[Federal Register Volume 71, Number 20 (Tuesday, January 31, 2006)]
[Notices]
[Pages 5094-5096]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-1166]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53167; File No. SR-CBOE-2005-89]

Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of a Proposed Rule Change and 
Amendment No. 1 Thereto Relating to the Adoption of a Hybrid Agency 
Liaison System for Automated Handling of Inbound Orders That Are 
Not Automatically Executed




January 23, 2006.
    On October 27, 2005, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') 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 adopt a Hybrid Agency Liaison 
(``HAL'') system for automated handling of inbound orders for option 
classes trading on CBOE's Hybrid System (``Hybrid''). On December 7, 
2005, the Exchange filed Amendment No. 1 to the

[[Page 5095]]

proposed rule change.\3\ The proposed rule change and Amendment No. 1 
were published for comment in the Federal Register on December 15, 
2005.\4\ No comments were received regarding the proposal, as amended. 
This order approves the proposed rule change, as amended.
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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 filing in its 
entirety.
    \4\ See Securities Exchange Act Release No. 52928 (December 8, 
2005), 70 FR 74388 (``Notice'').
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I. Description of the Proposal

    Hybrid currently provides electronic executions on the Exchange for 
orders that are marketable against the Exchange's quote when it 
represents the National Best Bid or Offer (``NBBO''). The entire 
process for those orders is automated; however, many electronically-
received orders that are not automatically executed upon receipt by the 
Hybrid System (usually because CBOE's disseminated quote is not the 
NBBO) are routed to a PAR terminal for manual handling.\5\ In proposed 
CBOE Rule 6.14, the Exchange proposes to automate the handling process 
for certain orders in designated classes that would be routed to a PAR 
terminal under the current rules--specifically, market orders and limit 
orders that are marketable against CBOE's disseminated quote while that 
quote is not the NBBO, and limit orders that improve CBOE's 
disseminated quote (whether or not they are marketable against the 
NBBO). These orders would be electronically exposed to all CBOE Market-
Makers appointed to the relevant option class as well as to all members 
acting as agent for orders at the top of the Exchange's book in the 
relevant option series (``Qualifying Members'').\6\ Like open outcry, 
this exposure and subsequent allocation period \7\ (together, the ``HAL 
auction'' or ``auction'') would afford crowd members an opportunity to 
match the away NBBO price.\8\
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    \5\ See CBOE Rule 7.12, PAR Officials (setting forth the rules 
for manual handling by the PAR Officials of orders routed to PAR 
terminals).
    \6\ Of course, eligible recipients of these messages (CBOE 
Market-Makers and Qualifying Members) may need to undertake some 
programming modifications to receive and respond to these messages. 
The Exchange will not require those programming changes.
    \7\ The allocation period affords Market-Makers and Qualifying 
Members that were interested in trading with an exposed order an 
opportunity to participate in the execution of an order following an 
exposure period. Each Market-Maker or Qualifying Member that submits 
an order or quote to trade with an order during the exposure or 
allocation periods would be entitled to receive an allocation of the 
order in accordance with the allocation algorithm in effect for the 
options class pursuant to CBOE Rule 6.45A or 6.45B. See proposed 
CBOE Rule 6.14(c).
    \8\ For a full description of the operation of the proposed HAL 
auction, see Notice, supra note 4.
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    If any portion of an exposed order remains unexecuted at the end of 
a HAL auction, then the remaining order would be booked if it is a 
limit order that is not marketable, or, if marketable, routed to the 
Exchange showing the NBBO via the options intermarket linkage. If the 
price of the Linkage Order is no longer available on any market, then 
HAL would execute the remainder of the order against the Exchange's 
existing quote provided such execution would not result in a trade-
through. However, if the Exchange's quote is inferior to the Exchange's 
best bid or offer at the time the order was received by HAL (``Exchange 
Initial BBO''), then the order would be executed against the Market-
Makers that constituted the Exchange Initial BBO at a price equal to 
the Exchange Initial BBO.
    In addition, the proposal provides for early termination of an 
auction in certain cases-for instance, when the Hybrid System receives 
an unrelated order on the opposite side of the market from the exposed 
order that could trade against the exposed order at the prevailing NBBO 
price; when the Hybrid System receives an unrelated order on the same 
side of the market as the exposed order that is priced equal to or 
better than the exposed order; or, in the case of exposure of an order 
that is marketable against the Exchange Initial BBO, when a Market-
Maker whose quote is part of the Exchange Initial BBO attempts to move 
its quote to an inferior price.\9\ In this last case, the auction would 
terminate and the Exchange would not permit any Market-Maker quotes to 
move to an inferior price until the exposed order was routed through 
the Linkage or, if a superior price is no longer available on another 
exchange, executed at the Exchange Initial BBO against the Market-
Makers that constituted the Exchange Initial BBO.\10\
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    \9\ For a full discussion of the auction termination provisions 
in proposed CBOE Rule 6.14(d) and (e), see Notice, supra note 4.
    \10\ See proposed CBOE Rule 6.14(d)(iii) and (e)(iii).
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II. Discussion

    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.\11\ In particular, the Commission believes that the proposal 
is consistent with the requirements of Section 6(b)(5) of the Act, 
which requires, among other things, that the rules of a national 
securities exchange be designed to 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.\12\
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    \11\ 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).
    \12\ 15 U.S.C. 78f(b)(5).
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    The Exchange noted in its proposal that the proposed Hybrid Agency 
Liaison system would be an improvement over open outcry auctions 
because HAL, an automated process, would reduce the duration of the 
auction to three seconds or less.\13\ In addition, customer order 
protections built into proposed CBOE Rule 6.14 (such as, most 
significantly, the guarantee that the customer order will receive an 
execution at the Exchange Initial BBO if no better price is available 
when the auction ends or is terminated) \14\ should guarantee that any 
order that is the subject of a HAL auction will be executed at a price 
at least as good as the price disseminated by the Exchange at the time 
the order was received by HAL.\15\ Thus, the HAL auction provisions 
should ensure both that orders that are ineligible for automatic 
execution under the CBOE's rules because the CBOE is not at the NBBO 
are handled electronically rather than manually, and that CBOE Market-
Makers honor their disseminated quotes, regardless of whether an 
auction has been initiated.
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    \13\ CBOE's proposed Rule 6.14(b) limits the total exposure and 
allocation time to three seconds.
    \14\ See proposed CBOE Rule 6.14(b)(i), (b)(ii), (d)(iii), and 
(e)(iii).
    \15\ See proposed CBOE Rule 6.14(b)(i) and (ii).
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    In addition, the Commission notes that the Exchange proposes to 
incorporate into its proposed rule provisions that would provide that a 
pattern or practice of submitting unrelated orders that cause an 
exposure period to conclude early and the dissemination of information 
regarding exposed orders to third parties will be deemed conduct 
inconsistent with just and equitable principles of trade and a 
violation of CBOE Rule 4.1 and other Exchange rules.\16\ The Commission 
believes that these provisions will require the CBOE to surveil for, 
and hopefully help to limit, any potential ``gaming'' of the HAL 
system.
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    \16\ See proposed CBOE Rule 6.14, Interpretations and Policies 
.01 and .02.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (File No. SR-

[[Page 5096]]

CBOE-2005-89), as amended, is approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-1166 Filed 1-30-06; 8:45 am]
BILLING CODE 8010-01-P