[Federal Register Volume 69, Number 33 (Thursday, February 19, 2004)]
[Notices]
[Pages 7829-7832]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-3578]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49213; File No. SR-CBOE-2003-35]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change, and Amendment Nos. 1, 2, and 3 Thereto, by the Chicago Board 
Options Exchange, Inc. Relating to Its Position and Exercise Limits

February 9, 2004.
    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 August 26, 2003, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') submitted to 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 September 
29, 2003, the CBOE submitted Amendment No. 1 to the proposed rule 
change. On January 29, 2004, the CBOE submitted Amendment No. 2 to the 
proposed rule change. On February 9, 2004, the CBOE submitted Amendment 
No. 3 to the proposed rule change. 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to issue a regulatory circular that contains 
additional guidance for member firms seeking non-aggregation treatment 
for the accounts of certain trading units of the member for purposes of 
the Exchange's position and exercise limit rules.
    The text of the proposed regulatory circular is below. Proposed 
additions are in italics.

Chicago Board Options Exchange, Incorporated Rules

* * * * *
Regulatory Circular RG04-XX \3\
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    \3\ This regulatory circular was filed with the SEC in 
connection with SR-CBOE-2003-35.
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Date: 2004
To: Members and Member Firms
From: Regulatory Services Division
Re: Aggregation of Accounts for Position and Exercise Limit Purposes

Aggregation of Accounts

    The purpose of this memorandum is to summarize the provisions of 
Exchange rules with respect to the aggregation of accounts for position 
and exercise limit purposes. Exchange Rules 4.11 and 4.12 require that 
positions maintained in accounts directly or indirectly controlled by 
the same individual or entity be aggregated for position and exercise 
limit purposes. Pursuant to Rule 4.11, control exists when an 
individual or entity makes investment decisions for an account or 
accounts, or materially influences directly or indirectly the actions 
of any person who makes investment decisions. Control is also presumed 
in the following circumstances: (a) among all participants of a joint 
account who have authority to act on behalf of the

[[Page 7830]]

account; (b) among all general partners to a partnership account; (c) 
when an individual or entity holds an ownership interest of 10% or more 
in an entity, or shares in 10% or more of profits and/or losses of an 
account; (d) when accounts have common directors or management; and (e) 
where an individual or entity has authority to execute transactions in 
an account.

Non-aggregation of Accounts

    Demonstrating that control does not exist can rebut the presumption 
of control. The rebuttal proof must be submitted to the Exchange by 
affidavit and other documentation as may be appropriate. The decision 
to grant non-aggregation is not retroactive and is handled on a case-
by-case basis. The Exchange has granted non-aggregation between the 
following accounts: between a market-maker's individual account and his 
joint account in which the market-maker's participation in the joint 
account is limited to providing financial backing to the other member 
of the account; and between affiliated broker-dealers.
    In situations involving requests for non-aggregation treatment 
between (i) affiliated broker-dealers and (ii) separate and distinct 
trading units within the same broker-dealer, the Exchange requires, at 
a minimum, the broker-dealer(s) to satisfy the following conditions:
    (i) Establish that the trading unit(s) requesting non-aggregation 
operates independently of other trading units of the broker-dealer, 
which must include the disclosure of the trading unit's trading 
objective;
    (ii) Create internal firewalls and information barriers to 
segregate the trading unit(s) receiving non-aggregation treatment from 
other trading units controlled by the broker-dealer that also have 
trading accounts; \4\
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    \4\ The Exchange will review this category on a case-by-case 
basis. With respect to physical separation, the presumption of 
control becomes easier to rebut as the physical separation between 
the trading units increases. At the minimum, the Exchange will 
require trading units located on the same floor to be physically 
isolated from each other to the extent that the Exchange is assured 
that no communication will take place between individuals staffed in 
the applicable trading units. In addition, the Exchange will require 
system firewalls to be in place in order to prevent the flow of 
information (e.g., trades, positions, trading strategies) between 
the trading unit(s) that receives non-aggregation treatment and 
other trading units controlled by the broker-dealer.
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    (iii) Maintain all trading activity of the trading unit(s) 
requesting non-aggregation in a segregated account, which shall be 
reported to the Exchange as such; and
    (iv) Maintain regulatory compliance oversight and internal controls 
and procedures.
    If the Exchange determines that the broker-dealer that requests 
non-aggregation treatment has successfully rebutted the presumption of 
control and grants non-aggregation status, the broker-dealer must, at a 
minimum, comply with the following requirements:
    (i) Retain written records of information concerning the non-
aggregated account, including, but not limited to, trading personnel, 
names of personnel making trading decisions, unusual trading 
activities, disciplinary action resulting from a breach of the broker-
dealer's systems firewalls and information-sharing policies, and the 
transfer of securities between the broker-dealer's non-aggregated 
accounts, which information shall be promptly made available to the 
Exchange upon its request;
     (ii) Promptly provide to the Exchange a written report at such 
time there is any material change with respect to the non-aggregated 
account, at which point the Exchange will reexamine the bases for its 
determination of non-aggregation; \5\ and
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    \5\ The Exchange reserves the right to freeze any position above 
the standard aggregation limit if the Exchange determines that 
aggregation is then appropriate due to changed circumstances.
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    (iii) Provide an acknowledgement to the effect that the Exchange 
reserves the right to impose additional restrictions and conditions 
with respect to the granting and removal of non-aggregation as the 
circumstances warrant.
    This memorandum is not intended to be a comprehensive description 
of all of the rules and requirements relating to the aggregation of 
accounts for position and exercise limit purposes. For a more detailed 
description of these rules and requirements members are advised to 
refer to Exchange Rule 4.11 and the Interpretations and Policies 
thereunder. Questions pertaining to this memorandum may be directed to 
Pat Cerny at (312) 786-7722 or Mike Felty at (312) 786-7504.
* * * * *

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 had 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
    The Exchange proposes to issue a regulatory circular that provides 
additional guidance with respect to the proof required to rebut the 
presumption of control for purposes of the Exchange's option contract 
position limit and option contract exercise limit rules (CBOE Rules 
4.11 and 4.12, respectively). The regulatory circular would set forth 
conditions and requirements, in addition to those that are set forth in 
Interpretation .03(c) to CBOE Rule 4.11, that must be satisfied by a 
member who seeks non-aggregation of the accounts of certain of its 
trading units, for purposes of CBOE Rules 4.11 and 4.12.
    The Exchange recently has received requests from member firms 
asking for non-aggregation treatment for separate trading accounts of 
those member firms with respect to the Exchange's position and exercise 
limits. Specifically, these member firms have requested that one or 
more of their internal trading units be treated as a separate 
aggregation unit distinct from other units of the member firm holding 
proprietary option positions for purposes of determining aggregate 
position and exercise limits in an option contract. These firms have 
indicated that common control does not exist with respect to certain 
trading units of the member firm, which would permit the trading units 
to be treated as separate aggregation units for purposes of CBOE Rules 
4.11 and 4.12.
    CBOE Rule 4.11 prohibits a member, for any account in which it has 
an interest or for the account of any customer, from effecting an 
opening transaction in an option contract if the member or its customer 
controls an aggregate position in that option class that exceeds a 
certain level.\6\ CBOE Rule 4.12 prohibits a member, for any account in 
which it has an interest or for the account of any customer, from 
exercising a long position in an option contract if the member or its 
customer exercises within any five consecutive business days aggregate 
long positions in that option class that exceed a certain

[[Page 7831]]

level.\7\ Pursuant to Interpretation .03(a) to CBOE Rule 4.11, control 
exists for purposes of CBOE Rules 4.11 and 4.12 when it is determined 
that an individual or entity (1) makes investment decisions for an 
account or accounts, or (2) materially influences directly or 
indirectly the actions of any person who makes investment decisions. 
Interpretation .03(b) to CBOE Rule 4.11 provides certain circumstances 
in which control will be presumed to exist.\8\ Interpretation .03(c) to 
CBOE Rule 4.11 explains how a member firm may rebut the presumption of 
control.\9\
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    \6\ See Interpretation .02 to CBOE Rule 4.11, which delineates 
position limits for option contracts.
    \7\ See Interpretation .02 to CBOE Rule 4.11, which, as directed 
by CBOE Rule 4.12, delineates exercise limits for option contracts.
    \8\ Interpretation .03(b) to CBOE Rule 4.11 states: ``In 
addition, control will be presumed in the following circumstances: 
(1) Among all parties to a joint account who have authority to act 
on behalf of the account; (2) among all general partners to a 
partnership account; (3) when an individual or entity (i) holds an 
ownership interest of 10 percent or more in an entity (ownership 
interest of less than 10 percent will not preclude aggregation), or 
(ii) shares in 10 percent or more of profits and/or losses of an 
account; (4) when accounts have common directors or management; (5) 
where a person or entity has the authority to execute transactions 
in an account.''
    \9\ Interpretation .03(c) to CBOE Rule 4.11 states in relevant 
part: ``Control * * * can be rebutted by proving the factor does not 
exist or by showing other factors which negate the presumption of 
control. The rebuttal proof must be submitted by affidavit and/or 
such other documentary evidence as may be appropriate in the 
circumstances. The Exchange will also consider the following factors 
in determining if aggregation of accounts is required: (1) Similar 
patterns of trading activity among separate entities; (2) the 
sharing of kindred business purposes and interests; (3) whether 
there is common supervision of the entities which extends beyond 
assuring adherence to each entity's investment objectives and/or 
restrictions; and (4) the degree of contact and communication 
between directors and/or managers of separate accounts.''
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    The Exchange believes that Interpretation .03 to CBOE Rule 4.11 
provides the Exchange with the authority to grant non-aggregation 
requests of the type described above because the limits set forth in 
CBOE Rules 4.11 and 4.12 are generally based on control, as opposed to 
ownership, of accounts.\10\ Therefore, if two accounts of a broker-
dealer are individually managed by separate trading units that have no 
relationship to the other except that each operates within a single 
corporate entity, the Exchange believes that the broker-dealer would 
have a basis to show that the accounts are not under common control. In 
fact, the Exchange has already permitted non-aggregation of accounts of 
affiliated entities of a member firm for purposes of CBOE Rules 4.11 
and 4.12 and does not believe the existence of a separate corporate 
entity, affiliated or otherwise, into which a trading unit and its 
corresponding account are placed should be the determinative factor 
with respect to rebutting the presumption of control. Instead, the 
Exchange believes that the existence of separate corporate entities is 
merely part of the analysis of whether the presumption of control has, 
in fact, been rebutted. For example, the separate corporate entity may 
still have to prove to the Exchange that it meets the requirements of 
Interpretation .03(c) to CBOE Rule 4.11 in order to have a non-
aggregated account. Of course, the Exchange may determine based on the 
circumstances that accounts must be aggregated for purposes of CBOE 
Rules 4.11 and 4.12, notwithstanding the establishment of separate 
corporate affiliated entities to manage those accounts.
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    \10\ See Securities and Exchange Act Release No. 34-22695 
(December 9, 1985), 50 FR 50976 (December 13, 1985) (approving SR-
CBOE-82-17, which established a system of control, rather than 
ownership, as the determinative factor for the aggregation of 
accounts).
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    The Exchange notes that Commission staff has taken a no-action 
position with respect to a broker-dealer that calculates its net 
position in a particular security of an individual trading unit (such 
as a block positioning desk) of the broker-dealer independently from 
other individual trading units of the broker-dealer for purposes of 
determining whether the broker-dealer is ``net long,'' as that term is 
used in Rules 3b-3 and 10a-1 under the Act.\11\ The CBOE believes that 
the Commission staff's recognition that trading units within a broker-
dealer can operate independently from each other for purposes of the 
Exchange Act's ``short sale'' rules \12\ further supports the concept 
that trading units within a broker-dealer may also be treated as 
separate, independent aggregation units for purposes of CBOE Rules 4.11 
and 4.12.
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    \11\ See Wilke Farr & Gallagher, SEC No-Action Letter, (1998 
Transfer Binder) Fed. Sec. L. Rep. (CCH) ] 77,483 (November 23, 
1998) (the ``SEC No-Action Letter'').
    \12\ 17 CFR 240.3b-3 and 17 CFR 240.10a-1.
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    Notwithstanding the Exchange's authority to grant a request for 
non-aggregation, the threshold for rebutting a presumption of control 
in the context of such a request would be high. In addition to 
satisfying all of the enumerated factors set forth in Interpretation 
.03(c) to CBOE Rule 4.11, the regulatory circular would require the 
member firm to satisfy additional conditions prior to the Exchange's 
grant of non-aggregation of the trading unit's account. Specifically, a 
member firm would have to (i) establish that the trading unit(s) 
requesting non-aggregation operates independently of other trading 
units of the member firm, which must include the disclosure of the 
trading unit's trading objective, (ii) create internal firewalls and 
information barriers to segregate the trading unit(s) receiving non-
aggregation treatment from other trading units controlled by the member 
firm that also have trading accounts,\13\ (iii) maintain all trading 
activity of the trading unit(s) requesting non-aggregation in a 
segregated account and report the activity to the Exchange as such, and 
(iv) maintain regulatory compliance oversight and internal controls and 
procedures.
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    \13\ The Exchange would review this category on a case-by-case 
basis. With respect to physical separation, the presumption of 
control becomes easier to rebut as the physical separation between 
the trading units increases. At the minimum, the Exchange would 
require trading units located on the same floor to be physically 
isolated from each other to the extent that the Exchange is assured 
that no communication will take place between individuals staffed in 
the applicable trading units. In addition, the Exchange would 
require system firewalls to be in place in order to prevent the flow 
of information (e.g., trades, positions, trading strategies) between 
the trading unit(s) that receives non-aggregation treatment and 
other trading units controlled by the broker-dealer.
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    As set forth in the proposed regulatory circular, a member firm 
that is granted non-aggregation would have to comply with the following 
requirements: (i) retain written records of information concerning the 
trading unit's non-aggregated account, which must be promptly provided 
to the Exchange upon request, (ii) promptly provide to the Exchange a 
written report at such time there is any material change with respect 
to the non-aggregated account, at which point the Exchange will 
reexamine the bases for its determination of non-aggregation,\14\ and 
(iii) provide an acknowledgement by the member firm that the Exchange 
reserves the right to impose additional restrictions and conditions 
with respect to the granting and removal of non-aggregation of the 
trading unit's account as the circumstances warrant.
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    \14\ The Exchange would reserve the right to freeze any position 
above the standard aggregation limit if the Exchange determines that 
aggregation is then appropriate due to changed circumstances.
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    The Exchange will review non-aggregation requests with members of 
the Intermarket Surveillance Group Options Sub-Group (the ``Sub-
Group''), which is comprised of representatives from the CBOE, American 
Stock Exchange, Boston Options Exchange, International Securities 
Exchange, Pacific Exchange and Philadelphia Stock Exchange (each, an 
``options exchange''). Generally, the options exchange that receives 
the initial request for non-aggregation (``the receiving exchange'') 
will distribute the material to the Sub-Group members and

[[Page 7832]]

thereafter discuss the request through one or more conference calls. 
The receiving exchange will collect input and comments from the Sub-
Group members and if need be, contact the requesting member for 
additional information. If necessary, the Sub-Group members may 
participate in a conference call to pose their questions directly to 
the requesting member. Once a decision has been reached, the receiving 
exchange will draft the response letter and circulate it to the Sub-
Group for comments.
2. Statutory Basis
    The CBOE believes that the proposed rule change will assist 
Exchange members by providing guidance on how an Exchange member firm 
can rebut the presumption of control with respect to CBOE Rules 4.11 
and 4.12 and is therefore consistent with section 6(b) of the Act \15\ 
in general and furthers the objectives of section 6(b)(5) \16\ in 
particular in that it should promote just and equitable principles of 
trade, 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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    \15\ 15 U.S.C 78f(b).
    \16\ 15 U.S.C 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition 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 CBOE consents, the Commission will:
    (A) By order approve such proposed rule change, as amended,; or
    (B) Institute proceedings to determine whether the proposed rule 
change, as amended, 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. Comments may also be submitted electronically at the 
following e-mail address: [email protected]. All comment letters 
should refer to File No. SR-CBOE-2003-35. This file number should be 
included on the subject line if e-mail is used. To help the Commission 
process and review your comments more efficiently, comments should be 
sent in hardcopy or by e-mail but not by both methods. 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 filings will also be available 
for inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-2003-35 and should be 
submitted by March 11, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-3578 Filed 2-18-04; 8:45 am]
BILLING CODE 8010-01-P