[Federal Register Volume 74, Number 217 (Thursday, November 12, 2009)]
[Notices]
[Pages 58355-58358]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-27087]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60931; File No. SR-CBOE-2009-078]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Proposed Rule Change, as Modified by 
Amendment No. 1, Related to Professional Orders

November 4, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on October 20, 2009, the Chicago Board Options Exchange, 
Incorporated (the ``Exchange'' or ``CBOE'') filed with the Securities 
and Exchange Commission (the ``Commission'') the proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by the Exchange. On November 3, 2009, the Exchange filed 
Amendment No. 1 to the proposal.\3\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as modified by 
Amendment No. 1, 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 proposed to revise a paragraph in the 
purpose section of the Form 19b-4 and in the Exhibit 1 thereto 
relating to the application of Section 11(a) of the Act.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend its priority rules to give 
certain non-broker-dealer orders the same priority as broker-dealer 
orders. The text of the proposed rule change is available on the 
Exchange's Web site (http://www.cboe.org/Legal), at the Office of the 
Secretary, CBOE and at the Commission.

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

    In its filing with the Commission, the self-regulatory organization 
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 those statements may be examined at 
the places specified in Item IV below. The Exchange has prepared 
summaries, set forth in sections A, B, and C below, of the most 
significant parts of such statements.

[[Page 58356]]

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

1. Purpose
    Under CBOE rules, a ``public customer'' or ``customer'' is a person 
or entity that is neither a member nor a broker/dealer. Each term is 
used in specific CBOE rules that provide certain marketplace advantages 
to public customer orders over non-customer orders (e.g., orders for 
the account of members or broker/dealers). In particular, under CBOE 
rules, subject to certain exceptions, (i) public customer orders are 
given priority over non-customer orders and Market-Maker quotes at the 
same price,\4\ and (ii) members are generally not charged a transaction 
fee for the execution of public customer orders. The purpose of 
providing these marketplace advantages to public customer orders is to 
attract retail investor order flow to the Exchange by leveling the 
playing field for retail investors over market professionals \5\ and 
providing competitive pricing.
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    \4\ See, e.g., CBOE Rules 6.45, Priority of Bids and Offers--
Allocation of Trades, 6.45A, Priority and Allocation of Equity 
Option Trades on the CBOE Hybrid System, and 6.45B, Priority and 
Allocation of Trades in Index Options and Options on ETFs on the 
CBOE Hybrid System.
    \5\ Market professionals have access to sophisticated trading 
systems that contain functionality not available to retail 
customers, including things such as continuously updated pricing 
models based upon real-time streaming data, access to multiple 
markets simultaneously, and order and risk management tools.
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    With respect to these CBOE marketplace advantages, the Exchange 
does not believe the definition of public customer versus a non-
customer properly distinguishes between non-professional retail 
investors and certain professionals. According to the Exchange, 
providing marketplace advantages based upon whether the order is for 
the account of a participant that is a registered broker-dealer is no 
longer appropriate in today's marketplace because some non-broker-
dealer individuals and entities have access to information and 
technology that enables them to professionally trade listed options in 
the same manner as a broker or dealer in securities.\6\ These 
individual traders and entities (collectively, ``Professionals'') have 
the same technological and informational advantages over retail 
investors as broker-dealers trading for their own account, which 
enables them to compete effectively with broker-dealer orders and 
market maker quotes for execution opportunities in the CBOE 
marketplace.\7\
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    \6\ For example, some broker-dealers provide their professional 
customers with multi-screened trading stations equipped with trading 
technology that allows the trader to monitor and place orders on all 
six options exchanges simultaneously. These trading stations also 
provide compliance filters, order management tools, the ability to 
place orders in the underlying securities, and market data feeds. 
See Securities Exchange Act Releases 59287 (January 23, 2009), 74 FR 
5694 (January 30, 2009) (SR-ISE-2006-26)(order approving 
International Securities Exchange (``ISE'') proposal to introduce 
priority customer and professional orders) and 57254 (February 1, 
2008), 73 FR 7345 (February 7, 2008) (SR-ISE-2006-26)(notice of ISE 
proposal to introduce priority customer and professional orders) at 
note 8.
    \7\ Market-Makers enter quotes based upon the theoretical value 
of the option, which moves with various factors in their pricing 
models, such as the value of the underlying security. Professional 
customers place and cancel orders in relation to an option's 
theoretical value in much the same manner as a Market-Maker. This is 
evidenced by the entry of limit orders that join the best bid or 
offer and by a very high rate of orders that are cancelled. In 
contrast, retail customers who enter orders as part of an investment 
strategy (such as a covered write or directional trade) most 
frequently enter marketable orders or limit orders that they do not 
cancel and replace. See, e.g., Securities Exchange Act Release 57254 
at note 9.
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    The Exchange therefore does not believe that it is consistent with 
fair competition for these professional account holders to continue to 
receive the same marketplace advantages as retail investors over 
broker-dealers trading on the CBOE. Moreover, because public customer 
orders at the same price are executed in time priority, retail 
investors are prevented from fully benefiting from the priority 
advantage when Professionals are afforded public customer order 
priority.
    Accordingly, the Exchange is seeking to adopt a new term that will 
be used to more appropriately provide CBOE marketplace advantages to 
retail investors on the CBOE. Under the proposal, a ``Professional'' 
will be defined in proposed Rule 1.1 as a person or entity that (i) is 
not a broker or dealer in securities, and (ii) places more than 390 
orders in listed options per day on average during a calendar month for 
its own beneficial account(s). Under the proposal, a Professional will 
be treated in the same manner as a broker or dealer in securities for 
purposes of CBOE Rules 6.2A (Rapid Opening System), 6.2B (Hybrid 
Opening System), 6.8C (Prohibition Against Members Functioning as 
Market-Makers), 6.9 (Solicited Transactions), 6.13A (Simple Auction 
Liaison), 6.45 (Priority of bids and Offers--Allocation of Trades), 
6.13B (Penny Price Improvement), 6.45A (Priority and Allocation of 
Equity Option Trades on the CBOE Hybrid System) (except that 
Professional orders may be considered public customer orders, and 
therefore not be subject to the exposure requirements for solicited 
broker-dealer orders, under Interpretation and Policy .02), 6.45B 
(Priority and Allocation of Trades in Index Options and Options on ETFs 
on the CBOE Hybrid System) (except that Professional orders may be 
considered public customer orders, and therefore not be subject to the 
exposure requirements for solicited broker-dealer orders, under 
Interpretation and Policy .02), 6.53C(c)(ii) and (d)(v) and 6.53C.06(b) 
and (c) (Complex Orders on the Hybrid System), 6.74 (Crossing Orders) 
(except that Professional orders may be considered public customer 
orders subject to facilitation under paragraphs (b) and (d)), 6.74A 
(Automated Improvement Mechanism) (except Professional orders may be 
considered customer Agency Orders or solicited orders eligible for 
customer-to-customer immediate crosses under Interpretation and Policy 
.09), 6.74B (Solicitation Auction Mechanism), 8.13 (Preferred Market-
Maker Program), 8.15B (Participation Entitlement of LMMs), 8.87 
(Participation Entitlement of DPMs and e-DPMs), 24.19 (Multi-Class 
Broad-Based Index Option Spread Orders), 43.1 (Matching Algorithm/
Priority), 44.4 (Obligations of SBT Market-Makers), and 44.14 (SBT DPM 
Obligations). In addition, the Professional designation is not 
available in Hybrid 3.0 classes.
    The use of this new term for purposes of the above-referenced 
execution rules will result in Professional account holders 
participating in CBOE's allocation process on equal terms with broker-
dealer orders. The proposal will not otherwise affect non-broker-dealer 
individuals or entities under CBOE rules, and in particular, all public 
customer orders will continue to be treated equally for purposes of the 
linkage-related rules. For example, CBOE will provide the same away-
market protection for all public customer orders, including non-broker-
dealer orders that are included in the definition of ``Professional'' 
orders.
    In order to properly represent orders entered on the Exchange 
according to the new definitions, members will be required to indicate 
whether public customer orders are ``Professional'' orders.\8\ To 
comply with this requirement, members will be required to review their 
customers' activity on at least a quarterly basis to determine whether 
orders that are not for the account of a broker or dealer should be

[[Page 58357]]

represented as customer orders or Professional orders.\9\
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    \8\ The Exchange intends to utilize a special order origin code 
for Professional orders.
    \9\ Orders for any customer that had an average of more than 390 
orders per day during any month of a calendar quarter must be 
represented as Professional orders for the next calendar quarter. 
Members will be required to conduct a quarterly review and make any 
appropriate changes to the way in which they are representing orders 
within five days after the end of each calendar quarter. While 
members only will be required to review their accounts on a 
quarterly basis, if during a quarter the Exchange identifies a 
customer for which orders are being represented as public customer 
orders but that has averaged more than 390 orders per day during a 
month, the Exchange will notify the member and the member will be 
required to change the manner in which it is representing the 
customer's orders within five days.
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    Lastly, the Exchange intends to establish, via a separate rule 
filing, transaction fees applicable to Professionals and the Exchange 
would not commence the Professional program until such fees are in 
place.
* * * * *
    Section 11(a) of the Act prohibits any member of a national 
securities exchange from effecting transactions on that exchange for 
its own account, the account of an associated person, or an account 
over which it or its associated persons exercises discretion unless an 
exception applies.\10\ Section 11(a)(1) contains a number of exceptions 
for principal transactions by members and their associated persons. One 
such exception, set forth in subparagraph (G) of Section 11(a)(1) and 
in Rule 11a1-1(T),\11\ permits any transaction for a member's own 
account provided, among other things, that the transaction yields 
priority, parity, and precedence to orders for the account of persons 
who are not members or associated with members of the exchange. 
Exchange rules, therefore, may require members to yield priority to the 
orders of non-members, including public customers, to satisfy this 
exception to Section 11(a).\12\ Another exception permits market makers 
to effect transactions on exchanges in which they are members.\13\
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    \10\ 15 U.S.C. 78k(a).
    \11\ 17 CFR 240.11a1-1(T).
    \12\ See, e.g., CBOE Rule 6.45A(b)(i)(D), which pertains to the 
allocation of orders in open outcry and provides that members 
relying on the Section 11(a)(1)(G) and Rule 11a1-1(T) thereunder as 
an exemption must yield priority to any bid (offer) at the same 
price of public customer orders and broker-dealer orders resting in 
the electronic book, as well as any other bids and offers that have 
priority over such broker-dealer orders under that rule.
    \13\ Section 11(a)(1)(A).
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    In addition to the exceptions noted above, Rule 11a2-2(T) under the 
Act \14\ provides exchange members with an exception from the 
prohibitions in Section 11(a). Rule 11a2-2(T), known as the ``effect 
versus execute'' rule, permits an exchange member, subject to certain 
conditions, to effect transactions for its own account, the account of 
an associated person, or an account with respect to which it or an 
associated person thereof exercises investment discretion (collectively 
``covered accounts'') by arranging for an unaffiliated member to 
execute the transaction on the exchange.
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    \14\ 17 CFR 240.11a2-2(T).
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    To comply with the ``effect versus execute'' rule's conditions, a 
member: (i) Must transmit the order from off the exchange floor; (ii) 
may not participate in the execution of the transaction once it has 
been transmitted to the member performing the execution; \15\ (iii) may 
not be affiliated with the executing member; and (iv) with respect to 
an account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in 
connection with effecting the transaction except as provided in the 
rule.\16\
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    \15\ The member, however, may participate in clearing and 
settling the transaction. See Securities Exchange Act Release No. 
14563 (March 14, 1978), 43 FR 11542 (March 17, 1978).
    \16\ 17 CFR 240.11a2-2(T).
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    The Exchange does not believe that its proposal relating to 
Professional orders would affect the availability of the exceptions to 
Section 11(a) of the Act, including the exceptions in subparagraph (G) 
of Section 11(a) and in Rules 11a1-1(T) and 11a2-2(T), as are currently 
available.\17\
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    \17\ See Securities Exchange Act Release No. 59546 (March 10, 
2009), 74 FR 11144 (March 16, 2009) (SR-CBOE-2009-016) and related 
regulatory circular, RG09-35.
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* * * * *
    The Exchange believes that identifying Professional account holders 
based upon the average number of orders entered for a beneficial 
account is an appropriately objective approach that will reasonably 
distinguish such persons and entities from retail investors. The 
Exchange proposes the threshold of 390 orders per day on average over a 
calendar month because it believes it far exceeds the number of orders 
that are entered by retail investors in a single day,\18\ while being a 
sufficiently low number of orders to cover the Professional account 
holders that are competing with broker-dealers in the CBOE marketplace. 
In addition, basing the standard on the number of orders that are 
entered in listed options for a beneficial account(s) assures that 
Professional account holders cannot inappropriately avoid the purpose 
of the rule by spreading their trading activity over multiple 
exchanges, and using an average number over a calendar month will 
prevent gaming of the 390 order threshold.
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    \18\ Three hundred ninety orders is equal to the total number of 
orders that a person would place in a day if that person entered one 
order every minute from market open to close. Many of the largest 
retail-oriented electronic brokers offer lower commission rates to 
customers they define as ``active traders.'' Publicly available 
information from the websites for Charles Schwab, Fidelity, TD 
Ameritrade and optionsXpress all define an ``active trader'' as 
someone who executes only a few options trades per month. The 
highest required trading activity to qualify as an active trader 
among these four firms was 35 trades per quarter. See Securities 
Exchange Act Release 57254 at note 11 (which also notes that a study 
of one of the largest retail-oriented options brokerage firms 
indicated that on a typical trading day, options orders were entered 
with respect to 5922 different customer accounts. There was only one 
order entered with respect to 3765 of the 5922 different customer 
accounts on this day, and there were only 17 customer accounts with 
respect to which more than 10 orders were entered. The highest 
number of orders entered with respect to any one account over the 
course of an entire week was 27).
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2. Statutory Basis
    The basis under the Act for this proposed rule change is the 
requirement under Section 6(b)(5)\19\ that an exchange have rules that 
are designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism for a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest. In particular, the proposal will assure that retail 
investors continue to receive the appropriate marketplace advantages in 
the CBOE marketplace, while furthering fair competition among 
marketplace professionals by treating them equally within the CBOE 
marketplace.
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    \19\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition 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

    No written comments were solicited or received 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

[[Page 58358]]

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, or
    (B) Institute proceedings to determine whether the proposed rule 
change 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 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-2009-078 on the subject line.

Paper Comments:

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2009-078. 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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of the CBOE. 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-2009-078 and should be 
submitted on or before December 3, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-27087 Filed 11-10-09; 8:45 am]
BILLING CODE 8011-01-P