[Federal Register Volume 71, Number 75 (Wednesday, April 19, 2006)]
[Notices]
[Pages 20145-20147]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-5853]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53637; File No. SR-CBOE-2004-65]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change and Amendments Nos. 
1 and 2 Thereto Relating to Restrictions on Arbitrators serving on 
CBOE's Arbitration Committee

April 12, 2006.

I. Introduction

    On October 14, 2004, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or the ``Exchange'') filed with the Securities 
and Exchange Commission (``Commission''), pursuant to Section 19(b)(1) 
of the Securities Exchange Act of 1934 (the ``Exchange Act'') \1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change to amend rules 
concerning restrictions on the activities of arbitrators who serve as 
members of the CBOE Arbitration Committee (``Committee''). On December 
13, 2005 and February 15, 2006, CBOE filed Amendments Nos. 1 and 2, 
respectively, to the proposed rule change including amendments to CBOE 
Rules 18.10, 18.13 and 18.14 concerning the removal of arbitrators and 
restrictions on the activities of arbitrators who serve as members of 
the Committee.\3\ The

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proposed rule change, as amended, was published for comment in the 
Federal Register on March 13, 2006.\4\ The Commission received no 
comments on the proposal. 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. Amendment No. 2 replaced the rule text in the original 
filing and Amendment No. 1 in their entirety. Also, Amendment No. 2 
supplemented the ``Purpose'' section of Amendment No. 1 with 
additional explanations as to the basis for certain proposed rule 
amendments.
    \4\ See Securities Exchange Act Release No. 53431 (March 7, 
2006), 71 FR 12755 (March 13, 2006).
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II. Description of the Proposed Rule Change

Proposed Changes to CBOE Rule 18.10

    The Exchange proposes to amend CBOE Rule 18.10 to codify its 
unwritten policy that restricts members of the Committee from 
representing parties as counsel \5\ in any arbitration dispute, claim 
or controversy that has been submitted to CBOE for resolution (``CBOE 
Arbitration''). This restriction would extend for six months after the 
date on which a Committee member ceases being a member of the 
Committee. Moreover, if a Committee member is appointed as an 
arbitrator in a pending CBOE Arbitration (``Pending CBOE Arbitration'') 
and subsequently ceases being a member of the Committee, but continues 
to serve as an arbitrator in the Pending CBOE Arbitration, that person 
cannot represent a party as counsel in a separate CBOE Arbitration 
until he or she has ceased serving as an arbitrator in the Pending CBOE 
Arbitration.
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    \5\ CBOE Rule 18.17 provides: ``All parties shall have the right 
to representation by counsel at any stage of the proceedings.'' 
Since persons who are eligible to act as ``counsel'' in CBOE 
arbitration proceedings are not limited to licensed attorneys, the 
proposed rule change would apply to any person acting as ``counsel'' 
in a CBOE arbitration proceeding whether the person is a licensed 
attorney or not.
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    Under CBOE rules, any CBOE Arbitration between parties who are 
members or persons associated with a member shall be resolved by an 
arbitration panel that consists of three members of the Committee.\6\ 
The Committee is maintained primarily as a means for managing a pool of 
qualified industry arbitrators that is composed of a cross-section of 
Exchange members and/or former members or associated persons of members 
or other individuals who are knowledgeable about the securities 
industry.\7\ All Committee members are appointed in accordance with 
Exchange governance rules and guidelines.\8\
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    \6\ See CBOE Rule 18.2(a). Rule 18.2(a) specifically provides 
that the arbitration panel appointed to resolve member-to-member 
arbitrations shall consist of ``not less than three members of the 
Arbitration Committee.'' However, as a matter of practice, 
arbitration panels typically consist only of three members of the 
Arbitration Committee.
    \7\ Unlike other Exchange committees, the Arbitration Committee 
does not meet as a whole except for training or to administer the 
annual Committee orientation. For a CBOE Arbitration involving 
customers or non-Exchange members and a member(s), CBOE rules 
require that the dispute be resolved by an arbitration panel that 
consists of no less than three arbitrators, the majority of which 
consists of arbitrators who are not from the securities industry 
(``Public Arbitrators''). (See CBOE Rule 18.10). In non-member CBOE 
Arbitrations, members of the Arbitration Committee may be appointed 
as industry arbitrators.
    \8\ See CBOE Rule 18.10.
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    The Exchange has long adhered to an unwritten policy that prohibits 
a Committee member who is an attorney from representing a party in a 
CBOE Arbitration while that person is serving on the Committee. This 
policy is consistent with the Exchange's belief that, while serving on 
the Arbitration Committee, arbitrators should be committed to the 
impartial resolution of any disputes that come before them and should 
avoid circumstances that could disqualify them from being appointed in 
future arbitrations or give rise to the appearance of partiality. The 
Exchange does not believe that a Committee member should act as an 
advocate in a CBOE Arbitration while serving as a member of the CBOE 
Arbitration Committee. Accordingly, the Exchange feels it would be 
prudent to codify its unwritten policy within the rules governing CBOE 
Arbitrations. Additionally, the Exchange notes that the proposed rule 
text relating to restricting an arbitrator from representing a party as 
counsel in any CBOE Arbitration (proposed Rule 18.10(c)) also would 
extend to restrict an arbitrator from representing a party as counsel 
in any capacity, not just acting as an attorney.
    In addition, the Exchange believes that a sufficient period of time 
should pass after an arbitrator is no longer a member of the Committee 
before that individual may represent a party as counsel in a CBOE 
Arbitration. Without this required separation period, a former 
Committee member conceivably could appear as counsel to a party before 
other members of the Committee in a CBOE arbitration immediately after 
resigning from the Committee. Although CBOE does not believe that 
membership on the Arbitration Committee necessarily creates meaningful 
relationships with other Committee members, such that present Committee 
members could not be impartial in considering a case on which a 
recently retired Committee member serves as counsel, a prescribed 
waiting period is a sensible precaution against the appearance of 
partiality. The Exchange believes that a six-month waiting period would 
be appropriate and would help to eliminate the appearance of partiality 
that could otherwise exist.
    Finally, the rule proposal provides that, if a Committee member is 
appointed as an arbitrator to a pending CBOE Arbitration and 
subsequently ceases to be a member of the Committee, but continues to 
serve as an arbitrator in the pending CBOE Arbitration, that person 
cannot represent a party in a separate CBOE Arbitration as counsel 
until the arbitrator ceases to be appointed as an arbitrator in the 
pending CBOE Arbitration. This provision of the proposed rule would 
address the unlikely, but possible, situation in which an arbitration 
proceeding remains pending more than six months after the date on which 
an appointed arbitrator to that case ceased being a member of the 
Committee.\9\ The Exchange believes that this provision is consistent 
with the purpose of this rule change, which is the avoidance of the 
appearance of partiality on the part of a CBOE Arbitrator.
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    \9\ Proposed CBOE Rule 18.10(c)(ii).
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    The proposed rules supplement existing policies and procedures that 
are in place to screen arbitrators for conflicts, potential conflicts, 
and the appearance of conflicts prior, and subsequent, to appointment. 
Specifically, CBOE policies and procedures require any arbitrator, 
prior to or subsequent to appointment to a CBOE Arbitration, to 
disclose any information that presents a conflict, existing or 
potential, or creates the appearance of a conflict with any party, 
fact, or circumstance related to the case in question.\10\ Arbitrators 
also are required to disclose any new information or circumstances that 
may arise after their appointment that would create a similar conflict 
or potential for conflict. Thus, if a former member of the Arbitration 
Committee were to serve as counsel to a party before a CBOE arbitration 
panel, the appointed arbitrators would be required to disclose any past 
relationships with the former Committee member regardless of how much 
time has passed since that former member resigned from the 
Committee.\11\
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    \10\ See CBOE Rule 18.13.
    \11\ Id.
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Proposed Changes to CBOE Rules 18.13 and 18.14

    The Exchange also proposes to adopt new rules governing the process 
for removing or disqualifying arbitrators: (1) When the appointed 
arbitrator has conflicts of interest with the parties or subject matter 
or if there is evidence of arbitrator bias, or (2) for failing to 
comply with arbitrator disclosure requirements. Specifically, Exchange 
Rules 18.13 and 18.14 would be

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amended to provide greater safeguards against the possibility that a 
CBOE Arbitration could proceed with an appointed arbitrator who should, 
by rule, not be hearing and resolving the arbitration. These amendments 
would be substantially similar to those recently proposed by the 
NASD.\12\
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    \12\ See Securities Exchange Act Release No. 51856 (June 15, 
2005); 70 FR 36442 (June 23, 2005) (proposing new NASD Code of 
Arbitration Procedure for Customer Disputes (``Proposed Customer 
Code'')); Securities Exchange Act Release No. 51857 (June 15, 2005); 
70 FR 36430 (June 23, 2005) (proposing new NASD Code of Arbitration 
Procedure for Industry Disputes (``Proposed Industry Code'')).
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    Rule 18.13(a)-(c) currently outlines the disclosures that a CBOE 
arbitrator must make that help to assess whether the arbitrator would 
be precluded from rendering an objective and impartial decision in a 
CBOE Arbitration.\13\ Proposed Rules 18.13(d)(1) and 18.13(d)(2) 
provide that the Director of Arbitration may remove an arbitrator based 
on the disclosures made under Rule 18.13(a)-(c) and information not 
known to the parties when the arbitrator was selected. The Exchange 
also proposes to amend Rule 18.13(d), in proposed Rule 18.13(d)(3), to 
clarify that the Director of Arbitration will grant a party's request 
to disqualify an arbitrator if it is reasonable to infer, based on 
information known at the time of the request, that the arbitrator is 
biased, lacks impartiality, or has an interest in the outcome of the 
CBOE Arbitration. Such interest or bias must be direct, definite, and 
capable of reasonable demonstration, rather than being remote or 
speculative. In addition, proposed Rule 18.13(d)(4) would help to 
ensure that parties to a CBOE Arbitration are informed of the 
disclosure of any new information that is required to be disclosed by 
an arbitrator under Rule 18.13 unless either the Director of 
Arbitration removes the arbitrator or the arbitrator withdraws 
voluntarily as soon as the arbitrator learns of any interest, 
relationship, or circumstances described under Rule 18.13(a) that might 
preclude the arbitrator from rendering an objective and impartial 
determination in the CBOE Arbitration. These proposed changes are 
substantially similar to the standards proposed by NASD.\14\
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    \13\ See CBOE Rule 18.13(a)-(c).
    \14\ See Proposed Customer Code and Proposed Industry Code, 
supra note 11.
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    Also, this proposal would amend CBOE Rule 18.14, which currently 
provides the process by which the Exchange fills vacancies of an 
arbitrator, who for any reason, is unable to perform as an 
arbitrator.\15\ The Exchange proposes to provide within Rule 18.14 a 
more detailed process by which the Director of Arbitration may remove 
or disqualify an arbitrator based on: (1) Conflicts of interest or bias 
involving an arbitrator; (2) challenges for cause; and (3) information 
required to be disclosed pursuant to Rule 18.13 and that was not 
previously disclosed.\16\ These proposed changes are also substantially 
similar to proposed NASD arbitration rules governing the same subject 
matter.\17\
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    \15\ Such reasons include the disqualification, resignation, 
death, disability, or withdrawal of the arbitrator.
    \16\ Proposed Rule 18.14(c) also would provide standards to be 
used in deciding challenges for cause, which standards are identical 
to those provided under proposed Rule 18.13(d).
    \17\ See Proposed Customer Code and Proposed Industry Code, 
supra note 12.
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III. Discussion and Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Exchange 
Act and the rules and regulations thereunder applicable to a national 
securities exchange, and in particular, with the requirements of 
Section 6(b)(5) of the Act.\18\ Section 6(b)(5) requires, among other 
things, that the rules of an 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 national market system, and in 
general, to protect investors and the public interest. The Commission 
believes that the proposed rule change furthers the objectives of 
Section 6(b)(5), in that it is designed to protect investors and the 
public interest by strengthening the integrity of the CBOE Arbitration 
program. The proposed rule change does so by limiting the possibility 
of conflicts of interest: (1) By restricting members of the Committee 
from representing parties to an arbitration while serving on the 
Committee and for six months after ceasing to be a member of the 
Committee, and (2) by adopting new rules governing the process for 
removing or disqualifying arbitrators when the appointed arbitrator has 
conflicts of interest with the parties or subject matter or if there is 
evidence of arbitrator bias, as well as for failing to comply with 
arbitrator disclosure requirements.
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    \18\ 15 U.S.C. 78f(b)(5).
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IV. Conclusions

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-CBOE-2004-65), as amended, 
be, and hereby is, approved.
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    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-5853 Filed 4-18-06; 8:45 am]
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