[Federal Register Volume 63, Number 180 (Thursday, September 17, 1998)]
[Notices]
[Pages 49722-49724]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-24886]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40430; File No. SR-CBOE-98-06]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendments Nos. 1 and 2 Thereto by the Chicago Board Options 
Exchange, Inc. Relating to the Rerouting of RAES Eligible Orders for 
the Last Five Minutes of the Scheduled Trading Day

September 10, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 20, 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. 
On April 9, 1998, the CBOE filed Amendment No. 1 to the proposed rule 
change with the Commission.\3\ On August 26, 1998, the CBOE filed 
Amendment No. 2 to the proposed rule change with the Commission.\4\ The

[[Page 49723]]

Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange clarified when the new rule 
will operate. See Letter from Timothy H. Thompson, Director, 
Regulatory Affairs, Legal Department, CBOE, to Ken Rosen, Attorney, 
Division of Market Regulation (``Division''), Commission, dated 
March 31, 1998 (``Amendment No. 1'').
    \4\ In Amendment No. 2, the Exchange amended the proposed rule 
language to account for a new ``RAES step-up'' feature and further 
explained the purpose of and justification for the proposal. See 
Letter from Timothy H. Thompson, Director, Regulatory Affairs, Legal 
Department, CBOE, to Richard Strasser, Assistant Director, Division, 
Commission, dated July 15, 1998 (``Amendment No. 2'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to turn off, five minutes prior to the scheduled 
close of the trading day, the feature of CBOE's Retail Automatic 
Execution System (``RAES'') \5\ that re-routes orders away from RAES 
when the RAES price is inferior to the best bid or offer in any other 
market (``NBBO reject''). Moreover, the design of RAES will not allow 
the RAES ``step-up'' feature, which provides automatic price 
improvement for RAES orders in some circumstances, to be used while the 
NBBO reject feature is turned off.\6\ The text of the proposed rule 
change is available at the Office of the Secretary, CBOE and at the 
Commission.
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    \5\ RAES is the Exchange's automatic execution system for small 
public customer market or marketable limit orders.
    \6\ See Amendments No. 2.
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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 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 forth in sections 
A, B, and C below, of the most significant aspects of such statments.

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

1. Purpose
    Currently, when an order is routed to the Exchange's order routing 
system and is eligible for execution through RAES,\7\ the system checks 
whether the bid or offer (as appropriate for the type of order) on any 
other U.S. exchange is better than the current CBOE displayed price for 
that series. The Exchange receives quotes from the other exchanges 
through a feed into its mainframe computer from the Options Price 
Reporting Authority (``OPRA''). If the CBOE price is no worse than the 
price elsewhere, the order will be automatically executed at that price 
through RAES. If there is a better price elsewhere, then, pursuant to 
Interpretation .02 to CBOE Rule 6.8, the order will be rerouted to the 
Designated Primary Market-Maker (``DPM'') (in the case of an option 
assigned to that DPM) or to an Order Book Official (in the case of an 
option assigned to a market-making crowd) for non-automated handling of 
the order.\8\ This rerouting function is called the ``NBBO reject'' 
feature.
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    \7\ See CBOE Rule 6.8.
    \8\ However, when the NBBO is within one pricing increment of 
the CBOE price, a new RAES ``step-up'' feature may be employed to 
provide automatic execution in RAES at the NBBO. See Securities 
Exchange Act Release No. 40096 (June 16, 1998) 63 FR 34209 (June 23, 
1998) (order approving proposal).
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    Interpretation .02 to CBOE Rule 6.8 provides two situations in 
which the NBBO reject feature may not be employed: where a ``fast 
market'' in the equity options that are the subject of the orders in 
question has been declared on the Exchange or where comparable 
conditions exist in the other market such that the firm quote 
requirements do not apply. The proposed rule change will add a third 
situation that will apply to all equity options at the close of the 
scheduled trading day.
    Under the proposal, the Exchange will turn off the NBBO reject 
feature of RAES for equity options five minutes prior to the scheduled 
close of the trading day. Thus, where the current rules set a closing 
time of 3:02 p.m. for equity options, the NBBO reject feature would be 
turned off at 2:57 p.m. The Exchange is proposing this change because 
trading is often hectic during the last few minutes of the trading day 
and the Exchange often receives large numbers of RAES orders at the end 
of the day. If a large number of orders are rejected, the number of 
orders to be handled in a nonautomated manner in a finite period of 
time will increase. The Exchange believes that this situation could 
interfere with the fair and orderly close of trading.
    It should be noted that when a RAES-eligible order is subjected to 
an NBBO reject, the order must still be filled in the crowd. There is 
no guarantee that the order will be executed at a better price than the 
order will be executed at a better price than the order would have 
received had it been automatically exected on RAES. During the trading 
day when there is not a fast market, a DPM or trading crowd will likely 
fill the order at the better bid or offer displayed elsewhere. However, 
at the end of the trading day, the order, once rerouted, may be filled 
behind at a number of other orders. By the time the crowd or DPM is 
able to fill the order, the market may have moved substantially from 
the time at which the order was re-routed and the order may be filled 
at a price inferior to that at which RAES would have executed the 
order. In fact, the order may not be filled at all if the market has 
moved away from the order's limit price. The Exchange believes that 
turning off the NBBO reject feature of RAES for the last five minutes 
of the scheduled trading day will reduce the likelihood of these 
occurrences. Of course, the Exchange also will still retain the right 
to turn off the NBBO reject feature at other times during the trading 
day when a ``fast market'' has been declared or when the other exchange 
is not honoring its firm quote commitment.
    The design of RAES also prevents the RAES ``step-up'' feature from 
being used while the NBBO reject feature is turned off. \9\ In 
Amendment No. 2, the Exchange represented that member firms that handle 
a large percentage of the RAES order flow have expressed their interest 
in turning off the reject feature, and consequently the RAES ``step-
up,'' during the last five minutes of the trading day because, in their 
informed opinion, it is more problematic if an order does not get 
filled at all (which is a possibility if the order is rejected for 
manual handling in the last few minutes of the trading day) than if an 
order is filled at the displayed CBOE price even though there may have 
been a better displayed quote on another exchange. These firms have 
stated that their customers are much more sensitive to the risk that 
their order will not be filled. In addition, these firms have indicated 
that in some circumstances the firm may talk to the trading crowd about 
making an adjustment for a customer if the customer believes he was 
disadvantaged by such a policy. \10\
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    \09\ See amendment No. 2.
    \10\ See amendment No. 2
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2. Statutory Basis
    The CBOE believes that the proposed rule change will help to allow 
the Exchange to close its market in a fair and orderly manner. As such, 
the Exchange believes the rule proposal is consistent with and furthers 
the objectives of Section 6(b)(5) \11\ of the Act, in that it is 
designed the perfect the mechanisms of a free and open market and to 
protect investors and the public interest.
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    \11\ 15 U.S.C. 78f(b)(5).

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[[Page 49724]]

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 Burden 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

    Interests persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. In particular, the Commission seeks 
comment on firms' continued best execution obligations in light of the 
proposal. 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-98-06 and should be 
submitteds by October 8, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-24886 Filed 9-16-98; 8:45am]
BILLING CODE 8010-01-M