[Federal Register Volume 65, Number 30 (Monday, February 14, 2000)]
[Notices]
[Pages 7404-7407]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3370]


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SECURITIES AND EXCHANGE COMMISSION

Release No. 34-42396; File No. SR-CBOE-99


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc., Relating to the 
Operation of the Retail Automatic Execution System

February 7, 2000.
    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 July 29, 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 CBOE. The proposal permits the appropriate CBOE Floor Procedure 
Committee (``FPC'') to implement a new order assignment procedure for 
the Exchange's Retail Automatic Execution System (``RAES''). The new 
RAES order assignment procedure is called ``100 Spoke RAES Wheel.'' On 
January 27, 2000, the Exchange filed 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\ See Letter from Timothy Thompson, Director, Regulatory 
Affairs, CBOE, to Nancy Sanow, Senior Special Counsel, Division of 
Market Regulation, SEC, dated January 19, 2000 (``Amendment No. 
1''). In Amendment No. 1, the CBOE restricted the market maker 
review period for determining RAES allocations to no more than two 
weeks. See Section II.A.1.b., infra.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to amend its rules governing the operation of 
RAES, as set forth below. Proposed new language is in italics.
* * * * *
RAES Operations
    This Rule governs RAES operations in all classes of options, except 
to the extent otherwise expressly provided in this or other Rules in 
respect of specified classes of options.
RULE 6.8.
    (a)-(g) No change.
...Interpretations and Policies
    .01-.05 No change.
    .06(a) In the exercises of the their authority to determine the 
procedure for assigning RAES-eligible orders to Participating Market-
Makers for execution, the appropriate FPCs have determined that in the 
absence of any specified alternative assignment methodology, an 
assigned Participating Market-Maker is required to buy/sell the 
entirety of each RAES order assigned to him up to the maximum size of 
RAES-eligible orders in that class of options. Alternatively, the 
appropriate FPC may specify that some or all options classes are 
subject to ``Variable RAES'' or to the ``100 Spoke RAES Wheel.''
    (b) No change.
    (c) Under the ``100 Spoke RAES Wheel,'' RAES orders would be 
assigned to logged-in market-makers according to the percentage of 
their in-person agency contracts traded in that class (excluding RAES 
contracts traded) compared to all of the market-maker in-person agency 
contracts traded (excluding RAES contracts) during the review period. 
The review period will be determined by the appropriate Floor Procedure 
Committee and may be for any period not in excess of two weeks. The 
percentage distribution determined during the review period will be 
effective for the succeeding review period. On each revolution of the 
RAES Wheel, subject to the exceptions described below, each 
participating market-maker (who is logged onto RAES at the time) will 
be assigned enough contracts to replicate

[[Page 7405]]

his percentage of contracts on RAES that he traded in-person in that 
class during the review period. A participation percentage will be 
calculated for each market-maker for each class that the market-maker 
trades. For this purpose all DPM Designees of the same DMP unit will 
have their percentage aggregated into a single percentage for the DPM 
unit.
    Once a market-maker has logged onto RAES, he will be assigned 
contracts on the RAES Wheel until his market-maker participation 
percentage has been met. This may mean that multiple orders (or an 
order and a part of the succeeding order) will be assigned to the same 
market-maker on the Wheel. To understand how the RAES orders will 
actually be allocated to market-makers to meet those percentages, one 
must understand the concepts of ``spokes'' and wedges.'' A ``spoke'' is 
1% of the RAES Wheel and often may be equal to one contract. The 
appropriate Floor Procedure Committee may determine the number of 
contracts that make up one spoke. Each market maker logged onto RAES 
for that class, regardless of his participation percentage, is entitled 
to be assigned at least one spoke on every revolution of the RAES 
Wheel. For example, if a spoke equals one contract then there will be 
100 spokes that will be assigned to market-makers on every revolution 
of the RAES Wheel. If a spoke is defined as five contracts then there 
will be 500 RAES contracts assigned to the participating market-makers 
before the RAES Wheel completes one revolution. Generally, the RAES 
Wheel will consist of the number of spokes replicating the cumulative 
percentage of all market-makers logged onto the system who have a 
participation percentage plus one spoke for each market-maker that does 
not have a specific participation percentage.
    A wedge is the maximum number of spokes that a market-maker may be 
consecutively assigned at any one time of the RAES Wheel. Because the 
size of the wedge may be smaller than the number of contracts to which 
a particular market-maker is entitled during one revolution of the RAES 
Wheel, that market-maker will receive more than one turn during one 
revolution of the RAES Wheel. The wedge size will be variable, at the 
discretion of the appropriate Floor Procedure Committee and may be 
different for different classes or the same for all classes.
    The appropriate Floor Procedure Committee will notify the 
membership of each class of options that it subject to the ``100 Spoke 
RAES Wheel''.
    (d) No change.
* * * * *

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

    In its filing with the Commission, 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. CBOE has prepared summaries, set forth in Section 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 purpose of the proposed rule change is to grant the appropriate 
FPC authority to institute a new procedure for assigning orders on RAES 
to individual market makers. This new procedure is referred to as the 
``100 Spoke RAES Wheel.''
    a. Background. CBOE FPCs currently have two options by which to 
allocate RAES orders: The ``entire-order'' procedure and Variable RAES. 
Under the entire order procedure, RAES orders are assigned to market 
makers participating on RAES one order at a time to the market maker 
next in line on the ``RAES Wheel.'' When a particular market maker 
reaches his turn on the RAES Wheel, the market maker is assigned one 
entire order whether the order is for one contract or for the maximum 
number of contracts eligible for entry into RAES for that particular 
class of options. By contrast, under Variable RAES, for each class of 
options in which a market maker participates in RAES, that market maker 
is required to designate the maximum number of contracts that he is 
willing to buy or sell each time it is his turn on the RAES Wheel.\4\ 
Additionally, the appropriate FPC may establish a minimum number of 
contracts which a market maker must be willing to accept. CBOE 
represents that its FPCs now employ Variable RAES for equity options 
and both narrow-based and broad-based index options.\5\ The current 
proposal provides the appropriate FPC with a third choice for 
apportioning RAES trades among participating market makers.
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    \4\ See Securities Exchange Act Release No. 41821 (September 1, 
1999), 64 FR 50313 (September 16, 1999) (approving implementation of 
Variable RAES).
    \5\ Telephone conversation between Timothy Thompson, Director, 
Regulatory Affairs, CBOE, and Gordon Fuller, Special Counsel, 
Division of Market Regulation, SEC (February 3, 2000).
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    b. The ```100 Spoke RAES Wheel''. Under the ``100 Spoke RAES 
Wheel,'' RAES orders would be assigned to logged-in market makers 
according to the percentage of their in-person agency contracts traded 
in that class (excluding RAES contracts traded) compared to all of the 
market maker in-person agency contracts traded (excluding RAES 
contracts) during the review period. Agency contracts are defined as 
contracts that are represented by an agent and do not include contracts 
traded between market makers in person in the trading crowd. CBOE 
represents that in-person agency contracts include trading by a market 
maker against an order represented by a broker in the trading crowd, or 
against a booked order, but do not include contracts traded on RAES.\6\
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    \6\ Id.
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    On each revolution of the RAES Wheel, subject to the exceptions 
described below, each participating market maker (who is logged onto 
RAES at the time) will be assigned enough agency contracts to replicate 
the percentage of contracts on RAES that he traded in-person in that 
class during the review period. The appropriate FPC will determine the 
review period but in no event will it be entitled to set the review 
period for a period greater than two weeks. A participation percentage 
will be calculated for each market maker for each class that the market 
maker trades. The percentage distribution determined during a review 
period will be effective for the succeeding review period. Thus, any 
new market maker entrant in the trading crowd will earn his percentage 
entitlement for RAES trades after spending no more than two weeks in 
the crowd.\7\ During the initial review period, a new market maker will 
receive a one-spoke entitlement. All designees of the same Designated 
Primary Market Maker (``DPM'') unit will have their percentage 
aggregated into a single percentage for the DPM unit. Because of this 
methodology, the DPM unit can still receive its entitled percentage 
even if any particular designee is not logged onto RAES at the time.
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    \7\ See Amendment No. 1, Letter from Timothy Thompson, Director, 
Regulatory Affairs, CBOE, to Nancy Sanow, Senior Special Counsel, 
Division of Market Regulatory, SEC, dated January 19, 2000.
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    Once a percentage has been determined for a particular market 
maker, to understand how the RAES orders will actually be allocated to 
market makers to meet those percentages, one must understand the

[[Page 7406]]

concepts of ``spokes'' and ``wedges.'' The RAES Wheel may be envisioned 
as having a number of ``spokes,'' each generally representing 1% of the 
total participation of all market makers in the class. That is, a 
market maker generally will be assigned one spoke for each 1% of his 
market maker participation during the review period. If all market 
makers who are active during the review period are logged on to RAES 
and no other makers are logged on, the RAES Wheel will consist of 100 
spokes, representing 100% of all market maker activity during the 
review period. Normally, one spoke on the Wheel will be equivalent to 
one contract, except that the appropriate FPC may establish a larger 
spoke size. For example, setting the spoke size to five contracts would 
redefine the RAES Wheel for a particular option class as a Wheel of 500 
contracts. Changing the spoke size (and thus, the Wheel size) does not 
change the participating percentages of the individual market makers.
    For example, if there are twelve market makers in a crowd, 
consisting of ten veteran market makers each of whom accounted for 10% 
of total market trading (exclusive of RAES trades) during the review 
period, and two new market makers, and if nine of the veteran market 
makers and both of the new market makers are logged on to RAES, the 
RAES Wheel will consist of 92 spokes (10 spokes for each of the nine 
veteran market makers, and one spoke for each of the two new market 
makers),\8\ accounting for 92 contracts in a complete revolution of the 
Wheel. In this case, each of the veteran market makers will participate 
in ten out of every 92 contracts traded on RAES, and the two new market 
makers will each receive one out of every 92 contracts.
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    \8\ The one-spoke allocation for each of the two new market 
makers will apply only during their initial review period. After 
that initial review period, each of the two new market makers will 
be entitled to the number of spokes they have earned during the 
applicable review period.
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    A wedge is the maximum number of spokes that may be assigned to a 
market maker in any one ``hit'' during a rotation of the RAES Wheel. 
The concept of the wedge is to break up the distribution of contracts 
into smaller groupings in order to reduce the exposure of any one 
market maker to market risk. If the size of the wedge is smaller than 
the number of spokes to which a particular market maker may be entitled 
based on his participation percentage, that market maker will be 
assigned more than once during one revolution of the RAES Wheel. For 
example, in the case where one spoke is equal to one contract and the 
market maker's participation percentage is 15% (so he is entitled to 15 
contracts on one RAES Wheel revolution, i.e., 15% of 100) and the wedge 
size is 10, that market maker first will be assigned 10 contracts on 
the RAES Wheel and then 5 contracts at a different place on the RAES 
Wheel during that same revolution. Thus, in one complete revolution of 
the RAES Wheel, he will be assigned two times for at total of 15 
contracts (assuming one contract per spoke), consisting of one 10-
contract assignment and one 5-contract assignment. The wedge size will 
be variable at the discretion of the appropriate FPC and may be 
established at different levels for different classes, or at the same 
level for all classes.
    Trade Example. To better understand how RAES contracts would be 
assigned under the ``100 Spoke RAES Wheel,'' the Exchange provides the 
following example. Assume ten market makers (``MM'') are logged into 
option class ABC with the following participation percentages: MM1=14%; 
MM2-1%; MM3=8%; MM4=24%; MM5=8%; MM6=5%; MM7=3%; MM8=2%; MM9=12%; 
MM10=23%.
    Now assume the maximum number of contracts that any market maker 
may receive during one turn on the Wheel, i.e., wedge size, is ten 
contracts. Assuming the Wheel starts with MM1 and spoke size is equal 
to 1 contract, the distribution of RAES contracts during one revolution 
of the RAES Wheel for class ABC will look as follows:

1. MM1 assigned 10 contacts
2. MM2 assigned 1 contact
3. MM3 assigned 8 contact
4. MM4 assigned 10 contacts
5. MM5 assigned 8 contracts
6. MM6 assigned 5 contracts
7. MM7 assigned 3 contracts
8. MM8 assigned 2 contracts
9. MM9 assigned 10 contracts
10. MM10 assigned 10 contracts
11. MM1 assigned 4 contracts
12. MM4 assigned 10 contracts
13. MM9 assigned 2 contracts
14. MM10 assigned 10 contracts
15. MM4 assigned 4 contracts
16. MM10 assigned 3 contracts

    As can be seen, market makers 1 and 9 receive two turns on the 
Wheel during one revolution because their entitlement was higher than 
the wedge size. Market makers 4 and 10 receive three turns on the Wheel 
during one revolution.
    The following example demonstrates how the orders of a particular 
size will be distributed under the scenario described above,

Order 1=20 contracts: Contra distribution is MM1=10 contracts; MM2=1; 
MM3=8; MM4=1
Order 2=4 contracts: Contra distribution is MM4=4 contracts
Order 3=20 contracts: Contra distribution is MM4=5 contracts; MM5=8; 
MM6=5; MM7=2
Order 4=20 contracts: Contra distribution is MM7=1 contract; MM8=2; 
MM9=10; MM10=7
Order 5=20 contracts: Contra distribution is MM10=3 contracts; MM1=4; 
MM4=10; MM9=2; MM10=1
    d. Benefit of the Proposed Distribution Via the 100 Spoke RAES 
Wheel. CBOE believes that, in those classes where the 100 Spoke RAES 
Wheel is employed, the distribution of RAES trades will be essentially 
identical to the distribution of in-person agency market maker trades 
on non-RAES trades in that class. CBOE further believes that the 
implementation of the 100 Spoke RAES Wheel will reward those market 
makers who are most active in providing the services that a market 
maker is expected to perform, i.e., providing liquidity to agency 
business in the assigned option class.
2. Statutory Basis
    CBOE believes that the proposed rule change will enhance the 
ability of the Exchange to provide instantaneous, automatic execution 
of public customers' orders at the best available prices, which 
furthers the objectives of Section 6(b)(5) \9\ of the Exchange Act to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and to protect investors and the public interest.
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    \9\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will result in 
any burden on competition that is 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

    Written comments were neither solicited nor received.

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

[[Page 7407]]

organization consents, the Commission will:
    A. By order approve the 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 at 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-99-40 and should 
be submitted by [insert date 21 days from date of publication].
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    \10\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-3370 Filed 2-11-00; 8:45 am]
BILLING CODE 8010-01-M