[Federal Register Volume 59, Number 202 (Thursday, October 20, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-26061]


[[Page Unknown]]

[Federal Register: October 20, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34841; File No. SR-CBOE-94-16]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., Relating to Order 
Service Firms

October 14, 1994.
    On June 1, 1994, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposal to amend CBOE Rule 6.77, ``Stock Execution 
Services,'' to allow order service firms to take market maker orders 
for the purchase or sale of commodity futures contracts and futures 
options and forward the orders to the appropriate futures exchange for 
execution.
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    \1\15 U.S.C. 78s(b)(1) (1982).
    \2\17 CFR 240.19b-4 (1993).
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    Notice of the proposed rule change was published for comment in 
Securities Exchange Act Release No. 34396 (July 18, 1994), 59 FR 37793 
(July 25, 1994). No comments were received on the proposal.
    Currently, CBOE Rule 6.77 states that a stock service is a member 
registered with the Exchange for the purpose of providing stock 
execution services to market makers on the CBOE's floor.\3\ The CBOE 
proposes to amend CBOE Rule 6.77 to replace the term ``stock service'' 
with the term ``order service firm'' and to allow order service firms 
to take orders from CBOE market makers for the purchase or sale of 
commodity futures contracts and futures options and forward market 
makers' orders to the appropriate futures exchange. The execution of 
all orders to purchase or sell commodity interests will occur on a 
futures exchange that has been designated as a contract market by the 
Commodity Futures Trading Commission (``CFTC'').
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    \3\The services provided by the stock services consist generally 
of taking orders for the purchase or sale of stocks and forwarding 
the orders to broker-dealers for execution.
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    Accordingly, proposed paragraph (d) of CBOE Rule 6.77 provides that 
order service firms that accept orders to buy or sell commodity 
interests must comply with the Commodity Exchange Act of 1974 (``CEA'') 
and the rules and regulations promulgated thereunder.\4\ Proposed 
paragraph (d) also requires order service firms to keep the CBOE's 
Department of Financial Compliance apprised of their registration 
status under the CEA on an ongoing basis, including any financial 
reporting or capital requirements.
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    \4\For example, Section 4(a)(1) of the CEA generally provides 
that transactions in commodity futures contracts may be executed 
only on a board of trade which has been designated as a ``contract 
market'' in the underlying commodity by the CFTC. In addition, 
Sections 4d and 4k of the CEA generally provide that any person that 
is engaged in soliciting or accepting orders for the purchase or 
sale of commodity interests must be registered as an introducing 
broker or as an associated person.
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    In addition to revising CBOE Rule 6.77, the CBOE proposes to adopt 
CBOE Rule 6.78, ``Letters of Guarantee Required of Order Service 
Firms,'' which requires a member acting as an order service firm to 
have on file with the Exchange and in effect an Order Service Firm 
Letter of Guarantee issued for the service firm by a member of the 
Options Clearing Corporation (``OCC''). Under proposed CBOE Rule 
6.78(b), the letter of guarantee must provide that the issuing clearing 
member accepts financial responsibility for all orders handled by the 
order service firm on the CBOE floor and for all financial obligations 
of the order service firm to the Exchange. In order to limit the 
potential risk to any single clearing member, no clearing member will 
be permitted to guarantee more than three order service firms without 
the prior written approval of the Department of Financial Compliance. 
In considering a request to guarantee more than three such firms, the 
Department of Financial Compliance will consider the clearing member's 
level of excess net capital, additional financial resources, and such 
other facts as the Department of Financial Compliance deems 
appropriate.
    The CBOE believes that the proposed rule change will facilitate 
market making capacity in stock index options. Market makers in stock 
index options are subject to the risk that market prices will change 
before they can liquidate their positions, and hedge this risk by 
executing transactions in related commodity interests.\5\ The CBOE 
believes that the proposed rule change will facilitate the ability of 
CBOE market makers in stock index options to execute hedging 
transactions by providing them with a more efficient means of effecting 
such transactions.
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    \5\See Division of Market Regulation, Market Analysis of October 
13 and 16, 1989 (December 1990) (``Division Report'') at 73-74.
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    The CBOE believes that the proposed rule change 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 will facilitate the ability 
of options market makers for which there are related commodity 
interests to reduce their exposure to market risk by providing them 
with a more efficient means of effecting hedging transactions in such 
commodity interests.
    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), in that it is designed 
to facilitate transactions in securities and to protect investors and 
the public interest.\6\ Specifically, the Commission notes, as it has 
stated in the past, that many CBOE index option market makers hedge 
their positions in index options by purchasing the corresponding 
futures contract.\7\ Under the Exchange's current rules, a CBOE market 
maker who hedges his position with futures contracts must leave his 
trading post in order to place a futures order. The proposal will 
enable CBOE market makers to remain at their trading posts while 
placing their futures orders with the order service firm clerks located 
on the CBOE's floor. Thus, the proposal should provide the CBOE's index 
option market makers with an efficient, convenient, and effective means 
to place their futures orders, thereby facilitating the market makers' 
ability to reduce their risks through hedging transactions and, in 
turn, helping to maintain the depth and liquidity of the CBOE's market 
for index options.
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    \6\15 U.S.C. 78f(b)(5) (1982).
    \7\See Division Report, supra note 5.
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    In addition, the Commission notes that the proposal contains 
safeguards designed to ensure that only qualified firms are permitted 
to register as order service firms. For example, CBOE Rule 6.77 retains 
the provisions currently applicable to stock services and requires 
firms to apply to the CBOE's Membership Department for registration as 
an order service firm. Under CBOE Rule 6.77, the applications will 
continue to be reviewed by the CBOE's Membership Committee, which will 
consider the applicant's financial condition, regulatory history, and 
other factors in determining whether to approve the firm's application 
for registration as an order service firm. The Commission believes, as 
it has stated in connection with stock services, that it is appropriate 
for an options exchange to monitor firms operating on its floor to 
ensure the proper operation of floor activities and thus to require 
Membership Committee approval of order service firms.\8\
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    \8\See Securities Exchange Act Release No. 24814 (August 18, 
1987), 52 FR 32224 (August 26, 1987) (order approving File No. SR-
CBOE-87-07).
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    The proposal also contains provisions designed to ensure the 
financial integrity of the order service firms. Specifically, proposed 
CBOE Rule 6.78 requires order service firms to obtain a letter of 
guarantee issued by a member of the OCC. Under the letter of guarantee, 
the issuing clearing member accepts financial responsibility for all 
orders handled by the order service firm on the CBOE floor and for all 
financial obligations of the order service firm to the Exchange. CBOE 
Rule 6.78 also provides that no clearing member shall be permitted to 
guarantee more than three order service firms without the prior written 
approval of the Department of Financial Compliance.
    In addition, paragraph (d) of CBOE Rule 6.77 makes clear that to 
the extent an order service firm takes orders for the purchase or sale 
of commodity futures contracts and options thereon, it must comply with 
the CEA and the rules and regulations promulgated thereunder. Paragraph 
(d) also requires order service firms to keep the CBOE's Department of 
Financial Compliance apprised of their registration status under the 
CEA on an ongoing basis, including any financial reporting or capital 
requirements. Accordingly, the Commission expects the CBOE to allow 
only those firms which meet the applicable requirements of the CEA to 
register with the Exchange as order service firms. In addition, the 
Commission expects the CBOE to carefully monitor the order service 
firms' compliance with the relevant provisions of the CEA and to revoke 
the CBOE registration of any order service firm that fails to satisfy 
those requirements.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\9\ that the proposed rule change (SR-CBOE-94-16) is approved.

    \9\  15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\  17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-26061 Filed 10-19-94; 8:45 am]
BILLING CODE 8010-01-M