[Federal Register Volume 69, Number 233 (Monday, December 6, 2004)]
[Notices]
[Pages 70482-70485]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3472]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50755; File No. SR-CBOE-2004-77]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to the 
Systematizing of Orders in Connection With the Requirement To Design 
and Implement a Consolidated Options Audit Trail System (``COATS'')

November 30, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on November 24, 2004, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``SEC'' or ``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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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend its rules relating to the systematizing of 
orders in connection with the requirement to design and implement a 
consolidated options audit trail system (``COATS''). The text of the 
proposed rule change is provided below. Proposed additions are in 
italics and proposed deletions are in brackets.
* * * * *
CHAPTER VI
Section B: Member Activities on the Floor
[Orders Required to Be in Written Form] Required Order Information

    Rule 6.24
    (a) [Transmitted to the Floor. Each order transmitted to the floor 
must be recorded legibly in a written form that has been approved by 
the Exchange, and the member receiving such order must record the time 
of its receipt on the floor. Each such order must be in legible written 
form when taken to the post for attempted execution.] Orders Must Be 
Systematized. The Exchange has undertaken with the other options 
exchanges to develop a Consolidated Options Audit Trail System 
(``COATS''), which when fully developed and implemented, will provide 
an accurate, time-sequenced record of electronic and other orders, 
quotations, and transactions in certain option classes listed on the 
Exchange. Unless otherwise provided, the requirements of this Rule 
shall commence on January 10, 2005. In connection with the 
implementation of COATS:
    (1) Except as provided in paragraphs (a)(2) through (a)(4), and 
(b), of this Rule, each order, cancellation of, or change to an order 
transmitted to the Exchange must be ``systematized'', in a format 
approved by the Exchange, either before it is sent to the Exchange or 
upon receipt on the floor of the Exchange. An order is systematized if: 
(i) the order is sent electronically to the Exchange; or (ii) the order 
that is sent to the Exchange non-electronically (e.g., telephone 
orders) is input electronically into the Exchange's systems 
contemporaneously upon receipt on the Exchange, and prior to 
representation of the order.
    (2) Market and Marketable Orders. With respect to non-electronic, 
market and marketable orders sent to the Exchange, the member 
responsible for systematizing the order shall input into the Exchange's 
systems at least the following specific information with respect to the 
order prior to the representation of the order: (i) The option symbol; 
(ii) the expiration month; (iii) the expiration year; (iv) the strike 
price; (v) buy or sell; (vi) call or put; (vii) the number of 
contracts; and (viii) the Clearing Member. Any additional information 
with respect to the order shall be input into the Exchange's systems 
contemporaneously upon receipt, which may occur after the 
representation and execution of the order.
    (3) Orders in Certain Index Option Classes. The requirement to 
systematize orders as set forth in this Rule shall commence on March 
28, 2005, in the following option classes: the S&P 500 index option 
class (SPX), the S&P 100 index option class (OEX), and the European-
style S&P 100 index option class (XEO).
    (4) In the event of a malfunction or disruption of the Exchange's 
systems such that a member is unable to systematize an order, the 
member or member organization shall follow the procedures as described 
in paragraph (b) of this Rule during the time period that the 
malfunction or disruption occurs. Upon the cessation of the malfunction 
or disruption, the member shall immediately resume systematizing 
orders. In addition, the member shall exert best efforts to input 
electronically into the Exchange's systems all relevant order 
information received during the time period when there was a 
malfunction or disruption of the Exchange's systems as soon as 
possible, and in any event shall input such data electronically into 
the Exchange's systems not later than the close of business on the day 
that the malfunction or disruption ceases. If, following a malfunction 
or disruption, the Exchange's systems were to become available for the 
systemization of orders after the close of business, the member would 
be expected to input electronically into the Exchange's systems all 
relevant order information received during the malfunction or 
disruption on the next business day.
    (b) With respect to orders received during a malfunction or 
disruption of the Exchange's systems under paragraph (a)(4) above:
    (1) Transmitted to the Floor. Each order transmitted to the 
Exchange must be recorded legibly in a written form that has been 
approved by the Exchange, and the member receiving such order must 
record the time of its receipt on the floor and legibly record the 
terms of the order, in written form.
    (2) Cancellations and Changes. Each cancellation of, or change to, 
an order that has been transmitted to the floor must be recorded 
legibly in a written form that has been approved by the

[[Page 70483]]

Exchange, and the member receiving such cancellation or change must 
record the time of its receipt on the floor.
    (c) Executions. A member transmitting from the floor a report of 
the execution of an order must record the time at which a report of 
such execution is received by such member.
    [(d) On-floor Market-Maker Orders. Each order transmitted by a 
Market-Maker while on the floor, including any cancellation of or 
change to such order, must be recorded legibly in a written form that 
has been approved by the Exchange, and must be time stamped immediately 
prior to its transmission.]

* * * Interpretations and Policies:

    .01 Any member desiring to use an order form other than those 
provided by the Exchange must submit such form to the appropriate Floor 
Procedure Committee and obtain its approval prior to using such form on 
the Floor. When approving an order form other than those provided by 
the Exchange, the appropriate Floor Procedure Committee shall ensure 
that the form complies with COATS.
    .02 [(a) Without limiting the applicability of the foregoing, the] 
The use of hand signal communications on the floor of the Exchange may 
be used to initiate an order, to increase or decrease the size of an 
order, to change an order's limit, to cancel an order, or to activate a 
market order. [Unless an options class is exempted by the Exchange, 
any] Any initiation, cancellation, or change of an order relayed to a 
floor broker through the use of hand signals also must be systematized 
in accordance with paragraph (a) of this Rule [relayed to the floor 
broker in written form, time-stamped, immediately thereafter]. All 
other rules applicable to order preparation and retention, and 
reporting duties are applicable to orders [in exempted option classes] 
under this Interpretation, except that the record-keeping obligation 
lies with the member signaling the order where a hand signal is used. 
All cancellations and changes of orders held by the [Board Broker or] 
Order Book Official must be provided in written form or electronically, 
and also must be systematized in accordance with paragraph (a) of this 
Rule. [(b) Until further notice the following are exempt options 
classes under this Interpretation: OEX, SPX, NSX, and DJX.]
    .03 The appropriate Floor Procedure Committee will from time to 
time prescribe the form of Telephone and Terminal Order Formats in a 
Manual and the contents of this Manual are hereby incorporated in these 
Rules and will have full force and effect as if fully set forth herein. 
The Telephone and Terminal Order Formats in the Manual shall comply 
with the requirements of COATS.
    .04 Accommodation liquidations as described in Rule 6.54 are exempt 
from the requirements of this Rule. However, the Exchange maintains 
quotation, order and transaction information for accommodation 
liquidations in the same format as the COATS data is maintained, and 
will make such information available to the SEC upon request.
    .05 FLEX options, as described in Chapter 24A of the Exchange's 
rules, are exempt from the requirements of this Rule. However, the 
Exchange will maintain as part of its audit trail quotation, order and 
transaction information for FLEX options in a form and manner that is 
substantially similar to the form and manner as the COATS data is 
maintained, and will make such information available to the SEC upon 
request.
    .06 Any proprietary system approved by the Exchange on the 
Exchange's trading floor which receives orders will be considered an 
Exchange system for purposes of paragraph (a)(1) of this Rule. Any 
proprietary system approved by the Exchange shall have the 
functionality to comply with the requirements of COATS.
    .07 On-floor Market-Maker Orders. Each order transmitted by a 
Market-Maker while on the floor, including any cancellation of or 
change to such order, must be systematized in accordance with the 
procedures described in Paragraph (a) and (b) of this Rule, as 
applicable.

Rule 6.73 Responsibilities of Floor Brokers

    (a)-(d) No change.
* * * Interpretations and Policies:

    .01--.03 No change.
    .04 Pursuant to Rule 6.73(a), and subject to the requirement to 
systematize orders prior to representation pursuant to Rule 6.24, a 
Floor Broker's use of due diligence in handling an order shall include 
the immediate and continuous representation at the trading station 
where the option class represented by the order is traded, any of the 
following types of orders: (1) market orders, (2) limit orders to sell 
where the specified price is at or below the current offer or, (3) 
limit orders to buy where the specified price is at or above the 
current bid.
* * * * *

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 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 parts 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 this rule change to comply with the requirement to 
implement COATS. In connection with the filing of this proposed rule 
change, CBOE is withdrawing SR-CBOE-2003-18, and Amendment Nos. 1 and 2 
thereto, which CBOE previously filed to comply with the requirement to 
implement COATS.\3\
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    \3\ Amendment No. 1 to SR-CBOE-2003-18 superceded the original 
filing in its entirety, and was published for comment by the SEC on 
July 31, 2003. See Securities Exchange Act Release No. 48267 (August 
1, 2003), 68 FR 47116 (August 8, 2003).
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    Specifically, CBOE is submitting the proposed change to Rule 6.24 
in connection with subparagraph IV.B.e(v) of the Commission's September 
11, 2000 Order (``Order''),\4\ which requires the options exchanges to 
design and implement COATS to ``incorporate into the audit trail all 
non-electronic orders such that the audit trail provides an accurate, 
time-sequenced record of electronic and other orders, quotations and 
transactions on such respondent exchange, beginning with the receipt of 
an order by such respondent exchange and further documenting the life 
of the order through the process of execution, partial execution, or 
cancellation of that order * * *'' (``Phase V'').
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    \4\ Order Instituting Public Administrative Proceedings Pursuant 
to Section 19(h)(1) of the Securities Exchange Act of 1934, Making 
Findings and Imposing Remedial Sanctions. See Securities Exchange 
Act Release No. 43268 (September 11, 2000).
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    In order to assure that all non-electronic orders are incorporated 
into COATS for Phase V, the proposed rule change proposes to amend CBOE 
Rule 6.24, which currently requires orders to be in written form. The 
proposed rule change generally requires that each order, change to an 
order, or

[[Page 70484]]

cancellation of an order transmitted to the Exchange must be 
``systematized,'' in a format approved by the Exchange, either before 
it is sent to the Exchange or contemporaneously upon receipt on the 
floor of the Exchange, and prior to representation of the order.\5\ 
Each order, change to an order, or cancellation of an order may be 
systematized in one of two ways. If an order, change to an order, or 
cancellation of an order is sent electronically to the Exchange, it is 
systematized. Alternatively, if an order, change to an order, or 
cancellation of an order that is sent to the Exchange non-
electronically is input electronically into the Exchange's systems 
contemporaneously upon receipt on the Exchange, it is systematized.\6\ 
The proposed rule states that this requirement will commence on January 
10, 2005.
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    \5\ CBOE notes that the execution or partial execution of an 
order has been incorporated into COATS in Phase II, and as described 
in Paragraph II of the formal COATS Plan that the options exchanges 
previously have provided to the SEC.
    \6\ The Exchange recognizes the need for effective and proactive 
surveillance for activities such as trading ahead and front-running. 
It currently conducts surveillance for such activities and will 
incorporate a review of order systemization as part of such 
surveillance. The Exchange also intends to implement supplementary 
surveillance and examination programs related to the systemization 
of orders requirement promptly after this requirement is instituted, 
and which will support, among other things, trading ahead and front-
running surveillances.
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    Although the proposed rule change generally requires that each 
order be systematized prior to representation, the Exchange believes 
that it is appropriate and necessary to treat market and marketable 
orders differently than other orders so that marketable orders may be 
represented immediately in the marketplace as customers expect and as 
members representing those orders are obligated to do.\7\ Accordingly, 
with respect to non-electronic market and marketable orders sent to the 
Exchange, the proposed rule change provides that the member responsible 
for systematizing the order shall input into the Exchange's systems a 
number of order terms that are sufficient to distinguish one order from 
another order that a member may receive at or about the same time to 
ensure an accurate audit trail. Accordingly, the proposed rule change 
requires that a member input into the Exchange's systems the following 
specific information with respect to a market or marketable order prior 
to the representation of the order: (i) The option symbol; (ii) the 
expiration month; (iii) the expiration year; (iv) the strike price; (v) 
buy or sell; (vi) call or put; (vii) the number of contracts; and 
(viii) the Clearing Member.\8\ Any additional information with respect 
to the order shall be input into the Exchange's systems 
contemporaneously thereafter, which may occur after the representation 
and execution of the order.
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    \7\ CBOE Rule 6.73(a) requires that ``[a] floor broker handling 
an order is to use due diligence to execute the order at the best 
price or prices available to him.'' Interpretation .04 to Rule 6.73 
further clarifies a broker's obligation to exercise due diligence, 
stating ``Pursuant to Rule 6.73(a), a Floor Broker's use of due 
diligence in handling an order shall include the immediate and 
continuous representation, at the trading station where the option 
class represented by the order is traded, any of the following types 
of orders: (1) Market orders, (2) limit orders to sell where the 
specified price is at or below the current offer or, (3) limit 
orders to buy where the specified price is at or above the current 
bid.''
    \8\ The ``Clearing Member'' means the CBOE clearing member firm 
that is required to be identified for each transaction on the 
Exchange pursuant to Rule 6.51(d). See Rule 1.1(f) defining 
``Clearing Member''.
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    This requirement for market and marketable orders necessarily 
requires the member receiving the market or marketable order to balance 
the requirement to immediately systematize non-electronic orders for 
audit trail purposes with the member's obligation under CBOE rules,\9\ 
the federal securities laws, and common law agency principles to 
immediately and continuously represent market and marketable customer 
orders.\10\ Because the requirement to systematize market and 
marketable orders will affect a member's ability to immediately 
represent market and marketable customer orders, the Exchange is also 
proposing to amend Interpretation .04 to CBOE Rule 6.73--
Responsibilities of Floor Brokers, to make explicit that a broker's 
responsibility to immediately and continuously represent market and 
marketable orders is subject to the requirement set forth in this rule 
change, namely, that each order must be systematized prior to 
representation.
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    \9\ See CBOE Rule 6.73.
    \10\ Following implementation of this rule change on would be 
sufficient to distinguish one order from another January 10, 2005, 
the Exchange intends to analyze whether some number of orders terms 
less than the eight identified above that a member may receive at or 
about the same time. If the Exchange's analysis supports eliminating 
the necessity to input some of these order terms prior to 
representation, the Exchange may propose to amend this requirement, 
which would be subject to Commission review and approval.
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    With respect to non-electronic orders received in the S&P 100 index 
option class (OEX), the S&P 500 index option class (SPX), and the 
European-style S&P 100 index option class (XEO), the proposed rule 
change states that the requirement to systematize orders prior to 
representation shall commence on March 28, 2005. The Exchange believes 
that the exception for these option classes is reasonable and 
appropriate because the manner in which these option classes trade is 
significantly different than equity option classes and because of the 
trading environment that exists in these option classes.\11\
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    \11\ As CBOE has advised the SEC staff, CBOE initially developed 
its floor broker workstation (``FBW'') to assist its members in 
complying with their obligations to systematize orders for COATS. 
However, the FBW was designed specifically for COATS compliance in 
equity option classes, and not for use in index option classes. Upon 
being advised in late December 2003 that the requirement to 
systematize orders also applied to non-equity option classes, the 
Exchange actively pursued developing an alternative technology to 
utilize in index option classes.
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    Additionally, in proposed new subparagraph (a)(4) of CBOE Rule 
6.24, the Exchange proposes that in the event of a malfunction or 
disruption of the Exchange's systems such that a member is unable to 
systematize an order, the member or member organization shall follow 
the procedures as described in paragraph (b) of CBOE Rule 6.24 during 
the time period that the malfunction or disruption occurs. Upon the 
cessation of the malfunction or disruption, the member shall 
immediately resume systematizing orders. In addition, the member shall 
exert best efforts to input electronically into the Exchange's systems 
all relevant order information received during the time period when 
there was a malfunction or disruption of the Exchange's systems as soon 
as possible, and in any event shall input such data electronically into 
the Exchange's systems not later than the close of business on the day 
that the malfunction or disruption ceases.\12\
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    \12\ If, following a malfunction or disruption, the Exchange's 
systems were to become available for the systemization of orders 
after the close of business, the member would be expected to input 
electronically into the Exchange's systems all relevant order 
information received during the malfunction or disruption on the 
next business day.
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    The proposed rule change also keeps the current Interpretation and 
Policy .02(a) of CBOE Rule 6.24, which permits the use of hand signal 
communications on the floor to, among other things, initiate an order, 
cancel an order or change material terms of an order. However, any 
initiation, cancellation, or change of an order relayed to a floor 
broker through the use of hand signals also must be systematized upon 
receipt in accordance with paragraph (a) of CBOE Rule 6.24. The 
proposed rule change also deletes paragraph (b) of Interpretation .02, 
as paragraph (a) of that interpretation is being amended to delete the 
reference to exempt classes.
    The Exchange has added a new Interpretation and Policy .04 to CBOE 
Rule 6.24, which states that

[[Page 70485]]

accommodation liquidations as defined in Rule 6.54 are exempted from 
the systematization requirement. However, the Exchange maintains 
quotation, order and transaction information for accommodation 
liquidations in the same format as the COATS data is maintained, and 
will make such information available to the SEC upon request.
    The Exchange also has added a new Interpretation and Policy .05 to 
CBOE Rule 6.24, which states that FLEX options, as described in Chapter 
24A of the Exchange's rules, are exempt from the requirements of this 
Rule. However, the Exchange will maintain as part of its audit trail 
quotation, order and transaction information for FLEX options in a form 
and manner that is substantially similar to the form and manner as the 
COATS data is maintained, and will make such information available to 
the SEC upon request.
    The proposed rule change also includes a new Interpretation .06 
which provides that any proprietary system approved by the Exchange on 
the Exchange's trading floor that receives orders will be considered an 
Exchange system for purposes of paragraph (a)(1) of this Rule. Any 
proprietary system approved by the Exchange shall comply with the 
requirements of COATS.
    Finally, the proposed rule change includes a new Interpretation .07 
which provides that each order transmitted by a Market-Maker while on 
the floor, including any cancellation of or change to such order, must 
be systematized in accordance with the procedures described in 
Paragraph (a) and (b) of this Rule, as applicable. Currently paragraph 
(d) of CBOE Rule 6.24 requires that each order transmitted by a Market-
Maker while on the floor, including any cancellation of or change to 
such order, must be recorded legibly in a written form that has been 
approved by the Exchange, and must be time stamped immediately prior to 
its transmission. This new interpretation thus requires that each order 
transmitted by a Market-Maker while on the floor, including any 
cancellation of or change to such order, is systematized in accordance 
with CBOE Rule 6.24.
2. Statutory Basis
    CBOE believes the proposed rule change is consistent with Section 
6(b) of the Act \13\ in general and furthers the objectives of Section 
6(b)(5) \14\ in particular in that it should promote just and equitable 
principles of trade, and protect investors and the public interest. 
CBOE believes that the proposed rule change will promote just and 
equitable principles of trade and protect investors and the public 
interest by electronically enhancing the audit trail for orders by 
incorporating non-electronic orders into COATS. This enhanced audit 
trail will permit CBOE to conduct surveillance of the activity on the 
Exchange and reconstruct markets in a more efficient and effective 
manner.
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    \13\ 15 U.S.C. 78f(b).
    \14\ 15 U.S.C. 78(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    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

    The Exchange neither received nor solicited written comments on 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 self-regulatory organization 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-2004-77 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-2004-77. 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 
available publicly. All submissions should refer to File Number SR-
CBOE-2004-77 and should be submitted on or before December 27, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E4-3472 Filed 12-3-04; 8:45 am]
BILLING CODE 8010-01-P