[Federal Register Volume 60, Number 170 (Friday, September 1, 1995)]
[Notices]
[Pages 45753-45754]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21702]



-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36159; File No. SR-CBOE-95-07]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving and Notice of Filing and Order Granting 
Accelerated Approval of Amendment to a Proposed Rule Change Relating to 
Solicited Transactions

August 25, 1995.

I. Introduction

    On February 14, 1995, 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 modify Paragraph (e) of CBOE Rule 6.9 
concerning solicited transactions. The proposal would eliminate the 
requirement that the terms of a matching order be disclosed to the 
trading crowd before a member or associated person would be permitted 
to trade based on knowledge of an imminent, undisclosed solicited 
transaction. The proposed rule change was published for comment and 
appeared in the Federal Register on March 28, 1995.\3\ No comments were 
received regarding the original proposal. On June 22, 1995, the CBOE 
filed Amendment No. 1 to its proposal.\4\ This order approves the 
proposal, as amended.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ See Securities Exchange Act Release No. 35519 (March 21, 
1995), 60 FR 15948.
    \4\ Amendment No. 1 effects two changes to the Exchange's 
proposal. First, Paragraph (e) of Rule 6.9 is revised to state 
explicitly that any change in the terms and conditions of the 
original order, as it is entered on the trading floor and of which 
the member has knowledge where there is a matching solicited order, 
must also be disclosed to the trading crowd before that member or 
that person associated with a member could permissibly trade an 
option of the same class as any option that is the subject of the 
original order, a security underlying such class, or a related 
instrument. Second, the Exchange proposes adding a new 
Interpretation .06 to Rule 6.9 stating that disclosing the terms and 
conditions of the original order any changes to the original order 
pursuant to Paragraph (e) for Rule 6.9 does not provide a safe 
harbor from possible front-running prohibitions. Front-running is 
considered to be a violation of CBOE Rule 4.1. See letter from 
Timothy Thompson, CBOE, to Michael Walinskas, Branch Chief, Division 
of Market Regulation, Commission, dated June 22, 1995 (``Amendment 
No. 1'').
---------------------------------------------------------------------------

II. Description of the Proposal

    On November 9, 1994, the Commission approved a CBOE proposal to 
adopt a new Rule 6.9 that regulates the execution of solicited orders, 
and sets forth specific priority principles applicable to such orders. 
In addition, Rule 6.9(e) restricts trading by members and associated 
persons of members possessing knowledge of imminent undisclosed 
solicited transactions.\5\

    \5\ See Securities Exchange Act Release No. 34959 (November 9, 
1994), 59 FR 59446.
---------------------------------------------------------------------------

    Pargaraph (e) of CBOE Rule 6.9 generally restricts the ability of a 
member, or an associated person, who has indicated in response to a 
solicitation an intention to place a responsive order, and anyone aware 
of that intention, to trade options of the same class as any option 
that is the subject of the original order, or securities underlying 
such options, or any related instruments. If either of two conditions 
is met, however, the restriction does not apply. The first condition is 
that all the terms of both the original order and the matching order be 
disclosed to the trading crowd.\6\

    \6\ The second condition is that the solicited order can no 
longer reasonably be considered imminent in view of the passage of 
time since the solicitation.
---------------------------------------------------------------------------

    The Exchange now proposes to amend paragraph (e) to eliminate the 
requirement contained in the first condition that the terms of the 
solicited matching order be disclosed to the trading crowd. Thus, when 
there has been advance solicitation of the other side of an original 
order, a member (or associated person) with knowledge of the original 
order and a matching responsive order is not permitted to trade options 
of the same class as any option that is the subject of the original 
order, the securities underlying such options, and any related 
instruments, until the terms of the original order, and any changes in 
the terms and conditions of the original order of which the member or 
associated person has knowledge,\7\ are disclosed to the trading crowd; 
once those terms are disclosed, however, the member or person 
associated with the member may trade even if the terms of the matching 
order are not disclosed. The Exchange has stated that this modification 
would place solicited parties on an equal footing with Exchange members 
who have knowledge of the terms of the original order only, and would 
conform the trading restriction in paragraph (e) to the various 
priority provisions of Rule 6.9, and Interpretation .02 thereunder, 
which generally require disclosure only of the terms of an original 
order, not the terms of a matching solicited order.

    \7\ See Amendment No. 1, supra note 4.
    Finally, the Exchange has proposed adding Interpretation .06 to 
Rule 6.9. Interpretation .06 states that disclosing all the terms of 
the original order and any changes in the terms and conditions of the 
original order to the crowd prior to effecting a trade does not provide 
a safe harbor from possible violations of front-running prohibitions, 
and that front-running is considered to be a violation of Exchange Rule 
4.1, Just and Equitable Principles of Trade.\8\

    \8\ Id.
---------------------------------------------------------------------------

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 remove 
impediments to and perfect the 

[[Page 45754]]
mechanism of a free and open market, and protect investors and the 
public interest. The Commission believes that the CBOE's proposal is 
appropriate to achieve Rule 6.9's primary purpose of facilitating and 
regulating solicited transactions without imposing undue restrictions 
on trading, particularly anticipatory hedge transactions. Under the 
present rule, once a solicited party has indicated, in response to a 
solicitation, an intention to place a matching responsive order, such a 
solicited party may not trade based on knowledge of the impending 
solicited transaction, even though the original order has been fully 
disclosed to the crowd, until the solicited order is also disclosed.
    The Commission notes that paragraph (e) does not restrict trading 
by other CBOE members who know the terms of a disclosed original order 
but who, if solicited, have not indicated an intention to trade at the 
original order's limit and who are otherwise unaware of any specific 
matching solicited order. Indeed, such parties may trade under the 
current rule even though they have good reason to believe that an 
execution of the original order is imminent based on market 
circumstances.
    The Commission believes that once the terms and conditions of an 
original order, as well as any changes to the terms and conditions of 
the original order of which the member or associated person has 
knowledge,\9\ are fully disclosed to the trading crowd, those in the 
crowd have essentially the same market information as do solicited 
persons. Moreover, any solicited person who has privately indicated an 
intention to place a responsive order, and anyone aware of that 
intention, necessarily remains subject to the risks of the market and 
the auction process when entering a responsive order or effecting 
anticipatory trades.

    \9\ Id. If the changes to the original order were not disclosed 
to the trading crowd, then the trading crowd would still be at a 
disadvantage to the solicited person who did have knowledge of the 
changes to the terms of the original order. The solicited person 
with knowledge of the changes to the original order then would have 
the opportunity to benefit from this knowledge that the trading 
crowd did not have. Thus, under the CBOE's proposal, all trading 
based on that knowledge is prohibited until the information is 
disclosed to the trading crowd. Id.
    The Commission further believes that the narrower disclosure 
requirement before granting relief from the trading restrictions 
described above will provide the trading crowd with a fair and full 
opportunity to make informed trading decisions without subjecting 
solicited parties and the solicitation process to overly burdensome 
restrictions. Nevertheless, the Commission notes that this narrower 
disclosure requirement does not relieve market participants of the 
general CBOE requirement that their acts and practices be consistent 
with just and equitable principles of trade.\10\ Thus, disclosing the 
terms and conditions of the original order, and any changes in the 
terms and conditions of the original order, to the crowd prior to 
effecting a trade does not provide a safe harbor from possible 
violations of front-running prohibitions. The Commission understands 
that the Exchange will issue a regulatory circular to its members 
describing the revisions to its solicitations rule.

    \10\ See CBOE Rule 4.1.
---------------------------------------------------------------------------

    Finally, the Commission notes that the Exchange's proposal relates 
only to the provision in the solicitations rule that restricts trading 
based on knowledge of an imminent undisclosed transaction. Thus, the 
Exchange's proposal does not affect the priority rules governing 
solicited transactions.\11\

    \11\ For example, under the priority rules, when an original 
order is disclosed in advance of a solicitation, and the matching 
order both matches the disclosed original order's limit and improves 
the market, the matching order has priority over other orders in the 
crowd (subject to customer limit order book priorities set forth in 
Rule 6.45). See CBOE Rule 6.9(b). Similarly, when a matching order 
does not match the original order's limit and does not improve the 
market, it does not have priority over other bids and offers 
represented in the crowd even if the original order was disclosed to 
the crowd for the full solicitation period. See CBOE Rule 6.9(c).
---------------------------------------------------------------------------

    The Commission finds good cause for approving Amendment No. 1 prior 
to the thirtieth day after the date of publication of notice of filing 
thereof in the Federal Register. Amendment No. 1 revises Paragraph (e) 
of Rule 6.9 by making it clear that any change in the terms and 
conditions of the original order must be disclosed to the crowd before 
a member or associated person with knowledge of such terms and 
conditions can enter into related transactions. Amendment No. 1 also 
adds Interpretation .06 to Rule 6.9 to make clear that Paragraph (e) of 
Rule 6.9 does not provide a safe harbor from possible violations of 
front-running prohibitions.\12\

    \12\ See Amendment No. 1, supra note 4.
---------------------------------------------------------------------------

    The Commission believes that these changes serve to strengthen and 
clarify the Exchange's proposals. Specifically, the revision to Rule 
6.9, Paragraph (e) addresses the concern that if changes to the 
original order have not been disclosed to the trading crowd, then the 
trading crowd would be at a disadvantage relative to the solicited 
party who has knowledge of the changes to the terms of the original 
order. New Interpretation .06 clarifies that CBOE Rule 4.1 continues to 
be applicable to Rule 6.9, notwithstanding the provisions of Paragraph 
(e) of Rule 6.9. Accordingly, the Commission believes that Amendment 
No. 1 raises no new or unique regulatory issues. Therefore, the 
Commission believes it is consistent with Sections 6(b)(5) and 19(b)(2) 
of the Act \13\ to approve Amendment No. 1 to the proposal on an 
accelerated basis.

    \13\15 U.S.C. 78f(b)(5) and 78s(b)(2) (1988).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549. 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. Sec. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-95-07 and should be 
submitted by September 22, 1995.

V. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal, as amended, 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,\14\ that the proposed rule change (File No. SR-CBOE-95-07), as 
amended, is approved.

    \14\ 15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\

    \15\ 17 CFR 200.30-3(a)(12) (1994).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-21702 Filed 8-31-95; 8:45 am]
BILLING CODE 8010-01-M