[Federal Register Volume 61, Number 178 (Thursday, September 12, 1996)]
[Notices]
[Pages 48182-48184]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23350]



[[Page 48182]]

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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37651; File No. SR-CBOE-96-24]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Chicago Board Options Exchange, Inc.; Relating to As of 
Add Submissions

September 5, 1996.
    On April 15, 1996, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to section 19(b) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to terminate its fee program for 
members who, for more than a prescribed percentage of transactions, 
submit trade information pursuant to CBOE Rule 6.51 (``Reporting 
Duties'') after the date on which the trade is executed. (These post-
trade date submissions are commonly referred to as ``as of adds.'') In 
conjunction with the foregoing, the Exchange also proposes to revise 
the structure of its as of add summary fine program.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    Notice of the proposal was published for comment and appeared in 
the Federal Register on May 17, 1996.\3\ No comment letters were 
received on the proposal. This order approves the CBOE's proposal.
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    \3\ See Securities Exchange Act Release No. 37201 (May 10, 
1996), 61 FR 24986 (May 17, 1996).
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I. Description of the Proposal

    CBOE Rule 6.51 requires, among other things, that (i) a participant 
in each transaction to be designated by the Exchange shall immediately 
report the transaction to the Exchange and (ii) each business day, each 
clearing member shall file with the Exchange trade information covering 
each Exchange transaction made by it or on its behalf during the 
business day.
    On October 1, 1993, the Exchange instituted an as of add fee 
program to collect fees from members who, for more than a prescribed 
percentage of transactions, submit trade information pursuant to Rule 
6.51 after the date on which the trade is executed. This program is set 
forth in CBOE Rule 2.26 and currently functions in the following 
manner. Each individual member is assessed a $10.00 fee for each as of 
add submitted by the member during a given month that is in excess of 
2.4% of the member's trade submissions during that month. Similarly, 
each clearing member is assessed a $3.00 fee for each as of add 
submitted by the clearing member during a given month that is in excess 
of 1.2% of the clearing member's trade submissions during that month. 
In addition, the total fees under the program that may be assessed 
against a member in a given month are capped at $500 for individual 
members and at $1,000 for clearing members.
    The reason the Exchange implemented the as of add fee program was 
to allocate the costs borne by the Exchange in processing as of add 
submissions to those members most responsible for generating those 
costs and thereby to encourage the submission of information with 
respect to a trade on the date the trade is executed by creating an 
economic incentive to submit the information on that day. The Exchange 
represents that during the first year of the program, the percentage of 
as of add submissions declined by 10% even though the Exchange 
experienced a 37% increase in trading volume. Based on past experience, 
the Exchange estimates that had the program not been in effect during 
that time period, the percentage of as of add submissions would have 
doubled. Since November, 1994, however, the percentage of as of add 
submissions has remained relatively constant. Therefore, although the 
program has clearly been effective in reducing the percentage of as of 
add submissions, it no longer appears to be causing a reduction in the 
rate of those submissions.
    Accordingly, the Exchange is proposing to terminate the as of add 
fee program and to seek further reductions in the percentage of as of 
add submissions by revising the structure of the Exchange's as of add 
summary fine program.\4\
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    \4\ The Exchange now believes that the costs to the Exchange of 
administering a program that imposes small fees or fines on 
occasional late-reporting members is not justified. Instead, the 
focus of the new program is on a small number of chronic late 
reporters who appear to be willing to accept fines as a cost of 
doing business. The proposed program would permit the Exchange to 
bring these chronic violators of trade reporting requirements before 
the CBOE's Business Conduct Committee much sooner than would be 
permitted under the existing program. This could result in formal 
charges being brought against such violators, which could lead to 
very severe sanctions such as major fines and suspensions of 
membership. See Letter from Michael L. Meyer, Esq., Schiff, Hardin & 
Waite, to Ivette Lopez, Assistant Director, Office of Market 
Supervision, Division of Market Regulation, Commission, dated August 
6, 1996 (``Clarification Letter'').
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    The Exchange institute its as of add summary fine program on 
February 1, 1995. The program is a part of the Exchange's minor rule 
violation plan (``Minor Rule Plan'') and is set forth in CBOE Rule 
17.50(g)(7). Under the program, any individual member whose monthly 
percentage of as of add submissions exceeds 7.2% for two consecutive 
months or any clearing member whose monthly percentage of as of add 
submissions exceeds 3.6% for two consecutive months is subject to a 
fine of $250 for the first offense, $500 for the second offense, and 
$1,000 for each subsequent offense occurring during any 12-month 
period.
    The Exchange is proposing to revise the structure of the as of add 
summary fine program in four primary respects in order to encourage 
further change in as of add behavior, and to the extent the Exchange 
collects fines under the program, to help the Exchange defray the 
additional costs it incurs in processing as of add submissions.
    First, the Exchange is proposing to replace the current as of add 
summary fine schedule for individual members. The proposed fine 
schedule would be stricter in two respects: (i) Action against an 
individual member under the fine schedule would be triggered when the 
member exceeds the maximum allowable as of add submission percentage in 
a given month instead of when the member exceeds that percentage in two 
consecutive months as is the case under the current fine schedule and 
(ii) the maximum allowable as of add submission percentage for 
individual members under the fine schedule would be reduced from its 
current level of 7.2% to 5%. Specifically, the current fine schedule 
for individual members would be replaced with the following fine 
schedule. Any individual member whose percentage of as of add 
submissions in any month exceeds 5% would receive a letter of 
information for the first offense, a letter of caution for the second 
offense, a $500 fine for the third offense, a $1,000 fine for the 
fourth offense, and would be referred to the Exchange's Business 
Conduct Committee for each subsequent offense occurring during any 12 
month period.\5\
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    \5\ In some respects the proposed fine schedule is less strict. 
Under the proposed fine schedule, a member would not receive any 
monetary sanction for the first two offenses, as compared to the 
existing schedule where a member is fined $250 and $500 for the 
first and second offenses, respectively. Moreover, because the 
Exchange is proposing to eliminate the as of add fee program, the 
monetary disincentive for as of adds will be reduced for all 
individual members except those relatively small number of chronic 
late reporters whom the Exchange has chosen to target. This is 
consistent with the Exchange's stated purpose of focusing on the 
chronic late reporters who appear to be willing to accept fines as a 
cost of doing business. See Clarification Letter, supra note 4.
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    In addition, as is currently the case, the Exchange would retain 
the discretion to initiate a formal disciplinary proceeding against an

[[Page 48183]]

individual member pursuant to Chapter XVII of the Exchange's rules in 
the event the Exchange determines that any violations of Rule 6.51 are 
not minor in nature.
    Second, the current as of add summary fine schedule for clearing 
members would be deleted and going forward as of add summary fines 
would only be assessed against individual members. The Exchange 
believes that such a fine structure is appropriate because individual 
members have primary control over the timing of trade submissions, and 
in the Exchange's experience, most as of adds are caused by delays and 
errors of individual members. Moreover, the Exchange believes that 
clearing members generally have a greater economic incentive than 
individual members to reduce as of adds because clearing members incur 
personnel and systems costs due to the extra work necessary to process 
as of adds whereas individual members do not incur such costs. 
Therefore, the Exchange believes that the most effective manner in 
which to achieve a reduction in the percentage of as of adds is to 
direct the as of add summary fine program toward individual members. Of 
course, notwithstanding the foregoing, the Exchange would still have 
the ability to initiate a formal disciplinary proceeding against a 
clearing member for violations of Rule 6.51.
    Third, the Exchange is proposing to implement a verification 
procedure under Rule 17.50 pursuant to which any member who receives an 
as of add summary fine would be able to request verification of that 
fine by the Exchange. Under this procedure, the Exchange would attempt 
to serve any member who incurs an as of add summary fine with a 
disciplinary notice on or before the 10th day of the month immediately 
following the month in which the fine is incurred. The member would 
then have until the 25th day of the month in which the disciplinary 
notice is served to request verification. After the Exchange's 
verification process is completed, it would notify the member in 
writing of the Exchange's determination, and if the member so desired, 
the member could appeal the fine within 30 days after the date of such 
notice in accordance with the appeal procedures under Rule 17.50(d). In 
addition, any member who incurs an as of add summary fine and does not 
request verification would be able to appeal the fine under Rule 
17.50(d) within 30 days after the Exchange's service of the 
disciplinary notice informing the member of the fine. The above-
described verification procedures would function in the same general 
manner as the verification procedures that are currently in place under 
Rule 17.50 for fines imposed for failure to submit accurate trade 
information and for failure to submit trade information to the price 
reporter, and these procedures would serve to replace the current as of 
add verification procedures under Rule 2.26(c) which would be 
eliminated under the proposed rule change along with the remainder of 
Rule 2.26.
    Finally, the current procedures set forth in Rule 2.26(d) which 
permit the Exchange to suspend the as of add fee program would also be 
eliminated along with the remainder of Rule 2.26, and instead, would be 
restated in Rule 17.50 and made applicable to the as of add summary 
fine program. As is currently the case with respect to the as of add 
fee program, these procedures would permit the Exchange's Clearing 
Procedures Committee, with the approval of the President of the 
Exchange, or his designee, to suspend the as of add summary fine 
program for periods no greater than seven calendar days, plus 
extensions, when unusual circumstances affect the ability of a 
significant number of members to submit trade information on a timely 
basis.
    The Exchange proposes to implement the proposed rule change within 
45 days after its approval by the Commission. The purpose of this time 
interval is to give the Exchange the opportunity to inform members of 
the approval of the proposed rule change in the Exchange's Regulatory 
Bulletin before the rule change is put into effect. The Exchange will 
publish the effective date of the rule change in the Exchange's 
Regulatory Bulletin and will notify the Commission of the effective 
date by letter.

II. 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, the requirements of Section 6(b)(5).\6\ Specifically, the 
Commission believes that the proposed rule change may serve to further 
reduce the total number of monthly as of add submissions by providing a 
clear sanction in those circumstances in which disciplining is clearly 
appropriate. As a result, the Commission believes that the proposal 
should benefit all Exchange members, and ultimately investors, by 
reducing the Exchange's processing costs, making the CBOE more 
efficient in terms of the time involved in trade processing, and 
reducing the risk exposure to investors and Exchange member firms.
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    \6\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that an exchange's ability to effectively 
enforce compliance by its members and member organizations with 
Commission and exchange rules is central to its self-regulatory 
functions. In this regard, the Commission finds that the CBOE's 
proposal also is consistent with Section 6(b)(6) \7\ of the Act in that 
it provides for the appropriate disciplining of the CBOE's members for 
violation of Exchange rules. Indeed, the Commission previously urged 
the CBOE to incorporate the as of add fee program into the Minor Rule 
Plan contained in Rule 17.50.\8\ The Commission continues to believe 
that fining and instituting disciplinary proceedings against members to 
encourage compliance with exchange rules is generally preferable to 
assessing fees.\9\
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    \7\ 15 U.S.C. 78f(b)(6).
    \8\ While the CBOE did not completely incorporate the as of add 
fee program into Rule 17.50, it did create the current summary fine 
program for the most egregious violations of Rule 6.51. See 
Securities Exchange Act Release No. 35297 (January 30, 1995), 60 FR 
7091 (February 6, 1995).
    \9\ See Securities Exchange Act Release No. 35190 (January 3, 
1995), 60 FR 3008 (January 12, 1995). Fines levied pursuant to the 
Minor Rule Plan provide for an appropriate response to minor 
violations of Exchange rules, while preserving the due process 
rights of the party accused through specified, required procedures.
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    The Commission finds that the proposed schedule of penalties 
pursuant to CBOE Rule 17.50(g)(7) is consistent with the Act.\10\
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    \10\ The Commission notes that under certain circumstances the 
new schedule of penalties pursuant to the Minor Rule Plan may be too 
lenient in that referral to the Business Conduct Committee takes a 
minimum of five months. However, the Commission's concerns in this 
regard are alleviated by the fact that at any time the Exchange has 
the discretion to initiate a formal disciplinary proceeding against 
a member pursuant to Chapter XVII of the CBOE's rules in the event 
the Exchange determines that any violations of Rule 6.51 are not 
minor in nature. Moreover, the Exchange has represented to the 
Commission that the new schedule of penalties was the subject of 
extensive consideration by the Exchange's Clearing Procedures and 
Financial Planning Committees as well as its Floor Directors 
Committee. See Clarification letter, supra note 4.
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    Further, the Commission does not believe that the fact that the new 
fine schedule will apply to individual members and not clearing members 
raises significant regulatory concerns. First, the Exchange represents 
that most as of adds are the result of late submissions by individual 
members, not clearing firms. Second, in its present form as previously 
approved by the Commission, both the as of add fee program and the 
summary fine program distinguish between clearing members and 
individual members. Accordingly,

[[Page 48184]]

the Commission believes that the difference in treatment between 
clearing members and individual members is reasonable and consistent 
with the Act.
    Additionally, the Commission believes that including a verification 
procedure under Rule 17.50, pursuant to which any member who receives 
an as of add summary fine would be able to request verification of that 
fine by the Exchange, provides adequate due process rights to the fined 
member and is consistent with the Act. The Commission notes that even 
if the accused fails to request verification, the member may appeal the 
fine under Rule 17.50(d) within 30 days after the Exchange's service of 
the disciplinary notice informing the member of the fine.
    Moreover, the Commission believes that the procedures currently set 
forth in Rule 2.26(d), which permit the Exchange to suspend the as of 
add fee program, are just as appropriate for inclusion in the as of add 
summary fine program. The Commission believes that when unusual 
circumstances exist that affect the ability of a significant number of 
members to submit trade information to the Exchange in a timely manner 
it may not be appropriate to assess fines against such members. These 
procedures will permit the CBOE's Clearing Procedures Committee, with 
the approval of the President of the Exchange, or his designee, to 
suspend the as of add summary fine program for periods no greater than 
seven calendar days, plus extensions, when unusual circumstances so 
warrant. The Commission notes, however, that it expects the CBOE to use 
its power to waive as of add fines only in highly unusual 
circumstances.
    Finally, the Commission believes that the Exchange will be 
providing adequate notice of the rule change to its members by 
publication in the Exchange's Regulatory Bulletin 45 days in advance of 
the effective date of the change. The Commission believes this is 
particularly important with rule changes such as this which affect 
members' susceptibility to disciplinary sanctions.
    Accordingly, the Commission finds that the CBOE's proposal is 
appropriate and consistent with the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-CBOE-96-24) is approved.
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    \11\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-23350 Filed 9-11-96; 8:45 am]
BILLING CODE 8010-01-M