Document ID: SEC-2007-1330-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Chicago Board Options Exchange, Inc.
Posted Date: 2007-09-27T04:00Z

[Federal Register: September 27, 2007 (Volume 72, Number 187)]
[Notices]
[Page 54952-54956]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27se07-102]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56492; File No. SR-CBOE-2007-106]

Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Notice of Filing of Proposed Rule Change Relating to CBOE
Rules Governing Doing Business With the Public

September 21, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on September 5, 2007, Chicago Board Options Exchange, Incorporated
(``CBOE'' or the ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II and III below, which Items have been substantially prepared
by the Exchange. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The Exchange is proposing to amend certain rules that govern an
Exchange member's conduct in doing business with the public.
Specifically, the proposed rule change would require member
organizations to integrate the responsibility for supervision of a
member organization's public customer options business into its overall
supervisory and compliance program. In addition, the Exchange proposes
to amend certain rules to strengthen member organizations' supervisory
procedures and internal controls as they relate to a member's public
customer options business. The text of the proposed rule change is
available at CBOE, the Commission's Public Reference Room and http://www.cboe.org/legal
.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CBOE included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. CBOE has prepared summaries, set forth in sections A, B,
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, Proposed Rule Change

1. Purpose
a. Integration of Options Supervision
    The purpose of the proposed rule change is to create a supervisory
structure for options that is similar to that required by New York
Stock Exchange (``NYSE'') and National Association of Securities
Dealers (``NASD'') rules.\3\ The proposed rule change would eliminate
the requirement that member organizations qualified to do a public
customer business in options must designate a single person to act as
Senior Registered Options Principal (``SROP'') for the member
organization and that each such member organization designate a
specific individual as a Compliance Registered Options Principal
(``CROP''). Instead member organizations would be

[[Page 54953]]

required to integrate the SROP and CROP functions into their overall
supervisory and compliance programs.
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    \3\ See NYSE Rule 342 and NASD Rule 3010. On July 26, 2007, the
Commission approved a proposed rule change filed by NASD to amend
NASD's Certificate of Incorporation to reflect its name change to
Financial Industry Regulatory Authority Inc., or FINRA, in
connection with the consolidation of the member firm regulatory
functions of NASD and NYSE Regulation, Inc. See Securities Exchange
Act Release No. 56146 (July 26, 2007).
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    The SROP concept was first introduced by CBOE during the early
years of the development of the listed options market. Previously,
under CBOE rules, member organizations were required to designate one
or more persons qualified as Registered Options Principals (``ROPs'')
having supervisory responsibilities in respect of the member
organization's options business. As the number of ROPs at larger member
organizations began to increase, CBOE imposed an additional requirement
that member organizations designate one of their ROPs as the SROP. This
was intended to eliminate confusion as to where the compliance and
supervisory responsibilities lay by centralizing in a single
supervisory officer overall responsibility for the supervision of a
member organization's options activities.\4\ Subsequently, following
the recommendation of the Commission's Options Study, CBOE and other
options exchanges required member organizations to designate a CROP to
be responsible for the member organization's overall compliance program
in respect of its options activities.\5\ The CROP may be the same
person who is designated as SROP.
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    \4\ Report of the Special Study of the Options Market (``Options
Study''), note 11 p. 316 (December 22, 1978).
    \5\ Id. at p. 335.
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    Since the SROP and CROP requirements were first imposed, the
supervisory function in respect of the options activities of most
securities firms has been integrated into the matrix of supervisory and
compliance functions in respect of the firms' other securities
activities. This not only reflects the maturity of the options market,
but also recognizes the ways in which the uses of options themselves
have become more integrated with other securities in the implementation
of particular strategies. Thus, the current requirement for a
separately designated senior supervisor in respect of all aspects of a
member organization's options activities, rather than clarifying the
allocation of supervisory responsibilities within the member
organization, may have just the opposite effect by failing to take into
account the way in which these responsibilities are actually assigned.
In addition, by permitting supervision of a member organization's
options activities to be handled in the same manner as the supervision
of its other securities activities as well as its futures activities,
the proposed rule change will ensure that supervisory responsibility
over each segment of the member organization's business is assigned to
the best qualified persons in the member organization, thereby
enhancing the overall quality of supervision. The same holds true for
the compliance function.
    For example, most member organizations have designated one person
to have supervisory responsibility over the application of margin
requirements and other matters pertaining to the extension of credit.
The proposed rule change would enable a member organization to include
within the scope of such a person's duties the supervision over the
proper margining of options accounts, thereby assuring that the most
qualified person is charged with this responsibility and at the same
time eliminating any uncertainty that might now exist as to whether
this responsibility lies with the senior credit supervisor or with the
SROP.
    Similarly, the proposed rule change would allow a member
organization to specifically designate one or more individuals as being
responsible for approving a ROP's acceptance of discretionary accounts
\6\ and exceptions to a member organization's suitability standards for
trading uncovered short options.\7\ The proposed rule changes would
allow member organizations the flexibility to assign such
responsibilities, which formerly rested with the SROP and/or CROP, to
more than one ROP qualified individual where the member organization
believes it advantageous to do so to enhance its supervisory or
compliance structure. Typically, a member organization may wish to
divide these functions on the basis of geographic region or functional
considerations. Rule 9.2 would be amended to clarify the qualification
requirements of individuals designated as ROPs.\8\ Rule 9.3 would be
amended to specify the registration requirements of individuals who
accept orders from non-broker-dealer customers.\9\
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    \6\ See proposed Rule 9.10(a).
    \7\ See proposed Rule 9.7(f)(3).
    \8\ See proposed Rules 9.2.01 and 9.2.02.
    \9\ See proposed Rule 9.3.01.
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    The proposed rule change would call for options discretionary
accounts, the acceptance of which must be approved by a ROP qualified
individual (other than the ROP who accepted the account), to be
supervised in the same manner as the supervision of other securities
accounts that are handled on a discretionary basis. The proposed rule
change would eliminate the requirement that discretionary options
orders be approved on the day of entry by a ROP (with one exception as
described below). This requirement predates the Options Study and is
not consistent with the use of supervisory tools in computerized format
or exception reports generated after the close of a trading day. No
similar requirement exists for supervision of other securities accounts
that are handled on a discretionary basis.\10\ Discretionary orders
must be reviewed in accordance with a member organization's written
supervisory procedures. The proposed rule change would ensure that
supervisory responsibilities are assigned to specific ROP-qualified
individuals, thereby enhancing the quality of supervision.
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    \10\ See, e.g., NYSE Rule 408.
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    Exchange Rule 9.10 would be revised by adding, as Interpretation
and Policy .01, a requirement that any member organization that does
not utilize computerized surveillance tools for the frequent and
appropriate review of discretionary account activity must establish and
implement procedures to require ROP qualified individuals who have been
designated to review discretionary accounts to approve and initial each
discretionary order on the day entered. The Exchange believes that any
member organization that does not utilize computerized surveillance
tools to monitor discretionary account activity should continue to be
required to perform the daily manual review of discretionary orders.
    Under the proposed rule change, options discretionary accounts will
continue to receive frequent appropriate supervisory review by
designated ROP-qualified individuals. Additionally, member
organizations will continue to be required to designate ROP-qualified
individuals to review and approve the acceptance of options
discretionary accounts in order to determine whether the ROP accepting
the account had a reasonable basis for believing that the customer was
able to understand and bear the risks of the proposed strategies or
transactions. This requirement provides an additional level of
supervisory audit over options discretionary accounts that does not
exist for other securities discretionary accounts.
    In addition, the proposed rule change would require that each
member organization submit to the Exchange a written report by April 1
of each year, that details the member organization's supervision and
compliance effort, including its options compliance program, during the
preceding year and reports on the adequacy of the member

[[Page 54954]]

organization's ongoing compliance processes and procedures.\11\
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    \11\ See proposed Rule 9.8(g), which is modeled after NYSE Rule
342.30.
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    Proposed Rule 9.8(h) would require that each member organization
submit, by April 1st of each year, a copy of the Rule 9.8(g) annual
report to one or more of its control persons or, if the member
organization has no control person, to the audit committee of its board
of directors or its equivalent committee or group.\12\
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    \12\ Proposed Rule 9.8(h) is modeled after NYSE Rule 354.
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    Proposed Rule 9.8(g) would provide that a member organization that
specifically includes its options compliance program in a report that
complies with substantially similar requirements of the NYSE and NASD
will be deemed to have satisfied the requirements of Rules 9.8(g) and
9.8(h).
    Additionally, where appropriate, the proposed rule change would
delete references to SROP and CROP in Rules 3.6A and 26.10.\13\
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    \13\ The Exchange notes that a separate proposed rule change
currently pending at the Commission (SR-CBOE-2007-30) proposes to
delete references to the CROP in Rule 9.21, among other things.
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    Although the proposed rule change would eliminate entirely the
positions and titles of the SROP and CROP, member organizations would
still be required to designate a single general partner or executive
officer to assume overall authority and responsibility for internal
supervision, control of the member organization and compliance with
securities laws and regulations.\14\ Member organizations would also be
required to designate specific qualified individuals as having
supervisory or compliance responsibilities over each aspect of the
member organization's options activities and to set forth the names and
titles of these individuals in their written supervisory
procedures.\15\ This is consistent with the integration of options
supervision into the overall supervisory and compliance structure of a
member organization. In connection with the approval of these proposed
rule changes, the Exchange intends to review member organizations'
written supervisory and compliance procedures in the course of the
Exchange's routine examination of member organizations to ensure that
supervisory and compliance responsibilities are adequately defined.
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    \14\ See proposed Rule 9.8(a).
    \15\ See proposed Rule 9.8.01.
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    The Exchange believes that the proposed rule changes recognize that
options are no longer in their infancy, have become more integrated
with other securities in the implementation of particular strategies,
and thus should not continue to be regulated as though they are a new
and experimental product. The Exchange believes that the proposed rule
change is appropriate and would not materially alter the supervisory
operations of member organizations. The Exchange believes the
supervisory and compliance structure in place for non-options products
at most member organizations is not materially different from the
structure in place for options.
b. Supervisory Procedures and Internal Controls
    The Exchange also proposes to amend certain rules to strengthen
member and member organizations' supervisory procedures and internal
controls as they relate to a member's public customer options business.
The proposed rule changes described below are modeled after NYSE and
NASD rules approved by the Commission in 2004.\16\ The Exchange
believes the following proposal to strengthen member supervisory
procedures and internal controls is appropriate and consistent with the
preceding proposal to integrate options and non-options sales practice
supervision and compliance functions.
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    \16\ See Securities Exchange Act Release No. 49882 (June 17,
2004), 69 FR 35108 (June 23, 2004) (SR-NYSE-2002-36), and Securities
Exchange Act Release No. 49883 (June 17, 2004), 69 FR 35092 (June
23, 2004) (SR-NASD-2002-162).
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    Exchange Rule 9.8(a)(3) would be revised to require the development
and implementation of written policies and procedures reasonably
designed to supervise sales managers and other supervisory personnel
who service customer options accounts (i.e., who act in the capacity of
a registered representative).\17\ This requirement would apply to
branch office managers, sales managers, regional/district sales
managers, or any person performing a similar supervisory function. Such
policies and procedures are expected to encompass all options sales-
related activities. Proposed Rule 9.8(a)(3)(i) would require that
supervisory reviews of producing sales managers be conducted by a
qualified ROP who is either senior to, or otherwise ``independent of'',
the producing manager under review.\18\ This provision is intended to
ensure that all options sales activity of a producing manager is
monitored for compliance with applicable regulatory requirements by
persons who do not have a personal interest in such activity.
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    \17\ Proposed Rule 9.8(a)(3) is modeled after NYSE Rule 342.19.
    \18\ An ``otherwise independent'' person would be defined in
proposed Rule 9.8(a)(3)(i) as one who: may not report either
directly or indirectly to the producing manager under review; must
be situated in an office other than the office of the producing
manager; must not otherwise have supervisory responsibility over the
activity being reviewed; and must alternate such review
responsibility with another qualified person every two years or
less. Further, if a person designated to review a producing manager
receives an override or other income derived from that producing
manager's customer activity that represents more than 10% of the
designated person's gross income derived from the member
organization over the course of a rolling twelve-month period, the
member organization must establish alternative senior or otherwise
independent supervision of that producing manager to be conducted by
a qualified ROP other than the designated person receiving the
income.
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    Proposed Rule 9.8(a)(3)(ii) would provide a limited exception for
members so limited in size and resources that there is no qualified
person senior to, or otherwise independent of, the producing manager to
conduct the review. In this case, the reviews may be conducted by a
qualified ROP to the extent practicable. Under proposed Rule
9.8(a)(3)(iii), a member relying on the limited size and resources
exception must document the factors used to determine that compliance
with each of the ``senior'' or ``otherwise independent'' standards of
Rule 9.8(a)(3)(i) is not possible, and that the required supervisory
systems and procedures in place with respect to any producing manager
comply with the provisions of Rule 9.8(a)(3)(i) to the extent
practicable.
    Paragraph (a)(3)(iv) of Rule 9.8 would provide that a member
organization that complies with requirements of the NYSE or the NASD
that are substantially similar to the requirements in Rules
9.8(a)(3)(i), (a)(3)(ii) and (a)(3)(iii) will be deemed to have met
such requirements.
    Proposed Rule 9.8(c)(i) would require member organizations to
develop and maintain adequate controls over each of their business
activities. The proposed rule would further require that such controls
include the establishment of procedures to independently verify and
test the supervisory systems and procedures for those business
activities. Member organizations would be required to include in the
annual report prepared pursuant to Rule 9.8(g) a review of the member
organization's efforts in this regard, including a summary of the tests
conducted and significant exceptions identified. The Exchange believes
proposed Rule 9.8(c)(i) would enhance the quality of member
organizations' supervision.\19\ Paragraph (c)(ii) of Rule 9.8 would
provide that a member organization that complies with requirements of
the NYSE or the NASD that are substantially similar to the requirements

[[Page 54955]]

in Rule 9.8(c)(i) will be deemed to have met such requirements.
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    \19\ Proposed Rule 9.8(c)(i) is modeled after NYSE Rule 342.23.
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    Proposed Rule 9.8(d) would establish requirements for branch office
inspections similar to the requirements of NYSE Rule 342.24.
Specifically, Rule 9.8(d) would require a member organization to
inspect each supervisory branch office at least annually and each non-
supervisory branch office at least once every three years.\20\ The
proposed rule would further require that persons who conduct a member
organization's annual branch office inspection must be independent of
the direct supervision or control of the branch office (i.e., not the
branch office manager, or any person who directly or indirectly reports
to such manager, or any person to whom such manager directly reports).
The Exchange believes that requiring branch office inspections to be
conducted by someone who has no significant financial interest in the
success of a branch office should lead to more objective and vigorous
inspections.
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    \20\ Proposed Rules 9.8(d)(1)(i) and (ii) would provide members
with two exceptions from the annual branch office inspection
requirement: A member may demonstrate to the satisfaction of the
Exchange that other arrangements may satisfy the Rule's requirements
for a particular branch office, or based upon a member
organization's written policies and procedures providing for a
systematic risk-based surveillance system, the member organization
submits a proposal to the Exchange and receives, in writing, an
exemption from this requirement pursuant to Rule 9.8(e).
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    Under proposed Rule 9.8(e), any member organization seeking an
exemption, pursuant to Rule 9.8(d)(1)(ii), from the annual branch
office inspection requirement would be required to submit to the
Exchange written policies and procedures for systematic risk-based
surveillance of its branch offices, as defined in Rule 9.8(e). Proposed
Rule 9.8(f) would require that annual branch office inspection programs
include, at a minimum, testing and verification of specified internal
controls.\21\ Paragraph (d)(3) of Rule 9.8 would provide that a member
organization that complies with requirements of the NYSE or the NASD
that are substantially similar to the requirements in Rules 9.8(d), (e)
and (f) will be deemed to have met such requirements.
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    \21\ Proposed Rules 9.8(e) and (f) are modeled after NYSE Rule
342.25 and 342.26.
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    In conjunction with the proposed changes to Rules 9.8(d), (e) and
(f), the Exchange proposes to amend Rule 9.6 to define ``branch
office'' in a way that is substantially similar to the definition of
branch office in NYSE Rule 342.10.
    Proposed Rule 9.8(g)(4) would require a member organization to
designate a Chief Compliance Officer (CCO).\22\ Proposed Rule 9.8(g)(5)
would require each member organization's chief executive officer (CEO),
or equivalent, to certify annually that the member organization has in
place processes to: (1) Establish and maintain policies and procedures
reasonably designed to achieve compliance with applicable Exchange
rules and federal securities laws and regulations; (2) modify such
policies and procedures as business, regulatory, and legislative
changes and events dictate; and (3) test the effectiveness of such
policies and procedures on a periodic basis, the timing of which is
reasonably designed to ensure continuing compliance with Exchange rules
and federal securities laws and regulations.
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    \22\ Rule 3.6A(b) would be revised to add Chief Compliance
Officer as a new associated person status under Chapter 9 of
Exchange Rules.
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    Proposed Rule 9.8(g)(5) would further require that the CEO attest
the CEO has conducted one or more meetings with the CCO in the
preceding 12 months to discuss the compliance processes in proposed
Rule 9.8(g)(5)(i), that the CEO has consulted with the CCO and other
officers to the extent necessary to attest to the statements in the
certification, and the compliance processes are evidenced in a report,
reviewed by the CEO, CCO, and such other officers as the member
organization deems necessary to make the certification, that is
provided to the member organization's board of directors and audit
committee (if such committee exists).\23\
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    \23\ Proposed Rule 9.8(g)(5) is modeled after NASD Rule 3013 and
NYSE Rule 342.30(e).
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    Under proposed Rule 9.8(b)(2), a member, upon a customer's written
instructions, may hold mail for a customer who will not be at his or
her usual address for no longer than two months if the customer is on
vacation or traveling, or three months if the customer is going abroad.
This provision would help ensure that members that hold mail for
customers who are away from their usual addresses, do so only pursuant
to the customer's written instructions and for a specified, relatively
short period of time.\24\
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    \24\ Proposed Rule 9.8(b)(2) is modeled after NASD Rule 3110(i).
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    Proposed Rule 9.8(b)(3) would require that, before a customer
options order is executed, the account name or designation must be
placed upon the memorandum for each transaction. In addition, only a
qualified ROP may approve any changes in account names or designations.
The ROP also must document the essential facts relied upon in approving
the changes and maintain the record in a central location. A member
would be required to preserve any account designation change
documentation for a period of not less than three years, with the
documentation preserved for the first two years in an easily accessible
place, as the term ``easily accessible place'' is used in SEC Rule 17a-
4. The Exchange believes the proposed rule would help to protect
account name and designation information from possible fraudulent
activity.\25\
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    \25\ Proposed Rule 9.8(b)(3) is modeled after NASD Rule 3110(j).
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    Rule 9.10(d) allows member organizations to exercise time and price
discretion on orders for the purchase or sale of a definite number of
options contracts in a specified security. The Exchange proposes to
amend Rule 9.10(d) to limit the duration of this discretionary
authority to the day it is granted, absent written authorization to the
contrary. In addition, the proposed rule would require any exercise of
time and price discretion to be reflected on the customer order ticket.
The proposed one-day limitation would not apply to time and price
discretion exercised for orders effected with or for an institutional
account \26\ pursuant to valid Good-Till-Cancelled instructions issued
on a ``not held'' basis. The Exchange believes that investors will
receive greater protection by clarifying the time such discretionary
orders remain pending.\27\
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    \26\ ``Institutional account'' would be defined in Rule 9.10(d)
as ``the account of: (i) A bank, savings and loan association,
insurance company, or registered investment company; (ii) an
investment adviser registered either with the Securities and
Exchange Commission under Section 203 of the Investment Advisers Act
of 1940 or with a state securities commission (or any agency or
office performing like functions); or (iii) any other entity
(whether a natural person, corporation, partnership, trust or
otherwise) with total assets of at least $50 million.''
    \27\ Proposed Rule 9.10(d) is modeled after NASD Rule
2510(d)(1).
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2. Statutory Basis
    The proposed rule change would integrate the supervision and
compliance functions relating to member organizations' public customer
options activities into the overall supervisory structure of a member
organization, thereby eliminating any uncertainty over where
supervisory responsibility lies. The proposed rule change would also
foster the strengthening of members' and member organizations' internal
controls and supervisory systems. As such, the proposed rule changes
are consistent with and further the objectives of

[[Page 54956]]

Section 6(b)(5) of the Act,\28\ in that they are designed to promote
just and equitable principles of trade, to prevent fraudulent and
manipulative acts and practices, to remove impediments to and perfect
the mechanisms of a free and open market and a national market system,
and in general, to protect investors and the public interest.
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    \28\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any
burden on competition not necessary or appropriate in furtherance of
purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) As the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change 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-2007-106 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-CBOE-2007-106. 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 provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549 on official business days between the hours
of 10 a.m. and 3 p.m. 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-2007-106 and should be
submitted on or before October 18, 2007.

    For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-19079 Filed 9-26-07; 8:45 am]

BILLING CODE 8010-01-P