[Federal Register Volume 71, Number 192 (Wednesday, October 4, 2006)]
[Notices]
[Pages 58646-58649]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-16364]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54526; File No. SR-CBOE-2006-70]


 Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment No. 1 
Thereto To Adopt Rules Relating to Regulation NMS

September 27, 2006.

I. Introduction

    On August 18, 2006, 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'' or ``Exchange Act'') \1\ 
and Rule 19b-4 thereunder,\2\ a proposal to modify its rules relating 
to the trading of non-option securities to conform with Regulation NMS. 
The proposal was published for comment in the Federal Register on 
August 25, 2006.\3\ The Commission received no comments on the 
proposal. The Exchange filed Amendment No. 1 with the Commission on 
September 27, 2006.\4\ This notice and order requests comment on 
Amendment No. 1 and approves the proposal, as amended, on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 53112 (January 12, 
2006), 71 FR 3579.
    \4\ Amendment No. 1 replaced the original filing in its 
entirety.
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II. Description of the Proposal

    The Commission recently approved the Exchange's proposal to 
establish a new electronic trading system for non-option securities 
known as ``Stock Trading on CBOEdirect'' or ``STOC.''\5\ In this 
filing, CBOE proposes additional rules and additional system 
functionality to STOC designed to comply with Regulation NMS and to 
enable CBOE to qualify as automated trading center whose quotations 
will be protected under Regulation NMS. In its release extending the 
compliance dates for Rules 610 (the Access Rule) and 611 (the Order 
Protection Rule) of Regulation NMS,\6\ the Commission established a 
``Specifications Date'' of October 16, 2006, by which final technical 
specifications for interaction with Regulation NMS-compliant trading 
systems of automated trading centers must be published on SRO Web 
sites. Among other things, these specifications must address: (1) The 
identification of quotations as automated or manual to meet the 
requirements of Rule 600(b)(4);\7\ (2) an immediate-or-cancel order 
(``IOC'') functionality that meets the requirements of Rule 
600(b)(3);\8\ and (3) an intermarket sweep order (``ISO'') 
functionality that allows other industry participants to meet the 
requirements of Rule 600(b)(30).\9\ The proposed rules would modify the 
existing STOC rules to address these requirements as well as other 
matters relating to Regulation NMS.
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    \5\ 5 See Securities Exchange Act Release No. 54422 (September 
11, 2006), 71 FR 54537 (September 15, 2006) (SR-CBOE-2004-21).
    \6\ Securities Exchange Act Release No. 53829 (May 18, 2006), 71 
FR 30038 (May 24, 2006) (``Regulation NMS Compliance Date 
Release'').
    \7\ 17 CFR 242.604(b)(4).
    \8\ 17 CFR 242.604(b)(3).
    \9\ 17 CFR 242.604(b)(30).
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    Unless execution of an order would cause an impermissible trade-
through of a protected quotation of another trading center, all 
marketable orders would automatically execute on the STOC system 
against the system's best bid or offer (which incorporates resting 
limit orders and interest from CBOE market-makers). There would be no 
manual quotations, and STOC is designed to provide quotations that are 
always ``automated'' for purposes of Rule 600(b)(4). If CBOE were to 
experience a technical failure, it would cease disseminating quotations 
(as opposed to disseminating manual quotations).\10\
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    \10\ See proposed CBOE Rule 52.13(a).
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    The Exchange also proposes to modify its existing rule defining and 
governing the handling of IOC orders to make clear that, consistent 
with the requirements of Regulation NMS, IOC orders routed to the STOC 
System would either be immediately executed (in part or in full) or 
canceled.\11\ The Exchange also is proposing to adopt a rule providing 
that, consistent with the requirements of Regulation NMS, ISOs routed 
to CBOE would be immediately and automatically executed on receipt 
without regard for better-priced protected quotations displayed by 
other trading centers.\12\
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    \11\ Such orders would not be ``held up'' for manual processing 
or for potential price improvement above CBOE's disseminated 
quotation. See proposed CBOE Rule 51.8(g)(4).
    \12\ See proposed CBOE Rule 51.8(n).
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    CBOE has proposed additional rules relating to Regulation NMS. 
First, as required by Rule 610(d) of Regulation NMS,\13\ CBOE has 
proposed to add language providing that members should reasonably avoid 
displaying quotations that lock or cross protected quotations from 
other trading centers.\14\
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    \13\ 17 CFR 242.610(d)
    \14\ See proposed CBOE Rule 52.12.
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    Second, the Exchange is proposing language that will allow it to 
invoke the ``self-help'' exception contained in Rule 611(b)(1) of 
Regulation NMS.\15\ CBOE could invoke self-help and bypass quotations 
displayed by a trading center if the trading center repeatedly fails to 
respond within one second to orders attempting to access its protected 
quotations, provided the failures are attributable to the trading 
center and not to transmission delays outside its control. CBOE must 
immediately notify the trading center of its determination to invoke 
self-help.\16\
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    \15\ 17 CFR 242.611(b)(1).
    \16\ See proposed CBOE Rule 52.13(b).
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    Third, when appropriate functionality is available on CBOE, the 
Exchange would provide outbound routing, through a third-party service 
provider (``Routing Service Provider''), to other trading centers 
displaying better-priced protected quotations on behalf of orders that 
may be routed.\17\ This outbound

[[Page 58647]]

routing would be provided directly and automatically by CBOE pursuant 
to three separate agreements: (1) An agreement between the Exchange and 
each member on whose behalf orders would be routed; (2) an agreement 
between the Exchange and each third-party broker-dealer that would 
serve as a ``give-up'' on an away trading center; and (3) an agreement 
between the Exchange and the Routing Service Provider, pursuant to 
which the Exchange would transmit to the Routing Service Provider 
orders for outbound routing, with embedded routing instructions as 
determined by the STOC System, which orders would then be routed via 
the Routing Service Provider's connectivity to the appropriate market 
centers for automatic execution.\18\ With respect to these routing 
services, CBOE would establish and maintain procedures and internal 
controls reasonably designed to adequately restrict the flow of 
confidential and proprietary information between the Exchange 
(including its facilities) and the Routing Service Provider. To the 
extent the Routing Service Provider reasonably receives confidential 
and proprietary information, its use of such information would be 
restricted to legitimate business purposes necessary for providing 
routing services.
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    \17\ Prior to that time, however, CBOE would access better-
priced quotations through the ITS Plan (or its successor). Under 
previously approved STOC rules, when STOC receives a marketable 
order that cannot be executed without causing a trade-through (and 
assuming that the order is not an IOC order), the system will 
display the order to market participants at the NBBO price for a 
short time (three seconds or less, to be determined by the 
Exchange's STOC Trading Committee). If no market participant ``steps 
up'' to the NBBO during the display period, the system will route 
the order to the STOC DPM for manual handling. The STOC DPM may 
either itself step up to the NBBO price and execute the order, or 
route the order via the ITS Plan (or its successor) to the other 
market(s) disseminating the NBBO. If a better price becomes 
available prior to the DPM routing away, such better price must be 
taken into account by the DPM. See CBOE Rule 52.6.
    \18\ See proposed CBOE Rule 52.10.
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    Fourth, the Exchange has proposed a change to CBOE Rule 
53.56(b)(6). This provision sets forth the obligation of a designated 
primary market-maker on the STOC System (``STOC DPM'') \19\ to act as 
agent for orders that are not executed on the system because CBOE is 
not at the NBBO, and requires the STOC DPM to accord priority to such 
public customer orders over the STOC DPM's principal transactions. In 
Amendment No. 1, the Exchange proposes to delete language that permits 
the STOC DPM to trade on parity with the public customer order the STOC 
DPM represents as agent in this situation if the customer consents to 
giving up its priority.
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    \19\ See CBOE Rule 53.50 (defining STOC DPM).
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    Finally, in Amendment No. 1, the Exchange has proposed to delete 
portions of existing CBOE Rules 52.1(d) and 53.24(b) relating to the 
priority of automatically regenerated quotations of STOC market-makers. 
As a result, an automatically regenerated quotation of a STOC market-
maker would be assigned the same priority that a newly generated 
quotation by the market-maker would have at the time of regeneration.

III. Discussion

    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.\20\ In particular, the Commission believes that 
the proposal is consistent with the requirements of 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 facilitate transactions in securities; to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system; and, in general, to protect 
investors and the public interest. The Commission also finds that the 
proposal is consistent with Section 6(b)(8) of the Act,\22\ which 
prohibits an exchange's rules from imposing a burden on competition 
that is not necessary or appropriate in furtherance of the Act. 
Finally, the Commission believes that the proposal is consistent with 
Section 11A(a)(1)(C) of the Act,\23\ in which Congress found that it is 
in the public interest and appropriate for the protection of investors 
and the maintenance of fair and orderly markets to assure: (1) 
Economically efficient execution of securities transactions; (2) fair 
competition among brokers and dealers and among exchange markets, and 
between exchange markets, and markets other than exchange markets; (3) 
the availability to brokers, dealers, and investors of information with 
respect to quotations and transactions in securities; (4) the 
practicability of brokers executing investors' orders in the best 
market; and (5) an opportunity for investors' orders to be executed 
without the participation of a dealer.
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    \20\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78f(b)(8).
    \23\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission did not receive any comments on the proposal. This 
order approves the rule change, as amended.

 A. Compliance With Regulation NMS

1. Automated Quotations/Automated Trading Center
    CBOE seeks to qualify as an automated trading center under 
Regulation NMS. To do so, an exchange must display automated 
quotations.\24\ An automated quotation is a quotation displayed by a 
trading center that, among other things, permits an incoming order to 
be marked immediate-or-cancel, immediately and automatically executes 
an order so marked against the displayed quotation or cancels without 
routing elsewhere, immediately transmits a response, and immediately 
and automatically displays information that updates the displayed 
quotation to reflect any change to its material terms.\25\
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    \24\ See 17 CFR 242.600(b)(4)(i).
    \25\ See 17 CFR 242.600(b)(3).
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    The Commission finds that the Exchange's proposed rules are 
consistent with the requirements of Regulation NMS with respect to 
automated quotations. CBOE Rule 51.8(g)(4) provides for submission of 
IOC orders that are either immediately executed (in whole or in part) 
or canceled. Moreover, CBOE Rule 52.6 has been amended to clarify that 
orders marked IOC will not be delayed for potential price improvement 
on the STOC System. Automated trading centers are also required to 
identify all quotations other than automated quotations as manual 
quotations, and to adopt reasonable standards limiting when the 
exchange's quotations change to manual quotations.\26\ CBOE has elected 
not to display manual quotations, but rather would cease disseminating 
quotations when a technical failure renders it unable to display 
automated quotations. The Commission finds that CBOE's election not to 
disseminate quotations when its quotations are not automated is 
consistent with the Act in general, and with Regulation NMS in 
particular.
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    \26\ See 17 CFR 242.600(b)(4).
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2. Protection of Automated Quotations
    The Order Protection Rule requires trading centers to establish, 
maintain, and enforce written policies and procedures that are 
reasonably designed to prevent trade-throughs on that trading center of 
protected quotations in NMS stocks, unless an exception applies.\27\ 
The provisions discussed below relate to the protection of automated 
quotations by the STOC System.
a. Intermarket Sweep Order
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    \27\ See 17 CFR 242.611(a)(1).
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    Rule 600(b)(30) of Regulation NMS details the requirement for an 
ISO functionality that allows other industry participants to meet the 
requirements of the Order Protection Rule. CBOE's proposed rules define 
an ISO as a limit

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order in an NMS stock that is received by the system from a member 
which is to be executed: (1) Immediately at the time such order is 
received; (2) without regard for better-priced protected quotations 
displayed at one or more other market centers; and (3) at prices equal 
to or better than the limit price, with any portion not so executed to 
be treated as canceled.\28\ The Commission believes that CBOE's 
proposed definition of intermarket sweep order is consistent with the 
requirements of Regulation NMS and thus is consistent with the Act.
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    \28\ However, if an order is received through the communications 
network operated pursuant to the ITS Plan or any successor to the 
ITS Plan, the order would trade only at a single price. See proposed 
CBOE Rule 51.8(n).
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b. Routing of Orders
    As described above, the Exchange would enter into agreements that 
govern the routing of orders to away markets displaying better-priced 
protected quotations.\29\ Proposed CBOE Rule 52.10 describes the 
arrangement between the Exchange and a Routing Service Provider. The 
Commission believes that engaging a Routing Service Provider, as set 
forth in the rule, is a reasonable means of promoting compliance with 
Rule 611 of Regulation NMS. The Exchange would be responsible for 
routing decisions and would retain control of the routing logic. The 
Commission also notes that the rule contemplates procedures and 
internal controls designed to protect confidential and proprietary 
information, which should help ensure that the Routing Service Provider 
does not misuse routing information obtained from the Exchange. In 
addition, the rule requires the equitable allocation of reasonable 
dues, fees, and other charges among Exchange members and other persons 
using the Exchange's facilities, and forbids unfair discrimination in 
connection with the routing services provided by the Exchange.
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    \29\ The Exchange intends to enter into the routing agreements 
described in proposed CBOE Rule 52.10 prior to the ``Trading Phase 
Date'' of February 5, 2007. See Regulation NMS Compliance Date 
Release.
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    Until such time as the Exchange enters into a routing agreement 
with a Routing Service Provider, CBOE would access better priced 
quotations through the ITS Plan (or its successor).\30\ Marketable 
orders that the system cannot execute at the NBBO (with the exception 
of IOC orders) are routed to the STOC DPM for manual handling. The STOC 
DPM may either step up to the NBBO price and execute the order, or 
route the order via the ITS Plan (or its successor) to the other 
market(s) disseminating better-priced quotations, as required by the 
ITS Plan.\31\
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    \30\ See supra note 17.
    \31\ See CBOE Rule 52.6.
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    The Commission believes that CBOE's order routing rules are 
reasonably designed to prevent trade-throughs on the STOC System, and 
therefore are consistent with the Exchange Act and Regulation NMS.
c. Self-Help
    Paragraph (b)(1) of Rule 611 permits a trade-through of a protected 
quotation if the trading center displaying the protected quotation was 
experiencing a failure, material delay, or malfunction of its systems 
or equipment when the trade-through occurred. The Commission stated in 
the Regulation NMS Adopting Release that, ``th[is] exception gives 
trading centers a self-help remedy if another trading center repeatedly 
fails to provide an immediate response (within one second) to incoming 
orders attempting to access its quotes.''\32\ The Commission believes 
that proposed CBOE Rule 52.13(b), which provides that the Exchange may, 
subject to certain conditions, bypass the quotations displayed by 
another trading center if such trading center repeatedly fails to 
respond within one second to orders attempting to access such trading 
center's protected quotations, is reasonably designed to allow CBOE to 
invoke self-help in a manner consistent with Rule 611 of Regulation NMS 
and is, therefore, consistent with the Act.
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    \32\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37495, 37535 (June 29, 2005).
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d. Outbound ISOs and the Identification of Permissible Trade-Throughs
    In Amendment No. 1, the Exchange proposed a new rule governing 
generation of outbound ISOs by the STOC System. The system would 
generate an outbound ISO to any away trading center displaying a 
protected quotation simultaneously with the execution of a transaction 
on the Exchange at a price inferior to a protected quotation, unless a 
specified exception to the Order Protection Rule applies.\33\ The 
proposed rule also requires the Exchange to identify all trades 
executed pursuant to an exception to or exemption from the Order 
Protection Rule in accordance with specifications approved by the 
operating committee of the relevant national market system plan.\34\ 
The provision of the rule requiring identification of trade-through 
exceptions is designed to create uniformity across the markets 
regarding how permissible trade-throughs are reported, and should 
create more transparency for investors and regulators. The Commission 
believes, therefore, that proposed CBOE Rule 52.7 furthers the public 
interest and is consistent with the Act.
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    \33\ See proposed CBOE Rule 52.7(a). The permitted exceptions in 
the Exchange's rule are consistent with those set forth in Rule 611 
of Regulation NMS. See 17 CFR 242.611(b).
    \34\ In addition, if a trade is executed pursuant to both the 
intermarket sweep order exception of Rule 611(b)(5) or (6) and the 
self-help exception of Rule 611(b)(1), such trade shall be 
identified as executed pursuant to the intermarket sweep order 
exception. See proposed CBOE Rule 52.7(b).
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3. Access Rule
    Paragraph (a) of the Access Rule \35\ prohibits a national 
securities exchange from imposing unfairly discriminatory terms that 
prevent or inhibit any person from obtaining efficient access through a 
member of the exchange to a quotation in an NMS stock displayed through 
the SRO quoting facility. The Commission believes that the STOC rules 
and the STOC System have been reasonably designed to meet the standard 
in paragraph (a) of the Access Rule. In addition, paragraph (d) of the 
Access Rule \36\ requires a national securities exchange to establish, 
maintain, and enforce rules that, among other things, require its 
members reasonably to avoid displaying quotations that lock or cross 
any protected quotation in an NMS stock and prohibit its members from 
engaging in a pattern or practice of doing so. Proposed CBOE Rule 52.12 
requires members of the Exchange to reasonably avoid displaying, and to 
not engage in a practice of displaying, any quotations that lock or 
cross a protected quotation, and any manual quotations that lock or 
cross a quotation previously disseminated pursuant to an effective 
national market system plan, subject to certain limited exceptions. The 
Commission believes that this rule is consistent with Rule 610(d) of 
Regulation NMS.
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    \35\ 17 CFR 242.610(a).
    \36\ 17 CFR 242.610(d).
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B. Accelerated Approval of Amendment No. 1

    Pursuant to Section 19(b)(2) of the Act,\37\ the Commission finds 
good cause for approving the amended proposal prior to the thirtieth 
day after the publication of Amendment No. 1 in the Federal Register. 
In Amendment No. 1, the Exchange revised the proposal: (1) To add 
proposed CBOE Rule 52.7, relating to the generation of outbound ISOs 
and the identification of trade-through exceptions; (2) to clarify 
that, until the Exchange's automated

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outbound routing capabilities are in place, the STOC System will route 
certain non-IOC orders to the STOC DPM for manual handling; (3) to 
clarify proposed CBOE Rule 52.10 regarding the Exchange's planned order 
routing arrangements; (4) to delete language from CBOE Rule 53.56(b)(6) 
that allows a STOC DPM who is acting as agent for a customer order that 
is not executed on the system because there is a better price on 
another exchange to be on parity with the customer if the customer 
consents; (5) to delete portions of CBOE Rules 52.1(d) and 53.24(b) 
relating to the priority of automatically regenerated quotations of 
STOC market-makers; and (6) to make additional non-substantive changes 
to the proposed rule text. These changes do not raise any novel or 
substantive regulatory issues. Therefore, the Commission finds good 
cause for approving the proposal, with these changes, on an accelerated 
basis. Doing so will help enable the Exchange to meet the requirements 
of Regulation NMS in an expeditious manner.
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    \37\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments Concerning Amendment No. 1

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether it 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-2006-70 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2006-70. 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 such 
filing 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 submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CBOE-2006-70 and should be submitted on or before 
October 25, 2006.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\38\ that the proposed rule change (File No. SR-CBOE-2006-70), as 
amended, is approved on an accelerated basis.
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    \38\ Id.
    \39\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
Nancy M. Morris,
Secretary.
 [FR Doc. E6-16364 Filed 10-3-06; 8:45 am]
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