[Federal Register Volume 70, Number 52 (Friday, March 18, 2005)]
[Notices]
[Pages 13217-13222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1185]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51366; File No. SR-CBOE-2004-75]


Self-Regulatory Organizations; Order Approving 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

March 14, 2005.

I. Introduction

    On November 22, 2004, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC''), 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 relating to the 
introduction of Remote Market-Makers (``RMMs''). On January 10, 2005, 
CBOE filed Amendment No. 1 to the proposed rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaces and supersedes CBOE's original 19b-
4 filing in its entirety.
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    On January 21, 2005, CBOE filed Amendment No. 2 to the proposed 
rule change.\4\ The proposed rule change and Amendments No. 1 and 2 
were published for comment in the Federal Register on February 4, 
2005.\5\ The Commission received no comment letters on the proposal. 
This order approves the proposed rule change and Amendments No. 1 and 
2.
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    \4\ Amendment No. 2 replaces and supersedes CBOE's original 19b-
4 filing and Amendment No. 1 in their entirety.
    \5\ Securities Exchange Act Release No. 51107 (January 31, 
2005), 70 FR 6051.
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II. Discussion

    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 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

[[Page 13218]]

makers may submit quotes from locations outside of the physical trading 
station for that class.
    The proposed rule change would accommodate remote market making, by 
authorizing a new membership status called 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.
    After careful review, the Commission 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 \6\ and, in particular, the requirements of Section 
6 of the Act.\7\ Specifically, the Commission finds that the proposal 
to add a new category of options market-making participant, RMMs, to 
the CBOE Hybrid trading platform is consistent with Section 6(b)(5) of 
the Act \8\ in that the proposal has been designed to promote just and 
equitable principles of trade, and to protect investors and the public 
interest.
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    \6\ The Commission has considered the amended proposed rule 
change's impact on efficiency, competition, and capital formation.15 
U.S.C. 78c(f).
    \7\ 15 U.S.C. 78f.
    \8\ 15 U.S.C. 78f(b)(5).
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A. Registration and Appointment of RMMs

    The Exchange proposes to adopt new Rule 8.4 to address the 
definitional, registration, affiliation, and appointment issues 
relating to RMMs.\9\ 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.\10\ The rule 
also proposes that transactions of RMMs that are executed on the 
Exchange are deemed market maker transactions for purposes of Chapter 
VIII of the CBOE Rules and CBOE Rules 3.1 and 12.3(f).
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    \9\ The Exchange also proposes to amend Rule 8.3 to clarify its 
non-applicability to RMMs.
    \10\ 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.
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    Proposed Rule 8.4(b), Registration and Approval of RMMs, provides 
that the registration and approval of RMMs would be in accordance with 
CBOE Rule 8.2.\11\ As a result, RMMs would be approved in the same 
manner that other market makers are approved and any member approved as 
a market maker would be approved as an RMM upon requesting RMM status 
with the Exchange's Membership department. Importantly, the Commission 
notes that CBOE has no authority under its rules to discriminate among 
applicants. 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.\12\
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    \11\ 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.
    \12\ 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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    Paragraph (d) of CBOE Rule 8.4 provides that an RMM may choose 
either a Physical Trading Crowd (``PTC'') or Virtual Trading Crowd 
(``VTC'') appointment.
    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; \13\ or 20 Hybrid 2.0 products traded in 
that specific trading station for each Exchange membership it 
leases.\14\
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    \13\ The Exchange proposes in CBOE Rule 1.1(aaa) definitions for 
Hybrid Trading System and Hybrid 2.0 Platform.
    \14\ For purposes of this rule, the term ``product'' refers to 
all options of the same single underlying security/value.
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    A VTC Appointment would confer 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 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. The Commission 
believes the proposed PTC and VTC appointment rules are consistent with 
the Act.

B. Affiliations Among Market Makers

    Proposed CBOE Rule 8.4 (c) provides that, except as specified in 
the rule, 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 market 
maker on CBOE. The Commission believes this prohibition is important 
because of the potential under CBOE's rules for allocations of trades 
to be based, in part, on an equal allocation methodology. Under an 
equal allocation methodology, a participant can be allocated contracts 
based solely on its quote or order at the best bid or offer, regardless 
of the size of such participant's quote or order. Accordingly, absent a 
prohibition, there could be an incentive for affiliated market makers 
to each post separate quotes to increase their total contract 
allocation.
1. Affiliated Floor Market-Maker Pilot Program
    CBOE Rule 8.4(b) would provide exception to this general 
prohibition 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 market 
maker affiliated with the RMM organization trading in open outcry in 
any specific option class

[[Page 13219]]

allocated to the RMM.\15\ The Commission is approving this limited 
exception on a pilot basis because CBOE represents that firms do not 
want to have an RMM and a market maker to increase their allocation of 
contracts in electronic trades, but instead to be able to both make 
electronic markets remotely and to participate outcry trading.
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    \15\ 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 market makers both trade with 
electronically; (2) the price and size of the RMM's and the 
affiliated market maker'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 market maker, and any other 
participants. The Commission will use this data to consider whether 
the practice of allowing a member organization to receive more of an 
allocation of orders based solely on the number of market-makers 
that it has quoting in an option class is unfairly discriminatory in 
any way to other quoting market participants, and to determine 
whether to extend or permanently approve this practice.
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2. Multiple Aggregation Units
    CBOE Rule 8.4(c) would also 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 has stated there are three primary 
instances in which this proposed multiple aggregation unit exception 
would be utilized.
     First, large broker-dealers are frequently 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 broker-dealer 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 
market makers involves a common financial backer providing capital to 
multiple independent, unaffiliated market makers. Each of these market 
makers trades independently and has its own profit-loss account that is 
separate and distinct from that of the other market makers receiving 
financial backing from the same entity. Without an aggregation unit 
exception, these independent market makers 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 market makers, in an effort to 
reduce their operating costs, have pooled resources to acquire such 
technology. Despite the shared expenses and pooled resources, these 
market makers 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 market maker to be treated as 
an aggregation unit, these market makers 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: \16\
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    \16\ The Exchange based these criteria 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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     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 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.
     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.\17\ 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.
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    \17\ Senior risk management personnel are prohibited from 
engaging in any of the following activities with respect to the 
Aggregation Units 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.
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     Individual traders are assigned to only one aggregation 
unit at any time; and
     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.
    The Commission believes that the proposed rules are designed to 
ensure that affiliated RMMs are sufficiently independent to allow them 
to operate as separate RMMs. The Commission believes such separation in 
important because, as stated above, CBOE's rules allocate trades among 
market makers quoting at the same price based, in part, on an equal 
allocation methodology unrelated to the size of each market makers 
quote. Thus, multiple RMMs at the same firm could be used to increase 
total allocation to that firm without a commensurate increase in the 
total size of its quote. The Commission notes that the proposed rule 
obligates the Exchange to conduct surveillance to ensure the 
independent operation of the multiple units operating as RMMs.

C. Integrated Market Making and Side-by-Side Market Making

    RMMs who effect transactions in a particular option may be 
affiliated with market makers or specialists who trade the underlying 
security (i.e., integrated market making). The Exchange has

[[Page 13220]]

indicated that CBOE Rule 4.18, which governs the use of material, non-
public information would apply to RMMs. The Exchange represents that 
this rule would require RMMs to maintain information barriers that are 
reasonably designed to prevent the misuse of material, non-public 
information by such member with any affiliates that may act as a 
specialist or market maker in any security underlying the options for 
which the CBOE member acts as an RMM.\18\ The Commission believes that 
the requirement that there be an information barrier between the RMM 
and its affiliates with respect to transactions in the option and the 
underlying security serve to reduce the opportunity for unfair trading 
advantages or misuse of material, non-public information.
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    \18\ Telephone conversation between Stephen M. Youhn, Managing 
Senior Attorney, and Elizabeth King, Associate Director, Division of 
Market Regulation, March 10, 2005. See also Exchange Act Release No. 
47628 (Apr. 10, 2003), 68 FR 17697 (order approving CBOEdirect).
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D. Limitations on Access Due to Systems Constraints

    Because of limited systems bandwidth capacity, the Exchange 
proposes to limit the number of members quoting electronically in each 
product traded on Hybrid or Hybrid 2.0. The number of members permitted 
to quote in each product is specified in proposed CBOE Rule 
8.3A.01.\19\ 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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    \19\ CBOE proposes that the CQL for all products trading on the 
Hybrid Trading System would be twenty-five (25).The CQLs for 
products trading on the Hybrid 2.0 Platform would vary based on 
trading volume over the preceding calendar quarter. 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 Rule 
8.3A.01. The Exchange would announce all changes regarding CQLs to 
the membership via Information Circular. The Exchange may increase 
the CQL levels 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.
    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. 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 for lowering the ``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 Commission in a rule filing pursuant to Section 19(b)(3)(A) of 
the Act.
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    The CBOE proposes that the DPM and e-DPMs (if applicable \20\) 
assigned to the product on January 6, 2005,\21\ and market makers 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 market maker on January 6, 2005, would be entitled to 
quote electronically in those products for as long as they maintain an 
appointment of those products.\22\
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    \20\ Non-Hybrid 2.0 classes do not have e-DPMs.
    \21\ The Commission understands that the CBOE currently intends 
to file a proposed rule change to change the January 6, 2005 date to 
a later date.
    \22\ CBOE represents that the practical effect of this rule is 
to ensure that the DPM, all market makers, 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 market makers, 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.
    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 also be entitled to quote electronically. All market makers 
quoting in the product prior to its addition to the Hybrid 2.0 Platform 
would be entitled to quote electronically provided that: (1) They 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 the product being added to the Hybrid 2.0 
Platform in option products traded in the trading station; or (2) they 
were physically present in the trading station acting in the capacity 
of a market maker on the day prior to the product being added to the 
Hybrid 2.0 Platform. The Exchange believes that these standards, which 
also are contained in paragraph (a) of this rule, would ensure that 
market makers 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 market makers 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).
    Finally, 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

[[Page 13221]]

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).
    The Commission believes that CBOE's proposal to limit the number of 
market makers quoting in each options class is not unfairly 
discriminatory and is otherwise consistent with the Act.

E. Obligations of RMMs

    The Exchange proposes to amend CBOE Rule 8.7 to clarify the 
obligations applicable to RMMs. RMMs would not be able to quote in open 
outcry. Accordingly, 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) of CBOE Rule 8.7, 
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). Specifically, RMMs would be 
required to provide continuous two-sided, 10-up, legal-width quotations 
in 60% of the series of their appointed classes.\23\ The Exchange would 
be permitted to consider exceptions to this quoting requirement based 
on demonstrated legal or regulatory requirements or other mitigating 
circumstances (e.g., excused leaves of absence, personal emergencies, 
or equipment problems). In addition, proposed CBOE Rule 8.4(f) provides 
that RMMs are subject to CBOE Rule 8.7.03A with respect to trading in 
appointed classes. 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. 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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    \23\ 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.
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    The Commission believes that these obligations for RMMs are 
consistent with the Act. In particular, the Commission believes that 
RMMs' affirmative obligations are sufficient to justify the benefits 
they receive as market makers.\24\ In this regard, the Commission 
believes that CBOE rules impose such affirmative obligations on RMMs.
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    \24\ For example, a lender may extend credit to a broker-dealer 
without regard to the restrictions in Regulation T of the Board of 
Governors of the Federal Reserve if the credit is to be used to 
finance the broker-dealer's activities as a specialist or market 
maker on a national securities exchange. See 12 CFR 221.5(c)(6).
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F. 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.
    The Commission believes that the trade allocation algorithm that 
would apply to RMMs is consistent with the Act. The Commission believes 
that treating RMMs and other CBOE Hybrid market participants the same 
under CBOE Rule 6.45A(a) should encourage RMMs to quote competitively.

G. CBOE Membership Rules

    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).'' Proposed CBOE Rule 3.8.02 would accommodate 
the creation of RMMs by allowing 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)).
    The Commission believes that this exception to the general rule 
that a member organization must designate a different individual to be 
the nominee for each of the memberships would not be inappropriate 
given that RMMs operate from locations outside of the trading crowds 
for their applicable option classes, thereby making it possible for a 
member to act as an nominee on more than one membership.\25\
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    \25\ The Commission notes that it would not be possible for an 
in-crowd market participant to act as nominee on more than one 
membership because such participant would be unable to physically be 
present in more than one trading crowd.
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    Proposed CBOE Rule 3.8.02(ii) would also 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 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.
    The Commission believes that this provision is reasonable and 
should accommodate members who choose to take advantage of their remote 
market making privileges while on the Exchange floor.

[[Page 13222]]

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5) of the Act.\26\
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    \26\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CBOE-2004-75), as amended, 
is approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-1185 Filed 3-17-05; 8:45 am]
BILLING CODE 8010-01-P