[Federal Register Volume 67, Number 56 (Friday, March 22, 2002)]
[Notices]
[Pages 13383-13385]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-6902]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45577; File No. SR-CBOE-2001-64]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange Inc. Relating to AutoQuote 
Parameters

March 15, 2002.

I. Introduction

    On December 17, 2001, 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 
thereunder,\2\ a proposed rule change relating to the Exchange's 
AutoQuote System. The Federal Register published the proposed rule 
change for comment on February 12, 2002.\3\ The Commission received no 
comments on the proposed rule change. This order approves the proposed 
rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 45394 (February 5, 
2002), 67 FR 6556.
---------------------------------------------------------------------------

II. Description of Proposal

    The CBOE submitted the proposed change to Interpretation and Policy 
.07 to CBOE Rule 8.7 pursuant to subparagraph IV.B.j of the 
Commission's September 11, 2000 Order,\4\ which requires in part that 
certain options exchanges, including the CBOE, adopt new, or amend 
existing, rules to make express any practice or procedure ``whereby 
market makers trading any particular option class determine by 
agreement the spreads or option prices at which they will trade any 
option class * * *.'' The proposed amendment to Interpretation and 
Policy .07 to CBOE Rule 8.7 would permit market makers to coordinate in 
setting the components of the formula used by an automated quotation 
updating system, or AutoQuote.\5\
---------------------------------------------------------------------------

    \4\ See Order Instituting Public Administrative Proceedings 
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, 
Making Findings and Imposing Remedial Sanctions. Securities Exchange 
Act Release No. 43268 (September 11, 2000).
    \5\ For purposes of this filing and the proposed interpretation, 
the term AutoQuote is used to refer to both the Exchange's own 
automatic quotation system that is offered to trading crowds to 
generate quotes and to proprietary automated quotation updating 
systems that are used by trading crowds, DPMs, LMMs, SMMs, or 
appointed market-makers to generate quotes in lieu of or in addition 
to the Exchange's own AutoQuote system.
---------------------------------------------------------------------------

    AutoQuote is the Exchange's electronic quotation system that

[[Page 13384]]

automatically monitors and updates market quotations using a 
mathematical formula measuring certain characteristics of the option 
and the underlying interest. According to the Exchange, AutoQuote 
provides a means to update the quotes for the tens of thousands of 
series the Exchange lists.\6\ AutoQuote formulas require the selection 
and input of the following components or variables: an option pricing 
calculation model, volatility, interest rate, dividend, and the measure 
used to represent the value of the underlying.
---------------------------------------------------------------------------

    \6\ Although the Exchange believes that AutoQuote is necessary, 
the Exchange notes that individual market makers can and do manually 
improve the quote themselves in order to gain a larger share of 
orders than competing market makers. In these instances, the manual 
quote overrides the AutoQuote for that particular series.
---------------------------------------------------------------------------

    The proposed amendment to Interpretation and Policy .07 to CBOE 
Rule 8.7 would set forth a more thorough description of AutoQuote. The 
proposed rule change also would identify who has responsibility under 
Exchange rules to determine a formula for generating automatically 
updated market quotations. For classes of options in which a DPM is 
appointed, the DPM would have primary responsibility to determine the 
formula, which includes determining the components or variables used in 
the AutoQuote formula.\7\ For classes of options in which an LMM or SMM 
is appointed, such as the S&P 100 option class (``OEX''), the LMM or 
SMM would have primary responsibility to determine the formula for 
generating automatically updated market quotations.\8\ For classes of 
options in which a DPM, LMM, or SMM has not been appointed, the 
appropriate Exchange Committee would be permitted to appoint one or 
more market makers in good standing with an appointment in the 
particular option class (``Appointed Market-Makers'') to determine a 
formula for generating automatically updated market quotations, using 
the Exchange's AutoQuote system or a proprietary automated quotation 
updating system.
---------------------------------------------------------------------------

    \7\ See CBOE Rule 8.85(a)(x).
    \8\ On December 17, 2001, the CBOE filed SR-CBOE-2001-63 which 
amends CBOE Rule 8.15 to make explicit in the rule that the 
appropriate Market performance Committee (``MPC'') may appoint LMMs 
and SMMs to determine a formula for generating automatically updated 
market quotations and use the Exchange's AutoQuote system or a 
proprietary automated quotation updating system to update market 
quotations during the trading day in an options class for which a 
DPM has not been appointed. See Securities Exchange Act Release No. 
45419 (February 7, 2002), 67 FR 6772 (February 13, 2002). The 
Commission is approving SR-CBOE-2001-63 simultaneously with the 
proposed rule change.
---------------------------------------------------------------------------

    Although DPMs, LMMs, SMMs, and Appointed Market-Makers would have 
the responsibility for determining the formula for generating 
automatically updated market quotations, the proposed amendment to 
Interpretation and Policy .07 expressly would provide that the DPM, 
LMM, SMM, or Appointed Market-Maker may, but is not required to, 
consult with and/or agree with other market makers in the trading crowd 
in setting the components or variables of the formula. However, members 
of the trading crowd would not be required to provide input to the DPM, 
LMM, SMM, or Appointed Market-Maker about these decisions and the 
decision is ultimately that of the DPM, LMM, SMM or Appointed Market-
Maker in the particular class.
    For classes of options in which a DPM, LMM, SMM or Appointed 
Market-Maker does not have the responsibility to determine a formula 
for generating automatically updated market quotations, the market 
makers would be permitted to coordinate and agree upon the variables 
for the AutoQuote formula. In some trading crowds, one or a few market 
makers may take responsibility (with the crowd's approval) for updating 
the AutoQuote variables without seeking input on a continual basis. The 
CBOE believes that such market maker coordination is necessary and 
appropriate because an AutoQuote system is centralized and applicable 
to all market participants. Thus, the obligations resulting from the 
quotes generated by AutoQuote, such as the firm quote obligation, are 
imposed on the crowd as a whole.\9\ Moreover, although AutoQuote is 
essential to ensure that quotes are updated on the numerous series 
traded by the Exchange on a timely basis, individual market makers can 
and do compete among each other to gain a larger share of orders by 
verbalizing quotes that improve the AutoQuote generated quotes. These 
verbalized quotes by market makers override the AutoQuote generated 
quotes for the particular series that is the subject of the verbalized 
quote.
---------------------------------------------------------------------------

    \9\ CBOE has always used, and the applicable CBOE rules 
envision, a centralized autoquote system. Although it may be 
technologically feasible at some point in the future to have a 
system that would permit each individual market-maker to have his or 
her own automatic quote updating capability (and although CBOE may 
eventually develop such a model), CBOE believes that its centralized 
autoquote system is essential to preserving CBOE's current model of 
a floor-based, open-outcry market that includes joint crowd 
obligations pursuant to rules that have been approved by the 
Commission.
---------------------------------------------------------------------------

    Finally, the proposed amendment to Interpretation .07 would provide 
that the provisions described above and set forth in the proposed 
amendment to Interpretation .07 would also apply to the use of 
automated quotation updating systems that generate indicative prices 
that are indications of interest and not firm quotes.\10\
---------------------------------------------------------------------------

    \10\ Interpretation and Policy .10 to CBOE Rule 8.7 provides 
that ``[m]arket-makers may display indicative spread prices on the 
websites of member organizations through a system licensed from a 
third party, developed by the Exchange or otherwise. Such indicative 
prices shall not be regarded as firm quotes, and a market-maker 
shall not be obligated to execute at the indicative prices spread 
orders that are entered into the market.``
---------------------------------------------------------------------------

III. Discussion

    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.\11\ 
Specifically, the Commission believes that the proposed rule change is 
consistent with the Section 6(b)(8)\12\ requirement that the rules of 
an exchange not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act.
---------------------------------------------------------------------------

    \11\ In approving the proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    The Commission believes that the proposed rule change should deter 
collective action, except as authorized by the Exchange's rules, by 
clearly establishing in the Exchange's rules the responsibilities of, 
and conduct permitted by, Exchange members in setting AutoQuote 
parameters. For instance, the proposal would permit the DPM, LMM, or 
SMM, or Appointed Market-Maker, as applicable, to receive input from 
members of the crowd in setting the parameters of the formula used to 
automatically update options quotations. At this time, the Commission 
believes it is reasonable for the Exchange's rules to permit the 
members of the crowd to be given a voice in setting autoquote 
parameters because, pursuant to the Exchange's rules, they will be 
obligated to execute orders at the resultant quote. In addition, the 
proposal codifies a more complete description of AutoQuote, which the 
Commission believes should protect investors and the public interest by 
providing important information regarding how options prices on the 
Exchange are derived. Moreover, the Commission notes that individual 
market makers can compete among each other to gain a larger share of 
orders and override the AutoQuote generated quotes by verbalizing 
quotes that improve the AutoQuote generated

[[Page 13385]]

quotes, which should limit any anticompetitive effects of the proposed 
rule change.
    The Commission notes that in its filing, the Exchange states its 
belief that the proposed rule change is ``procompetitive'' because it 
is necessary to provide for a fair and orderly market in the thousands 
of options series traded on the Exchange. While the Commission does not 
agree that the proposed rule change enhances competition, the 
Commission finds that the burden that the proposal imposes on 
competition is appropriate in furtherance of the purposes of the Act 
and, thus, is not inconsistent with the Act.\13\ Finally, the 
Commission finds that the proposed rule change is designed to 
effectively limit the circumstances in which collective action is 
permissible.
---------------------------------------------------------------------------

    \13\ The Commission expects the Exchange to monitor the 
collective actions that are undertaken pursuant to the rule change 
approved herein for any undesirable or inappropriate anticompetitive 
effects. The Commission's examination staff will monitor the 
Exchange's efforts in this regard.
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-CBOE-2001-64) is approved.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
---------------------------------------------------------------------------

    \15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-6902 Filed 3-21-02; 8:45 am]
BILLING CODE 8010-01-P