[Federal Register Volume 65, Number 152 (Monday, August 7, 2000)]
[Notices]
[Pages 48264-48266]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-19911]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43099; File No. SR-CBOE-99-35]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 1, 2 and 3 to the Proposed Rule change by the Chicago 
board Options Exchange, Inc., Relating to Facilitation Crosses of Index 
Options Orders

July 31, 2000.

1. Introduction

    On June 29, 1999, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with 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 
thereunder,\2\ a proposed rule change to amend the Exchange's rule 
governing facilitation crosses as it applies to index option orders. 
Notice of the proposed rule change was published for comment in the 
Federal Register on August 20, 1999.\3\ the Commission received two 
comment letters regarding the proposal.\4\ On April 20, June 1, and 
July 18, 2000, the CBOE filed, respectively, Amendment Nos. 1, 2, and 3 
to the proposal.\5\ This order approves the proposed rule change, as 
amended, and solicits comments from interested persons on Amendment 
Nos. 1, 2 and 3.
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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. 41742 (August 13, 
1999), 64 FR 45578).
    \4\ See Section III below.
    \5\ The substantive modifications made by these amendments are 
incorporated in the description of the proposal in Section II below, 
and are further discussed in Section IV below.
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II. Description of the Proposal

    CBOE Rule 6.74(b) sets forth the procedures by which a floor broker 
representing the order of a member firm's public customer may cross it 
with a contra side order provided by the firm from its own proprietary 
account. In these circumstances, the firm is said to be 
``facilitating'' the customer order, and the transaction is called a 
``facilitation cross.''
    Under the current version of the rule as applicable to index 
options,\6\ a floor broker seeking to execute a facilitation cross must 
first bring the transaction to the trading floor and request a market 
from the trading crowd. After receiving bids and offers from the crowd, 
the floor broker must propose a price at which to cross the order that 
improves upon the price provided by the crowd. However, before the 
floor broker can execute the cross, the market makers in the crowd are 
given the opportunity to take all or part of the transaction at the 
proposed price.
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    \6\ A related rule change recently approved by the Commission 
separately amended CBOE Rule 6.74 with respect to equity options. 
See Securities Exchange Act Release No. 42835 (May 26, 2000), 65 FR 
35683 (June 5, 2000)(File No. SR-CBOE-99-10).
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    Under the current rule, if the crowd does not want to participate 
in the trade, the floor broker may proceed with the cross. If the crowd 
wants to take part of the order, however, the crowd has precedence and 
the floor broker may cross only that amount remaining after the crowd 
has taken its portion. If the crowd wants to take the entire order, the 
floor broker will not be able to cross any part of the order.
    The proposed rule change would add new paragraph (e) to Rule 6.74, 
to apply to facilitation crosses in broad-based index options that are 
not traded in equity option crowds.\7\ The proposal would entitle the 
floor broker, under certain conditions, to cross a specified percentage 
of the customer order on behalf of the member firm before market makers 
in the crowd could participate in the transaction. The floor broker 
would be permitted to exercise this right even when he proposes the 
facilitation cross a price that matches, but does not improve upon, the 
best bid or offer

[[Page 48265]]

provided by the crowd in response to his initial request for a 
market.\8\
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    \7\ See Amendment No. 3, which specifies that the proposed rule 
change, originally described as applicable to index options, would 
apply only to broad-based index options not traded in equity option 
trading crowds. ``Broad-based index'' is defined in CBOE Rule 
24.1(i). The CBOE represents that broad-based index options 
currently not traded at equity options posts on the Exchange include 
Standard & Poor's 100 Stock Index options (``OEX'', Standard & 
Poor's 500 Stock Index options (``SPX''), and options on the Dow 
Jones Industrial Average (``DJX''). )
    \8\ See Amendment No. 1, which extends the proposed guaranteed 
participation to the situation where the facilitation cross is 
proposed at the best bid or offer provided by the crowd.
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    Under the proposal, all public customer orders in the book and 
those represented in the trading crowd at the time the market was 
established would first need to be satisfied.\9\ Afterward, the floor 
broker would be entitled to cross 20% of the remaining contracts with 
the facilitation order provided by the firm, which priority over 
members of the crowd.\10\
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    \9\ See Amendment No. 2.
    \10\ The same 20% participation would be guaranteed to the 
member firm whether the transaction takes place at or between the 
best bid or offer provided by the trading crowd in response to the 
floor broker's request for a market. See Amendment No. 1.
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    The proposed rule change would pertain only to orders of a certain 
minimum size determined by the appropriate Floor Procedure Committee of 
the Exchange on a class by class basis. That size could not be less 
than 50 contracts.\11\
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    \11\ See Amendment No. 1. The original proposal would have 
restricted the eligible order size to 500 contracts or more.
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    As under existing procedures in Rule 6.74(b), the floor broker 
seeking to execute a facilitation cross under proposed paragraph (e) 
would be required, when initially asking for a market in the option 
series, to make all persons in the trading crowd, including the Order 
Book Official, aware of his request.
    Proposed paragraph (e)(i) provides, in addition, that once the 
trading crowd has provided a market, it would remain in effect until 
(a) a reasonable amount of time has passed; (b) a significant change 
has occurred in the price of the underlying security of the option; or 
(c) the market is improved. In case of dispute, ``significant change'' 
would be determined on a case-by-case basis by two Floor Officials, 
based upon the extent of recent trading in the option and the 
underlying security and any other relevant factor.\12\
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    \12\ See Amendment No. 1.
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    In the case of a multi-part or spread order, one leg alone of the 
order would need to meet the eligible size requirement to qualify for 
the provisions of the proposed rule change. In addition, the 
facilitating firm would be required to disclose on the order ticket for 
the public customer order all terms of the order, including any 
contingency involving, and all related transactions in, either options 
or underlying or related securities. The floor broker would be required 
to disclose all securities that are components of the public customer 
order before requesting bids and offers for the execution of all 
components of the order.\13\
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    \13\ Id.
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    If the same member firm of the Exchange is both the firm from which 
the customer order originated and the Designated Primary Market Maker 
(``DPM'') for the class of options in which the transaction takes 
place, and the floor broker acting on behalf of the member firm takes 
advantage of the crossing right provided by the proposed rule change, 
the firm would not be entitled to any participation in the trade based 
on the guaranteed percentage ordinarily granted to DPMs.\14\
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    \14\ Id. The CBOE represents that none of the options classes 
covered by the proposed rule change currently is traded in a DPM 
trading crowd. However, the Exchange is including provisions in the 
proposed rule change concerning DPM participation guarantees because 
at some time in the future these options classes may be traded in 
DPM crowds. See Amendment No. 3
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    If the DPM in the options class is not the same member organization 
as the facilitating firm, and the trade takes place at the DPM's 
principal bid or offer, the DPM will be entitled to participate in a 
percentage of the contracts remaining after relevant public customer 
orders have been filled and the originating firm's crossing rights have 
been exercised. The percentage that the DPM will receive is determined 
by reference to the established DPM participation rate--subject to 
limitation. If the floor broker crosses the full 20% of the 
facilitating firm's entitlement, the number of contracts guaranteed to 
the DPM may not exceed 25% of the remainder of the order after the 
facilitating firm has taken its share.\15\ If the floor broker does not 
cross 20%, the DPM may be entitled to more, but in no case will the DPM 
be guaranteed a percentage that, when combined with the percentage 
crossed by the floor broker, exceeds 40% of the original order (after 
relevant public customer orders have been satisfied).\16\
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    \15\ See Amendment No. 3. Thus, if the original order was for 
1,000 contracts, and the facilitating firm, crossing at the best bid 
or offer price given by the crowd, took its full share of 200 
contracts (20%)--assuming no public customer order were represented 
in the book or in the crowd--the DPM would be entitled to 200 
contracts (25% of the remaining 800) and the total combined 
participation guarantees of the facilitating firm and the DPM would 
be limited to 400 contracts, or 40% of the original order.
    \16\ See Amendment No. 3.
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    The proposed rule change makes clear, however, that it is not 
intended to prohibit either a floor broker or DPM from trading more 
than their percentage entitlements if the other members of the trading 
crowd do not choose to trade with the remainder of the order.\17\
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    \17\ See Amendment Nos. 1 and 3.
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    The proposed rule change also provides that the members of the 
crowd who establish the market in response to the floor broker's 
initial request would have priority over all other orders that were not 
represented in the crowd at the time the market was estblished, except 
for orders that improve upon those quotes. Further, a floor broker who 
holds a customer order and a facilitation order and who makes a request 
for a market would be deemed to be representing both the customer order 
and the facilitation order, so that the customer order and the 
facilitation order would also have priority over all other orders that 
were not being represented in the trading crowd at the time the market 
was established.\18\
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    \18\ See Amendment Nos. 1 and 2.
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III. Summary of Comments

    The Commission received two comment letters regarding the proposed 
rule change, both from the Amex Options Markets Makers Association 
(``OMMA''). \19\ The OMMA states that the proposed rule change would 
harm investors because the allocation of a fixed percentage of trades 
to member firms seeking to cross orders would reward the firms for 
trading at an unfair price. The association also argues that the 
proposal would create a disincentive for price improvement.
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    \19\ Letters from Daniel Mintz, Chairman, Amex Option Market 
Makers Association, to the Securities and Exchange Commission, dated 
August 31, 1999, and September 15, 1999.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the provisions of the Act applicable to a 
national securities exchange, particularly Sections 6(b)(5) \20\ and 
6(b)(8) \21\ of the Act, and the rules and regulations thereunder. \22\ 
The Commission believes that the proposal will enable the CBOE to 
better compete with other options exchanges in attracting the order 
flow or broker-

[[Page 48266]]

dealer firms seeking to facilitate customer orders, without adversely 
impacting the prices those orders receive.
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    \20\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the 
rules of a national securities exchange be designated to, among 
other things, promote just and equitable principles of trade, remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. It 
also requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
    \21\ 15 U.S.C. 78f(b)(8). Section 6(b)(8) requires that the 
rules of the exchange do not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act.
    \22\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    The Commission finds that the CBOE's proposal to grant a 20% 
participation right, under certain conditions, to member firms seeking 
to execute facilitation crosses on the Exchange is reasonable. 
Currently, CBOE market makers have priority rights for the full size of 
a customer order over the firm that brings a crossing transaction to 
the CBOE floor.
    The Commission does not find persuasive the OMMA's argument that 
the proposal would allow member firms to trade at an unfair price. A 
member firm could never execute a facilitation cross, under the 
proposal, at an inferior price. It would be required at least to match 
the best bid or offer provided by the crowd in response to the floor 
broker's request for a market in order to participate in the 
transaction at all.
    While the proposal entitles the member firm to 20% of a 
facilitation transaction, it leaves 80% of the order to the trading 
crowd. The Commission believes that because 80% of an order would 
remain available to the market maker or market makers quoting the best 
price, the proposal raises no serious concern that price competition 
will be eroded on the Exchange. \23\
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    \23\ As the Commission recently stated, it is difficult to 
assess the precise level at which guarantees may begin to erode 
competitive market maker participation and potential price 
competition within a given market. However, for the immediate term, 
the Commission has approved participation guarantees of up to 40% of 
an order as not clearly inconsistent with the statutory standards of 
competition and free and open markets. See Securities Exchange Act 
Release No. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000). 
The proposed rule change, which would allocate only 20% of an order 
to the member firm, falls well within these parameters.
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    The Commission finds good cause for approving Amendment Nos. 1, 2, 
and 3 to the proposal prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register 
pursuant to Section 19(b)(2) of the Act.\24\ Amendment No. 1 adds the 
provision, described above, that would provide a participation 
guarantee to a member firm seeking to facilitate a customer order even 
when it only matches, but does not improve upon, the prices given by 
the crowd in response to the floor broker's initial request for a 
market. Amendment No. 1 also reduces the minimum size of orders to 
which the proposed rule change would be applicable, from 500 to 50 
contracts.
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    \24\ 15 U.S.C. 78s(b)(2)
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    The Commission has already approved rules of several options 
exchanges that establish participation guarantees of 20% or more for 
firms seeking to facilitate orders at the best prices offered by other 
market participants. \25\ Similarly, the Commission has already 
approved rules of several options exchanges that provide such 
guarantees for order sizes with a minimum of 50 contracts. \26\ Thus, 
these aspects of Amendment No. 1 raise no new regulatory issues.
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    \25\ See Securities Exchange Act Release Nos. 42894 (June 2, 
2000) (concerning File No. SR-Amex-99-36); 42835 (May 26, 2000), 65 
FR 35683 (June 5, 2000) (concerning File No. SR-CBOE-99-10, for 
equity options); 42848 (May 26, 2000) (concerning File No. SR-PCX-
99-18); and 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000) 
(concerning registration of the International Securities Exchange 
(``ISE'') as a national securities exchange, and, among other 
features of the exchange, the ISE's facilitation provisions).
    \26\ See Securities Exchange Act Release Nos. 42894 (June 2, 
2000) (concerning File No. SR-Amex-99-36); 42835 (May 26, 2000) 
(concerning File No. SR-CBOE-99-10, for equity options); and 42455 
(February 24, 2000), 65 FR 11388 (March 2, 2000) (concerning ISE's 
facilitation provisions, among other features).
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    Amendment No. 1, as supplemented and revised by Amendment No. 2, 
also include further clarifications of procedures and priority rights 
under the proposed rule change consistent with CBOE's facilitation 
cross rule for equity options. These provisions strengthen the proposed 
rule change and raise no new regulatory issues.
    Amendment No. 3 specifies that the proposed rule change would apply 
only to broad-based index options that are not traded in equity trading 
crowds, clarifying the proposal's applicability and raising no new 
issues. Amendment No. 3 also includes the provision described above 
concerning DPM participation, which limits the total percentage of an 
order that may be guaranteed, to the originating firm and the DPM 
combined, to no more than 40%. This limitation accords with rules that 
the Commission has previously found consistent with the Act. \27\
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    \27\ See surpa, note 23.
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    Accordingly, the Commission finds good cause, consistent with 
Sections 6(b)(5) \28\ and 19(b)(2) \29\ of the Act to accelerate 
approval of Amendments Nos. 1, 2, and 3 to the proposed rule change.
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    \28\ 15 U.S.C. 78f(b)(5).
    \29\ 15 U.S.C. 78s(b)(2).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1, 2, an 3, including whether 
Amendment Nos. 1, 2, and 3 are 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-99-35 and should be submitted by August 28, 2000.

VI. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-CBOE-99-35), as amended, be and 
hereby is approved.
    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\30\
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    \30\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-19911 Filed 8-4-00; 8:45 am]
BILLING CODE 8010-01-M