[Federal Register Volume 65, Number 103 (Friday, May 26, 2000)]
[Notices]
[Pages 34238-34239]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13234]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42799; File No. SR-CBOE-99-20]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 1 to Proposed Rule Change by the Chicago Board Options 
Exchange, Inc. Relating to the Exchange's Rapid Opening System

May 19, 2000.

I. Introduction

    On May 21, 1999, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4\2\ thereunder, a 
proposed rule change. In its proposal, the CBOE seeks to amend its 
Rapid Opening System (``ROS'') rule to permit two Floor Officials to 
adjust affected trades in cases where an underlying stock has been 
opened at an erroneous price and later corrected on the underlying 
market. The proposed rule change was published for comment in the 
Federal Register on July 14, 1999.\3\ On March 22, 2000, the CBOE filed 
Amendment No. 1 to the proposed rule change.\4\ The Commission received 
no comments on the proposal. This order approves the proposal, as 
amended. In addition, the Commission is publishing this notice to 
solicit comments on Amendment No. 1 to the proposed rule change and is 
simultaneously approving Amendment No. 1 on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 41599 (July 6, 
1999), 64 FR 38058.
    \4\ In Amendment No. 1, the CBOE amended the text of the rule 
language to provide notification of trade adjustments, clarify the 
trades that can be adjusted, and limit the time period that trades 
can be adjusted to the day when the correction of the erroneous 
print occurs. See letter from Timothy Thompson, Director, Regulatory 
Affairs, CBOE, to Terri Evans, Special Counsel, Division of Market 
Regulation (``Division''), Commission, dated March 2, 2000 
(``Amendment No. 1'').
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II. Description of the Proposal

    In 1999, the Commission approved ROS on a pilot basis.\5\ CBOE 
represents that ROS enables the Exchange to open classes of options 
within seconds of the opening of the underlying security, which in turn 
enables firms and customers to enter orders in open trading almost 
immediately after the opening bell. In addition, CBOE believes that in 
those classes where it has been employed, ROS has prevented backlogs of 
orders from developing during the opening. However, according to the 
Exchange, there have been a few instances where ROS has opened an 
option class at a price based upon an erroneous opening price of the 
underlying security disseminated by the primary market which is later 
corrected by the primary market only after ROS had opened the option 
class.\6\
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    \5\ See Securities Exchange Act Release No. 41033 (February 9, 
1999), 64 FR 8156 (February 18, 1999) The pilot was 
initially approved through March eq, 2000. The termination of the 
pilot was subsequently extended to September 30, 2000. See 
Securities Exchange Act Release No. 42596 (March 30, 2000), 65 FR 
18397 (April 7, 2000).
    \6\ Because ROS employs the Exchange's AutoQuote system and the 
Exchange's AutoQuote system relies on a data feed of the price of 
the underlying security to determine the option's price, an 
inaccurate underlying price can lead to an inaccurate ROS opening 
price.
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    In those instances when ROS opened on an erroneous print, the 
Exchange represents that it had to expend a substantial amount of time 
working with the participants in the trades to get their agreement to 
adjusts the trades and to determine which customer orders should have 
been filled at the opening. According to the Exchange, market makers in 
classes where ROS is employed have suffered significant deleterious 
financial consequences from these openings on an erroneous print 
because only those market maker trades that occurred at a price that 
disfavored a customer were adjusted. As a result, the Exchange believes 
market makers may become discouraged from participating in ROS because, 
even though the incidences where an erroneous print occur are rare, the 
financial consequences to a particular market maker can be substantial.
    The Exchange also notes that when ROS opens based upon an incorrect 
price of the underlying security, certain customer orders can be 
adversely affected. In particular, customer orders that would have been 
executed had ROS opened based on a correct price may not be executed. 
Further, certain customer-to-customer trades may be executed at an 
erroneous price.
    After these problems first occurred, the Exchange represents that 
it tried to educated trading crowds about ways to avoid them. For 
example, the trading crowds may wait to send their AutoQuote values 
until after the initial bid/ask quotes on the underlying are 
disseminated to ensure that the initial disseminated opening price for 
the underlying security is in line with the bid/ask quotes. Also, a 
system enhancement was put in place that provides as indication to 
crowds when ROS is being opened at a price that appears erroneous. The 
Exchange believes, however, that there is no guarantee that these 
methods can prevent every occurrence of an opening on ROS based on an 
erroneous underlying price.
    The Exchange believes, therefore, that it is necessary to grant 
Floor Officials the authority to adjust opening trades in the event 
that the class is opened at an erroneous price.\7\ The Exchange 
represents that this authority is similar to the authority Floor 
Officials currently

[[Page 34239]]

have with respect to RAES trades.\8\ The Exchange believes this change 
will prevent market makers from becoming discouraged from participating 
on ROS and will save time spent by Exchange staff negotiating with 
participants on trades that occur on erroneous prints. At the same 
time, the Exchange believes the rule change will give Floor Officials 
the authority to determine which trades should be adjusted so that a 
fair and equitable result is achieved for all market participants, 
including those customers that might not have been filled on the 
opening but otherwise would have been filled had the class opened at 
the correct price.
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    \7\ The concurrent approval of two Floor Officials would be 
needed before a trade could be adjusted. Telephone conversation 
between Timothy Thompson, Director, Regulatory Affairs, CBOE, and 
Terri Evans, Special Counsel, Division, Commission, on May 17, 2000.
    \8\ CBOE Rule 6.8(a)(ii) states in part; ``A trade execute on 
RAES at an erroneous quote should be treated as a trade reported at 
an erroneous price and adjusted to reflect the accurate market after 
receiving a Floor Official's approval.''
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    Under the proposed rule change, the Exchange will notify its 
members as soon as practicable after the correction of an erroneous 
print on the underlying.\9\ In addition, the Exchange will indicate 
that this may result in the adjustment of opening trades that were 
either executed on ROS or should have been executed on ROS. Further, 
all adjustments will be made the day of the erroneous print 
correction.\10\
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    \9\ According to the Exchange, either Exchange staff or the 
traders in the crowd where the particular options class is traded 
will know that the conditions have been met just as soon as the 
underlying market disseminates a corrected opening price, which 
usually occurs within a few minutes of the erroneous print's 
dissemination. The traders who trade the options have access to the 
underlying market's quotes and will receive a message that the 
opening print has been corrected. See Amendment No. 1, supra note 4.
    \10\ According to the Exchange, it does not have an automated 
system to handle the adjusting of these trades so it could require a 
significant amount of staff time to determine exactly which trades 
may need to be adjusted. Where there have been only a very few 
affected trades, the Exchange represents that its staff may be able 
to provide Floor Officials with the necessary information to adjust 
the trades within a few minutes. In an opening where a large number 
of trades are affected, the Exchange believes that it may take a 
number of hours to sift through the various trades and determine how 
each should be adjusted. As a result, the Exchange proposes to 
provide prompt notice that the situation has occurred and that 
trades may be adjusted. In this way, any trader or customer that may 
be affected by the adjustment can take any appropriate action to 
adjust his or her position. Because the opening print and its 
correction will be known as soon as any notice is disseminated, 
traders and customers should be able to determine the likelihood of 
their trade being adjusted and what the adjustment is likely to be. 
See Amendment No. 1, supra note 4.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether the amendment 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 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-99-20 and should be 
submitted by June 16, 2000.

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act.\11\ In 
particular, the Commission finds the proposal is consistent with 
Section 6(b)(5) \12\ of the Act. Section 6(b)(5) requires, among other 
things, that the rules of an exchange be designed to promote just and 
equitable principles of trade and to protect investors and the public 
interest.
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    \11\ In addition, pursuant to Section 3(f) of the Act, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change promotes just 
and equitable principles of trade. In particular, the proposal allows 
two Floor Officials to adjust trades when ROS opens a class based on an 
erroneous opening print disseminated by the underlying market.\13\ In 
addition, the proposal would not only affect market makers, but also 
customers whose orders should or should not have been executed at 
opening. The Commission believes that procedures to correct erroneous 
trades in a timely manner are in the interest of all parties.
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    \13\ Concurrent approval of both Floor Officials is necessary 
before a trade can be adjusted. See supra note 7.
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    The Commission also believes the proposal includes adequate 
Exchange oversight and review procedures by requiring the concurrent 
approval of two Floor Officials before a trade can be adjusted. In 
addition, CBOE amended the proposal with Amendment No. 1 to include 
certain other procedural protections that limit the Exchange's and 
Floor Officials' discretion in adjusting trades. In particular, 
Amendment No. 1 requires the Exchange to notify its members as soon as 
practicable about the possibility of a trade adjustment, limits the 
adjustment of trades to those that were or should have been executed at 
the opening, and requires that the Exchange make the adjustments on the 
day when the correction of the erroneous print occurred. The Commission 
believes these requirements should help protect investors who execute 
trades at the opening that are later adjusted.
    The Commission finds good cause for approving Amendment No. 1 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. The Commission believes that Amendment No. 1 
strikes a reasonable balance between the need to correct erroneous 
trades and the need for adequate Exchange oversight over the process. 
Further, the Commission did not receive any comments on the original 
proposal, which did not contain the protections that were incorporated 
into the proposal through Amendment No. 1.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-CBOE-99-20), as amended, is 
approved.
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    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 00-13234 Filed 5-25-00; 8:45 am]
BILLING CODE 8010-01-M