[Federal Register Volume 61, Number 214 (Monday, November 4, 1996)]
[Notices]
[Pages 56724-56726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-28181]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37885; File No. SR-CBOE-96-55]


Self-Regulatory Organizations; Order Granting Permanent Approval 
of a Pilot Program Proposed by Chicago Board Options Exchange, 
Incorporated Relating to its System for Suspending the Retail Automatic 
Execution System for Equity Options in the Event of News Announcements 
Near the Close of Trading

October 29, 1996.

I. Introduction

    On August 14, 1996, the Chicago Board Options Exchange, 
Incorporated (``CBOE''), 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 seek permanent approval 
of a program for suspending the Exchange's automatic execution system 
in the event of news announcements near the close of trading, as 
described in Interpretation and Policy .01 under CBOE Rule 6.6.
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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 August 21, 1996.\3\ On October 17, 1996, the 
Exchange filed with the Commission, Exhibit A to the proposal which 
sets forth the text of the proposed rule change.\4\ No comment letters 
were received on the proposed rule change. This order approves the 
Exchange's proposal.
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    \3\ The Commission concurrently granted accelerated approval of 
the Exchange's request to extend the program pending consideration 
of the request for permanent approval. See Securities Exchange Act 
Release No. 37577 (August 15, 1996), 61 FR 43281 (``Release No. 
37577'').
    \4\ Exhibit A was mistakenly omitted from the original proposal. 
The exhibit reflects minor and non-substantive changes to 
Interpretation and Policy .01 under CBOE Rule 6.6. The changes to 
the text of the proposed rule, as originally proposed in SR-CBOE-96-
37, merely eliminate words associated with the pilot status of the 
program. See Letter from Michael Meyer, Attorney, Schiff Hardin & 
Waite, to John Ayanian, Attorney, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Market Regulation''), 
Commission, dated October 15, 1996 (``CBOE Letter'').
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II. Description of the Proposal

    The Exchange proposes to make permanent the Exchange's system that 
suspends its Retail Automatic Execution System (``RAES'') in the event 
of news announcements near the close of

[[Page 56725]]

trading, as described in Interpretation .01 under CBOE Rule 6.6.\5\
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    \5\ The 30-day pilot was proposed in File No. SR-CBOE-96-37. See 
Securities Exchange Act Release No. 37380 (June 28, 1996). The pilot 
was extended for an additional 15 days in File No. SR-CBOE-96-53. 
See Securities Exchange Act Release No. 37505 (July 31, 1996). The 
pilot was then extended pending Commission review of the Exchange's 
request for permanent approval. See Release No. 37577, supra note 3.
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    The automatic RAES suspension system is designed to respond to the 
problem presented when issuers of stocks underlying options make 
significant news announcements during the ten minutes after the close 
of trading in stocks when options continue to trade.\6\ The system 
monitors news wires during this period, and automatically suspends RAES 
in options on stocks that are the subject of such announcements in 
order to prevent automatic executions at prices that do not reflect the 
news. This program has been in place on a pilot basis since July 1, 
1996.
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    \6\ CBOE may soon propose reducing to five minutes the time when 
options continue to trade after the close of stock trading. So long 
as options trade for any period of time after the close of stock 
trading, CBOE believes it would need to maintain the system for 
suspending RAES in the event of news announcements during this 
period. Only if options trading and stock trading close concurrently 
would there be no need for such a system. CBOE does not support 
concurrent closings because this would not allow time for closing 
options prices to be determined based on closing stock prices, or 
for participants to open or close options positions for hedging 
purposes based on closing stock prices. For a more detailed 
discussion of the reasons for continuing to trade options after the 
close of trading in the primary markets for underlying stocks and 
the problems this presents for RAES, see the discussion in SR-CBOE-
96-37, which proposed the initial 30-day pilot in the system that is 
the subject of this filing, notice of which was given in Securities 
Exchange Act Release No. 37380 (June 28, 1996).
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    Based on its experience with the pilot operation of the system, the 
Exchange has now determined to propose its adoption on a permanent 
basis. During the first four weeks of the pilot operation of the 
system, the Exchange believes that it performed as intended to suspend 
RAES in particular classes of options each time there was a news 
announcement pertaining to an underlying stock during the period of 
time when options continued to trade after the close of trading in 
underlying stocks. The Exchange submitted a report of the operation of 
the pilot from July 1, 1996 through July 26, 1996 to the Commission. 
The report shows that during this period, RAES was suspended a total of 
90 times and was reinstated after suspension 36 times. Although the 
news announcements covered a range of subjects, at least 15 were 
earnings reports, evidencing that many issuers continue to release such 
news after the close of stock trading while options continue to be 
traded. Of the 90 suspensions, 26 were in classes in which there were 
RAES-eligible orders after the suspension. Of the 132 RAES-eligible 
orders in these classes, 69 were executed after RAES was reactivated 
(63 of which related to a single suspension and subsequent reactivation 
of RAES in connection with the release of earnings for IBM), and 63 
were rerouted as follows: to PAR terminals (30 orders), to printers at 
the post (4 orders), to members' booths (22 orders), or to the limit 
order book (7 orders). Forty-five of these rerouted orders (71%) were 
filled in the auction market. Eighteen orders during the pilot period 
expired unfilled. The orders that expired unfilled were marketable 
limit orders submitted at or after the close of stock trading, that 
were not longer marketable in the auction market following the RAES 
suspension for the subject options classes.\7\ The Exchange believes 
that the system appears to have worked as intended to prevent the 
execution of these orders at inappropriate prices, while permitting 
most orders to be executed at prices established in the auction market. 
The Exchange notes that reactivation of RAES was generally not a 
significant factor in the execution of these orders (with the one 
exception of the IBM orders noted above), because most had already been 
executed in the auction market by the time RAES was reactivated.
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    \7\ Telephone conversation between Mike Meyer, Attorney, Schiff 
Hardin & Waite, and Holly Smith, Associate Director, and John 
Ayanian, Attorney, OMS, Market Regulation, Commission, on August 15, 
1996.
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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.\8\ 
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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    \8\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change provides a 
reasonable method of suspending RAES for a limited period in a 
particular options class that is subject to a news announcement near 
the close of trading in the underlying security. The Commission notes 
that the Exchange has not reported any significant problems with the 
operation of the system to date. Upon reviewing the Exchange's report 
regarding the operation of the system during the pilot, the Commission 
believes that the proposed system should help to prevent the execution 
of trades at inaccurate quotes while continuing to ensure prompt and 
accurate execution of customer orders in the particular class subject 
to a news announcement.
    The Commission also believes that the proposed rule change is 
reasonable because during the time when options continue to be traded 
after the close of trading in the primary market for underlying stocks 
(1) RAES executions will still be available in classes of options not 
subject to news announcements; and (2) orders for an options class 
subject to a news announcement 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 
Order Routing System 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 the Exchange to monitor the system and 
ensure that (1) the system responds to news announcements, and if the 
system responds to an item disseminated over the wires that is not 
``news'' related, that RAES operations for the particular options class 
will be resumed as soon as possible; \9\ (2) if there is enough time 
before the close of options trading, and if options prices have been 
adjusted to reflect the current state of the market, that Floor 
Officials will resume RAES operations for the subject options class; 
and (3) market orders and marketable limit orders that are still 
marketable, receive efficient and accurate executions after being re-
routed in the manner described above.
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    \9\ For example, block transactions in a given stock are 
sometimes disseminated by a news service. When this occurs near or 
after the close of trading, the identification of the stock triggers 
an automatic suspension of RAES under the system. The CBOE has 
indicated that in such circumstances, RAES will be immediately 
reactivated, if time remains before the close of options trading. 
See CBOE Letter, supra note 4.

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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (File No. SR-CBOE-96-55) is 
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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. 96-28181 Filed; 11-1-96; 8:45 am]
BILLING CODE 8010-01-M