[Federal Register Volume 61, Number 177 (Wednesday, September 11, 1996)]
[Notices]
[Pages 47992-47993]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23123]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37633; File No. SR-CBOE-96-36]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Chicago Board Options Exchange, Incorporated Relating to 
the Deactivation of RAES During Unusual Market Activity

September 4, 1996.

I. Introduction

    On June 12, 1996, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed a proposed rule change with the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ to allow the interruption 
of the Exchange's Retail Automatic Execution System (``RAES'') due to 
unusual market activity. The proposed rule change was published for 
comment and appeared in the Federal Register on July 3, 1996.\3\ No 
comments were received regarding the proposal. This order approves the 
Exchange's proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 37364 (June 25, 
1996), 61 FR 34911.
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II. Description of the Proposal

    The Exchange proposes to add a new paragraph (e) to CBOE Rule 6.6 
that will authorize Order Book Officials (``OBOs'') and, in the case of 
options traded at Designated Primary Market Maker (``DPM'') stations, 
Post Directors to deactivate RAES for a period not to exceed five 
minutes in specified classes of options traded at the posts where such 
persons are stationed when in their judgement such action is warranted 
by an influx of orders or other unusual market conditions in such 
options or their underlying securities and the OBO or Post Director 
determines that such action is appropriate in the interests of 
maintaining a fair and orderly market. Whenever such action is taken, 
notice thereof shall immediately be given to two Floor Officials who 
may continue the deactivation of RAES, provided that the necessary 
conditions provided for in Rule 6.6 have been met.\4\
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    \4\ The Exchange represents that two Floor Officials will 
promptly exercise their authority under Rule 6.6 once notified of 
the RAES deactivation by the OBO or Post Director. The proposal also 
provides that the two Floor Officials will make all further 
determinations pursuant to Rule 6.6 regarding the particular options 
class once they arrive at the particular trading post, but until 
such time the OBO or Post Director can reactivate RAES if they 
determine such action is in the interest of a fair and orderly 
market. Telephone conversation between Michael Meyer, Schiff Hardin 
& Waite, and John Ayanian, Attorney, Office of Market Supervision, 
Division of Market Regulation, Commission, on August 27, 1996.
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    The Exchange believes that this proposed rule change should allow a 
more immediate response to temporary order imbalances related to market 
disruptions in stocks that underlie options traded on CBOE caused by 
certain events, such as significant news announcements. The Exchange 
believes that in these situations stock prices may move sharply, and 
Exchange market-makers may not have time to adjust their options quotes 
in the numerous series of options that overlie these stocks. The 
Exchange notes that this may result in published options quotes that do 
not reflect current stock prices. Because orders sent to RAES are 
executed automatically at published quotations, the Exchange believes 
that customers may receive executions at stale prices, which may be 
more favorable, or less favorable, than fair market price.
    Exchange Rule 6.6 currently authorizes two Floor Officials to 
respond to this situation by declaring the market in particular classes 
of options to be ``fast,'' and then turning off RAES (and taking other 
action) until there has been time for prices to be adjusted. The 
Exchange believes that because of the speed with which computerized 
order routing systems can direct orders to RAES, and because RAES 
itself provides for instantaneous automatic executions, there can be a 
significant number of executions at prices that do not reflect the 
current state of the market during the several minutes that it could 
take for two Floor Officials to declare a fast market. The Exchange 
believes that by authorizing OBOs and Post Directors to turn off RAES 
for up to five minutes during unusual market activity, the response 
time to such a situation will be considerably shortened, and the number 
of executions at inaccurate prices should be reduced accordingly. 
Currently, Post Directors or OBOs are authorized to suspend trading in 
specific classes of options for up to five minutes when there is a 
trading halt of suspension of trading in the underlying security in the 
primary market pursuant to CBOE Rule 6.3. The Exchange notes that the 
OBOs and Post Directors, in those situations, are able to deal quickly 
and on an interim basis when an immediate response is necessary, 
pending further consideration of the matter by two Floor Officials.
    The Exchange anticipates that in most instances where RAES is 
deactivated by

[[Page 47993]]

an OBO or Post Director, the period of time when RAES is unavailable 
should be very brief, lasting fewer than five minutes. Even then, 
orders will continue to be delivered to the trading crowd via the 
Exchange's electronic order routing system (``ORS'') and the trading 
crowd will remain obligated to fill customer orders in accordance with 
Exchange rules, including the firm quote rule.\5\ Accordingly, orders 
that would have been routed to RAES will be automatically re-routed to 
a Public Automated Routing System (``PAR'') workstation,\6\ a floor 
broker printer in the trading crowd, or to the appropriate member firm 
booth, where they can be immediately executed at the then current 
price.
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    \5\ The firm quote rule, which obligates the trading crowd to 
fill public orders for up to 10 contracts at published quotes, 
remains in effect unless suspended by two Floor Officials acting 
under Rule 6.6(b) in the event of a fast market. The proposed rule 
change would not authorize an OBO or DPM to declare a fast market or 
suspend the firm quote rule.
    \6\ A PAR workstation is an automated, computer-based 
workstation that provides users with the ability to execute trades, 
transmit trade reports, and enter other data and commands at the 
touch of a screen, thereby eliminating the delay inherent in a 
keyboard-based system.
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    Members will be notified of any deactivation of RAES in particular 
classes of options by an OBO or a Post Director pursuant to proposed 
Rule 6.6(e) by means of a message that is printed to each trading post 
on the floor and is transmitted to terminals throughout the floor over 
the Exchange's TextNet system.

III. Commission Finding and Conclusions

    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) of the Act.\7\ 
Specifically, the Commission finds that the Exchange's proposal strikes 
a reasonable balance between the Commission's mandates under Section 
6(b)(5) to remove impediments to and perfect the mechanism of a free 
and open market and a national market system, while protecting 
investors and the public interest.
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    \7\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change is reasonable 
in that it provides Post Directors and OBOs the limited authority to 
suspend RAES for no more than five minutes in a particular options 
classes during unusual market conditions. The Commission believes that 
Post Directors and OBOs are appropriate parties, to exercise this 
limited authority, in part, because of (1) their knowledge of assigned 
options classes, (2) their close proximity with the trading crowd, and 
(3) their clearly defined administrative role with the Exchange. 
Accordingly, the Commission believes that Post Directors and OBOs 
should be able to initially assess market conditions and deactivate 
RAES for this limited period, thereby reducing the potential for orders 
being executed at inaccurate prices until Floor Officials can further 
assess the market conditions. The Commission notes that the standard 
for OBOs and Post Directors to deactivate RAES is the same standard 
used by Floor Officials to declare a fast market, which in turn, 
authorizes Floor Officials to deactivate RAES if they determine that 
such action is in the interest of maintaining a fair and orderly 
market.
    The Commission notes that two Floor Officials, once immediately 
notified by the OBO or the Post Director of the RAES deactivation, must 
promptly determine whether to (1) immediately reactivate RAES pursuant 
to Rule 6.6(c); or (2) declare a fast market pursuant to Rule 6.6(b) in 
order to continue the deactivation of RAES for that particular options 
class.\8\ Under no circumstances, can the deactivation of RAES continue 
for more than five minutes, unless two Floor Officials declare a fast 
market pursuant to Rule 6.6(b).\9\
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    \8\ The Commission understands that if two Floor Officials 
declare a fast market, they have the authority to, among other 
things, continue the deactivation of RAES, suspend the firm quote 
requirement of Rule 8.51(a), or take such other actions as are 
deemed necessary in the interest of maintaining a fair and orderly 
market. See CBOE Rule 6.6(b).
    \9\ The Commission notes that the five-minute period is an 
absolute time limit imposed by the Exchange on Post Director and OBO 
directed RAES deactivations. Accordingly, the Commission expects 
that in most situations, two Floor Officials should be able to 
exercise their authority under Rule 6.6 before the five-minute 
period has expired.
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    Additionally, the Commission believes that the proposed rule change 
is reasonable because during this limited five-minute period when RAES 
is deactivated by the Post Director or OBO, orders that would have been 
routed to RAES will be automatically re-routed to a PAR workstation, a 
floor broker printer in the trading crowd, or to the appropriate member 
firm booth, where they can be immediately executed at the then current 
price. Accordingly, the Commission believes that the Exchange's 
electronic ORS should provide small investors an efficient and 
effective method for order execution in circumstances where RAES is 
turned off pursuant to this proposed rule change.
    The Commission expects that such authority as proposed herein, will 
only be exercised when unusual market conditions exist, and for the 
shortest time possible. As a general matter, the commission prefers 
that automated systems such as RAES remain operational at all times. 
While extreme circumstances may call for the deactivation of the 
system, it should only be done when absolutely necessary.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (File No. SR-CBOE-96-36) is 
approved.

    \10\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-23123 Filed 9-10-96; 8:45 am]
BILLING CODE 8010-01-M