[Federal Register Volume 70, Number 23 (Friday, February 4, 2005)]
[Notices]
[Pages 6051-6057]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-429]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51107; File No. SR-CBOE-2004-75]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendments No. 1 and 2 Thereto by the Chicago Board Options 
Exchange, Incorporated Relating to the Introduction of Remote Market-
Makers

January 31, 2005.
    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 22, 2004, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by CBOE. On 
January 10, 2005, CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ On January 21, 2005, CBOE filed Amendment No. 2 to the 
proposed rule change.\4\ 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.
    \3\ Amendment No. 1 replaces and supercedes CBOE's original 19b-
4 filing in its entirety.
    \4\ Amendment No. 2 replaces and supercedes CBOE's original 19b-
4 filing and Amendment No. 1 in their entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to adopt rules authorizing remote market making. The 
text of the proposed rule change is available on the CBOE's Web site 
(http://www.cboe.com), at the CBOE's Office of the Secretary, and at 
the Commission's Public Reference Room.

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 aspects of such 
statements.

[[Page 6052]]

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

1. Purpose
    CBOE's Hybrid Trading System merges the electronic and open outcry 
trading models, offering market participants the ability to stream 
electronically their own firm disseminated market quotes representing 
their trading interest. The current Hybrid rules allow Market-Makers 
(``Market-Maker'' or ``MMs'' or ``market maker'') to stream electronic 
quotes only when they are physically present in their appointed trading 
stations. This requirement prevents ``remote market making,'' a 
practice whereby Market-Makers may submit quotes from locations outside 
of the physical trading station for that class.
    CBOE proposes to adopt rules accommodating remote market making. To 
this end, CBOE proposes to authorize a new membership status called 
Remote Market-Maker (``RMM''). RMMs would have the ability to submit 
quotes to the CBOE from a location outside of the physical trading 
station for the subject class. To accommodate RMMs, the Exchange 
proposes to amend existing, and adopt new, rules addressing RMM 
obligations, RMM appointments, Priority and Allocation of Trades, and 
Evaluation of RMMs, as described below.

CBOE Rule 8.1 Market-Maker Defined

    The Exchange proposes to amend CBOE Rule 8.1 to eliminate from the 
definition of Market-Maker the requirement that transactions be 
effected on the trading floor. Transactions by market makers that 
comply with the requirements of CBOE Rule 8.7.03 would be considered 
market maker transactions.\5\ The Exchange also proposes to clarify 
that the term market maker includes an RMM.
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    \5\ CBOE Rule 8.7.03 is discussed in greater detail below.
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CBOE Rule 8.3 Appointment of Market-Makers

    The Exchange proposes to amend CBOE Rule 8.3 to clarify its non-
applicability to RMMs.

CBOE Rule 8.4 RMMs

    The Exchange proposes to adopt new CBOE Rule 8.4 to address the 
definitional, registration, affiliation, and appointment issues 
relating to RMMs. Proposed CBOE Rule 8.4(a) defines an RMM as an 
individual member or member organization registered with the Exchange 
that makes transactions as a dealer-specialist from a location other 
than the physical trading station for the subject class. The rule also 
proposes that transactions of RMMs that are executed on the Exchange 
are deemed MM transactions for purposes of Chapter VIII of the CBOE 
Rules and CBOE Rules 3.1 and 12.3(f).
    Proposed paragraph (b), Registration and Approval of RMMs, provides 
that the registration and approval of RMMs would be in accordance with 
CBOE Rule 8.2.\6\ As a result, RMMs would be approved in the same 
manner that MMs are approved and any member approved as a MM would be 
approved as an RMM upon requesting RMM status with the Exchange's 
Membership department. An RMM retains its approval to act as an RMM 
until the RMM requests the Exchange to relieve it of its approval to 
act as an RMM and the Exchange grants such approval or until the 
Exchange terminates its approval to act as an RMM pursuant to Exchange 
Rules.\7\ Proposed paragraph (b) also states that an RMM may not 
transfer its approval to act as an RMM unless approved by the Exchange.
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    \6\ The Exchange proposes a corresponding change to CBOE Rule 
8.2(a) to provide that applicants must pass a member's exam as 
opposed to a floor member's exam.
    \7\ The termination of an RMM's approval to act as an RMM would 
be pursuant to proposed CBOE Rules 8.61 or 8.4(e).
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    Proposed paragraph (c) governs affiliation limitations and provides 
that except as provided in subparagraphs (i) and (ii), an RMM may not 
have an appointment as an RMM in any class in which it or its member 
organization serves as Designated Primary Market-Maker (``DPM''), 
electronic DPM (``e-DPM''), RMM, or MM on CBOE. Subparagraph (i) 
proposes an exception to allow a CBOE Member or Member Firm operating 
as an RMM in a class to have, as part of an 18-month pilot program, one 
MM affiliated with the RMM organization trading in open outcry in any 
specific option class allocated to the RMM, provided such market maker 
trades on a separate membership.\8\ This is identical to the e-DPM 
pilot program in which an e-DPM also may have an affiliated MM in the 
same class.\9\
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    \8\ As part of the pilot program, CBOE represents that it would 
confidentially provide the Commission with data on (1) the size of 
orders that RMMs and affiliated MMs both trade with electronically; 
(2) the price and size of the RMM's and the affiliated MM's 
respective quotes; (3) the price and size of quotes of other 
participants in classes where an RMM and an affiliate are quoting; 
and, (4) a breakdown of how orders are allocated to the RMM, the 
affiliated MM, and any other participants.
    \9\ See CBOE Rule 8.93(vii).
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    Subparagraph (ii) proposes an exception to allow a CBOE Member or 
Member Firm to have, as part of a 12-month pilot program, multiple 
aggregation units operating as separate RMMs within the same class 
provided specific criteria are satisfied. CBOE believes there to be 
three primary instances in which this proposed multiple aggregation 
unit exception would be utilized. For example, large broker-dealers 
(``BDs'') are divided into desks that pursue separate trading 
strategies, and each of these trading desks may be interested in 
serving in an RMM capacity. Without an aggregation unit exception, each 
BD would be limited to only one RMM, regardless of the number of 
trading desks it employs and regardless of the degree of autonomy or 
separation between each desk.
    Second, a common organizational structure utilized by CBOE MMs 
involves a common financial backer providing capital to multiple 
independent, unaffiliated MMs. Each of these MMs trades independently 
and has its own profit-loss account that is separate and distinct from 
that of the other MMs receiving financial backing from the same entity. 
Without an aggregation unit exception, these independent MMs could be 
viewed as affiliated and thus be precluded from being RMMs in the same 
classes. Third, given the rapidly escalating costs of acquiring 
sophisticated quoting technology, many MMs, in an effort to reduce 
their operating costs, have pooled resources to acquire such 
technology. Despite the shared expenses and pooled resources, these MMs 
continue to operate independently with their own separate profit-loss 
accounts, which are unaffected by the profitability (or lack thereof) 
of others with whom they have shared costs/pooled resources. Without 
the ability for each MM to be treated as an aggregation unit, these MMs 
would be precluded from trading as RMMs within the same classes.
    In this regard, CBOE proposes to allow multiple aggregation units 
to operate as RMMs in the same class provided they comply with the 
following criteria.\10\
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    \10\ These criteria are based on the criteria contained in 
Regulation SHO, which was recently adopted by the Commission. 
Securities Exchange Act Release No. 50103 (July 28, 2004), 69 FR 
48008 (August 6, 2004) (File No. S7-23-03).
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    (A) The member or member firm has a written plan of organization 
that identifies each aggregation unit, specifies its trading 
objective(s), and supports its independent identity. The independence 
of aggregation units may

[[Page 6053]]

be evidenced by separate management structures, location, business 
purpose, or separate profit-and-loss treatment within the member firm. 
Each aggregation unit must maintain all trading activity of that 
aggregation unit in a segregated account, which would be reported to 
the Exchange as such.
    (B) Each aggregation unit must operate independently of other 
aggregation units of the member or member firm. Moreover, all traders 
in an aggregation unit may pursue only the trading objectives or 
strategy(ies) of that aggregation unit and may not transmit or 
otherwise share information relating to those trading objectives or 
strategies to the member's or member firm's other aggregation units. 
The member or member firm may have risk management personnel outside of 
the RMM aggregation units view the positions of the multiple RMMs 
within the entity and direct position adjustments for risk management 
purposes. However, such persons may not transmit information to traders 
in an RMM aggregation unit about the trading strategies, objectives, or 
positions of another RMM aggregation unit.
    Senior risk management personnel are prohibited from engaging in 
any of the following activities with respect to the Aggregation Units 
for which they oversee: (i) Establishing quoting parameters for any 
trader including but not limited to delta and volatility values; (ii) 
directing the submission of specific quotes by any trader; or (iii) 
directing the timing of a trader's trading activities with anything 
other than general, nonspecific timeframes. Prior to being approved in 
an RMM capacity, each member or member organization operating multiple 
Aggregation Units would be required to certify that it is aware of 
these prohibitions, that it would comply with these prohibitions, and 
that it would ensure continued compliance with these prohibitions.
    (C) Individual traders are assigned to only one aggregation unit at 
any time; and
    (D) The member or member firm as part of its compliance and/or 
internal audit routines establishes and maintains surveillance and 
audit procedures that facilitate the review and surveillance programs 
of the firm and CBOE to ensure the independent operation of the 
separate aggregation units operating as RMMs. As part of these 
routines, the member or member firm must retain written records of 
information concerning the aggregation units, including, but not 
limited to, trading personnel, names of personnel making trading 
decisions, unusual trading activities, disciplinary action resulting 
from a breach of the member or member firm's systems firewalls and 
information-sharing policies, and the transfer of securities between 
the members or member firm's aggregation units, which information would 
be promptly made available to the Exchange upon its request. The member 
or member firm must promptly provide to the Exchange a written report 
at such time there is any material change with respect to the 
aggregation units, at which point the Exchange would reexamine its 
status.
    Proposed paragraph (d) governs the RMM appointment process and 
provides that an RMM may choose either a Physical Trading Crowd 
(``PTC'') or Virtual Trading Crowd (``VTC'') appointment, as described 
below. The proposed rule change, as amended, includes a restriction to 
prevent members from using a membership for multiple purposes. In this 
respect, proposed CBOE Rule 8.4(d) provides that memberships used to 
satisfy membership requirements to possess an RMM PTC or VTC 
appointment may not be used for any other purpose while being used in 
an RMM capacity, including being leased to another member or for 
trading on the trading floor.\11\
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    \11\ An Exchange membership includes a transferable regular 
membership or a Chicago Board of Trade full membership that has 
effectively been exercised pursuant to Article Fifth(b) of the 
Certificate of Incorporation.
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    A PTC Appointment would correspond to the location of a physical 
trading station on the floor of the CBOE. An RMM that chooses a PTC 
appointment would have the right to quote electronically (and not in 
open outcry): 30 Hybrid 2.0 Platform (``Hybrid 2.0'' or ``Hybrid 2.0 
Platform'') products traded in that specific trading station for each 
Exchange membership it owns; \12\ or 20 Hybrid 2.0 products traded in 
that specific trading station for each Exchange membership it 
leases.\13\
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    \12\ The Exchange proposes in CBOE Rule 1.1(aaa) definitions for 
Hybrid Trading System and Hybrid 2.0 Platform.
    \13\ For purposes of this rule, the term ``product'' refers to 
all options of the same single underlying security/value.
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    As proposed, a VTC Appointment confers the right to quote 
electronically (and not in open outcry) an appropriate number of 
products selected from ``tiers'' that have been structured according to 
trading volume statistics. By being able to choose the products it 
wishes to trade, an RMM would have unparalleled flexibility in choosing 
and structuring its appointment. As proposed, RMMs would be able to 
choose from all products included in the Hybrid 2.0 Platform. Of those 
products, Tier A would consist of the 20% most actively-traded products 
over the preceding three calendar months, Tier B the next 20%, etc., 
through Tier E, which would consist of the 20% least actively-traded 
products. All products within a specific Tier would be assigned an 
``appointment cost'' depending upon its Tier location. Each Tier A 
product would have an ``appointment cost'' of .10, each Tier B product 
would be .0667, each Tier C product would be .05, each Tier D product 
would be .04, and each Tier E product would be .033. An RMM as part of 
its VTC appointment may select for each membership it owns or leases 
any combination of Hybrid 2.0 products whose aggregate ``appointment 
cost'' does not exceed 1.0. For example, an RMM could request six ``A 
Tier'' products (6x.10), four ``C Tier'' products (4x.05), and five ``D 
Tier'' products (5x.04) to constitute its VTC appointment.
    The Exchange would rebalance the ``tiers'' once each calendar 
quarter, which may result in additions or deletions to their 
composition. When a product changes ``tiers'' it would be assigned the 
``appointment cost'' of that tier. Upon rebalancing, each RMM with a 
VTC appointment would be required to own or lease the appropriate 
number of Exchange memberships reflecting the revised ``appointment 
costs'' of the products constituting its appointment. Proposed 
paragraph (d) also provides that an RMM may only change its appointment 
upon providing advance notification to the Exchange in a form and 
manner prescribed by the Exchange.
    Proposed paragraph (e) provides that the Exchange may suspend or 
terminate any appointment of an RMM in one or more classes under this 
rule whenever, in the Exchange's judgment, the interests of a fair and 
orderly market are best served by such action. This is similar to ISE 
Rule 802 and CBOE Rule 8.3. An RMM may seek review of any action taken 
by the Exchange pursuant to CBOE Rule 8.4 in accordance with Chapter 
XIX of the CBOE Rules.
    Proposed CBOE Rule 8.4(f) provides that RMMs are subject to CBOE 
Rule 8.7.03A with respect to trading in appointed classes.\14\ RMMs may 
not enter quotations in option classes that are not included within 
their appointments although they may submit orders in non-appointed 
classes.
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    \14\ CBOE Rule 8.7.03A requires at least 75% of a Market-Maker's 
total contract volume (measured quarterly) be in his/her appointed 
classes.

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[[Page 6054]]

CBOE Rule 8.3A Maximum Number of Market Participants Quoting 
Electronically Per Product

    The Exchange does not have unlimited systems bandwidth capacity to 
support an unlimited number of electronic quoters in every class. For 
this reason, the Exchange proposes to limit the number of members 
quoting electronically in each product (``Class Quoting Limit'' or 
``CQL'') traded on Hybrid or Hybrid 2.0.\15\ By limiting the number of 
quoters in all Hybrid and Hybrid 2.0 classes/products, the Exchange 
ensures it would have the ability to effectively handle all quotes 
generated by members. The number of members permitted to quote in each 
product is specified in proposed CBOE Rule 8.3A.01. The methodology for 
determining which members would be able to quote electronically in a 
product is governed by proposed CBOE Rule 8.3A(a)-(c).
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    \15\ For purposes of this rule, the term ``product'' refers to 
all options of the same single underlying security/value.
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    When a CQL is established for each product, the following criteria 
govern which members are entitled to quote electronically in that 
subject product. A Market-Maker (excluding an RMM and e-DPM) that is 
not eligible to quote electronically in a product still may quote in 
open outcry in that product.

Products Trading on the Hybrid 2.0 Platform as of January 6, 2005 and 
Products Trading on the Hybrid Trading System as of January 6, 2005

    The DPM and e-DPMs (if applicable \16\) assigned to the product on 
January 6, 2005, and MMs who: (1) Are in good standing with the 
Exchange; and (2)(i) have transacted at least 80% of their Market-Maker 
contracts and transactions in-person in each of the three immediately 
preceding calendar months prior to January 6, 2005 in option products 
traded in the trading station; or (ii) were physically present in the 
trading station acting in the capacity of a MM on January 6, 2005, 
would be entitled to quote electronically in those products for as long 
as they maintain an appointment in those products.\17\
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    \16\ Non-Hybrid 2.0 classes do not have e-DPMs.
    \17\ CBOE represents that the practical effect of this rule is 
to ensure that the DPM, all MMs, and all e-DPMs would be guaranteed 
the ability to quote electronically in products trading at their 
primary trading stations as of January 6, 2005. CBOE further 
represents that there were no products as of this date for which the 
number of members quoting electronically exceeded the CQL for that 
product.
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    All other MMs, RMMs, and approved e-DPMs that request the ability 
to submit quotes electronically in the subject product would be 
entitled to quote electronically in that product in the order in which 
they so request provided the number of members quoting electronically 
in the product does not exceed the CQL. When the number of members in 
the product quoting electronically equals the CQL, all other members 
requesting the ability to quote electronically in that product would be 
wait-listed in the order in which they submitted the request.
    The waiting list would operate based on time priority. When the 
product can accommodate another electronic quoter (whether due to 
attrition or an increase in the CQL), the member at the ``top'' of the 
list (i.e., the member that has been on the waiting list the longest 
amount of time) would have priority. Once a member is wait-listed, the 
Exchange may not alter his/her position on the wait-list other than to 
improve such position (i.e., the Exchange may not place other members 
ahead of a previously wait-listed member). If a wait-listed member is 
offered, yet refuses, the ability to quote electronically in the 
subject product, the member would be removed from that waiting list.

Products Added to the Hybrid 2.0 Platform After January 6, 2005

    With respect to a product that is added to the Hybrid 2.0 Platform 
after January 6, 2005, the DPM and e-DPMs appointed to the product 
would be entitled to quote electronically. All MMs quoting in the 
product prior to its addition to the Hybrid 2.0 Platform would be 
entitled to quote electronically provided that: (i) They have 
transacted at least 80% of their MM contracts and transactions in-
person in each of the three immediately preceding calendar months prior 
to the product being added to the Hybrid 2.0 Platform in option 
products traded in the trading station; or (ii) they were physically 
present in the trading station acting in the capacity of a MM on the 
day prior to the product being added to the Hybrid 2.0 Platform. These 
standards, which also are contained in paragraph (a) of this rule, 
would ensure that MMs that maintained a presence in the class prior to 
its conversion to the Hybrid 2.0 Platform would be guaranteed the 
ability to quote electronically upon conversion to Hybrid 2.0. If at 
the time a product is added to the Hybrid 2.0 Platform the aggregate 
number of DPMs, e-DPMs, and MMs entitled to quote electronically in the 
product exceeds the CQL, then the product would have an ``increased 
CQL,'' as described in proposed Interpretations and Policies .01(a). 
Reduction of any ``increased CQL'' would be in accordance with the 
procedures described in proposed Interpretations and Policies .01(a).
    All other members would be entitled to quote electronically in that 
product in the order in which they so request provided the number of 
members quoting electronically in the product does not exceed the CQL. 
When the number of members quoting electronically in the product equals 
the CQL, all other members would be wait-listed in the order in which 
they request the ability to quote electronically. The wait-list would 
operate as described in proposed CBOE Rule 8.3A(a).

Products Added to the Hybrid Trading System After January 6, 2005

    With respect to a new product that commences trading on the Hybrid 
Trading System after January 6, 2005, the assigned DPM would be 
entitled to quote electronically. Thereafter, all other members would 
be entitled to quote electronically in that product in the order in 
which they so request provided the number of members quoting 
electronically does not exceed the CQL. When the number of members 
quoting electronically in the product equals the CQL, all other members 
would be wait-listed in the order in which they request the ability to 
quote electronically. The wait-list would operate as described in 
proposed CBOE Rule 8.3A(a).

Establishing the Class Quoting Limits (Proposed Interpretations and 
Policies .01)

    There would not be a uniform CQL for each class traded on the 
Exchange, rather the CQL would vary by product. The section below 
describes the process for affixing CQLs for all products.

Products Trading on the Exchange as of January 6, 2005

    CBOE proposes that the CQL for all products trading on the Hybrid 
Trading System would be twenty-five (25). The twenty-sixth member to 
request the ability to quote electronically in a Hybrid class would be 
first on the wait-list for that product.
    The CQLs for products trading on the Hybrid 2.0 Platform would vary 
based on trading volume over the preceding calendar quarter. CBOE 
proposes that the CQL would be as follows: 40 for the 20% most 
actively-traded products over the preceding quarter; 35 for the next 
20% most actively-traded products; 30 for the next 20% most actively-
traded products; and 25 for all other Hybrid 2.0 Platform products.\18\ 
The Exchange has selected these levels because they strike

[[Page 6055]]

the optimum balance between the Exchange's need to not exceed its 
internal quote capacity by allowing an unlimited number of quoters in 
every class and the need to provide greater liquidity in the more 
actively-traded classes.
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    \18\ See proposed CBOE Rule 8.3A.01.
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    At the end of each calendar quarter, products would be assigned a 
different CQL based on the revised trading volume statistics (``new 
CQL''). For example, if a product with 25 electronic quoters now 
qualifies (based on increased trading volume) for 35 electronic 
quoters, the CQL increases immediately and those on the wait-list would 
be added (if applicable). Otherwise, time priority governs who would be 
entitled to quote electronically in that class.
    If the number of members quoting electronically in the product on 
the last day of the quarter equals or is less than the new CQL, then 
the previous CQL would be reduced immediately to the new CQL.\19\ If 
the number of members quoting electronically in the product on the last 
day of the quarter is greater than the new CQL, then that product would 
have an ``increased'' CQL. CBOE represents that the reason for the 
``increased'' CQL is to avoid having to prevent members from quoting 
electronically in a product in which they are already quoting. In this 
regard, the ``increased'' CQL would equal the number of members quoting 
electronically in the product on the last day of the quarter. If a 
member changes his/her appointment and ceases quoting electronically in 
that product, the ``increased'' CQL would decrease by one until such 
time that the number of remaining members quoting electronically in the 
product equals the new CQL.\20\ From that point forward, the number of 
members quoting electronically in the product may not exceed the new 
CQL.
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    \19\ See proposed CBOE Rule 8.3A.01(i).
    \20\ See proposed CBOE Rule 8.3A.01(ii).
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    As an example, assume product ABC's existing CQL is 40, the new CQL 
on rebalancing date should be 30, and that 33 members are quoting 
electronically in the product on the last day of the quarter. Rather 
than prevent three members from quoting, the CQL would be increased to 
33. If one of those 33 members ``drops'' the product from his/her 
appointment and thus no longer quotes electronically, the ``increased'' 
CQL would drop to 32. When two others leave, the CQL would become 30 
and the first member on the wait-list would be entitled to quote 
electronically when one other member leaves the product.

Products Not Traded on the Exchange as of January 6, 2005

    The CQL for all products newly-listed on the Exchange after January 
6, 2005 would be 25 until such time that the CQL increases in 
accordance with this proposed Interpretations and Policies .01. In this 
regard, when the product's trading volume increases such that the 
product then qualifies for a higher CQL, it would receive a higher CQL.

Increasing the Class Quoting Limit in Exceptional Circumstances

    CBOE believes that having an established upper limit on the number 
of members that may quote electronically in any given product works 
effectively for the overwhelming vast majority of products traded on 
CBOE. Nevertheless, there are bound to be instances in which the demand 
to quote in a new or existing product greatly exceeds the CQL for that 
product. For example, more than 150 members trade options on the S&P 
500 (``SPX'') index. If the Exchange were to trade SPX options on 
Hybrid, a CQL of 25 would be low. It is for these rare instances that 
the Exchange proposes to adopt a rule to allow for a higher CQL.
    In this regard, when exceptional circumstances warrant, the 
President of the Exchange (or in his absence his designee, who must be 
a Senior Vice President of the Exchange or higher) may increase the CQL 
for an existing or new product. ``Exceptional circumstances'' refers to 
substantial trading volume, whether actual or expected (e.g., in the 
case of a new product or a major news announcement). The Exchange does 
not intend for this discretion (i.e., to increase the CQL) to be 
exercised on an intra-day basis. Rather, the primary instance for which 
the Exchange anticipates this discretion being exercised is for the 
addition of new products to Hybrid or Hybrid 2.0 for where the standard 
CQL is not high enough to accommodate the anticipated trading volume 
and member demand. When the CQL increases pursuant to the President 
exercising his authority in accordance with this paragraph, members on 
the wait-list (if applicable, with respect to a product already trading 
on Hybrid), would have first priority and remaining capacity would be 
filled on a time priority basis.\21\
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    \21\ For new products, proposed CBOE Rule 8.3A(a)-(c) governs.
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    Upon cessation of the exceptional circumstances, the President (or 
his designee), in his discretion, may determine to reduce the CQL. Any 
reduction in the CQL must be undertaken in accordance with the 
procedure established in paragraph .01(a)(ii) above with respect to 
lowering the ``increased CQL.'' This means that if the new CQL is less 
than the number of members quoting electronically in that product, 
there would be an ``increased'' CQL. Any actions taken by the President 
of the Exchange pursuant to this paragraph (to increase or decrease the 
CQL) would be submitted to the SEC in a rule filing pursuant to Section 
19(b)(3)(A) of the Act.
    The Exchange would announce all changes regarding CQLs to the 
membership via Information Circular. The Exchange may increase the CQL 
levels established in paragraphs .01(a) and (b) by submitting to the 
SEC a rule filing pursuant to Section 19(b)(3)(A) of the Act. The 
Exchange may decrease the CQL levels established above upon SEC 
approval of a rule filing submitted pursuant to Section 19(b)(2) of the 
Act.

CBOE Rule 8.7 Obligations of Market-Makers

    The Exchange proposes to amend CBOE Rule 8.7 to clarify the 
obligations applicable to RMMs. As RMMs would not be able to quote in 
open outcry, the Exchange proposes to amend paragraph (b)(iii) to 
specify the permissible methods by which in-crowd market makers and 
RMMs may quote or submit orders.
    The Exchange also proposes to amend paragraph (d), Market Making 
Obligations Applicable in Hybrid Classes, to exclude RMMs from the 
application of this paragraph. RMMs instead would be subject to the 
obligations contained in new paragraph (e), which are based on the 
Hybrid obligations in CBOE Rule 8.7(d). Subparagraph (e)(i) states that 
RMMs must provide continuous two-sided, 10-up, legal-width quotations 
in 60% of the series of their appointed classes.\22\ The Exchange may 
consider exceptions to this quoting requirement based on demonstrated 
legal or regulatory requirements or other mitigating circumstances 
(e.g., excused leaves of

[[Page 6056]]

absence, personal emergencies, or equipment problems).\23\
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    \22\ If the underlying primary market disseminates a 100-share 
quote, an RMM's undecremented quote may be for as low as 1-contract 
(``1-up''), however, this ability is expressly conditioned on the 
process being automated (i.e., an RMM may not manually adjust its 
quotes to reflect 1-up sizes). Quotes must automatically return to 
at least 10-up when the underlying primary market no longer 
disseminates a 100-share quote. RMMs that have not automated this 
process may not avail themselves of the relief provided herein. The 
ability to quote 1-up would operate on a pilot basis and would 
terminate on August 17, 2005, which is the same expiration date 
contained in CBOE Rules 8.7(d)(i)(B) and (d)(ii)(B) for Hybrid 
trading.
    \23\ This is virtually identical to PCX Rule 6.37(h)(3).
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    Proposed subparagraph (ii) states that an RMM may be called upon by 
an Exchange official designated by the Board of Directors to submit a 
single quote or maintain continuous quotes in one or more series of an 
issue to which the RMM is appointed whenever, in the judgment of such 
official, it is necessary to do so in the interest of maintaining a 
fair and orderly market.\24\ Proposed subparagraph (iii) provides that 
all Exchange rules applicable to market makers would also apply to RMMs 
unless otherwise provided or unless the context clearly indicates 
otherwise. RMMs are not considered trading crowd members except as 
provided in CBOE Rules 6.13 and 8.60.\25\
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    \24\ This is virtually identical to PCX Rule 6.37(h)(4).
    \25\ This is based on PCX Rule 6.37(h)(1) and (2).
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    Proposed subparagraph (iv) provides that the evaluation of RMM 
performance would be pursuant to proposed CBOE Rule 8.61. Subparagraph 
(v) states that failure by an RMM to engage in a course of dealings as 
specified above would subject the RMM to disciplinary action or 
suspension or revocation of registration by the Exchange in one or more 
of the option classes in which the RMM holds an appointment.\26\ 
Finally, proposed subparagraph (vi) requires RMMs to maintain 
information barriers that are reasonably designed to prevent the misuse 
of material, non-public information with any affiliates that may 
conduct a brokerage business in option classes allocated to the RMM or 
that may act as specialist or market maker in any security underlying 
options allocated to the RMM, and otherwise comply with the 
requirements of CBOE Rule 4.18 regarding the misuse of material non-
public information.
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    \26\ This is virtually identical to PCX Rule 6.37(h)(6).
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    The Exchange also proposes to amend CBOE Rule 8.7.03B regarding a 
MM's in-person trading percentage requirements to clarify that it has 
no application to RMMs (as RMMs cannot quote in person). Finally, the 
Exchange proposes to make CBOE Rule 8.7.09 applicable to RMMs.

CBOE Rule 8.8 Restrictions on Acting as Market-Maker and Floor Broker

    The Exchange proposes to amend CBOE Rule 8.8 to eliminate the 
requirement that an appointment must at least include all of the 
classes of options traded at one station. As RMMs may customize their 
appointments, this requirement has no applicability.

CBOE Rule 8.61 Evaluation of RMMs

    Proposed CBOE Rule 8.61 provides that the appropriate Market 
Performance Committee (``MPC'') would periodically conduct an 
evaluation of RMMs to determine whether they have fulfilled performance 
standards relating to, among other things, quality of markets, 
competition among market makers, observance of ethical standards, and 
administrative factors. The appropriate MPC may consider any relevant 
information including, but not limited to, the results of an RMM 
evaluation, trading data, an RMM's regulatory history and such other 
factors and data as may be pertinent in the circumstances.
    Proposed paragraph (b) provides that the Exchange may terminate, 
place conditions upon, or otherwise limit a member's approval to act as 
an RMM on the same basis that market maker privileges may be terminated 
and/or conditioned under CBOE Rule 8.60. If a member's approval to act 
as an RMM is terminated, conditioned, or otherwise limited by the 
Exchange, the member may seek review of that decision under Chapter XIX 
of the CBOE Rules.

CBOE Rule 6.45A Priority and Allocation of Trades for CBOE Hybrid 
System

    The Exchange proposes to amend certain portions of CBOE Rule 6.45A 
regarding allocation of trades on Hybrid. The first change is to expand 
the introductory paragraph definition of ``market participant'' to 
include RMMs. The second proposed change is to clarify in Paragraph 
(a), Allocation of Incoming Electronic Orders, that market participants 
may enter quotes or orders and receive allocations pursuant to the 
Ultimate Matching Algorithm.
    The third proposed change is to amend paragraph (b), Allocation of 
Orders Represented in Open Outcry, to clarify that only in-crowd market 
participants would be eligible to participate in open outcry trade 
allocations. This is consistent with the prohibitions in CBOE Rules 8.4 
and 8.7 that prevent an RMM from trading in open outcry. The Exchange 
also proposes to limit the duration of paragraph (b) to six months from 
the date of approval of this proposal, unless otherwise extended.

CBOE Rule 6.73 Responsibilities of Floor Brokers

    The Exchange proposes to amend CBOE Rule 6.73(d) to require a Floor 
Broker holding an order for the account of a Market-Maker or Specialist 
to verbally identify the order as such in open outcry prior to 
requesting a quote.

Changes to CBOE Membership Rules (3.2, 3.3, and 3.8)

    CBOE proposes to amend CBOE Rule 3.2 to make clear that a member is 
deemed to have an authorized trading function if the member is approved 
to act as a nominee or person registered for an RMM organization. This 
would ensure under CBOE Rule 3.9(g) that the RMM nominee completes 
CBOE's Member Orientation Program and passes CBOE's Trading Member 
Qualification Exam. The proposed amendments to CBOE Rules 3.2 and 3.3 
would also clarify that a member may elect membership status as an RMM.
    CBOE also proposes to amend CBOE Rule 3.8(a)(ii), which currently 
states that ``if the member organization is the owner or lessee of more 
than one such membership, the organization must designate a different 
individual to be the nominee for each of the memberships (except that 
this subparagraph would not apply to memberships designated for use in 
an e-DPM capacity pursuant to CBOE Rule 8.92 by a member organization 
approved as an e-DPM).'' New proposed CBOE Rule 3.8.02 would provide 
two exceptions to CBOE Rule 3.8(a)(ii) to accommodate the creation of 
RMMs. First, CBOE proposes to exclude RMMs from the CBOE Rule 
3.8(a)(ii) requirement in the same manner as e-DPMs are excluded. As 
with e-DPMs, the CBOE Rule 3.8(a)(ii) requirement serves no useful 
purpose in the context of electronic access and market-making and may 
negatively affect an RMM member organization's operating structure by 
imposing upon it unnecessary expenses. To this end, CBOE proposes to 
restrict application of this rule such that it would not apply to 
memberships used in an RMM and e-DPM capacity. This would allow a 
member organization to designate one individual to be the nominee of 
the memberships that are designated for use in an RMM capacity and an 
e-DPM capacity, provided that a member organization may not have more 
than one RMM appointment in an option class (except to the extent 
provided in CBOE Rule 8.4(c)) and may not have an RMM appointment in an 
option class in which the organization serves as a DPM, e-DPM, or 
Market-Maker on the Exchange (except to the extent provided in CBOE 
Rule 8.4(c)).
    New proposed CBOE Rule 3.8.02(ii) would also provide a second 
exception to CBOE Rule 3.8(a)(ii) to permit an individual to act as a 
nominee of an organization with respect to one membership utilized in 
an RMM capacity and a membership not utilized in an RMM or e-DPM 
capacity in order

[[Page 6057]]

to allow the nominee to use those memberships to simultaneously trade 
as an in-crowd Market-Maker and in an RMM capacity (but not in the same 
classes), provided that the RMM trading activity of the nominee is from 
a location other than the physical trading station for any of the 
classes traded by the nominee in an RMM capacity. CBOE represents that 
the purpose of this exception is to accommodate members who choose to 
take advantage of his or her remote market making privileges while on 
the Exchange floor.
2. Statutory Basis
    The Exchange believes that the adoption of rules allowing for 
remote market making would attract and encourage member firms to 
provide supplemental liquidity to that currently provided on the floor 
by in-crowd market participants. Accordingly, the Exchange believes 
that the addition of RMMs would provide investors with deeper and more 
liquid markets. For these reasons, the Exchange believes the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations under the Act applicable to a national securities exchange 
and, in particular, the requirements of Section 6(b) of the Act.\27\ 
Specifically, the Exchange believes the proposed rule change, as 
amended, is consistent with the Section 6(b)(5) \28\ requirements that 
the rules of an exchange be designed to promote just and equitable 
principles of trade, to prevent fraudulent and manipulative acts and, 
in general, to protect investors and the public interest.
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    \27\ 15 U.S.C. 78f(b).
    \28\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange 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 solicited nor received comments on the proposal.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, 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-2004-75 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-2004-75. 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-2004-75 and should be submitted on or before February 25, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
 [FR Doc. E5-429 Filed 2-3-05; 8:45 am]
BILLING CODE 8010-01-P