[Federal Register Volume 64, Number 84 (Monday, May 3, 1999)]
[Notices]
[Pages 23691-23710]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10985]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41325 ; File No. SR-CBOE-98-54]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. To Update and 
Reorganize Its Rules Relating to Designated Primary Market-Makers

April 22, 1999.
    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 December 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\ On February 18, 1999, the Exchange submitted an amendment to 
the proposed rule filing.\4\ The Commission is publishing this notice 
to solicit

[[Page 23692]]

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.
    \3\ As discussed below, CBOE filed a substantially similar 
proposal in 1998, which it subsequently withdrew. See note 5 below.
    \4\ The amendment deleted a proposed change to CBOE Rule 8.7.07 
because the proposed change amended language proposed by another 
pending CBOE rule filing that has not been approved by the 
Commission. Letter from Arthur B. Reinstein, Assistant General 
Counsel, CBOE is Kelly McCormick, Division of Market Regulation, 
SEC, dated February 11, 1999 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to update and reorganize its rules relating to 
designated primary market-makers (``DPMs''). The text of the proposed 
rule change is as follows. Additions are italicized, deletions are 
bracketed.

Chapter III--Membership

* * * * *

Rule 3.27.--Membership Options Trading Permits

* * * * *
    (c) DPMs. The DPM trading system described in Section C of Chapter 
VIII [Modified Trading System established in Rule 8.80] will be 
employed in NYSE Options. Each specialist firm to which a Permit is 
issued pursuant to subparagraph (a)(2) of this Rule shall be appointed 
as the DPM in the same classes of NYSE Options as those for which it 
was designated as a specialist on NYSE. Subject to the provisions of 
the Rules, a Permit holder qualified to act as a DPM pursuant to the 
Rules shall be appointed to act as the DPM for each class of equity 
options designated by the Exchange pursuant to the last sentence of 
paragraph (b) of this Rule. Each specialist firm appointed as a DPM in 
a class of NYSE Options pursuant to the foregoing two sentences shall, 
subject to the provisions of the Rules, continue to act as such DPM 
during the term of the Permits and thereafter so long as it is a 
regular member or member organization of the Exchange.
* * * * *

Chapter VI--Doing Business on the Exchange Floor

* * * * *

Rule 6.8.--RAES Operations in Equity Options

* * * * *
    [(a)(iii) This rule shall apply to RAES in classes handled by DPM's 
except that the MTS Appointments Committee may make available 
additional series or raise the size of eligible orders in a DPM's 
classes pursuant to Rule 8.80.]
* * * * *

Chapter VIII--Market-Makers, Trading Crowds and Designated Primary 
Market-Makers

* * * * *
Section A: Market-Makers
* * * * *

Rule 8.3.--Appointment of Market-Makers

* * * * *
[Interpretations and Policies:]
    [01  The Exchange has adopted the policy that no Market-Maker may 
act as an independent Market-Maker in a class of options for which the 
Market-Maker has been approved to act as a DPM.]
* * * * *

Rule 8.16.--RAES Eligibility in Option Classes Other Than DJX

* * * * *
    (a)(ii) The Market-Maker may designate that his trades be assigned 
to and clear into either his individual account or a joint account in 
which he is a participant. Each individual member of the joint account 
must be physically present in the trading crowd while that member is 
signed onto RAES and each joint account member is subject to all of the 
following provisions of this rule. [DPM participation shall also be 
governed by the MTS Committee as provided in Rule 8.80.]
* * * * *
Section C: Designated Primary Market-Makers [Modified Trading System]

DPM Defined

    Rule 8.80. A ``Designated Primary Market-Maker'' or ``DPM'' is a 
member organization that is approved by the Exchange to function in 
allocated securities as a Market-Maker (as defined in Rule 8.1), as a 
Floor Broker (as defined in Rule 6.70), and as an Order Book Official 
(as defined in Rule 7.1). Determinations concerning whether to grant or 
withdraw the approval to act as a DPM are made by the Modified Trading 
System Appointments Committee (``MTS Committee'') in accordance with 
Rules 8.83 and 8.90. DPMs are allocated securities by the Allocation 
Committee and the Special Product Assignment Committee in accordance 
with Rule 8.95.

DPM Designees

    Rule 8.81. (a) A DPM may act as a DPM solely through its DPM 
Designees. A ``DPM Designee'' is an individual who is approved by the 
MTS Committee to represent a DPM in its capacity as a DPM. The MTS 
Committee may subclassify DPM Designees and require that certain DPM 
Designees be subject to specified supervision and/or be limited in 
their authority to represent a DPM.
    (b) Notwithstanding any other rules to the contrary, an individual 
must satisfy the following requirements in order to be a DPM Designee 
of a DPM:
    (i) The individual must be a member of the Exchange;
    (ii) The individual must be a nominee of the DPM or of an affiliate 
of the DPM or must own a membership that has been registered for the 
DPM or for an affiliate of the DPM;
    (iii) The individual must be registered as a Market-Maker pursuant 
to Rule 8.2 and as a Floor Broker pursuant to Rule 6.71;
    (iv) On such form or forms as the Exchange may prescribe, the DPM 
must authorize the individual to enter into Exchange transactions on 
behalf of the DPM in its capacity as a DPM, must authorize the 
individual to represent the DPM in all matters relating to the 
fulfillment of the DPM's responsibilities as a DPM, and must guaranty 
all obligations arising out of the individual's representation of the 
DPM in its capacity as a DPM in all matters relating to the Exchange; 
and
    (v) The individual must be approved by the MTS Committee to 
represent the DPM in its capacity as a DPM.
    Notwithstanding the provisions of subparagraph (b)(ii) of this 
Rule, the MTS Committee shall have the discretion to permit an 
individual who is not affiliated with a DPM to act as a DPM Designee 
for the DPM on an emergency basis provided that the individual 
satisfies the other requirements of subparagraph (b) of this Rule.
    (c) The approval of an individual to act as a DPM Designee shall 
expire in the event the individual does not have trading privileges on 
the Exchange for a six month time period.
    (d) Each DPM shall have at least two DPM Designees who are nominees 
of the DPM or who own a membership that has been registered for the 
DPM.
    (e) A DPM Designee of a DPM may not trade as a Market-Maker or 
Floor Broker in securities allocated to the DPM unless the DPM Designee 
is acting on behalf of the DPM in its capacity as a DPM. When acting on 
behalf of a DPM in its capacity as a DPM, a DPM Designee is exempt from 
the provisions of Rule 8.8.

MTS Committee

    Rule 8.82. (a) The MTS Committee shall consist of the Vice-Chairman 
of the Exchange, the Chairman of the Market Performance Committee, and 
nine members elected by the membership of the Exchange.
    (b) The nine elected MTS Committee members shall include: four 
members whose primary business is as a Market-Maker, two members whose 
primary business is as a Market-Maker or as a DPM Designee, one member 
whose primary business is as a Floor Broker and who is not associated 
with a member organization that conducts a

[[Page 23693]]

public customer business, and two persons associated with member 
organizations that conduct a public customer business. No more than two 
of the nine elected MTS Committee members may be associated with a DPM. 
The nine elected MTS Committee members shall have three-year terms, 
three of which shall expire each year.
    (c) The election procedures for the nine elected MTS Committee 
members shall be the same as the election procedures for elected 
Directors that are set forth in Article IV and Article V of the 
Exchange Constitution. Accordingly, the following shall occur as part 
of these procedures: During October of each year, the Nominating 
Committee shall select nominees to fill expiring terms and vacancies on 
the MTS Committee. Nominations may also be made by petition, signed by 
not less than 100 members and filed with the Secretary of the Exchange 
no later than 5:00 p.m. (Chicago time) on November 15, or the first 
business day thereafter in the event November 15 occurs on a holiday or 
a weekend. The election to fill the expiring terms and vacancies on the 
MTS Committee shall be held as part of the annual election.

Approval To Act as a DPM

    Rule 8.83. (a) A member organization desiring to be approved to act 
as a DPM shall file an application with the Exchange on such form or 
forms as the Exchange may prescribe.
    (b) The MTS Committee shall determine the appropriate number of 
approved DPMs. Each DPM approval shall be made by the MTS Committee 
from among the DPM applications on file with the Exchange, based on the 
MTS Committee's judgment as to which applicant is best able to perform 
the functions of a DPM. Factors to be considered in making such a 
selection may include, but are not limited to, any one or more of the 
following:
    (i) Adequacy of capital;
    (ii) Operational capacity;
    (iii) Trading experience of and observance of generally accepted 
standards of conduct by the applicant, its associated persons, and the 
DPM Designees who will represent the applicant in its capacity as a 
DPM;
    (iv) Number and experience of support personnel of the applicant 
who will be performing functions related to the applicant's DPM 
business;
    (v) Regulatory history of and history of adherence to Exchange 
Rules by the applicant, its associated persons, and the DPM Designees 
who will represent the applicant in its capacity as a DPM;
    (vi) Willingness and ability of the applicant to promote the 
Exchange as a marketplace;
    (vii) Performance evaluations conducted pursuant to Rule 8.60; and
    (viii) In the event that one or more shareholders, directors, 
officers, partners, managers, members, DPM Designees, or other 
principals of an applicant is or has previously been a shareholder, 
director, officer, partner, manager, member, DPM Designee, or other 
principal in another DPM, adherence by such DPM to the requirements set 
forth in this Section C of Chapter VIII respecting DPM responsibilities 
and obligations during the time period in which such person(s) held 
such position(s) with the DPM.
    (c) Each applicant for approval as a DPM will be given an 
opportunity to present any matter which it wishes the MTS Committee to 
consider in conjunction with the approval decision. The MTS Committee 
may require that a presentation be solely or partially in writing, and 
may require the submission of additional information from the applicant 
or individuals associated with the applicant. Formal rules of evidence 
shall not apply to these proceedings.
    (d) In selecting an applicant for approval as a DPM, the MTS 
Committee may place one or more conditions on the approval, including, 
but not limited to, conditions concerning the capital, operations, or 
personnel of the applicant and the number or type of securities which 
may be allocated to the applicant.
    (e) Each DPM shall retain its approval to act as a DPM until the 
MTS Committee relieves the DPM of its approval and obligations to act 
as a DPM or the MTS Committee terminates the DPM's approval to act as a 
DPM pursuant to Rule 8.90.
    (f) If a member organization resigns as a DPM or if pursuant to 
Rule 8.90 the MTS Committee terminates or otherwise limits its approval 
to act as a DPM, the MTS Committee shall have the discretion to do one 
or both of the following:
    (i) Approve an interim DPM, pending the final approval of a new DPM 
pursuant to paragraphs (a) through (d) of this Rule; and
    (ii) Allocate on an interim basis to another DPM or to other DPMs 
the securities that were allocated to the affected DPM, pending a final 
allocation of such securities pursuant to Rule 8.95.
    Neither an interim approval or allocation made pursuant to this 
paragraph (f) should be viewed as a prejudgment with respect to the 
final approval or allocation.

Conditions on the Allocation of Securities to DPMs

    Rule 8.84. (a) The MTS Committee may establish (i) restrictions 
applicable to all DPMs on the concentration of securities allocable to 
a single DPM and to affiliated DPMs and (ii) minimum eligibility 
standards applicable to all DPMs which must be satisfied in order for a 
DPM to receive allocations of securities, including but not limited to 
standards relating to adequacy of capital and number of personnel.
    (b) The MTS Committee has the authority under other Exchange rules 
to restrict the ability of particular DPMs to receive allocations of 
securities, including but not limited to, Rules 8.88(b) and 8.60, Rule 
8.83(d), and Rule 8.90.

DPM Obligations

    Rule 8.85. (a) Dealer Transactions. Each DPM shall fulfill all of 
the obligations of a Market-Maker under the Rules, and shall satisfy 
each of the following requirements, in respect of each of the 
securities allocated to the DPM:
    (i) assure that disseminated market quotations are accurate;
    (ii) assure that each displayed market quotation is honored for at 
least the number of contracts prescribed pursuant to Rule 8.51;
    (iii) in the case of option contracts, comply with the bid/ask 
differential requirements of Rule 8.7(b)(iv);
    (iv) assure that the number of DPM Designees and support personnel 
continuously present at the trading station throughout every business 
day is not less than the minimum required by the MTS Committee;
    (v) trade in all securities allocated to the DPM only in the 
capacity of a DPM and not in any other capacity;
    (vi) segregate in a manner prescribed by the MTS Committee (A) all 
transactions consummated by the DPM in securities allocated to the DPM 
and (B) any other transactions consummated by or on behalf of the DPM 
that are related to the DPM's DPM business;
    (vii) with respect to any security traded pursuant to Chapter XXX 
that is allocated to the DPM, fill any odd lot portion combined with a 
round lot order in that security at a price determined in accordance 
with Rule 30.22, Interpretation and Policy .05;
    (viii) participate at all times in any Exchange sponsored automated 
order handling system, including the Retail Automatic Execution System 
(RAES); and
    (ix) determine a formula for generating automatically updated

[[Page 23694]]

market quotations and disclose the following components of the formula 
to the other members trading at the trading station at which the 
formula is used: option pricing calculation model, volatility, interest 
rate, dividend, and what is used to represent the price of the 
underlying.
    Notwithstanding the provisions of subparagraph (a)(ix) of this 
Rule, the MTS Committee shall have the discretion to exempt DPMs using 
proprietary automated quotation updating systems from having to 
disclose proprietary information concerning the formulas used by those 
systems. In addition, to the extent that there is any inconsistency 
between the specific obligations of a DPM set forth in subparagraphs 
(a)(i) through (a)(ix) of this Rule and the general obligations of a 
Market-Maker under the Rules, subparagraphs (a)(i) through (a)(ix) of 
this Rule shall govern.
    (b) Agency Transactions. Each DPM shall fulfill all of the 
obligations of a Floor Broker (to the extent that the DPM acts as a 
Floor Broker) and of an Order Book Official under the Rules, and shall 
satisfy each of the following requirements, in respect of each of the 
securities allocated to the DPM:
    (i) place in the public order book any order in the possession of 
the DPM which is eligible for entry into the book unless (A) the DPM 
executes the order upon its receipt or (B) the customer who placed the 
order has requested that the order not be booked, and upon receipt of 
the order, the DPM announces in public outcry the information 
concerning the order that would be displayed if the order were a 
displayed order in the public order book;
    (ii) not remove from the public order book any order placed in the 
book unless (A) the order is canceled, expires, or is executed or (B) 
the DPM returns the order to the member that placed the order with the 
DPM in response to a request from that member to return the order;
    (iii) accord priority to any order which the DPM represents as 
agent over the DPM's principal transactions, unless the customer who 
placed the order has consented to not being accorded such priority;
    (iv) not charge any brokerage commission with respect to the 
execution of any order for which the DPM has acted as both agent and 
principal, unless the customer who placed the order has consented to 
paying a brokerage commission to the DPM with respect to the DPM's 
execution of the order while acting as both agent and principal;
    (v) act as a Floor Broker to the extent required by the MTS 
Committee; and
    (vi) not represent discretionary orders as a Floor Broker or 
otherwise. Notwithstanding the provisions of subparagraph (b)(vi) of 
this Rule, the MTS Committee shall have the discretion to authorize a 
DPM, on a temporary basis, to accept and represent types of orders in 
one or more of the securities allocated to the DPM which vest the DPM 
with limited discretion, if the MTS Committee determines that unusual 
circumstances are present and that the acceptance and representation of 
such orders by the DPM is necessary in order to assure that there will 
be adequate representation in such securities of those types of orders. 
In addition, to the extent that there is any inconsistency between the 
specific obligations of a DPM set forth in subparagraphs (b)(i) through 
(b)(vi) of this Rule and the general obligations of a Floor Broker or 
of an Order Book Official under the Rules, subparagraphs (b)(i) through 
(b)(vi) of this Rule shall govern.
    (c) Other Obligations. In addition to the obligations described in 
paragraphs (a) and (b) of this Rule, a DPM shall fulfill each of the 
following obligations:
    (i) resolve disputes relating to transactions in the securities 
allocated to the DPM, subject to Floor Official review, upon the 
request of any party to the dispute;
    (ii) promote the Exchange as a marketplace, including meeting and 
educating market participants, maintaining communications with member 
firms in order to be responsive to suggestions and complaints, and 
performing other like activities;
    (iii) act to increase the Exchange's order flow in the securities 
which are allocated to the DPM and respond to competitive developments 
by improving market quality and service and otherwise acting to 
increase the Exchange's market share in those securities;
    (iv) promptly inform the MTS Committee of any desired change in the 
DPM Designees who represent the DPM in its capacity as a DPM and of any 
material change in the financial or operational condition of the DPM;
    (v) supervise all persons associated with the DPM to assure 
compliance with the Rules;
    (vi) segregate in a manner prescribed by the MTS Committee the 
DPM's business and activities as a DPM from the DPM's other businesses 
and activities; and
    (vii) continue to act as a DPM and to fulfill all of the DPM's 
obligations as a DPM until the MTS Committee relieves the DPM of its 
approval and obligations to act as a DPM or the MTS Committee 
terminates the DPM's approval to act as a DPM pursuant to Rule 8.90.
    (d) Obligations of DPM Associated Persons. Each person associated 
with a DPM shall be obligated to comply with the provisions of this 
Rule when acting on behalf of the DPM.

* * * Interpretations and Policies:

    .01  The Exchange may make personnel available to assist a DPM in 
the DPM's performance of the obligations of an Order Book Official, for 
which the Exchange may charge the DPM a reasonable fee.

DPM Financial Requirements

    Rule 8.86. Each DPM shall maintain (i) net liquidating equity in 
its DPM account of not less than $100,000, and in conformity with such 
guidelines as the MTS Committee may establish from time to time, and 
(ii) net capital sufficient to comply with the requirements of Exchange 
Act Rule 15c3-1. Each DPM which is a Clearing Member shall also 
maintain net capital sufficient to comply with the requirements of the 
Clearing Corporation.

Participation Entitlement of DPMs

    Rule 8.87. (a) Subject to the review of the Board of Directors, the 
MTS Committee may establish from time to time a participation 
entitlement formula that is applicable to all DPMs.
    (b) To the extent established pursuant to paragraph (a) of this 
Rule, each DPM shall have a right to participate for its own account 
with the Market-Makers present in the trading crowd in transactions in 
securities allocated to the DPM that occur at the DPM's previously 
established principal bid or offer.

Review of DPM Operations and Performance

    Rule 8.88. (a) The MTS Committee or a subcommittee of the MTS 
Committee may conduct a review of a DPM's operations or performance at 
any time and at a minimum shall conduct a review of each DPM's 
operations and performance on an annual basis. A DPM and its associated 
persons shall submit to the MTS Committee such information requested by 
the Committee in connection with a review of the DPM's operations or 
performance.
    (b) The MTS Committee shall perform the market performance 
evaluation and remedial action functions set forth in Rule 8.60 with 
respect to DPMs and the Market-Makers and Floor Brokers that regularly 
trade at DPM trading stations.

[[Page 23695]]

The MTS Committee may combine a review conducted pursuant to paragraph 
(a) of this Rule with an evaluation conducted pursuant to Rule 8.60.
    (c) Members of the MTS Committee may perform the functions of a 
Floor Official at DPM trading stations.

Transfer of DPM Appointments

    Rule 8.89. (a) A DPM proposing any sale, transfer, or assignment of 
any ownership interest or any change in its capital structure, voting 
authority, or distribution of profits or losses shall give not less 
than thirty (30) days prior written notice thereof to the MTS 
Committee. No such transaction that is deemed to involve the transfer 
of a DPM appointment within the meaning of paragraph (b) of this Rule 
may take place unless (i) the transferee is qualified to act as a DPM 
in accordance with the Rules, and (ii) the transaction has received the 
prior approval of the MTS Committee.
    (b) For purposes of this Rule 8.89, the following transactions are 
deemed to involve the transfer of a DPM appointment: (i) any sale, 
transfer, or assignment of any significant share of the ownership of a 
DPM; (ii) any change or transfer of control of a DPM; [sic](iii) any 
merger, sale of assets, or other business combination or reorganization 
of a DPM. A sale, transfer, or assignment of a five percent (5%) or 
more interest in the equity or profits or losses of a DPM (or any 
series of smaller changes that in the aggregate amount to a change of 
five percent or more) shall be deemed to be a sale, transfer, or 
assignment of a significant share of the ownership of the DPM; 
provided, however, that any sale, transfer, or assignment of a less 
than five percent interest may also be found by the MTS Committee to 
represent a significant share of the ownership of a DPM depending on 
the surrounding facts and circumstances, in which event the MTS 
Committee shall notify the DPM within fifteen (15) days after receiving 
notice thereof that the approval of the transaction by the MTS 
Committee is required.
    (c) An application for the approval of a transaction deemed to 
involve the transfer of a DPM appointment shall be submitted in writing 
to the MTS Committee at least thirty (30) days prior to the proposed 
effective date of the transaction, unless the MTS Committee approves a 
shorter period for its review. The application shall contain a full and 
complete description of the proposed transaction, including (i) the 
identity of the transferee, (ii) a description of the transferee's 
ownership and capital structure, (iii) the identity of those persons 
who will be the partners, shareholders, directors, officers, and other 
managers or affiliates of the transferee, as well as those persons who 
will be responsible for performing the duties of the DPM following the 
transfer, (iv) the terms of the transaction including the consideration 
proposed to be paid by the transferee, (v) the terms of any other 
business relationships between the parties to the transaction, and (vi) 
any other material information pertaining to the transaction that the 
MTS Committee may request.
    (d) Promptly after receipt of a completed application for the 
approval of a proposed transfer of a DPM appointment, the MTS Committee 
shall post notice of the proposed transfer on the Exchange Bulletin 
Board and in the Exchange Bulletin. The MTS Committee shall not 
ordinarily consider a proposed transfer sooner than ten (10) business 
days following the day notice is posted on the Bulletin Board, unless 
the MTS Committee finds it necessary to give earlier consideration to 
the matter in the interest of the maintenance of fair and orderly 
markets and the protection of investors. During this period, the MTS 
Committee will accept written comments on the proposed transfer from 
any member, and will accept written proposals from other members or 
from Market-Maker crowds who wish to be considered for appointment in 
some or all of the classes that are the subject of the proposed 
transfer.
    (e) No application shall be finally approved by the MTS Committee 
until it is accompanied by complete and final documents pertaining to 
the transfer (all corporate or partnership documents and amendments 
thereto, voting trust, ``buy-sell'' or similar agreements, employment 
agreements, pro forma financial statements), except as the MTS 
Committee may agree to defer the delivery of specific documents for 
good cause shown. In considering the approval of a proposed transfer of 
a DPM appointment, the MTS Committee shall give due consideration to 
all relevant facts and circumstances, including but not limited to each 
of the following factors, if applicable: (i) the financial and 
operational capacity of the transferee; (ii) continuity of control, 
management, and persons responsible for the operation of the DPM; (iii) 
avoiding undue concentration of DPM appointments on the Exchange; (iv) 
available alternatives for reallocating the DPM's appointment taking 
into account comments made and alternatives proposed by other members 
during the posting period; and (v) the best interests of the Exchange. 
If the proposed transferee is not approved to act as a DPM at the time 
the application is considered by the MTS Committee, the approval of the 
transfer may be made contingent on the transferee's being so approved 
within a stated period of time.
    (f) The approval or failure to approve a proposed transfer of a DPM 
appointment is subject to direct review by the Board of Directors upon 
receipt by the Secretary of the Exchange, within ten (10) days of the 
time the decision of the MTS Committee is announced, of (i) a written 
request for such review made by the applicant, specifying why the 
applicant believes the decision of the Committee should be reversed or 
modified (in the case of a failure to approve an application as 
submitted) or (ii) a request for review made by at least five Directors 
of the Exchange (in any case).

* * * Interpretations and Policies

    .01  For purposes of paragraph (b) of this Rule, a transfer of an 
interest in the profits (but not the ownership) of a DPM to an 
associated person of the DPM solely as compensation for the associated 
person's services in support of the business of the DPM shall not 
ordinarily be deemed to be a sale, transfer, or assignment of a 
significant share of the ownership of the DPM.

Termination, Conditioning, or Limiting Approval to Act as a DPM

    Rule 8.90. (a) The MTS Committee may terminate, place conditions 
upon, or otherwise limit a member organization's approval to act as a 
DPM under any one or more of the following circumstances:
    (i) if the member organization incurs a material financial, 
operational, or personnel change;
    (ii) if the member organization fails to comply with any of the 
requirements under this Section C of ChapterVIII, including, but not 
limited to, any conditions imposed under Rule 8.83(d), Rule 
8.84(a)(ii), or this Rule; or
    (iii) if for any reason the member organization should no longer be 
eligible for approval to act as a DPM or to be allocated a particular 
security or securities.

Before the MTS Committee takes action to terminate, condition, or 
otherwise limit a member organization's approval to act as a DPM, the 
member organization will be given notice of such possible action and an 
opportunity to present any matter which it wishes the MTS Committee to 
consider in determining whether to take such action. Such proceedings 
shall be conducted in the same manner as MTS

[[Page 23696]]

Committee proceedings concerning DPM approvals which are governed by 
Rule 8.83(c).
    (b) Notwithstanding the provisions of paragraph (a) of this Rule, 
the MTS Committee has the authority to immediately terminate, 
condition, or otherwise limit a member organization's approval to act 
as a DPM if it incurs a material financial, operational, or personnel 
change warranting such action or if the member organization fails to 
comply with any of the financial requirements of Rule 8.86.
    (c) Limiting a member organization's approval to act as a DPM may 
include, among other things, limiting or withdrawing the member 
organization's DPM participation entitlement provided for under Rule 
8.87, withdrawing the right of the member organization to act in the 
capacity of a DPM in a particular security or securities which have 
been allocated to the member organization, and/or requiring the 
relocation of the member organization's DPM operation on the Exchange's 
trading floor.
    (d) If a member organization's approval to act as a DPM is 
terminated, conditioned, or otherwise limited by the MTS Committee 
pursuant to this Rule, the member organization may seek review of that 
decision under Chapter XIX of the Rules.

Limitations on Dealings of DPMs and Affiliated Persons of DPMs

    RULE 8.91. (a) No person or entity affiliated with a DPM shall 
purchase or sell on the Exchange, for any account in which such person 
or entity has a direct or indirect interest, any security which is 
allocated to the DPM. Any such person or entity may, however, reduce or 
liquidate an existing position in a security which is allocated to an 
affiliated DPM provided that any order to consummate such a transaction 
is (i) identified as being for an account in which such person or 
entity has a direct or indirect interest, (ii) approved for execution 
by a Floor Official, and (iii) executed by the DPM in a manner 
reasonably calculated to contribute to the maintenance of price 
continuity with reasonable depth. No order entered pursuant to this 
paragraph (a) shall be given priority over, or parity with, any order 
represented in the market at the same price. This paragraph (a) shall 
not apply to a DPM Designee of a DPM acting on behalf of the DPM in its 
capacity as a DPM.
    (b) Neither a DPM for an equity option, nor any member affiliated 
with the DPM, shall engage in any material business transaction with 
the issuer of the security that underlies the equity option or with any 
officer, director, or 10% shareholder of the issuer of the security. 
Neither a DPM for a security traded pursuant to Chapter XXX, nor any 
member affiliated with the DPM, shall engage in any material business 
transaction with the issuer of the security or with any officer, 
director, or 10% shareholder of the issuer of the security. For the 
purposes of this paragraph (b), a material business transaction shall 
be deemed to be a transaction which is material in value either to the 
issuer or the DPM, would provide access to material non-public 
information relating to the issuer, or would give rise to a control 
relationship between the issuer and the DPM. Notwithstanding the 
foregoing, the receipt of routine business services, goods, materials, 
or insurance, on terms that would be generally available shall not be 
deemed a material business transaction for the purposes of this 
paragraph (b).
    (c) Neither a DPM for an equity option, nor any member affiliated 
with the DPM, shall accept any orders directly from the issuer of the 
security that underlies the equity option or directly from any officer, 
director, or 10% shareholder of the issuer of the security. Neither a 
DPM for a security traded pursuant to Chapter XXX, nor any member 
affiliated with the DPM, shall accept any orders directly from the 
issuer of the security or directly from any officer, director, or 10% 
shareholder of the issuer of the security.
    (d) No member affiliated with a DPM may act as a Floor Broker in 
any trading crowd in which the DPM acts as a DPM. This paragraph (d) 
shall not apply to a DPM Designee of a DPM acting on behalf of the DPM 
in its capacity as a DPM.
    (e) Paragraphs (a), (b), and (c) of this Rule shall not apply to 
any member affiliated with a DPM that has established and obtained 
Exchange approval of procedures restricting the flow of material non-
public corporate and market information (i.e., a ``Chinese Wall'') 
between such member on the one hand and the DPM and persons affiliated 
with the DPM on the other hand. Any such procedures shall comply with 
the following Guidelines:

Guidelines for Exemptive Relief Under Rule 8.91(e) for Members 
Affiliated with DPMs

    These Guidelines set forth the steps that a member affiliated with 
a DPM must undertake, at a minimum, to seek to obtain an exemption 
under Rule 8.91(e) from the requirements of paragraphs (a) through (c) 
of Rule 8.91. These Guidelines may be supplemented or modified by the 
Exchange in individual cases when the Exchange deems it appropriate to 
do so.
    (a) Generally, an affiliated member seeking a Rule 8.91(e) 
exemption should establish its operational structure along the lines 
discussed below.
    (i) The affiliated member and the DPM must be organized as separate 
and distinct organizations. At a minimum, the two organizations must 
maintain separate and distinct books, records, and accounts and satisfy 
separately all applicable financial and capital requirements. While the 
Exchange will permit the affiliated member and the DPM to be under 
common management, in no instance may persons on the affiliated 
member's side of the ``Wall'' exercise influence over or control the 
DPM's conduct with respect to particular securities or vice versa. Any 
general managerial oversight must not conflict with or compromise in 
any way the DPM's market-making responsibilities pursuant to the Rules.
    (ii) The affiliated member and the DPM must establish procedures 
designed to prevent the use of material non-public corporate or market 
information in the possession of the affiliated member to influence the 
DPM's conduct and to avoid the misuse of DPM market information to 
influence the affiliated member's conduct. Specifically, the affiliated 
member and the DPM must ensure that material non-public corporate 
information relating to trading positions taken by the affiliated 
member in a DPM security are not made available to the DPM or to any 
shareholder, director, officer, partner, manager, member, principal, 
DPM Designee, or employee associated therewith; that no trading is done 
by the DPM while in possession of non-public corporate information 
derived by the affiliated member from any transaction or relationship 
with the issuer or any other person in possession of such information; 
that advantage is not taken of knowledge of pending transactions or the 
affiliated member's recommendations; and that all information 
pertaining to positions taken or to be taken by the DPM and to the 
DPM's ``book'' in a DPM security is kept confidential and is not made 
available to the affiliated member except to the extent that such 
information is made available to the affiliated member in accordance 
with subparagraph (b)(iii) of these Guidelines.
    (b) An affiliated member seeking a Rule 8.91(e) exemption shall 
submit to the Exchange a written statement which shall set forth:
    (i) The manner in which the affiliated member intends to satisfy 
each of the

[[Page 23697]]

conditions stated in subparagraphs (a)(i) and (a)(ii) of these 
Guidelines, and the compliance and audit procedures the affiliated 
member proposes to implement to ensure that the functional separation 
is maintained between the affiliated member and the DPM;
    (ii) The designation and identification of the individuals 
associated with the affiliated member responsible for maintenance and 
surveillance of such procedures;
    (iii) That the DPM shall make available to the affiliated member 
only the sort of market information that the DPM would make available 
in the normal course of its DPM activity to any other member; that the 
DPM shall only make such information available to the affiliated member 
in the same manner that it is made available to any other member; and 
that the DPM shall only make such information available to the 
affiliated member pursuant to a request by the affiliated member for 
such information;
    (iv) That where the affiliated member ``popularizes'' a security in 
which the DPM acts as DPM the affiliated member shall disclose that an 
associated DPM makes a market in the security, may have a position in 
the security, and may be on the opposite side of public orders executed 
on the Exchange in the security; and that the affiliated member shall 
forward to the Exchange, immediately after its issuance, a copy of any 
research report or written recommendation which ``popularizes'' a 
security in which the DPM acts as DPM;
    (v) That the affiliated member shall file with the Exchange such 
information and reports as the Exchange may, from time to time, require 
relating to its transactions in a security in which the DPM acts as 
DPM;
    (vi) That the affiliated member shall take appropriate remedial 
action against any person violating these Guidelines and/or the 
affiliated member's internal compliance and audit procedures adopted 
pursuant to subparagraph (b)(i) of these Guidelines, and that the 
affiliated member and the DPM each recognizes that the Exchange may 
take appropriate remedial action, including (without limitation) 
removal of securities from the DPM and/or revocation of the Rule 
8.91(e) exemption, in the event of such a violation;
    (vii) Whether the affiliated member intends to clear proprietary 
trades of the DPM and, if so, the procedures established to ensure that 
information with respect to such clearing activities will not be used 
to compromise the affiliated member's ``Chinese Wall'' (the procedures 
followed shall, at a minimum, be the same as those used by the 
affiliated member to clear for unaffiliated third parties); and
    (viii) That no individual associated with the affiliated member 
shall trade on the Exchange as a Market-Maker in any security in which 
the DPM acts as DPM. (Any written statements submitted pursuant to this 
paragraph (b) shall be collectively referred to herein as the 
``Exemption Request''.)
    (c) In the event that, notwithstanding the procedures established 
pursuant to these Guidelines, any DPM Designee of a DPM becomes aware 
of the fact that the Designee has received from the affiliated member 
any material non-public corporate or market information relating to any 
of the DPM securities, the DPM Designee shall promptly communicate that 
fact and disclose the information so received to the person associated 
with the affiliated member responsible for compliance with securities 
laws and regulations (the compliance officer) and shall seek a 
determination from the compliance officer as to whether the DPM 
Designee should, as a consequence of the Designee's receipt of such 
information, give up the DPM Designee's appointment as a DPM Designee 
in the security involved. If the compliance officer determines that the 
DPM Designee should give up the Designee's appointment as a DPM 
Designee, the DPM Designee shall, at a minimum, give the appointment up 
to another DPM Designee who is not in possession of the information so 
received. In any such event, the compliance officer shall determine 
when it is appropriate for the DPM Designee to recover the Designee's 
appointment as a DPM Designee and recommence acting as DPM Designee in 
the security involved. Procedures shall be established by the 
affiliated member to assure that in any instance when the compliance 
officer determines that a DPM Designee should give up the Designee's 
appointment as a DPM Designee, such transfer is effected in a manner 
which will prevent the market sensitive information from being 
disclosed to the remaining DPM Designees.
    The compliance officer shall keep a written record of each request 
received from a DPM Designee for a determination as referred to above. 
Such record shall be adequate to record the pertinent facts and shall 
include, at a minimum, the identification of the security, the date, a 
description of the information received by the DPM Designee, the 
determination made by the compliance officer, and the basis therefor. 
If the appointment is given up, the record shall also set forth the 
time at which the DPM Designee reacquired the appointment and the basis 
upon which the compliance officer determined that such reacquisition 
was appropriate. The Exchange shall be given prompt notice of any 
instance when the compliance officer determines that a DPM Designee 
should give up the DPM Designee's appointment and also of the 
determination that the DPM Designee should be permitted to reacquire 
the appointment. In accordance with such schedules as the Exchange 
shall from time to time prescribe (at least monthly), the written 
record of all requests received by the compliance officer from DPM 
Designees for a determination as referred to above shall be furnished 
to the Exchange for its review. Members are cautioned that any trading 
by any person while in possession of material non-public information 
received as a result of any breach of the internal controls required by 
these Guidelines may violate Exchange Act Rule 10b-5, Exchange Act Rule 
14e-3, just and equitable principles of trade, or one or more other 
provisions of the Exchange Act, regulations thereunder, or Rules of the 
Exchange. The Exchange intends to review carefully any such trading of 
which it becomes aware to determine whether any such violation has 
occurred.
    (d) Subparagraph (b)(vii) of these Guidelines permits an affiliated 
member to clear the DPM transactions of the DPM provided that the 
affiliated member establishes procedures to ensure that information 
with respect to such clearing activities will not be used to compromise 
the affiliated member's ``Chinese Wall.'' Such procedures should 
provide that any information pertaining to security positions and 
trading activities of the DPM, and information derived from any 
clearing and margin financing arrangements between the affiliated 
member and the DPM, may be made available only to those (other than 
employees actually performing clearing and margin financing functions) 
associated with the affiliated member that are in senior management 
positions and are involved in exercising general managerial oversight 
over the DPM. Generally, such information may be made available only to 
the affiliated member's chief executive officer, chief operations 
officer, chief financial officer, and senior officer responsible for 
managerial oversight of the DPM, and only for the purpose of exercising 
permitted managerial oversight. Such information may not be made 
available to anyone actually engaged in making day-to-day

[[Page 23698]]

trading decisions for the affiliated member, or in making 
recommendations to the customers or potential customers of the 
affiliated member. Any margin financing arrangements must be 
sufficiently flexible so as not to limit the ability of the DPM to meet 
market-making or other obligations under Exchange Rules.
    (e) The Exemption Request shall detail the internal controls which 
both the affiliated member and the DPM intend to adopt to satisfy each 
of the conditions stated in paragraphs (b)(i) through (b)(viii) of 
these Guidelines, and the compliance and the audit procedures they 
propose to implement to ensure that the internal controls are 
maintained. If the Exchange determines that the organizational 
structure and the compliance and audit procedures proposed by the 
affiliated member and the DPM are acceptable under these Guidelines, 
the Exchange shall so inform the affiliated member and the DPM, in 
writing, at which point a Rule 8.91(e) exemption shall be granted with 
or without conditions. Absent such prior written Exchange approval, an 
exemption shall not be available. The Exemption Request should identify 
the individuals associated with the affiliated member that are in 
senior management positions (and their titles/levels of responsibility) 
to whom information concerning the DPM trading activities and security 
positions, and information concerning clearing and margin financing 
arrangements, is to be made available, the purpose for which the 
information is to be made available, the frequency with which the 
information is to be made available, and the format in which the 
information is to be made available. If any shareholder, director, 
officer, partner, manager, member, principal, or employee of the 
affiliated member intends to serve in any such capacity with the DPM, 
or vice versa, the written statement must include a statement of the 
duties of the particular individual at both entities, and why it is 
necessary for such individual to be a shareholder, director, officer, 
partner, manager, member, principal, or employee of both entities. The 
Exchange will grant approval for service at both entities only if the 
dual affiliation is for overall management control purposes or for 
administrative and support purposes. Dual affiliation will not be 
permitted for an individual who intends to be active in the day-to-day 
business operations of both entities. Nothing in the foregoing, 
however, shall preclude an employee of one entity who performs strictly 
administrative or support functions (such as facilities, accounting, 
data processing, personnel, or similar types of functions) from 
performing similar functions on behalf of the other entity, provided 
that such individual is clearly identified, and the functions performed 
on behalf of each entity are specified in the Exemption Request, and 
all requirements in paragraph (a) of these Guidelines as to maintaining 
the confidentiality of information are satisfied.
    (f) In the event that the Exchange grants a Rule 8.91(e) exemption 
to an affiliated member: (i) the affiliated member and DPM shall abide 
by any representations and undertakings set forth in the Exemption 
Request and shall comply with any conditions placed by the Exchange 
upon the grant of such exemption; (ii) the affiliated member shall 
promptly notify the Exchange in writing in the event that any of the 
information set forth in the Exemption Request changes or becomes 
inaccurate; and (iii) the Exchange may amend or revoke its grant of 
exemptive relief pursuant to Rule 8.91(e) in the event that there is a 
change in the policies, procedures, or organizational structure of the 
affiliated member or DPM or in any of the information set forth in the 
Exemption Request.
[Modified Trading System]
    [RULE 8.80. (a) Deleted April 16, 1998. (See Rule 8.95.)]
    [(b) The MTS Designated Primary Market-Makers (``DPM'') shall be 
selected and removed as follows:]
    [(1) The selection and removal of DPMs will be conducted by the MTS 
Appointments Committee (``MTS Committee'' or ``Committee''). The 
Committee will consist of the Vice-Chairman of the Exchange, the 
Chairman of the Market Performance Committee, and nine other members, 
to be nominated by the Nominating Committee and appointed by the Board, 
whose business functions are as follows: Six market-makers, one floor 
broker not associated with a member organization that conducts a public 
customer business, and two persons associated with member organizations 
that conduct a public customer business. The nine appointed committee 
members shall have two year terms four or five of which will expire 
each year.]
    [(2) Any regular member or member organization is eligible for 
appointment as a DPM. The MTS Committee will select that candidate who 
appears best able to perform the functions of DPM in the designated 
options class or classes. Factors to be considered for selection 
include the following: adequacy of capital, experience with trading the 
option class or a similar option class, willingness to promote the 
Exchange as a marketplace, operational capacity, support personnel, 
history of adherence to Exchange rules and to all criteria specified in 
this Rule as DPM responsibilities, and trading crowd evaluations under 
Rule 8.60.]
    [(3) Applications for DPM appointment by member organizations shall 
include the name of specified nominees. The MTS Committee shall specify 
whether a DPM appointment is as an individual, or as a member 
organization. The Committee may also specify any one or more conditions 
on the appointment, in respect of any representations made in the 
application process, including but not limited to capital, operations, 
or personnel. The DPM is obligated promptly to inform the Committee of 
any material change in financial or operational condition, or in 
personnel. The appointment may not be transferred without approval of 
the MTS Committee. The DPM shall serve until he is relieved of his 
obligations by the Committee.]
    [(4) The MTS Committee may, in its discretion, open an option class 
or classes to a new DPM selection process under any of the following 
circumstances:
    (i) If upon review, the Committee determines that a DPM has not 
performed satisfactorily any condition of his appointment under Subpart 
(b)(3) or his functions as described in subpart (c) hereof. The 
Committee may conduct reviews of appointments at any time, and shall do 
so at least quarterly.
    (ii) If a DPM incurs a material financial, operational, or 
personnel change. Provided, however, that the Committee shall open an 
option class or classes to a new DPM selection process upon request, if 
a DPM member organization changes its specified nominee and the former 
nominee so requests.
    (iii) If for any reason the DPM should no longer be eligible for 
appointment, should resign appointment, or fail to perform his duties. 
The incumbent DPM may apply for the appointment in the new selection 
process.]
    [(5) The MTS Committee has discretion to relieve a DPM of his 
appointment due to a material financial, operational, or personnel 
change warranting immediate action.]
    [(6) If a DPM has been relieved of his appointment or the 
appointment otherwise becomes vacant, the MTS Committee has discretion 
to appoint an interim DPM pending the conclusion of a new DPM selection 
process. The appointment as interim DPM is not a

[[Page 23699]]

prejudgment of the new DPM selection process.]
    [(7) Deleted April 16, 1998. (See Rule 8.95.)]
    [(8) If the MTS Committee decides to terminate a DPM's appointment 
under subpart (b)(7) of this Rule, the terminated DPM will receive a 
proportionate share of the net book revenues, not to exceed one-half, 
for any period specified by the Committee up to a maximum of five 
years. This award will take into account the length of time of DPM 
service, capital commitment and efforts expended during the DPM 
appointment.]
    [(9) The hearing process before the MTS Committee will be as 
follows:
    (i) Appointment Decisions: Each applicant for appointment as DPM 
will be given an opportunity to present any matter which he wishes the 
Committee to consider in conjunction with the appointment decision. The 
Committee may require that presentation to be solely or partially in 
writing, and may require the submission of additional information from 
an applicant, member, or any person associated with a member. Formal 
rules of evidence do not apply to these proceedings.
    (ii) Decisions to Terminate Appointments: The DPM who is the 
subject of Committee review in conjunction with the termination of a 
DPM appointment will be so advised and given an opportunity to present 
any matter which he wishes the Committee to consider in conjunction 
with the termination decision. The procedure shall be as described in 
paragraph 9(i) above.
    (iii) Review: A DPM relieved of an appointment under subpart 
(b)(5), (6) or (7) of this Rule, and, in the case of a member 
organization DPM, the relieved nominee, may seek review of that 
decision under Chapter XIX of the Rules. A DPM relieved of an 
appointment under subpart (b)(4) of this Rule may also seek review of 
that decision under Chapter XIX of the Rules, but only if he applies 
for reappointment and is denied.]
    [(10) The MTS Committee may perform all functions of the Market 
Performance Committee under the Rules in respect of review and 
evaluation of the conduct of DPMs in the classes of his DPM 
appointment, including but not limited to Rules 6.71, 8.1, 8.2, 8.3, 
8.7, and 8.60. The process for review of any action taken by the MTS 
Committee under this subpart shall be the same as if the action had 
been taken by the Market Performance Committee.]
    [(c) The DPM is a member who functions in approved classes as a 
market-maker, floor broker, and in the place of the Order Book Official 
(``OBO'') exempt from Rule 8.8. In acting as a market-maker, the DPM 
shall fulfill all obligations of a market-maker in his appointed option 
class or classes. In acting as a floor broker, and in place of the OBO 
in appointed options classes, the DPM shall fulfill his obligation of 
due diligence (and all other obligations associated with these 
functions). In addition, the DPM shall:]
    [(1) assure that disseminated market quotations are accurate.]
    [(2) assure that each disseminated market quotation in appointed 
options classes shall be honored up to five contracts, or such other 
minimum number as set from time to time by the MTS Committee.]
    [(3) determine any formula for generating the automatically updated 
market quotations, disclosing the elements of the formula to the 
members of the trading crowd.]
    [(4) in addition to fulfilling general market-maker obligations 
under Rule 8.7, be present at the trading post throughout every 
business day, and, with respect to his trading as market-maker, effect 
trades which have a high degree of correlation with the overall pattern 
of trading for each series in the options classes involved.]
    [(5) participate at all times in any automated execution system 
which may be open in appointed option classes.]
    [(6) resolve trading disputes, subject to Floor Official review 
upon the request of any party to the dispute.]
    [(7) In executing transactions for his own account as market-maker, 
the DPM shall (i) accord priority to orders he represents as floor 
broker over his activity as market-maker; (ii) have a right to 
participate pro rata with the trading crowd in trades that take place 
at the DPM's principal bid or offer; and (iii) not initiate a 
transaction for his own account that would result in putting into 
effect any stop or stop limit order which may be in the book or which 
he represents as floor broker except with the approval of a Floor 
Official and when the DPM guarantees that the stop or stop limit order 
will be executed at the same price as the electing transaction.]
    [(8) In appointed options classes and in other securities traded 
subject to the rules in Chapter XXX for which a DPM has been appointed, 
the DPM shall perform all functions of the Order Book Official, 
pursuant to Rules 7.3 through 7.10, and may, but is not obligated to, 
accept non-discretionary orders which are not eligible to be placed on 
the public order book, and to represent such orders as a Floor Broker. 
The DPM may not represent discretionary orders as a Floor Broker or 
otherwise. All orders in the DPM's possession which are eligible to be 
booked shall be booked.]
    [(9) The DPM is designated to disclose book information under Rule 
7.8.]
    [(d) The Exchange shall continue to be responsible for the 
maintenance, handling, and billing of the book in option classes in 
which a DPM has been appointed, and shall retain and compensate the DPM 
for performing the OBO function. The Exchange will make personnel 
available to assist the DPM, as the DPM shall require in the DPM's OBO 
function, for which personnel the Exchange may charge the DPM a 
reasonable fee.]
* * * [Interpretations and Policies:]
    [.01  Willingness to promote the Exchange as a marketplace includes 
assisting in meeting and educating market participants (and taking the 
time for travel related thereto), maintaining communications with 
member firms in order to be responsive to suggestions and complaints, 
responding to suggestions and complaints, responding to competition in 
offering competitive markets and competitively priced services, and 
other like activities.]
    [.02  Every registered DPM shall maintain a cash or liquid asset 
position in the amount of $100,000 or in an amount sufficient to assume 
a position of twenty trading units of each security in which the DPM 
holds an appointment, whichever amount is greater. In the event that 
two or more DPMs are associated with each other and deal for the same 
DPM account, this requirement shall apply to such DPMs as one unit, 
rather than to each DPM individually.]
    [.03  In addition to his responsibilities as a Market-Maker, a 
person appointed to serve as DPM in one or more securities traded 
subject to the rules in Chapter XXX shall continuously maintain on the 
floor of the Exchange a two-sided market in the securities for which he 
has been appointed, consisting of a current bid and a current offer for 
his account, at prices reasonably calculated, under existing 
circumstances, to contribute to the maintenance of a supply of and 
demand for such securities sufficient to afford liquidity to other 
buyers and sellers of such securities whose orders are represented on 
the Exchange floor.]
[Limitations on Dealings of Designated Primary Market-Makers]
    [Rule 8.81. (a) No member (other than a Designated Primary Market 
Maker (``DPM'') acting pursuant to Rule 8.80 above), limited partner, 
officer, employee, approved person or party

[[Page 23700]]

approved, who is affiliated with a DPM or member organization, shall, 
during the period of such affiliation, purchase or sell any option in 
which such DPM is registered for any account in which such person or 
party has a direct or indirect interest. Any such person or party may, 
however, reduce or liquidate an existing position in an option in which 
such DPM is registered provided that such orders are (i) identified as 
being for an account in which such person or party has a direct or 
indirect interest; (ii) approved for execution by a Floor official; and 
(iii) executed by the DPM in a manner reasonably calculated to 
contribute to the maintenance of price continuity with reasonable 
depth. No order entered pursuant to this paragraph (a) shall be given 
priority over, or parity with, any order represented in the market at 
the same price.]
    [(b) Notwithstanding the provisions of Rule 8.80, an approved 
person or member organization which is affiliated with a DPM shall not 
be subject to Rule 8.81(a), provided that it has established and 
obtained Exchange approval of procedures restricting the flow of 
material non-public corporate or market information between itself and 
the DPM and any member, officer, or employee associated therewith.]
    [(c) For such member organization which controls or is controlled 
by or is under common control with, another organization, the exemption 
provided in paragraph (b) of this Rule shall be available to it only 
where the Exchange has determined that the relationship between the 
DPM, each person associated therewith, and such other organization 
satisfies all the conditions specified in the guidelines.]
    [(d) The procedures referred to in paragraph (b) of this rule shall 
comply with such guidelines as are promulgated by the Exchange.]
[Guidelines for Exemptive Relief Under Rule 8.81 for Members or Member 
Organizations Affiliated with a Designated Primary Market-Maker]
    [(a) The following restrictions apply to a member or member 
organization which is affiliated with a designated primary market-maker 
(``DPM''):
    It may not purchase or sell for any account in which it has a 
direct or indirect interest any security in which its affiliate is a 
DPM.
    It may not engage in any business transaction with the issuer of a 
security or its insiders in which its affiliate is a DPM.
    The member firm may not accept orders directly from the issuer, its 
insiders or certain designated parties in securities in which its 
affiliate is a DPM.]
    [This Rule provides a means by which an affiliated firm doing 
business with the public as defined in Rule 9.1 (hereafter ``member 
organization'') may obtain an exemption from the restrictions discussed 
above. This exemption is only available to a member firm which obtains 
prior Exchange approval for procedures restricting the flow of 
material, non-public information between it and its affiliated DPM, 
i.e., a ``Chinese Wall.'' This Rule sets forth the steps a member firm 
must undertake, at a minimum, to seek to qualify for exemptive relief. 
Any firm that does not obtain Exchange approval for its procedures in 
accordance with these Guidelines shall remain subject to the 
restrictions set forth above.]
    [(b) These Guidelines require that an affiliated member firm 
establish procedures which are sufficient to restrict the flow of 
information between itself and the DPM. Generally, an affiliated member 
firm seeking an exemption from the Rules discussed in paragraph (a) 
above should establish its operational structure along the lines 
discussed below.
    (i) The affiliated member firm and the DPM must be organized as 
separate and distinct organizations. At a minimum, the two 
organizations must maintain separate and distinct books, records and 
accounts and satisfy separately all applicable financial and capital 
requirements. While the Exchange will permit the affiliated member firm 
and the DPM to be under common management, in no instance may persons 
on the member firm's side of the ``Wall'' exercise influence over or 
control the DPM's conduct with respect to particular securities or vice 
versa. Any general managerial oversight must not conflict with or 
compromise in any way the DPM's market making responsibilities pursuant 
to the Rules of the Exchange.
    (ii) The affiliated member firm and the DPM must establish 
procedures designed to prevent the use of material non-public corporate 
or market information in the possession of the affiliated member firm 
to influence the DPM's conduct and avoid the misuse of DPM market 
information to influence the affiliated member firm's conduct. 
Specifically, the affiliated member firm and the DPM organization must 
ensure that material non-public corporate information relating to 
trading positions taken by the affiliated member firm in a DPM security 
are not made available to the DPM; or to any member, partner, director 
or employee thereof; by a DPM while in possession of non-public 
corporate information derived by the affiliated member firm from any 
transaction or relationship with the issuer or any other person in 
possession of such information; that advantage is not taken of 
knowledge of pending transactions or the member firm's recommendations; 
and that all information pertaining to positions taken or to be taken 
by the DPM and to the DPM's ``book'' in a DPM security is kept 
confidential and is not made available to the affiliated member firm.]
    [(c) An affiliated member firm seeking exemption shall submit to 
the Exchange a written statement which shall set forth:
    (i) The manner in which it intends to satisfy each of the 
conditions stated in subparagraphs (b)(i) and (b)(ii) of these 
Guidelines, and the compliance and audit procedures it proposes to 
implement to ensure that the functional separation is maintained;
    (ii) The designation and identification of the individual(s) within 
the affiliated member firm responsible for maintenance and surveillance 
of such procedures;
    (iii) That the DPM may make available to a broker affiliated with 
it only the sort of market information that it would make available in 
the normal course of its DPM activity to any other broker and in the 
same manner that it would make information available to any other 
broker; and that the DPM may only make such information available to a 
broker affiliated with the member firm pursuant to a request by such 
broker for such information and may not, on its own initiative, provide 
such broker with such information;
    (iv) That where it ``popularizes'' a security in which it acts as 
DPM it must disclose that an associated DPM makes a market in the 
security, may have a position in the security, and may be on the 
opposite side of public orders executed on the Floor of the Exchange in 
the security, and the firm will notify the Exchange immediately after 
the issuance of a research report or written recommendation;
    (v) That it will file with the Exchange such information and 
reports as the Exchange may, from time to time, require relating to its 
transactions in a specialty security;
    (vi) That it will take appropriate remedial action against any 
person violating these Guidelines and/or its internal compliance and 
audit procedures adopted pursuant to subsection (c)(i) of these 
Guidelines, and that it and its associated DPM each recognizes that the 
Exchange may take appropriate remedial action, including (without 
limitation) reallocation of

[[Page 23701]]

securities in which it serves as DPM and/or revocation of the 
exemption, in the event of such a violation;
    (vii) Whether the firm intends to clear proprietary trades of the 
DPM and, if so, the procedures established to ensure that information 
with respect to such clearing activities will not be used to compromise 
the firm's Chinese Wall (the procedures followed shall, at a minimum, 
be the same as those used by the firm to clear for unaffiliated third 
parties); and
    (viii) That no individual associated with it may trade as a market-
maker in any security in which the associated DPM has an appointment.]
    [(d) Paragraph (b) of these Guidelines requires the establishment 
of procedures designed to prohibit the flow of certain market sensitive 
information from a member firm to its affiliated DPM or to any member, 
partner, director or employee thereof. In the event that, 
notwithstanding these procedures, any DPM becomes aware of the fact 
that he has received any such information relating to any of his DPM 
securities from his organization's affiliated member firm, the DPM 
shall promptly communicate that fact and disclose the information so 
received to the person in the affiliated member firm responsible for 
compliance with securities laws and regulations (the compliance 
officer) and shall seek a determination from the compliance officer as 
to whether he should, as a consequence of his receipt of such 
information, give up the appointment in the option class involved. If 
the compliance officer determines that the DPM should give up the DPM 
appointment, the DPM shall, at a minimum, give it up to another member 
who is registered as DPM in the security and who is not in possession 
of the information so received. In any such event, the compliance 
officer shall determine when it is appropriate for the DPM to recover 
the DPM security and recommence acting as DPM in the DPM security 
involved. Procedures shall be established by the affiliated member firm 
to assure that in any instance when the compliance officer determines 
that a DPM should give up the appointment, such transfer is effected in 
a manner which will prevent the market sensitive information from being 
disclosed to the temporary DPM.]
    [The compliance officer shall keep a written record of each request 
received from a DPM for a determination as referred to above. Such 
record shall be adequate to record the pertinent facts and shall 
include, at a minimum, the identification of the security, the date, a 
description of the information received by the DPM, the determination 
made by the compliance officer and the basis therefor. If the 
appointment is given up, the record shall also set forth the time at 
which the DPM reacquired the appointment and the basis upon which the 
compliance officer determined that such reacquisition was appropriate. 
The Exchange shall be given prompt notice of any instance when the 
compliance officer determines that a DPM should give up the appointment 
and also of the determination that such DPM should be permitted to 
reacquire the appointment. In accordance with such schedules as the 
Exchange shall from time to time prescribe (at least monthly), the 
written record of all requests received by the compliance officer from 
the affiliated DPM for a determination as referred to above shall be 
furnished to the Exchange for its review. Members and member 
organizations are cautioned that any trading by any person while in 
possession of material, non-public information received as a result of 
any breach of the internal controls required by the Guidelines may have 
violated Rule 10b-5, Rule 14e-3, just and equitable principles of trade 
or one or more other provisions of the Exchange Act, or regulations 
thereunder or rules of the Exchange. The Exchange intends to review 
carefully any such trading of which it becomes aware to determine 
whether any such violation has occurred.]
    [(e) Subparagraph (c)(vii) of these Guidelines permits a member 
firm to clear the DPM transactions of its affiliated DPM provided it 
establishes procedures to ensure that information with respect to such 
clearing activities will not be used to compromise the firm's Chinese 
Wall. Such procedures should provide that any information pertaining to 
security positions and trading activities of the DPM, and information 
derived from any clearing and margin financing arrangements between the 
affiliated member firm and the DPM, may be made available only to those 
(other than employees actually performing clearing and margin financing 
functions) in senior management positions in the affiliated member firm 
who are involved in exercising general managerial oversight over the 
DPM. Generally, such information may be made available only to the 
affiliated member firm's chief executive officer, chief operations 
officer, chief financial officer, and senior officer responsible for 
managerial oversight of the DPM, and only for the purpose of exercising 
permitted managerial oversight. Such information may not be made 
available to anyone actually engaged in making day-to-day trading 
decisions for the affiliated member firm, or in making recommendations 
to the customers or potential customers of the affiliated member firm. 
Any margin financing arrangements must be sufficiently flexible so as 
not to limit the ability of any DPM to meet market-making or other 
obligations under Exchange Rules.]
    [(f) The written statement required by Paragraph (c) of these 
Guidelines shall detail the internal controls which both the affiliated 
member firm and the DPM intend to adopt to satisfy each of the 
conditions stated in subparagraphs (c)(i) through (c)(viii) of these 
Guidelines, and the compliance and the audit procedures they propose to 
implement to ensure that the internal controls are maintained. If the 
Exchange determines that the organizational structure and the 
compliance and audit procedures proposed by the member firm and its 
affiliated DPM are acceptable under the Guidelines, the Exchange shall 
so inform the member firm and its affiliated DPM, in writing, at which 
point an exemption shall be granted. Absent such prior written 
approval, an exemption shall not be available. The written statement 
should identify the individuals in senior management positions (and 
their titles/levels of responsibility) of the affiliated member firm to 
whom information concerning the DPM trading activities and security 
positions, and information concerning clearing and margin financing 
arrangements, is to be made available, the purpose for which it is to 
be made available, the frequency with which the information is to be 
made available, and the format in which the information is to be made 
available. If any partner, director, officer or employee of the 
affiliated member firm intends to serve in any such capacity with the 
DPM, or vice versa, the written statement must include a statement of 
the duties of the particular individual at both entities, and why it is 
necessary for such individual to be a partner, director, officer or 
employee of both entities. The Exchange will grant approval for service 
at both entities only if the dual affiliation is for overall management 
control purposes or for administrative and support purposes. Dual 
affiliation will not be permitted for an individual who intends to be 
active in the day-to-day business operations of both entities. Nothing 
in the foregoing, however, shall preclude an employee of one entity who 
performs strictly administrative or support functions (such as 
facilities, accounting, data processing, personnel and similar types of 
services) from

[[Page 23702]]

performing similar functions on behalf of the other entity, provided 
that such individual is clearly identified, and the functions performed 
on behalf of each entity are specified, in the written statement 
described above, and all requirements in Paragraph (b) above as to 
maintaining the confidentiality of information are met.]
Section D: Allocation of Securities and Location of Trading Crowds and 
DPMs
    RULE 8.95--Allocation of Securities and Location of Trading Crowds 
and DPMs.
* * * * *
* * * Interpretations and Policies.
    .01  Subject to Rule 8.83(f)[8.80(b)(6)], it shall be the 
responsibility of the Allocation Committee and the Special Product 
Assignment Committee pursuant to paragraph (a) of this Rule to 
reallocate a security in the event that the security is removed 
pursuant to another Exchange Rule from the trading crowd or 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 such allocation.
* * * * *

Chapter XXIII--Interest Rate Option Contracts

* * * * *
    RULE 23.7.--RAES.
    The Retail Automated Execution System (RAES) for interest rate 
options uses the provisions established for equity options except as 
otherwise provided in this Rule.
    (i) The appropriate Floor Procedure Committee [Modified Trading 
System Committee] (``Committee'') shall determine what series will be 
eligible for RAES and the size of eligible orders.
    (ii) Eligible orders must be market or marketable limit orders for 
one hundred or fewer contracts, as determined by the Committee, in 
series placed on the system.
* * * * *

Chapter XXX--Stocks, Warrants and Other Securities

* * * * *
    RULE 30.40.--Market-Makers.
* * * * *
    (b) Classes of Contracts Other Than Those to Which Appointed. With 
respect to securities in which he does not hold an appointment, a 
Market-Maker should not engage in transactions for an account in which 
he has an interest which are disproportionate in relation to, or in 
derogation of, the performance of his obligations, as specified in 
paragraph (a) of this Rule, with respect to those securities to which 
he does hold appointments. Whenever a Market-Maker enters the trading 
crowd for securities in which he does not hold an appointment in other 
than a floor brokerage capacity, he shall fulfill the obligations 
established by paragraph (a) of this Rule. On a day on which a 
transaction in a non-appointed security is effected for the account of 
a Market-Maker, such Market-Maker may be required to undertake the 
obligations specified in paragraph (a) of this Rule upon request by a 
Floor Broker, or by the Order Book Official or DPM in accordance with 
Rules 7.5 and 8.85(b) [8.80(c)], as applicable. Furthermore, Market-
Makers should not:
    (i) Congregate in a particular security; or
    (ii) Individually or as a group, intentionally or unintentionally, 
dominate the market in a particular security; or
    (iii) Effect purchases or sales on the floor of the Exchange except 
in a reasonable and orderly manner.
* * * * *
    RULE 30.73--Application of Exchange Rules.
* * * * *
 * * * Interpretations and Policies.
* * * * *
    .02  Any acceptance of a commitment or obligation to trade received 
on the floor through ITS or any other application of the System shall 
comply with the rules applicable to the making of bids and offers and 
transactions on the floor, except where the context otherwise requires. 
In addition, the following rules shall be applicable in the case where 
commitments or obligations to trade are issued (transmitted) from the 
floor of the Exchange Rules 6.3, 6.6, 6.21, 6.22, 6.24, 8.1 through 
8.6, 8.8, 8.85, 8.87, 8.91, [8.80, 8.81], 30.3, 30.4, 30.16, 30.18 and 
30.40.

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 parts of such statements.

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

1. Purpose
    The Exchange's DPM program began as a pilot program in 1987 with 4 
DPMs allocated a total of 11 equity option classes. The DPM program was 
granted permanent approval by the Commission in 1994.\5\ In the more 
than 11 years since its introduction, the DPM program has experienced 
significant growth and success. Currently, the program includes 30 DPMs 
which have been allocated over 725 equity option classes, as well as 
numerous index option classes and structured products.
---------------------------------------------------------------------------

    \5\ Securities Exchange Act Release No. 34999 (November 22, 
1994), 59 FR 61361 (November 30, 1994) (File No. SR-CBOE-94-36).
---------------------------------------------------------------------------

    Over the course of the program's evolution, the Exchange has 
developed various procedures for implementing the rule provisions that 
govern the program. The current rules are set forth in CBOE Rules 8.80 
and 8.81 and the Exchange has made relatively few changes to these 
rules since they were promulgated in 1987. The purpose of the current 
proposed rule change is to update the DPM rules to incorporate the 
various procedures that the Exchange implemented pursuant to Rules 8.80 
and 8.81 and to incorporate various proposed improvements and 
enhancements that the Exchange believes will be beneficial to the 
operation of the DPM program. In addition, the Exchange proposes to 
reorganize the rules governing the DPM program by segregating them into 
12 separate rules that each address 1 of the 12 primary aspects of the 
DPM program. The Exchange believes that this restructuring will improve 
the organization of the rules relating to DPMs making it easier for the 
Exchange's members to reference and understand the provisions.
    The proposed rule changes are the product of a comprehensive review 
and evaluation by the Exchange of the current rules relating to DPMs. 
This thorough and detailed review and evaluation was conducted by 
Exchange staff, the Exchange's Modified Trading System Appointments 
Committee (``MTS Committee''), the Exchange's Floor Directors 
Committee, and the Exchange's Board of Directors, and involved numerous 
meetings and discussions by and among these groups over several years.
    The Exchange filed substantially similar proposed rule change with 
the

[[Page 23703]]

Commission in 1998.\6\ After the submission of this proposed rule 
change, the Exchange received a member petition concerning the portion 
of the proposed rule change that related to the transfer of DPM 
appointments. Although the petition only addressed the portion of the 
proposed rule change that related to the transfer of DPM appointments, 
the Board of Directors decided to withdraw the entire proposal from the 
Commission because it believed the proposed rule change to be an 
integrated reorganization of all of the rule provisions relating to the 
operation of the DPM program. The Exchange then engaged in a period of 
dialogue with the Exchange's members regarding DPM transferability 
which included, among other things, Exchange membership meetings at 
which member roundtable discussions were held regarding this issue. 
Following this period of dialogue, the Board of Directors re-approved a 
substantially similar proposed rule change to update and reorganize the 
Exchange's rules relating to DPMs, subject to the approval of the 
proposed rule change by a membership vote. The proposed rule change was 
submitted to the Exchange's membership for a vote and approved on 
December 14, 1998.
---------------------------------------------------------------------------

    \6\ Securities Exchange Act Release No. 40041 (May 28, 1998), 63 
FR 30525 (June 4, 1998) (File No. SR-CBOE-98-15).
---------------------------------------------------------------------------

    The proposed rule change amends the Exchange's rule provisions 
relating to DPMs and are proposed to be segregated into proposed Rules 
8.80 through 8.91. Set forth below is a summary of each of the proposed 
rules.
    Rule 8.80--DPM Defined. Proposed Rule 8.80 defines a DPM as a 
member organization that is approved by the Exchange to function in 
allocated securities as a Market-Maker, Floor Broker, and Order Book 
Official. The only change to this definition from the current DPM 
definition is that proposed Rule 8.80 requires a DPM to be a member 
organization. The purpose of this additional requirement is to ensure 
that each DPM has a formal organizational structure in place to govern 
the manner in which it will operate and to define the relationship 
between the individuals associated with the DPM. Proposed Rule 8.80 
also clarifies that DPMs are approved by the MTS Committee and are 
allocated securities by the Exchange's Allocation Committees.\7\
---------------------------------------------------------------------------

    \7\ The Exchange's process for allocating securities to DPMs and 
Market-Maker trading crowds is set forth in CBOE Rule 8.95.
---------------------------------------------------------------------------

    Rule 8.81--DPM Designees. Proposed Rule 8.81 is divided into five 
subparagraphs, (a) through (e), and sets forth the requirements 
applicable to DPM Designees.
    Proposed Rule 8.81(a) makes explicit that a DPM may act as a DPM 
solely through its DPM Designees. A DPM Designee is defined as an 
individual who is approved by the MTS Committee to represent a DPM in 
its capacity as a DPM. Proposed Rule 8.81(a) also provides that the MTS 
Committee may subclassify DPM Designees and require certain DPM 
Designees to be subject to specified supervision and/or be limited in 
their authority to represent the DPM. For example, the MTS Committee 
may wish to require that less experienced DPM Designees only act in 
this capacity when a more experienced DPM Designee is also present at 
the trading station to provide supervision.
    Proposed Rule 8.81(b) requires each DPM Designee to (i) be an 
Exchange member, (ii) be a nominee of, or have a membership that has 
been registered for, the DPM or an affiliate of the DPM, (iii) be 
registered with the Exchange as a Market-Maker and a Floor Broker, (iv) 
have in place an authorization and guarantee from the DPM, and (v) be 
approved by the MTS Committee. Additionally, proposed Rule 8.81(b) 
provides that the MTS Committee shall have the discretion to permit an 
individual who is not affiliated with a DPM to act as a DPM Designee 
for the DPM on an emergency basis as long as the individual satisfies 
the other requirements of proposed Rule 8.81(b).
    Proposed Rule 8.81(c) provides that a DPM Designee approval will 
expire if the individual does not have trading privileges on the 
Exchange for a 6 month period. This provision is intended to ensure 
that any DPM Designee who has not had trading privileges for 6 months 
(and therefore does not engage in trading activities during that 
period) and who then desires to act again in the capacity of a DPM 
Designee will be reviewed by the MTS Committee. This will allow the 
Committee to evaluate whether the individual remains qualified to act 
as a DPM Designee.
    Proposed Rule 8.81(d) requires each DPM to have at least two DPM 
Designees who are nominees of the DPM or who have a membership that has 
been registered for the DPM.
    Exchange rules require that each member organization have at least 
one nominee or person who has registered his or her membership for the 
organization. The purpose of proposed Rule 8.81(d) is to help ensure 
that a DPM remains qualified to act as a member organization, and hence 
a DPM, if a nominee or person who has registered his or her membership 
for the organization departs from the organization.
    Proposed Rule 8.81(e) incorporates two existing rule provisions. 
First, proposed Rule 8.81(e) provides that a DPM Designee may not trade 
as a Market-Maker or Floor Broker in securities allocated to the DPM 
unless the DPM Designee is acting on behalf of the DPM in its capacity 
as a DPM. This provision is currently embodied in CBOE Rule 8.3.01 
(which is proposed to be deleted) and in current Rule 8.81 (which is 
proposed to be restated in proposed Rule 8.91). Second, proposed Rule 
8.81(e) provides that a DPM Designee is exempt from the provisions of 
CBOE Rule 8.8 when acting on behalf of the DPM in its capacity as a 
DPM. CBOE Rule 8.8 generally prohibits a member from acting as both a 
Market-Maker and Floor Broker in a trading station on the same day, and 
the exemption to CBOE Rule 8.8 for DPMs is currently set forth in 
current Rule 8.80(c).
    Rule 8.82--MTS Committee. Proposed Rule 8.82 governs the 
composition of the MTS Committee. It retains the current 11 member 
composition of the Committee which consists of the Vice-Chairman of the 
Exchange, the Chairman of the Exchange's Market Performance Committee, 
four members whose primary business is as a Market-Maker, two members 
whose primary business is as a Market-Maker or as a DPM Designee, one 
member whose primary business is as a Floor Broker who is not 
associated with a member organization that conducts a public customer 
business, and two persons associated with member organizations that 
conduct a public customer business. Currently, the nine members of the 
MTS Committee, other than the Vice-Chairman and the Chairman of the 
Market Performance Committee, are nominated by the Nominating Committee 
and appointed by the Board of Directors to serve two-year terms. Under 
proposed Rule 8.82, these nine members of the Committee will be elected 
by the Exchange's membership in the same manner that Exchange Directors 
are elected by the membership. In addition, proposed Rule 8.82 
increases the terms served by these nine members of the Committee to 
three-year terms \8\ and provides that no

[[Page 23704]]

more than two of the nine elected MTS Committee members may be 
associated with a DPM. Because of the important responsibilities of the 
MTS Committee, the Exchange believes that the MTS Committee should be 
composed of individuals who have been elected by the membership. The 
Vice-Chairman is already elected by the membership and the Chairman of 
the Market Performance Committee is typically one of the Exchange's 
elected Directors. Moreover, the Exchange believes that increasing the 
terms of the MTS Committee members by one year will provide the 
Committee with more continuity and expertise in addressing issues that 
comes before it.
---------------------------------------------------------------------------

    \8\ Upon effectiveness of this proposed rule change, the MTS 
Committee members at the time will remain as members of the 
Committee until their then current terms expire. Because MTS 
Committee members currently serve two-year terms (with 4 or 5 of 
those terms expiring each year) and because proposed Rule 8.82 
provides that the MTS Committee members will serve three-year terms 
(with three of those terms expiring each year), the Exchange's 
Nominating Committee will shorten the length of some of the terms of 
the MTS Committee members elected in the first two years following 
the effectiveness of the proposed rule change to ensure that three 
positions will come up for election each year once the three-year 
terms are fully phased in.
---------------------------------------------------------------------------

    Rule 8.83--Approval to Act as a DPM. Proposed Rule 8.83 addresses 
the DPM approval process. It is substantially similar to the current 
provisions that govern the DPM approval process set forth in current 
Rule 8.80. For example, proposed Rule 8.83 describes the criteria that 
may be considered by the MTS Committee in deciding whether to approve 
an applicant as a DPM (including such factors as adequacy of capital, 
operational capacity, trading experience, regulatory history, and 
market performance), and provides that each applicant will be given an 
opportunity to present any matter that it wishes the MTS Committee to 
consider in conjunction with the approval decision. In addition, as 
with any decision of the MTS Committee (other than an approval or 
disapproval a proposed transfer of a DPM appointment which is subject 
to direct review by the Board of Directors as discussed below), any 
applicant not approved by the MTS Committee to act as a DPM may appeal 
that decision to the Exchange's Appeals Committee under Chapter XIX of 
the Exchange's Rules. The appeal procedures provide the right to a 
formal Appeals Committee hearing concerning any approval decision, and 
the decision of the Appeals Committee may be appealed to the Board of 
Directors pursuant to CBOE Rule 19.5.
    Rule 8.84--Conditions on the Allocation of Securities to DPMs. 
Proposed Rule 8.84 grants the MTS Committee new authority to establish 
(i) restrictions applicable to all DPMs regarding the concentration of 
securities allocable to a single DPM and to affiliated DPMs, and (ii) 
minimum eligibility standards applicable to all DPMs which must be 
satisfied in order for a DPM to receive allocations of securities, 
including but not limited to, standards relating to adequacy of capital 
and number of personnel. One of the reasons for granting the MTS 
Committee the authority to limit the concentration of securities 
allocable to a single DPM and to affiliated DPMs is to promote 
competition on the Exchange's trading floor. Moreover, the Exchange 
believes this authority should help ensure that no DPM or group of 
affiliated DPMs is allocated such a large number of securities as to 
make it difficult for the Exchange to quickly reallocate those 
securities to other DPMs and/or Market-Maker trading crowds in the 
event that a DPM or group of affiliated DPMs is no longer able to 
perform in its DPM capacity. The reasons for granting the MTS Committee 
the authority to establish minimum eligibility standards for DPMs to 
receive allocations of securities is to help ensure that a DPM has the 
financial and operational ability to handle additional allocations of 
securities. Similarly, the MTS Committee may utilize this Rule to 
establish specific minimum market performance standards that must be 
satisfied by DPMs in order to receive allocations of securities so that 
a DPM that is not performing adequately with respect to the securities 
that have already been allocated to the DPM is not allocated additional 
securities.
    Rule 8.85--DPM Obligations. Proposed Rule 8.85 describes the 
obligations of a DPM. The proposed rule change states the general 
obligation of a DPM, with respect to each of its allocated securities, 
is to fulfill all of the obligations under Exchange Rules of a Market-
Maker, a Floor Broker (to the extent that the DPM acts as a Floor 
Broker), and an Order Book Official.
    Most of the obligations and other provisions contained in proposed 
Rule 8.85 are contained in current Rule 8.80. In some instances, these 
provisions are proposed to be slightly modified to clarify their scope. 
For example, proposed Rule 8.85(a)(vi) requires a DPM to segregate in a 
manner prescribed by the MTS Committee (i) all transactions consummated 
by the DPM in securities allocated to the DPM and (ii) any other 
transactions consummated by or on behalf of the DPM that are related to 
the DPM's DPM business. This will permit the Exchange to monitor each 
DPM's trading positions in order to ensure that each DPM is in 
compliance with DPM financial and other requirements.
    In addition, the Exchange proposes to charge a $250 processing fee 
for each DPM Designee that will be executing transactions on behalf of 
a DPM in that DPM's segregated account(s). This is the same fee amount 
that is charged for each participant in a joint account established 
pursuant to CBOE Rule 8.9. Since DPMs currently utilize joint accounts 
to segregate their transactions, the proposed $250 fee will essentially 
replace the $250 joint account fee that DPMs are currently being 
assessed in this regard.
    Currently, Rule 8.80(c)(3) requires each DPM to determine a formula 
for generating automatically updated market quotations and to disclose 
the components of the formula to the other members trading at the DPM's 
trading station. Proposed Rule 8.85(a)(ix) restates this requirement 
and clarifies the requirement by specifying that the components of the 
formula that are required to be disclosed include the option pricing 
calculation model, volatility, interest rate, dividend, and what is 
used to represent the price of the underlying. Proposed Rule 8.85(a) 
also provides that the MTS Committee shall have the discretion to 
exempt DPMs using proprietary automated quotation updating systems from 
having to disclose proprietary information concerning the formulas used 
by those systems. Most DPMs utilize the Exchange's Auto Quote System to 
generate automatically updated market quotations and therefore would 
not be eligible for an exemption of this kind. However, proposed Rule 
8.85(a) will permit the MTS Committee to exempt those DPMs that utilize 
proprietary automated quotation updating systems from disclosing 
confidential information concerning those systems.
    Proposed Rule 8.85(b)(i) restates the current requirement that a 
DPM is obligated to place in the public order book any order in the 
DPM's possession which is eligible for entry, subject to two limited 
exceptions. First, proposed Rule 8.85(b)(i)(A) clarifies that a DPM is 
not obligated to book a book-eligible order if the DPM immediately 
executes the order upon its receipt. This permits a DPM to immediately 
execute a marketable customer order without having to delay the 
execution by first placing the order in the public order book. Second, 
proposed Rule 8.85(b)(i)(B) provides that a DPM may refrain from 
booking a book-eligible order if the customer who placed the order has 
requested that the order not be booked, and upon receipt of the order, 
the DPM announces in public outcry the information concerning the order 
that would be displayed if the order were displayed in the public order 
book. Proposed Rule 8.85(b)(i)(B) is intended

[[Page 23705]]

to accommodate the wishes of customers who desire an opportunity for 
price improvement before the execution of a limit order at its limit 
price, while at the same time requiring the information concerning the 
order that would have been displayed in the public order book to be 
disclosed to the other members of the trading crowd, so that the other 
members of the trading crowd are not at an informational disadvantage.
    Proposed Rule 8.85(b)(ii) elaborates upon the requirement set forth 
in proposed Rule 8.85(b)(i) by requiring that a DPM not remove any 
order from the public order book except in two circumstances. First, 
proposed Rule 8.85(b)(ii) clarifies that a DPM may remove an order from 
the book if the order is canceled, expires, or is executed. Second, 
proposed Rule 8.85(b)(ii) clarifies that a DPM may return an order to 
the member that placed the order upon the member's request. For 
example, a Floor Broker may desire to leave an order with a DPM 
temporarily while the Floor Broker attends to business elsewhere on the 
trading floor, or until such time as the prevailing market moves closer 
to the order's limit price. Proposed Rule 8.85(b)(ii) is intended to 
clarify that a DPM may return an order to a Floor Broker in such 
situations.
    Proposed Rule 8.85(b)(iii) restates the current requirement that a 
DPM is obligated to accord priority to any order which the DPM 
represents as agent over the DPM's principal transactions, and sets 
forth one narrow exception to this requirement--when the customer who 
placed the order consents to not being accorded this priority. This 
exception is intended to address situations such as the following. 
Under both the current and proposed DPM rules, a DPM may, but is not 
obligated to, accept non-discretionary orders which are not eligible to 
be placed in the public order book, such as orders from a competing 
specialist or other broker-dealer. Competing specialists have on 
occasion inquired as to whether a DPM would be willing to represent an 
order on behalf of the competing specialist if the competing specialist 
were to agree to waive the priority requirement and/or allow the DPM to 
participate (or match) with the competing specialist's order. Under the 
current rules, regardless of the DPM's and customer's desire to have 
such an arrangement, they are unable to do so because the current rules 
do not allow a DPM to give priority to the orders it represents. 
Proposed Rule 8.85(b)(iii) would permit a DPM to accommodate a customer 
who desires to have a DPM represent an order and to waive this priority 
requirement with respect to the order.
    Proposed Rule 8.85(b)(iv) restates the current requirement that a 
DPM may not charge any brokerage commission with respect to the 
execution of any order for which the DPM has acted as both agent and 
principal. There is, however, an exception to the requirement set forth 
in proposed Rule 8.85(b)(iv) if the customer consents. The reasons for 
this exception are the same as the reasons for the exception to the 
priority requirement in proposed Rule 8.85(b)(iii). It should also be 
noted that although proposed Rule 8.85(b)(iv) would not permit a DPM to 
charge a brokerage commission with respect to the execution of an order 
for which the DPM acts as both agent and principal (subject to the 
limited exception described above), the DPM would be permitted under 
proposed Rule 8.85(b)(iv) to bill back to the customer any Exchange 
fees charged to the DPM with respect to the execution of the order.
    As noted above, a DPM may, but is not obligated to, accept non-
discretionary orders which are not eligible to be placed in the public 
order book. Proposed Rule 8.85(b)(v), however, also provides that a DPM 
is required to act as a Floor Broker to the extent required by the MTS 
Committee. The purpose of proposed Rule 8.85(b)(v) is to permit the MTS 
Committee to require a DPM to act as a Floor Broker if there is a need 
for the DPM to act in this capacity. For example, the MTS Committee may 
require a DPM to act as a Floor Broker if regular Floor Brokers are not 
available to represent orders in the securities allocated to the DPM.
    Proposed Rule 8.85(b)(vi) restates the current requirement that a 
DPM may not represent discretionary orders as a Floor Broker or 
otherwise. Proposed Rule 8.85 also provides that the MTS Committee may 
authorize a DPM, on a temporary basis, to accept and represent types of 
orders in one or more of the securities allocated to the DPM which vest 
the DPM with limited discretion, if the MTS Committee determines that 
unusual circumstances are present and that the acceptance and 
representation of such orders by the DPM is necessary in order to 
assure that there will be adequate representation in such securities of 
those types of orders. As with proposed Rule 8.85(b)(v), the purpose of 
this provision is to grant the MTS Committee the ability to invoke this 
provision if there is a need for a DPM to act in this capacity, such as 
if regular Floor Brokers are not available to do so.
    Proposed Rule 8.85(c)(vi) sets forth a new requirement that each 
DPM is required to segregate, in a manner prescribed by the MTS 
Committee, the DPM's business and activities as a DPM from the DPM's 
other businesses and activities. This provision will permit the MTS 
Committee to establish segregation requirements that will help to 
reduce the risk that a DPM's financial integrity will be adversely 
impacted by financial losses that may be incurred by the DPM in 
connection with its other businesses and activities.
    Rule 8.86--DPM Financial Requirements. Proposed Rule 8.86 restates 
the current requirement that each DPM is required to maintain net 
liquidating equity in its DPM account of not less than $100,000. It 
also includes two requirements which, although currently applicable to 
DPMs, are not referenced in the current DPM rules. Specifically, 
proposed Rule 8.86 requires that each DPM maintain sufficient net 
capital to comply with the requirements of Rule 15c3-1 under the Act 
and that each DPM which is an Exchange Clearing Member also maintain 
sufficient net capital to comply with the requirements of The Options 
Clearing Corporation. Although there are other rules which already 
subject DPMs to these requirements, the Exchange believes that it is 
worthwhile to also include these requirements in proposed Rule 8.86 so 
that the Rule is more informative and complete.
    Moreover, proposed Rule 8.86 requires DPMs to maintain net 
liquidating equity in their DPM accounts to conform with such 
guidelines as the MTS Committee may establish from time to time. The 
Exchange currently uses DPM financial guidelines in connection with the 
process of allocating securities to DPMs. Proposed Rule 8.86 would 
permit the Exchange to implement and enforce such guidelines and other 
future equity guidelines. The MTS Committee has established the 
financial guidelines it intends to use under proposed Rule 8.86, which 
are set forth in a draft regulatory circular that is available for 
inspection at the places specified in Section IV. The guidelines 
require that a DPM applying for the allocation of securities must have 
in its DPM account $350,000 plus $25,000 in equity for each security 
that has been allocated to the DPM in excess of the initial eight 
securities allocated to the DPM. Because these guidelines are more 
stringent than the current requirement, which states that a DPM must 
maintain an equity amount sufficient to assume a position of 20 trading 
units of each security which has been allocated to the DPM, the current 
requirement has been eliminated.

[[Page 23706]]

    Rule 8.87--Participation Entitlement of DPMs. A DPM's right to 
participate as principal in a transaction is generally governed by the 
principles of time and price priority as set forth in CBOE Rule 6.45. 
Under these principles, if a DPM announces a bid (offer) for the DPM's 
own account ahead of other members in response to a request for a 
market from a member not acting on behalf of the DPM, the DPM is 
entitled to participate up to 100% in any resulting transaction. In 
addition to the rights granted by Rule 6.45, current Rule 
8.80(c)(7)(ii) grants each DPM a right to participate ``pro rata'' with 
the Market-Makers present in the trading crowd, in any transaction in a 
security that has been allocated to the DPM if the DPM's previously 
established principal bid (offer) was equal to the highest bid (lowest 
offer) in the trading crowd, even if the DPM's bid (offer) is not 
entitled to priority under CBOE Rule 6.45. Because the term ``pro 
rata'' is not precisely defined by current Rule 8.80(c)(7)(ii), the 
scope of that term, and hence the participation right, has historically 
been interpreted by the MTS Committee.
    Since 1993, the MTS Committee has interpreted a DPM's participation 
right in transactions that occur in an allocated security (when the 
DPM's previously established principal bid (offer) was equal to the 
highest bid (lowest offer) in the trading crowd) to consist of the 
following: an initial 40% participation right, a 30% participation 
right when average daily volume in the security over the previous 
calendar quarter reaches 2501 contracts, and no guaranteed 
participation right when average daily volume in the security over the 
previous calendar quarter reaches 5,000 contracts. Additionally, the 
MTS Committee has determined to maintain all multiply traded securities 
at the 40% participation level until further notice.
    Proposed Rule 8.87 formalizes the authority of the MTS Committee to 
determine the appropriate participation right for DPMs by providing 
that the MTS Committee, subject to review by the Board of Directors, 
may establish from time to time a participation entitlement formula 
that is applicable to all DPMs. Additionally, proposed Rule 8.87 
further provides that, in accordance with the established formula, each 
DPM shall have a right to participate for its own account with the 
Market-Makers present in the trading crowd in transactions in the DPM's 
allocated securities that occur at the DPM's previously established 
principal bid or offer.
    Rule 8.88--Review of DPM Operations and Performance. Proposed Rule 
8.88(a) restates the current rule provision that the MTS Committee may 
conduct a review of a DPM's operations or performance any time, and 
clarifies that the reviews may be conducted by a subcommittee of the 
MTS Committee. Proposed Rule 8.88(a) also clarifies that a DPM and its 
associated persons are obligated to submit information requested by the 
MTS Committee in connection with a review. The current rule provision 
which contemplates that these reviews will be conducted at least 
quarterly has been revised to provide that, at a minimum, a review of 
each DPM's operations and performance shall be conducted on an annual 
basis. The reason for this change is that the Exchange does not believe 
it is necessary to conduct a formal and detailed operational and 
performance review of each DPM more than once a year. In the interim, 
the MTS Committee will review information regarding each DPM's 
operations and performance on an ongoing basis and will conduct a 
review of, and/or speak with, any DPM that has any operational or 
performance issues that need to be addressed prior to that DPM's next 
annual review. The Exchange believes that this approach is more 
effective than quarterly reviews, since it will permit the MTS 
Committee to timely address any operational or performance issues that 
require immediate attention, while allowing more time to be spent on 
each formal and detailed DPM review.
    Proposed Rule 8.88(b) provides that the MTS Committee shall perform 
the market performance evaluation and remedial action functions set 
forth in CBOE Rule 8.60 with respect to DPMs and that the MTS Committee 
may combine a review conducted pursuant to proposed Rule 8.88(a) with 
an evaluation conducted pursuant to Rule 8.60. This is consistent with 
current Rule 8.80(b)(10) which also provides that the MTS Committee may 
review and evaluate the conduct of DPMs pursuant to Rule 8.60.
    In addition, current Rule 8.80(b)(10) grants the MTS Committee 
market performance authority with respect to other issues relating to 
DPMs that the Exchange now believes should be handled by other Exchange 
committees. The Exchange believes that this authority should be 
transferred from the MTS Committee to these other committees because 
these other committees already have responsibility concerning these 
issues for non-DPMs and because consolidating responsibility for these 
issues will result in greater efficiency. Thus, for example, the 
authority to determine the series eligible for the Exchange's Retail 
Automatic Execution System (RAES) and the eligible size of RAES orders 
for securities allocated to DPMs, which is currently exercised by the 
MTS Committee pursuant to CBOE Rule 6.8, has been consolidated in the 
Exchange's Floor Procedure Committees since they have responsibility 
for these issues for securities that are allocated to non-DPM trading 
crowds. Similarly, the authority under the Rules with respect to DPM 
RAES participation and eligibility, which is currently exercised by the 
MTS Committee pursuant to CBOE Rule 8.16, has been consolidated in the 
Exchange's Market Performance Committee since it has responsibility for 
these issues for non-DPMs.
    One market performance related authority that the Exchange has 
determined the MTS Committee should retain is Floor Official authority. 
Thus, proposed Rule 8.88(c) provides that members of the MTS Committee 
may perform the functions of a Floor Official at DPM trading stations. 
MTS Committee members currently possess this authority by virtue of 
current Rule 8.80(b)(10), which provides that the MTS Committee may 
perform all of the functions of the Market Performance Committee under 
the Rules, and CBOE Rule 6.20.09, which provides that members of the 
Market Performance Committee may perform the functions of a Floor 
Official for the purpose of enforcing trading conduct policies. The 
Exchange believes that MTS Committee members should retain Floor 
Official authority with respect to DPM trading stations because MTS 
Committee members have expertise with respect to the trading conduct 
rules that are applicable to DPMs. In addition, acting as Floor 
Officials at DPM trading stations allows MTS Committee members to stay 
abreast of issues that may arise at these stations and provides the MTS 
Committee with a valuable source of information which the Committee 
utilizes in connection with its oversight of the performance and 
operations of DPMs.
    Proposed Rule 8.88 expands the market performance responsibilities 
of the MTS Committee by providing that the MTS Committee shall perform 
the market performance evaluation and remedial action functions set 
forth in Rule 8.60 with respect to the Market-Makers and Floor Brokers 
that regularly trade at DPM trading stations, in addition to performing 
these functions with respect to DPMs. The primary reason for this 
change is that the performance of a DPM trading crowd is influenced by 
both the DPM and the Market-Makers and Floor Brokers that trade in the 
crowd. Accordingly, the

[[Page 23707]]

Exchange believes that it will be more efficient if one committee 
exercises the market performance and remedial action responsibilities 
with respect to both the DPM and the Market-Makers and Floor Brokers 
that trade in a DPM trading crowd, instead of the current bifurcated 
structure in which the MTS Committee has market performance authority 
with respect to the DPM and the Market Performance Committee has market 
performance authority with respect to the Market-Makers and Floor 
Brokers.
    Rule 8.89--Transfer of DPM Appointments. Current Rule 8.80(b)(3) 
provides that a DPM appointment may not be transferred without the 
approval of the MTS Committee. Proposed Rule 8.89 expands upon this 
provision by setting forth both a detailed procedure for the 
consideration of any proposal to sell, transfer, or assign an interest 
in a DPM, and the standards that apply to such consideration. This 
procedure is set forth in proposed Rules 8.89(a) through 8.89(f).
    Proposed Rule 8.89(a) provides that a DPM proposing any sale, 
transfer, or assignment of any ownership interest or any change in its 
capital structure, voting authority, or distribution of profits or 
losses shall give at least 30 days prior written notice of the proposed 
change to the MTS Committee. Proposed Rule 8.89(a) further provides 
that if the transaction is deemed to involve the transfer of a DPM 
appointment, the transaction is required to be approved by the MTS 
Committee before it may be consummated.
    Proposed Rule 8.89(b) defines the transfer of a DPM appointment to 
include, among other things, any sale, transfer, or assignment of any 
significant share of the ownership of a DPM. A significant share of the 
ownership of a DPM is defined to include any sale, transfer, or 
assignment of a 5% or more interest in the equity or profits or losses 
of the DPM (or a series of smaller changes that in the aggregate amount 
to a change of 5% or more). Additionally, proposed Rule 8.89(b) 
provides that a sale, transfer, or assignment of less than 5% may also 
be found by the MTS Committee to represent a significant share of the 
ownership of a DPM depending on the surrounding facts and 
circumstances.
    Proposed Rule 8.89(c) provides that any DPM desiring to obtain 
approval of a transaction deemed to involve the transfer of a DPM 
appointment is required to submit a written application to the MTS 
Committee at least 30 days prior to the proposed effective date of the 
transaction. Proposed Rule 8.89(c) also requires that the application 
contain a full and complete description of the proposed transaction, 
including among other things, the transferee's ownership and capital 
structure, the identity of those persons who will perform the duties of 
the DPM following the transaction, the terms of the transaction, and 
any other material information pertaining to the transaction that the 
MTS Committee may request.
    Proposed Rule 8.89(d) provides that promptly after the receipt of a 
completed application for the approval of a proposed transfer of a DPM 
appointment, the MTS Committee will post notice of the proposed 
transfer on the Exchange Bulletin Board and in the Exchange Bulletin 
and that the MTS Committee will not ordinarily consider the proposed 
transfer until it has been posted on the Bulletin Board for at least 10 
business days. Proposed Rule 8.89(d) also provides that during this 
posting period the MTS Committee will accept written comments on the 
proposed transfer from any member and will accept written proposals 
from other members and from Market-Maker trading crowds who wish to be 
considered for appointment in some or all of the classes that are the 
subject of the proposed transfer.
    Proposed Rule 8.89(e) sets forth the factors that may be considered 
by the MTS Committee in determining whether to approve a proposed 
transfer of a DPM appointment. These factors include (i) the financial 
and operational capacity of the transferee, (ii) the continuity of 
control, management, and persons responsible for the operation of the 
DPM, (iii) avoiding undue concentration of DPM appointments on the 
Exchange, (iv) available alternatives for reallocating the DPM's 
appointment taking into account comments made and alternatives proposed 
by other members during the posting period, and (v) the best interests 
of the Exchange. In addition, proposed Rule 8.89(e) provides that no 
application relating to a proposed transfer of a DPM appointment will 
be approved by the MTS Committee until it is accompanied by complete 
and final documents pertaining to the transfer, except as the MTS 
Committee may agree to defer the delivery of specific documents for 
good cause shown.
    Proposed Rule 8.89(f) provides that the approval or disapproval of 
a proposed DPM appointment transfer is subject to direct review by the 
Board of Directors. The Secretary of the Exchange must receive within 
10 days of the announcement of the MTS Committee's decision either: (i) 
a written request for review made by the applicant (in the case of a 
failure to approve an application as submitted) or (ii) a request for 
review made by at least five Directors of the Exchange (in any case). 
In the event of a request for review, the Board will appoint a panel of 
Directors to review the matter. Following this review, the panel, with 
the assistance of Board counsel, will prepare a proposed written 
decision of the Board concerning the matter and will submit the 
proposed decision to the full Board for discussion and consideration. 
The Board will then decide whether to adopt or modify the proposed 
decision and will issue its final decision to the applicant and to the 
MTS Committee.
    In conjunction with proposed Rule 8.89, the Board of Directors has 
also issued a memo to the MTS Committee which conveys the Board's views 
with respect to the various factors that may bear upon whether a 
request to transfer an interest in a DPM appointment should be 
approved. The memo is available for inspection at the places specified 
in Section IV. The purpose of the memo is to provide guidance to the 
MTS Committee concerning the types of considerations that the Board 
believes should be taken into account in evaluating such requests. For 
example, the memo states Board's view that a DPM's franchise in its 
allocated securities is not a transferable property interest owned by 
the DPM. Thus, the Board does not believe that the outright sale of all 
or a part of a DPM's business should ordinarily be approved. 
Nevertheless, the Board also states that it recognizes that there are 
circumstances where it may be in the best interests of both the DPM and 
the Exchange to permit the transfer of some or all of the DPM's 
interest in its DPM appointment, even though this may result in the DPM 
being paid for the value of the goodwill in its DPM business. For 
example, the Board states that such circumstances might include 
situations where a transfer is for the purpose of attracting new 
capital to an existing successful DPM to enable it to expand its 
market-making activities, or to enable the DPM to bring in a new 
partner or other principal, or in response to an emergency need for 
capital where there is reason to permit the existing DPM to remain 
involved in the operation and therefore not to reallocate its 
appointment, assuming in each case that the expansion or increase in 
capital is found to be necessary or desirable in the best interests of 
the Exchange.
    The Exchange believes that proposed Rule 8.89 and the accompanying 
memo from the Board of Directors will improve the current rule 
provision regarding transfer of DPM appointments

[[Page 23708]]

both by setting forth a detailed procedure for considering such 
requests, which will help to ensure that the MTS Committee has 
sufficient information on which to base decisions regarding such 
requests, including member input, and by setting forth the appropriate 
criteria to be utilized in evaluating such requests.
    Rule 8.90--Termination, Conditioning, or Limiting Approval to Act 
as a DPM. Proposed Rule 8.90 governs the termination, conditioning, and 
limiting of approval to act as a DPM. For the most part, it restates, 
with certain clarifications, provisions that are contained in current 
Rule 8.80. For example, proposed Rule 8.90(a) clarifies that the MTS 
Committee may condition or limit a DPM's appointment (in addition to 
being permitted to terminate the appointment) if the DPM (i) incurs a 
material financial, operational, or personnel change, (ii) fails to 
comply with the DPM rules or any conditions placed on its DPM 
appointment, or (iii) is no longer eligible to act as DPM. In addition, 
proposed Rule 8.90(c) clarifies that limiting a DPM's appointment may 
include, among other things, limiting or withdrawing a DPM's 
participation entitlement, withdrawing a DPM's right to act as DPM in 
one or more of its allocated securities, and requiring a relocation of 
the DPM on the trading floor.
    As is the case under current Rule 8.80, proposed Rule 8.90(a) 
generally provides that before the MTS Committee may take any action to 
terminate, condition, or otherwise limit a member organization's 
approval to act as a DPM, the member organization will be given notice 
of a possible action and an opportunity to present any matter which it 
wishes the MTS Committee to consider in determining whether to take 
action. The only exception to this provision is that, as under current 
Rule 8.80, the MTS Committee has the authority to immediately 
terminate, condition, or otherwise limit a member organization's 
approval to act as a DPM if the DPM incurs a material financial, 
operational, or personnel change warranting action or if the DPM fails 
to comply with any of the financial requirements applicable to DPMs.
    As is also the case under the current DPM rules, if a member 
organization's approval to act as a DPM is terminated, conditioned, or 
otherwise limited by the MTS Committee pursuant to proposed Rule 8.90, 
proposed Rule 8.90(d) provides that the member organization may appeal 
that decision to the Appeals Committee under Chapter XIX. In addition, 
as described above, these appeal procedures provide the right to a 
formal Appeals Committee hearing concerning a MTS Committee's decision. 
The decision of the Appeals Committee may be appealed to the Board of 
Directors.
    Rule 8.91--Limitations on Dealings of DPMs and Affiliated Persons 
of DPMs Guidelines for Exemptive Relief Under Rule 8.91(e) for Members 
Affiliated with DPMs. Proposed Rule 8.91 and the accompanying proposed 
guidelines for exemptive relief under proposed Rule 8.91(e) restate the 
rule provisions that are currently contained in current Rule 8.81 and 
the current guidelines for exemptive relief that accompany that Rule. 
Proposed Rule 8.91 and its accompanying guidelines are intended to more 
clearly reflect those provisions and how they have historically been 
interpreted by the Exchange. For example, the Exchange believes that 
the organization of these provisions has been improved by including in 
proposed Rule 8.91 all of the restrictions on DPM affiliates that are 
set forth in the current provisions, instead of including only one of 
these restrictions in the Rule and including other restrictions in the 
accompanying guidelines, as is currently the case. In addition, the 
restrictions on DPM dealings with an issuer are restated to include in 
the case of options, which are nominally issued by The Options Clearing 
Corporation, that these restrictions are intended to apply to dealings 
with the issuer of the underlying security, whereas in the case of 
securities other than options, they apply to dealings with the issuer 
of the security itself. Moreover, other clarifying revisions of a 
similar nature have been made to the current provisions without 
changing the substance of those provisions as they have been 
interpreted by the Exchange.
    In addition, consistent with the Exchange's long-standing 
interpretation of current Rule 8.80, proposed Rule 8.91(d) explicitly 
prohibits any member affiliated with a DPM from acting as a Floor 
Broker in any trading crowd in which the DPM acts as a DPM, unless the 
member is a DPM Designee of the DPM acting on behalf of the DPM in its 
capacity as a DPM. The Exchange has interpreted current Rule 8.80 to 
provide for such a prohibition since permitting a Floor Broker 
affiliated with a DPM to represent orders in the DPM's trading crowd 
could potentially allow the DPM to direct orders to the Floor Broker 
and thus circumvent certain of the DPM's obligations such as the 
obligation to place eligible orders in the public order book , the 
obligation to accord priority to any order which the DPM represents as 
agent over the DPM's principal transactions, the obligation not to 
charge any brokerage commission with respect to the execution of any 
order for which the DPM acts as both agent and principal, and the 
obligation not to represent discretionary orders.
    Deletions from Current DPM Rules. Current Rule 8.80(b)(4)(ii) 
provides that the MTS Committee shall open a DPM's allocated option 
classes to a new DPM selection process if the DPM changes its specified 
nominee and the former nominee so requests. The Exchange no longer 
believes that this provision is appropriate because DPM organizations 
are generally much larger than they used to be. Today, DPMs often have 
many nominees, and nominees are added to and depart from DPM 
organizations more frequently than in the early years of the DPM 
program. For this reason, most DPM nominees no longer have the same 
stake in their DPM organizations that many DPM nominees may have had in 
the past. Thus, it is often no longer equitable to allow a DPM nominee 
to request a new DPM selection process for that DPM's allocated 
securities following the nominee's departure from the DPM organization.
    Two provisions relating to maintenance of the public order book 
have also been deleted. First, current Rule 8.80(b)(8), which provides 
that under certain circumstances a terminated DPM will receive a 
proportionate share of the net book revenues for a period specified by 
the MTS Committee (up to a maximum of 5 years), has not been retained 
in the proposed DPM rules. The original purpose of this provision was 
to provide incentive to members to apply to be appointed as a DPM. 
Because the interest in becoming a DPM has grown throughout the years, 
the Exchange believes this incentive is no longer necessary to attract 
DPM candidates.
    Second, the Exchange is eliminating the provision of current Rule 
8.80(d) which provides that the Exchange shall be responsible for the 
maintenance, handling, and billing of the public order book and shall 
retain and compensate the DPM for performing the Order Book Official 
function. The reason for this deletion is that over time DPMs have 
taken on the responsibility for the maintenance, handling, and billing 
of the public order book, and the Exchange no longer retains this 
responsibility nor compensates DPMs for performing these functions. The 
current provision of Rule 8.80(d), however, which contemplates that the 
Exchange may make personnel available to assist a DPM in the DPM's 
performance as an Order Book Official, for which the Exchange may 
charge the DPM a reasonable fee, has been retained

[[Page 23709]]

in proposed Rule 8.85.01 with one minor modification. Specifically, 
proposed Rule 8.85.01 merely permits, and does not require, the 
Exchange to provide this assistance when it is requested. This change 
has been made because, although the Exchange is often able to provide 
such assistance to DPMs, the Exchange may not always be able to do so.
    Finally, current Rule 8.80(c)(7)(iii) is being deleted because the 
Exchange believes the procedure called for under the Rule is cumbersome 
and because the concern that the Rule addresses is adequately addressed 
by another Exchange Rule. Current Rule 8.80(c)(7)(iii) provides that a 
DPM may not initiate a transaction for its own account that would 
result in putting into effect any stop or stop limit order which may be 
in the public order book or which the DPM represents as Floor Broker, 
except with the approval of a Floor Official and when the DPM 
guarantees that the stop or stop limit order will be executed at the 
same price as the electing transaction. The Exchange believes that this 
procedure is cumbersome because it necessitates that a Floor Official 
be summoned to the trading station each of the many times this 
situation arises. Moreover, the required approval mechanism leads to 
delay in the execution of customer orders. The Exchange believes that 
the concern addressed by current Rule 8.80(c)(7)(iii) is adequately 
addressed by CBOE Rule 6.73(a), which requires a Floor Broker handling 
an order, including a DPM, to use due diligence to execute the order at 
the best price or prices available to the Floor Broker, in accordance 
with the Rules. Thus, if a DPM were to initiate a transaction for its 
own account in order to disadvantage a customer by putting into effect 
a stop or stop limit order, the Exchange would have the ability to 
discipline the DPM for such activity under Rule 6.73 for failure to 
exercise due diligence with respect to the representation of the order.
    Conforming Rule Changes. The Exchange also proposes to make 
conforming changes to other CBOE rules to make them consistent with the 
proposed rule changes described above.
2. Basis
    The Exchange believes the proposed rule change will improve the 
operation of the DPM trading system which, in accordance with Section 
11A(a)(1)(C)(i) of the Act,\9\ assures the economic and efficient 
execution of securities transactions. Accordingly, the Exchange 
beleives that the proposed rule change is consistent with Section 6(b) 
of the Act,\10\ in general, and further the objectives of Section 
6(b)(5) \11\ in particular, in that it is designed to remove 
impediments to and perfect the mechanism of a free and open market.
---------------------------------------------------------------------------

    \9\ 15 U.S.C. 78k-1(a)(1)(C)(i).
    \10\ 15 U.S.C. 78f(b).
    \11\ 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.
    As set forth above, the Exchange filed a substantially similar 
proposed rule change with the Commission in 1998 as part of CBOE Rule 
File No. SR-CBOE-98-15 and received a member petition concerning the 
proposed rule change prior to the Exchange's withdrawal of the filing 
from the Commission. The petition objected to proposed Rule 8.89 and 
requested a membership vote regarding whether proposed Rule 8.89 should 
be approved or should be revised to absolutely prohibit any sale, 
transfer, or assignment of a DPM appointment or a DPM's allocated 
securities.
    Current Rule 8.80(b)(3) provides the MTS Committee with the 
discretion to determine whether to approve the transfer of a DPM 
appointment by setting forth that a DPM appointment may not be 
transferred without the approval of the MTS Committee. As is more fully 
described in the section entitled Rule 8.89--Transfer of DPM 
Appointments, the Exchange believes that proposed Rule 8.89 and the 
accompanying memo from the Board of Directors improve the current rule 
provision by setting forth a detailed procedure for considering 
proposals to sell, transfer, or assign an interest in a DPM, which will 
help to ensure that the MTS Committee has sufficient information on 
which to base decisions regarding such proposals, including member 
input, and by setting forth the appropriate criteria to be utilized in 
evaluating such proposals. In addition, the Exchange does not believe 
that it is in the best interest of the Exchange, customers, or the 
market to prohibit the Exchange from approving any sale, transfer, or 
assignment of a DPM appointment. To the contrary, the Exchange believes 
that there are circumstances where it may be in the best interests of 
the Exchange, customers, and the market to permit the transfer of some 
or all of the DPM's interest in its DPM appointment. Therefore, the 
Exchange believes that it is important for the Exchange to have the 
flexibility to approve such transfers in appropriate circumstances. For 
example, a transfer for the purpose of attracting new capital to an 
existing successful DPM can benefit the Exchange, customers, and the 
market by allowing the DPM to increase its personnel, to service its 
customers better, and to make tighter and deeper markets. Accordingly, 
the Exchange believes that proposed Rule 8.89 is in the best interest 
of the Exchange, customers, and the market as well as in furtherance of 
the objectives of the Act.
    The Exchange also notes that since the time the member petition 
concerning proposed Rule 8.89 was submitted to the Exchange, the 
Exchange has engaged in a period of dialogue with the Exchange's 
membership regarding the issue of DPM transferability and that the 
proposed rule changes to update and reorganize the Exchange's rules 
relating to DPMs, including proposed Rule 8.89, have been approved by 
the Exchange's membership in a membership vote.

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-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule

[[Page 23710]]

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. 20549-0609. 
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-98-54 and should be submitted by May 24, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-30(a)(12).
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Margaret H. McFarland,
Deputy Secretary
[FR Doc. 99-10985 Filed 4-30-99; 8:45 am]
BILLING CODE 8010-01-U