[Federal Register Volume 63, Number 179 (Wednesday, September 16, 1998)]
[Notices]
[Pages 49619-49622]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-24819]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40419; File No. SR-CBOE-98-35]


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

September 9, 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 July 27, 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. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes to adopt a new rule that would allow market-
makers in a trading crowd to subsidize the activity of floor brokers 
who represent orders in that crowd. The proposed rule would also allow 
market-makers to determine to subsidize the execution of orders from 
the Exchange's public customer limit order book. Set forth below is the 
text of the proposed rule.
* * * * *
(The entire rule is new.)

Chicago Board Options Exchange, Inc. Rules

Chapter II--Organization and Administration

Part C--Dues, Fees, and Other Charges; Market-Maker Surcharge for 
Brokerage

Rule 2.40
    (a) Definitions.
    (i) Stationary Floor Broker. A Stationary Floor Broker (``SFB'') in 
a particular option class is a floor broker (A) who has established a 
business in the trading crowd for that class of accepting and executing 
orders for members or registered broker-dealers and (B) who transacted 
at least 80% of his orders for the previous month in the trading crowd 
at which that option class is traded.
    (ii) Resident Market-Maker. A Resident Market-Maker in a particular 
class of options is a market-maker who transacted at least 80% of his 
market-maker contracts in option classes traded in the trading crowd 
where the particular option class is traded in the prior calendar 
month.
    (iii) ORS Orders. For purposes of this Rule, an ORS order is an 
order that is (A) sent over the Exchange's Order Routing System, (B) 
given an ORS identification number and (C) not an order of the firm for 
which the SFB acts as a nominee or for whom the SFB has registered his 
membership.
    (iv) Standard OBO Rate. The Standard OBO Rate is any rate for OBO 
floor brokerage established by the Exchange for the particular equity 
option class traded on the Exchange floor.
    (b) Generally.
    The Resident Market-Makers for a particular option class may vote, 
as set forth in paragraph (d) of this Rule, to impose a fee on a per 
contract basis for every contract traded by every market-maker, whether 
in-person or by order, in that option class during the period for which 
the fee is instituted. This fee will be collected by the Exchange and 
used to reimburse the Exchange to the extent the market-makers vote to 
reduce the Exchange's book rate pursuant to paragraph (g) of this Rule. 
Any amount remaining after the Exchange has been reimbursed will be 
paid to every SFB who executed an ORS Order in that option class during 
the relevant period of time. To the extent more than one SFB executed 
ORS Orders during the relevant period, this amount remaining shall be 
paid to the SFBs on a pro rata basis based on the number of ORS 
contracts executed by the respective SFBs during the period. The fee 
likely will be assessed after the end of the

[[Page 49620]]

month in which transactions on which the fee was based occurred.
    (c) Time Period.
    The fee shall be instituted for a minimum period of one month. The 
fee voted upon shall remain effective until the next vote is held.
    (d) Vote.
    (i) Any Resident Market-Maker may recommend a fee amount by the 
Friday prior to the vote or by any other time and date required by the 
OBO. The vote of the Resident Market-Makers to institute the fee shall 
take place at the station where the applicable option class is traded 
on the Tuesday of expiration week, or on any other day selected by the 
OBO for that option class. The Order Book Official (``OBO'') shall 
provide 24 hour notice of the time and date of the vote to the trading 
crowd if the vote is to be held at a different time or on a different 
day. The OBO shall determine how the vote shall be conducted. Any 
Resident Market-Maker personally present at the trading station when 
the vote is conducted may vote on the amount of the fee to be assessed 
for the next period.
    (ii) Each Resident Market-Maker's vote shall be weighted in 
accordance with that Market-Maker's percentage of the contracts traded 
in the relevant option class during the six calendar months prior to 
the month in which the vote is taken. For example, the vote of a 
Market-Maker that traded 5% of the contracts in the previous month will 
be counted five times as much as the vote of a Market-Maker that traded 
1% of the contracts in that options class over the previous six 
calendar months. In the case of a class that has not traded for six 
months, the weighting shall be determined in accordance with the 
respective number of trades for the period of time the option class has 
traded. For a class that has not traded at all, all Resident Market-
Maker's votes shall be weighted equally.
    (iii) Any fee amount that receives a majority of the votes cast by 
weight shall be the fee effective for the following calendar month. If 
any fee amount does not receive a majority by weight on the first 
ballot, the OBO may conduct subsequent ballots with the proposed fees 
receiving the most votes by weight or may solicit Resident Market-
Makers for other proposed fee amounts.
    (e) Option Classes.
    The appropriate Floor Procedure Committee may specify those option 
classes on which Resident Market-Makers may vote to assess a fee 
pursuant to paragraph (d) of this Rule.
    (f) Floor Brokerage Commission.
    Although any SFB who executes ORS Orders in the crowd will be paid 
the appropriate fee, each SFB may charge any commission rate that floor 
broker so desires.
    (g) Book Brokerage Rates.
    The Resident Market-Makers for a particular option class may vote 
to reduce the Exchange's OBO brokerage rate for that option class 
pursuant to the terms of the vote in paragraph (d). If the Resident 
Market-Makers vote to reduce the OBO brokerage rate the Exchange will 
make the appropriate filing as required by the Exchange Act. To the 
extent the Resident Market-Makers vote to lower the rate below the 
Standard OBO Rate, the market-makers who trade that option class shall 
reimburse the Exchange for the difference pursuant to any fee 
instituted in paragraph (b). If the Exchange determines on its own to 
reduce the OBO brokerage rate for a particular class below the Standard 
OBO Rate the market-makers will not be responsible for reimbursing the 
Exchange.
* * * * *

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

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

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

1. Purpose
    Many options traded on the CBOE floor are traded in crowds in which 
the quotes are established in a competing market-maker system. The 
Exchange believes the competitive market-maker system has served to 
provide deep and liquid markets and extremely competitive quotes to the 
benefit of the Exchange's customers throughout the twenty-five year 
history of the Exchange. The Exchange has learned, however, that in 
recent years it has become increasingly difficult for the floor brokers 
who service customer orders in the Exchange's market-maker crowds to 
compete in brokerage rates against options' specialists at other 
exchanges in multiply-traded classes.
    Unlike the situation in market-maker crowds, specialists control 
both the agency and principal functions on other exchanges. As a 
result, these specialists have the luxury of lowering their brokerage 
rates to induce firms to send them the firm's order flow. These 
specialists can still make a comfortable living, even while they reduce 
their brokerage rates below a level at which the activity could be 
provided economically as an independent venture, through the income 
produced from the principal part of the business. The stationary floor 
brokers on the CBOE floor, however, do not have the ability to reduce 
their rates to compete with these specialists and still survive, 
because (unlike these specialists on other exchanges) they have no 
dealer profits. In some cases, these floor brokers have had to rely on 
the superior service provided by the CBOE market-maker system to 
attract order flow even in situations where their rates may be higher 
than those charged by specialists on other exchanges. In order to allow 
the Exchange's stationary floor brokers to compete better against other 
exchange specialists without sacrificing the many advantages inherent 
in having a number of option classes trade in the competing market-
maker crowds, the Exchange has determined to allow its market-makers to 
provide a subsidy to the floor brokers to provide them the ability to 
lower their rates and still earn an acceptable level of income.
a. Generally
    The proposed rule would allow certain market-makers in a trading 
crowd to vote to impose a fee on a per contract basis for every 
contract traded by every market-maker, whether by person or by order, 
in a particular option class. This fee will be collected by the 
Exchange and will be used for two purposes. First, the amount collected 
will be used to reimburse the Exchange to the extent the market-makers 
vote to reduce the rate charged by the Exchange to execute Order Book 
Official (``OBO'') orders. The amount paid the Exchange will be the 
amount of the Standard OBO Rate minus the rate voted on by the market-
makers multiplied by the number of contracts executed by market-makers, 
in person or by order. Any remaining amount of the subsidy collected 
will then be paid to the stationary floor broker as an inducement for 
that floor broker to reduce his brokerage rates. The Exchange believes 
the proposed rule will allow the Exchange's market-maker crowds to 
compete effectively for order flow against specialists from other 
exchanges by allowing the brokerage

[[Page 49621]]

rates to be reduced to competitive levels. It should be noted that the 
stationary floor broker would be entitled to charge whatever brokerage 
rate he feels appropriate, but it is expected that the floor broker 
will consider the extent to which his business is being subsidized by 
the market-makers in the crowd in making that determination.
    Generally, there is only one stationary floor broker in a trading 
crowd. In some cases, where there is more than one stationary floor 
broker in a trading crowd, the amount remaining after the Exchange has 
been reimbursed will be paid to the stationary floor brokers on a pro 
rata basis based on the number of Order Routing System (``ORS'') Orders 
executed by each floor broker. For the sake of ease of administration, 
the fee likely will be assessed after the end of the month in which 
transactions on which the fee was based occurred.
b. Definitions
    Proposed new Rule 2.40(a)(i) defines the category of brokers who 
will be entitled to receive part of the market-maker subsidy as a 
Stationary Floor Broker (``SFB''). An SFB in a particular option class 
is a floor broker (A) who has established a business in the trading 
crowd for that class of accepting and executing orders for members or 
registered broker-dealers, and (B) who transacted at least 80% of his 
orders for the previous month in the trading crowd at which that option 
class is traded. The limitations in the definition are designed to 
ensure that those floor brokers who have made a commitment to the 
particular option class and who are willing to accept orders from a 
wide variety of market participants are the ones who will benefit from 
the subsidy. It is these floor brokers whose reduced brokerage rates 
for a class of options will be most likely to attract or retain order 
flow in that class, which will be of benefit to the market-makers in 
the trading crowd for that class of options.
    Proposed new Rule 2.40(a)(ii) defines that category of market-
makers who will be entitled to vote on the market-maker surcharge and 
on any reduction from the Standard OBO Rate as a Resident Market-Maker. 
A Resident Market-Maker is defined as a market-maker in a particular 
option class who transacted at least 80% of his market-maker contracts 
in option classes traded in the trading crowd where the particular 
option class is traded in the prior calendar month. The limitation in 
this definition ensures that those market-makers who have made a 
commitment to fulfilling their market-maker obligations in the relevant 
trading crowd are the ones who determine to what extent they will be 
willing to compete to attract business to the trading crowd.
    Proposed new Rule 2.40(a)(iii) defines the types of orders for 
which SFBs can earn a subsidy. An ORS Order, for purposes of this rule, 
is an order sent over the Exchange Order Routing System and given an 
ORS identification number and that is not an order of the firm for whom 
the SFB acts as a nominee or for whom the SFB has registered his 
membership. The Exchange decided to make the determination on the 
amount of a subsidy an SFB receives by reference to the number of ORS 
contracts that SFB executed because the rate the SFB charges for ORS 
orders is most likely to be the rate which will attract the most order 
flow. Non-ORS orders--such as spreads, large telephone orders, and 
complex or contingent orders--may require more effort and expertise 
from the floor broker and are not as sensitive to rates as to level of 
service. In addition, the Exchange determined not to allow ORS orders 
executed by an SFB on behalf of the firm for whom the SFB is a nominee 
or for whom he has registered his membership because these orders will 
be executed by the SFB by virtue of the relationship and not by virtue 
of the rate charged.
c. Option Classes/Time Period
    The Exchange has determined to allow the appropriate Floor 
Procedure Committee to determine on which classes of options the 
market-makers will have the authority to vote to assess a fee and to 
reduce the OBO brokerage rate. The Exchange believes that it is likely 
that the program will be started in a few options classes initially to 
determine the effects of the program on allowing the market-maker 
crowds to compete with specialists from other options exchanges. Over 
time it is expected that the program may be expanded more broadly 
across the floor. Any subsidy agreed to be paid by the market-makers 
would have to be in effect for at least one month in order not to 
disrupt normal Exchange billing and accounting procedures.
d. Voting Procedures
    Proposed new Rule 2.40(d)(i) requires that the vote of the Resident 
Market-Makers to institute a fee shall take place in the crowd where 
the applicable option class is traded and the vote will be conducted by 
the OBO in that option class. The normal date and time set for the vote 
will be 8:15 a.m. on the Tuesday of expiration week. Expiration week is 
chosen because that is the week when the attendance is generally 
highest. The OBO, however, can set a different time and/or date by 
providing a 24-hour notice of the different time and/or date. Any 
Resident Market-Maker in the crowd at the time of the vote will be 
entitled to vote on the amount of the fee or on any reduction in the 
OBO brokerage rate for the next calendar month. The votes shall be 
weighted in accordance with the number of contracts traded by the 
particular market-maker in the relevant option class in the six 
calendar months prior to the vote. For example, the vote of a Resident 
Market-Maker that traded 5% of the contracts in the previous six 
calendar months will be counted five times as much as the vote of a 
Market-Maker that traded 1% of the contracts in that options class over 
the previous six calendar months. In the case of a class that has not 
traded for at least six months, the weighting shall be determined in 
accordance with the respective number of trades for the period of time 
the option class has traded. For a class that has not traded at all, 
all Resident Market-Makers' votes shall be weighted equally.
    Any proposed fee amount that receives a majority of the weighted 
votes shall become effective for the next calendar month. If any fee 
amount does not receive a majority by weight on the first ballot, the 
OBO may conduct subsequent ballots by seeking approval of the proposed 
fees receiving the most votes by weight or by seeking approval for 
other fee amounts proposed by Resident Market-Makers. Similarly, the 
Resident Market-Makers may vote to reduce the OBO brokerage rate to the 
rate receiving the majority of the weighted votes being effective for 
the next calendar month. Again, the OBO may conduct subsequent votes if 
no proposed OBO brokerage rate received the majority of the weighted 
votes. If the Exchange determines to reduce the OBO brokerage rate for 
a particular class of options to a new lower Standard OBO Rate, the 
market-makers will not be responsible for reimbursing the Exchange.
2. Statutory Basis
    The proposed rule change is consistent with Section 6(b)( \3\ of 
the Act in general and further the objectives of Section 6(b)(5) \4\ in 
particular in that they are designed to promote just and equitable 
principles of trade and to protect investors and the public interest.
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    \3\ 15 U.S.C. 78f(b).
    \4\ 15 U.S.C. 78f(b)(5).

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[[Page 49622]]

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

    The proposed rule change is anticipated to enhance the ability of 
market-makers to compete with the other exchanges for order flow.

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 organizations 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 proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 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 Section, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of such filing will also be available for inspection and copying 
at the principal office of CBOE. All submissions should refer to File 
No. SR-CBOE-98-35 and should be submitted by October 7, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-24819 Filed 9-15-98; 8:45 am]
BILLING CODE 8010-01-M