[Federal Register Volume 71, Number 14 (Monday, January 23, 2006)]
[Notices]
[Pages 3579-3582]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-662]



[[Page 3579]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53112; File No. SR-CBOE-2004-21]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Proposed Rule Change To Establish 
Rules for a Screen-Based Trading System for Non-option Securities

January 12, 2006.

    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 April 14, 2004, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC'') the proposed rule change as 
described in Items I, II, and III below, which Items have been 
substantially prepared by the Exchange. On January 11, 2006, CBOE 
submitted Amendment No. 1 to the proposed rule change.\3\ 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 replaced the original rule filing in its 
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 governing the trading of non-option 
securities on CBOEdirect, the Exchange's screen-based trading platform. 
The proposed new system would be called the Stock Trading on CBOEdirect 
System (``STOC System'' or ``System''). The text of the proposed rule 
change is available at CBOE's Web site (http://www.cboe.org/legal/default.aspx), at CBOE's principal office, 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, CBOE 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. CBOE has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

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

1. Purpose
    As an Intermarket Trading System (``ITS'') participant, CBOE trades 
a small number of non-option securities.\4\ These products are not 
traded on CBOE's options trading platform. Instead, they trade on 
CBOE's stand-alone stock platform in an open-outcry environment 
pursuant to Chapter XXX (30) of CBOE's rules. In 2003, the Commission 
approved Chapters XL (40) through XLVI (46) of CBOE's rules,\5\ which 
established a purely screen-based trading platform for the trading of 
options on CBOE.\6\ That screen-based platform is commonly referred to 
as CBOEdirect, and components of that system have been successfully 
used to create CBOE's Hybrid Trading System (currently in use for 
options trading), to facilitate the trading of single-stock futures by 
OneChicago, and to trade security futures products on the newly-created 
CBOE Futures Exchange.\7\ CBOE now proposes to adopt a new set of rules 
as Chapters L (50) through LV (55) of CBOE's rules to allow for the 
trading of non-option securities in a purely screen-based environment. 
CBOEdirect would be the foundation for this platform. CBOE intends that 
all products currently traded under Chapter 30 would migrate to the new 
platform and trade pursuant to Chapters 50-55. The proposed new 
platform is called the Stock Trading on CBOEdirect System, or STOC 
System. The STOC System would be substantially similar to CBOE's 
screen-based platform for options in that it (1) would be entirely 
screen-based; (2) would utilize a DPM/LMM-driven model with optional 
supplemental liquidity provided by STOC Market-Makers; (3) would 
utilize a configurable matching algorithm based on either price-time or 
pro-rata priority with optional priority overlays; and (4) would 
integrate all quotes and orders entered into the system into the STOC 
book.
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    \4\ Currently, CBOE trades four such products.
    \5\ See Securities Exchange Act Release No. 47628 (April 3, 
2003), 68 FR 17697 (April 10, 2003) (approving SR-CBOE-00-55); see 
also Securities Exchange Act Release No. 45829 (April 25, 2002), 67 
FR 31002 (May 8, 2002) (notice of filing of SR-CBOE-00-55).
    \6\ At this time, CBOE does not trade options pursuant to 
Chapters 40-46.
    \7\ CBOE represents that these different uses of the CBOEdirect 
platform have not had, and will not have, an adverse affect on 
trading or the stability of the platform.
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    CBOE believes the STOC System would greatly enhance the trading of 
stock products on the Exchange. Unlike CBOE's current non-option 
security trading system, the STOC System would be fully integrated with 
ITS to facilitate the sending and receipt of ITS Commitments. It would 
automatically execute marketable orders against CBOE's quote up to the 
size of the quote (assuming such executions would not cause an 
impermissible trade-through of another exchange's quote). STOC Market-
Maker quotes and all orders (customer or otherwise) would be integrated 
into the STOC Book. Further, the audit trail process would be greatly 
simplified for regulatory purposes.
    Almost all of the rules contained in proposed Chapters 50-55 are 
substantially identical to previously approved rules contained in 
Chapters 30 and 40-46 of CBOE's rules. Of course, not all the rules 
from those chapters are proposed to be adopted for the STOC System 
rules--only ones that would be appropriate for screen-based stock 
trading. Any new rules or material modifications to the rules proposed 
to be adopted from Chapters 30 and 40-46 are explained below.
Chapter 50
    This chapter provides an introduction to the STOC System by setting 
forth definitions (including definitions of the various market 
participant types), explaining the application of other CBOE rules, 
setting forth the registration process for members,\8\ stating 
communication access guidelines, and establishing a limitation on 
liability with respect to certain reporting authorities. All of the 
rules in this chapter come from Chapters 40 and 41 of CBOE's rules, 
except for proposed CBOE Rule 50.7, Limitation on Reporting 
Authorities' Liability, which is based on CBOE Rule 30.55.
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    \8\ With respect to the registration process for members, any 
Exchange member who chooses to participate on the STOC System must 
apply with the Exchange to act as a STOC Market-Maker, STOC Broker, 
or Proprietary Trader in accordance with proposed CBOE Rule 50.4. 
Such applications must be submitted to the Exchange Membership 
Committee for approval pursuant to CBOE Rule 3.9. CBOE Rule 3.9 
provides that an applicant must submit an application in a form and 
manner prescribed by the Exchange and describes the application 
procedures and process for approval or disapproval.
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Chapter 51
    This chapter contains rules concerning operational matters--for 
example, business hours, units of trading, minimum increments for bids 
and offers, and types or orders handled. Proposed CBOE Rules 51.1, 
51.2, 51.4, 51.5, 51.7, and 51.8 through 51.11 are rules that can also 
be found in Chapter

[[Page 3580]]

30. CBOE Rule 51.3 is based on current CBOE Rule 42.2.
Chapter 52
    This chapter contains proposed trading and order processing rules 
for the STOC System. Proposed CBOE Rule 52.1 describes the System's 
matching algorithm and governs priority on the System. It is similar to 
CBOE Rule 43.1, which governs priority for options orders. As proposed, 
the appropriate STOC Trading Committee would apply one of two priority 
schemes, on a security-by-security basis. Trades would be allocated by 
the System pursuant to either price-time priority or pro-rata priority. 
Once one of those two priority schemes is in place, the appropriate 
STOC Trading Committee could implement additional optional priority 
overlays. Namely, an additional priority could be provided to public 
customer orders, the market turner, or to the STOC DPM/LMM (CBOE's 
specialist equivalent) \9\ as part of a participation entitlement.\10\ 
Thus, if pro-rata priority were in place for a particular security, and 
the market turner, public customer, and trade participation right 
overlays were in place (in that order of priority), incoming marketable 
orders would be allocated by the System to all participants in pro-rata 
fashion after the participant that first established that price (the 
market turner), any public customers resting at the best price, and the 
STOC DPM/LMM for the product (assuming its order and/or quote is at the 
best price) have been satisfied (in that order). As part of the 
participation right, the STOC DPM/LMM could never receive a quantity 
larger than the size of its quote. The participation right percentage 
would be established pursuant to proposed CBOE Rule 53.56 by the STOC 
DPM Committee and could not exceed 40%. Any participant (including a 
public customer) could be a market turner.
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    \9\ Throughout the proposed rules, references to STOC DPMs are 
also applicable to STOC LMMs (which are essentially rotating STOC 
DPMs). A product cannot have both a STOC DPM and a STOC LMM 
appointed to it. See proposed CBOE Rule 53.51 (defining STOC LMM).
    \10\ Proposed CBOE Rule 52.1(b)(3)(C) provides that the 
participation entitlement may not be in effect unless the public 
customer priority is in effect and ahead of the participation 
entitlement in the priority sequence.
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    Proposed CBOE Rule 52.2 would govern the System's opening 
procedures. The opening would occur in one of two ways, depending on 
whether CBOE was the primary market for a security. If CBOE were the 
primary market, the System would calculate a price point at which the 
most pre-opening buy and sell orders could be matched (based on share 
volume) and then execute those orders to establish an opening price and 
open trading. If CBOE were not the primary market, the STOC DPM/LMM 
would open the security at a single price that matches the primary 
market or at a price that does not trade-through another exchange's 
quotes. This would allow the STOC DPM to assess the quantity and 
balance of pre-opening orders and to interact with the primary market 
as necessary via ITS.
    Proposed CBOE Rule 52.4 would govern ``clearly erroneous'' 
transactions executed on the Exchange. The proposed rule sets forth the 
procedure for requesting Exchange review, the review procedures, and 
the steps taken in the event of system disruption or malfunction. The 
Exchange notes that this proposed rule is based on PCX Equities 
(``PCXE'') Rule 7.10, which governs clearly erroneous executions.
    Proposed CBOE Rule 52.6 would govern market order processing. It 
provides that market orders would automatically execute against the 
STOC Book (including against orders behind the best price at varying 
price points) until the order is fully executed or until such execution 
would result in an impermissible trade-through.\11\ To the extent a 
market order is not automatically executed against the STOC book 
because CBOE is not the NBBO, the System would ``flash'' the order at 
the NBBO price to STOC Market-Makers on the System (to see if they 
would match or improve the NBBO) for a period of time not to exceed 
three seconds. After such time, if the order has not been traded, the 
System will route it to the STOC DPM/LMM for manual handling (which 
would allow the DPM/LMM to transmit an ITS commitment on behalf of the 
order).
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    \11\ In most cases any trade-through would be impermissible, but 
the Commission has provided a temporary 3-tick exemption for certain 
products. See Securities Exchange Act Release No. 46428 (August 28, 
2002), 67 FR 56607 (September 4, 2002) (order implementing the 
exemption as a pilot program); Securities Exchange Act Release No. 
52382 (September 6, 2005), 70 FR 53695 (September 9, 2005) (order 
extending pilot program through June 28, 2006). Any such exemption 
would be factored into what can automatically execute on the STOC 
System.
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    Proposed CBOE Rule 52.7, which would govern limit order processing, 
provides that limit orders would be booked by the System and that they 
would not automatically execute at prices inferior to the NBBO. When a 
limit order is received that is marketable against the quote of another 
exchange but not marketable on CBOE, the System would ``flash'' the 
order at its limit price to STOC Traders on the System (to see if they 
would match or improve the NBBO) for a period of time not to exceed 
three seconds. After such time, if the limit order has not been traded, 
the System would route it to the STOC DPM/LMM for manual handling 
(which would allow the DPM/LMM to transmit an ITS Commitment on behalf 
of the limit order).
    Proposed CBOE Rule 52.8 provides that market odd-lot orders would 
be executed against STOC Market-Maker interest on the STOC Book 
provided such interest equals the NBBO. If no STOC Market-Makers are 
quoting at the NBBO, odd-lot orders would route to the STOC DPM/LMM for 
execution. Limit odd lot orders would execute against the STOC DPM/LMM 
if (i) the limit price is marketable against the STOC DPM/LMM quote, or 
(ii) a trade occurs at the limit price on another exchange. Pre-opening 
odd lot orders that are marketable against the opening price would 
receive the opening price.
    Proposed CBOE Rule 52.10 would provide that the System would 
automatically execute inbound ITS Commitments against the best prices 
available in the STOC Book to the extent such commitments are 
marketable. When an ITS Commitment is not marketable against the STOC 
Book, the System would ``flash'' the commitment at its limit price to 
STOC Traders on the System (to see if they would match or improve the 
NBBO) for a period of time not to exceed 3 seconds. After such time, 
any unexecuted portion would be cancelled by the System. Inbound market 
ITS Commitments would be executed at the NBBO or cancelled.
    Proposed CBOE Rule 52.11(a) governs the facilitation of the non-
option security portion of option-related complex orders. This rule 
defines a complex order as an order involving one or more option order 
components and one or more non-option security order components. Such 
facilitation transactions would be entered into the STOC System at a 
price at or within the prevailing quotation for the non-option security 
at the time the options portion of the complex orders are executed. The 
non-option security portion of the order would have priority at that 
price irrespective of pre-existing bids and offers and any priority 
designations in place pursuant to proposed CBOE Rule 52.1, provided 
that the option order component(s) bettered the corresponding bid 
(offer) in the options market on which they were executed.
    Proposed CBOE Rule 52.11(b), regarding crossing transactions on the 
STOC System, provides that a STOC Trader that wishes to cross two 
original orders or to facilitate an original order

[[Page 3581]]

must first send a Request for Quote (RFQ) with size. Within 10-30 
seconds, as determined by the appropriate STOC Trading Committee, from 
the conclusion of the RFQ response period, the orders may, at the STOC 
Trader's discretion, be crossed (i) between the bid-offer if the 
transaction would be less than 25,000 shares; or (ii) at or between the 
bid-offer if the transaction would be greater than 25,000 shares and in 
which case the cross transaction will have priority. The cross 
transaction information would be received and effected by the 
Exchange's Help Desk.
    The remaining rules in proposed Chapter 52 are taken from existing 
CBOE rules. CBOE Rule 52.3 (Unusual Market Conditions) is based on 
existing CBOE Rule 30.5, and CBOE Rules 52.5 (Order Entry and 
Maintenance), 52.13 (Firm Quotations), and 52.14 (Quote and Trading 
Information) are based on rules contained in Chapter 30. CBOE Rule 52.9 
(Processing of Requests for Quotes) is based on existing CBOE Rule 
43.11.
Chapter 53
    The chapter relates to requirements and obligations of members, 
both generally and by participant type (e.g., STOC DPM, STOC Broker, 
etc.). Proposed Section A carries over Chapter 30 rules that currently 
apply to all members trading non-option securities on CBOE. They relate 
to matters such as trading in member accounts, members acting as 
brokers, short sale requirements, and doing business with the public.
    Proposed Section B contains provisions that are applicable to all 
STOC Market-Makers (including STOC DPMs/LMMs). These provisions are 
based on similar provisions that apply to SBT Market-Makers trading 
options under Chapters 40-46. Accordingly, the registration and 
appointment process for STOC Market-Makers is identical to the process 
in place for SBT Market-Makers. Further, STOC Market-Maker obligations, 
as set forth in proposed CBOE Rule 53.23, are centered on RFQ response 
requirements. STOC Market-Makers that are not providing a two-sided 
quote at the time of an RFQ would have to respond to the RFQs with a 
two-sided market that must last in duration for at least 30 seconds 
(unless traded) and for a minimum size designated by the appropriate 
STOC Market Performance Committee. As part of their obligations, STOC 
Market-Makers would be required to respond to at least 75% of all RFQs 
in their appointed securities.
    Proposed Section C sets forth additional considerations and 
requirements applicable to STOC DPMs and LMMs. As previously stated, a 
STOC LMM essentially would be a rotating STOC DPM. There would never be 
a STOC DPM and STOC LMM for the same security. As with the STOC Market-
Maker provisions, these provisions are patterned after rules in Chapter 
44. STOC DPMs/LMMs would be required to provide continuous two-sided 
markets in assigned securities and to handle customer orders received 
by the STOC System that are not automatically executed or booked. Thus, 
STOC DPMs/LMMs would have dealer and agent functions and obligations.
    Proposed Sections D and E relate to definitions and requirements 
applicable to STOC Brokers and Clearing Firm Brokers. These provisions 
are identical to provisions in Chapter 45.
Chapters 54 and 55
    Proposed Chapter 54 sets forth additional provisions that would be 
applicable to certain product types that could trade on the STOC 
System. These product types, which include index portfolio receipts 
(IPRs) \12\ and Index Portfolio Shares (IPSs),\13\ are currently 
available for trading on CBOE under Chapter 30. All of the proposed 
rules in this Chapter are identical to rules contained in Chapter 30. 
Proposed Chapter 55 contains CBOE's ITS-related rules, which are 
modeled on PCXE's ITS rules. CBOE deemed those an appropriate model 
because, like the proposed STOC system, PCXE is an all-electronic 
trading platform. Lastly, CBOE is attaching an index to Chapters 50-55 
to set forth the applicability of other CBOE rules to trading under 
Chapters 50-55.
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    \12\ See CBOE Rule 1.1, Interpretations and Policies .02.
    \13\ See CBOE Rule 1.1, Interpretations and Policies .03.
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Conclusion
    CBOE believes that the proposed migration of trading of non-option 
securities to the STOC System would significantly enhance the trading 
of these products on the Exchange. CBOE proposes that Chapters 50-55 be 
approved on a pilot basis for a period commencing on the approval date 
of this filing and ending on the final compliance date for the Order 
Protection Rule of Regulation NMS.\14\ CBOE acknowledges that it will 
need to file additional rule changes to comply with Regulation NMS,\15\ 
and the Exchange commits to submitting such filings in a timely manner.
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    \14\ 17 CFR 242.611.
    \15\ See generally Securities Exchange Act Release 51808 (June 
9, 2005), 70 FR 37496 (June 29, 2005) (order adopting rules under 
Regulation NMS).
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Exchange Act in general and furthers the objectives 
of Section 6(b)(5) in particular in that it would enhance the trading 
of non-option securities on CBOE and it should promote just and 
equitable principles of trade, serve to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and protect investors and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change would not 
impose any burden on competition that is 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 with respect 
to the proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, as amended, or
    (B) institute proceedings to determine whether the proposed rule 
change, as amended, 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-2004-21 on the subject line.

[[Page 3582]]

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-9303.
    All submissions should refer to File Number SR-CBOE-2004-21. 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. Copies of 
such filings also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should only submit information you 
wish to make available publicly. All submissions should refer to File 
Number SR-CBOE-2004-21 and should be submitted on or before February 
13, 2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-662 Filed 1-20-06; 8:45 am]
BILLING CODE 8010-01-P