[Federal Register Volume 74, Number 240 (Wednesday, December 16, 2009)]
[Notices]
[Pages 66699-66710]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-29877]



[[Page 66699]]

=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61152; File No. 10-191]


In the Matter of the Application of C2 Options Exchange, 
Incorporated for Registration as a National Securities Exchange 
Findings, Opinion, and Order of the Commission

December 10, 2009.

I. Introduction

    On January 21, 2009, the Chicago Board Options Exchange, 
Incorporated (``CBOE'') submitted to the Securities and Exchange 
Commission (``Commission'') an Application for Registration as a 
National Securities Exchange (``Form 1'') seeking registration under 
Section 6 of the Securities Exchange Act of 1934 \1\ (the ``Act'') of a 
second national securities exchange, referred to as C2 Options 
Exchange, Incorporated (``C2'' or the ``Exchange''). Notice of the 
application was published for comment in the Federal Register on March 
3, 2009.\2\ The Commission received one comment letter regarding the C2 
Form 1.\3\ On December 8, 2009, C2 filed Amendment No. 1 to its Form 
1.\4\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78f.
    \2\ See Securities Exchange Act Release No. 59441 (February 24, 
2009), 74 FR 9322 (``Notice'').
    \3\ See E-mails from Bryan Rule, dated July 8, 2009 and November 
9, 2009. While the July correspondence does not contain any 
substantive comments on the Form 1 application, the November 
correspondence asks the Commission not to approve C2's application 
for registration until CBOE ``adequately disciplines its members for 
their large number of SEC Firm Quote violations * * *.'' Mr. Rule 
asserted that ``the new C2 Rules seek to diminish the public's 
priority in option trading.'' As discussed further below, the 
Commission believes that C2's proposed rules, including provisions 
relating to order execution and priority, are consistent with the 
Act. In addition, as a self-regulatory organization, C2--as well as 
CBOE--is required to comply with the provisions of the Act and the 
rules and regulations thereunder and enforce compliance with such 
provisions by its members. See 15 U.S.C. 78s(g).
    \4\ In Amendment No. 1, CBOE modified its application by: 
Revising Exhibits C and D to reflect the removal of entities that do 
not qualify as affiliates and to provide more current financial 
information; revising its proposed Bylaws to clarify an 
inconsistency in Section 3.1; revising Exhibit J to reflect current 
information; and revising and clarifying the operation of certain 
proposed rules. The changes proposed in Amendment No. 1 either are 
not material or are otherwise responsive to the concerns of the 
Commission.
---------------------------------------------------------------------------

II. Statutory Standards

    Under Sections 6(b) and 19(a) of the Act,\5\ the Commission shall 
by order grant an application for registration as a national securities 
exchange if it finds that the proposed exchange is so organized and has 
the capacity to carry out the purposes of the Act and can comply, and 
can enforce compliance by its members and persons associated with its 
members, with the provisions of the Act, the rules and regulations 
thereunder, and the rules of the exchange.
---------------------------------------------------------------------------

    \5\ 15 U.S.C. 78f(b) and 15 U.S.C. 78s(a), respectively.
---------------------------------------------------------------------------

    As discussed in greater detail below, the Commission finds that 
C2's application for exchange registration meets the requirements of 
the Act and the rules and regulations thereunder. Further, the 
Commission finds that the proposed rules of C2 are consistent with 
Section 6 of the Act in that, among other things, they are designed to: 
(1) Assure fair representation of the Exchange's members in the 
selection of its directors and administration of its affairs and 
provide that, among other things, one or more directors shall be 
representative of investors and not be associated with the exchange, or 
with a broker or dealer;\6\ (2) prevent fraudulent and manipulative 
acts and practices, promote just and equitable principles of trade, 
foster cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, remove impediments to and 
perfect the mechanisms of a free and open market and a national market 
system;\7\ (3) not permit unfair discrimination between customers, 
issuers, or dealers;\8\ and (4) protect investors and the public 
interest.\9\ Finally, the Commission finds that the proposed rules of 
C2 do not impose any burden on competition not necessary or appropriate 
in furtherance of the purposes of the Act.\10\
---------------------------------------------------------------------------

    \6\ See 15 U.S.C. 78f(b)(3).
    \7\ See 15 U.S.C. 78f(b)(5).
    \8\ See id.
    \9\ See id.
    \10\ See 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    Overall, the Commission believes that approving C2's application 
for exchange registration could confer important benefits on the public 
and market participants. In particular, C2 will provide market 
participants with an additional venue for executing orders in 
standardized options and should increase competition between the 
options exchanges. Consequently, investors should benefit as markets 
compete on service, price, and execution.

III. Discussion and Commission Findings

A. Background

    CBOE, a national securities exchange registered under Section 6 of 
the Act, has proposed the formation of C2 as a stand-alone options 
exchange that will operate under a separate exchange license and have 
separate access rules, separate governance, and a separate fee schedule 
from that of CBOE. Unlike CBOE, which uses a hybrid model market 
structure, C2 will be an all-electronic marketplace and will not 
maintain a physical options trading floor. CBOE filed its C2 proposal 
during a time of increasing consolidation among U.S. registered 
exchanges in which exchange holding companies have sought to control 
multiple, separate exchange licenses in order to offer multiple and 
varied trading venues to appeal to a broad array of market 
participants.\11\ The primary features of the C2 proposal, discussed in 
more detail in C2's Form 1, are discussed below.
---------------------------------------------------------------------------

    \11\ See, e.g., Securities Exchange Act Release Nos. 58179 (July 
17, 2008), 73 FR 42874 (July 23, 2008) (File No. SR-Phlx-2008-31) 
(approval order concerning changes to the governing documents of the 
Philadelphia Stock Exchange, Inc. in connection with its acquisition 
by The NASDAQ OMX Group, Inc.); and 58673 (September 29, 2008), 73 
FR 57707 (October 3, 2008) (File Nos. SR-Amex-2008-62 and SR-NYSE-
2008-60) (approval order concerning the acquisition of the American 
Stock Exchange LLC by NYSE Euronext).
---------------------------------------------------------------------------

B. Corporate Structure of C2

1. Ownership
    C2 will be a wholly-owned subsidiary of its parent company, CBOE. 
The C2 governing documents explicitly state that CBOE owns 100% of the 
common stock of C2 and that any sale, transfer, or assignment by CBOE 
of its ownership stake in C2 will not be permitted without Commission 
approval pursuant to the rule filing procedures under Section 19 of the 
Act.\12\ CBOE, itself a self-regulatory organization (``SRO''), will 
therefore own C2, which will be a separate SRO.\13\
---------------------------------------------------------------------------

    \12\ See Article Fourth of the Certificate of Incorporation of 
C2 (``C2 Certificate of Incorporation''). See also 15 U.S.C. 78s.
    \13\ The acquisition of the American Stock Exchange LLC 
(``Amex'') by the National Association of Securities Dealers, Inc. 
(``NASD'') in 1998 involved a similar corporate structure. See 
Securities Exchange Act Release No. 40622 (October 30, 1998), 63 FR 
59819 (November 5, 1998) (File Nos. SR-Amex-98-32; SR-NASD-98-56; 
and SR-NASD-98-67) (approval order).
---------------------------------------------------------------------------

    While recent consolidation among U.S. exchanges has involved 
ownership of multiple exchanges under a single holding company 
structure, that structure is unavailable to CBOE, which presently is 
structured as a mutually-held member-owned organization. CBOE has, 
however, proposed to demutualize, though its C2 proposal

[[Page 66700]]

precedes its efforts to effectuate its planned demutualization.\14\
---------------------------------------------------------------------------

    \14\ CBOE's planned demutualization has been noticed for comment 
but has not yet received member approval. See Securities Exchange 
Act Release No. 58425 (August 26, 2008), 73 FR 51652 (September 4, 
2008) (File No. SR-CBOE-2008-88) (``CBOE Demutualization Notice'').
---------------------------------------------------------------------------

    The Commission notes that, while C2 will be responsible for 
complying with the legal obligations that govern an exchange, CBOE, in 
its capacity as the parent company with a controlling interest in C2, 
also will be responsible for ensuring that C2 meets its obligations as 
an SRO. In this respect, CBOE has adopted a rule to reflect and codify 
CBOE's ultimate responsibility to ensure that C2 meets its statutory 
obligations as an SRO.\15\ Among other things, CBOE's policy with 
respect to C2 represents that CBOE will ensure that necessary and 
appropriate resources are available to C2 so that it can meet the 
evolving demands of operating a regulatory and supervisory compliance 
program. Further, in discharging this responsibility, CBOE's policy 
states it will exercise its powers and its managerial influence to 
ensure that C2 fulfills its self-regulatory obligations by directing C2 
to take action necessary to effectuate its purposes and functions as a 
national securities exchange operating pursuant to the Act, and 
ensuring that C2 has and appropriately allocates such financial, 
technological, technical, and personnel resources as may be necessary 
or appropriate to meet its obligations under the Act. Finally, CBOE has 
committed to refrain from taking any action with respect to C2 that, to 
the best of its knowledge, would impede, delay, obstruct, or conflict 
with efforts by C2 to carry out its SRO obligations under the Act, and 
the rules and regulations thereunder. The Commission believes that 
CBOE's policy statement specifies the role and responsibility of CBOE 
in the operation of C2.
---------------------------------------------------------------------------

    \15\ See Securities Exchange Act Release Nos. 61140 (December 
10, 2009) (File No. SR-CBOE-2009-048) (approval order); and 60307 
(July 15, 2009), 74 FR 36289 (July 22, 2009) (File No. SR-CBOE-2009-
048) (notice of filing). The policy adopted by CBOE is consistent 
with the resolution of similar questions in the context of the NASD-
Amex combination referenced above. See Securities Exchange Act 
Release Nos. 40622 (October 30, 1998), 63 FR 59819 (November 5, 
1998) (File Nos. SR-Amex-98-32; SR-NASD-98-56; and SR-NASD-98-67) 
(approval order); and 40443 (September 16, 1998), 63 FR 51108 
(September 24, 1998) (File No. SR-NASD-98-67) (notice of filing of 
NASD's policy with respect to its authority over the Amex).
---------------------------------------------------------------------------

    The Commission believes that the proposed corporate structure of C2 
is consistent with the Act and that C2 will be so organized and have 
the capacity to be able to carry out the purposes of the Act and to 
comply and enforce compliance by its members and persons associated 
with its members with all applicable rules and regulations. C2's 
proposed ownership by CBOE, coupled with the explicit restriction on 
any indirect or direct transfer of such control by CBOE, should 
minimize the potential that any person could interfere with or restrict 
the ability of C2, CBOE, or the Commission to effectively carry out 
their respective regulatory oversight responsibilities. Further, the 
Commission notes that CBOE has undertaken to ensure and maintain the 
regulatory independence of C2 to enable C2 to operate in a manner that 
complies with the Federal securities laws, including the objectives of 
Sections 6(b) and 19(g) of the Act.\16\
---------------------------------------------------------------------------

    \16\ 15 U.S.C. 78f(b) and 15 U.S.C. 78s(g), respectively.
---------------------------------------------------------------------------

2. Governance
    As part of its Form 1 application, C2 submitted a proposed 
Certificate of Incorporation and Bylaws. In these documents, among 
other things, C2 establishes the composition of the Exchange's board of 
directors and the Exchange's governance committees.\17\
---------------------------------------------------------------------------

    \17\ The governance structure of C2 is based primarily upon the 
governance structure that CBOE has proposed in connection with its 
demutualization. See CBOE Demutualization Notice, supra note 14, at 
73 FR 51654.
---------------------------------------------------------------------------

a. The C2 Board of Directors
    C2's Board of Directors (``Board'') will be the governing body of 
C2 and will possess all of the powers necessary for the management of 
the business and affairs of the Exchange and the execution of its 
responsibilities as an SRO, including regulating the business conduct 
of Trading Permit Holders (``TPHs''), imposing fees, and adopting and 
amending rules.\18\ C2 has proposed the following Board composition 
requirements, which are comparable to those the Commission has approved 
for other SROs:\19\
---------------------------------------------------------------------------

    \18\ See C2 Bylaws Article III, Section 3.3.
    \19\ See, e.g., Section 9 of the Limited Liability Company 
Agreement of The NASDAQ Stock Market LLC (``Nasdaq'') and Article 
III of Nasdaq's By-Laws.
---------------------------------------------------------------------------

     The Board will be composed of between 11 and 23 directors 
(the exact number to be fixed from time to time by the Board);\20\
---------------------------------------------------------------------------

    \20\ See C2 Bylaws Article III, Section 3.1.
---------------------------------------------------------------------------

     One director position will be held by the Chief Executive 
Officer of C2 (``CEO'');
     The number of Non-Industry Directors \21\ will equal or 
exceed the sum of the number of Industry Directors \22\ (excluding the 
CEO from the calculation of Industry Directors for such purpose);
---------------------------------------------------------------------------

    \21\ ``Non-Industry Director'' is defined as a person who is not 
an ``Industry Director.'' See id.
    \22\ C2's Bylaws define ``Industry Director'' as a director 
that: (i) Is a holder of a Trading Permit or otherwise subject to 
regulation by the Exchange; (ii) is a broker-dealer or an officer, 
director or employee of a broker-dealer or has been in any such 
capacity within the prior three years; (iii) is, or was within the 
prior three years, associated with an entity that is affiliated with 
a broker-dealer whose revenues account for a material portion of the 
consolidated revenues of the entities with which the broker-dealer 
is affiliated; (iv) has a material ownership interest in a broker-
dealer and has investments in broker-dealers that account for a 
material portion of the director's net worth; (v) has a consulting 
or employment relationship with or has provided professional 
services to the Exchange or any of its affiliates or has had such a 
relationship or has provided such services within the prior three 
years; or (vi) provides, or has provided within the prior three 
years, professional or consulting services to a broker-dealer, or to 
an entity with a 50% or greater ownership interest in a broker-
dealer whose revenues account for a material portion of the 
consolidated revenues of the entities with which the broker-dealer 
is affiliated, and the revenue from all such professional or 
consulting services accounts for a material portion of either the 
revenues received by the director or the revenues received by the 
director's firm or partnership. See id.
---------------------------------------------------------------------------

     At all times, at least one Non-Industry Director will 
qualify as a Non-Industry Director other than by operation of the 
limited exceptions provided for ``outside directors'' under the 
definition of ``Industry Director'' and will have no material business 
relationship with a broker or dealer, an entity that is affiliated with 
a broker-dealer, or the Exchange or any of its affiliates;\23\
---------------------------------------------------------------------------

    \23\ C2's Bylaws provide a limited exception such that a 
director would not be deemed to be an ``Industry Director'' solely 
because either (A) the person is or was within the prior three years 
an outside director of a broker-dealer or an outside director of an 
entity that is affiliated with a broker-dealer, provided that the 
broker-dealer is not a holder of a Trading Permit or otherwise 
subject to regulation by the Exchange, or (B) the person is or was 
within the prior three years associated with an entity that is 
affiliated with a broker-dealer whose revenues do not account for a 
material portion of the consolidated revenues of the entities with 
which the broker-dealer is affiliated, provided that the broker-
dealer is not a holder of a Trading Permit or otherwise subject to 
regulation by the Exchange. At all times, however, at least one Non-
Industry Director must qualify as a Non-Industry Director exclusive 
of the exceptions provided for in the immediately preceding sentence 
and shall have no material business relationship with a broker or 
dealer or the Exchange or any of its affiliates. C2's Bylaws specify 
that the term ``outside director'' means a director of an entity who 
is not an employee or officer (or any person occupying a similar 
status or performing similar functions) of such entity. See id.
---------------------------------------------------------------------------

     The number of Industry Directors will equal or exceed 30% 
of the Board;\24\ and
---------------------------------------------------------------------------

    \24\ See id.
---------------------------------------------------------------------------

     At least 20% of the directors on the Board will be 
nominated (or otherwise selected by a petition of C2 members) by the 
Industry-Director Subcommittee of

[[Page 66701]]

the Nominating and Governance Committee (such directors are referred to 
collectively as the ``Representative Directors'').\25\
---------------------------------------------------------------------------

    \25\ Only persons who are nominated by the Nominating and 
Governance Committee as Representative Directors will be eligible 
for election as Representative Directors and the Nominating and 
Governance Committee is bound to accept and nominate the 
Representative Director nominees recommended by the Industry-
Director Subcommittee, provided that the Representative Director 
nominees are not opposed by a petition candidate. If such 
Representative Director nominees are opposed by a petition candidate 
then the Nominating and Governance Committee is bound to accept and 
nominate the Representative Director nominees who receive the most 
votes pursuant to a run-off election. See C2 Bylaws Article III, 
Section 3.2.
---------------------------------------------------------------------------

    The initial Board will be divided into two classes. The initial 
term of the Class I and II directors will end with the annual 
stockholders meeting to be held by the Exchange in 2009 and 2010, 
respectively. Thereafter, directors will serve two-year terms ending on 
the second annual meeting following the meeting at which such directors 
were elected. Class I directors will initially consist of the Chief 
Executive Officer, five Non-Industry Directors, and five Industry 
Directors (two of whom will be Representative Directors). Class II 
directors will initially consist of seven Non-Industry Directors and 
five Industry Directors (three of whom will be Representative 
Directors).\26\ All directors will continue in office until their 
successors are elected or appointed and qualified, except in the event 
of their earlier death, resignation, or removal.\27\
---------------------------------------------------------------------------

    \26\ See C2 Bylaws Article III, Section 3.1. and Amendment No. 
1.
    \27\ See C2 Bylaws Article III, Section 3.1.
---------------------------------------------------------------------------

    In addition, within 45 days from the date on which trading 
commences on C2, the Industry-Director Subcommittee will issue a 
circular to TPHs identifying a slate of Representative Director 
nominees.\28\ TPHs will thereafter be able to file petitions for the 
nomination of alternate Representative Directors. In the event of a 
contested election, a run-off election will be held prior to the 
initial Board election. The Commission notes that because CBOE intends 
to seed the initial C2 Board with members of CBOE's current board of 
directors, the Representative Directors on C2's initial Board will have 
been subject to CBOE member input. As C2's initial permit holders will 
likely consist substantially of CBOE members,\29\ the Commission 
believes C2's initial Board will provide member representation 
sufficient to allow the Exchange to commence operations. However, to 
assure a fair representation of C2 members in the selection of C2's 
directors and administration of its affairs, C2 has committed to 
provide C2 members with the prompt opportunity to participate in the 
selection of Representative Directors, thereby satisfying the 
compositional requirements for the Board contained in the C2 
Bylaws.\30\
---------------------------------------------------------------------------

    \28\ See C2 Bylaws Article III, Section 3.2.
    \29\ See infra Section III.C.1.a (TPH Access).
    \30\ See C2 Bylaws Article III, Section 3.2.
---------------------------------------------------------------------------

    The Nominating and Governance Committee will nominate individuals 
for election as directors of the Board subsequent to the initial Board 
election process set forth above.\31\ The Board will appoint the 
initial Nominating and Governance Committee and thereafter the 
Nominating and Governance Committee members will recommend their 
successors for approval by the Board.
---------------------------------------------------------------------------

    \31\ See C2 Bylaws Article III, Section 4.5. The Nominating and 
Governance Committee will be comprised of at least seven directors 
and will at all times have a majority of directors that are Non-
Industry Directors. See id.
---------------------------------------------------------------------------

    The Industry-Director Subcommittee \32\ of the Nominating and 
Governance Committee will recommend candidates to the Nominating and 
Governance Committee for each new or vacant Representative Director 
position on the Board.\33\ Alternate candidates for Representative 
Director positions may be nominated by TPHs pursuant to a petition 
process.\34\ If no candidates are nominated pursuant to a petition 
process, then the Nominating and Governance Committee is bound to 
accept and nominate the Representative Director nominees recommended by 
the Industry-Director Subcommittee. If a petition process produces 
additional candidates, then the candidates nominated pursuant to a 
petition process, together with those nominated by the Industry-
Director Subcommittee, will be presented to TPHs in a contested 
election to determine the final slate of nominees for Representative 
Director.\35\ Candidates who receive the most votes will be nominated 
as Representative Directors by the Nominating and Governance 
Committee.\36\ CBOE, as the sole shareholder of C2, has committed to 
elect the candidates nominated by the Nominating and Governance 
Committee as Representative Directors.\37\
---------------------------------------------------------------------------

    \32\ The Industry-Director Subcommittee will consist of all of 
the Industry Directors then serving on the Nominating and Governance 
Committee. See C2 Bylaws Article III, Section 3.2.
    \33\ The Industry-Director Subcommittee will provide a mechanism 
for TPHs to provide input to the Industry-Director Subcommittee with 
respect to open Representative Director positions. Once selected, 
the Industry-Director Subcommittee will issue a circular to TPHs 
identifying the Representative Director nominees selected by the 
committee. See C2 Bylaws Article III, Section 3.2.
    \34\ See C2 Bylaws Article III, Section 3.2. TPHs may nominate 
alternative candidates for election to the Representative Director 
positions to be elected in a given year by submitting a petition 
signed by individuals representing not less than 10% of the total 
outstanding Trading Permits at that time. See id.
    \35\ See C2 Bylaws Article III, Section 3.2. Each TPH will have 
one vote with respect to each Trading Permit held for each 
Representative Director position to be filled that year; provided, 
however, that no holder of Trading Permits, either alone or together 
with its affiliates, may account for more than 20% of the votes cast 
for a candidate, and any votes cast by a holder of Trading Permits, 
either alone or together with its affiliates, in excess of this 20% 
limitation will be disregarded. See id.
    \36\ See id.
    \37\ CBOE, as sole shareholder of C2, has entered into a voting 
agreement with C2 with respect to the election by CBOE of the 
Representative Directors whereby CBOE has agreed to vote in favor of 
those individuals nominated by C2's Nominating and Governance 
Committee for election as Representative Directors of C2.
---------------------------------------------------------------------------

    The Commission believes that the requirement in the C2 Bylaws that 
20% of directors be Representative Directors, together with the process 
by which such directors are to be nominated and elected, provides for 
the fair representation of members in the selection of directors and 
the administration of C2 in a manner consistent with the requirement in 
Section 6(b)(3) of the Act.\38\ As the Commission has previously noted 
in the context of other exchange governance proposals, this requirement 
helps to ensure that an exchange's members have a voice in the 
governing body of the exchange and the corresponding exercise by the 
exchange of its self-regulatory authority, and that the exchange is 
administered in a way that is equitable to all who trade on its market 
or through its facilities.\39\
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78f(b)(3).
    \39\ See, e.g., Securities Exchange Act Release Nos. 53128 
(January 13, 2006), 71 FR 3550, 3553 (January 23, 2006) (File No. 
10-131) (``Nasdaq Exchange Registration Order''); 53382 (February 
27, 2006), 71 FR 11251, 11259 (March 6, 2006) (File No. SR-NYSE-
2005-77) (``NYSE/Archipelago Merger Approval Order''); and 58375 
(August 18, 2008), 73 FR 49498, 49501 (August 21, 2008) (File No. 
10-182) (``BATS Exchange Registration Order'').
---------------------------------------------------------------------------

    In addition, the requirement that the number of Non-Industry 
Directors equal or exceed the number of Industry Directors on the Board 
is designed to assure the inclusion of a significant non-industry 
presence in the governance of the Exchange, which the Commission 
believes is a critical element in an exchange's ability to protect the 
public interest.\40\ Further, the Commission notes that at all times at 
least one Non-Industry Director will qualify as not an ``Industry 
Director'' without using the limited exceptions provided for ``outside 
directors'' under the definition of ``Industry Director'' and will have 
no

[[Page 66702]]

material business relationship with a broker or dealer, an entity that 
is affiliated with a broker-dealer, or the Exchange or any of its 
affiliates.\41\ In other words, at least one of C2's directors will not 
have any association with C2, a member of C2, or a broker or dealer, 
consistent with Section 6(b)(3) of the Act.\42\
---------------------------------------------------------------------------

    \40\ See, e.g., Nasdaq Exchange Registration Order, supra note 
39, at 71 FR 3553.
    \41\ See C2 Bylaws Article III, Section 3.1.
    \42\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------

    The Commission believes that non-industry directors help ensure 
that no single group of market participants has the ability to unfairly 
disadvantage other market participants through the exchange governance 
process. Non-industry directors can provide unique and unbiased 
perspectives, which should enhance the ability of the Board to address 
issues in a non-discriminatory fashion and consequently support the 
integrity of C2's governance.\43\ Accordingly, the Commission finds 
that C2's proposed Board satisfies the requirements in Section 6(b)(3) 
of the Act,\44\ which requires that one or more directors be 
representative of issuers and investors and not be associated with a 
member of the exchange, or with a broker or dealer.
---------------------------------------------------------------------------

    \43\ See, e.g., Nasdaq Exchange Registration Order, supra note 
39, at 71 FR 3553; and NYSE/Archipelago Merger Approval Order, supra 
note 39, at 71 FR 11261.
    \44\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------

b. C2 Exchange Committees
    C2 has proposed to establish the following standing committees of 
the Board: Executive Committee; \45\ Audit Committee; \46\ Compensation 
Committee; \47\ Regulatory Oversight Committee; \48\ and Nominating and 
Governance Committee.\49\ The Board will appoint the initial members of 
the Nominating and Governance Committee, and thereafter the Nominating 
and Governance Committee will promptly act to recommend candidates for 
the other committees of the Board. Members of the standing committees 
will not be subject to removal except by the Board.\50\ The Commission 
believes that C2's proposed committees, which are similar to the 
committees maintained by other exchanges,\51\ are designed to enable C2 
to carry out its responsibilities under the Act and are consistent with 
the Act.
---------------------------------------------------------------------------

    \45\ See C2 Bylaws, Article IV, Section 4.2. The Executive 
Committee will include the Chairman of the Board, the Chief 
Executive Officer (if a director), the Vice Chairman of the Board, 
the Lead Director, if any, at least one Representative Director and 
such other number of directors that the Board deems appropriate, 
provided that in no event will the number of Non-Industry Directors 
constitute less than the number of Industry Directors serving on the 
Executive Committee (excluding the Chief Executive Officer from the 
calculation of Industry Directors for such purpose). Members of the 
Executive Committee (other than those specified in the immediately 
preceding sentence) will be recommended by the Nominating and 
Governance Committee for approval by the Board.
    \46\ See C2 Bylaws, Article IV, Section 4.3. The Audit Committee 
will consist of at least three directors, all of whom will be Non-
Industry Directors and all of whom will be recommended by the 
Nominating and Governance Committee for approval by the Board. The 
exact number of Audit Committee members will be determined from time 
to time by the Board. The Chairman of the Audit Committee will be 
recommended by the Nominating and Governance Committee for approval 
by the Board.
    \47\ See C2 Bylaws, Article IV, Section 4.4. The Compensation 
Committee will consist of at least three directors, all of whom will 
be Non-Industry Directors and all of whom will be recommended by the 
Nominating and Governance Committee for approval by the Board. The 
exact number of Compensation Committee members will be determined 
from time to time by the Board. The Chairman of the Compensation 
Committee will be recommended by the Nominating and Governance 
Committee for approval by the Board.
    \48\ See C2 Bylaws, Article IV, Section 4.6. The Regulatory 
Oversight Committee will consist of at least four directors, all of 
whom will be Non-Industry Directors and all of whom will be 
recommended by the Non-Industry Directors on the Nominating and 
Governance Committee for approval by the Board. The exact number of 
Regulatory Oversight Committee members will be determined from time 
to time by the Board. The Chairman of the Regulatory Oversight 
Committee will be recommended by the Non-Industry Directors of the 
Nominating and Governance Committee for approval by the Board.
    \49\ See C2 Bylaws, Article IV, Section 4.5. The Nominating and 
Governance Committee will consist of at least seven directors, 
including both Industry Directors and Non-Industry Directors, and 
will at all times have a majority of directors that are Non-Industry 
Directors. All members of the committee, except for the initial 
members of the committee (appointed to the committee in accordance 
with Section 4.1 of the Bylaws), will be recommended by the 
Nominating and Governance Committee for approval by the Board. The 
exact number of Nominating and Governance Committee members will be 
determined from time to time by the Board. The Chairman of the 
Nominating and Governance Committee will be recommended by the 
Nominating and Governance Committee for approval by the Board. 
Subject to Section 3.2 and Section 3.5 of the Bylaws, the Nominating 
and Governance Committee will have the authority to nominate 
individuals for election as directors of the Corporation.
    \50\ See, e.g., C2 Bylaws, Article IV, Section 4.5.
    \51\ See BATS Exchange Registration Order, supra note 39, at 73 
FR 49501; and Nasdaq Exchange Registration Order, supra note 39, at 
71 FR 3554.
---------------------------------------------------------------------------

C. Regulation of C2

    As a prerequisite for the Commission's approval of an exchange's 
application for registration, an exchange must be organized and have 
the capacity to carry out the purposes of the Act.\52\ Specifically, an 
exchange must be able to enforce compliance by its members, and persons 
associated with its members, with the Federal securities laws and the 
rules of the exchange.\53\
---------------------------------------------------------------------------

    \52\ See Section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1).
    \53\ See id. See also Section 19(g) of the Act, 15 U.S.C. 
78s(g).
---------------------------------------------------------------------------

    C2 has not proposed to be a party to any regulatory services 
agreements or bilateral plans for the allocation of regulatory 
responsibilities pursuant to Rule 17d-2 of the Act, though it will 
become a party to the existing multiparty options 17d-2 plans 
concerning sales practice regulation and market surveillance.\54\
---------------------------------------------------------------------------

    \54\ See Securities Exchange Act Release Nos. 57987 (June 18, 
2008), 73 FR 36156 (June 25, 2008) (File No. S7-966) (notice of 
filing and order approving and declaring effective an amendment to 
the multiparty 17d-2 plan concerning options-related sales practice 
matters); and 58765 (October 9, 2008), 73 FR 62344 (October 20, 
2008) (File No. 4-551) (notice of filing and order approving and 
declaring effective an amendment to the multiparty 17d-2 plan 
concerning options-related market surveillance). See also infra 
Section III.C.3 (Multiparty 17d-2 Agreements); and 17 CFR 240.17d-2.
---------------------------------------------------------------------------

    C2 proposes to use ``dual hat'' employees to staff its regulatory 
program. In other words, current CBOE employees will also serve in a 
similar capacity for C2. Similar to other exchanges, C2 has proposed a 
requirement that confidential information (e.g., disciplinary matters, 
trading data, trading practices, and audit information) pertaining to 
the self-regulatory function of C2 will be retained in confidence by C2 
and its officers, directors, employees, and agents.\55\
---------------------------------------------------------------------------

    \55\ See Article Eleventh of the C2 Certificate of 
Incorporation. See also, e.g., Article VII of the Second Amended and 
Restated Operating Agreement of the New York Stock Exchange LLC 
(containing a similar provision).
---------------------------------------------------------------------------

    As discussed further below, the Commission believes that C2's 
application for registration describes a market structure that is 
designed to provide for sufficient regulatory oversight of C2 members 
and the operation of C2 as an SRO, as required by the Act. The 
Commission notes that C2 will have the statutory authority and 
responsibility to, among other things, discipline its members, amend 
its Bylaws and rules, list and delist securities, and grant or deny 
membership in C2. Further, the Commission believes that the use of 
``dual hat'' employees by C2 is appropriate, as the operations, rules, 
and management of CBOE and C2 will overlap to a considerable degree 
such that C2 should benefit by leveraging the experience of current 
CBOE staff. However, the Commission expects both CBOE and C2 to monitor 
the workload of their dual hat employees and supplement their staffs if 
necessary so that C2 maintains sufficient personnel to allow it to 
carry out the purposes of the Act and enforce compliance with the rules 
of C2 and the Federal securities laws.

[[Page 66703]]

1. Membership and Access
a. TPH Access
    Membership on C2 will be available to any registered broker or 
dealer that meets the standards for membership set forth in Chapter 3 
of C2's proposed rules.\56\ Members will access C2 through trading 
permits, which will not convey any ownership interest in the Exchange 
but will confer the ability to transact on the Exchange. There is no 
limit on the number of permits that C2 is authorized to issue.\57\ 
Permits will not be transferable except in the event of a change in 
control of a TPH, subject to meeting certain criteria.\58\ There will 
be two types of TPHs: (1) Market makers with certain affirmative and 
negative obligations and (2) regular TPHs.\59\
---------------------------------------------------------------------------

    \56\ See C2 Rule 3.1(b). If a TPH intends to transact business 
with the public, it will be required to obtain approval pursuant to 
C2 Rule 9.1 or must have been previously approved to transact 
business with the public by another national securities exchange. 
See id.
    \57\ While C2 does not anticipate reaching any capacity limits, 
it has proposed a rule that will allow C2, in the event of a 
capacity restriction, to limit access to new market makers pursuant 
to a filing with the Commission. See C2 Rule 8.1(c). This proposed 
rule is similar to a rule of Nasdaq. See Nasdaq Rule Chapter VII, 
Section 2(c).
    \58\ See C2 Rule 3.1(d).
    \59\ See C2 Rules 3.1 and 8.1. See also Exhibit E to C2's Form 1 
(describing the operation of the proposed Exchange).
---------------------------------------------------------------------------

    Each CBOE member in good standing will be eligible to obtain one 
trading permit on C2 regardless of the number of seats owned by that 
CBOE member.\60\ CBOE member applicants will not be required to submit 
a full application for membership on C2, but rather will only need to 
complete selected forms concerning their election to trade on C2, 
consent to C2's jurisdiction, and other operational matters.\61\ This 
waive-in process is similar to arrangements in place at other SROs.\62\
---------------------------------------------------------------------------

    \60\ See C2 Rule 3.1(c)(1).
    \61\ See id.
    \62\ See, e.g., Nasdaq Rule 1013(a)(5)(C) (containing a similar 
expedited waive-in membership process for members of the Financial 
Industry Regulatory Authority, Inc. (``FINRA'')).
---------------------------------------------------------------------------

    Non-CBOE members could apply for a C2 trading permit by submitting 
a full application to the Exchange in a manner similar to the current 
process for firms applying to membership on CBOE.\63\ C2 will 
establish, and will distribute via regulatory circular, procedures that 
outline submission deadlines and payment of any applicable application 
fees.\64\ Pursuant to C2's rules, every applicant must have and 
maintain membership in another options exchange that is registered 
under the Act and that is not registered solely under Section 6(g) of 
the Act.\65\
---------------------------------------------------------------------------

    \63\ See C2 Rule 3.1(c)(2).
    \64\ See id. The Commission notes that C2 will be required to 
file any such proposed fees pursuant to Section 19(b) of the Act and 
Rule 19b-4 thereunder, 15 U.S.C. 78s(b) and 17 CFR 240.19b-4, 
respectively.
    \65\ See C2 Rule 3.1(c)(2)(G).
---------------------------------------------------------------------------

    The Exchange will receive and review all trading permit 
applications, and will provide to the applicant written notice of the 
Exchange's determination, specifying in the case of disapproval of an 
application the grounds thereof.\66\ The Exchange also will register 
and qualify associated persons of permit holders.\67\ Once an applicant 
becomes a TPH or a person associated with a TPH, it must continue to 
satisfy all of the qualifications set forth in the C2 rules.\68\ When 
the Exchange has reason to believe that a member or associated person 
or a member fails to meet such qualifications, the Exchange may suspend 
or revoke such person's membership or association.\69\ Appeals from any 
denial, suspension, or conditional approval will be heard pursuant to 
the appeals process specified in Chapter 19.\70\
---------------------------------------------------------------------------

    \66\ See C2 Rule 3.1(c)(2)(E) and (F). The Exchange also could 
condition an applicant's approval for the reasons specified in C2 
Rule 3.2.
    \67\ See C2 Rules 3.3 and 3.4. See also Amendment No. 1.
    \68\ See C2 Rule 3.2(c)(1).
    \69\ See, e.g., C2 Rule 3.2 (Denial of and Conditions to Being a 
Permit Holder or an Associated Person); 3.4 (Qualification and 
Registration); and 3.5 (Permit Holders and Persons Associated with a 
Permit Holder Who Are or Become Subject to a Statutory 
Disqualification). See also Amendment No. 1.
    \70\ See infra note 117 (regarding Chapter 19). C2's Chapter 19 
rules (Hearings and Review) incorporate by reference CBOE's Chapter 
19 rules and C2 participants will be required to comply with CBOE 
Chapter 19 rules, as such rules may be in effect from time to time, 
as if such rules were part of the C2 rules.
---------------------------------------------------------------------------

    The Commission finds that C2's membership rules are consistent with 
Section 6 of the Act,\71\ including Section 6(b)(2) of the Act \72\ in 
particular, which requires that a national securities exchange have 
rules that provide that any registered broker or dealer or natural 
person associated with such broker or dealer may become a member and 
any person may become associated with an exchange member. The 
Commission notes that pursuant to Section 6(c) of the Act,\73\ an 
exchange must deny membership to any person, other than a natural 
person, that is not a registered broker or dealer, any natural person 
that is not, or is not associated with, a registered broker or dealer, 
and registered broker-dealers that do not satisfy certain standards, 
such as financial responsibility or operational capacity. As a 
registered exchange, C2 must independently determine if an applicant 
satisfies the standards set forth in the Act, regardless of whether an 
applicant is a member of another SRO (e.g., CBOE).\74\
---------------------------------------------------------------------------

    \71\ 15 U.S.C. 78f.
    \72\ 15 U.S.C. 78f(b)(2).
    \73\ 15 U.S.C. 78f(c).
    \74\ See, e.g., BATS Exchange Registration Order, supra note 39, 
at 73 FR 49502; and Nasdaq Exchange Registration Order, supra note 
39, at 71 FR 3555.
---------------------------------------------------------------------------

b. Non-TPH Access
    C2 proposes to permit access to non-TPH ``Sponsored Users'' whose 
access is authorized in advance by a TPH (``Sponsoring 
Participant'').\75\ C2's proposed ``Sponsored Users'' rule is similar 
to rules of other SROs that provide for sponsored access.\76\ 
Specifically, the Sponsoring Participant must agree to be responsible 
for all orders entered into on C2 by the Sponsored User. In addition, 
Sponsored Users must agree to comply with all applicable rules of C2 
governing the entry, execution, reporting, clearing, and settling of 
orders in securities eligible for trading on C2 and the Sponsored User 
must agree that it will be bound by and comply with the Exchange's 
rules as if the Sponsored User were a Permit Holder.\77\ Sponsored 
Participants will also be required by C2 rules to enter into a 
``Sponsored User Agreement'' with their Sponsoring Permit Holder 
setting forth the obligations of both parties.
---------------------------------------------------------------------------

    \75\ See C2 Rule 3.15.
    \76\ See, e.g., CBOE Rule 6.20A (Sponsored Users).
    \77\ See C2 Rule 3.15(b)(1)(B)(iii).
---------------------------------------------------------------------------

c. Linkage
    C2 intends to become a participant in the Plan Relating to Options 
Order Protection and Locked/Crossed Markets or any successor plan 
(``Linkage Plan'').\78\ If admitted as a participant to the Linkage 
Plan, other plan participants (including CBOE) would be able to send 
orders to C2 in accordance with the terms of the Linkage Plan.
---------------------------------------------------------------------------

    \78\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) (order 
approving the national market system Plan Relating to Options Order 
Protection and Locked/Crossed Markets Submitted by the Chicago Board 
Options Exchange, Incorporated, International Securities Exchange, 
LLC, The NASDAQ Stock Market LLC, NASDAQ OMX BX, Inc., NASDAQ OMX 
PHLX, Inc., NYSE Amex LLC, and NYSE Arca, Inc.) (``Linkage Plan'').
---------------------------------------------------------------------------

    C2 will incorporate by reference the Intermarket Linkage rules 
contained in Section E of Chapter VI of CBOE's rulebook, as such rules 
may be in effect from time to time. Accordingly, C2's proposed Linkage 
rules will include relevant definitions, establish the conditions 
pursuant to which members may enter Linkage orders, impose obligations 
on the Exchange regarding how it must process incoming Linkage

[[Page 66704]]

orders, establish a general standard that members and the Exchange 
should avoid trade-throughs, establish potential regulatory liability 
for members that engage in a pattern or practice of trading through 
other exchanges, and establish obligations with respect to locked and 
crossed markets.
    The Commission believes that C2 has proposed rules that are 
designed to comply with the requirements of the Linkage Plan.\79\ 
Further, before C2 can commence operations as an exchange, C2 must 
become a participant in the Linkage Plan.
---------------------------------------------------------------------------

    \79\ The Commission notes that it has approved CBOE rules to 
accommodate the Linkage Plan. See Securities Exchange Act Release 
No. 60551 (August 20, 2009), 74 FR 43196 (August 26, 2009) (File No. 
SR-CBOE-2009-040). These amended rules will be incorporated by 
reference into C2's rulebook. See C2 Rules Chapter 6, Section E 
(Intermarket Linkage). See also infra Section IV (discussing the 
Section 36 exemption).
---------------------------------------------------------------------------

d. Market Makers
i. Registration of Market Makers
    A TPH may register with C2 as a market maker by filing a written 
application with C2, which will consider an applicant's market making 
ability and other factors it deems appropriate in determining whether 
to approve an applicant's registration.\80\ All market makers will be 
designated as specialists on C2 for all purposes under the Act and 
rules thereunder.\81\ C2 will not limit the number of qualifying 
entities that may become market makers.\82\ The good standing of a 
market maker may be suspended, terminated, or withdrawn if the 
conditions for approval cease to be maintained or if the market maker 
violates any of its agreements with C2 or any provisions of the C2 
rules.\83\
---------------------------------------------------------------------------

    \80\ See C2 Rule 8.1(a). In considering a TPH's application for 
registration as a market maker on C2, the provision permitting the 
Exchange to consider ``such other factors as the Exchange deems 
appropriate'' must be applied consistent with the Act, including 
that the Exchange's rules must not be unfairly discriminatory.
    \81\ See C2 Rule 8.1.
    \82\ See C2 Rule 8.1(c). However, C2 may limit access to the C2 
system based on system constraints, capacity restrictions, or other 
factors relevant to protecting the integrity of the system, pending 
action required to address the issue of concern. To the extent that 
C2 places limitations on access to the system on any TPH, such 
limits will be objectively determined and submitted to the 
Commission via a proposed rule change filed under Section 19(b) of 
the Act. See id.
    \83\ See C2 Rule 8.4(b).
---------------------------------------------------------------------------

    The Commission finds that C2's proposed market maker qualifications 
requirements are consistent with the Act. In particular, C2's rules 
provide an objective process by which a TPH could become a market maker 
on C2 and provide for appropriate continued oversight by the Exchange 
to monitor for continued compliance by market makers with the terms of 
their application for such status. The Commission notes that C2's 
proposed market maker registration requirements are similar to those of 
other options exchanges.\84\
---------------------------------------------------------------------------

    \84\ See, e.g., Nasdaq Rules, Chapter VII, Sections 2 and 4; 
Boston Options Exchange Rules, Chapter VI, Section 2; and 
International Securities Exchange Rule 804.
---------------------------------------------------------------------------

ii. Market Maker Obligations
    Pursuant to C2 rules, the transactions of a market maker in its 
market making capacity must constitute a course of dealings reasonably 
calculated to contribute to the maintenance of a fair and orderly 
market.\85\ Among other things, a market maker must: (1) Maintain a 
two-sided market on a continuous basis (defined as 99% of the time) in 
60% of the series of each registered class that have a time to 
expiration of less than nine months; \86\ (2) engage in dealings for 
their own accounts when there is a lack of price continuity, a 
temporary disparity between the supply of and demand for a particular 
option contract, or a temporary distortion of the price relationships 
between options contracts of the same class; (3) compete with other 
market makers; (4) update quotations in response to changed market 
conditions; (5) maintain active markets; and (6) make markets that will 
be honored for the number of contacts entered.\87\ C2 will impose an 
upper limit on the aggregate number of market makers that may quote in 
each product (``Class Quoting Limit'' or ``CQL''). The CQL will be set 
at 50 market makers, and could be increased or decreased for an 
existing or new product.\88\ If C2 finds any substantial or continued 
failure by a market maker to engage in a course of dealings as 
specified in Rule 8.5(a), then such market maker will be subject to 
disciplinary action, suspension, or revocation of registration in one 
or more of the securities in which the market maker is registered.\89\ 
In addition, market makers must maintain minimum net capital in 
accordance with Commission and C2 rules.\90\ Market makers must also 
maintain information barriers that are reasonably designed to prevent 
the misuse of material, non-public information.\91\
---------------------------------------------------------------------------

    \85\ See C2 Rule 8.5(a).
    \86\ While not specified in the rule text, the Commission notes 
that a market maker's quote would need to be represented by a size 
of at least 1 contract.
    \87\ See C2 Rule 8.5(a) and Amendment No. 1.
    \88\ See C2 Rule 8.11. Any such changes to the CQL would be 
announced by C2 in an Information Circular, and would be filed with 
the Commission pursuant to Section 19(b)(1) of the Act (15 U.S.C. 
78s(b)). See C2 Rule 8.11(b) and (c).
    \89\ See C2 Rule 8.5(c).
    \90\ See C2 Rule 8.4(a)(1).
    \91\ See C2 Rule 8.9. The Commission notes that, as with any 
rule of an exchange, C2 will be responsible, pursuant to Sections 6 
and 19 of the Act (15 U.S.C. 78f and 15 U.S.C. 78s, respectively), 
for enforcing compliance with Rule 8.9, which will require C2 to 
conduct periodic examinations of its market maker members with this 
rule.
---------------------------------------------------------------------------

    The Commission notes that market makers receive certain benefits 
for carrying out their responsibilities.\92\ For example, a lender may 
extend credit to a broker-dealer without regard to the restrictions in 
Regulation T of the Board of Governors of the Federal Reserve System if 
the credit is used to finance the broker-dealer's activities as a 
specialist or market maker on a national securities exchange.\93\ In 
addition, market makers are excepted from the prohibition in Section 
11(a) of the Act.\94\ The Commission believes that a market maker must 
have sufficient affirmative obligations, including the obligation to 
hold itself out as willing to buy and sell options for its own account 
on a regular or continuous basis, to justify this favorable 
treatment.\95\ The Commission further believes that the rules of all 
U.S. options markets need not provide the same standards for market 
maker participation, so long as they impose affirmative obligations 
that are consistent with the Act.\96\ The Commission believes that C2's 
market maker participation requirements impose sufficient affirmative 
obligations on C2 market makers and, accordingly, that C2's 
requirements are consistent with the Act. In particular, the Commission 
notes that the Act does not mandate a particular market model for 
exchanges, and while market makers may become an important source of 
liquidity on C2, they will likely not be the only source as C2 is 
designed to match buying and selling interest of all participants on 
C2.\97\ The Commission therefore believes that C2's proposed structure 
is consistent with the Act.
---------------------------------------------------------------------------

    \92\ See, e.g., Securities Exchange Act Release No. 57478 (March 
12, 2008), 73 FR 14521, 14526 (March 18, 2008) (File No. SR-NASDAQ-
2007-004) (approval order concerning the establishment of the NASDAQ 
Options Market LLC (``NOM'')) (``NOM Approval Order'') (discussing 
the benefits and obligations of market makers).
    \93\ 12 CFR 221.5(c)(6).
    \94\ 15 U.S.C. 78k(a).
    \95\ See NOM Approval Order, supra note 92, at 73 FR 14526.
    \96\ See id.
    \97\ See, e.g., NOM Approval Order, supra note 92, at 73 FR 
14527 (discussing NOM's single market maker requirement).
---------------------------------------------------------------------------

2. Regulatory Independence
    C2 has proposed several measures to help ensure the independence of 
its

[[Page 66705]]

regulatory function from its market operations and other commercial 
interests. The regulatory operations of C2 will be monitored by the 
Regulatory Oversight Committee (``ROC''). The ROC will consist of at 
least four directors, all of whom will be Non-Industry Directors and 
all of whom will be recommended by the Non-Industry Directors on the 
Nominating and Governance Committee for approval by the Board. The ROC 
generally will be responsible for monitoring the adequacy and 
effectiveness of the Exchange's regulatory program, assessing the 
Exchange's regulatory performance, and assisting the Board in reviewing 
the Exchange's regulatory plan and the overall effectiveness of the 
Exchange's regulatory functions.\98\ Further, a Chief Regulatory 
Officer of the Exchange will have general supervision over the 
Exchange's regulatory operations.\99\ In addition, any revenues 
received by the Exchange from fees derived from its regulatory function 
or regulatory penalties will not be used for non-regulatory 
purposes.\100\
---------------------------------------------------------------------------

    \98\ See C2 Bylaws Article IV, Section 4.6.
    \99\ See Cover letter accompanying Amendment No. 1 (representing 
that, while not specified as an officer in the proposed Bylaws, C2 
will have a Chief Regulatory Officer).
    \100\ See C2 Rule 2.3 and Amendment No. 1.
---------------------------------------------------------------------------

    The Commission continues to be concerned about the potential for 
unfair competition and conflicts of interest between an exchange's 
self-regulatory obligations and its commercial interests that could 
exist if an exchange were to otherwise become affiliated with one of 
its members, as well as the potential for unfair competitive advantage 
that the affiliated member could have by virtue of informational or 
operational advantages, or the ability to receive preferential 
treatment.\101\ To this end, C2 Rule 3.2(f) provides that without the 
prior approval of the Commission, C2 or any entity with which it is 
affiliated will not directly acquire or maintain an ownership interest 
in a C2 member, and a C2 member will not be or become an affiliate of 
C2 or an affiliate of C2.\102\
---------------------------------------------------------------------------

    \101\ See, e.g., NYSE/Archipelago Merger Approval Order, supra 
note 39, at 71 FR 11263.
    \102\ See C2 Rule 3.2(f). The rule would not prohibit a TPH from 
acquiring an equity interest in CBSX LLC and would not prohibit a 
TPH from being affiliated with One Chicago, LLC under limited 
conditions. See id.
---------------------------------------------------------------------------

    The Commission believes that the Exchange's proposed provisions 
relating to the regulatory independence of the Exchange are consistent 
with the Act, particularly with Section 6(b)(1), which requires an 
exchange to be so organized and have the capacity to carry out the 
purposes of the Act.\103\
---------------------------------------------------------------------------

    \103\ 15 U.S.C. 78f(b)(1).
---------------------------------------------------------------------------

3. Multiparty 17d-2 Agreements
    Section 19(g)(1) of the Act \104\ requires every SRO to examine its 
members and persons associated with its members and to enforce 
compliance with the Federal securities laws and the SRO's own rules, 
unless the SRO is relieved of this responsibility pursuant to Section 
17(d) of the Act.\105\ Section 17(d) was intended, in part, to 
eliminate unnecessary multiple examinations and regulatory duplication 
with respect to members of more than one SRO (``common members'').\106\ 
Rule 17d-2 of the Act permits SROs to propose joint plans allocating 
regulatory responsibilities concerning common members.\107\ These 
agreements, which must be filed with and approved by the Commission, 
generally cover such regulatory functions as personnel registration and 
sales practices. Commission approval of a 17d-2 plan relieves the 
specified SRO of those regulatory responsibilities allocated by the 
plan to another SRO.\108\ Many SROs have entered into 17d-2 
agreements.\109\ C2 currently does not intend to enter into any 
bilateral 17d-2 agreements, but rather will retain direct 
responsibility for all aspects of its operations as an SRO through the 
use of CBOE ``dual hat'' employees.\110\ C2 does, however, plan to join 
the existing multiparty agreements concerning intermarket options 
surveillance.\111\ Under these agreements, the examining SROs will 
examine firms that are common members of C2 and the particular 
examining SRO for compliance with certain provisions of the Act, 
certain rules and regulations adopted thereunder, and certain C2 rules.
---------------------------------------------------------------------------

    \104\ 15 U.S.C. 78s(g)(1).
    \105\ 15 U.S.C. 78q(d).
    \106\ See Securities Exchange Act Release No. 12935 (October 28, 
1976), 41 FR 49091 (November 8, 1976) (``Rule 17d-2 Adopting 
Release'').
    \107\ 17 CFR 240.17d-2.
    \108\ See Rule 17d-2 Adopting Release, supra note 106.
    \109\ See, e.g., Securities Exchange Act Release Nos. 59218 
(January 8, 2009), 74 FR 2143 (January 14, 2009) (File No. 4-575) 
(FINRA/Boston Stock Exchange, Inc.); 58818 (October 20, 2008), 73 FR 
63752 (October 27, 2008) (File No. 4-569) (FINRA/BATS Exchange, 
Inc.); 55755 (May 14, 2007), 72 FR 28057 (May 18, 2007) (File No. 4-
536) (National Association of Securities Dealers, Inc. (``NASD'') n/
k/a FINRA and CBOE concerning the CBOE Stock Exchange); 55367 
(February 27, 2007), 72 FR 9983 (March 6, 2007) (File No. 4-529) 
(NASD/International Securities Exchange, LLC); and 54136 (July 12, 
2006), 71 FR 40759 (July 18, 2006) (File No. 4-517) (NASD/Nasdaq).
    \110\ See supra text accompanying note 55 (regarding dual hat 
employees).
    \111\ See Securities Exchange Act Release Nos. 57987 (June 18, 
2008), 73 FR 36156 (June 25, 2008) (File No. S7-966) (notice of 
filing and order approving and declaring effective an amendment to 
the multiparty 17d-2 plan concerning options-related sales practice 
matters) and 58765 (October 9, 2008), 73 FR 62344 (October 20, 2008) 
(File No. 4-551) (notice of filing and order approving and declaring 
effective an amendment to the multiparty 17d-2 plan concerning 
options-related market surveillance). See also Cover letter 
accompanying Amendment No. 1 (representing that C2 intends to join 
the options multiparty agreements).
---------------------------------------------------------------------------

4. Discipline and Oversight of Members
    As noted above, one prerequisite for Commission approval of an 
exchange's application for registration is that a proposed exchange 
must be organized and have the capacity to carry out the purposes of 
the Act. Specifically, an exchange must be able to enforce compliance 
by its members and persons associated with its members with Federal 
securities laws and the rules of the exchange.\112\
---------------------------------------------------------------------------

    \112\ See 15 U.S.C. 78f(b)(1).
---------------------------------------------------------------------------

    C2 proposed to incorporate by reference \113\ Chapter 17 of the 
CBOE rulebook relating to member discipline. As such, C2 members will 
be required to comply with Chapter 17 of the CBOE rulebook as such 
rules may be in effect from time to time, as if such rules were part of 
the C2 rulebook. In addition, C2 proposes to use ``dual hat'' 
employees, i.e., current CBOE employees who will also serve in a 
similar capacity for C2, to administer its disciplinary and oversight 
functions. These C2 employees will, among other things, investigate 
potential securities laws violations, issue complaints, conduct 
hearings, and issue disciplinary decisions pursuant to C2 rules.\114\
---------------------------------------------------------------------------

    \113\ See infra Section IV (discussing an exemption from Section 
19(b) of the Act for CBOE rules incorporated by reference by C2). 
Citations to incorporated CBOE rules herein are referred to as 
``C2'' rules.
    \114\ See C2 Rules 17.2--17.9.
---------------------------------------------------------------------------

    Upon petition, appeals from disciplinary decisions rendered by C2 
will be heard by the Board (or a committee of the Board composed of at 
least three directors whose decision will need to be ratified by the 
Board) and the Board's decision will be final.\115\ In addition, the 
Board may on its own initiative order review of a disciplinary 
decision.\116\
---------------------------------------------------------------------------

    \115\ See C2 Rule 17.10(b).
    \116\ See C2 Rule 17.10(c).
---------------------------------------------------------------------------

    Appeal of a denial, suspension, or termination of a trading permit 
will be heard by the Exchange's Appeals Committee.\117\ Decisions of 
the Appeals

[[Page 66706]]

Committee will be made in writing and will be sent to the parties to 
the proceeding.\118\ The decisions of the Appeals Committee will be 
subject to review by the Board, on its own motion, or upon written 
request by the aggrieved party, the President of C2, or by the Chairman 
of the committee whose action was subject to the prior review of the 
Appeals Committee.\119\ The Board, or a committee of the Board, will 
have sole discretion to grant or deny the request.\120\ The Board, or a 
committee of the Board, will conduct the review of the Appeals 
Committee's decision and the Board may affirm, reverse, or modify the 
Appeals Committee's decision.\121\
---------------------------------------------------------------------------

    \117\ See C2 Rule 19.4. The Commission notes that C2's Chapter 
19 rules (Hearings and Review) incorporate by reference CBOE's 
Chapter 19 rules and C2 participants will be required to comply with 
CBOE Chapter 19 rules, as such rules may be in effect from time to 
time, as if such rules were part of the C2 rules. Further, the 
Commission notes that C2 will establish its own Appeals Committee 
that includes C2 participants. See Cover letter accompanying 
Amendment No. 1 (representing that C2 will establish its own Appeals 
Committee).
    \118\ See C2 Rule 19.4(e).
    \119\ See C2 Rule 19.5(a).
    \120\ See id.
    \121\ See C2 Rule 19.5(b). Decisions concerning denial of 
membership in an exchange are subject to review by the Commission.
---------------------------------------------------------------------------

    C2 rules codify the Exchange's disciplinary jurisdiction over its 
members, thereby facilitating its ability to enforce its members' 
compliance with its rules and the Federal securities laws.\122\ The 
Exchange's rules also permit it to sanction members for violations of 
its rules and violations of the Federal securities laws by, among other 
things, expelling or suspending members; limiting members' activities, 
functions, or operations; fining or censuring members; suspending or 
barring a person from being associated with a member; or any other 
appropriate sanction.\123\
---------------------------------------------------------------------------

    \122\ See generally C2 Rule 17.1.
    \123\ See C2 Rule 17.11.
---------------------------------------------------------------------------

    The Commission finds that C2's proposed disciplinary and oversight 
rules and structure are consistent with the requirements of Sections 
6(b)(6) and 6(b)(7) of the Act \124\ in that they provide fair 
procedures for the disciplining of members and persons associated with 
members. The Commission further finds that the proposed C2 rules are 
designed to provide the Exchange with the ability to comply, and with 
the authority to enforce compliance by its members and persons 
associated with its members, with the provisions of the Act, the rules 
and regulations thereunder, and the rules of C2.\125\
---------------------------------------------------------------------------

    \124\ 15 U.S.C. 78f(b)(6) and (b)(7), respectively.
    \125\ See Section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1).
---------------------------------------------------------------------------

D. The C2 Trading System

1. Order Display, Execution, and Priority
    C2 will operate a fully-automated electronic platform for trading 
standardized options with a continuous, automated matching function. 
Liquidity will be derived from market maker quotes as well as orders to 
buy and sell submitted to C2 electronically by users (collectively, 
``Participants''). There will be no physical trading floor.
    All orders/quotes submitted to C2 will be displayed unless 
designated otherwise by the Participant submitting the order (e.g., the 
non-displayed portion of a Reserve Order). The Exchange has represented 
that any top-of-book feed (or comparable market data feed) that it 
makes available to C2 members will also be made available to other 
market participants.\126\
---------------------------------------------------------------------------

    \126\ See Cover letter accompanying Amendment No. 1 
(representing that the Exchange will offer the data feed to all 
market participants). The Exchange noted that it may adopt fees for 
non-member access to a C2 data feed. See id. The Commission notes 
that C2 would be required to file any such proposed fees pursuant to 
Section 19(b) of the Act and Rule 19b-4 thereunder, 15 U.S.C. 78s(b) 
and 17 CFR 240.19b-4, respectively.
---------------------------------------------------------------------------

    Non-displayed orders will not be displayed to any Participants and 
will not have time priority over displayed orders.\127\ While orders 
will generally be submitted on an anonymous basis, C2 will allow 
Participants on a voluntary basis to submit Attributable Orders, which 
will display the firm's identity along with the order to all market 
participants simultaneously.\128\ In addition, Participants will be 
able to submit the following types of orders to C2: Day; Good `til 
Canceled; Contingency (including All-Or-None, Immediate Or Cancel, 
Market On Close, Fill Or Kill, Stop, and Reserve); and Complex Orders 
(including Spreads, Combination, Straddle, Strangle, Ratio, Butterfly, 
Box/Roll, Collar and Risk Reversal).\129\ The Commission notes that 
these order types are substantially similar to the order types offered 
by CBOE.\130\
---------------------------------------------------------------------------

    \127\ See C2 Rule 6.12(a).
    \128\ NOM offers a similar attributable order type. See NOM 
Approval Order, supra note 92, at 73 FR 14528 (discussing NOM's 
attributable order type).
    \129\ See C2 Rule 6.10 (Order Types Defined) for additional 
information on each order type. See also Amendment No. 1 (revising 
the definition of Ratio Order).
    \130\ See CBOE Rules 6.53 and 6.53C.
---------------------------------------------------------------------------

    The Commission believes that C2's proposed order types are 
consistent with the Act. Among other things, the Commission believes 
that C2's proposed order types appropriately provide priority to 
displayed orders and portions of orders over non-displayed orders and 
portions of orders, thereby encouraging the posting of displayed 
orders, which contribute visible depth to the displayed market.\131\
---------------------------------------------------------------------------

    \131\ See, e.g., Securities Exchange Act Release Nos. 37619A 
(September 6, 1996), 61 FR 48290, 48294 (September 12, 2006) (File 
No. S7-30-95) (adopting Rule 11Ac1-4) (``The Commission believes 
that limit orders are a valuable component of price discovery. The 
uniform display of such orders will encourage tighter, deeper, and 
more efficient markets.''); and 57441 (March 6, 2008), 73 FR 13267 
(March 12, 2008) (File No. SR-ISE-2007-95) (noting the incentive for 
market participants to display their trading interest in the context 
of reserve orders).
---------------------------------------------------------------------------

    After the open, trades on C2 will execute when a buy order/quote 
and a sell order/quote match on C2's order book. All orders will be 
matched according to one of two priority structures, as determined by 
C2 on a class-by-class basis: (1) Price-time priority or (2) pro-rata 
priority.\132\ In addition, public customer and/or market turner 
priority \133\ overlays will also be available at C2's discretion on a 
series-by-series basis.\134\ In the event that less than the full size 
of an order is executed, the unexecuted portion of the order will 
continue to reside on C2's order book. The non-reserve portion of any 
partially-executed order will retain priority at the same price. 
Regardless of the priority structure, Contingency Orders will be last 
in priority because they are not displayed.
---------------------------------------------------------------------------

    \132\ Under pro rata priority, orders will be prioritized 
according to price. If there are two or more orders at the best 
price then trades will be allocated proportionally according to 
size. See C2 Rule 6.12(a)(2).
    \133\ C2 defines a ``market turner'' as a party that was the 
first to enter an order or quote at a better price than the previous 
best disseminated Exchange price and the order/quote is continuously 
in the market until it trades. The market turner priority at a given 
price could only be established after the opening rotation and would 
remain with the order once it is earned and last until the 
conclusion of the trading session. See C2 Rule 6.12(b)(2).
    \134\ C2 will issue a Regulatory Circular periodically that will 
specify which series are subject to these additional priorities, and 
will update the Regulatory Circular any time it makes a change to 
any of the designated priorities. See C2 Rule 6.12(b).
---------------------------------------------------------------------------

    C2 will limit a Participant's ability to trade as principal with an 
order it represents as agent, unless the agency order is first given 
the opportunity to interact with other trading interest on the 
Exchange. Specifically, in order to trade as principal with an agency 
order a Participant represents, either: (1) The agency order is first 
exposed on C2 for at least 1 second; \135\ (2) the Participant has been 
bidding or offering for at least 1 second prior to receiving an agency 
order that is executable against its bid or offer; or (3) the 
Participant uses the Automated Improvement Mechanism or Solicitation 
Auction Mechanism.\136\
---------------------------------------------------------------------------

    \135\ All-or-none contingency orders on C2 will not be deemed 
``exposed'' for purposes of Rule 6.50. See C2 Rule 6.50(c) and 
Amendment No. 1.
    \136\ See C2 Rule 6.50. See also proposed C2 Rule 1.1 (defining 
NBBO as the national best bid or offer). For purposes of the order 
exposure requirements contained in C2 Rule 6.50, all-or-none orders 
are not deemed exposed. See C2 Rule 6.50(c). The 1 second exposure 
period is consistent with the operation of the CBOE Hybrid System. 
See CBOE Rule 6.45A Interpretations and Policies .01 and .02 
(regarding the 1 second exposure on the CBOE Hybrid System).

---------------------------------------------------------------------------

[[Page 66707]]

    C2 may offer a Simple Auction Liaison (``SAL'') system to auction 
eligible agency orders and provide the opportunity for price 
improvement better than the NBBO.\137\ C2 would designate the eligible 
order size, order type, and origin code (i.e., public customer, non-
market maker broker-dealer, or market maker order), and classes in 
which SAL may be activated. For classes in which SAL is activated, SAL 
will automatically initiate an auction process for a non-contingency 
order that is marketable against C2's NBBO quote, except when C2's 
disseminated quote on the opposite side does not contain sufficient 
market-maker quotation size to satisfy the entire order. Prior to 
commencing an auction, SAL would stop the order at the NBBO against the 
market maker quotes displayed at the NBBO on the opposite side. SAL 
auctions will last for a period of time not to exceed 2 seconds. 
Auction responses could be submitted by any Participant.\138\ At the 
end of the auction, the agency order will first be allocated against 
public customer interest at the best price. Any remaining balance of 
the agency order will then be allocated pursuant to the matching 
algorithm in effect for the class.\139\
---------------------------------------------------------------------------

    \137\ See C2 Rule 6.14. C2's SAL is based on CBOE's SAL rule. 
See CBOE Rule 6.13A.
    \138\ See C2 Rule 6.14(b) and Amendment No. 1.
    \139\ See C2 Rule 6.14. See also CBOE Rule 6.13A.
---------------------------------------------------------------------------

    The Automated Improvement Mechanism (``AIM'') will allow 
Participants to cross an agency order they hold against principal 
interest or a solicited order provided that they first expose the 
agency order to a 1-second auction.\140\ To be eligible for an AIM 
auction, at least three market makers must be quoting in the applicable 
series.\141\ If the agency order is greater than 50 contracts, the 
Participant must stop the agency order at the NBBO (or the order's 
limit price if better), and if it is less than 50 contracts, the 
Participant must stop the agency order at the NBBO improved by one 
minimum increment (or the order's limit price if better).\142\ When 
initiating an auction, a Participant submitting an agency orders to AIM 
must either indicate a single-price at which it seeks to cross the 
order or must indicate that it will match as principal the price and 
size of all auction responses.\143\ Request for responses will then be 
sent to any Participant that has elected to receive such requests, and 
the exposure period will last for 1 second.\144\ If the auction 
attracts responses (which may be submitted by Participants),\145\ the 
agency order will be allocated at the best price(s), and public 
customer orders in the book will have priority.\146\ If the best price 
equals the initiating Participant's single-price submission, then the 
initiating Participant will be allocated 40% of the order (or 50% in 
the case of a single price submission where only one other market maker 
matches the price).\147\ C2's proposed AIM is based on CBOE's AIM 
rule.\148\
---------------------------------------------------------------------------

    \140\ See C2 Rule 6.51.
    \141\ See C2 Rule 6.51(a)(4).
    \142\ See C2 Rule 6.51(a)(2) and (3).
    \143\ See C2 Rule 6.51(b)(1).
    \144\ See id.
    \145\ See C2 Rule 6.51(b)(1)(D) and Amendment No. 1.
    \146\ See C2 Rule 6.51(b)(3) and Amendment No. 1.
    \147\ See id.
    \148\ See C2 Rule 6.51. See also CBOE Rule 6.74A.
---------------------------------------------------------------------------

    C2's Solicitation Auction Mechanism (``SAM'') is based on CBOE's 
SAM.\149\ The SAM will allow Participants to execute agency orders of 
500 or more contracts against solicited orders after a 1-second auction 
exposure. The orders must be designated as all-or-none, and the 
initiating Participant must signify a single price at which it seeks to 
cross the order. At the conclusion of the auction, the agency order 
will trade with the solicited order provided that the trade price of 
the agency order is equal to or better than C2's best bid or 
offer.\150\ Further, if there are any public customer orders resting in 
the book on the opposite side at the execution price with sufficient 
size to fill the agency order, then the agency order will be executed 
against the public customer interest and the solicited order will be 
cancelled. If the public customer order lacks sufficient size, then the 
agency order and solicited order will be cancelled. Likewise, if the 
auction generates a response at an improved price that contains 
sufficient size to fill the agency order, then the agency order will 
execute against the improved price and the solicited order will be 
cancelled.\151\
---------------------------------------------------------------------------

    \149\ See C2 Rule 6.52. See also CBOE Rule 6.74B.
    \150\ See C2 Rule 6.52(b)(2)(A)(i). If the trade would take 
place at a price outside of the C2 best bid or offer, then the 
agency order and solicited order would cancel. See id.
    \151\ See C2 Rule 6.52(b)(2)(A)(ii)-(iii). If the response does 
not contain sufficient size, then the agency order will trade with 
the solicited order. See id.
---------------------------------------------------------------------------

    C2 also will make available certain additional order processing and 
matching features. For example, C2 will maintain a complex order book 
(``COB'') that permits any C2 market participant to enter complex 
orders into the COB to automatically execute against marketable orders 
and quotes resting in the book or against other complex orders in the 
COB.\152\ In addition, C2 will offer an optional complex order auction 
that will allow orders, prior to routing to the COB, to be auctioned 
for price improvement through an automated request for response auction 
process, subject to certain conditions.\153\ C2's complex order 
execution rule is based on CBOE's rule.\154\
---------------------------------------------------------------------------

    \152\ See C2 Rule 6.13(b). See also C2 Rule 6.12(g) and 
Amendment No. 1 (regarding complex order priority). Orders entered 
by any C2 market participant also may rest in the COB.
    \153\ See C2 Rule 6.13(c). See also C2 Rule 6.12(g) and 
Amendment No. 1 (a complex order may be executed at a net debit or 
credit price without giving priority to equivalent bids (offers) in 
the individual series legs that are represented in the System 
provided at least one leg of the order betters the best 
corresponding public customer bid (offer) in the system by at least 
one minimum trading increment or, if COB or COA are activated for 
all market participants in the subject option class, a $0.01 
increment to be determined by C2 on a class-by-class basis); and C2 
Rule 4.18 (prohibiting the misuse of material, nonpublic information 
as such would be applicable in the context of preventing the 
disclosure of nonpublic information about a complex order auction).
    \154\ See CBOE Rule 6.53C. As on CBOE, on C2, a member seeking 
to trade with its customer's complex order would be required to 
comply with C2 Rule 6.50(a), and a member seeking to cross its 
customer's complex order with solicited orders would be required to 
comply with C2 Rule 6.50(b). In addition, the complex order priority 
provision in C2 Rule 6.12(g) will apply to complex orders.
---------------------------------------------------------------------------

    Finally, C2 has proposed a rule prohibiting trading on knowledge of 
imminent undisclosed solicited transactions, otherwise known as the 
``anticipatory hedge'' rule.\155\ Pursuant to this rule, it will be 
considered conduct inconsistent with just and equitable principles of 
trade and a violation of Rule 4.1 for any Participant or person 
associated with a Participant, who has knowledge of all material terms 
and conditions of an original order and a solicited order, including a 
facilitation order, that matches the original order's limit, the 
execution of which are imminent, to enter, based on such knowledge, an 
order to buy or sell an option of the same class as an option that is 
the subject of the original order, or an order to buy or sell the 
security underlying such class, or an order to buy or sell any related 
instrument until either (i) all the terms and conditions of the 
original order and any changes in the terms and conditions of the 
original order of which that member or associated person has knowledge 
are disclosed to the trading crowd or (ii) the solicited trade can no 
longer reasonably be considered imminent in view of the passage of time 
since the solicitation.
---------------------------------------------------------------------------

    \155\ See C2 Rule 6.55. See also Amendment No. 1 (containing the 
proposed rule).
---------------------------------------------------------------------------

    For the reasons discussed above, the Commission believes that C2's 
proposed display, execution, and priority rules

[[Page 66708]]

are consistent with the Act. In particular, the Commission finds that 
the proposed rules are consistent with Section 6(b)(5) of the Act,\156\ 
which, among other things, requires that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating 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, and to not permit unfair discrimination between 
customers, issuers, or dealers. The Commission also finds that the 
proposed rules are consistent with Section 6(b)(8) of the Act,\157\ 
which requires that the rules of an exchange not impose any burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Act. In particular, the Commission believes that the 
proposed matching mechanisms should facilitate the prompt execution of 
orders, while providing Participants with an opportunity to compete for 
exposed bids and offers.\158\
---------------------------------------------------------------------------

    \156\ 15 U.S.C. 78f(b)(5).
    \157\ 15 U.S.C. 78f(b)(8).
    \158\ See, e.g., Securities Exchange Act Release No. 58088 (July 
2, 2008), 73 FR 39747 (July 10, 2008) (File No. CBOE-2008-16) (order 
approving a proposal to reduce certain order exposure times).
---------------------------------------------------------------------------

2. Opening
    C2 will employ an opening process that is designed to match the 
greatest number of pending buy and sell orders.\159\ Prior to opening a 
series, C2 will make available to all Participants the expected opening 
price and size, which should help attract additional orders that, in 
turn, could offset any imbalances at the open.\160\ After the start of 
trading in the underlying security, the Exchange will open each series 
at a price that executes the greatest amount of pre-opening interest 
and that does not trade-through the NBBO (if one exists).\161\ The 
Commission believes that C2's opening rules are designed to conduct the 
opening on C2 in a fair and orderly fashion and are consistent with the 
Act.
---------------------------------------------------------------------------

    \159\ C2 will accept pre-opening orders. See C2 Rule 6.11(a).
    \160\ See C2 Rule 6.11(a) and Amendment No. 1.
    \161\ See C2 Rule 6.11.
---------------------------------------------------------------------------

3. Obvious and Catastrophic Errors
    C2 proposed an obvious and catastrophic error rule based on the 
corresponding rule of the International Securities Exchange, LLC.\162\ 
The Commission believes that in most circumstances trades that are 
executed between parties should be honored. On rare occasions, the 
price of the executed trade indicates an ``obvious'' or 
``catastrophic'' error may exist, suggesting that it is unlikely that 
the parties to the trade had come to a meeting of the minds regarding 
the terms of the transaction. In the Commission's view, the 
determination of whether an error has occurred should be based on 
specific and objective criteria and subject to specific and objective 
procedures.\163\ The Commission believes that C2's proposed obvious 
error rule provides clear and objective standards and procedures for 
determining whether an obvious error has occurred, is consistent with 
the Act, and is substantively the same as obvious error rules 
previously approved by the Commission for other exchanges.\164\
---------------------------------------------------------------------------

    \162\ See C2 Rule 6.15 and Amendment No. 1. See also 
International Stock Exchange Rule 720. With respect to no bid 
series, C2's rule provides that transactions in series quoted no bid 
and $0.05 or less offer can be nullified provided, among other 
things, that at least one strike price below (for calls) or above 
(for puts) in the same options class was quoted zero bid and $0.05 
or less offer at the time of execution. ISE Rule 720 requires two 
such strikes below (for calls) or above (for puts). See Securities 
Exchange Act Release No. 59548 (March 10, 2009), 74 FR 11147 (March 
16, 2009) (File No. SR-ISE-2009-10) (notice of filing and immediate 
effectiveness of proposed rule change to amend ISE's obvious error 
rule). C2's rule is similar to NYSE Arca Rule 6.87 (Obvious Errors 
and Catastrophic Errors) in that it only provides for one strike. 
See also CBOE Rule 6.25 (Nullification and Adjustment of Equity 
Options Transactions).
    \163\ See NOM Approval Order, supra note 92, at 73 FR 14532.
    \164\ See, e.g., Securities Exchange Act Release No. 57398 
(February 28, 2008), 73 FR 12240 (March 6, 2008) (File No. SR-ISE-
2007-112) (order approving amendments to ISE Rule 720).
---------------------------------------------------------------------------

4. Section 11(a) of the Act
    Section 11(a)(1) of the Act\165\ prohibits a 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 person exercises discretion 
(collectively, ``covered accounts'') unless an exception applies. Rule 
11a2-2(T) under the Act,\166\ known as the ``effect versus execute'' 
rule, provides exchange members with an exemption from the Section 
11(a)(1) prohibition. Rule 11a2-2(T) permits an exchange member, 
subject to certain conditions, to effect transactions for covered 
accounts by arranging for an unaffiliated member to execute 
transactions on the exchange. To comply with Rule 11a2-2(T)(a)(2)'s 
conditions, a member: (i) May not be affiliated with the executing 
member; (ii) must transmit the order from off the exchange floor; (iii) 
may not participate in the execution of the transaction once it has 
been transmitted to the member performing the execution;\167\ 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.
---------------------------------------------------------------------------

    \165\ 15 U.S.C. 78k(a)(1).
    \166\ 17 CFR 240.11a2-2(T).
    \167\ The member may, however, participate in clearing and 
settling the transaction. See 1978 Release, infra note 173.
---------------------------------------------------------------------------

    In a letter to the Commission, C2 requests that the Commission 
concur with C2's conclusion that Participants that enter orders into C2 
satisfy the requirements of Rule 11a2-2(T).\168\ For the reasons set 
forth below, the Commission believes that Participants entering orders 
into C2 would satisfy the conditions of the Rule.
---------------------------------------------------------------------------

    \168\ See Letter from Angelo Evangelou, Assistant General 
Counsel, CBOE, to Elizabeth King, Associate Director, Division of 
Trading and Markets, Commission, dated October 16, 2009 (``C2 11(a) 
Letter'').
---------------------------------------------------------------------------

    The Rule's first condition is that the order be executed by an 
exchange member who is unaffiliated with the member initiating the 
order.\169\ The Commission has stated that this requirement is 
satisfied when automated exchange facilities, such as the C2 system, 
are used, as long as the design of these systems ensures that members 
do not possess any special or unique trading advantages in handling 
their orders after transmitting them to the exchange.\170\ C2 has 
represented that the design of the C2 system ensures that no member has 
any special or unique trading advantage in the handling of its orders 
after transmitting its orders to C2.\171\ Based on C2's representation, 
the Commission believes that the C2 system satisfies this requirement.
---------------------------------------------------------------------------

    \169\ 17 CFR 240.11a2-2(T)(a)(2)(i).
    \170\ See, e.g., NOM Approval Order, supra note 92, at note 269 
(citing to the 1979 Release). In considering the operation of 
automated execution systems operated by an exchange, the Commission 
noted that while there is not an independent executing exchange 
member, the execution of an order is automatic once it has been 
transmitted into the systems. Because the design of these systems 
ensures that members do not possess any special or unique trading 
advantages in handling their orders after transmitting them to the 
exchange, the Commission has stated that executions obtained through 
these systems satisfy the independent execution requirement of Rule 
11a2-2(T). See 1979 Release, infra note 173.
    \171\ See C2 11(a) Letter, supra note 168.
---------------------------------------------------------------------------

    Second, the Rule requires that orders for covered accounts be 
transmitted from off the exchange floor.\172\ The C2 system receives 
orders electronically through remote terminals or computer-

[[Page 66709]]

to-computer interfaces. In the context of other automated trading 
systems, the Commission has found that the off-floor transmission 
requirement is met if a covered account order is transmitted from a 
remote location directly to an exchange's floor by electronic 
means.\173\ Because the C2 system receives orders electronically 
through remote terminals or computer-to-computer interfaces, the 
Commission believes that the C2 system satisfies the off-floor 
transmission requirement.\174\
---------------------------------------------------------------------------

    \172\ 17 CFR 240.11a2-2(T)(a)(2)(ii).
    \173\ See, e.g., NOM Approval Order, supra note 92, at 73 FR 
14538; Nasdaq Exchange Registration Order, supra note 39, at 71 FR 
3560; and Securities Exchange Act Release Nos. 49068 (January 13, 
2004), 69 FR 2775 (January 20, 2004) (File No. SR-BSE-2002-15) 
(order approving the rules of the Boston Options Exchange); 44983 
(October 25, 2001), 66 FR 55225 (November 1, 2001) (File No. SR-PCX-
00-25) (order approving the Archipelago Exchange as an electronic 
trading facility of the Pacific Exchange (``PCX'')); 29237 (May 24, 
1991), 56 FR 24853 (May 31, 1991) (File Nos. SR-NYSE-90-52 SR-NYSE-
90-53) (regarding NYSE's Off-Hours Trading Facility); 15533 (January 
29, 1979), 44 FR 6084 (January 31, 1979) (File No. S7-163) 
(regarding the American Stock Exchange Post Execution Reporting 
System, the Amex Switching System, the Intermarket Trading System, 
the Multiple Dealer Trading Facility of the Cincinnati Stock 
Exchange, the PCX Communications and Execution System, and the 
Philadelphia Stock Exchange's Automated Communications and Execution 
System (``1979 Release'')); and 14563 (March 14, 1978) 43 FR 11542 
(March 17, 1978) (File No. S7-163) (regarding the NYSE's Designated 
Order Turnaround System (``1978 Release'')).
    \174\ See, e.g., NOM Approval Order, supra note 92, at 73 FR 
14538-39.
---------------------------------------------------------------------------

    Third, the Rule requires that the member not participate in the 
execution of its order.\175\ C2 represented that at no time following 
the submission of an order is a Participant able to acquire control or 
influence over the result or timing of an order's execution. According 
to C2, the execution of a member's order is determined solely by what 
other orders, bids, or offers are present in the C2 system at the time 
the Participant submits the order and on the priority of those orders, 
bids, and offers.\176\ Based on these representations, the Commission 
believes that a Participant does not participate in the execution of an 
order submitted to the C2 system.
---------------------------------------------------------------------------

    \175\ 17 CFR 240.11a2-2(T)(a)(iii).
    \176\ See C2 11(a) Letter, supra note 168. The Participant may 
cancel or modify the order, or modify the instruction for executing 
the order, but only from off the floor. The Commission has stated 
that the non-participation requirement is satisfied under such 
circumstances so long as such modifications or cancellations are 
also transmitted from off the floor. See 1978 Release, supra note 
173 (stating that the ``non-participation requirement does not 
prevent initiating members from canceling or modifying orders (or 
the instructions pursuant to which the initiating member wishes 
orders to be executed) after the orders have been transmitted to the 
executing member, provided that any such instructions are also 
transmitted from off the floor'').
---------------------------------------------------------------------------

    Fourth, in the case of a transaction effected for an account with 
respect to which the initiating member or an associated person thereof 
exercises investment discretion, neither the initiating member nor any 
associated person thereof may retain any compensation in connection 
with effecting the transaction, unless the person authorized to 
transact business for the account has expressly provided otherwise by 
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T).\177\ Participants trading for covered accounts over which they 
exercise investment discretion must comply with this condition in order 
to rely on the rule's exemption.\178\
---------------------------------------------------------------------------

    \177\ 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written 
contract to retain compensation, in connection with effecting 
transactions for covered accounts over which such member or 
associated persons thereof exercises investment discretion, to 
furnish at least annually to the person authorized to transact 
business for the account a statement setting forth the total amount 
of compensation retained by the member in connection with effecting 
transactions for the account during the period covered by the 
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra 
note 173 (stating ``[t]he contractual and disclosure requirements 
are designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such 
arrangements are suitable to their interests.'').
    \178\ See C2 11(a) Letter, supra note 168.
---------------------------------------------------------------------------

E. Listing Procedures

    C2 will incorporate by reference CBOE's listing rules for 
options.\179\ As such, the Commission finds that C2's proposed initial 
and continued listing rules, which are based on CBOE rules previously 
approved by the Commission, are consistent with the Act, including 
Section 6(b)(5), in that they are designed to protect investors and the 
public interest and to promote just and equitable principles of trade. 
The Commission notes that, before beginning operation, C2 will need to 
become a participant in the Plan for the Purpose of Developing and 
Implementing Procedures Designed to Facilitate the Listing and Trading 
of Standardized Options Submitted Pursuant to Section 11A(a)(3)(B) of 
the Securities Exchange Act of 1934 (``OLPP''). In addition, before 
beginning operation, C2 will need to become a participant in the 
Options Clearing Corporation.
---------------------------------------------------------------------------

    \179\ See infra Section IV (discussing an exemption from Section 
19(b) of the Act for CBOE rules incorporated by reference by C2). 
See also C2 Rules Chapter 5.
---------------------------------------------------------------------------

IV. Exemption From Section 19(b) of the Act With Regard to CBOE Rules 
Incorporated by Reference

    C2 proposes to incorporate by reference certain CBOE rules as C2 
rules, including Chapters 4 (Business Conduct), 5 (Securities Dealt 
In), 6 Section E (Intermarket Linkage), 9 (Doing Business with the 
Public), 10 (Closing Transactions), 11 (Exercises and Deliveries), 12 
(Margins), 13 (Net Capital Requirements), 15 (Records, Reports and 
Audits), 16 (Summary Suspension by Chairman of the Board or Vice 
Chairman of the Board), 17 (Discipline), 18 (Arbitration), 19 (Hearings 
and Review), and 24 (Index Options). In each Chapter including 
incorporated rules, C2 states that these such rules ``as such rules may 
be in effect from time to time, shall apply to C2 and are hereby 
incorporated into this Chapter'' and that C2 members shall comply with 
a C2 rule by complying with the CBOE rules incorporated by reference 
``as if such rules were part of the C2 Rules.'' \180\ In connection 
with its proposal to incorporate certain CBOE rules by reference, C2 
requested, pursuant to Rule 0-12,\181\ an exemption under Section 36 of 
the Act \182\ from the rule filing requirements of Section 19(b) of the 
Act for changes to those C2 rules that are affected solely by virtue of 
a change to a cross-referenced CBOE rule. C2 proposes to incorporate by 
reference categories of rules (rather than individual rules within a 
category) that are not trading rules. C2 also agrees to provide written 
notice to its members whenever CBOE proposes a rule change to a CBOE 
rule that C2 has incorporated by reference.\183\
---------------------------------------------------------------------------

    \180\ See, e.g., C2 Rules Chapter 4 (Business Conduct).
    \181\ See 17 CFR 240.0-12.
    \182\ 15 U.S.C. 78mm.
    \183\ See Letter from Angelo Evangelou, Assistant General 
Counsel, CBOE, to Elizabeth M. Murphy, Secretary, Commission, dated 
October 16, 2009.
---------------------------------------------------------------------------

    Using its authority under Section 36 of the Act, the Commission 
previously exempted several other SROs from the requirement to file 
proposed rule changes under Section 19(b) of the Act.\184\ Each such 
exempt SRO agreed to be governed by the incorporated rules, as amended 
from time to time, but is not required to file a separate proposed rule

[[Page 66710]]

change with the Commission each time the SRO whose rules are 
incorporated by reference seeks to modify its rules. In addition, each 
such exempt SRO incorporated by reference only regulatory rules (i.e., 
margin, suitability, arbitration), not trading rules, and incorporated 
by reference whole categories of rules. Each such exempt SRO had 
reasonable procedures in place to provide written notice to its members 
each time a change is proposed to the incorporated rules of another SRO 
in order to provide its members with notice of a proposed rule change 
that affects their interests, so that they would have an opportunity to 
comment on it.
---------------------------------------------------------------------------

    \184\ See, e.g., Securities Exchange Act Release No. 49260 
(February 17, 2004), 69 FR 8500 (February 24, 2004) (order granting 
application for exemptions pursuant to Section 36(a) of the Act by 
the American Stock Exchange LLC, the International Securities 
Exchange, Inc., the Municipal Securities Rulemaking Board, the 
Pacific Exchange, Inc., the Philadelphia Stock Exchange, Inc., and 
the Boston Stock Exchange, Inc.); and Nasdaq Exchange Registration 
Order, supra note 39, at 71 FR 3565-66.
---------------------------------------------------------------------------

    The Commission is granting C2's request for exemption, pursuant to 
Section 36 of the Act, from the rule filing requirements of Section 
19(b) of the Act with respect to the rules that C2 proposes to 
incorporate by reference. This exemption is conditioned upon C2 
providing written notice to its members whenever CBOE proposes to 
change a rule that C2 has incorporated by reference. The Commission 
believes that this exemption is appropriate in the public interest and 
consistent with the protection of investors because it will promote 
more efficient use of Commission and SRO resources by avoiding 
duplicative rule filings based on simultaneous changes to identical 
rules sought by more than one SRO. Consequently, the Commission grants 
C2's exemption request.

V. Conclusion

    It is ordered that the application of C2 for registration as a 
national securities exchange be, and hereby is, granted.
    It is further ordered that operation of C2 is conditioned on the 
satisfaction of the following requirements:
    A. Participation in National Market System Plans Relating to 
Options Trading. C2 must join: (1) The Plan for the Reporting of 
Consolidated Options Last Sale Reports and Quotation Information (i.e., 
the Options Price Reporting Authority); (2) the OLPP; (3) the Linkage 
Plan; \185\ and (4) the Plan of the Options Regulatory Surveillance 
Authority.
---------------------------------------------------------------------------

    \185\ See Linkage Plan, supra note 78.
---------------------------------------------------------------------------

    B. Participation in Multiparty 17d-2 Plans. C2 must become a party 
to the multiparty 17d-2 agreements concerning sales practice regulation 
and market surveillance.\186\
---------------------------------------------------------------------------

    \186\ See supra note 111 (citing to the most recent versions of 
the two plans). See also infra Section III.C.3 (Multiparty 17d-2 
Agreements); and 17 CFR 240.17d-2.
---------------------------------------------------------------------------

    C. Participation in the Options Clearing Corporation. C2 must join 
the Options Clearing Corporation.
    D. Participation in the Intermarket Surveillance Group. C2 must 
join the Intermarket Surveillance Group.
    E. Examination by the Commission. C2 must have, and represent in a 
letter to the staff in the Commission's Office of Compliance 
Inspections and Examinations that it has, adequate procedures and 
programs in place to effectively regulate C2.
    It is further ordered, pursuant to Section 36 of the Act,\187\ that 
C2 shall be exempt from the rule filing requirements of Section 19(b) 
of the Act \188\ with respect to the CBOE rules C2 proposes to 
incorporate by reference into C2's rules, subject to the conditions 
specified in this Order.
---------------------------------------------------------------------------

    \187\ 15 U.S.C 78mm.
    \188\ 15 U.S.C 78s(b).

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-29877 Filed 12-15-09; 8:45 am]
BILLING CODE 8011-01-P