[Federal Register Volume 67, Number 118 (Wednesday, June 19, 2002)]
[Notices]
[Pages 41743-41746]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-15428]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46073; File No. SR-CBOE-2002-31]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to Handling 
of Customer Orders

June 13, 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 June 10, 2002, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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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 its rules to adopt an order handling 
facility to allow customer orders larger than CBOE's ``auto-ex'' size 
to automatically secure CBOE's disseminated prices up to the 
disseminated size of the Exchange, while allowing for potential price 
improvement. The text of the proposed rule change is set forth below. 
Proposed new language is italicized.
* * * * *
Chicago Board Options Exchange, Incorporated Rules
* * * * *

Rule 6.10  LOU System Operations

    This Rule governs the operation of the Large Order Utility 
(``LOU'') system.

[[Page 41744]]

    (a) Definitions. For purposes of this Rule, the following 
definitions shall apply.
    (i) The term ``LOU'' means a facility of the Exchange that provides 
order routing, handling, and execution for eligible options orders 
routed electronically to the Exchange.
    (ii) The term ``In-Person Wheel'' means an order allocation 
mechanism whereby orders are evenly assigned to Market-Makers logged 
onto the In-Person Wheel for up to five contracts per Market-Maker for 
each order.
    (iii) The term ``Linkage Order'' means an order routed to the 
Exchange through the Options Intermarket Linkage pursuant to the Plan 
for the Purpose of Creating and Operating an Intermarket Options 
Linkage.
    (b) LOU Eligibility.
    The following criteria must be met for an order to be eligible for 
LOU:
    (i) The order must be a market order or marketable limit order that 
is not for an account in which a member, or any non-member broker-
dealer (including foreign broker-dealer) has an interest;
    (ii) The order must be of a size greater than the RAES eligibility 
limit for the subject option series as established pursuant to Rule 
6.8(c);
    (iii) the order may not be a Linkage Order;
    (iv) at the time the order is received, the Exchange must be 
disseminating a quote at the national best bid or offer (NBBO) for the 
appropriate side of the market;
    (v) at the time the order is received, the Exchange's disseminated 
quote may not be a manual quote;
    (vi) the order must be in an option class which is designated as 
subject to the terms of Rule 6.8.B concerning booked orders; and,
    (vii) the order must be in an option class designated by the 
appropriate FPC as subject to this Rule 6.10.
    The senior person then in charge of the Exchange's Control Room 
shall have the authority to turn off LOU with respect to a class of 
options if there is a system malfunction that affects the Exchange's 
ability to disseminate or update market quotes.
    (c) Order Receipt.
    (i) Orders Equal to or Smaller than the Exchange's Disseminated 
Quotation Size. When LOU receives an order smaller than the Exchange's 
disseminated quotation size, the system will automatically stop the 
order against the Exchange's disseminated market. The order will then 
be automatically routed for representation in the crowd to allow for 
price improvement and to allocate the order to members of the trading 
crowd pursuant to paragraph (d) below.
    (ii) Orders Larger than the Exchange's Disseminated Quotation Size. 
When LOU receives an order larger than the Exchange's disseminated 
quotation size, the system will automatically stop a portion of the 
order against the Exchange's disseminated market up to the Exchange's 
disseminated size. The stopped portion of the order will then be 
automatically routed for representation in the crowd to allow for price 
improvement and to allocate the order to members of the trading crowd 
pursuant to paragraph (d) below. Simultaneously, the balance of the 
order that was not stopped at the Exchange's disseminated price will be 
routed for normal order handling.
    (d) Execution and Allocation. Upon receipt, the LOU order (or the 
stopped portion of the LOU order) shall be announced and exposed to the 
crowd to allow for price improvement. Any portion of a LOU order that 
does not receive price improvement will be allocated as follows:
    (i) The LOU order will be assigned in open outcry consistent with 
Rule 6.45 and Rule 8.87. To the extent an order is not fully assigned 
in open outcry, the remaining portion of the order will be assigned to 
Market-Makers via the In-Person Wheel. If a portion of the LOU order 
still remains after the In-Person Wheel allocations are exhausted, the 
balance of the order shall be assigned in accordance with the RAES 
trade allocation methodology in effect for the subject option class 
pursuant to Rule 6.8, Interpretation and Policy .06.
    (e) Obligations of Participating Market-Makers. Any Market-Maker 
who is present in the trading crowd and who makes markets in a 
particular security traded in that crowd, must be logged onto the In-
Person Wheel for that security.
    * * * Interpretations and Policies:
    .01 The provisions of Rule 8.17 regarding stopping of option orders 
shall not apply to orders received pursuant to this Rule 6.10.
* * * * *

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 Exchange 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
    Introduction. The Exchange is proposing to adopt a new Rule 6.10 
governing the handling of larger customer orders. Under the new system, 
to be called the Large Order Utility (``LOU''), the Exchange will stop 
eligible customer orders at the Exchange's disseminated price up to the 
size of the disseminated quote, and subsequently allocate those 
customer orders in open-outcry, thereby allowing for price-improvement 
while guaranteeing an execution at a price equal to or better than the 
stop price. As proposed, the appropriate Floor Procedure Committee 
(``FPC'') would determine which option classes would be subject to the 
requirements of proposed Rule 6.10.
    Large electronically routed public customer orders would generally 
be eligible for LOU. By immediately stopping these customer orders at 
the CBOE's disseminated market and transmitting a stop notification to 
the order sender, the Exchange believes that the LOU system would allow 
customers to quickly secure disseminated prices up to the CBOE's 
disseminated size (i.e., to effectively trade against CBOE's dynamic 
quote) with the added benefit of potential price improvement via an 
open-outcry allocation.
    Eligibility for LOU. To be eligible for LOU, an incoming electronic 
order would be required to meet the following criteria: (i) the order 
would be required to be a market order or marketable limit order that 
is not for an account in which a member or any non-member broker-dealer 
(including foreign broker-dealer) has an interest; (ii) the order would 
be required to be of a size greater than the RAES \3\ eligibility limit 
for the subject option series as established pursuant to Rule 6.8(c); 
(iii) the order could not be a ``linkage order,'' i.e., an order routed 
to the Exchange through the Options Intermarket Linkage pursuant to the 
Plan for the Purpose of Creating and Operating an Intermarket Options 
Linkage (``Linkage Plan'') \4\; and (iv) the order would be required to 
be in an options class designated by the appropriate FPC as subject to 
the terms of Rule 6.10.
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    \3\ RAES is the Exchange's Retail Automatic Execution System.
    \4\ See Securities Exchange Act Release No. 43086 (July 28, 
2000), 65 FR 48023 (August 4, 2000).

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[[Page 41745]]

    Additionally, an incoming electronic order would only be eligible 
for LOU if at the time of the order's receipt by the LOU system, the 
CBOE's disseminated market was equal to the national best bid or offer 
(``NBBO''). This would allow customers to receive the benefits of LOU 
(guaranteed prices and quick executions at CBOE's published market) 
when the CBOE's published price equals the NBBO. If CBOE's disseminated 
market was not the NBBO when an electronic customer order was received, 
the order would be handled under existing procedures. This would allow 
the trading crowd the opportunity to match the NBBO if it was so 
inclined. Further, once the intermarket linkage was in place, the 
Designated Primary Market Maker (``DPM'') would have the added ability 
to route an order to the exchange disseminating the NBBO if the trading 
crowd chooses not to match the NBBO.
    Also, as previously noted, once the intermarket linkage is in 
place, linkage orders routed to CBOE from other exchanges would not be 
eligible for routing to LOU. The CBOE states that because of the unique 
features of the Linkage Plan, such orders must be handled in accordance 
with the requirements of the Linkage Plan (which allow for partial 
executions), and therefore would not be subject to the order handling 
requirements under proposed Rule 6.10.
    There are two other eligibility requirements relating to the CBOE 
market at the time an eligible order is received that would need to be 
met for the order to be routed to LOU: (1) CBOE Rule 6.8.B must be in 
effect for the subject option class; and (2) CBOE's quote may not be a 
manual quote (i.e., a quote submitted manually by a market-maker).
    Rule 6.8.B essentially provides that, for classes in which the rule 
is in effect, public customer orders routed to CBOE through the 
Exchange's Order Routing System (``ORS'') will be automatically 
executed against orders resident in the Exchange's book when such 
booked orders equal the NBBO. Because Rule 6.8.B is in effect for 
option classes designated by the appropriate FPC (i.e., it is not 
mandatory for all classes), and because customer orders in the book 
priced at the NBBO are accorded certain priorities over the trading 
crowd, the Exchange believes it is necessary to require that Rule 6.8.B 
be in effect for any option class in which proposed Rule 6.10 would be 
in effect.
    With respect to manual quotes, LOU would not accept orders received 
while a manual quote is the Exchange's disseminated quote. This is to 
ensure that the DPM can make every possible effort to allow the 
incoming order to trade against the market maker responsible for the 
manual quote.
    In sum, for an incoming order to be eligible for LOU, the order 
would be required to: (i) Be a market order or marketable limit order 
that is not for an account in which a member or any non-member broker-
dealer (including foreign broker-dealer) has an interest; (ii) be of a 
size greater than the RAES eligibility limit for the subject option 
series as established pursuant to Rule 6.8(c); (iii) be in an option 
class which is designated by the appropriate FPC as eligible for LOU; 
and (iv) not be a linkage order. Further, at the time of the order's 
receipt, the state of the Exchange's disseminated market would need to 
meet the following: (i) the CBOE quote would be required to be priced 
equal to the NBBO; (ii) the requirements of CBOE Rule 6.8.B (governing 
automated book priority for larger than RAES-size public customer 
orders received through ORS) would have to be in effect for the subject 
option class; and (iii) the CBOE quote could not be a manual quote. LOU 
would accept orders when the above criteria are met.
    How LOU would handle and allocate orders. Orders received by LOU 
would be automatically stopped at CBOE's disseminated price up to the 
disseminated size. The Exchange would transmit a stop notification to 
the order-sending firm. The stopped order would then be immediately 
routed to allow for price improvement and to allocate the order in open 
outcry. If the incoming order is larger than the CBOE's disseminated 
size, LOU would stop the portion of the order equal to the Exchange's 
disseminated size and handle that stopped portion as described above. 
The balance of the order would be routed for non-LOU order handling.
    Once a stopped LOU order was routed to the trading crowd for 
assignment, it would be announced and exposed to the crowd to allow for 
price improvement. If price improvement was not attainable, the order 
would be allocated at the stop price in open outcry consistent with 
existing open outcry procedures under CBOE Rule 6.45. The DPM 
participation right would apply to the extent the order was stopped at 
the DPM's previously established market. If there still remains an 
unallocated portion of the order, such unallocated portion would be 
assigned to LOU's ``In-Person Wheel.''
    The In-Person Wheel is an order allocation mechanism that would 
only be applicable to LOU orders. The mechanism would evenly assign 
contracts to logged-on market-makers (including DPM Designees) up to a 
5-contract maximum per order. Under the proposed rule, any market-maker 
who is present in the trading crowd and who makes markets in a 
particular security traded in that crowd would be required to be logged 
onto the In-Person Wheel for that security. If the In-Person Wheel has 
been exhausted for a particular LOU order and a balance still remains 
on the LOU order, the entirety of such balance would be assigned in 
accordance with the RAES trade allocation methodology in effect for the 
subject option class (i.e., 100-Spoke Wheel or Variable RAES) pursuant 
to CBOE Rule 6.8, Interpretation and Policy .06.
    Examples. Below are some examples of how the LOU system would 
operate. Assume in all of the examples below that the CBOE disseminated 
market is the NBBO and that Rule 6.8.B is in effect. Also assume that 
there are 20 members in the trading crowd.

    Example 1. CBOE quote: 5-5.20; 300 x 450. A customer order to 
buy 300 contracts at the market is received electronically. Here, 
LOU will stop the entire order at 5.20 (thus, the order cannot 
receive a price worse than 5.20) and route it for potential price 
improvement and for allocation. A market-maker has just determined 
that his risk parameters allow him to sell 50 contracts for 5.10. He 
trades 50 of the order at 5.10. The rest of the order is allocated 
in open outcry to the members of the trading crowd that were willing 
to sell for 5.20 (including the DPM) in accordance with applicable 
open outcry rules including the DPM participation entitlement.
    Example 2. CBOE quote: 5-5.20; 300 x 450. A customer order to 
buy 300 contracts at the market is received electronically. The 
order is stopped and routed as in Example 1. No price improvement is 
received this time, and only 220 contracts of the 300-contract order 
are allocated in open outcry. The remaining portion, 80 contracts, 
will be allocated to the In-Person Wheel. In this case, each of the 
20 crowd members would receive 4 contracts via the In-Person Wheel.
    Example 3. Assume the same scenario as in Example 2, except that 
225 contracts are allocated in open outcry. Here, the In-Person 
Wheel will provide that 15 crowd members receive 4 contracts, and 
the other five members receive 3 contracts.
    Example 4. Assume the same scenario as in Example 2, except that 
150 contracts are allocated in open outcry. In this case, the In-
Person Wheel would assign 5 contracts to each of the 20 crowd 
members (for a total of 100 contracts). Thus, the In-Person Wheel is 
exhausted while a portion of the order (50 contracts) remains 
unexecuted. The remaining 50 contracts are therefore assigned via 
the RAES allocation methodology in effect for that trading crowd 
(either the 100-Spoke Wheel or Variable RAES, both of which are 
governed by Rule 6.8, Interpretation and Policy .06).
    Example 5. CBOE quote: 5-5.20; 300 x 500. The offer represents a 
customer limit order in

[[Page 41746]]

the book to sell 50 contracts and the CBOE trading crowd's market of 
450 contracts. A customer order to buy 300 contracts at the market 
is received electronically. Here, the order will automatically 
execute against the order in the book for 50 contracts pursuant to 
Rule 6.8.B before LOU stops the remaining 250 contracts on the buy 
order at 5.20 and then routes those contracts to the crowd for 
potential price improvement and allocation.
    Example 6. CBOE quote: 5-5.20; 300 x 200. A customer order to 
buy 300 contracts at the market is received electronically. Here, 
LOU will stop a 200-contract portion of the order at 5.20 (and send 
a stop notification for 200 contracts). The remaining 100 contracts 
of the order (the unstopped portion) will be routed for normal 
handling and representation. It will not be guaranteed a fill at the 
disseminated price at the time of receipt because that price was 
exhausted.

    Lastly, the Exchange notes that the provisions of Rule 8.17 
relating to the manual stopping of options order on the Exchange shall 
not apply to orders received and handled pursuant to proposed Rule 
6.10. Rule 8.17 is applicable to manual stops and its terms would not 
make sense for electronically stopped orders.
2. Statutory Basis
    The Exchange believes the proposed rule change will help customer 
orders receive fast and secure executions at disseminated prices and is 
therefore consistent with section 6(b) of the Act \5\ in general and 
furthers the objectives of Section 6(b)(5) \6\ in particular in that it 
should promote just and equitable principles of trade, serve to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and protect investors and the public 
interest.
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change does not impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the 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. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 the filing will also be 
available for inspection and copying at the principal offices of the 
CBOE. All submissions should refer to File No. SR-CBOE-2002-31 and 
should be submitted by July 10, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-15428 Filed 6-18-02; 8:45 am]
BILLING CODE 8010-01-P