[Federal Register Volume 64, Number 182 (Tuesday, September 21, 1999)]
[Notices]
[Pages 51158-51160]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-24496]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41872; File No. SR-CBOE-99-37]
September 13, 1999.


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., To Establish a 
Membership Ownership Requirement and Assess a Capitalization Transfer 
Fee Applicable to Designated Primary Market Makers

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on July 9, 1999, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the CBOE. On July 13, 1999, the Exchange submitted Amendment No. 1 
to the proposed rule change.\3\ The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Arthur B. Reinstein, Assistant General Counsel, 
CBOE, to Kelly Riley, Attorney, Division of Market Regulation, SEC, 
dated July 12, 1999 (``Amendment No. 1''). In Amendment No. 1, the 
Exchange re-designated the rule change as amendments to current CBOE 
Rule 8.80. The original filing amended proposed rules that are 
currently pending with the Commission and not approved as of the 
time of this filing.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to require each Exchange designated primary 
market maker (``DPM'') to own at least one Exchange membership and to 
assess a transfer fee on any DPM that is allocated, after June 29, 
1999, one or more option classes that has been traded on CBOE or 
another exchange before June 29, 1999, if that DPM undergoes a change 
in its capitalization during the five year period following the 
allocation of the pre-June 29, 1999 option class.
    The text of the proposed rule change is available at the Office of 
the Secretary, CBOE and at the Commission.

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

    In its filing with 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 for in sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    The Exchange is proposing two rule changes applicable to DPMs. 
These rule changes are part of the Exchange's initiative to expand its 
DPM program to allow for the appointment of DPMs in most, if not all, 
equity option classes traded on the Exchange. This initiative was 
approved in principle by the Exchange's membership as part of a 
membership vote that was held on June 29, 1999.
a. Requirement That DPM Own an Exchange Membership
    The Exchange proposes to require that each DPM own at least one 
Exchange membership. An Exchange membership would include a 
transferable regular membership of the Exchange or a Chicago Board of 
Trade (``CBOT'') full membership that has effectively been exercised 
pursuant to Article Fifth(b) of the CBOE Certificate of 
Incorporation.\4\ A DPM would be deemed to satisfy this ownership 
requirement if the DPM or a senior principal of the DPM owned an 
Exchange membership. In addition, no single Exchange membership could 
be used to satisfy this ownership requirement for more than one DPM. 
DPMs would be given 18 months from the effective date of this proposed 
rule change to satisfy the requirement.
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    \4\ Pursuant to Article Fifth(b) of the Certificate of 
Incorporation and CBOE Rule 3.16(c), any member of the CBOT who is 
an Eligible CBOT Full Member or an Eligible CBOT Full Member 
Delegate is entitled to become a member of CBOE. Any eligible CBOT 
member who has effectively exercised this entitlement to be a CBOE 
member is referred to as a CBOT exerciser member of CBOE.
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    The purpose of this ownership requirement is to assure that DPMs 
have a long-term commitment to the Exchange given the important 
functions they perform and to recognize that DPMs are a pivotal 
component of the Exchange's marketplace.
b. Assessment of Transfer Fee
    The Exchange is also proposing to assess a transfer fee on certain 
DPMs that change their capitalization during a defined five-year 
period. This transfer fee would only be assessed on those

[[Page 51159]]

DPMs that have been allocated one or more options classes that have 
been traded on the CBOE or other exchange prior to June 29, 1999. 
Furthermore, the transfer fee will only be imposed on those DPMs that 
have been allocated a pre-June 29, 1999 option after June 29, 1999. The 
five-year period will begin as of the allocation date of the pre-June 
29, 1999 option.
    For purposes of this transfer fee, a change in the capitalization 
of a DPM would be deemed to include any sale, transfer, or assignment 
of any ownership interest in the DPM or any change in the DPM's capital 
structure, voting authority, or distribution of profits or losses.
    The transfer fee would generally be equivalent to an applicable 
percentage of the larger of: (i) the dollar amount of the change in a 
DPM's capitalization attributable to pre-June 29, 1999 option classes 
allocated to the DPM after June 29, 1999 or (ii) the value of the 
change in the DPM's capitalization attributable to pre-June 29, 1999 
option classes allocated to the DPM after June 29, 1999, as determined 
by a formula for ascertaining an approximate value of that portion of 
the transaction. The applicable percentage to be applied in determining 
this transfer fee would be: 50% in the first year of the five-year 
period during which the DPM is subject to this transfer fee, 40% in the 
second year, 30% in the third year, 20% in the fourth year, and 10% in 
the fifth year.
    Specifically, this transfer fee would be equal to the larger of two 
figures determined by the following formulas. The first formula to 
determine the dollar amount of change in the DPM's capitalization 
attributable to pre-June 29, 1999 options classes is: (the applicable 
percentage listed above based on the year)  x  (the actual dollar value 
of the change in capitalization of the DPM as determined by the 
Exchange)  x  (the percentage of the DPM's market-maker trading volume 
in its capacity as a DPM in the previous 12 months attributable to pre-
June 29, 1999 option classes allocated to the DPM after June 29, 1999).
    With respect to the first formula, the Exchange would determine the 
actual dollar value of the change in capitalization of the DPM by 
examining the DPM's organizational documents, the documents related to 
the transactions, and the other information provided by the DPM 
concerning the transaction to ascertain the dollar value of the change 
in capitalization that is revealed by that information.
    If not all of the pre-June 29, 1999 option classes allocated to a 
DPM following that date have been traded by the DPM for at least 12 
months, the Exchange would determine the percentage of the DPM's 
market-maker trading volume attributable to those option classes based 
on the time period since the last such option class was allocated to 
the DPM for purposes of the first formula.
    The second formula to determine the value of the change in the 
DPM's capitalization attributable to pre-June 29, 1999 option classes 
is: (the applicable percentage listed above based on the year)  x  (the 
current level of overall DPM profitability per contract as determined 
by the Exchange based on DPM financial reporting)  x  (the DPM's 
market-maker trading volume in the previous 12 months in pre-June 29, 
1999 option classes allocated to the DPM after June 29, 1999)  x  (2) 
x  (the percentage change in the DPM's capitalization as determined by 
the Exchange).
    With respect to the second formula, the Exchange would determine 
the current level of overall DPM profitability per contract based on 
DPM financial reporting by examining FOCUS Reports submitted to the 
Exchange by DPMs during the prior 12 months. Specifically, the Exchange 
would determined the total net profit reported by DPMs on FOCUS Reports 
submitted during the prior 12 months and divide this total net profit 
amount by the total market-maker trading volume of DPMs (in their 
capacity as DPMs) in the prior 12 months to arrive at a proxy for the 
current level of overall DPM profitability per contract. If a DPM has 
other operations in addition to its DPM operation for which financial 
information is reflected on its FOCUS Reports, the Exchange may exclude 
the data related to that DPM from this calculation so that the 
calculation is not skewed by the level of profitability from non-DPM 
activities.
    If not all of the pre-June 29, 1999 option classes allocated to a 
DPM following that date have been traded by the DPM for at least 12 
months, the Exchange would determine the DPM's market-maker trading 
volume in those option classes during the time period since the last 
such option class was allocated to the DPM and convert that volume 
number to an annualized amount in order to determine the DPM's market-
maker trading volume figure in those classes for the purposes of the 
second formula.
    The multiple of 2 in the second formula is intended to represent 
two calendar years of assumed DPM operation.
    Finally, the Exchange would determine the percentage change in the 
DPM's capitalization for purposes of the second formula by examining 
the DPM's organizational documents, the documents related to the 
transaction, and the other information provided by the DPM concerning 
the transaction in order to ascertain this percentage change as 
revealed by that information.
    This transfer fee has three primary purposes. First, the transfer 
fee is designed to provide those who own DPMs that are allocated one or 
more existing option classes with a significant incentive to 
sufficiently capitalize the DPM and to have sufficient capital of their 
own to operate the DPM given that any transaction to transfer an 
interest in the DPM in order to raise capital in the subsequent five 
years will be subject to the transfer fee. In addition, the Exchange 
believes that allocating an existing option class to a DPM is a 
valuable right because of the established order flow and contract 
volume. Therefore, the Exchange believes it would be inequitable to 
allow those who own a DPM organization that is allocated one or more 
existing option classes to shortly thereafter sell this right by 
transferring all or a portion of their interest in the DPM organization 
to other parties. Accordingly, a second purpose of the transfer fee is 
to discourage these types of transactions, or if they occur, to require 
a significant portion of the value of the transaction to be paid to the 
Exchange. Third, as with the proposed ownership requirement, the 
transfer fee will contribute toward assuring that DPMs have a long-term 
commitment to the Exchange.
2. Basis
    The proposed ownership requirements and transfer fee will 
contribute toward assuring that DPMs have a long-term commitment to the 
Exchange. Moreover, the proposed transfer fee will provide DPMs with 
significant incentive to be sufficiently capitalized while at the same 
time discouraging transfer of interest in DPMs that are inequitable to 
the Exchange and its membership. Accordingly, the Exchange believes 
that the proposed rule change is consistent with Section 6(b) of the 
Act,\5\ in general, and furthers the objectives of Section 6(b)(5) \6\ 
in particular, because it is designated to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market, and to protect investors and the public 
interest.
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    \5\ 15 U.S.C. 78f.
    \6\ 15 U.S.C. 78f(b)(5).

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[[Page 51160]]

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 not necessary or appropriate in furtherance 
of the purposes of the Act.

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

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

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CBOE. All submissions should refer to File No.SR-CBOE-99-37 and should 
be submitted by October 12, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 99-24496 Filed 9-20-99; 8:45 am]
BILLING CODE 8010-01-M