[Federal Register Volume 59, Number 47 (Thursday, March 10, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-5478] [[Page Unknown]] [Federal Register: March 10, 1994] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-33701; File No. SR-CBOE-93-24] Self-Regulatory Organizations; Order Approving Proposed Rule Change by the Chicago Board Options Exchange, Inc. Relating to Telephones Located on the Floor of the Exchange March 2, 1994. On June 7, 1993, the Chicago Board Options Exchange, Inc. (``CBOE'' or ``Exchange''), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ filed with the Securities and Exchange Commission (``SEC'' or ``Commission'') a proposed rule change to incorporate into the rules of the Exchange the conditions imposed by the Exchange governing the use of member- owned and Exchange-owned telephones located at equity option trading posts on the floor of the Exchange. Notice of the proposal appeared in the Federal Register on July 21, 1993.\3\ No comment letters were received on the proposed rule change. This order approves the Exchange's proposal. --------------------------------------------------------------------------- \1\15 U.S.C. 78s(b)(1) (1988). \2\17 CFR 240.19b-4 (1992). \3\See Securities Exchange Act Release No. 32633 (July 14, 1993), 58 FR 33471 (July 21, 1993). --------------------------------------------------------------------------- CBOE Rule 6.23 prohibits members from establishing or maintaining any telephone or other wire communications between their offices and the Exchange floor without prior approval by the Exchange, and it authorizes the Exchange to direct the discontinuance of any communication facility terminating on the Exchange floor. In October 1992, the Exchange determined to permit the installation of both Exchange-owned and member-owned telephones at equity option posts on the trading floor,\4\ and it promulgated Information Circular IC92-118 (``Circular'') to inform the membership of this new policy and the fees, charges, and conditions associated with the use of such telephones. At the time the Circular was issued, the Exchange determined that the conditions applicable to the use of floor telephones would not be treated as rules of the Exchange, and accordingly, no surveillance obligations were imposed on the Exchange nor were members subject to formal disciplinary proceedings for violations of the polices contained in the Circular. --------------------------------------------------------------------------- \4\The Exchange has not allowed telephones to be installed at index option trading posts for use by market markers. Telephone conversation between Pat Cerny, Market Surveillance, CBOE, and Brad Ritter, Attorney, Office of Derivatives Regulation, Division of Market Regulation, SEC, on February 24, 1994. --------------------------------------------------------------------------- The Exchange now proposes to incorporate into its rules those conditions set forth in the Circular as applying to the use of telephones at equity options trading posts. Specifically, these conditions are as follows: 1. There will be no restrictions on where a member may call. 2. Floor telephones may not be used to receive orders, although they may be used to provide quotations. 3. Members may give their clerks their personal identification (``PIN'') access codes. Although both members and clerks may use the post telephones, members will have priority. Liability for all calls made using a member's PIN access code will be that of the member. 4. Stock clerks will not be permitted to establish a base of operations utilizing post telephones. 5. Members and their clerks using the telephones consent to the Exchange requiring that any telephone or line be subject to tape recording. 6. The telephones will be used for voice service only. Data (PC's, fax, etc.) will remain subject to Exchange consent under a separate program. 7. Cellular or portable telephone may not be used on the trading floor. 8. Telephone headsets may not be used on the equity options floor. The Exchange shall republish the Circular as a Regulatory Circular in order to inform members that these conditions are rules and that violations may lead to disciplinary proceedings. The Exchange believes it is now appropriate to treat these conditions as Exchange rules in order to be able to utilize both informal and formal disciplinary proceedings and sanctions to promote compliance.\5\ --------------------------------------------------------------------------- \5\The Exchange has represented that it has received no complaints, nor has it detected any violations of the procedures contained in the Circular since telephones have been installed at the equity options trading posts. Telephone conversation between Pat Cerny, Market Surveillance, CBOE, and Brad Ritter, Attorney, Office of Derivatives Regulation, Division of Market Regulation, SEC, on February 23, 1994 (``February 23 Conversation''). --------------------------------------------------------------------------- The Exchange intends to police compliance with these conditions by means of customary floor surveillance procedures, including reliance on surveillance by floor officials and Exchange employees. Additionally, the Exchange represents that it has in place a surveillance sharing agreement with the Chicago Mercantile Exchange (``CME'') whereby transaction information is continually made available to the CBOE by the CME regarding futures transaction activity by CBOE members that is above certain defined parameters.\6\ The CBOE also receives New York Stock Exchange (``NYSE'') program trading information and analyzes this information against options activity to conduct surveillance for options strategies implemented ahead of and in anticipation of programmed equity trades.\7\ Finally, the Exchange represents that it has systems in place to detect and deter frontrunning.\8\ These systems generate a report of options trades occurring within a certain time period prior to the purchase or sale of blocks of 10,000 or more shares of the securities underlying the options.\9\ 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),\10\ in that it is designed to promote just and equitable principles of trade, prevent fraudulent and manipulative acts and practices, and maintain fair and orderly markets. Specifically, the Commission agrees with the Exchange's position as stated in the Circular that the proposed rule change may facilitate efficient access to underlying markets by providing market makers with more immediate access to those markets. Providing procedures whereby market makers in the equity options crowds can readily communicate with the off-floor offices of member firms as well as other locations off of the Exchange's trading floor, will allow them to obtain and transmit information more efficiently which may result in benefits to investors by improving execution of orders. --------------------------------------------------------------------------- \6\Id. \7\Id. \8\Frontrunning is the practice of effecting an options transaction based upon non-public information regarding an impending block transaction in the underlying stock, in order to obtain a profit when the options market adjusts to the price at which the block trades. \9\February 23 Conversation, supra note 5. \10\15 U.S.C. 78f(b)(5) (1988). --------------------------------------------------------------------------- Further, incorporating the procedures contained in the Circular into the Rules of the Exchange will enable the Exchange to monitor better the use of the floor telephones and to discipline members for violations of those rules. As noted above, because the proposed telephone policy does not restrict where a member may call, the telephones may be used to place orders in underlying stocks and in futures markets.\11\ With respect to equity-related transactions, while the telephones may give options market makers more immediate access to the market in the underlying securities, the Commission believes that the CBOE's surveillance systems currently in place are adequate to detect and deter any such attempts at manipulation including frontrunning. Although the surveillance procedures will not directly detect that a potential frontrunning may have been attempted through use of the floor telephones, the Exchange's existing surveillance procedures will ensure that the CBOE is aware of any options transactions that raise frontrunning concerns. Accordingly, although the placement of telephones on the equity options trading floor may make it easier for a market maker to place hedging orders in the underlying security, the use of the floor telephones will not diminish the ability of the Exchange to detect and deter manipulation. Similarly, the CBOE will continue to analyze options trading against NYSE program trading data for potential frontrunning.\12\ With respect to futures-related transactions, the Commission believes that the Exchange would be able to adequately conduct surveillance for improper activities as a result of the transaction information provided to the Exchange by the CME pursuant to the Exchange's surveillance sharing agreement with CME.\13\ Although the surveillance information obtained by the Exchange will not indicate that the floor telephones were used to enter into a potentially improper futures transactions, the Exchange's ability to conduct surveillance for potential manipulation will not be hindered because of the existence of floor telephones at the equity options posts on the floor of the Exchange. Additionally, the Commission also notes that surveillance information is shared through the Intermarket Surveillance Group (``ISG'').\14\ Because of potential opportunities for trading abuses involving stock index futures, stock options, and the underlying stock and the need for greater sharing of surveillance information for these potential intermarket trading abuses, the CME and the Chicago Board of Trade joined the ISG as affiliate members in 1990. --------------------------------------------------------------------------- \11\The proposed rule change also allows members to use the floor telephones for the purpose of providing quotations on equity options. In using the telephones for this purpose, members may only provide quotations that have been publicly disseminated pursuant to CBOE Rule 30.11. \12\See supra note 7 and accompanying text. \13\See supra note 6 and accompanying text. \14\ISG was formed on July 14, 1983 to, among other things, coordinate more effectively surveillance and investigative information sharing arrangements in the stock and options market. See Intermarket Surveillance Group Agreement, July 14, 1983. --------------------------------------------------------------------------- The Exchange's proposal also prohibits the use of portable and cellular telephones on the equity options trading floor. Prohibiting the use of portable telephones aids in ensuring that market makers will be physically present at the equity options trading posts where the options classes to which they have been appointed are traded. The Commission believes that ensuring the physical presence of market makers at the trading posts helps to promote the maintenance of fair and orderly markets. As a result, the Commission believes that this restriction is within the discretion of the Exchange and does not raise regulatory concerns. Finally, the Exchange has represented that since the Circular was issued and telephones at equity options trading posts have been installed, the Exchange has not received any complaints concerning their use, nor detected any violations of the procedures set forth in the Circular.\15\ --------------------------------------------------------------------------- \15\February 23 Conversation, supra note 5. --------------------------------------------------------------------------- In summary, because the Commission believes that installing telephones at the equity options posts on the floor of the Exchange may result in benefits to investors by allowing market makers to more efficiently hedge their options positions through improved immediate access to underlying markets while not impairing or diminishing the ability of the Exchange to conduct surveillance for improper equity- related or futures-related trading activity, the Commission finds that the proposed rule change is consistent with the requirements of the Act. It is therefore ordered, Pursuant to section 19(b)(2) of the Act,\16\ that the proposed rule change (File No. SR-CBOE-93-24) is approved. --------------------------------------------------------------------------- \16\15 U.S.C. 78s(b)(2) (1988). For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\17\ --------------------------------------------------------------------------- \17\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-5478 Filed 3-9-94; 8:45 am] BILLING CODE 8010-01-M