[Federal Register Volume 60, Number 198 (Friday, October 13, 1995)]
[Notices]
[Pages 53442-53444]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-25369]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36332; File No. SR-CBOE-95-48]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Board Options 
Exchange, Inc., Relating to the Use of Proprietary Brokerage Order 
Routing Terminals on the Floor of the Exchange

October 4, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on August 25, 1995, the 
Chicago Board Options Exchange, Inc. (``CBOE'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the self-regulatory organization. On 
October 3, 1995, the Exchange filed Amendment No. 1 to the proposed 
rule change.\2\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ In Amendment No. 1, the CBOE states that Section II.C. of 
Exhibit 1 to its Form 19b-4 filing incorporates by reference the 
language from Section 5 of its Form 19b-4 filing (``Self-Regulatory 
Organization's Statement on Comments on the Proposed Rule Change 
Received from Members, Participants, or Others''). Letter from 
Burton R. Rissman, Schiff Hardin & Waite, to Francois Mazur, 
Attorney, Office of Market Supervision, Division of Market 
Regulation, Commission, dated October 3, 1995 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to adopt a policy pursuant to its Rule 6.23.\3\ 
Under the proposed policy, no member will be permitted to establish, 
maintain or use on the floor of the Exchange any proprietary brokerage 
order routing terminal and its related system (``Terminal'') without 
the written approval of the Exchange. No Terminal will be approved 
unless and until the member who proposes to establish it on the floor 
of the Exchange has filed with the Exchange an ``Application & 
Agreement for Brokerage/Order Routing Terminals in Trading Crowds'' 
(``Application Agreement''), and, until further action of the Board of 
Directors of the Exchange, Terminals will be approved solely for the 
use in the crowd trading S&P 500 Index options (``SPX options'') for 
the routing of orders in SPX options.

    \3\ The proposed policy was submitted to the Commission as 
Exhibit A to the filing and is available from the Commission at the 
address provided in Part IV of this notice, as well as at the 
principal office of the CBOE.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections (A), (B), and (C) below, 
of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    A firm that has applied and been approved for membership on the 
Exchange (but which has not yet completed the process of becoming an 
effective member) \4\ has sought Exchange 

[[Page 53443]]
approval to establish and use a Terminal in the SPX options crowd. The 
Terminal proposed to be used by the firm would be a wireless, hand-held 
device designed to receive orders entered by the firm or its customers 
from off the floor. Use of the Terminal would thus permit the firm and 
its customers to transmit orders electronically directly to one or more 
of its floor brokers on the floor of the Exchange, including to a 
broker who is in the trading crowd. The firm's application for use of a 
Terminal, which is the only such application that has been received to 
date by the Exchange, has raised a number of issues that the Exchange 
has determined to resolve as a matter of policy that will be applicable 
to all members.

    \4\ Pursuant to an extension granted by the membership 
committee, the firm may become an effective member at any time on or 
prior to December 19, 1995. Telephone Conversation between Michael 
L. Meyer, Schiff Hardin & Waite, and Francois Mazur, Attorney, 
Office of Market Supervision, Division of Market Regulation, 
Commission, on September 27, 1995.
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    On the one hand, the use of Terminals may facilitate the 
transmission of brokerage orders to the floor of the Exchange, and, if 
Terminals are successful, they may attract new customers to the 
Exchange's market and provide competitive advantages to the firms which 
develop and use them. On the other hand, the proposed Terminals raise a 
number of important concerns that must be addressed before their use 
can be approved. The purpose of the proposed rule change is to allow 
Terminals to be introduced under conditions designed to address the 
Exchange's concerns, and to allow a determination whether Terminals 
lead to any unforeseen consequences. The following is a discussion of 
those concerns and the manner in which they are dealt with by the 
proposed rule change.

(a) Surveillance, Audit Trails and Compliance

    The use of Terminals must be subject to adequate inspection and 
audit by the Exchange. Moreover, the use of the Terminals must comply 
with all applicable regulatory requirements.
    Paragraph D of the Application Agreement requires an applicant to 
agree that the use of its Terminal will conform to all applicable laws, 
the rules, policies and procedures of the Commission and the Exchange, 
and the provisions of the Application Agreement. Paragraph F of the 
Application Agreement requires the applicant to agree that the 
operation and use of all aspects of its Terminal and all orders entered 
through the Terminal will be subject to inspection and audit by the 
Exchange at any time upon reasonable notice. It also requires the 
applicant to furnish the Exchange with such information as the Exchange 
may request concerning the Terminal.

(b) Physical, Electrical and Communication Requirements

    The space and frequency transmission capacity available on the 
floor of the Exchange must be fairly allocated among members and other 
Exchange uses, and the Terminals must be regulated to assure that they 
do not interfere with other uses. Moreover, although the Exchange will 
not immediately require the Terminals to interface with other Exchange 
systems (such as the Exchange trade match and price reporting systems), 
the Exchange reserves the authority to require such interfaces.
    The Application Agreement requires the applicant to specify the 
necessary physical, electrical and communication requirements of its 
proposed Terminal and to describe its Terminal system in detail. 
Paragraph H of the Application Agreement requires the applicant to 
coordinate the installation, maintenance and use of the Terminal on the 
trading floor through the Exchange's Telecommunications Department, and 
Paragraph K permits the Exchange to reallocate the space allocated to 
the applicant's Terminal. These requirements will allow the Exchange to 
take into consideration the needs of all members in the allocation of 
limited space and communication resources and to assure that Terminals 
do not interfere with one another or with other Exchange systems. In 
addition, Paragraph K of the Application Agreement expressly 
acknowledges the authority of the Exchange to require the interface of 
Terminals with other Exchange systems.

(c) Market-Making Restriction

    As a result of the speed with which non-members will be able to 
transmit orders through a Terminal directly to the point of their trade 
on the Exchange floor, it may be possible for persons who are not 
subject to Exchange regulation to perform marketmaking functions from 
off the floor of the Exchange without being burdened by the cost of 
maintaining Exchange memberships, or by the obligations imposed on 
Exchange market makers, including the obligations to trade in the 
manner prescribed by Exchange Rule 8.7, to respond to calls of Order 
Book Officials pursuant to Exchange Rule 7.5, and to trade at quotes 
displayed in the market maker's crowd as required as Exchange Rule 
8.51, as well as other obligations, limitations and regulations imposed 
on Exchange market makers by the Exchange's rules. The Exchange is 
concerned that if Terminals can be used to perform market making 
functions from off the floor of the Exchange, it may become undesirable 
for Exchange market makers to continue to assume the costs and 
obligations attendant to being a registered market maker, which, in 
turn, would harm the liquidity and quality of the Exchange's market and 
be detrimental to the substantial majority of public investors.
    Nevertheless, the purpose of the proposed Terminals is to 
facilitate the transmission of customer orders to the floor of the 
Exchange. It is not to permit, whether by design or by accident, the 
creation of a market-making system for Exchange transactions that will 
serve as an alternative to the system established under the Exchange's 
rules.
    Accordingly, Paragraph C of the Application Agreement requires the 
applicant to agree that its Terminal will be used to receive brokerage 
orders only, that it will not be used to perform a market-making 
function, and that the Terminal system will be separate from any system 
which the applicant or an associated person of the applicant may use 
for market making.

(d) Misuse of Information

    The Exchange is concerned that knowledge of the information 
transmitted through a Terminal system could be misused before that 
information is disclosed to the trading crowd.\5\ One concern is that 
the information in an order would not be known to the trading crowd 
until the applicant or one of its associated persons had interacted 
with that order--in effect internalizing it--which would be 
inconsistent with the open auction market principles governing the 
Exchange's trading system. A second concern is that knowledge of the 
order information in the system could give the applicant or its 
associated persons the ability to effect transactions or to change 
quotes in the Exchange's market or in the markets for the underlying 
interest or related interests before the information was available in 
the market.

    \5\ The Exchange believes that it would be inconsistent with 
just and equitable principles of trade for a member or its 
associated persons to use, or to permit the use of, information in a 
customer's order prior to the disclosure of that information to the 
market, except if such use is in accordance with the instructions of 
the customer and is consistent with Exchange rules. Telephone 
Conversation between Burton R. Rissman, Schiff Hardin & Waite, and 
Francois Mazur, Attorney, Office of Market Supervision, Division of 
Market Regulation, Commission, on October 3, 1995.
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    Accordingly, Paragraph E of the Application Agreement requires the 
applicant to agree that neither it nor its 

[[Page 53444]]
associated persons (as defined in the Application Agreement) will trade 
with others transmitted through the Terminal. There are two exceptions 
to this restriction. First, the applicant or an associated person will 
be able to trade with an order in the Terminal system if no one wishes 
to trade with it. Second, the applicant and its associated persons will 
be able, if they so desire, to participate in the order on the same 
basis that other market makers who do not have priority participate. 
Paragraph E also prohibits the applicant and its restricted persons 
from using for their own benefit any information contained in any order 
in the Terminal system until that information has been disclosed to the 
trading crowd.
    Initially, the Exchange will limit the use of Terminals to the SPX 
options trading crowd for routing of orders in SPX options. This 
limitation will give the Exchange the opportunity to observe how the 
Terminals are being used in a crowd which is active enough to bring to 
light any unforeseen problems and to gain experience with the use of 
Terminals in that trading crowd before the Exchange implements the 
policy floor-wide.\6\

    \6\ The Commission notes that any decision to extend the policy 
floor-wide would have to be submitted to the Commission as a 
proposed rule change pursuant to Section 19(b) of the Act.
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    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act, in general, and furthers the objectives 
of Sections 6(b)(1) and 6(b)(5) of the Act, in particular, in that the 
proposal is designed to improve communications to and from the 
Exchange's trading floor in a manner that gives the Exchange necessary 
monitoring tools and that is designed to prevent fraudulent and 
manipulative acts and practices, promote just and equitable principles 
of trade, perfect the mechanisms of a free and open market, and protect 
investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change will not impose 
any inappropriate burden on competition. To the contrary, the Exchange 
believes that the proposed rule change will promote competition among 
brokers by encouraging the development and use of new systems designed 
to facilitate the execution of customer orders, while preserving the 
benefits of the auction market for all customers. The proposed rule 
change does place conditions on the use of the proposed Terminals, but 
the Exchange believes those conditions are reasonably necessary and 
appropriate for the protection of investors and in furtherance of the 
other purposes of the Act.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received. In a collateral document addressed to the Exchange after 
the proposed policy was adopted, counsel for the firm referred to above 
which seeks to establish a Terminal on the Exchange floor stated that 
the conditions imposed by the Application Agreement were ``unauthorized 
restrictions'' and then stated:

    In particular, paragraph C of the [Application] Agreement limits 
the use of the terminals to certain kinds of orders, namely, ones 
that ``do not create a pattern of offering in the aggregate either 
to make two-sided markets or simultaneously to represent opposite 
sides of the market in any class of options.'' In addition to being 
vague and ambiguous, this restriction lacks any basis in the rules 
of the Exchange. Equally important, this restriction violates the 
letter and spirit of the Securities Exchange Act of 1934, as 
amended, in that it: undermines investor protections; erects 
impediments to the mechanism of a free and open market and a 
national market system; inhibits the economically efficient 
execution of securities transactions; and unnecessarily impairs 
competition.\7\

    \7\ See Amendment No. 1 supra note 2.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) by order approve such proposed rule change, or
    (b) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW., Washington, D.C. 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. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street NW., 
Washington, D.C. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to File No. 
SR-CBOE-95-48 and should be submitted by November 3, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\

    \8\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 95-25369 Filed 10-12-95; 8:45 am]
BILLING CODE 8010-01-M