[Federal Register Volume 63, Number 125 (Tuesday, June 30, 1998)]
[Notices]
[Pages 35629-35631]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-17294]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40111); File No. SR-CBOE-97-41]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 to the Proposed Rule Change by the Chicago Board 
Options Exchange, Inc., Relating to the Definition of Stop Orders

June 23, 1998.

I. Introduction

    On August 25, 1997, the Chicago Board Options Exchange, Inc. 
(``CBOE or Exchange''), filed 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\ a proposed rule change to amend its Rule 6.53 
(``Rule''), governing the definition of option stop orders, to clarify 
that option stop orders on the CBOE are triggered when the option 
contract reaches a specified price ``on the CBOE floor.'' The proposed 
rule change was published for comment in Securities Exchange Act 
Release No. 39100 (September 19, 1997), 62 FR 50644 (September 26, 
1997). No comments were received on the proposal.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Stephanie C. Mullins, Attorney, CBOE, to 
Mike Walinskas, Deputy Associate Director, Division of Market 
Regulation (``Division''), Commission, dated May 26, 1998 
(``Amendment No. 1''). In Amendment No. 1, the CBOE amends the 
filing by clarifying that: (1) an option stop order is triggered by 
a trade, as well as by a bid or offer; (2) while the options markets 
do have access to information from other exchanges, they do not have 
an electronic linkage that provides for the transmission of orders 
similar to the Intermakert Trading System; and (3) while the CBOE 
does not explicitly prohibit trade-throughs, Rule 6.73(a) requires a 
floor broker ``to use due diligence to execute the order at the best 
price or prices available to him in accordance with the rules.'' and 
in some circumstances, a floor broker may determine that he should 
try to execute his order on another market.
---------------------------------------------------------------------------

    On May 26, 1998, the Exchange submitted Amendment No. 1 to the 
proposed rule change.\3\ This order approves the proposal and approves

[[Page 35630]]

Amendment No. 1 on an accelerated basis.

II. Description of the Proposal

    The CBOE proposes to amend its Rule 6.53 (``Rule'') governing the 
definition of stop orders to clarify that an option stop order on the 
CBOE is triggered when the option contract reaches a specified price 
``on the CBOE floor.''
    Currently, paragraph (c)(iii) of Exchange Rule 6.53 defines a stop 
order as a contingency order to buy or sell when the market for a 
particular option contract reaches a specified price. The Rule does not 
specify, but has always been interpreted by the CBOE to mean, that the 
contingency to buy or sell is satisfied when the option contract trades 
or is bid at or above the stop price (in the case of a buy order) or 
trades or is offered at or below the stop price (in the case of a sell 
order) ``on the floor of the CBOE.'' \4\ The proposed amendment will 
make it clear, therefore, that a stop order is not activated when the 
bid or offer (as appropriate) reaches the stop limit on another options 
exchange or when an options transaction occurs at the stop limit on 
another options exchange. The CBOE believes that the proposed rule 
change will clarify the required treatment of option stop orders under 
the CBOE's rules.
---------------------------------------------------------------------------

    \4\ See Amendment No. 1, supra note 3.
---------------------------------------------------------------------------

III. Discussion

    After careful review of the Exchange's proposal, and for the 
reasons discussed below, the Commission believes that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to national securities exchanges, 
and, in particular, with the requirements of Section 6(b) of the 
Act.\5\ Specifically, the Commission believes the proposal is 
consistent with the Section 6(b)(5) requirements that the rules of an 
exchange be designed to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and a national market system, to prevent fraudulent and 
manipulative acts, and, in general, to protect investors and the public 
interest.\6\
---------------------------------------------------------------------------

    \5\ 15 U.S.C. 78f(b).
    \6\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission believes that the proposal is reasonable in that it 
will not adversely affect the depth and liquidity necessary to maintain 
fair and orderly markets because the proposal represents a codification 
of the existing practice of the CBOE requiring that stop orders left 
with CBOE members must be effected and executed based on transactions 
or quotes that occur only on the floor of the CBOE.\7\ It also serves 
to clarify the responsibility of CBOE members regarding the handling of 
stop orders by removing a potential ambiguity contained in the existing 
Rule.
---------------------------------------------------------------------------

    \7\ The Commission notes that the American Stock Exchange 
(``Amex'') and the Pacific Exchange, Inc. (``PCX''), interpret their 
rules to mean that a stop order left with a member will be executed 
based on transactions or quotes that occur only on the floor of 
their own exchange. Telephone conversation between Stuart Diamond, 
Director of Rulings, Amex, and Chester A. McPherson, Staff Attorney, 
Division, Commission, February 3, 1998; telephone conversation 
between Michael D. Pierson, Senior Attorney, Regulatory Policy, PCX, 
and James T. McHale, Special Counsel, Division, Commission, on June 
18, 1998.
---------------------------------------------------------------------------

    The Commission notes that the CBOE has retracted a statement made 
in its original filing that claimed CBOE options traders have no way of 
knowing whether a contract has reached a specified ``stop'' in another 
options market place.\8\ CBOE now states that it recognizes that 
options markets do have access to trade and quote information occurring 
on other options exchanges; however, CBOE maintains that the absence of 
an electronic linkage providing for the transmission of orders to other 
options exchanges in order to access current quotes makes it 
impracticable for CBOE members to rely on such data.
---------------------------------------------------------------------------

    \8\ The Commission notes that various available proprietary 
systems provide quotes and transactions reports on a real time 
basis.
---------------------------------------------------------------------------

    The Commission disagrees that the existence of an electronic order 
routing linkage between options markets should be a requirement to 
``triggering'' option stop orders based on quotes or transactions 
occurring in another options market. In determining the proper 
triggering event(s) that apply to option stop orders, the most 
important factor to consider is whether the triggering quotes or trades 
are bona fide and available on a timely and reliable basis. However, it 
is not necessary to have an electronic order routing linkage, such as 
the Intermarket Trading System (``ITS''), to ensure that quotes and 
trades occurring on other options exchanges meet this test.
    Notwithstanding its disagreement with CBOE over the relevance of 
the existence of an intermarket electronic order routing system to the 
present proposal, the Commission believes there are valid reasons for 
approving the CBOE's proposal at this time. The rule proposal codifies 
an interpretation of CBOE Rule 6.53 that has been observed by market 
participants for many years. Indeed, this interpretation is consistent 
with the practices of the Annex and PCX.\9\ Ideally, the extension of 
national market system principles to the options exchanges would 
include the existence of electronic linkages ensuring the availability 
to all market participants of real-time quote and trade information and 
the ability of exchange markets to access each other's markets at the 
touch of a button. Another reason to approve the present filing is that 
while real-time quote and trade information originating from other 
options markets is currently available to all market participants, 
including CBOE floor members, this information is not always reliable. 
For instance, during the last several years, the dissemination of 
options trade information has been subject, during certain peak market 
volatility events, to ``queuing,'' whereby quote and trade data become 
bottlenecked and cannot be delivered on a real-time basis. Until 
options quote and trade information becomes more reliable, it is 
reasonable for the options exchanges to limit instances where members 
must automatically trigger and execute customer orders based on quote 
and trade information emanating from the other options exchanges.
---------------------------------------------------------------------------

    \9\ See supra note 7.
---------------------------------------------------------------------------

    Given that CBOE's policy regarding options stop orders ignores 
quotes and transactions occurring on other options markets, it is 
important to emphasizes that broker-dealers representing customer 
options orders, including CBOE floor brokers, must continue to fulfill 
their best execution obligations, this includes monitoring the prices 
available on all exchanges that trade the particular option and may 
require the broker-dealer to attempt execution on the exchange with the 
best available price. Moreover, the CBOE, along with the other 
exchanges, should continue to efforts to increase the reliability of 
the dissemination of timely quote and trade information. At some point 
in future, when such reliability increases, it may be appropriate to 
activate stop orders or other contingency orders based on bids, offers, 
or executions occurring on other options markets.
    The Commission finds good cause for approving Amendment No. 1 prior 
to the thirtieth day after the date of publication of notice of filing 
thereof in the Federal Register. The Amendment clarifies the 
description of the proposed rule change and explains several statements 
in the filing. For these reasons, the Commission finds good cause for 
approving Amendment No. 1 on an accelerated basis.

[[Page 35631]]

IV. Solicitation of Comments

    Interested person are invited to submit written data, views and 
arguments concerning Amendment No. 1, including whether it 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, DC 20549. Copies of the 
submissions, 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 the 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 at the Commission's 
Public Reference Room, 450 Fifth Street, N.W., Washington, DC 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-97-41, and should be submitted by July 21, 1998.

V. Conclusion

    It is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (SR-CBOE-97-41) is approved.

    \10\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
---------------------------------------------------------------------------

    \11\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-17294 Filed 6-29-98; 8:45 am]
BILLING CODE 8010-01-M