[Federal Register Volume 67, Number 104 (Thursday, May 30, 2002)]
[Notices]
[Pages 37888-37891]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-13481]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45967; File No. SR-CBOE-2002-22]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendment No. 
1 Thereto by the Chicago Board Options Exchange, Inc. Relating to a 
Pilot Program To Give the Index Floor Procedure Committee the Authority 
To Permit Broker-Dealer Orders for Options on the QQQs to be Executed 
on RAES

May 20, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 26, 2002, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the CBOE. CBOE 
submitted Amendment No. 1 to the proposed rule change on May 3, 
2002.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange revised Exhibit 1 to 
conform to the requirements of the Act. See letter from Madge M. 
Hamilton, Legal Division, CBOE, to Nancy Sanow, Assistant Director, 
Division of Market Regulation (``Division''), Commission, dated May 
2, 2002 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to amend Interpretations and Policies .01 of CBOE 
Rule 6.8 to give the Index Floor Procedure Committee (``IFPC''), on a 
six-month pilot, the authority to permit broker-dealer orders for 
options on Nasdaq-100 Index[reg] Tracking Stock (``QQQ'') to be 
executed on the Exchange's Retail Automatic Execution System 
(``RAES''). Below is the text of the proposed rule change. Proposed new 
language is italicized.

Rule 6.8

* * * * *
* * * Interpretations and Policies:
    .01 [[Reserved.]] a. Notwithstanding 6.8(c)(ii), for a six-month 
pilot period ending [insert date six months from approval of proposed 
rule change], the Index Floor Procedure Committee may determine to 
allow the following types of orders for options on Nasdaq-100 
Index[reg] Tracking Stock (``QQQ'') to be executed on RAES:
    1. Broker-dealer orders; or
    2. Broker-dealer orders that are not for the accounts of market-
makers or specialists on an exchange who are exempt from the provisions 
of Regulation T of the Federal Reserve Board pursuant to Section 
7(c)(2) of the Securities Exchange Act of 1934.
    b. Broker-dealer orders entered through the Exchange's order 
routing system will not be automatically executed against orders in the 
limit order book. Broker-dealer orders may interact with orders in the 
limit order book only after being re-routed to a floor broker for 
representation in the trading crowd. Broker-dealer orders are not 
eligible to be placed in the limit order book pursuant to Rule 7.4.
    c. If the Index Floor Procedure Committee permits broker-dealer 
orders to be automatically executed in the QQQ pursuant to this 
Interpretations and Policies .01 of Rule 6.8, then it may also permit 
the following with respect to such orders:
    1. The maximum order size eligibility for the broker-dealer orders 
may be less

[[Page 37889]]

than the applicable order size eligibility for non-broker-dealer 
orders.
    2. Non-broker-dealer orders may be eligible for automatic execution 
at the NBBO pursuant to Interpretations and Policies .02 of Rule 6.8, 
while broker-dealer orders are not so eligible.
    d. CBOE market-makers must assure that orders for their own 
accounts are not entered on the Exchange and represented or executed in 
violation of the following provisions: Interpretations and Policies .02 
of Rule 6.55 and Interpretations and Policies .06 of Rule 8.9 
(concurrent representation of a joint account), Rule 6.55(concurrent 
representation of a market-maker account), and Section 9 of the 
Securities Exchange Act of 1934 (wash sales).

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

    In its filing with the Commission, the CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CBOE has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    CBOE proposes to amend CBOE Rule 6.8 by adding a new Interpretation 
and Policy .01, which would establish a six-month pilot program that 
would give the IFPC the authority to allow orders for the accounts of 
brokers or dealers to be executed on RAES.\4\ According to the CBOE, 
this proposed rule change mimics the Pacific Exchange's (``PCX'') Rule 
6.87(a), which was approved by the Commission on November 6, 2001.\5\ 
The proposed rule change would permit IFPC to allow RAES access in the 
options on QQQ for (1) all broker-dealer orders or (2) broker-dealer 
orders, except for market-makers and specialists who are exempt from 
the provisions of Regulation T of the Federal Reserve Board pursuant to 
Section 7(c)(2) of the Act.\6\ In addition, broker-dealer orders would 
not be automatically executed against the limit order book, but would 
be rerouted to a floor broker for execution in the crowd. The broker-
dealer orders could not be placed in the limit order book.
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    \4\ The Exchange represented that this proposal is consistent 
with the interim intermarket options linkage. Telephone conversation 
among Madge Hamilton, Legal Division, CBOE, Angelo Evangelou, Legal 
Division, CBOE, Kelly Riley, Senior Special Counsel, Division, 
Commission, and Jennifer Lewis, Attorney, Division, Commission, on 
May 10, 2002.
    \5\ See Exchange Act Release No. 45032, 66 FR 57145 (November 
14, 2001). According to the CBOE, this proposed rule change has 
minor differences from the PCX rule to accommodate for the 
differences in rule numbers and the names of the automatic execution 
systems. In addition, PCX Rule 6.87(b)(2)(C) has not been included 
in CBOE's proposed rule change. Under the PCX rule, the PCX Options 
Floor Trading Committee may determine that when the NBBO is crossed 
and locked, broker-dealer orders will be re-routed for manual 
representation. CBOE will treat customer orders and broker-dealer 
orders in the same manner when the NBBO is crossed and locked.
    \6\ 15 U.S.C. 78g(c)(2).
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    RAES currently distinguishes between customer and non-customer 
orders based upon the order origin information required to be provided 
as part of each order. Manual and electronic order tickets must 
specify, for each order, a valid order origin code which designates 
whether the order is, for example, for a ``non-broker-dealer public 
customer'' account, a ``firm'' account, a ``market-maker'' account, or 
a ``broker-dealer'' account by the designators ``C'', ``F'', ``M'', or 
``B'' respectively. These designators are intended to assure that 
orders executed on CBOE clear into the proper margin accounts at the 
Options Clearing Corporation. They are also intended to assure that the 
orders are handled in a manner that is consistent with various CBOE 
rules, such as eligibility for placement in the limit order book (CBOE 
Rule 7.4(b)), order identification requirements (CBOE Rule 6.24), 
priority of bids and offers (CBOE Rule 6.45), firm quote size 
guarantees (CBOE Rule 8.51), and eligibility for RAES (CBOE Rule 6.8). 
Currently only orders with ``C'' designators are allowed on RAES. The 
proposed rule change would give the IFPC the discretion to allow orders 
for the QQQ with ``F'', ``M'', or ``B'' designators on RAES.
    IFPC would also have the authority to permit the maximum order size 
for broker-dealer orders for the QQQs that are executed on RAES to be 
set at a lower level than the RAES size requirement for non-broker-
dealer orders. IFPC would also be able to allow non-broker-dealer 
orders for the QQQs to be eligible for automatic execution at the 
National Best Bid or Offer (``NBBO'') pursuant to Interpretations and 
Policies .02 of CBOE Rule 6.8, while broker-dealer orders for the QQQs 
that are RAES eligible would not be eligible for automatic step-up 
unless so authorized by IFPC. Unless automatic step-up executions on 
RAES are authorized by IFPC for RAES eligible broker-dealer orders, 
such orders would be rejected from RAES and re-routed for manual 
handling by a floor broker.
    If CBOE market-makers and other broker-dealer accounts are 
permitted to enter orders on RAES, they must assure that orders for 
their accounts do not violate any of the following CBOE Rules: CBOE 
Rule 6.55 Interpretation and Policy .02 and CBOE Rule 8.9, regarding 
multiple representation of orders for market-maker accounts and joint 
accounts; CBOE Rule 6.55, which prohibits a market-maker from entering 
or being present in a trading crowd while a floor broker present in the 
trading crowd is holding an order on behalf of the market-maker's 
individual account or account in which the market-maker has an 
interest, unless the market-maker or floor broker cancels the order 
pursuant to Interpretation .01 of such rule; and Section 9 of the 
Act,\7\ which prohibits wash sales. In other words, a market-maker or 
broker-dealer would be prohibited from ``dual representation.'' This 
prohibition against ``dual representation'' would be violated, for 
example, in the following situation: A market-maker in the XYZ trading 
crowd enters an order in XYZ options for his or her own account with a 
floor broker (via telephone, electronically or in-person), and the 
floor broker then represents the order while the market-maker is still 
present in the XYZ trading crowd. A similar violation would occur if, 
under the proposed rule change, a market-maker in the XYZ trading crowd 
initiated an order in XYZ options with his or her upstairs brokerage 
firm and the brokerage firm then routed the order to the CBOE, where it 
was either automatically executed or defaulted for manual handling by a 
floor broker. In either case, the market-maker will have violated CBOE 
Rule 6.55 (even if the order is automatically executed via RAES). 
Likewise, if the market-maker were trading in person for a joint 
account in that situation, and that same market-maker initiated the 
order on behalf of the same joint account which order was then routed 
to the CBOE for execution then that market-maker would have violated 
CBOE Rule 6.55 and CBOE Rule 8.9 Interpretation and Policy .06, which 
provide a similar prohibition on concurrent representation when a 
market-maker is trading in a joint account. Furthermore, if a market-
maker enters an order for his or her own account with a brokerage firm, 
and the order is routed to CBOE where it is executed against the same

[[Page 37890]]

market-maker's account via RAES or as a result of an open outcry trade, 
there will be a possible ``wash sale'' rule violation regardless of 
whether the trade was subsequently nullified.
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    \7\ 15 U.S.C. 78i.
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    For competitive reasons, the CBOE believes that it is appropriate, 
in the limited context of options on QQQs, to give the IFPC the 
discretion to permit broker-dealers orders to be entered and executed 
on RAES.\8\ The CBOE is proposing to implement this rule on a six-month 
pilot basis, so that it can evaluate the program and determine what 
changes, if any, should be made. In addition, the CBOE believes that 
options on the QQQs are the appropriate product to use in the pilot, 
given the unique nature of this product and its liquidity.
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    \8\ This Rule gives discretion to IFPC to permit broker-dealer 
orders for options on QQQs to be executed on RAES by saying that 
IFPC ``may determine to allow'' these orders to be executed on RAES. 
Under the proposed rule change, if IFPC voted to permit broker-
dealer orders that are not for the account of market makers or 
specialists on an exchange who are exempt from Regulation T to be 
executed on RAES for options on the QQQs, pursuant to CBOE Rule 
6.8.01(a)(2), it could at a later time determine pursuant to CBOE 
Rule 6.8.01(a)(1) that all broker-dealer orders could be executed on 
RAES for options on the QQQs. Or, it could determine that broker-
dealer orders for options on QQQs will no longer be permitted to be 
executed on RAES.
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act,\9\ in general and furthers the objectives 
of Section 6(b)(5),\10\ in particular, because it is designed to 
promote just and equitable principles of trade, to enhance competition 
and to protect investors and the public interest. The CBOE believes 
that the proposed rule change could enhance competition for the 
automatic execution of the orders of broker-dealers in options on the 
QQQs. The CBOE also believes that this pilot program will give the 
Exchange the ability to evaluate the appropriateness of competing for 
orders of the accounts of broker-dealers in this manner.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, 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-2002-22 and should be submitted by June 20, 2002.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\11\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\12\ which 
requires, among other things, that the rules of an exchange be designed 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market, and 
to protect investors and the public interest.\13\
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    \11\ In approving this proposed rule change, 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).
    \13\ The Exchange submitted a letter to the Division 
representing that the proposal is consistent with Section 11(a) of 
the Act and Rule 11a2-2(T) under the Act. See letter to Catherine 
McGuire, Chief Counsel, Division, Commission, from Joanne Moffic-
Silver, General Counsel and Corporate Secretary, CBOE, dated April 
25, 2002. In response to the Exchange's request, Commission staff 
has provided interpretive guidance to the Exchange under Section 
11(a) of the Act, 15 U.S.C. 78k(a). See letter from Paula R. Jenson, 
Deputy Chief Counsel, Division, Commission, to Joanne Moffic-Silver, 
General Counsel and Corporate Secretary, CBOE, dated May 16, 2002.
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    The Commission finds that the proposed rule change should allow the 
Exchange to improve the efficiency with which orders for the accounts 
of broker-dealers in options on the QQQs are currently executed. 
Currently, broker-dealer orders are not eligible to receive automatic 
execution in RAES. By providing broker-dealers with access to RAES for 
orders for options on QQQs, the Exchange should enhance executions in 
options on QQQs. Specifically, broker-dealer orders for options in QQQs 
that are RAES eligible should receive faster executions. By providing 
prompt execution for broker-dealer orders for options in QQQs, the 
proposal may help attract broker-dealer options orders to the Exchange, 
and thus help to improve the depth and liquidity of the Exchange's 
options market.
    The Commission notes that CBOE represented that RAES has sufficient 
capacity to handle the processing of the potential increased order 
flow.\14\ The Commission expects that during the six-month pilot 
period, the Exchange will monitor RAES in light of the additional order 
flow and will implement any necessary systems enhancements to 
accommodate any increase in volume resulting from this proposal.
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    \14\ Telephone conversation between Madge Hamilton, Legal 
Division, CBOE and Kelly Riley, Senior Special Counsel, Division, 
Commission, on May 8, 2002.
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    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. Both the Philadelphia Stock 
Exchange \15\ and PCX permit, to some extent, broker-dealer orders to 
be executed on their automatic execution systems. Accordingly, the 
Commission believes that no new issues are being raised by CBOE's 
proposed rule change. The Commission believes, therefore, that granting 
accelerated approval of the proposed rule change is appropriate and 
consistent with Sections 6 and 19(b) of the Act.\16\
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    \15\ See Securities Exchange Act Release No. 45758 (April 15, 
2002), 67 FR 19610 (April 22, 2002).
    \16\ 15 U.S.C. 78f.
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V. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-CBOE-2002-

[[Page 37891]]

22), as amended, is approved on a six-month pilot basis, until November 
15, 2002, on an accelerated basis.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-13481 Filed 5-29-02; 8:45 am]
BILLING CODE 8010-01-M