345-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Chicago Board Options Exchange, Inc.
Posted Date: 2007-03-08T05:00Z

[Federal Register: March 8, 2007 (Volume 72, Number 45)]
[Notices]               
[Page 10572-10575]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08mr07-114]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55392; File No. SR-CBOE-2006-112]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Amendment No. 1 and Order Granting 
Accelerated Approval to a Proposed Rule Change as Modified by Amendment 
No. 1 Relating to Its Non-option Security Trading Rules

March 2, 2007.

I. Introduction

    On December 29, 2006, the Chicago Board Options Exchange, 
Incorporated (``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'' or ``Exchange Act'') \1\ 
and Rule 19b-4 thereunder,\2\ a proposal to modify its trading rules 
for non-option securities. The proposal was published for comment in 
the Federal Register on January 11, 2007.\3\ The Commission received no 
comments on the proposal. The Exchange filed Amendment No. 1 with the 
Commission on March 2, 2007.\4\ This order provides notice of and 
solicits comment on the proposed rule change as modified by Amendment 
No. 1 and approves the proposal on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 55034 (December 29, 
2006), 72 FR 1350 (the ``Notice'').
    \4\ Amendment No. 1 amended the proposal: (i) To set forth 
restrictions on the use of hand signals between the CBSX Floor Post 
and the option trading posts; (ii) to limit the types of proprietary 
orders that may be submitted by non-DPM members at the CBSX Floor 
Post; and (iii) to allow CBSX traders to avail themselves of any 
exemptions from Rule 611 of Regulation NMS that are granted by the 
Commission.
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II. Description of the Proposal

    In September 2006, the Commission approved Exchange Chapters 50-55 
governing the trading of non-option securities on the Exchange through 
a new electronic trading platform known as Stock Trading on CBOEdirect 
(``STOC''). Also in September 2006, the Commission approved 
\5\modifications \6\ to the STOC rules to conform them to aspects of 
Regulation NMS.\7\ In this filing, the Exchange proposes to further 
modify its trading rules for equity securities and rename its equity 
trading facility the CBOE Stock Exchange (``CBSX'').8 CBOE anticipates 
launching CBSX as of the compliance date for Regulation NMS. A full 
discussion of the proposed rule change is set forth in the Notice; 
significant aspects of the proposal are discussed below.
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    \5\ See Securities Exchange Act Release No. 54422 (September 11, 
2006), 71 FR 54537 (September 15, 2006) (approving SR-CBOE-2004-21).
    \6\ Securities Exchange Act Release No. 54526 (September 27, 
2006), 71 FR 58646 (October 4, 2006) (approving SR-CBOE-2006-70).
    \7\ 17 CFR 242.600 et seq.
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    First, the Exchange has proposed to further automate order handling 
and trade-through prevention. Under the current rules, if CBOE receives 
an order in an equity security when it is not at the national best bid 
or offer (``NBBO''), the designated primary market-maker (``DPM'') for 
that security must route the order to the NBBO market for execution if 
no STOC trader steps up to match the NBBO. The Exchange now proposes to 
program CBSX to automatically route, via an unaffiliated routing 
broker, a marketable order in such circumstances (except if the order 
is labeled immediate-or-cancel (``IOC'')).\8\ \9\
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    \8\ The Exchange separately filed with the Commission a proposal 
to establish a new corporate structure for CBSX (the ``CBSX Facility 
Filing''). See Securities Exchange Act Release No. 55172 (January 
25, 2007), 72 FR 4745 (February 1, 2007) (notice of filing of SR-
CBOE-2006-110). The Commission also approves the CBSX Facility 
Filing today. See Securities Exchange Act Release No. 55389 (March 
2, 2007).
    \9\ IOC orders would be cancelled if a better-priced protected 
quotation existed on another exchange. See CBOE Rule 51.8(g)(4). In 
addition, the Commission notes that an Intermarket Sweep Order 
(``ISO'') received by CBSX will be executed or cancelled immediately 
and not ``flashed'' to CBSX traders for possible matching of the 
NBBO. See CBOE Rule 51.8(n).
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    Second, the Exchange has proposed to move the CBSX opening from 
8:30 a.m. Central Time (``CT'') to 8:15 a.m. CT and eliminate a DPM's 
obligation to open its assigned securities at a single price that 
matches the primary market or at a price that does not trade-through 
another exchange's quote. At the opening, the CBSX system would 
automatically execute pre-opening orders at a price that allows the 
greatest number of shares to trade.
    Third, the Exchange is proposing to add a floor component to its 
electronic trading system. CBSX would dedicate a space on the 
Exchange's trading floor (the ``CBSX Floor Post'') that CBSX DPMs will 
be required to staff for the purpose of responding to price

[[Page 10573]]

discovery inquiries from brokers. Open-outcry trading is not permitted, 
and time priority would attach to the order only when it was entered 
into the system. Any order entered at the CBSX Floor Post would be 
executed electronically in the same manner as an order entered from any 
other location. In Amendment No. 1, the Exchange also proposed to amend 
the rule governing the CBSX Floor Post to permit only cross orders and 
IOC orders to be submitted by non-DPM members from the CBSX Floor Post.
    The CBSX Floor Post would be located near the Exchange's index 
options pits in a location that is generally isolated from the equity 
options trading posts. Proposed Rule 51.12 stipulates that there shall 
be no direct sightlines between the CBSX Floor Post and the equity 
option trading posts. In Amendment No. 1, the Exchange is adding 
restrictions on the use of hand signals between the CBSX Floor Post and 
the equity option trading posts.
    Fourth, the Exchange proposes to adopt the following new order 
types in connection with the establishment of CBSX:
    A Reserve Order is a limit order in which the order originator 
designates a portion of the order for display and dissemination (the 
``display amount'') and designates a portion of the order in 
``reserve.'' A reserve portion is not displayed but is available for 
execution against incoming orders. If a quantity remains on the Reserve 
Order after an execution, the order would be refreshed to include the 
display amount while any remaining balance would remain in reserve.
    A Middle Market Cross Order is an order submitted to trade at the 
midpoint of the NBBO. It must always be submitted with a contra order 
for the same size and could be entered only when the bid price for the 
stock is $1 or greater. These orders could be executed in increments as 
small as one-half the minimum quoting increment established under CBSX 
rules. However, proposed CBSX Rule 51.8(p) would prohibit a member from 
entering a Middle Market Cross Order as principal buyer (seller) if the 
NBBO spread is one cent wide and that member is an agent for any 
customer order resting at the prevailing national best bid (offer).
    A Cross Only Order is an order that could be executed only against 
another Cross Only Order for the same size and price. These orders 
could be entered only at or between the NBBO, and when entered at the 
CBSX BBO, only when the terms of the orders meet the crossing 
parameters set forth in proposed CBSX Rule 52.11 relating to priority 
for crosses at the CBSX's disseminated market price.
    A Cross and Sweep Order is an order that is priced outside of the 
NBBO and/or the BBO where the applicable side of the CBSX book is 
satisfied by the Cross and Sweep Order and any disseminated better-
priced protected quotations at away market centers are swept with ISOs 
by the CBSX system. In other words, before executing the cross, a Cross 
and Sweep Order will satisfy (i) Any protected quotations that are 
priced better than the crossing price, and (ii) any interest on CBSX 
that is priced at or better than the crossing price. Any remaining 
imbalance on either side of a partially executed Cross and Sweep Order 
which results from satisfying protected quotations or other CBSX 
interest would be cancelled by the CBSX system.
    The Exchange proposes to modify the manner in which Stop Orders 
(including Stop Limit Orders) are handled. CBOE rules currently provide 
that a stop buy (or sell) order is elected when the stock trades, or is 
bid (or offered), at or above (or below) the stop price on the 
Exchange. The Exchange proposes to change the provision that stipulates 
when a stop buy (or sell) order is elected to state that the order is 
elected (not when the stock is bid or offered) at, or above or below, 
the stop price. The Exchange also proposes to change the rule to 
provide that a stop buy (or sell) order is elected when the stop price 
is reached on the primary market for the stock, rather than on CBSX.
    Fifth, in Amendment No. 1, the Exchange has proposed to amend CBOE 
Rule 52.7, ``Sweeping and Trading Through Away Markets,'' to 
incorporate any future exemptions from Rule 611 of Regulation NMS (the 
``Order Protection Rule'') \10\ granted by the Commission. Rule 52.7 
already incorporates several of the exceptions codified in Rule 611(b) 
of Regulation NMS. With this provision, CBSX would automatically 
incorporate into its rules any future exemptions from the Order 
Protection Rule granted by Commission order.
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    \10\ 17 CFR 242.611.
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    Sixth, CBOE proposes to adopt a provision in Rule 53.55 stating 
that routine failure to qualify for the thresholds set forth in any fee 
incentive program \11\ that may be employed by CBSX from time to time 
could subject a DPM to remedial action by CBSX under that rule.
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    \11\ CBSX has also adopted, via a separate rule filing, a fee 
structure that would discount fees for CBSX Market-Makers that meet 
certain competitive quoting thresholds. See File No. SR-CBOE-2007-25 
(filed March 1, 2007).
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    Seventh, certain existing rules are being eliminated because the 
Exchange does not believe that they are necessary or relevant to the 
operation and regulation of the CBSX platform.\12\ Most notably, all 
rules regarding the Intermarket Trading System are being deleted as the 
Exchange anticipates using private linkages with the CBSX platform and 
because the ITS Plan will terminate upon the trading phase date for 
Regulation NMS.
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    \12\ See Notice, 72 FR at 1352 (discussing these proposed 
changes).
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III. 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.\13\ In particular, the Commission believes that 
the proposal is consistent with the requirements of Section 6(b)(5) of 
the Act,\14\ which requires, among other things, that the rules of a 
national securities exchange be designed to promote just and equitable 
principles of trade; to facilitate transactions in securities; to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system; and, in general, to protect 
investors and the public interest. The Commission did not receive any 
comments on the proposal. This order approves the proposed rule change, 
as modified by Amendment No. 1, in its entirety, although only selected 
aspects of the proposed rules governing the CBSX system are discussed 
below.
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    \13\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \14\ 15 U.S.C. 78f(b)(5).
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A. Compliance With the Order Protection Rule

    The Order Protection Rule of Regulation NMS provides that a trading 
center shall establish policies that are reasonably designed to prevent 
trade-throughs on that trading center of protected quotations in NMS 
stocks that do not fall within one of the enumerated exceptions of the 
Rule. The Commission believes that the proposed CBSX rules are 
reasonably designed to promote compliance with the Order Protection 
Rule. The CBSX system is programmed to automatically process and route 
orders to avoid trading through any protected quotations on away 
markets. Like its predecessor, the STOC system, CBSX will automatically 
match a market

[[Page 10574]]

or marketable limit order against the best-priced orders in the CBSX 
book until the order is fully executed or until an execution would 
result in a trade-through of a protected quotation at another automated 
market center (unless an exception is available). An incoming order 
(other than an IOC order or ISO) in a security will be ``flashed'' to 
CBSX traders for a short period if CBSX is not at the NBBO for that 
security. If no CBSX trader determines to step up and match the NBBO, 
the order will be routed to the market center disseminating the 
protected quotation for execution. Under the existing rules, such 
orders would be routed manually by the DPM. CBOE now proposes that CBSX 
would route such orders automatically, via an unaffiliated routing 
broker. As a result, CBSX DPMs would no longer serve as agent for such 
orders.

B. CBSX Opening Procedures

    Proposed Rule 51.2(a) provides that the CBSX system would open for 
trading at 8:15 a.m. CT (9:30 a.m. Eastern Time), 15 minutes before the 
primary markets. The Commission believes that establishing trading 
hours is generally within the business discretion of an exchange, and 
CBOE's proposal in this regard does not appear to raise any regulatory 
issues. The Commission notes that other exchanges have trading sessions 
before 9:30 a.m. Eastern Time.
    Proposed Rule 52.2 provides that the CBSX system would 
automatically open each security at a price that provides the highest 
matched quantity of order volume. In connection with the automation of 
the opening, the Exchange also proposes to eliminate a DPM's obligation 
to open a security at a single price that matches the opening price on 
the primary market. The Commission believes that the proposed opening 
matching algorithm is reasonable and consistent with the Act.

C. Hybrid Trading Model

    The Commission believes that CBOE's integration of the electronic 
CBSX system with a post on the Exchange floor is generally consistent 
with the Act and is within the business discretion of the Exchange. The 
Commission previously has found hybrid trading rules of other exchanges 
to be consistent with the Act.\15 \
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    \15\ See Securities Exchange Act Releases No. 54552 (September 
29, 2006), 71 FR 59546 (October 10, 2006) (approving the Amex 
Auction & Electronic Market Integration hybrid market structure) and 
53539 (March 22, 2006), 71 FR 16353 (March 31, 2006) (approving the 
NYSE Hybrid Market).
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    The CBSX Floor Post is near the posts where related options may be 
traded. CBOE has proposed to prohibit members from using hand signals 
or other like means of communication to communicate between the CBSX 
Floor Post and the equity options trading posts. CBOE's proposed rule 
is substantially similar to policies adopted by the American Stock 
Exchange in connection with its proposal to permit side-by-side trading 
that the Commission previously has found consistent with the Act.\16\ 
For the same reasons, the Commission believes that the CBOE rule also 
is consistent with the Act.
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    \16\ See Securities Exchange Act Release No. 39631 (February 9, 
1998), 63 FR 8229 (February 18, 1998) (approving SR-Amex-97-37).
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    CBOE also has proposed to prohibit members, except DPMs, from 
entering proprietary orders while at the CBSX Floor Post, unless such 
orders are cross orders or IOC orders. These restrictions appear 
reasonably designed to prevent a non-DPM CBOE member from executing a 
trade ahead of a non-member at the same price and thus are generally 
consistent with Section 11(a) of the Act.\17\
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    \17\ 15 U.S.C. 78k(a).
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D. New Order Types

    The Exchange proposes to adopt several new order types in 
connection with the establishment of CBSX: Reserve Orders, Middle 
Market Cross Orders, Cross Only Orders, and Cross and Sweep Orders. The 
Commission finds that the rules relating to these order types are 
consistent with the Act and should provide market participants with 
additional flexibility in executing transactions while protecting 
displayed interest on the CBSX book and protected quotations of other 
trading centers.
    The Commission notes in particular that it previously has approved 
order types on other exchanges similar to what CBOE terms the Middle 
Market Cross Order.\18\ The Commission notes that proposed CBSX Rule 
51.8(p) prohibits a member from entering a Middle Market Cross Order as 
principal buyer (seller) if the NBBO spread is one cent wide and that 
member was an agent for any customer order resting at the prevailing 
NBBO bid (offer). This provision would preclude a member from trading 
as principal at a price that is less than one cent better than a price 
expressed by its customer. By requiring at least a one-cent improvement 
over the customer limit order that the member represents as agent, this 
rule promotes compliance by the member with its Manning obligation to 
the customer order.\19\
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    \18\ See, e.g., Securities Exchange Act Releases No. 54528 
(September 28, 2006), 71 FR 58650 (October 4, 2006) (approving SR-
ISE-2006-48) and 54101 (July 5, 2006), 71 FR 39382 (July 12, 2006) 
(approving SR-NASD-2005-140).
    \19\ See NASD Interpretive Materials 2110-2.
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E. Accelerated Approval

    Pursuant to Section 19(b)(2) of the Act,\20\ the Commission finds 
good cause for approving the proposal prior to the thirtieth day after 
the publication of the proposal, as modified by Amendment No. 1, in the 
Federal Register. The revisions to the proposed rule change made by 
Amendment No. 1 do not raise any novel or substantive regulatory 
issues. Therefore, the Commission finds good cause for approving the 
amended proposal on an accelerated basis.
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    \20\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments Concerning Amendment No. 1

    Interested persons are invited to submit written data, views, and 
arguments concerning the proposed rule change as modified by Amendment 
No. 1, including whether it is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-CBOE-2006-112 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2006-112. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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

[[Page 10575]]

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 also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CBOE-2006-112 and should be submitted on or before March 
29, 2007.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (File No. SR-CBOE-2006-112), as 
modified by Amendment No. 1, be, and it hereby is, approved on an 
accelerated basis.
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    \21\ Id.
    \22\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-4124 Filed 3-7-07; 8:45 am]

BILLING CODE 8010-01-P