[Federal Register Volume 61, Number 55 (Wednesday, March 20, 1996)]
[Notices]
[Pages 11453-11455]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-6676]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36964; File No. SR-CBOE-95-68]


Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval to Amendment No. 1 to Proposed Rule Change by the 
Chicago Board Options Exchange, Inc., Relating to an Expansion of the 
Firm Facilitation Exemption to All Non-Multiply-Listed Exchange Option 
Classes

March 13, 1996.

I. Introduction

    On November 16, 1995, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to expand the firm facilitation 
exemption for position and exercise limits that is currently available 
for the Standard & Poor's (``S&P'') 500 Index (``SPX'') options and for 
interest rate options to all non-multiply-listed Exchange option 
classes.
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    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
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    Notice of the proposed rule change appeared in the Federal Register 
on December 27, 1995.\3\ No comments were received on the proposed rule 
change. The Exchange subsequently filed Amendment No. 1 to the proposed 
rule

[[Page 11454]]

change on March 12, 1996.\4\ This order approves the CBOE's proposal, 
as amended.
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    \3\ See Securities Exchange Act Release No. 36609 (December 20, 
1995), 60 FR 67002 (December 27, 1995).
    \4\ In Amendment No. 1, the CBOE deleted reference to a 
facilitating firm's ability to receive a position limit exemption 
when hedging a facilitation exemption order with opposite side of 
the market option contracts. In addition, Amendment No. 1 clarified 
the Exchange's proposal by stating that facilitation exempted 
positions are to be viewed in the aggregate. See letter from Mary L. 
Bender, Senior Vice President, Division of Regulatory Services, 
CBOE, to Holly Smith, Associate Director, Division of Market 
Regulation, Commission, dated March 12, 1996 (``Amendment No. 1'').
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II. Background and Description

    The CBOE has previously established firm facilitation \5\ 
exemptions for SPX index options (Rule 24.4.03) \6\ and for interest 
rate options (Rule 23.3(c)).\7\ Exchange member firms have expressed to 
the CBOE's Department of Market Regulation their belief that the 
current firm facilitation exemptions that are available in these option 
classes, which allow member firms to meet the investing needs of their 
customers in such options, should be expanded floor-wide. The CBOE has 
also noted situations in which a member firm was willing to accommodate 
a large customer order \8\ that could not be filled by the trading 
crowd, but was prevented from facilitating the order because of a 
position limit constraint. In light of the above, the CBOE proposes 
that the firm facilitation exemption be made available to all non-
multiply-listed Exchange options classes.\9\
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    \5\ The CBOE defines a facilitation trade as a transaction that 
involves crossing an order of a member firm's public customer with 
an order for the member firm's proprietary account.
    \6\ See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992) (approval order for File No. SR-
CBOE-92-09).
    \7\ See Securities Exchange Act Release No. 33106 (October 26, 
1993), 58 FR 58358 (November 1, 1993) (approval order for File No. 
SR-CBOE-93-21).
    \8\ The CBOE notes that the SPX facilitation exemption defines a 
customer order as one that is entered, cleared, and in which the 
resulting position is carried on behalf of the customer with the 
firm.
    \9\ The CBOE's general exercise limit provisions (Rule 4.12) 
also will be amended to increase exercise limits to the levels 
permitted by the firm facilitation exemption. Several other non-
substantive, editorial changes to the position and exercise limit 
rules, interpretations, and policies will be made as well.
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    The CBOE proposes to expand the firm facilitation exemption by 
incorporating it as new Interpretation and Policy .06 to Rule 4.11, the 
general position limit rule.\10\ By including the firm facilitation 
exemption within Rule 4.11, the exemption would be available to equity, 
broad-based index, narrow-based index, Flexible Exchange (``FLEX''), 
interest rate, and government securities option classes to the extent 
and at the levels specified therein.\11\
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    \10\ Through the rule proposal, the firm facilitation exemption 
provisions contained in Rule 24.4.03 (for SPX index options) and in 
Rule 23.3(c) (for interest rate options) would be eliminated.
    \11\ The CBOE notes that the structuring of the rule proposal in 
this manner is important because the special position limits for 
broad-based index options (Rule 24.4), for narrow-based index 
options (Rule 24.4A), for FLEX options (Rule 24A.7), for interest 
rate options (Rule 23.3), and for government securities options 
(Rule 21.3) each mandate compliance with Rule 4.11. CBOE Rule 4.11 
also specifically governs the position limits applicable to equity 
option classes.
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    As is the case with the SPX and interest rate firm facilitation 
exemptions, Exchange Rule 6.74(b) procedures for crossing a customer 
order with a firm facilitation order must be followed. In this regard, 
before a customer order can be crossed with a firm facilitation order, 
the trading crowd must be given reasonable opportunity to participate. 
Moreover, only after it has been determined that the trading crowd will 
not fill the order, may the firm's customer order be crossed with the 
firm's facilitation order.
    In addition, except for the existing SPX and interest rate firm 
facilitation exemptions which are set at higher levels, the expended 
firm facilitation exemption will be twice the standard limit. \12\
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    \12\ The CBOE notes that this filing does not propose to change 
the existing SPX and interest rate firm facilitation exemptions.
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    The CBOE notes that the firm facilitation exemption will be in 
addition to and separate from the standard limit, as well as other 
exemptions available under Exchange position limit rules. For example, 
if a firm desires to facilitate customer orders in the XYZ option 
class, which is assumed to be a class of options that is not multiply-
listed and has a 25,000 contract standard position limit, the firm may 
qualify for a firm facilitation exemption of up to twice the standard 
limit (50,000 contracts), as well as an equity hedge exemption of up to 
twice the standard limit (50,000 contracts), in addition to the 25,000 
contract standard limit. If both exemptions are allowed, the 
facilitation firm may hold or control a combined position of up to 
125,000 XYZ contracts on the same-side of the market.
    The CBOE notes, however, that the firm facilitation exemption will 
not presently extend to all option classes listed on the Exchange. 
Rather, until coordinated intermarket procedures are developed, the 
exemption will be extended only to non-multiply-listed option classes. 
\13\
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    \13\ The CBOE notes, however, that the Intermarket Surveillance 
Group (``ISG'') is currently working on developing such procedures.
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    Under the CBOE's proposal, the facilitation firm must receive 
approval from the Exchange's Exemption Committee prior to executing 
facilitating trades. Although Exchange approval may be granted on the 
basis of verbal representations, the facilitation firm is required to 
furnish to the Exchange's Department of Market Regulation, within two 
business days or such other time period designated by the Exchange, 
\14\ forms and documentation substantiating the basis for the 
exemption. Within five business days after the execution of a 
facilitation exemption order, a facilitation firm must hedge all exempt 
options positions that have not previously been liquidated, and furnish 
to the Exchange's Department of Market Regulation documentation 
reflecting the resulting hedging positions. In meeting this 
requirement, the facilitation firm must liquidate and establish its 
customer's and its own options and stock positions or their equivalent 
in an orderly fashion, and not in a manner calculated to cause 
unreasonable price fluctuations or unwarranted price changes. In 
addition, a facilitation firm is not permitted to use the facilitation 
exemption for the purpose of engaging in index arbitrage. Moreover, the 
facilitation firm is required to promptly provide to the exchange any 
information or documents requested concerning the exempted options 
positions and the positions hedging them, as well as to promptly notify 
the Exchange of any material change in the exempted options position or 
the hedge.
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    \14\ Telephone conversation between Mary Bender, Senior Vice 
President, Division of Regulatory Services CBOE, and Matthew S. 
Morris, Attorney, Office of Market Supervision, Division of Market 
Regulation, Commission, on March 6, 1996.
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III. Discussion

    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). \15\ 
Specifically, the Commission believes that the CBOE's proposal is 
reasonably designed to accommodate the needs of investors and other 
market participants without substantially increasing concerns regarding 
the potential for manipulation and other trading abuses. The Commission 
also believes that the proposed rule change has the potential to 
enhance the depth and liquidity of the options market by providing 
Exchange members greater flexibility in executing large customer 
orders.

[[Page 11455]]

Accordingly, as discussed below, the Commission believes that the rule 
proposal is consistent with the requirements of Section 6(b)(5) that 
exchange rules facilitate transactions in securities while continuing 
to further investor protection and the public interest.
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    \15\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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    The CBOE proposal contains several safeguards in connection with 
the expanded facilitation exemption that will serve to minimize any 
potential disruption or manipulation concerns. These safeguards are 
very similar to the structure and process that is currently employed in 
obtaining a facilitation exemption in SPX and interest rate options. 
\16\
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    \16\ In approving the firm facilitation exemptions for SPX and 
interest rate options, the Commission expressed its opinion that 
providing member organizations with exemptions for the purpose of 
facilitating large customer orders would better serve the needs of 
the investing public. At that time, the Commission also noted that 
safeguards were built into the exemption to minimize any potential 
disruption or manipulation concerns. See supra notes 6 and 7.
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    First, the facilitation firm must receive approval from the 
Exchange's Exemption Committee prior to executing facilitating trades. 
Although Exchange approval may be granted on the basis of verbal 
representations, the Commission believes that trading abuses are 
unlikely because the facilitation firm is required to furnish to the 
Exchange's Department of Market Regulation, within two business days or 
such other time period designated by the Exchange, forms and 
documentation substantiating the basis for the exemption.
    Second, a facilitation firm must, within five business days after 
the execution of a facilitation exemption order, hedge all exempt 
options positions that have not previously been liquidated, and furnish 
to the Exchange's Department of Market Regulation documentation 
reflecting the resulting hedging positions. In meeting this 
requirement, the facilitation firm must liquidate and establish its 
customer's and its own options and stock positions or their equivalent 
in an orderly fashion, and not in a manner calculated to cause 
unreasonable price fluctuations or unwarranted price changes. In 
addition, a facilitation firm is not permitted to use the facilitation 
exemption for the purpose of engaging in index arbitrage. The 
Commission believes that these requirements will help to ensure that 
the facilitation exemption will not have an undue market impact on the 
options or any underlying stock positions.
    Third, the facilitation firm is required to promptly provide to the 
Exchange any information or documents requested concerning the exempted 
options positions and the positions hedging them, as well as to 
promptly notify the Exchange of any material change in the exempted 
options position or the hedge.
    Fourth, neither the member's nor the customer's order may be 
contingent on ``all or none'' or ``fill or kill'' instructions, and the 
orders may not be executed until Exchange Rule 6.74(b) procedures have 
been satisfied and crowd members have been given a reasonable time to 
participate in the trade.
    Fifth, in no event may the aggregate exempted position under this 
interpretation exceed the number of contracts specified in the 
exemption's table, i.e., twice the applicable standard limit, excluding 
SPX and interest rate options.\17\
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    \17\ The Commission notes that for SPX options, the facilitating 
exemption is 100,000 contracts, and for interest rate options, the 
facilitating exemption is three times the applicable standard limit. 
These levels are the same as under the current rules.
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    Sixth, the facilitation firm may not increase the exempted options 
position once it is closed, unless approval from the Exchange is again 
received pursuant to a reapplication under Interpretation .06.
    In summary, the Commission believes that the safeguards built into 
the facilitation exemption process discussed above should serve to 
minimize the potential for disruption and manipulation concerns, while 
at the same time benefitting market participants by allowing member 
firms greater flexibility to facilitate large customer orders. This 
structure substantially mirrors the process that has existed for 
granting firm facilitation exemption requests for SPX and interest rate 
options, and the CBOE has surveillance procedures to surveil for 
compliance with the rule's requirements. Accordingly, the Commission 
believes it is appropriate to extend the benefits of the SPX and 
interest rate option facilitation exemptions to other option classes 
traded on the CBOE.
    The Commission finds good cause to approve Amendment No. 1 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 1 deletes reference to a facilitating firm's ability to 
receive a position limit exemption when hedging a facilitation 
exemption order with opposite side of the market option contracts. In 
addition, Amendment No. 1 clarifies the Exchange's proposal by stating 
the facilitation exempted positions are to be viewed in the aggregate. 
Both revisions narrow the scope of the proposed rule change, thereby 
reducing concerns regarding the potential for manipulation or market 
disruption. Accordingly, the Commission believes that it is consistent 
with Section 6(b)(5) of the Act to approve Amendment No. 1 to the 
proposal on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1 to the rule proposal. Persons 
making written submissions should file six copies thereof with the 
Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., 
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. Sec. 552, will 
be available for inspection and copying at the Commission's Public 
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of such filing also will be available for inspection and copying 
at the principal office of the CBOE. All submissions should refer to 
File No. SR-CBOE-95-68 and should be submitted by April 10, 1996.

V. Conclusion

    For the foregoing reasons, the Commission finds that the CBOE's 
proposal to expand the firm facilitation exemption for position and 
exercise limits to all non-multiply-listed Exchange option classes is 
consistent with the requirements of the Act and the rules and 
regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-CBOE-95-68), including 
Amendment No. 1, is approved.
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    \18\ 15 U.S.C. Sec. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegate authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-6676 Filed 3-19-96; 8:45 am]
BILLING CODE 8010-01-M