[Federal Register Volume 65, Number 134 (Wednesday, July 12, 2000)]
[Notices]
[Pages 43060-43066]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-17595]



[[Page 43060]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43004; File No. SR-CBOE-98-54]


Self Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving a Proposed Rule Change and Amendment No. 1 to the 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment Nos. 2, 3, 4, 5 and 6 to the Proposed 
Rule Change Relating to Designated Primary Market Makers

June 30, 2000.

I. Introduction

    On December 22, 1998, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to update and reorganize its 
rules concerning designated primary market makers (``DPMs''). On 
February 18, 1999, the Exchange submitted Amendment No. 1 to the 
proposed rule change.\3\ The proposed rule change, as amended by 
Amendment No. 1, was published in the Federal Register on May 3, 
1999.\4\
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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 McCormick, Attorney, Division of Market Regulation 
(``Division''), SEC, dated February 11, 1999 (``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 41325 (April 22, 1999), 
64 FR 23691.
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    On May 11, 1999, the Exchange submitted Amendment No. 2 to the 
proposed rule change.\5\ On September 29, 1999, the Exchange submitted 
Amendment No. 3 to the proposed rule change.\6\ On December 21, 1999, 
the Exchange submitted Amendment No. 4 to the proposed rule change.\7\ 
On February 23, 2000, the Exchange submitted Amendment No. 5 to the 
proposed rule change.\8\ Finally, on May 25, 2000, the Exchange 
submitted Amendment No. 6 to the proposed rule change.\9\
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    \5\ Letter from Arthur B. Reinstein, Assistant General counsel, 
CBOE, to Kelly McCormick, Attorney, Division, SEC, dated May 10, 
1999 (``Amendment No. 2''). In Amendment No. 2, the CBOE made non-
substantive, grammatical changes to the proposed rule change.
    \6\ Letter from Arthur B. Reinstein, Assistant General Counsel, 
CBOE, to Kelly Riley, Attorney, Division, SEC, dated September 28, 
1999 (``Amendment No. 3''). In Amendment No. 3, the Exchange 
proposed changes to propose Rule 8.82 regarding election procedures. 
These changes were made to conform proposed Rule 8.82 to changes 
proposed to be made to the Exchange's constitution. Specifically, 
Amendment No. 3 would change the date by which member petitions for 
the election of members of the Modified Trading System (``MTS'') 
Committee must be submitted and clarifies that petitions must be 
signed by 100 voting members. See Securities Exchange Act Release 
No. 42026 (October 18, 1999), 64 FR 57499 (October 25, 1999) (SR-
CBOE-99-43).
    \7\ Letter from Arthur B. Reinstein, Assistant General Counsel, 
CBOE, to Kelly Riley, Attorney, Division, SEC, dated December 16, 
1999 (``Amendment No. 4''). In Amendment No. 4, the Exchange 
proposes four changes to the proposed rule change. First, Amendment 
No. 4 proposed subparagraph (a)(viii) to proposed Rule 8.85 to 
provide that a DPM shall not initiate a transaction for its own 
account that would result in putting into effect any stop or stop 
limit order, which the DPM represents as agent, unless approved by a 
Floor Official and guaranteed by the DPM that the stop or stop limit 
order will be executed at the same price as the electing 
transaction.
    Second, Amendment No. 4 deletes the portion of proposed Rule 
8.85(b) that granted the MTS Committee the discretion to authorize a 
DPM to represent discretionary orders in unusual circumstances.
    Third, Amendment No. 4 revises the Guidelines for Exemptive 
Relief under proposed Rule 8.91(e), which provides that the 
guidelines may be supplemented or modified by the Exchange in 
individual cases when the Exchange deems it appropriate. The 
provision would be amended to better define the Exchange's 
discretion to be limited to only allow the Exchange to supplement 
the guidelines in a manner that is consistent with the intent of the 
original requirements. But see Amendment No. 6 infra, note 9.
    Fourth, Amendment No. 4 deletes the phrase ``approve an interim 
DPM'' and replaced it with ``approve a DPM on an interim basis'' in 
proposed Rule 8.83(f)(i), to clarify that a DPM appointed on an 
interim basis is subject to all of the DPM obligations.
    \8\ Letter from Arthur B. Reinstein, Assistant General Counsel, 
CBOE, to Kelly Riley, Attorney, Division, SEC, dated February 17, 
2000 (``Amendment No. 5''). In Amendment No. 5, the CBOE confirms 
that any changes to the DPM financial guidelines proposed by the MTS 
Committee must be submitted to the Commission, pursuant to SEC Rule 
19b-4.
    \9\ Letter from Arthur B. Reinstein, Assistant General Counsel, 
CBOE, to Kelly Riley, Attorney, Division, SEC, dated May 24, 2000 
(``Amendment No. 6''). In Amendment No. 6, the Exchange proposes 
three changes to the rule filing. First, the Exchange proposes to 
add language to proposed Rule 8.85 (a)(viii) to make it consistent 
with the current language of CBOE Rule 8.80(c)(7).
    Second, the Exchange proposes to delete paragraph (c)(iii) of 
proposed Rule 8.85 and adds language addressing the same issue to 
proposed rule 8.88. Therefore, proposed Rule 8.88 now states that 
the review of a DPM's operations and performance shall include, 
among other things, an evaluation of the extent to which a DPM has 
satisfied its obligations under proposed Rule 8.85 and has otherwise 
acted in ways reasonably designed to make the Exchange competitive 
with other markets that trade the same options allocated to the DPM, 
taking into account the Exchange's market share.
    Third, the Exchange proposed to delete the proposed provision 
granting discretion to the Exchange under the Guidelines for 
Exemptive Relief under proposed Rule 8.91(e). As amended, the 
Exchange proposes to allow DPMs and members affiliated with DPMs to 
structure their corporate organizations in a manner so as to create 
a functional separation between the DPM and the affiliate, instead 
of the current requirement of separate and distinct organizations. 
All of the other requirements under the guidelines, however, remain 
intact.
    Finally, in Amendment No. 6, the Exchange clarifies that any 
changes to the formula for determining the participation 
entitlement, pursuant to proposed Rule 8.87, must be submitted to 
the Commission, pursuant to SEC Rule 19b-4.
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    The Commission received two comment letters on the proposal.\10\ 
This order approves the proposed rule change, as amended by Amendment 
No. 1, and approves Amendment Nos. 2, 3, 4, 5, and 6 to the proposed 
rule change on an accelerated basis. The Commission is also soliciting 
comment on Amendment Nos. 2, 3, 4, 5 and 6 to the proposed rule change 
from interested persons.
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    \10\ Letter from James I. Gelbort, to Jonathan G. Katz, 
Secretary, SEC, dated May 21, 1999; letter from John L. Rushlie, to 
Kelly Riley, Attorney, Division, received on November 19, 1999.
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II. Background

    The Exchange's DPM program began as a pilot program in 1987 with 4 
DPMs that were allocated a total of 11 equity option classes. In 1994, 
the Commission approved the DPM program on a permanent basis.\11\ Since 
its introduction, the DPM program has grown significantly. In June 
1999, the members of the Exchange voted to expand the DPM program 
floor-wide to all equity options classes, as well as specified index 
options and structured products. According to the Exchange, currently 
there are 58 DPMs that have been allocated over 1400 options products.
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    \11\ Securities Exchange Act Release No. 34999 (November 22, 
1994), 59 FR 61361 (November 30, 1994) (File No. SR-CBOE-94-36).
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    Since its inception, the Exchange has developed procedures for 
implementing the rule provisions that govern the program. Currently, 
CBOE Rules 8.80 and 8.81 govern the DPM program. In this rule filing, 
the Exchange seeks to update these DPM rules to incorporate the various 
procedures that have been implemented pursuant to CBOE Rules 8.80 and 
8.81 and to incorporate various proposed changes. In addition, the 
Exchange proposes to reorganize the rules by creating 12 separate rules 
that each address the 12 primary aspects of the DPM program.\12\
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    \12\ The Exchange filed a substantially similar proposed rule 
change with the Commission in 1998. See Securities Exchange Act 
Release No. 40041 (May 28, 1998), 63 FR 30525 (June 4, 1998) 
(``Original Proposal''). After the Original Proposal was submitted, 
however, the Exchange received a member petition concerning the 
transfer of DPM appointments. As a result of the member petition, 
the CBOE withdrew the Original Proposal. After the CBOE withdrew the 
Original Proposal, it engaged its members in a dialogue about DPM 
transferability by, among other things, holding membership meetings. 
The CBOE Board of Directors re-approved a substantially similar 
proposed rule change, which was then presented to the CBOE members 
for a vote. The CBOE members approved the current proposed rule 
change on December 14, 1998.

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[[Page 43061]]

III. Description of the Proposed Rule Change

A. Proposed Rule 8.80--DPM Defined

    Proposed Rule 8.80 defines a DPM as a member organization that is 
approved by the Exchange to function as a market maker, floor broker, 
and order book official in allocated securities. Proposed Rule 8.80 
also clarifies that the MTS Committee approves DPM appointments while 
the Exchange's Allocation Committee and Special Product Assignment 
Committee determines which securities will be allocated to each 
DPM.\13\
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    \13\ The Exchange's process for allocating securities to DPMs 
and market-maker trading crowds is set forth in CBOE Rule 8.95.
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B. Proposed Rule 8.81--DPM Designees

    Proposed Rule 8.81 sets forth the requirements applicable to DPM 
Designees. A DPM Designee is an individual approved by the MTS 
Committee to represent the DPM in its capacity as a DPM, Since a DPM, 
as defined in proposed Rule 8.80, must be a member organization, 
proposed Rule 8.81 provides that a DPM may only act through its DPM 
Designees.

C. Proposed Rule 8.82--MTS Committee

    Proposed Rule 8.82 governs the composition of the MTS Committee. 
The proposal retains the current 11 members composition, which consists 
of the Vice-Chairman of the Exchange, the Chairman of the 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 
public customer business, and two persons associated with member 
organizations that conduct public customer business.

D. Proposed Rule 8.83--Approval To Act as a DPM

    Proposed Rule 8.83 sets forth the criteria that may be considered 
by the MTS Committee when making DPM application decisions. 
Specifically, the MTS Committee may consider such factors as adequacy 
of capital, operational capacity, trading experience, regulatory 
history, and market performance. In addition, an applicant may present 
any other matter that it wishes the MTS Committee to consider in 
conjunction with the approval decision. As with most decisions of the 
MTS Committee, any applicant not approved by the MTS Committee to act 
as a DPM may appeal that decision to the Exchange's Appeals Committee, 
pursuant to 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.

E. Proposed 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 for a DPM to receive allocations of securities, 
including but not limited to, standards relating to adequacy of capital 
and number of personnel. If a DPM is not performing to the required 
level with the securities it has already been allocated, the MTS 
Committee may limit the DPM's eligibility to recieve additional 
securities.

F. Proposed Rule 8.85--DPM Obligations

    Proposed Rule 8.85 establishes that each DPM, with respect to each 
of its allocated securities, must fulfill all of the obligations under 
Exchange Rule applicable to market makers, floor brokers, and order 
book officials. The proposed rule also sets forth the specific 
obligations of DPMs that are currently contained in CBOE Rule 8.80, 
some of which have been modified to clarify their scope.
    For example, proposed Rule 8.85(a)(ix) restates the current 
requirement that the DPM is responsible for determining any formula 
used for generating automatically updated market quotes and for 
disclosing the elements of the formula (unless exempted as proprietary 
by the MTS Committee) to the trading crowd. Proposed Rule 8.85(a)(ix) 
provides the specific elements of the formula that must be disclosed, 
such as the option pricing calculation model, volatility, interest 
rate, dividend, and what is used to represent the price of the 
underlying security.
    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 that is eligible for entry, subject to two exceptions. 
First, proposed Rule 8.85(b)(i)(A) clarifies that a DPM is not 
obligated to place a book-eligible order in the book if the DPM 
immediately executes the order upon receipt. Second, proposed Rule 
8.85(b)(ii)(B) provides that a DPM may refrain from placing a book-
eligible order in the public order book if the customer who placed the 
order so requests, so long as the DPM announces the information 
concerning the order that would have been displayed had the order been 
placed in the public order book in public open outcry.
    Proposed Rule 8.85(b)(ii) states that a DPM may 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 orders, which 
have been cancelled, executed, or have expired from the public order 
book. Second, proposed Rule 8.85(b)(ii) clarifies that a DPM may return 
an order to the number that placed the order upon such member's 
request.
    In proposed Rule 8.85(b)(iii), the Exchange restates its current 
requirement that a DPM must accord priority to any order that the DPM 
represents as agent over the DPM's principal transactions. Proposed 
Rule 8.85(b)(iv) restates the current DPM prohibition that a DPM may 
not charge any brokerage commission for any order execution for which 
the DPM acted as both principal and agent. There is, however, an 
exception to this prohibition set forth in proposed Rule 8.85(b)(iv), 
if the customer consents.
    Finally, proposed Rule 8.85(c)(vi) is a new provision that requires 
that each DPM segregate, in a manner prescribed by the MTS Committee, 
its DPM businesses and activities from its other non-DPM businesses and 
activities.

G. Proposed Rule 8.86--DPM Financial Requirements

    Proposed Rule 8.86 sets forth the financial requirements for DPMs.

H. Proposed Rule 8.87--Participation Entitlement of DPMs

    The Exchange proposes to formalize the authority of the MTS 
Committee to determine the participation entitlement for DPMs in 
proposed Rule 8.87.\14\
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    \14\ Any changes to the formula established by the MTS Committee 
shall be submitted to the Commission, pursuant to SEC Rule 19b-4. 
See Amendment No. 6.
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I. Proposed Rule 8.88--Review of DPM Operations and Performance

    Proposed Rule 8.88(a) restates the current rule provision that the 
MTS Committee or a subcommittee thereof may conduct a review of a DPM's

[[Page 43062]]

operations and performance at any time. In addition, proposed Rule 
8.88(a) clarifies that a DPM and its associated persons are obligated 
to submit information requested by the MTS Committee relating to such a 
review. The proposed rule requires that each DPM be reviewed on an 
annual basis rather than a quarterly basis as is currently required. As 
part of the review, the MTS Committee will consider, among other 
things, whether a DPM has satisfied its obligations under proposed Rule 
8.85.\15\
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    \15\ See Amendment No. 6, supra note 9. As set forth in 
Amendment No. 6, the MTS Committee will consider whether the DPM has 
acted in ways that are reasonably designed to make the Exchange 
competitive with other markets that trade the same securities by 
considering the Exchange's market share in those multiple-traded 
options.
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    Proposed Rule 8.88(b) expands the market performance evaluation 
responsibilities of the MTS Committee by requiring it to perform market 
performance evaluations and remedial action functions for market makers 
and floor brokers that regularly trade at DPM stations. Proposed Rule 
8.88(c) provides that members of the MTS Committee may perform the 
functions of a floor official at DPM trading stations.

J. Proposed Rule 8.89--Transfer of DPM Appointments

    Under current CBOE Rule 8.80(b)(3), 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 a detailed procedure 
to be followed by a DPM in the event it proposes to sell, transfer, or 
assign any of its interest. The proposed rule change also includes 
standards to be applied by the MTS Committee to determine whether or 
not to approve the transfer request.

K. Proposed Rule 8.90--Termination, Conditioning, or Limiting Approval 
To Act as a DPM

    Proposed Rule 8.90 governs the MTS Committee's authority to 
terminate, condition, and limit the approval of a DPM. The proposed 
rule restates, with certain clarifications, provisions that are 
currently contained in CBOE Rule 8.80.

L. Proposed Rule 8.91--Limitations on Dealings of DPMs and Affiliated 
Persons of DPMs and Guidelines for Exemptive Relief Under Rule 8.91(e) 
for Members Affiliated With DPMs

    Proposed Rule 8.91 restates that rule provisions that are currently 
found in CBOE Rule 8.81, which restricts the dealings of DPMs and 
persons associated with DPMs.
    The proposed Guidelines for Exemptive Relief set forth the steps 
that a member affiliated with a DPM must undertake to seek an exemption 
from the prohibitions found in proposed Rule 8.91 (a) through (c). The 
Guidelines provide specific requirements and procedures that affiliated 
members must establish to prevent, among other things, the use of 
material non-public corporate or market information that may be in the 
possession of the affiliated member from influencing the conduct of the 
DPM or to avoid the use of DPM market information to influence the 
affiliated member's conduct. The Exchange has proposed to allow DPMs 
and their affiliated members to structure their corporate organizations 
in such a manner as to create a functional separation, unlike the 
current rule, which requires that the DPM and its affiliate be actual 
separate and distinct organizations.\16\
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    \16\ See Amendment No. 6, supra note 9.
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M. Deletions from Current DPM Rules

    The CBOE also proposes to delete several provisions of the current 
DPM rules.

IV. Summary of Comments and CBOE Response

    The Commission received two comment letters on the proposed rule 
change.\17\ The Exchange submitted written responses to the issues 
raised in each comment letter.\18\ The issues raised by the commenters 
and the Exchange's response are summarized below.
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    \17\ See supra note 10.
    \18\ See letters from Arthur B. Reinstein, Assistant General 
Counsel, CBOE, to Kelly Riley, Attorney, Division, SEC, dated July 
7, 1999 and February 17, 2000.
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    First, Mr. Gelbort requested that the Exchange clarify the 
relationship between CBOE Regulatory Circular RG97-114, and the 
proposed rule change. In RG97-114, the commenter stated that the 
Exchange ``arguably expanded the scope of DPM responsibilities and 
obligations beyond those specifically enumerated in CBOE rules.''
    The Exchange responded that it strongly disagreed with Mr. 
Gelbort's assertion that RG97-114 exceeded the provisions of the 
Exchange's rules. The Exchange stated that the regulatory circular 
merely restated various responsibilities and obligations of DPMs that 
were specifically set forth in the Exchange's rules. Furthermore, the 
Exchange stated that the regulatory circular merely provided an 
explanation regarding how these provisions apply to specific 
situations.
    The Exchange stated that it intends to issue a new regulatory 
circular upon the effectiveness of this proposed rule change that will 
replace RG97-114. The new circular will contain updated rule references 
and will describe the updated rule provisions. The Exchange further 
stated that since RG97-114 will be superceded, there should be no 
confusion about the relationship between it and the new proposed rules.
    Second, Mr. Gelbort stated that proposed Rule 8.85(a)(ix), which 
provides that the DPM has the obligation to determine the formula for 
generating automatically updated market quotes and to disclose the 
formula to members at the trading station, mandates continued DPM 
control over the sole system for setting quotes in a crowd and 
restricts the ability of most other market makers to adequately make 
independent markets.
    The Exchange responded that the obligation set forth in proposed 
Rule 8.85(a)(ix) is a restatement of current Rule 8.80(c)(3). The 
Exchange stated that the proposal clarifies the components of the 
formula generated by the DPM for automatically updating market quotes 
that must be disclosed to the trading crowd. In addition, the proposal 
provides the MTS Committee with the discretion to allow a DPM to keep 
proprietary information about the formula confidential.
    In response to Mr. Gelbort's statement that DPMs should not have 
control over these formulas, the Exchange responds that this would be 
antithetical to the nature and purpose of the DPM system. The Exchange 
states that the DPM system is a unitary specialist-type trading system 
and one of its primary objectives is to provide for the centralization 
of trading functions. The Exchange believes it is imperative that the 
DPM have control over the disseminated market quotations to be able to 
fulfill its DPM obligations. An integral part of controlling the DPM's 
disseminated quotes, CBOE argues, is the ability of the DPM to 
determine how automatically updated market quotes are generated.
    Responding to Mr. Gelbort's assertion that this proposal would 
restrict the ability of other market makers to make an independent 
market, the Exchange stated that market makers will continue to have 
the ability to improve an automatically updated market quote through 
open outcry. The Exchange explained that CBOE quote reporters are 
assigned to each trading crowd to input market quotations verbalized by 
members of the crowd. Moreover, a DPM has the obligation to assure that 
disseminated market quotes are

[[Page 43063]]

accurate, which includes assuring any market maker quote that improves 
the market is properly disseminated.
    Third, Mr. Gelbort suggested that the last sentence of 8.85(a)(ix) 
could be read to relieve non-DPM market makers of certain market maker 
obligations while in the presence of a DPM. This sentence states that, 
in the event of inconsistency between specific DPM obligations in 
proposed Rule 8.85 and the general market maker obligations found under 
the market maker rules, the specific obligations applying to the DPM 
shall govern. The Exchange responded that it did not agree with the 
commenter's interpretation and stated that proposed Rule 8.85(a)(ix) 
does not, and will not be interpreted to, relieve market makers of any 
obligations under the Exchange's rules.
    Finally, Mr. Gelbort suggested, in reference to proposed Rule 
8.88(c), that MTS Committee members acting as floor officials or 
otherwise should be specifically precluded from intervening in any 
dispute that involves an affiliated member or co-employee.
    The Exchange responded that current Exchange procedures already 
preclude such conflicts. The CBOE submitted Regulatory Circular RG96-
81, which sets forth committee standards and procedures and 
specifically provides that a committee member should recuse himself 
from participation in any committee action if he believes that he may 
not be able to participate in a fair and impartial manner. In 
particular, if the committee member has a business relationship with an 
individual or entity that is the subject of a committee discussion or 
vote, member recusal would be appropriate. The Exchange believes that 
this regulatory circular specifically addresses the concerns raised by 
Mr. Gelbort.
    In his comment letter, Mr. Rushlie raised two concerns with the 
proposed rule change. First, Mr. Rushlie asserted that he believed that 
the ``new'' DPM system would limit competition within each pit because 
non-DPM traders would be forced to ``go along with the DPM's markets'' 
or risk being cut out of trades. Second, Mr. Rushlie questioned the 
validity of the member vote taken to approve the proposed rule change. 
Specifically, he asserted that seat holders not present on the floor of 
the Exchange were not given the opportunity to vote on the proposal.
    In response to Mr. Rushlie's comments, the Exchange first clarified 
that the DPM system is not new to the CBOE floor and that the proposal 
only seeks to reorganize and restructure the current rules applicable 
to DPMs. The Exchange strongly disagreed with Mr. Rushlie's first 
concern about market makers being forced to go along with DPMs or risk 
being cut out of trades. The Exchange stated that any action on the 
floor that would act to discourage a member from making competitive 
markets would be a serious rule violation. Further, the Exchange noted 
that Mr. Rushlie failed to identify any proposed rule that would 
restrict the ability of a market maker from competing with a DPM to 
improve DPM markets.
    In response to Mr. Rushlie's comment that the vote was invalid 
because seat owners were not provided with the right to vote on the 
proposal, the Exchange cited CBOE Rule 8.95.03. This rule states that a 
trading crowd may decide that it no longer wishes to trade an options 
class that opened for trading prior to May 1, 1987. Pursuant to this 
rule, market makers and floor brokers that satisfy specified 
transaction requirements may vote. The rule, however, does not require 
that a member own a membership to be eligible to vote. Thus, according 
to the Exchange, the vote was held in a manner consistent with its 
rules.
    Finally, the Exchange stated that Exchange members were given ample 
notice and opportunity to vote on the proposal before its submissions 
to the Commission and that members voted to approve the proposal.

V. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\19\ In particular, the Commission believes that the proposal 
is consistent with the requirements of Sections 6(b)(3)\20\ and 
6(b)(5)\21\ of the Act. Section 6(b)(3) requires, among other things, 
that the rules of an exchange assure a fair representation of its 
members in the administration of its affairs.\22\ Section 6(b)(5) 
requires, among other things, that the rules of an exchange be designed 
to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and in general, protect investors and the public interest.\23\ 
Moreover, Section 6(b)(5) requires that the rules of a national 
securities exchange be designed to not permit unfair discrimination 
between customers, issuers, brokers, or dealers.\24\
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    \19\ In approving this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \20\ 15 U.S.C. 78f(b)(3).
    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78f(b)(3).
    \23\ 15 U.S.C. 78f(b)(5).
    \24\ Id.
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    The CBOE's DPM program has been utilized for approximately 13 
years. During this time, the program has successfully grown to include 
58 DPMs that are allocated over 1400 options classes. The Commission is 
not aware of any substantial problems arising from the workings of the 
program and believes that the proposed rules approved today will help 
clarify and govern the DPM program.
    As stated above, the Commission believes that the proposed rule 
change is consistent with Section 6(b)(3) of the Act.\25\ Specifically, 
proposed Rule 8.82 provides members with the ability to nominate 
members of the MTS Committee, which is the committee that implements 
and monitors the DPM program. Further, members will now be able to vote 
for the candidates for this committee. Currently, the CBOE Board of 
Directors appoints members of the MTS Committee that are nominated by 
the CBOE Nominating Committee. By providing members with the 
opportunity to choose their representation on the MTS Committee, 
members will now have a voice and be actively involved in the policies 
and oversight of the DPM system.
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    \25\ 15 U.S.C. 78f(b)(3).
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    The Commission finds that the proposed rules approved today promote 
just and equitable principles of trade consistent with Section 6(b)(5) 
of the Act \26\ because they provide a cohesive set of rules governing 
the DPM trading program. For example, proposed Rule 8.85 sets forth an 
extensive list of obligations to be fulfilled by each DPM. Under this 
proposed rule, the DPM is required to fulfill all of the obligations 
under Exchange rules that are applicable to market makers, floor 
brokers, and order book officials. Proposed Rule 8.85 also sets forth 
specific DPM obligations, such as the manner in which the DPM must 
segregate its transactions and the manner in which it must disseminate 
automatically updated market quotes. These DPM obligations should 
ensure that the DPM maintains a fair and orderly market in its 
allocated securities.
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    \26\ 15 U.S.C. 78f(b)(5).
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    The proposed rule also mandates how a DPM must handle customer 
limit orders and the priority that must be

[[Page 43064]]

afforded to customer orders. Proposed Rule 8.85(b)(i) states that a DPM 
is required to place in the public order book any order in its 
possession that is book eligible (subject to two exceptions), while 
proposed Rule 8.85(b)(ii) requires that a DPM may not remove any order 
from the public order book, except in two specific circumstances.
    One of the exceptions to proposed Rule 8.85(b)(i) states that a DPM 
is not required to place a book-eligible order in the public order book 
if the DPM executes the order immediately upon receipt. This exception 
should ensure investors that have marketable orders receive more timely 
executions by clarifying that the DPM is not required to first place 
the order in the public order book if it intends to immediately execute 
the book-eligible order. The second exception to proposed Rule 
8.85(b)(i) allows a DPM to not place a book-eligible order in the 
public order book if the customer so requests. Upon receipt of such 
order, however, the DPM must announce the order in public outcry. This 
requirement should accommodate investors who desire a price improvement 
opportunity before execution, while also requiring that the order be 
disclosed to members of the trading crowd so that they are not at an 
informational disadvantage. These proposed changes should ensure that 
DPMs handle orders in a fair manner, which should, in turn, help to 
ensure liquidity and best execution of customer orders.
    The Commission also finds that the proposed rules provide 
protection to investors and the public interest consistent with the 
requirements of Section 6(b)(5).\27\ For example, the definition of the 
term, DPM, has been amended to allow only member organizations to 
become DPMs. This modification should ensure that each DPM has a formal 
organizational structure to govern the manner in which it operates, 
which should provide investors with a more stable and professional DPM 
program. In addition, this requirement should enhance the 
qualifications and abilities of DPMs on the Exchange floor.
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    \27\ 15 U.S.C. 78f(b)(5).
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    The proposed rule change also deletes a provision that allowed DPM 
nominees, upon departure from the DPM, to request that the DPM's 
allocated securities be open to reallocation. By eliminating this 
requirement, the DPM program should have more continuity. Today, 
according to the Exchange, many DPMs are much larger and nominee 
turnover is more frequent. Therefore, the departure of nominees does 
not have the impact it once had and the current rule is no longer 
justified.
    Investors' interests also are protected by the clarified role of 
the MTS Committee. For example, under proposed Rule. 8.81, the MTS 
Committee will now have the authority to limit the activities or 
require the supervision of DPM Designees. This requirement should 
provide an additional layer of supervision over inexperienced DPM 
Designees, which should ensure that customer orders are handled 
properly.
    Moreover, the MTS Committee, pursuant to proposed Rule 8.83, must 
take into consideration many factors in determining whether to allow a 
member organization to act as a DPM. Such factors include the 
organization's adequacy of capital, operational capacity, trading 
experience, regulatory history, and market performance. These factors 
should ensure that those organizations approved to act as DPMs have the 
ability to perform successfully and competently. In addition, the MTS 
Committee will be required to review DPMs on an annual basis pursuant 
to proposed Rule 8.88. The MTS Committee will review each DPM's 
operations and performance to determine if the DPM is adequately 
performing its duties. Although the proposed rule change reduces the 
number of reviews from quarterly to annually, the annual review 
conducted by the MTS Committee should be more extensive. Moreover the 
MTS Committee will continue monitor DPMs throughout the year and 
address any problems or issues as they may arise.
    Proposed Rule 8.86 and the accompanying proposed regulatory 
circular increase the financial requirements of DPMs. The Commission 
finds that the increased requirements should enhance investor 
protections by ensuring that DPMs have sufficient capital to maintain 
an orderly market for its allocated securities.
    Further, the proposal to delegate specific oversight authority to 
other appropriate Exchange committees should enhance the fair and 
consistent application of the CBOE's rules and policies for all 
members. While all Exchange members have be held to the same standards, 
those standards will now be interpreted and applied by a single 
committee in a more consistent fashion.
    The Commission finds that the transfer rules set forth in proposed 
Rule 8.89 generally protect the public interest because it provides a 
detailed procedure that must be followed in the event of a sale, 
transfer, or assignment of any ownership interest or any change in its 
capital structure. Because the Exchange has an interest in approving 
transfers to ensure that its members are qualified and able to execute 
their obligations, the Commission finds that the proposed rule to be 
consistent with the Act.
    Finally, proposed Rule 8.91 should ensure that DPMs are not 
involved in inappropriate conflicts of interest, which could 
potentially harm investors and the integrity of the Exchange. The 
proposed guidelines for exemptive relief allow DPMs to be affiliated 
with other persons or entities so long as procedures are established to 
restrict any improper flow of material, non-public information. The 
CBOE has proposed to require that a DPM and its affiliates be 
functionally separate entities, rather than specifically separate 
organizations, as currently required. The functional separation must 
include approprirate procedures to restrict the flow of material, non-
public information. Thus, a DPM must establish an information barrier 
between its DPM activities and its affiliate's business activities.
    The Commission believes that this proposed structure is consistent 
with Section 6(b)(5) of the Act \28\ because it is designed to prevent 
fraudulent and manipulative acts and practices, and to protect 
investors and the public interest. The CBOE guidelines have been 
drafted to prevent inappropriate use of non-public information by DPMs 
and their affiliates that could result in market manipulation. The 
Commission expects the CBOE to continue to monitor DPMs and their 
affiliates to ensure that their corporate structures and information 
barriers continue to satisfy these goals.
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    \28\ 15 U.S.C. 78f(b)(5).
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    The Commission also finds that the proposed rule change is 
consistent with the requirements of the Act because it clearly sets 
forth the obligations of DPMs. The Exchange has added new rules, which 
should provide DPMs with adequate notice of the obligations and duties 
expected by the Exchange and the procedures and ramifications for 
failing to adequately comply with such obligations and duties.
    The Exchange also proposed to delete paragraph (c)(iii) of proposed 
Rule 8.85 and added language addressing the same issue to proposed Rule 
8.88. This proposed amendment deletes the affirmative obligation that a 
DPM be required to increase the Exchange's order flow in securities 
allocated to the DPM. The Commission believes that it is more 
appropriate to measure a DPM's performance in its allocated securities 
by considering, among other things, the

[[Page 43065]]

Exchange's market share in a DPM's allocated securities rather than 
generically requiring a DPM to act in such a manner to increase the 
Exchange's market share.
    Finally, the commission is satisfied that the Exchange adequately 
addressed the issues raised in the comment letters. Upon approval of 
this order, the Exchange represents that it will issue a regulatory 
circular to inform its members of the changes to the DPM rules. This 
regulatory circular will replace the current RG97-114 and should 
minimize member confusion.
    The Commission finds good cause to accelerate approval of Amendment 
Nos. 2 through 6 to the proposed rule change prior to the thirtieth day 
after the date of publication in the Federal Register. In Amendment No. 
2, the Exchange only made non-substantive, grammatical changes to the 
proposed rule change and did not change the meaning or intent of the 
proposed rule change. Moreover, the changes submitted in Amendment No. 
2 did not raise any issue of regulatory concern regarding the proposed 
rule change. Therefore, the Commission believes that good cause exists, 
consistent with Section 6(b)(5) \29\ and Section 19(b) \30\ of the Act, 
to approve the amendment on an accelerated basis.
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    \29\ 15 U.S.C. 78(f)(b)(5).
    \30\ 15 U.S.C. 78s(b).
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    In Amendment No. 3, the Exchange made conforming changes to 
proposed Rule 8.82 to make it consistent with the proposed changes to 
the Exchange's constitution.\31\ The Commission notes that these 
changes were approved by the Exchange's membership and have been 
noticed in the Federal Register for public comment. The Commission did 
not receive any comment on these changes. Thus, the Commission is 
satisfied that the Exchange's membership and the public received 
adequate notice and had a reasonable opportunity to comment on these 
changes and therefore, there changes may be approved without further 
publication.
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    \31\ See supra note 6.
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    In Amendment No. 4, the Exchange reinstated the current provision 
that prohibits a DPM from initiating a transaction for its own account 
that would result in a stop or stop limit order, which the DPM 
represents as agent, from being put into effect except with the 
approval of a floor official. The Commission believes that this 
provision provides significant protections for investors and, thus, it 
is appropriate to accelerate approval.
    In Amendment No. 4, the Exchange also deleted a provision of 
proposed Rule 8.85(b) that would have permitted a DPM, with MTS 
Committee approval, to represent discretionary orders under unusual 
circumstances. Given the potential for conflicts of interest in 
representing such orders, the Commission believes that it is 
appropriate to accelerate approval of the proposed deletion of this 
provision.
    Finally, in Amendment No. 4, the Exchange clarified the use of DPMs 
on an interim basis. The Amendment expressly provides that DPMs 
appointed on an interim basis must satisfy all of the DMP obligations. 
The Commission believes that this should help protect investors by 
ensuring that DMPs appointed on an interim basis satisfy all of the 
organizational and financial requirements that are required of 
permanent DPMs.
    In Amendment No. 5, the Exchange confirmed that any changes to the 
DMP financial guidelines proposed by the MTS Committee must be 
submitted to the Commission, pursuant to SEC Rule 19b-4. The Commission 
is required to review the financial requirements imposed on DPMs as 
part of its regulatory responsibilities. Thus, Amendment No. 5 did not 
contain any new issue of regulatory concern.
    In Amendment No. 6, the Exchange proposed to add language to 
proposed Rule 8.85(a)(viii) to make it consistent with the current 
language of CBOE Rule 8.80(c)(7). Since this change does not change the 
intent or meaning of the proposed rule change and only made non-
substantive changes, the Commission believes that good cause exists to 
accelerate its approval.
    The Exchange also proposed to delete paragraph (c)(iii) of proposed 
Rule 8.85 and add language addressing the same issue to proposed Rule 
8.88. The Commission notes that the Exchange proposed this change in 
response to concerns raised by Commission staff.
    In addition, the Exchange proposed to delete the discretion it 
proposed to be granted to itself under the Guidelines for Exemptive 
Relief Under proposed Rule 8.91(e). Instead, the CBOE proposes to allow 
DMPs and their affiliates to be structured so as to create a functional 
separation. The Commission notes that the CBOE has based this proposal 
on language found in the rules of the Pacific Stock Exchange and the 
International Securities Exchange.\32\ The Commission believes that the 
proposed amended language adequately addresses the potential misuse of 
material, non-public information between DPMs and their affiliates. 
Further, the Commission believes that deleting proposed provision 
granting the non-specific discretion of the Exchange should ensure that 
the guidelines are applied evenly and consistently.
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    \32\ See PCX Rule 4.20 and ISE Rule 810.
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    Finally, in Amendment No. 6, the Exchange clarified that any 
changes to the formula for determining the participation entitlement, 
pursuant to proposed Rule 8.87, must be submitted to the Commission, 
pursuant to Rule 19b-4. Therefore, the Amendment only clarified the 
Commission's regulatory authority and did not change the meaning or 
intent of the proposed rule change. Therefore, for the reasons 
discussed above, the Commission believes that good cause, consistent 
with Section 6(b)(5) \33\ and 19(b) \34\ of the Act, to accelerate 
approval of Amendment Nos. 2, 3, 4, 5, and 6.
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    \33\ 15 U.S.C. 78f(b)(5).
    \34\ 15 U.S.C. 78s(b).
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Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 2 through 6, including whether they 
are 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 form 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 filings also will be available 
for inspection and copying at the principal office of the CBOE. All 
submissions should refer to File SR-CBOE-98-54 and should be submitted 
by August 2, 2000.

VII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\35\ that the amended proposed rule change (SR-CBOE-98-54) is approved, 
and Amendment Nos. 2, 3, 4, 5, and 6 are approved on an accelerated 
basis.
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    \35\ 15 U.S.C. 78s(2).


[[Page 43066]]


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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\36\
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    \36\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-17595 Filed 7-11-00; 8:45 am]
BILLING CODE 8010-01-M