[Federal Register Volume 67, Number 206 (Thursday, October 24, 2002)]
[Notices]
[Pages 65384-65388]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-27116]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46683; File No. SR-CBOE-2002-27]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1 and 2 Thereto by the Chicago Board Options 
Exchange, Inc. Relating to Permanent Approval of the 100 Spoke RAES 
Wheel

October 17, 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 May 24, 2002, the Chicago Board Options Exchange, Inc. (``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 CBOE. On July 17, 
2002, the Exchange filed Amendment No. 1 to the proposed rule 
change.\3\ On September 26, 2002, the Exchange filed Amendment No. 2 to 
the proposed rule change.\4\ The Commission is publishing this notice 
to solicit

[[Page 65385]]

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\ See Letter from Nancy L. Nielsen, Director of Arbitration 
and Assistant Secretary, CBOE, to Nancy Sanow, Assistant Director, 
Division of Market Regulation, Commission, dated July 16, 2002 
(``Amendment No. 1''). Amendment No. 1 is described in Section 
II.A., below.
    \4\ See Letter from Madge M. Hamilton, Legal Division, CBOE, to 
Nancy Sanow, Assistant Director, Division of Market Regulation, 
Commission, dated September 26, 2002 (``Amendment No. 2''). 
Amendment No. 2 is described in Section II.A., below.
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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 eliminate the pilot program 
and make permanent the 100 Spoke RAES Wheel System. The CBOE further 
proposes to modify the calculation of the participation distribution 
for market makers participating on the 100 Spoke RAES Wheel by 
eliminating the ``vacation penalty.''
    Below is the text of the proposed rule change, as amended. Proposed 
new language is in italics; proposed deletions are in brackets.
Chapter VI Doing Business on the Exchange Floor
Section A: General
RULE 6.8
* * * * *
* * * Interpretations and Policies
    .01-.05 No change.
    .06(a)-(b) No change.
    (c) Under the ``100 spoke RAES Wheel,'' [for a pilot period ending 
November 28, 2002,] RAES orders would be assigned to logged-in market 
makers according to the percentage of their in-person agency contracts 
traded in that class (excluding RAES contracts traded) compared to all 
of the market-maker in-person agency contracts traded (excluding RAES 
contract) during the review period. The review period will be 
determined by the appropriate Floor Procedure Committee and may be for 
any period not in excess of 10 trading days, [two weeks] within the 
previous 30 calendar days. The trading days within the review period 
may be for non-consecutive trading days. The percentage distribution 
will be calculated at the conclusion of each trading day and will be 
applied to the 100 Spoke RAES Wheel distribution on the following 
trading day [determined during a review period will be effective for 
the succeeding review period]. On each revolution of the RAES wheel, 
subject to the exceptions described below, each participating market 
maker (who is logged onto RAES at the time) will be assigned enough 
contracts to replicate his percentage of contracts on RAES that he 
traded in-person in that class during the review period. [The review 
period will most likely be for an expiration cycle with the percentage 
distribution to be effective for the succeeding calendar month.] A 
participation percentage will be calculated for each market-maker for 
each class that the market-maker trades. For this purpose all DPM 
Designees of the same DPM unit will have their percentage aggregated 
into a single percentage for the DPM unit.
    Once a market-maker has logged onto RAES, he will be assigned 
contracts on the RAES Wheel until his market-maker participation 
percentage has been met. This may mean that multiple orders (or an 
order and a part of the succeeding order) will be assigned to the same 
market-maker on the Wheel. To understand how the RAES orders will 
actually be allocated to market-makers to meet those percentages, one 
must understand the concepts of ``spokes'' and ``wedges.'' A ``spoke'' 
is 1% of the RAES wheel and often may be equal to one contract. The 
appropriate Floor Procedure Committee may determine the number of 
contracts that make up one spoke. Each market-maker logged onto RAES 
for that class, regardless of his participation percentage, is entitled 
to be assigned at least one spoke on every revolution of the RAES 
wheel. For example, if a spoke equals one contract then there will be 
100 spokes that will be assigned to market-makers on every revolution 
of the RAES wheel. If a spoke is defined as five contracts then there 
will be 500 RAES contracts assigned to the participating market-makers 
before the RAES wheel completes one revolution. Generally, the RAES 
Wheel will consist of the number of spokes replicating the cumulative 
percentage of all market-makers logged onto the system who have a 
participation percentage plus one spoke for each market-maker that does 
not have a specific participation percentage.
    A ``wedge'' is the maximum number of spokes that a market-maker may 
be consecutively assigned at any one time on the RAES wheel. Because 
the size of the wedge may be smaller than the number of contracts to 
which a particular market-maker is entitled during one revolution of 
the RAES Wheel, that market-maker will receive more than one turn 
during one revolution of the RAES wheel. The wedge size will be 
variable, at the discretion of the appropriate Floor Procedure 
Committee and may be different for different classes or the same for 
all classes.
    The appropriate Floor Procedure Committee will notify the 
membership of each class of options that is subject to the ``100 Spoke 
RAES Wheel''.
    (d) No change.
    .07-.09 No change.
* * * * *

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

    In its filing with the Commission, 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

a. The Initial Proposal

    On May 25, 2000, the Commission approved, on a pilot basis, the 
Exchange's proposal to amend Rule 6.8 to provide the appropriate Floor 
Procedure Committee (``FPC'') with a third choice for apportioning RAES 
trades among participating market-makers, the 100 Spoke RAES Wheel.\5\ 
In those classes where the 100 Spoke RAES Wheel is employed, the 
distribution of RAES trades to participating market-makers is 
essentially identical to the distribution of in-person agency market-
maker trades for non-RAES trades in that class. The pilot program has 
been extended five times, most recently until November 28, 2002.\6\
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    \5\ Securities Exchange Act Release No. 42824 (May 25, 2000), 65 
FR 37442 (June 14, 2000). RAES is the Exchange's automatic execution 
system for public customer market or marketable limit orders of less 
than a certain size.
    \6\ Securities Exchange Act Release No. 46644 (October 10, 2002) 
(pilot program extended until November 28, 2002) (SR-CBOE-2002-60); 
Securities Exchange Act Release No. 46149 (June 28, 2002), 67 FR 
45161 (July 8, 2002) (pilot program extended until September 28, 
2002) (SR-CBOE-2002-34); Securities Exchange Act Release No. 45230 
(January 3, 2002), 67 FR 1380 (January 10, 2002) (pilot program 
extended until June 28, 2002) (SR-CBOE-2001-68); Securities Exchange 
Act Release No. 44749 (August 28, 2001), 66 FR 46487 (September 5, 
2001) (pilot program extended until December 28, 2001) (SR-CBOE-
2001-47); Securities Exchange Act Release No. 44020 (February 28, 
2001), 66 FR 13985 (March 8, 2001) (pilot program extended until 
August 28, 2001) (SR-CBOE-01-07).
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    Under the 100 Spoke RAES Wheel, RAES orders are assigned to market-
makers according to the percentage of their in-person agency contracts 
(excluding RAES contracts) traded in that class compared to the in-
person agency contracts (excluding RAES contracts) of all of the 
market-makers traded during the review period. Agency

[[Page 65386]]

contracts are any contracts represented by an agent (booked orders and 
orders represented by brokers) and do not include contracts traded 
between market-makers in person in the trading crowd. A particular 
market-maker's entitlement will change based upon the percentage of 
agency contracts that market-maker traded in the review period. For 
example, if a particular market-maker traded 10% of all the in-person 
agency contracts (excluding RAES contracts) of class ABC for a 
particular review period, then that market-maker would be assigned 10% 
of the RAES contracts during the next trading period. The review period 
is determined by the appropriate FPC.
    The RAES Wheel can be envisioned as having a number of spokes, each 
generally representing one percent of the total participation of all 
market-makers in the class. Thus, a market-maker will generally be 
assigned one spoke for each one percent of his or her market-maker 
participation during the review period. If the spoke size is one and 
all market-makers who traded in-person agency contracts in that option 
class during the review period are logged onto RAES, and no other 
market-makers are logged on, the RAES Wheel would consist of 100 
spokes, representing 100 percent of all market-maker activity during 
the review period. The appropriate FPC may establish a larger spoke 
size. Setting the spoke size to five contracts, for example, would 
redefine the RAES Wheel for a particular option class as a Wheel of 500 
contracts. A larger Wheel would mean the Wheel would not revolve as 
quickly through the logged on market-makers, but a larger Wheel would 
not change the participation percentage of the individual market-
makers.
    A wedge is the maximum number of spokes that may be consecutively 
assigned at any one time to a market-maker during a rotation of the 
RAES Wheel. The purpose of the wedge is to break up the distribution of 
contracts into smaller groupings to reduce the exposure of any one 
market-maker to market risk. If the size of the wedge is smaller than 
the number of spokes to which a particular market-maker may be entitled 
based on his or her participation percentage, then that market-maker 
would receive one or more additional assignments during one revolution 
of the RAES Wheel. For example, in the case where one spoke is equal to 
one contract and the market-maker's participation percentage is 15 
percent (15 percent of 100 spokes) and the wedge size is ten, that 
market-maker first would be assigned ten contracts on the RAES Wheel 
and then five contracts at a different place on the RAES during the 
same revolution of the RAES Wheel. The wedge size is variable at the 
discretion of the appropriate FPC and may be established at different 
levels for different classes, or at the same level for all classes.
    The Exchange represents that the 100 Spoke RAES Wheel has worked as 
anticipated by providing an efficient and effective alternative 
allocation method for assigning RAES trades. The Exchange further 
represents that, in those classes where the 100 Spoke RAES Wheel is 
employed, the distribution of RAES trades is essentially identical to 
the distribution of in-person agency market-maker trades on non-RAES 
trades in that class during the relevant review period. Therefore, CBOE 
requests permanent approval of the 100 Spoke RAES Wheel.

b. Amendment No. 1

    In Amendment No. 1, CBOE clarified the calculation of the 
participation distribution for market-makers participating on the 100 
Spoke RAES Wheel. Specifically, Amendment No. 1 modified Interpretation 
.06(c) of Rule 6.8 to adjust the applicable review period to account 
for vacations by market-makers. CBOE indicated that without this 
revision, if a market-maker takes even a single trading day off over 
the two-week review period, the market-maker is allocated a number of 
spokes that is less than the market-maker's average daily percentage of 
the trading volume, resulting in a ``vacation penalty.'' Thus, in 
Amendment No. 1, CBOE amended the rule text to specify that rather than 
``two weeks'' (as previously specified) the operative review period 
will be the prior ``10 trading days,'' i.e., last ten days in which the 
market-maker had trading activity, subject to the condition that the 
review period cannot extend back more than 30 calendar days (in order 
to assure that the review period is not based on stale activity). The 
Amendment further specified that the trading days within the review 
period may be non-consecutive trading days, and that the percentage 
distribution ``will be calculated at the conclusion of each trading day 
and will be applied to the 100 Spoke RAES Wheel distribution on the 
following trading day''.

c. Amendment No. 2

    CBOE filed Amendment No. 2 in order to clarify various items 
discussed in the narrative portion of the original filing and Amendment 
No. 1. Although Amendment No. 2 did not propose changes to the proposed 
rule text (as amended by Amendment No. 1), it did provide further 
explanation of the following items.
    First, CBOE explained that, in calculating the review period, the 
10 trading days used to compute one market-maker's RAES participation 
distribution may be a different 10 trading days than another market-
maker signed onto RAES in the same trading crowd, and that the 10-day 
review periods may overlap. In addition, CBOE clarified that the 
individual market-makers have no discretion over which 10 trading days 
will be used in the calculation. The proposed rule change permits the 
appropriate FPC to set a review period not to exceed 10 trading days. 
Once the appropriate FPC has set the number of days to be used in the 
calculation of the market-maker's participation distribution, the 
Exchange looks back that number of trading days to calculate each 
market-maker's participation right.
    Second, CBOE reiterated that, under the proposed rule, the Exchange 
will conduct the calculation for the market-maker participation 
distribution at the conclusion of each trading day and apply the 
market-makers' RAES participation distribution to the following trading 
day. CBOE further explained that, since the calculation of the 
participation distribution is done at the end of each trading day, the 
10-day review period for each market-maker will be done on a rolling 
basis, i.e., each time the calculation is conducted the non-RAES agency 
trading volume for the current day, if any, is added to the 10-day 
review period, and the non-RAES agency trading volume for the oldest 
day used for the previous day's calculation is deleted. According to 
CBOE, this calculation encourages market-makers to actively trade every 
day, since each day's trading activity will have an effect on the 
market-maker's RAES participation distribution for the next trading 
day.
    Third, CBOE corrected the formula for determining market-maker 
participation percentage on the 100 Spoke RAES Wheel, which had been 
stated incorrectly in Amendment No. 1 (the numerator and denominator 
were inadvertently reversed). In Amendment No. 2, CBOE clarified that 
in order to obtain a market-maker's participation percentage, the 
``non-RAES agency trading volume'' for a given market-maker is divided 
by the ``total volume,'' i.e., the sum of the volume of the non-RAES 
agency trades for all traders in a particular options class (which is 
determined by adding together the trading volume for each market-maker 
and DPM during his or her relevant 10-day review period). CBOE provided 
the

[[Page 65387]]

following example: Market-Maker A traded every day for three weeks, 
then in week four did not trade on Monday or Tuesday, but traded the 
rest of the week, and the appropriate FPC set the review period at ten 
non-consecutive trading days. CBOE would calculate Market-Maker A's 
participation percentage by looking at the last ten days out of the 
last 30 calendar days that Market-Maker A traded. Thus, the Exchange 
would count Wednesday, Thursday, and Friday in week four, all five 
trading days of week three and Thursday and Friday of week two to 
compute the ten-day review period for Market-Maker A. The Exchange then 
would sum the volume of the non-RAES agency trades for Market-Maker A 
in order to calculate Market-Maker A's ten-day non-RAES agency trading 
volume. The Exchange then would sum the volume of the non-RAES agency 
trades for all traders in a particular options class to obtain the 
total non-RAES agency trading volume (``total volume'').\7\ The non-
RAES agency trading volume for Market-Maker A would then be divided by 
the total volume to obtain Market-Maker's A's participation percentage 
on the 100 Spoke RAES Wheel. This calculation would eliminate the 
``vacation penalty'' and provide greater incentive for market-makers to 
participate on the 100 Spoke RAES Wheel.
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    \7\ The Exchange noted that the total volume is not based on a 
specific two-week calendar period, but instead is calculated by 
adding together the trading volume for each market-maker and DPM 
during his or her relevant 10-day review period.
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    To further explain its proposal, in Amendment No. 2 CBOE included 
the following specific example showing how market makers' review 
periods and participation percentages on the 100 Spoke RAES Wheel would 
be calculated.
    For example, the trading pit for XYZ option consists of Market-
Makers A, B, C, D and E. Market-Maker A took the week of January 21, 
2002, off for vacation. January 21, 2002, was a holiday and the 
Exchange was closed for trading. After the close on Friday, January 25, 
2002, the Exchange calculates the participation percentage for Monday, 
January 28, 2002. The Exchange would calculate the non-RAES agency 
trading volume for each market-maker during each market-maker's 10-day 
review period. Market-Maker A had total non-RAES agency trading volume 
of 20,000 contracts for trading on January 7, 8, 9, 10, 11,14, 15, 16, 
17, and 18. Market-Maker B had total non-RAES agency trading volume of 
20,000 contracts for trading on January 11, 14, 15, 16, 17, 18, 22, 23, 
24 and 25. Market-Maker C had total non-RAES agency trading volume of 
10,000 contracts for trading on January 11, 14, 15, 16, 17, 18, 22, 23, 
24 and 25. Market-Maker D had total non-RAES agency trading volume of 
20,000 for trading on January 11, 14, 15, 16, 17, 18, 22, 23, 24 and 
25. Market-Maker E had total non-RAES agency trading volume of 30,000 
contracts for trading on January 11, 14, 15, 16, 17, 18, 22, 23, 24 and 
25. The Exchange would add the total non-RAES agency trading volume for 
Market-Makers A, B, C, D and E to get a total volume of 100,000 
contracts. Each market-maker's total non-RAES agency trading volume 
would be divided by 100,000 contracts. Therefore, on Monday, January 
28, 2002, Market-Maker A would have a RAES participation distribution 
of 20 percent, Market-Maker B would have a RAES participation 
distribution of 20 percent; Market-Maker C would have a RAES 
participation distribution of 10 percent, Market-Maker D would have a 
RAES participation distribution of 20 percent and Market-maker E would 
have a RAES participation distribution of 30 percent.
2. Statutory Basis
    The Exchange believes that the proposed rule change, as amended, 
will continue to be consistent with the requirements of section 6(b)(5) 
of the Act.\8\ Section 6(b)(5) of the Act requires, among other things, 
that the rules of an exchange be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to facilitate 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, to protect 
investors and the public interest.\9\ The Exchange represents that, as 
anticipated, the 100 Spoke RAES Wheel has rewarded those market-makers 
who are most active in providing the services that a market-maker is 
expected to perform, i.e., providing liquidity to agency business in 
the assigned product. The Exchange represents that this has enhanced 
the ability of the Exchange to provide instantaneous, automatic 
execution of RAES-eligible orders at the best available prices. In 
addition, the Exchange believes that the proposed rule change, as 
amended, promotes just and equitable principles of trade by eliminating 
the ``vacation penalty.'' The Exchange further believes that the 
proposed rule change, as amended, protects investors and is in the 
public interest by creating an incentive for more market-makers to 
participate on the 100 Spoke RAES Wheel, which provides more liquidity 
for the automatic execution of orders.
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    \8\ 15 U.S.C. 78f(b)(5).
    \9\ Id.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange represents that the proposed rule change, as amended, 
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, as amended.

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 self-regulatory organization consents, the Commission will:
    A. By order approve the 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, 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 at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No.

[[Page 65388]]

SR-CBOE-2002-27 and should be submitted by November 14, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-27116 Filed 10-23-02; 8:45 am]
BILLING CODE 8010-01-P