[Federal Register Volume 62, Number 125 (Monday, June 30, 1997)]
[Notices]
[Pages 35241-35243]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17008]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38763; File No. SR-CBOE-96-68]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1, and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 2 to the Proposed Rule Change by 
the Chicago Board Options Exchange, Incorporated Relating to RAES 
Orders That Are Rerouted to the Exchange's Order Routing System

June 24, 1997.

I. Introduction

    On November 12, 1996, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') a proposed rule change pursuant 
to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') 
\1\ and Rule 19b-4 thereunder,\2\ to specify the trading crowd's firm 
quote obligations for certain Retail Automatic Execution System 
(``RAES'') orders rerouted through the Exchange's Order Routing System 
(``ORS''). On February 28, 1997, the Exchange filed Amendment No. 1 to 
the rule proposal.\3\ On June 13, 1997, the Exchange filed Amendment 
No. 2 to the rule proposal.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Timothy Thompson, CBOE, to Janice Mitnick, 
Commission, dated February 28, 1997 (``Amendment No. 1''). Amendment 
No. 1 made several changes to the rule proposal in order to clarify 
the scope of the rule filing and to conform the rule language to 
reflect the clarifications. In particular, Amendment No. 1 clarifies 
the trading crowd's firm quote obligation for RAES kickouts and 
further defines which orders are eligible for the proposed RAES 
kickout treatment, as discussed more fully herein.
    \4\ Letter from Timothy Thompson, CBOE, to Janice Mitnick, 
Commission, dated June 13, 1997 (``Amendment No. 2''). Amendment No. 
2 is a technical amendment, clarifying that Rule 8.51(a)(2), which 
establishes when RAES orders are deemed to reach the trading 
station, does not apply to RAES orders eligible for the RAES kickout 
price guarantee pursuant to Interpretation .04 to Rule 6.8.
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    Notice of the substance of the proposed rule change and Amendment 
No. 1 was provided by issuance of a release \5\ and by publication in 
the Federal Register.\6\ No comments were received. This order approves 
the proposed rule change and Amendment No. 1 to the proposed rule 
change, and approves Amendment No. 2, on an accelerated basis.
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    \5\ Securities Exchange Act Release No. 38535 (April 21, 1997).
    \6\ 62 FR 22982 (April 28, 1997).
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II. Description of the Proposal

    The Exchange proposes to amend Rule 6.8 to add Interpretation .04 
to specify the trading crowd's firm quote obligation for certain RAES 
orders rerouted through the Exchange's ORS. Specifically, the rule 
change would provide a price guarantee for the first order to be 
rerouted at a particularly market when the prevailing market bid or 
offer equals the best bid or offer on the Exchange's limit order 
book.\7\ This change will permit the same execution for the covered 
RAES order as if the order had been executed based upon the displayed 
quote market.
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    \7\ See Rules 6.8(b) and (c).
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    The Exchange states that under ordinary trading conditions, only 
customer market or marketable limit orders are eligible to be routed to 
RAES. When RAES receives such an order, the system automatically 
attaches the execution price to the order. The execution price is 
determined by the prevailing market quote at the time of the order's 
entry to the system.\8\ A market-maker who is participating in the RAES 
system will be designated as the contra-broker on the trade, and the 
trade will be automatically executed against the designated market-
maker.
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    \8\ A buy order will pay the prevailing market offer and a sell 
order will sell at the prevailing market bid.
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    The Exchange states that when the prevailing market bid or offer is 
equal to the best bid or offer on the Exchange's customer limit order 
book, the RAES order generally \9\ will be rerouted away from RAES on 
ORS, under existing ORS parameters. According to the Exchange, the 
rerouting occurs because the rule governing priority of bids and 
offers, Rule 6.45, gives priority to orders on the Exchange's customer 
limit order book over any other order at the post. As a result, 
Exchange rules do not permit a RAES sell order to be filled by the RAES 
system at a price lower than or equal to the best book bid, nor may a 
RAES buy order be filled by the RAES system at a price higher than or 
equal to the best book offer. The Exchange states that when the RAES 
order is rerouted over the ORS, the rerouted order ordinarily will be 
routed to a floor broker in the crowd via a printer or Public Automated 
Routing System (``PAR'') workstation,\10\ or will be routed to the 
firm's booth.\11\ Once the floor broker receives the order, it is the 
broker's responsibility to represent the order in the crowd.
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    \9\ Rule 6.8(b) provides an exception to this rule for options 
on IBM and other option classes following the determination of 
special market conditions. See Rules 6.8(b) and (c).
    \10\ 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 delay inherent in a keyboard-
based system.
    \11\ Whether the order gets routed to the booth or to the 
trading station is determined by the order routing instructions the 
broker's firm provides to the Exchange.
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    The Exchange proposes to guarantee that the first rerouted RAES 
order (``RAES kickout'') for up to ten contracts be filled at the bid 
or offer that existed at the time the order was entered into the RAES 
system (i.e., the price the order would have received had it traded 
directly with the customer limit order book).\12\ The Exchange defines 
the first rerouted RAES order in Rule 6.8, Interpretations and Policies 
.04 as the first order rerouted at a particular market which existed at 
the time of the order's entry into the RAES system.\13\ Therefore, if 
more than one RAES order is rerouted at approximately the same time and 
at the same market, the rule change does not guarantee that the second 
order will be filled at the price that existed at the time of the 
second order's entry into the RAES system.\14\ Further, the Exchange 
states that the rule change would only apply to the first RAES kickout 
that is routed directly to the trading station.\15\
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    \12\ The Exchange states that if the market price is better than 
the guaranteed RAES kickout price when the order is represented in 
the crowd pursuant to Rule 6.73, the RAES kickout order would be 
filled at the better market price.
    \13\ See Amendment No. 1, supra n.3.
    \14\ See Amendment No. 1, supra n.3.
    \15\ In the case of an order that the firm has chosen to route 
to the firm's booth, the Exchange believes that the trading crowd 
should not bear the risk that the price will move away from the 
price that the customer could have received had the order not been 
rerouted, given the potential greater delay in the order being 
represented to the crowd. In these cases, the Exchange states the 
floor broker will be responsible for ensuring that the customer's 
order is represented in a timely fashion.

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[[Page 35242]]

    RAES kickouts not eligible for the RAES kickout price guarantee are 
ordinarily eligible for firm quote treatment under Rule 8.51 when the 
order is represented in the trading crowd.\16\ Rule 8.51(a)(1) states a 
trading crowd is required to sell (buy) at least ten contracts at the 
offer (bid) which is displayed when a buy (sell) customer order 
``reaches the trading station where the particular option contract is 
located for trading.'' Because the trading crowd will be expected to 
fill the first order at the price that existed when the RAES order was 
re-routed to the trading station, it is important that the floor broker 
represent the order in a timely fashion.
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    \16\ In some instances, the firm quote obligation for a 
particular option may be for other than ten contracts. See Rule 
8.51(a).
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    The Exchange proposes to amend Rule 8.51 to codify the Exchange's 
current understanding that the firm quote rule generally applies when 
an order reaches the trading station and is represented in the crowd by 
a floor broker, except in the case of a rerouted RAES order that is 
eligible for the RAES kickout price in accordance with Rule 6.8, 
Interpretations and Policies .04. As proposed in Rule 6.8, 
Interpretations and Policies .04, rerouted RAES orders that are 
eligible for the RAES kickout price are deemed to reach the trading 
station and entitled to firm quote protection of up to 10 contracts 
when the order is entered into the RAES system.\17\
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    \17\ See Amendments No. 2, supra n.4.
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    The Exchange notes that, consistent with the terms of Rule 8.51, 
the trading crowd would be entitled to change their quotes after the 
first order of up to ten contracts has been traded at the quoted price. 
Therefore, the price at which the second (or any subsequent) RAES 
kickout order would be filled may be better or worse than the RAES 
kickout price for the first order.
    The Exchange generally believes that the public customer should not 
have to bear the risk that the option price will change adversely 
during the period between the rerouting of the order to the floor 
broker via the printer or PAR workstation, and the time the floor 
broker actually represents the order in the crowd. The Exchange 
believes that it is appropriate to limit the price guarantee to only 
the first RAES kickout at a particular market which existed at the time 
of the order's entry into the RAES system \18\ because most RAES 
kickout situations involve only one order which is kicked out of RAES. 
In addition, the Exchange believes that in situations where there is 
more than one kickout at a certain price, the market in these options 
is likely very busy and floor brokers may as a practical matter be 
incapable of representing these kicked out orders immediately. In 
proposing to limit the guarantee to the first RAES kickout order, the 
Exchange states that it weighed the benefits of this guarantee against 
the potential disruptive effect of numerous orders kicked out of RAES 
within a second or two of each other. The Exchange states that if the 
guarantee were extended to all orders that are kicked out at that 
price, market-makers would be forced to fill these customer orders at 
quotes that might no longer reflect current market situations by the 
time the floor broker was able to represent the orders. The Exchange 
notes, however, that the orders that do not get filled at the 
guaranteed RAES kickout price will be entitled to be filled at the 
disseminated market quotes at the time they are represented in the 
crowd, which may be better than the guaranteed RAES kickout price.\19\
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    \18\ See Amendment No. 1, supra n.3.
    \19\ See Amendment No. 1, supra n.3. In addition, as noted 
above, the Exchange states that if the current market price is 
better than the guaranteed RAES kickout price when the first RAES 
kickout is represented in the crowd, that order would be filled at 
the current market price.
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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, Section 6(b)(5).\20\ Section 6(b)(5) requires, among other 
things, that the rules of an exchange be designed to promote just and 
equitable principles of trade, perfect the mechanism of a free and open 
national market, and in general, to further investor protection and the 
public interest.\21\
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    \20\ 15 U.S.C. 78f(b)(5).
    \21\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    As a general matter, the Commission believes that RAES-eligible 
orders should receive efficient, fair, and accurate executions after 
being rerouted to the trading floor for manual execution. The 
Commission further believes that this concern must be balanced against 
the desire to ensure that customer orders on the limit order book are 
not disadvantaged.
    The Commission believes that the proposed rule change reasonably 
balances these concerns by ensuring greater price protection for RAES 
kickout orders when the prevailing market bid or offer is equal to the 
best bid or offer on the Exchange's customer limit order book. The 
Commission also believes that the price guarantee for the first RAES 
kickout provides a greater benefit to RAES public customer orders than 
currently exists, while continuing to ensure that customer orders on 
the limit order book that touch the market receive executions 
consistent with time and price priority principles.
    The Commission also believes that the proposed rule change is 
reasonable because RAES kickouts that do not qualify for the RAES 
kickout price, as described above, will be automatically rerouted 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 market quote. The Commission believes, however, 
that because these public customer orders may be filled at an inferior 
bid or offer than existed at the time their orders were entered into 
the RAES system, the Exchange should continue to explore methods to 
give all customers the benefit provided to the first RAES kickout by 
this rule change through the development of a customer limit order book 
which is fully integrated with RAES.
    Finally, the Commission believes that it is reasonable for the 
Exchange to amend its rules to better identify when an order is deemed 
to have reached the trading station for firm quote protection purposes. 
In particular, the Commission believes the proposed change to Rule 8.51 
appropriately codifies existing firm quote obligations and clearly 
addresses the proposed exception for RAES kickouts eligible for the 
RAES kickout price guarantee, as described above.
    The Commission finds good cause for approving Amendment No. 2 to 
the filing prior to the 30th day after the date of publication in the 
Federal Register. Amendment No. 2 to the proposed rule change is a 
technical amendment, clarifying that Rule 8.51(a)(2), which establishes 
when RAES orders are deemed to reach the trading station, does not 
apply to RAES orders eligible for the RAES kickout price guarantee 
pursuant to Interpretation .04 to Rule 6.8. The Commission believes 
amendment No. 2 further clarifies and strengthens the Exchange's 
proposal, as originally intended, and raises no new regulatory 
issues.\22\ Accordingly, the

[[Page 35243]]

Commission believes there is a good cause, consistent with Sections 
6(b)(5) and 19(b)(2) of the Act, to approve Amendment No. 2 to the 
proposal on an accelerated basis.
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    \22\ See Amendment No. 2, supra n.4.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2. 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. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the CBOE. All submissions should refer to File No. 
SR-CBOE-96-68, and should be submitted by July 21, 1997.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\23\ that the proposed rule change (SR-CBOE-96-68), as amended, is 
approved.

    \23\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17008 Filed 6-27-97; 8:45 am]
BILLING CODE 8010-01-M