[Federal Register Volume 63, Number 48 (Thursday, March 12, 1998)]
[Notices]
[Pages 12119-12122]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-6336]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39725; File No. SR-CBOE-98-03]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., Relating to 
Allocation Procedures

March 5, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on January 22, 1998, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
CBOE.\3\ The

[[Page 12120]]

Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On January 23, 1998, the CBOE filed a technical amendment to 
the filing, clarifying that the Exchange's Board of Directors had 
approved the proposed rule change in February 1997 (Amendment No. 
1).
    On February 12, 1998, the CBOE filed Amendment No. 2 to the 
proposal, to delete CBOE Rules 8.80(a) and 8.80(b)(7) and to insert 
an inadvertently omitted part of the Federal Register notice. See 
Letter from Arthur Reinstein, Assistant General Counsel, CBOE, to 
Joshua Kans, Attorney, Division of Market Regulation (``Division''), 
Commission, dated February 12, 1998.
    On March 4, 1998, the CBOE filed Amendment No. 3 to the 
proposal, clarifying the basis for deleting CBOE Rule 8.80(b)(7). 
The amendment also noted that the CBOE is in the process of 
comprehensively amending CBOE Rule 8.80. See Letter from Arthur 
Reinstein, CBOE, to Joshua Kans, Division, Commission, dated March 
4, 1998.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to adopt a rule to codify the Exchange's process 
for allocating securities to market-maker trading crowds and designated 
primary market-makers (``DPMs'').
    The text of the proposed rule change is available at the Office of 
Secretary, CBOE and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with Commission, the CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CBOE has prepared summaries, set for in sections A, 
B, and C below, of the most significant parts of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The Exchange's Board of Directors has delegated to the Exchange's 
Allocation Committee and Special Product Assignment Committee the 
authority to allocate the securities traded on the Exchange. Each 
allocation is made to either a market-maker trading crowd or to a DPM. 
The purpose of the proposed rule change is to codify the Exchange's 
allocation process in new CBOE Rule 8.95, ``Allocation of Securities 
and Location of Trading Crowds and DPMs'' \4\
---------------------------------------------------------------------------

    \4\ On the effective date of the proposed rule change, the 
Exchange will delete existing CBOE Rules 8.80(a) and 8.80(b)(7). See 
Amendment Nos. 2 and 3, supra note 3.
---------------------------------------------------------------------------

    CBOE Rule 8.95 is proposed to consist of seven subparagraphs, (a) 
through (g), and to contain two interpretations.
    Proposed CBOE Rule 8.95(a) provides that the Allocation Committee 
shall be responsible for determining for each equity option class 
traded on the Exchange (i) Whether the option class should be a trading 
crowd or to a DPM and (ii) which trading crowd DPM should be allocated 
the option class. Similarly, proposed CBOE Rule 8.95(a) provides that 
the Special Product Assignment Committee shall be responsible for 
determining for each security traded on the Exchange other than an 
equity option (i) whether the security should be allocated to a trading 
crowd or to a DPM and (ii) which trading crowd or DPM should be 
allocated the security. Securities other than equity options that are 
traded on the Exchange include index options and securities traded 
pursuant to Chapter XXX of the Exchange's Rules, such as structured 
products.
    Proposed CBOE Rule 8.95(a) further provides that the Allocation 
Committee shall be responsible for determining the location on the 
Exchange's trading floor of each trading crowd, each DPM, and each 
security traded on the Exchange. For example, this provision permits 
the Allocation Committee to place a large trading crowd or DPM 
operation in a trading floor location that is large enough to 
accommodate the crowd or DPM. As another example, if a DPM operated as 
a DPM at more than one trading station, this provision permits the 
Allocation Committee to determine the station, and the location within 
each station, at which the securities allocated to the DPM will trade.
    Proposed CBOE Rule 8.95(b) describes the criteria that may be 
considered by the Allocation Committee and Special Product Assignment 
Committee in making allocation determinations and by the Allocation 
Committee in making location determinations. The factors to be 
considered may include, but are not limited to, any one or more of the 
following: performance, volume, capacity, market performance 
commitments, operational factors, efficiency, competitiveness, 
environment in which the security will be traded, expressed preferences 
of issuers, and recommendations of other Exchange committees.
    The following are some examples of the many ways in which these 
criteria may be applied. For example, in considering performance, the 
appropriate Allocation Committee (i.e., the Allocation Committee or 
Special Product Assignment Committee, as applicable) might look at the 
market performance ranking of the applicable trading crowds or DPMs, as 
established by market performance reviews that are conducted by the 
Exchange's Market Performance Committees and Modified Trading System 
(``MTS'') Appointments Committee.\5\ In considering volume, the 
appropriate Allocation Committee might look at the anticipated trading 
volume of the security and the trading volume attributable to the 
applicable trading crowds or DPMs in determining which trading crowds 
or DPMs would be best able to handle the additional volume. Similarly, 
in considering capacity, operational factors, and efficiency, the 
appropriate Allocation Committee might look to criteria such as the 
number of market-makers or DPM personnel, the ability to process order 
flow, and the amount of trading crowd or DPM capital in determining 
which trading crowds or DPMs would be best able to handle additional 
securities. In considering market performance commitments, the 
appropriate Allocation Committee might look at the pledges a trading 
crowd or DPM has made with respect to how narrow its bid-ask spreads 
will be and the number of contracts for which it will honor its 
disseminated market quotations beyond what is required by the 
Exchange's Rules. In considering competitiveness, the appropriate 
Allocation Committee might look at percentage of volume attributable to 
a trading crowd or DPM in allocated securities that are traded on more 
than one exchange. In considering the environment in which the security 
will be traded, the appropriate Allocation Committee might seek a 
proportionate distribution of securities between the market-maker 
system and the DPM system and across individual trading crowds and 
DPMs. Also, in considering expressed preferences of issuers, the 
appropriate Allocation Committee might give consideration to the views 
of the issuer of a security traded pursuant to Chapter XXX with respect 
to the allocation of that security or to the licenser of an index on 
which an index option is based with respect to the allocation of that 
index option. Similarly, the appropriate Allocation Committee might 
give consideration to the recommendations of other Exchange committees, 
particularly those that

[[Page 12121]]

evaluate trading crowd and DPM market performance.
---------------------------------------------------------------------------

    \5\ The Exchange has three committees that perform market 
performance functions, including the evaluation of market 
performance. The Exchange's Market Performance Committee performs 
market performance functions with respect to all trading crowds, 
market-makers (other than DPMs), and floor brokers that trade in 
securities other than DJX, NDX, OEX, and SPX index options; the 
Index Market Performance Committee performs market performance 
functions with respect to the trading crowds, market-makers (other 
than DPMs), and floor brokers that trade DJX, NDX, OEX, and SPX 
index options; and the MTS Appointments Committee performs market 
performance functions with respect to all DPMs.
---------------------------------------------------------------------------

    Proposed CBOE Rule 8.95(c) provides that that appropriate 
Allocation Committee may remove an allocation and reallocate the 
applicable security during the first six months following its 
allocation to a trading crowd or DPM if the trading crowd or DPM fails 
to adhere to any market performance commitments made by the trading 
crowd or DPM in connection with receiving the allocation. The 
Allocation Committees typically request that trading crowds and DPMs 
make market performance commitments as part of their applications to 
receive allocations of particular securities. As described above, these 
commitments may relate to pledges to keep bid-ask spreads within a 
particular width or to make disseminated quotations firm for a 
designated number of contracts beyond what is required by Exchange 
Rules. Proposed CBOE Rule 8.95(c) permits the appropriate Allocation 
Committee to remove an allocation if these commitments are not met and 
gives trading crowds and DPMs incentive to abide by these commitments. 
Following the initial six months period after an allocation is made, 
all the responsibility for monitoring market performance with respect 
to that security is vested in the appropriate Market Performance 
Committee or MTS Appointments Committee which continually evaluate 
trading crowd and DPM market performance, as applicable, and are 
authorized pursuant to CBOE Rule 8.60, CBOE Rule 8.80, and other 
Exchange rules to take remedial action for failure to satisfy minimum 
market performance standards.
    Proposed CBOE Rule 8.95(c) also provides that the appropriate 
Allocation Committee may change an allocation determination, and that 
the appropriate Allocation Committee may change a location 
determination, if the appropriate Allocation Committee concludes that 
doing so is in the best interest of the Exchange based on operational 
factors or efficiency. For example, if due to market conditions the 
trading volume in a security greatly increased over a very short time 
frame and the trading crowd or DPM allocated the security could not 
handle the order flow, it may become necessary for the appropriate 
Allocation Committee to reallocate the security to a trading crowd or 
DPM with the capacity to do so. Similarly, if the trading volume at a 
trading crowd or DPM post greatly increased the number of crowd members 
or DPM personnel grew along with the increase in volume, it may become 
necessary for the appropriate Allocation Committee to relocate the 
trading crowd or DPM to a larger trading post.\6\
---------------------------------------------------------------------------

    \6\ Once proposed CBOE Rule 8.95(c) has become effective, it 
will be necessary to delete existing CBOE Rule 8.80(b)(7).
    Existing CBOE Rule 8.80(b)(7)(i) states that the MTS 
Appointments Committee may discontinue the use of a DPM in an option 
class if the trading activity in that class exceeds a predetermined 
volume. That provision is now superfluous because the CBOE 
membership voted in December 1993 to advise the MTS Appointments 
Committee not to exercise that authority. See Amendment 2, supra 
note 3.
     Existing CBOE Rule 8.80(b)(7)(ii) permits the MTS Appointments 
Committee to discontinue use of a DPM in an option class if it 
determines that trading would be better accommodated by using a 
market-maker system without a DPM. Proposed CBOE Rule 8.95(c) will 
give similar authority to the appropriate Allocation Committee. See 
Amendment Nos. 2 and 3, supra note 3.
---------------------------------------------------------------------------

    Proposed CBOE Rule 8.95(d) provides that prior to taking any action 
to remove an allocation or to change a location, the appropriate 
Allocation Committee shall generally give the affected trading crowd or 
DPM prior notice of the contemplated action and an opportunity to be 
heard concerning the action. The only exception to this requirement 
would be in those unusual situations when expeditious action is 
required due to extreme market volatility or some other situation 
requiring emergency action. Specifically, except when expeditious 
action is required, proposed CBOE Rule 8.95(d) requires that prior to 
taking any action to remove an allocation or to change a location, the 
appropriate Allocation Committee shall notify the trading crowd or DPM 
involved of the reasons the committee is considering taking the 
contemplated action, and shall either convene one or more informal 
meetings of the committee (or a committee panel) with the trading crowd 
or DPM to discuss the matter, or provide the trading crowd or DPM with 
the opportunity to submit a written statement to the committee 
concerning the matter. Due to the informal nature of the meetings 
provided for under proposed CBOE Rule 8.95(d) and to encourage 
constructive communication between the committee and the affected 
trading crowd or DPM at those meetings, ordinarily neither counsel for 
the committee nor counsel for the trading crowd or DPM shall be invited 
to attend these meetings and no verbatim record of the meetings shall 
be kept.
    As with any decision made by the Allocation Committee and the 
Special Product Assignment Committee, any person adversely affected by 
a decision made by the appropriate Allocation Committee to remove an 
allocation or change a location may appeal the decision to the 
Exchange's Appeals Committee under Chapter XIX of the Exchange's Rules. 
The appeal procedures in Chapter XIX provide for the right to a formal 
hearing concerning any such decision and for the right to be 
accompanied, represented, and advised by counsel at all stages of the 
proceeding. In addition, any decision of the Appeals Committee may be 
appealed to the Exchange's Board of Directors pursuant to CBOE Rule 
19.5.
    Proposed CBOE Rule 8.95(e) provides that the allocation of a 
security to a trading crowd or DPM and the location of a trading crowd 
or DPM on the Exchange's trading floor does not convey ownership rights 
in the allocation or location or in the order flow associated with the 
allocation or location. Proposed CBOE Rule 8.95(e) is intended to make 
clear that trading crowds and DPMs may not buy, sell, or otherwise 
transfer an allocation or location to another party, and that instead, 
it is the Exchange which has the sole authority to determine 
allocations and locations on the Exchange's trading floor. It should be 
noted, however, that notwithstanding proposed CBOE Rule 8.95(e), 
Exchange rules will continue to permit the transfer of DPM appointments 
pursuant to CBOE Rule 8.80(b)(3) subject to Exchange approval.
    Proposed CBOE Rule 8.95(f) is intended to reflect the current 
restrictions that are in place with respect to the allocation of 
securities to DPMs. Proposed CBOE Rule 8.95(f) reiterates the provision 
currently contained in CBOE Rule 8.80(a) that no option classes opened 
for trading prior to May 1, 1987, shall be allocated to a DPM, except 
to the extent authorized by a membership vote.\7\ In addition, proposed 
CBOE Rule 8.95(f) contains a modification to the foregoing provision 
that was approved pursuant to an Exchange membership vote taken in 
November 1989. Under this modification, if a trading crowd indicates 
that it no longer wishes to trade an option class opened for trading 
prior to May 1, 1987, the option class may be reallocated to another 
trading crowd or to a DPM giving priority to trading crowd applications 
over DPM applications, provided that the trading crowd's commitment to 
market quality is competitive and that operational considerations are 
satisfied.
---------------------------------------------------------------------------

    \7\ In amendment No. 2, the Exchange proposed to delete CBOE 
Rule 8.80(a) to eliminate the redundancy between it and proposed 
CBOE Rule 8.95(f).
---------------------------------------------------------------------------

    Proposed CBOE Rule 8.95(g) provides that in allocating and 
reallocating

[[Page 12122]]

securities to trading crowds and DPMs, the appropriate Allocation 
Committee shall act in accordance with any limitation or restriction on 
the allocation of securities that is established pursuant to another 
Exchange rule. For example, the appropriate Market Performance 
Committee or the MTS Appointments Committee may take remedial action 
against a trading crowd or DPM pursuant to CBOE Rule 8.60 and CBOE Rule 
8.80(b)(10) for failure to satisfy minimum market performance 
standards, and such action may involve a restriction related to the 
allocation of securities to that trading crowd or DPM. Similarly, the 
MTS Appointments Committee may place restrictions on a DPM's ability to 
receive or retain allocations of securities pursuant to various 
provisions of CBOE Rule 8.80, including as a condition of appointment 
as a DPM (CBOE Rule 8.80(b)(3)), due to failure to perform DPM 
functions (CBOE Rule 8.80(b)(4)(i)), or due to a material financial, 
operations, or personnel change (CBOE Rule 8.80(b)(4)(ii)). Proposed 
CBOE Rule 8.95(g) is intended to make clear that the appropriate 
Allocation Committee must act in accordance with any such restrictions 
in making allocation and location determinations.
    Proposed CBOE Rule 8.95, Interpretation .01 generally provides that 
it shall be the responsibility of the appropriate Allocation Committee 
to reallocate a security in the event that the security is removed 
pursuant to another Exchange rule from the trading crowd of DPM to 
which the security has been allocated or in the event that for some 
other reason the trading crowd or DPM to which the security has been 
allocated no longer retains the allocation. For example, as described 
above, CBOE Rules 8.60 and 8.80 authorize the Market Performance 
Committees and the MTS Appointments Committee to take remedial actions 
against trading crowds and DPMs in specified circumstances, including 
the removal of an allocation. Proposed CBOE Rule 8.95, Interpretation 
.01 is intended to make clear that in the event the appropriate Market 
Performance Committee or the MTS Appointments Committee removes an 
allocation pursuant to CBOE Rule 8.60 or CBOE Rule 8.80, it is the 
responsibility of the appropriate Allocation Committee (and not the 
committee that took the action to remove the allocation) to reallocate 
the security pursuant to proposed CBOE Rule 8.95. The only exception to 
this provision is that the MTS Appointments Committee is authorized 
pursuant to CBOE Rule 8.80(b)(6) to allocate to an interim DPM on a 
temporary basis a security that is removed from another DPM, until such 
time as the appropriate Allocation Committee has made a final 
allocation of the security.
    Finally, proposed CBOE Rule 8.95, Interpretation .02 provides that 
it shall be the responsibility of the Allocation Committee to relocate 
a trading crowd or DPM in the event that the trading crowd or DPM is 
required to be relocated pursuant to another Exchange rule. As has been 
discussed, CBOE Rule 8.60 and CBOE Rule 8.80(b)(10) permit the Market 
Performance Committees and the MTS Appointments Committee to take 
remedial actions against trading crowds and DPMs in specified 
circumstances, including requiring that a trading crowd or DPM be 
relocated. Like with proposed CBOE Rule 8.95, Interpretation .01 
proposed CBOE Rule 8.95, Interpretation .02 is intended to make clear 
that in the event the appropriate Market Performance Committee or the 
MTS Appointments Committee requires the relocation of trading crowd or 
DPM pursuant to CBOE Rule 8.60 or CBOE Rule 8.80(b)(10), it is the 
responsibility of the Allocation Committee (and not the Committee that 
took the action to require the relocation) to relocate the trading 
crowd or DPM.
    The CBOE believes that the proposed rule change is consistent with 
Section 6(b) of the Act,\8\ in general, and furthers the objectives of 
Section 6(b)(5),\9\ in particular, in that it is designed to remove 
impediments to and perfect the mechanism of a free and open market and 
to protect investors and the public interest by providing for 
allocation procedures and policies that will ensure that securities 
traded by the Exchange are allocated in an equitable and fair manner 
and that all trading crowds and DPMs have a fair opportunity for 
allocations based on established criteria and procedures.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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, 450 Fifth Street, N.W., Washington, 
D.C. 20549. 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-98-03 and should be submitted by April 2, 
1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
---------------------------------------------------------------------------

    \10\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 98-6336 Filed 3-11-98; 8:45 am]
BILLING CODE 8010-01-M