[Federal Register Volume 59, Number 104 (Wednesday, June 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-13276]


[[Page Unknown]]

[Federal Register: June 1, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34104; File Nos. SR-CBOE-93-19]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to 
Extension of Market Maker Margin and Capital Treatment to Certain 
Market Maker Orders Entered From Off the Trading Floor

May 25, 1994.
    On April 20, 1993, as amended on March 16, 1994, the Chicago Board 
Options Exchange, Inc. (``CBOE'' or ``Exchange'') filed 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\ a proposal which would 
extend market maker capital and margin treatment to orders entered by 
CBOE market makers from off the Exchange floor, provided that at least 
80% of their total transactions on the Exchange are executed in person 
and not through the use of orders.\3\ In addition, the proposal 
requires all off-floor orders for which a market maker receives market 
maker treatment to be subject to the obligations of CBOE Rule 8.7(a), 
``Obligations of Market Makers,'' and in general to be effected for the 
purpose of hedging, reducing the risk of, rebalancing or liquidating 
open positions of the market maker.
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    \1\15 U.S.C. 78s(b)(1) (1984).
    \2\17 CFR 240.19b-4 (1993).
    \3\The CBOE originally proposed requiring that 75% of a market 
maker's total transactions be executed in person on the CBOE's floor 
in order to be eligible for the special off-floor order treatment. 
In addition, the original proposal did not contain a reference to 
market making obligations.
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    The original proposal was published for comment in Securities 
Exchange Act Release No. 32500 (June 23, 1993), 58 FR 35060 (June 30, 
1993). Amendment No. 1 to the proposal was published for comment in 
Securities Exchange Act Release No. 33853 (April 1, 1994), 59 FR 16869 
(April 8, 1994). No comments were received on the original proposal or 
on Amendment No. 1 to the proposal. This order approves the Exchange's 
proposal, as amended.
    Currently, under CBOE Rule 8.1, ``Market Maker Defined,'' only 
transactions initiated on the CBOE's floor count as market maker 
transactions. Thus, only on-floor market maker transactions qualify for 
favorable capital and margin treatment under the CBOE's rules, even if 
such orders are entered to adjust or hedge the risk of positions of the 
market maker that result from his on-floor market making activity.\4\ 
The CBOE states that because a market maker cannot effectively adjust 
his positions or engage in hedging or other risk limiting opening 
transactions from off the Exchange floor without incurring a 
significant economic penalty, CBOE market makers must either be 
physically present on the floor at all times while the market is open, 
or face significant risks of adverse market movements during those 
times when they must necessarily be absent from the trading floor. The 
CBOE argues that by imposing costs on certain hedging or risk-adjusting 
transactions of market makers, the CBOE's current rules may prevent 
market makers from effectively discharging their market making 
obligations and expose them to unacceptable levels of risk.
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    \4\Questions of margin and capital treatment do not arise in 
connection with closing transactions initiated from off the floor, 
since they only reduce or eliminate existing positions.
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    The Exchange states that its proposal is designed to accommodate 
the needs of market makers occasionally to adjust or hedge options 
positions in their market maker accounts at times when they are not 
physically present on the trading floor, without diluting the 
requirement that the trading activity of market makers must fulfill 
their market making obligations and must contribute to the maintenance 
of a fair and orderly market on the Exchange.
    Currently, under CBOE Rule 8.7, Interpretation and Policy .03(b), a 
market maker must execute at least 25% of his total transactions in 
person on the trading floor and not by entry of orders. The CBOE 
proposes to amend Exchange Rule 8.7 to allow market makers who elect to 
meet a more stringent in--person requirement to receive market maker 
margin and capital treatment for opening transactions executed through 
off-floor orders. Specifically, the CBOE proposes to amend CBOE Rule 
8.7, Interpretation and Policy .03, to allow makers to elect to receive 
market maker treatment for off-floor opening transactions if the market 
maker, in addition to satisfying the requirements of Interpretation and 
Policy .03(a),\5\ executes at least 80% of his total transactions for 
any calendar quarter in person and not through the use of orders. In 
addition, the off-floor orders for which a market maker receives market 
maker treatment shall be subject to the obligations of CBOE Rule 
8.7(a)\6\ and in general shall be effected for the purpose of hedging, 
reducing risk of, rebalancing or liquidating open positions of the 
market maker.\7\
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    \5\Under Interpretation and Policy .03(a), at least 75% of a 
market maker's total contract volume in each calendar quarter must 
be in option classes to which he has been appointed pursuant to CBOE 
Rule 8.3, ``Appointment of Market Makers.''
    \6\CBOE 8.7(a) states that the ``[t]ransactions of a market 
maker should constitute a course of dealings reasonably calculated 
to contribute to the maintenance of a fair and orderly market, and 
no market maker should enter into transactions or make bids or 
offers that are inconsistent with such a course of dealings.''
    \7\See Amendments No. 1, supra.
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    CBOE market makers who elect market who elect market maker 
treatment for off-floor opening transactions but fail to satisfy the 
proposal's requirements, including the 80% in-person requirement, will 
be referred to the CBOE's Business Conduct Committee and subject to the 
disciplinary measures provided in Chapter 17 of the CBOE's rules.\8\ 
Under CBOE Rule 17.1, ``Disciplinary Jurisdiction,'' the Exchange may 
impose appropriate discipline for violations of the Act and the 
Exchange's rules, including expulsion, suspension, limitation of 
activties, functions, and operations, fine, censure, being suspended or 
barred from being associated with a member or any other fitting 
sanction.
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    \8\Telephone conversation between Mary Bender, First Vice 
President, Division of Regulatory Services, CBOE, and Sharon Lawson, 
Assistant Director, Commission, on May 4, 1994.
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    The CBOE believes that the amended proposal presents a more 
appropriate and realistic treatment of market maker transactions 
initiated from off the trading floor than what is provided for under 
existing Exchange Rule 8.1. The CBOE believes that extending favorable 
margin and capital treatment for off-floor transactions only to those 
market makers who submit to an 80% in-person requirement should have 
the effect of increasing the extent to which market maker transactions 
contribute to liquidity and to the maintenance of fair and orderly 
markets on the CBOE by providing for a greater degree of in-person 
trading by market makers and by enabling market makers to better manage 
the risk of their market making activities. Thus, the CBOE believes 
that the proposal is consistent with and in furtherance of the 
objectives of section 6(b)(5) and section 11(a) of the Act in that it 
will promote the maintenance of fair and orderly markets on the CBOE 
and will contribute to the protection of investors and the public 
interest.
    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of section 6(b)(5) in that the 
proposal is designed to promote just and equitable principles of trade 
and to protect investors and the public interest.\9\ In addition, the 
Commission finds that the proposal is consistent with the requirement 
under section 11(b) of the Act and the rules thereunder that require 
market maker transactions to be consistent with the maintenance of fair 
and orderly markets.\10\
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    \9\15 U.S.C. 78f(b)(5) (1982).
    \10\15 U.S.C. 78k (1982) and 17 CFR 240.11b-1.
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    The Commission believes that the proposal is a reasonable effort by 
the CBOE to accommodate the needs of CBOE market makers to effect off-
floor opening transactions while maintaining the requirement under CBOE 
rule 8.7(a) that market makers' transactions constitute a course of 
dealings reasonably calculated to contribute to the maintenance of a 
fair and orderly market. Specifically, in order to qualify for market 
maker treatment for off-floor orders, the proposal requires a market 
maker to execute at least 80% of his total transactions for any 
calendar quarter in person and not through the use of orders. In 
addition, the proposal states that the off-floor orders for which a 
market maker receives market maker treatment shall be subject to the 
obligations of CBOE Rule 8.7(a) and in general shall be effected for 
the purpose of hedging, reducing risk of, rebalancing or liquidating 
open positions of the market maker. The Commission believes that these 
requirements, taken together, will help to ensure that all market maker 
transactions continue to contribute to the maintenance of fair and 
orderly markets while, at the same time, enabling market makers to 
better manage the risk of their market making activities.\11\
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    \11\The CBOE believes that the proposal will facilitate the 
maintenance of fair and orderly markets by reducing risk to market 
makers and their clearing firms. Specifically, the CBOE believes 
that allowing market makers to receive market maker treatment for 
off-floor transactions will encourage market makers to adjust their 
positions to respond to changing market conditions, thereby helping 
them to avoid losses. In addition, the ability to manage their 
positions when away from the floor may help market makers to avoid 
significant ``wind downs'' due to planned absences. See Letter from 
Charles J. Henry, President and Chief Operating Office, CBOE, to 
Richard Zack, Branch Chief, Options Regulation, Division of Market 
Regulation, Commission, dated September 22, 1993.
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    As the CBOE has noted, under the current requirements market makers 
who adjust existing positions for hedging purposes while not physically 
present on the floor cannot receive market maker margin treatment for 
such orders under any circumstances and must decide whether to close 
out their positions or place their orders in a customer margin account 
requiring 50% margin. While the Commission believes that this may not 
be an unreasonably result in many cases, the Commission believes that 
the CBOE has set forth a reasonable proposal that permits market maker 
treatment for certain off-floor orders under very limited circumstances 
that ensure that such orders must contribute to the maintenance of fair 
and orderly markets and that require market makers comply with a 
heightened 80% in person trading requirement.
    By requiring both more stringent in person trading requirements and 
that off-floor opening transactions be effected only for the purpose of 
hedging, reducing the risk of, rebalancing or liquidating open 
positions, the proposal should help to ensure the stability and 
orderliness of the CBOE's markets.
    The Commission expects the CBOE to closely monitor those market 
makers electing to receive market maker treatment for certain off-floor 
orders as provided under the proposal to ensure that they are meeting 
the in person trading requirements in addition to other market making 
obligations required under the proposal. The CBOE has represented that 
market makers who choose to receive favorable margin and capital 
treatment under the proposal but fail to satisfy the proposal's 
requirements will be subject to full disciplinary proceedings under 
Chapter 17 of the CBOE's rules. As noted above, the sanctions possible 
under Chapter 17 include expulsion, suspension, limitation of 
activities, functions, and operations, fine, censure, being suspended 
or barred from being associated with a member or any other fitting 
sanction. The Commission expects the Exchange to impose strict 
sanctions for violations of the rule, particularly in cases of 
egregious or repeated failures to comply with the rule's 
requirements.\12\
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    \12\The CBOE plans to issue a circular to its membership 
describing the rule change and emphasizing the importance of 
monitoring off-floor trading activity.
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    Finally, the Commission notes that the staff of the Board of 
Governors of the Federal Reserve System (``Board'') has issued a letter 
raising no objection to the Commission's approval of the proposal based 
on the Commission's belief that the off-floor transactions of CBOE 
market makers under the proposal are designed to contribute to the 
maintenance of a fair and orderly market and are consistent with the 
obligations of a specialist under Section 11 of the Act.\13\
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    \13\See Letter from Scott Holz, Senior Attorney, Board, to 
Howard Kramer, Associate Director, Division, Commission, dated March 
9, 1994.
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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-93-19) is 
hereby approved.

    \14\15 U.S.C. 78s(b)(2) (1982).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\17 CFR 200.30-3(a)(12) (1993).
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Jonathan G. Katz,
Secretary.
[FR Doc. 94-13276 Filed 5-31-94; 8:45 am]
BILLING CODE 8010-01-M