[Federal Register Volume 69, Number 230 (Wednesday, December 1, 2004)]
[Notices]
[Pages 69967-69970]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3406]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50732; File No. SR-CBOE-2004-71]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Notice of Filing of Proposed Rule Change To Modify the 
Distribution of the DPM Participation Entitlement for Orders Specifying 
a Preferred DPM Under CBOE Rule 8.87

November 23, 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 November 10, 2004, 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. 
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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[[Page 69968]]

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to modify the distribution of the Designated 
Primary Market-Maker (``DPM'') participation entitlement for orders 
specifying a Preferred DPM under CBOE Rule 8.87. Below is the text of 
the proposed rule change. Proposed new language is in italics; proposed 
deletions are in brackets.
Rule 8.87 Participation Entitlements of DPMs and e-DPMs
    (a) No change.
    (b) The participation entitlement for DPMs and e-DPMs (as defined 
in Rule 8.92) shall operate as follows:
    (1) Generally.
    (i) To be entitled to a participation entitlement, the DPM/e-DPM 
must be quoting at the best bid/offer on the Exchange.
    (ii) A DPM/e-DPM may not be allocated a total quantity greater than 
the quantity that the DPM/e-DPM is quoting at the best bid/offer on the 
Exchange.
    (iii) The participation entitlement is based on the number of 
contracts remaining after all public customer orders in the book at the 
best bid/offer on the Exchange have been satisfied.
    (2) Participation Rates applicable to DPM Complex. The collective 
DPM/e-DPM participation entitlement shall be: 50% when there is one 
Market-Maker also quoting at the best bid/offer on the Exchange; 40% 
when there are two Market-Makers also quoting at the best bid/offer on 
the Exchange; and, 30% when there are three or more Market-Makers also 
quoting at the best bid/offer on the Exchange.
    (3) Allocation of Participation Entitlement Between DPMs and e-
DPMs. The participation entitlement shall be as follows: If the DPM and 
one or more e-DPMs are quoting at the best bid/offer on the Exchange, 
the e-DPM participation entitlement shall be one-half (50%) of the 
total DPM/e-DPM entitlement and shall be divided equally by the number 
of e-DPMs quoting at the best bid/offer on the Exchange. The remaining 
half shall be allocated to the DPM. If the DPM is not quoting at the 
best bid/offer on the Exchange and one or more e-DPMs are quoting at 
the best bid/offer on the Exchange, then the e-DPMs shall be allocated 
the entire participation entitlement (divided equally between them). If 
no e-DPMs are quoting at the best bid/offer on the Exchange and the DPM 
is quoting at the best bid/offer on the Exchange, then the DPM shall be 
allocated the entire participation entitlement. If only the DPM and/or 
e-DPMs are quoting at the best bid/offer on the Exchange (with no 
Market-Makers at that price), the participation entitlement shall not 
be applicable and the allocation procedures under Rule 6.45A shall 
apply.
    (4) Allocation of Participation Entitlement Between DPMs and e-DPMs 
for Orders Specifying a Preferred DPM. Notwithstanding the provisions 
of subparagraph (b)(3) above, the Exchange may allow, on a class-by-
class basis, for the receipt of marketable orders, through the 
Exchange's Order Routing System when the Exchange's disseminated quote 
is the NBBO, that carry a designation from the member transmitting the 
order that specifies a DPM or e-DPM in that class as the ``Preferred 
DPM'' for that order.
    In such cases and after the provisions of subparagraph (b)(1)(i) 
and (iii) above have been met, then the participation entitlement 
applicable to the DPM Complex (as set forth in subparagraph (b)(2) 
above) shall be allocated to the Preferred DPM subject to the 
following:
    (i) If the Preferred DPM is an e-DPM and the DPM is also quoting at 
the best bid/offer on the Exchange, then \1/3\ of the participation 
entitlement shall be allocated to the DPM and the balance of the 
participation entitlement shall be allocated to the Preferred DPM;
    (ii) If the Preferred DPM is the DPM and one or more e-DPMs are 
also quoting at the best bid/offer on the Exchange, then \1/3\ of the 
participation entitlement shall be allocated to the e-DPMs and the 
balance of the participation entitlement shall be allocated to the 
Preferred DPM;
    (iii) If the Preferred DPM is not quoting at the best bid/offer on 
the Exchange then the participation entitlement set forth in 
subparagraph (b)(3) above shall apply;
    (iv) If only members of the DPM Complex are quoting at the best 
bid/offer on the Exchange then the participation entitlement applicable 
to the Preferred DPM shall be: 50% when there is one other member of 
the DPM Complex also quoting at the best bid/offer on the Exchange; 40% 
when there are two other members of the DPM Complex quoting at the best 
bid/offer on the Exchange; and, 30% when there are three or more 
members of the DPM Complex also quoting at the best bid/offer on the 
Exchange. The other members of the DPM Complex shall not receive a 
participation entitlement and the allocation procedures under Rule 
6.45A shall apply; and
    (v) In no case shall a DPM/e-DPM be allocated, pursuant to this 
participation right, a total quantity greater than the quantity that 
the DPM/e-DPM is quoting at the best bid/offer on the Exchange.
    The Preferred DPM participation entitlement set forth in 
subparagraph (b)(4) of this Rule shall be in effect until [insert 1 
year from SEC approval date] on a pilot basis.
* * * * *

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 Exchange 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
    On July 12, 2004 the Commission approved a proposed rule change 
allowing competing remote electronic DPMs (``e-DPMs'').\3\ Under these 
new rules, the Exchange may approve one or more e-DPMs for any option 
class trading on the CBOE's Hybrid System. Among other things, e-DPMs 
are required to meet certain quoting obligations in at least 90% of the 
series of each allocated class,\4\ and to promote the Exchange in a 
manner that is likely to enhance the ability of the Exchange to compete 
for order flow. The Exchange has approved seven e-DPMs to date. Option 
classes have been allocated to these e-DPMs in a manner that has 
resulted in no option class having more than four e-DPMs (in addition 
to a floor-based DPM).
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    \3\ See Securities Exchange Act Release No. 50003 (July 12, 
2004), 69 FR 43028 (July 19, 2004) (SR-CBOE-2004-24).
    \4\ Alternatively, if a Request for Quote (``RFQ'') 
functionality is enabled for CBOE's Hybrid System, e-DPMs could be 
required to respond to 98% of RFQs.
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    As part of SR-CBOE-2004-24, the CBOE also amended CBOE Rule 8.87 
relating to the participation entitlement of DPMs to account for e-
DPMs.\5\ More specifically, CBOE Rule 8.87 now

[[Page 69969]]

provides that the DPM Complex (the DPM and e-DPM(s) combined) 
participation entitlement rate is 30% when there are three or more 
Market-Makers also quoting at the best price, 40% when there are two 
Market-Makers also quoting at the best price, and 50% when there is one 
Market-Maker also quoting at the best price. The rule further details 
the manner in which the participation entitlement is divided between 
members of the DPM Complex. If the DPM and one or more e-DPMs are 
quoting at the best price, the collective e-DPM participation 
entitlement shall be one-half of the total entitlement and shall be 
divided equally by the number of e-DPMs quoting at the best price with 
the remaining half allocated to the DPM. If the DPM is not quoting at 
the best price and one or more e-DPMs are quoting at the best price, 
then the e-DPMs shall be allocated the entire participation entitlement 
(divided equally between them). If no e-DPMs are quoting at the best 
price and the DPM is quoting at the best price, then the DPM shall be 
allocated the entire participation entitlement. Lastly, if only the DPM 
and/or e-DPMs are quoting at the best price (with no Market-Makers at 
that price), the participation entitlement shall not be applicable and 
the allocation procedures under CBOE Rule 6.45A shall apply. The 
following example illustrates the application of the current 
participation entitlement for e-DPMs:
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    \5\ DPMs and e-DPMs are only entitled to a guaranteed 
participation percentage if they are quoting at the best price on 
the Exchange. Further, the participation entitlement is based on the 
number of contracts remaining after public customer orders on the 
book have been filled.

    Example 1. Assume the CBOE market is 1-1.15 and both sides equal 
the NBBO. Also assume that the DPM and three e-DPMs are part of the 
$1 bid along with ten Market-Makers and one customer order in the 
book for 10 contracts. A market order to sell 110 contracts will 
execute against the customer order in the book first for 10 
contracts. After that, the participation right (which may or may not 
be used in the allocation of the order under CBOE Rule 6.45A) would 
be as follows: 15 contracts to the DPM and five contracts to each of 
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the three e-DPMs.

    The Exchange now seeks to modify the participation entitlement for 
orders designated with a Preferred DPM (the modified participation 
entitlement is being proposed as a one-year pilot program). Only a DPM 
or e-DPMs allocated a particular option class would be eligible for the 
``preferred'' designation in such class, and the Preferred DPM 
participation entitlement (described below) would only be granted if 
the Preferred DPM were quoting at the best price at the time the order 
is received and executed electronically by the Hybrid System. Thus, the 
preferred entitlement will only apply to orders executed at the NBBO. 
The proposed participation entitlement for the Preferred DPM is as 
follows:
     If the Preferred DPM is an e-DPM and the DPM is also 
quoting at the best bid/offer on the Exchange, then \1/3\ of the 
participation entitlement shall be allocated to the DPM and the balance 
of the participation entitlement shall be allocated to the Preferred 
DPM;
     If the Preferred DPM is the DPM and one or more e-DPMs are 
also quoting at the best bid/offer on the Exchange, then \1/3\ of the 
participation entitlement shall be allocated to the e-DPMs and the 
balance of the participation entitlement shall be allocated to the 
Preferred DPM;
     If the Preferred DPM is not quoting at the best bid/offer 
on the Exchange then the Preferred DPM participation entitlement shall 
not apply and the ``regular'' participation entitlement set forth in 
subparagraph (b)(3) of CBOE Rule 8.87 shall apply; and,
     If only members of the DPM Complex are quoting at the best 
bid/offer on the Exchange then the participation entitlement applicable 
to the Preferred DPM shall be: 50% when there is one other member of 
the DPM Complex also quoting at the best bid/offer on the Exchange; 40% 
when there are two other members of the DPM Complex quoting at the best 
bid/offer on the Exchange; and, 30% when there are three or more 
members of the DPM Complex also quoting at the best bid/offer on the 
Exchange. All members of the DPM Complex other than the Preferred DPM 
will not receive a participation entitlement (but may participate on a 
trade pursuant to CBOE Rule 6.45A).
    In no case shall a DPM/e-DPM be allocated a total quantity greater 
than the quantity that the DPM/e-DPM is quoting at the best bid/offer 
on the Exchange. Below are examples detailing how the proposed 
participation entitlement would operate:

    Example 2. (With DPM as the Preferred DPM)--Assume the CBOE 
market is 1-1.15 and both sides equal the NBBO. Also assume that the 
DPM and two e-DPMs are part of the $1 bid along with ten Market-
Makers and one customer order in the book for 10 contracts. A market 
order designating the DPM as the Preferred DPM to sell 110 contracts 
will execute against the customer order in the book first for 10 
contracts. After that, the participation entitlement (which may or 
may not be used in the allocation of the order under CBOE Rule 
6.45A) would be as follows: 20 contracts to the DPM and five 
contracts to each of the two e-DPMs.
    Example 3. (With e-DPM as the Preferred DPM)--Same market as 
Example 2 above. A market order designating e-DPM 1 as the 
Preferred DPM to sell 110 contracts will execute against the 
customer order in the book first for 10 contracts. After that, the 
participation entitlement (which may or may not be used in the 
allocation of the order under CBOE Rule 6.45A) would be as follows: 
20 contracts to e-DPM 1, 10 contracts to the DPM, and no 
entitlement for e-DPM 2.
    Example 4. (Only members of the DPM Complex quoting at the best 
price)--Assume the CBOE market is 1-1.15 and both sides equal the 
NBBO. Also assume that the DPM and two e-DPMs are the only quoters 
on the $1 bid. A market order designating e-DPM 1 as the 
Preferred DPM to sell 100 contracts is received. The participation 
entitlement (which may or may not be used in the allocation of the 
order under CBOE Rule 6.45A) would be as follows: 40 contracts to e-
DPM 1. The balance of the order would be allocated to the 
DPM and e-DPM 2 pursuant to CBOE Rule 6.45A.
    Example 5. (Preferred DPM not quoting at best price)--Assume the 
CBOE market is 1-1.15 and both sides equal the NBBO. Also assume 
that the DPM and three e-DPMs are part of the $1 bid along with ten 
Market-Makers and one customer order in the book for 10 contracts. A 
market order designating e-DPM 4 (not part of $1 bid) as 
the Preferred DPM to sell 110 contracts will execute against the 
customer order in the book first for 10 contracts. After that, the 
participation entitlement (which may or may not be used in the 
allocation of the order under CBOE Rule 6.45A) would be as follows: 
15 contracts to the DPM and 5 contracts to each of the three e-DPMs. 
e-DPM 4 would not participate.

    There would be no requirement that orders submitted to the Exchange 
carry a Preferred DPM designation. Further, by requiring DPMs to quote 
on the NBBO in order to receive a Preferred DPM participation 
entitlement, the Exchange believes that the proposed rule will 
significantly enhance quote competition and will result in greater 
liquidity for customers. Lastly, by providing e-DPMs with a greater 
participation right in cases where orders designate them as a Preferred 
DPM, the CBOE believes the proposal creates incentives for e-DPMs to 
competitively quote and to attempt to attract order-flow to the CBOE. 
This benefits the Exchange and its customers by adding liquidity to the 
CBOE's markets.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\6\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\7\ in particular. By Rewarding DPMs and e-
DPMs for making deep and tight markets and by enhancing their ability 
to compete for order flow, the Exchange believes the proposed rule 
change would: (i) Promote just and equitable

[[Page 69970]]

principles of trade; (ii) serve to remove impediments to and perfect 
the mechanism of a free and open market and a national market system; 
and (iii) help ensure that the Exchange can attract well capitalized 
firms as specialists which in turn serves to protect investors and the 
public interest.
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    \6\ 15 U.S.C. 78f(b).
    \7\ 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; 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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-CBOE-2004-71 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-CBOE-2004-71. 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, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
CBOE. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
publicly available. All submissions should refer to File Number SR-
CBOE-2004-71 and should be submitted on or before December 22, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-3406 Filed 11-30-04; 8:45 am]
BILLING CODE 8010-01-P