[Federal Register Volume 70, Number 42 (Friday, March 4, 2005)]
[Notices]
[Pages 10712-10715]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-897]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51271; File No. SR-CBOE-2004-45]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 2 and Notice of Filing and Order Granting 
Accelerated Approval to Amendment Nos. 3 and 5 by the Chicago Board 
Options Exchange, Inc. Relating to the Trading of Complex Orders on the 
CBOE Hybrid System

February 28, 2005.

I. Introduction

    On July 16, 2004, the Chicago Board Options, Inc. (``CBOE'') filed 
with the Securities and Exchange Commission (``Commission''), pursuant 
to section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') 
\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to create a 
complex order book (``COB'') for certain complex orders traded on the 
CBOE Hybrid System (``Hybrid''). On November 8, 2004, the CBOE filed 
and withdrew Amendment No. 1 to the proposal and filed Amendment No. 2 
to the proposal.\3\ The CBOE filed Amendment No. 3 to the proposal on 
January 31, 2005.\4\ The CBOE filed Amendment No. 4 to the proposal on

[[Page 10713]]

February 4, 2005, and withdrew Amendment No. 4 on February 10, 2005. 
The CBOE filed Amendment No. 5 to the proposal on February 11, 2005.\5\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 2 supersedes and replaces the original filing 
in its entirety.
    \4\ Amendment No. 3 revises the proposal to add Interpretation 
and Policy .01 to CBOE Rule 6.53C. Interpretation and Policy .01 
states that conversions and reversals are not eligible for routing 
to the COB, and that the CBOE will file any changes to 
Interpretation and Policy .01 with the Commission pursuant to 
section 19(b)(3)(A) of the Act.
    \5\ Amendment No. 5 adds Interpretation and Policy .02 to CBOE 
Rule 6.53C. Interpretation and Policy .02 states that until May 27, 
2005, the N-second group timer, as described in CBOE Rule 6.45A(c), 
for complex order transactions will be set at zero seconds. 
Effective May 30, 2005, the N-second timer for complex order 
transactions will be set at the same length for complex order 
transactions and for transactions that do not involve complex 
orders.
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    The proposed rule change and Amendment No. 2 were published for 
comment in the Federal Register on November 23, 2004.\6\ The Commission 
received one comment letter regarding the proposal.\7\ The CBOE 
responded to the comment letter on January 13, 2005.\8\ This order 
approves the proposed rule change, as amended. In addition, the 
Commission is publishing notice to solicit comments on and is 
simultaneously approving, on an accelerated basis, Amendment Nos. 3 and 
5.
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    \6\ See Securities Exchange Act Release No. 50682 (November 17, 
2004), 69 FR 61897.
    \7\ See letter from Matthew Hinerfeld, Managing Director and 
Deputy General Counsel, Citadel Investment Group, LLC, to Jonathan 
G. Katz, Secretary, Commission, dated December 15, 2004 (``Citadel 
Letter'').
    \8\ See letter from Stephen M. Youhn, Managing Senior Attorney, 
CBOE, to Jonathan G. Katz, Secretary, Commission, dated January 13, 
2005 (``CBOE Letter'').
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II. Description of the Proposed Rule Change

    Complex options orders involve multiple options transactions that 
are executed simultaneously as part of a single strategy. The CBOE 
currently routes complex orders to the PAR terminal in an options 
trading crowd. A complex order resides on PAR until the Designated 
Primary Market Maker (``DPM'') announces the order to the trading crowd 
and the order trades in open outcry. Thus, under the CBOE's current 
rules, a DPM must intervene to execute complex orders. To facilitate 
more automated handling of complex orders, the CBOE proposes to adopt 
CBOE Rule 6.53C, ``Complex Orders on the Hybrid System,'' which 
establishes a COB for certain complex orders traded on Hybrid.\9\
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    \9\ Complex orders in non-Hybrid classes will not be placed in 
the COB. The following types of complex orders, as defined in CBOE 
Rule 6.53C(a), will be eligible for routing to the COB: spread 
orders; straddle orders; strangle orders; combination orders; ratio 
orders; butterfly spread orders; box/roll spread orders; and collar 
orders and risk reversals. Only complex orders with no more than 
four legs are eligible for the COB. See CBOE Rule 6.53C(c)(iv). 
Conversions and reversals will not be eligible for routing to the 
COB. See Amendment No. 3, supra note 4.
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    The appropriate CBOE committee will decide, on a class by class 
basis, whether complex orders in an options class will route directly 
to the COB or to PAR.\10\ In addition, the appropriate CBOE committee 
will decide whether to allow complex orders from non-broker-dealer 
public customers and from broker-dealers that are not options exchange 
market makers or specialists to route from PAR to the COB.\11\ The CBOE 
will announce routing decisions to members via Regulatory Circular.\12\
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    \10\ See CBOE Rule 6.53C(c)(i).
    \11\ See CBOE Rule 6.53C(c)(i).
    \12\ See CBOE Rule 6.53C(c)(i).
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    When a complex order routes to PAR, the DPM will announce the order 
to the trading crowd, which may trade with the order at its limit price 
or offer price improvement. If the trading crowd chooses not to trade 
with the order, the order will reside on PAR until the DPM routes the 
order to the COB.
    An order routed to the COB may trade in one of three ways. First, 
the order may execute automatically against individual orders or quotes 
in the CBOE's electronic book (``EBook''), provided that the complex 
order can be executed in full, or in a permissible ratio, by orders in 
EBook. Second, an incoming complex order that is marketable against a 
complex order resting in the COB may execute automatically against the 
resting order. Third, market participants, as defined in CBOE Rule 
6.45A, ``Priority and Allocation of Trades for CBOE Hybrid System,'' 
may trade against orders in the COB.\13\ CBOE members with an interface 
connection to the CBOE will be able to view orders resting in the COB.
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    \13\ CBOE Rule 6.45A defines ``market participant,'' for 
purposes of that rule, to include an in-crowd market maker, a market 
maker complying with the in-person requirements of CBOE Rule 
8.7.03(B)(1) who submits quotes from off the CBOE floor through the 
facilities of the CBOE, an in-crowd DPM, an e-DPM, and a floor 
broker representing orders in the trading crowd.
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    A complex order in the COB will be allocated to market participants 
in accordance with the allocation procedures described in CBOE Rule 
6.45A(c). In addition, CBOE Rule 6.45A, Interpretation and Policies .01 
and .02, apply to complex orders on Hybrid.\14\
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    \14\ CBOE Rule 6.45A, Interpretation and Policy .01, ``Principal 
Transactions,'' prohibits an order entry firm from executing as 
principal against an order it represent as agent unless: (1) The 
agency order is first exposed on Hybrid for at least 30 seconds; (2) 
the order entry firm has been bidding or offering for at least 30 
seconds prior to receiving an agency order that is executable 
against such bid or offer; or (3) the order entry firm proceeds in 
accordance with the crossing rules in CBOE Rule 6.74, `` `Crossing' 
Orders.'' CBOE Rule 6.45A, Interpretation and Policy .02, 
``Solicitation Orders,'' requires an order entry firm to expose for 
at least 30 seconds an order it represents as agent before the order 
may be executed electronically via the electronic execution 
mechanism of Hybrid, in whole or in part, against orders solicited 
from members and non-member broker-dealers to transact with the 
order.
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    Complex orders resting in the COB may be executed without 
consideration to the prices of the same complex orders that might be 
available on other exchanges.\15\ Orders of public customers in the COB 
will have priority over orders from non-public customers, and multiple 
public customer complex orders at the same price will be accorded 
priority based on time.\16\
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    \15\ See CBOE Rule 6.53C(c)(iii). The Options Price Reporting 
Authority does not disseminate complex order prices. This provision 
of the CBOE's proposal is similar to International Securities 
Exchange Rule 722(b)(3).
    \16\ See CBOE Rule 6.53C(c)(ii).
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    CBOE Rules 6.45, ``Priority of Bids and Offers,'' and 6.45A(b)(iii) 
generally allow a member holding a complex order to trade ahead of the 
book on one leg of the order, provided that the other leg of the order 
betters the corresponding bid (offer) in the limit order book. These 
rules will continue to apply to the trading of complex orders.
    Amendment No. 3 adopts Interpretation and Policy .01 to CBOE Rule 
6.53C. Interpretation and Policy .01 states that conversions and 
reversals will not be eligible for routing to the COB and that the CBOE 
will file any changes to Interpretation and Policy .01 with the 
Commission pursuant to Section 19(b)(3)(A) of the Act.
    Amendment No. 5 adopts Interpretation and Policy .02 to CBOE Rule 
6.53C. Interpretation and Policy .02 states that until May 27, 2005, 
the N-second group timer, as described in CBOE Rule 6.45A(c), for 
complex order transactions will be set at zero seconds.\17\ Effective 
May 30, 2005, the N-second timer for complex order transactions will be 
set at the same length for complex order transactions and for 
transactions that do not involve complex orders. According to the CBOE, 
the systems changes required to extend the N-second timer to the COB 
will not be ready until May. Interpretation and Policy .02 affects only 
the length of the N-second timer and has no impact on customer orders.
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    \17\ CBOE Rule 6.45A(c)(ii) states that each market participant 
that submits an order or quote to buy (sell) an order in the 
electronic book within a period of time not to exceed five seconds 
of the first market participant to submit an order (``N-second 
group'') will be entitled to receive an allocation of the order in 
the electronic book pursuant to the allocation algorithm specified 
in CBOE Rule 6.45A(c)(ii). The appropriate Floor Procedure Committee 
(``FPC'') determines the length of the N-second group timer, 
provided, however, that the duration of the N-second group timer may 
not exceed five seconds. See CBOE Rule 6.45A(c)(ii)(A).
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III. Summary of Comments Received and CBOE Response

    The Commission received one comment letter regarding the 
proposal.\18\ Although the commenter believed that the COB would 
increase transparency, the commenter expressed

[[Page 10714]]

concern that the proposal would allow a CBOE committee, rather than 
DPMs and order routers, to determine the options classes that would be 
eligible for routing to the COB. The commenter believed that DPMs and 
order routers should have the ability to decide where complex orders 
would be routed. In this regard, the commenter stated that a DPM would 
have first-hand knowledge and experience with respect to the level of 
trading activity in his or her crowd and would know when it would be 
beneficial to route orders directly for automatic execution. The 
commenter also believed that order routers should be able to choose 
whether to route orders directly to the COB or to have their orders 
represented manually in the trading crowd.
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    \18\ See Citadel Letter, supra note 7.
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    In its response, the CBOE states that CBOE committees historically 
have had the responsibility, by CBOE rule and by charter, to determine 
the routing of orders. The CBOE notes that CBOE Rules 6.8, ``RAES 
Operations,'' and 6.13, ``CBOE Hybrid System's Automatic Execution 
Feature,'' provide CBOE committees with the authority to determine 
whether to allow orders from certain market professionals to auto-ex or 
to route to PAR.\19\ Similarly, the CBOE notes that CBOE Rule 7.4, 
``Obligations for Orders,'' allows CBOE committees to determine whether 
orders from certain market professionals should be eligible for routing 
into the electronic order book. According to the CBOE, the committees, 
which represent a broad cross-section of CBOE members, including market 
makers, DPMs, and order flow providers, consider multiple factors in 
making order routing decisions. The CBOE believes that providing DPMs 
and order routers with the unilateral ability to make order routing 
decisions would undermine the committee process and prevent the 
development of uniform order routing policies.
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    \19\ See CBOE Letter, supra note 8.
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    In addition, CBOE notes that its committees have yet to make any 
routing determinations for complex orders. CBOE states that such 
determinations would be evaluated on an ongoing basis and would take 
into account competitive forces and customer requests.

IV. Discussion

    The Commission has carefully reviewed the proposed rule change, the 
comment letter, and the CBOE's response and finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities exchange.\20\ In particular, the Commission finds that the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act,\21\ which requires, among other things, that the rules of a 
national securities exchange be designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market, and, in general, to protect investors and 
the public interest.
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    \20\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \21\ 15 U.S.C. 78f(b)(5).
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    A complex order sent to the CBOE currently routes to the PAR 
terminal in a trading crowd, where the DPM announces the order to the 
trading crowd. If the trading crowd does not trade immediately with the 
order, the order will reside on PAR until it trades in open outcry. 
Thus, a complex order currently cannot be executed on the CBOE without 
manual intervention by a DPM.
    The COB will allow complex orders to trade electronically, without 
the intervention of a DPM, and orders on the COB will be displayed to 
all CBOE members with an interface connection to the CBOE. As described 
more fully above, a complex order routed to the COB may execute 
automatically against orders in the EBook or against an order resting 
in the COB. In addition, market participants, as defined in CBOE Rule 
6.45A, may trade against orders resting in the COB. Accordingly, the 
Commission believes that the COB should increase the transparency of 
complex orders and could facilitate the execution of complex orders.
    Under the proposal, the appropriate CBOE committee will decide, on 
a class by class basis, the options classes that will route directly to 
the COB and those that will route to PAR.\22\ As noted above, CBOE 
committees currently make some order routing determinations under 
existing CBOE rules.\23\ Accordingly, the Commission believes that the 
discretion granted to CBOE committees with respect to the routing of 
complex orders under the proposal is consistent with the authority 
granted to CBOE committees under the CBOE's existing rules.
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    \22\ The appropriate CBOE committee also will determine whether 
to allow complex orders from non-broker-dealer customers and from 
broker-dealers that are not options exchange market makers or 
specialists to route from PAR to the COB. See CBOE Rule 6.53C(c)(i).
    \23\ See e.g., CBOE Rule 6.13(b)(i)(C)(ii) (allowing the 
appropriate FPC to determine, on a class-by-class basis, to allow 
orders from options market makers to be eligible for automatic 
execution on Hybrid); and CBOE Rule 7.4(a)(1) (allowing the 
appropriate FPC to determine on an issue-by-issue basis that orders 
from broker-dealers or from broker-dealers that are not options 
market makers are eligible for entry into the electronic book).
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    The Commission notes that CBOE Rule 6.45A, Interpretation and 
Policies .01 and .02 apply to complex orders on Hybrid.\24\ 
Accordingly, a CBOE member seeking to trade with its customer's complex 
order would be required to comply with CBOE 6.45A, Interpretation and 
Policy .01, and a CBOE member seeking to cross its customer's complex 
order with solicited orders would be required to comply with CBOE Rule 
6.45A, Interpretation and Policy .02.
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    \24\ See note 14, supra.
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    In addition, the complex order priority provisions in CBOE Rules 
6.45(e) and 6.45A(b)(iii) will continue to apply to complex orders. 
Accordingly, complex orders will be able to trade ahead of orders in 
the EBook or the limit order book only under the conditions specified 
in CBOE Rules 6.45(e) and 6.45A(b)(iii). The Commission also notes that 
complex orders from public customers will have priority over complex 
orders from non-public customers.\25\
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    \25\ See CBOE Rule 6.53C(c)(ii).
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    The Commission finds good cause for approving Amendment Nos. 3 and 
5 to the proposal prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 3 merely clarifies the text of CBOE Rule 6.53C by 
indicating that conversions and reversals currently are not eligible 
for routing to the COB and that the CBOE will file any changes to this 
policy with the Commission pursuant to Rule 19(b)(3)(A) under the Act. 
Amendment No. 5 also clarifies the operation of the COB by indicating 
that the N-second timer will be temporarily set at zero. Accordingly, 
the Commission finds that it is consistent with Sections 6(b)(5) and 
19(b) of the Act to approve Amendment Nos. 3 and 5 to the proposal on 
an accelerated basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 3 and 5, including whether 
Amendment Nos. 3 and 5 are 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

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     Send an e-mail to [email protected]. Please include 
File Number SR-CBOE-2004-45 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-2004-45. 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 Room. Copies of the 
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-2004-45 and should be submitted on or before March 
25, 2005.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\26\ that the proposed rule change (SR-CBOE-2004-45), as amended, 
is approved, and that Amendment Nos. 3 and 5 are approved on an 
accelerated basis.
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    \26\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-897 Filed 3-3-05; 8:45 am]
BILLING CODE 8010-01-P