[Federal Register Volume 60, Number 22 (Thursday, February 2, 1995)]
[Notices]
[Pages 6575-6577]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-2552]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35281; File No. SR-CBOE-94-38]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Granting Temporary Approval of a Proposed Rule Change 
Relating to the Short Sale of Securities in the Nasdaq National Market

January 26, 1995.

I. Introduction

    On October 25, 1994, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposal to amend its Rule 15.10 regarding short sales 
of Nasdaq National Market (``Nasdaq/NM'' or ``NM'') securities. The 
proposed rule change was published for comment and appeared in the 
Federal Register on 

[[Page 6576]]
November 16, 1994.\3\ No comments were received on the proposal.\4\

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
    \3\See Securities Exchange Act Release No. 34947 (November 7, 
1994), 59 FR 59262.
    \4\The CBOE filed its proposal after receiving a comment letter 
concerning its Rule 15.10. See letter from Michael J. Carusillo, 
General Partner, O'Connor & Associates, to Jeff Schroer, Vice 
President, Market Surveillance, CBOE, dated September 21, 1994 
(``O'Connor Letter'').
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II. Description of the Proposal

    CBOE Rule 15.10 concerns the availability to Exchange market 
markers of the bid test exemption from the National Association of 
Securities Dealers' (``NASD'') short sale rule.\5\ The Exchange is 
amending Rule 15.10 to expand the definition of ``designated Nasdaq/NM 
security''\6\ to include all Nasdaq/NM securities which underlie the 
options classes for which a market maker holds an appointment. 
Currently, the rule limits designated Nasdaq/NM securities to no more 
than three trading stations of a market maker, although CBOE Rule 8.3 
allows market makers to have appointments, absent an exemption, in up 
to five trading stations. The CBOE believes the limitation to three 
trading stations is unnecessarily restrictive and that the proposed 
change is consistent with the application of the exemption for options 
market makers on other exchanges.\7\

    \5\The Commission approved the NASD's bid test (or ``short 
sale'') rule in Securities Exchange Act Release No. 34277 (June 6, 
1994), 59 FR 34885 (amending the NASD's Rules of Fair Practice 
(``NASD Rules''). The CBOE's proposal concerning the market maker 
exemption from the bid test rule, along with the proposals of the 
other options exchanges, was approved in Securities Exchange Act 
Release No. 34632 (September 2, 1994), 59 FR 46999 (approving 
proposals by the American Stock Exchange (``Amex''), CBOE, New York 
Stock Exchange (``NYSE''), Pacific Stock Exchange (``PSE''), and 
Philadelphia Stock Exchange (``Phlx'').
    \6\CBOE Rule 15.10(c)(2)(ii)(B).
    \7\See O'Connor Letter, supra note 4.
    The O'Connor Letter compares the application of the CBOE's rule 
to the application of the corresponding rules of the other options 
exchanges concerning the market maker exemption to the NASD short 
sale rule. It concludes that the CBOE's rule is more restrictive, 
causing CBOE market makers to be placed at a disadvantage relative 
to market makers at other exchanges. Id.
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    The CBOE also is proposing to amend Interpretation .02 to CBOE Rule 
15.10 to permit an options market maker, with prior notice to an 
Exchange Floor Official or Order Book Official, to facilitate an off-
floor options or combination order and contemporaneously hedge the 
resulting options position with a short sale in applicable Nasdaq/NM 
securities as if such securities were designated securities under 
paragraph (c)(2) of the Rule. The Floor Official or Order Book official 
notified of such a transaction is required to file a report describing 
it with the Department of Market Surveillance, and must give a copy of 
the report to the market maker.
    Finally, the CBOE is proposing to amend Interpretation .03 to CBOE 
Rule 15.10 to allow a nominee of a market maker organization to effect 
bid test exempt short sales in a Nasdaq/NM security which the market 
maker nominee has not designated as qualifying for the exemption 
contained in paragraph (c)(2), provided that the security is a 
designated Nasdaq/NM security for another nominee of the market maker 
organization and such other nominee is not also present or represented 
by a Floor Broker in the applicable trading station at the time of the 
bid test exempt sale. The CBOE believes that this will allow a market 
maker organization to manage its obligations better when nominees are 
absent from the trading floor for reasons such as illness.

III. Discussion

    The Commission finds the proposed rule change consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange. Specifically, the 
proposed rule change is consistent with the requirements of Section 
6(b)(5) of the Act, because the proposal is designed to promote just 
and equitable principles of trade, remove impediments to and perfect 
the mechanism of a free and open market, and protect investors and the 
public interest.
    The Commission believes that the CBOE's proposal to expand the 
definition of ``designated Nasdaq/NM security'' is consistent with the 
market maker exemption from the NASD's bid test rule. This exemption 
recognizes the need for options market makers to hedge their options 
positions by buying or selling (including selling short) shares of 
underlying stocks or certain underlying component stocks contained in 
stock indexes. In relevant part, the NASD's market maker bid test 
exemption provides that a ``qualified options market maker'' is an 
options market maker who has received an appointment as a ``qualified 
options market maker'' for certain classes of stock options on Nasdaq/
NM securities and indexes pursuant to the rules of a ``qualified 
options exchange.''\8\ The exemption further provides that a 
``qualified options exchange'' is a national securities exchange that 
has approved rules and procedures providing for designating market 
makers as qualified options market makers that are designed to identify 
options market makers who regularly engage in market making activities 
in the particular options classes.\9\

    \8\NASD Rules, Art. III, section 20(h)(2)(b).
    \9\NASD Rules, Art. III, section 48(h)(2)(c).
    The CBOE's proposal would expand the classes of stock options for 
which its market makers may be deemed ``qualified options market 
makers'' by extending the definition of ``designated Nasdaq/NM 
security'' to all Nasdaq/NM securities underlying options for which a 
market maker holds an appointment.\10\ The new provision is consistent 
with the comparable provisions adopted by other options exchanges.\11\

    \10\As noted above, CBOE Rule 8.3(c) provides that a market 
maker's appointment is limited to the options classes trading at no 
more than five trading stations absent an exemption by the Market 
Performance Committee. The Exchange recently filed a proposal (File 
No. SR-CBOE-94-44) to expand market maker appointments from five 
trading stations to 10, stating that the current five station limit 
puts it at a competitive disadvantage relative to other options 
exchanges. See Securities Exchange Act Release No. 35192 (January 4, 
1995), 60 FR 3012.
    \11\See Amex Rule 957(d)(2)(b)(i); NYSE Rule 959A(a); PSE Rule 
4.19(c)(2)(B) (these exchanges allow the short sale exemption to be 
available to all Nasdaq/NM securities which underlie the options 
classes for which a market maker holds an appointment); Phlx Rule 
1072(c)(2)(ii) (the Phlx limits the short sale exemption to Nasdaq/
NM securities underlying no more than 20 options allocated or 
assigned).
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    The CBOE's proposal also is consistent with NASD Rules given that 
the exemption's availability is limited to securities underlying 
options contracts in which a market maker holds an appointment. A 
market maker has a continuous obligation to maintain a fair and orderly 
market with respect to such securities, and must conduct a certain 
percentage of trading on the CBOE in the appointed classes.\12\ 
Additionally, the CBOE requires that to qualify for the market maker 
short sale exemption, a short sale in a Nasdaq/NM security must be 
effected to hedge, and in fact services to hedge, an options 
transaction.\13\ The CBOE has adopted surveillance procedures designed 
to monitor its market makers' use of the market maker exemption so as 
to ensure that short sales effected by qualified options market makers 
are exempt hedge transactions and that other, nonqualified market 
makers, are not using the exemption.\14\

    \12\See CBOE Rule 8.7, Obligations of Market-Makers (setting 
forth specific obligations of market makers).
    \13\CBOE Rule 15.10(c)(2)(ii).
    \14\See Securities Exchange Act Release No. 34632, supra note 4.
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    Proposed Interpretation .02 will allow an options market maker, 
with prior notice to a Floor Official or Order Book Official, to 
facilitate an off-floor order, and contemporaneously hedge the 

[[Page 6577]]
resulting options position with a short sale in applicable Nasdaq/NM 
securities as if such security was a designated Nasdaq/NM security. The 
Floor Official or Order Book Official who is notified of such a 
transaction must file a report describing the transaction with the 
Department of Market Surveillance and must provide the market maker 
with a copy of the report. The market maker, in turn, must maintain a 
copy of the report to demonstrate the transaction was bid test exempt. 
The Commission believes that this provision is consistent with the 
NASD's interpretation regarding hedging activities associated with the 
facilitation of customer transactions in options and that the 
procedures for reporting a transaction under the provision will ensure 
adequate monitoring.\15\

    \15\See letter from Richard G. Ketchum, Chief Operating Officer 
and Executive Vice President, NASD, to David A. Dami, First Vice 
President & Associate General Counsel, Global Derivatives, Paine 
Webber, Inc., dated September 13, 1994.
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    As noted above, Proposed Interpretation .03 will give a market 
maker organization more flexibility to manage its market making 
obligations by allowing a nominee of such organization to affect short 
sales of securities as bid test exempt even though the nominee has not 
designated such securities as bid test exempt eligible, provided that 
the securities have been designated bid test exempt eligible by another 
nominee of the market maker organization, and further provided that the 
bid test exempt eligible nominee is not present on the trading floor. 
The Commission believes this is a reasonable provision designed to 
address instances where a market maker nominee is absent from the 
trading floor due to illness, personal, or other business. The 
Commission believes that this provision is consistent with the intent 
of the market maker exemption to the short sale rule, in that the 
exemption continues to be limited to those Nasdaq/NM securities which 
are used to hedge options transactions in the primary classes in which 
the market maker organization makes markets. The CBOE will monitor the 
use of this provision pursuant to the short sale exemption surveillance 
procedures currently in place.\16\

    \16\See letter from Patricia Sizemore, Director, Department of 
Market Surveillance, CBOE, to Francois Mazur, Attorney, Division of 
Market Regulation, Commission, dated January 25, 1995.
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    Finally, it should be noted that CBOE Rule 15.10 was approved on a 
temporary basis, to remain in effect so long as there exists a market 
maker exemption to the NASD's short sale rule.\17\ Accordingly, the 
changes approved herein also are being approved for the same temporary 
period.

    \17\See Securities Exchange Act Release No. 34632, supra note 4. 
If the NASD later amends its short sale rule in a manner that 
affects the market maker exemption, including its definition, 
conditions, and requirements, the CBOE and other options exchanges 
might be required to amend their own companion market maker 
exemption rules so that market makers may avail themselves of any 
continued market maker exemption. Id.
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IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act, and, in particular, Section 6 of 
the Act.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (File No. SR-CBOE-94-38) is 
approved on a temporary basis, to remain in effect so long as CBOE Rule 
15.10 remains in effect.

    \18\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.\19\

    \19\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-2552 Filed 2-1-95; 8:45 am]
BILLING CODE 8010-01-M