[Federal Register Volume 76, Number 117 (Friday, June 17, 2011)]
[Notices]
[Pages 35491-35493]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-15058]
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SECURITIES AND EXCHANGE COMMISSION
Release No. 34-64653; File No. SR-CBOE-2011-041
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Granting Approval of Proposed Rule Change Establishing
Qualified Contingent Cross Orders
June 13, 2011.
I. Introduction
On April 18, 2011, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to establish qualified contingent
cross orders (``QCC Order''). The proposed rule change was published in
the Federal Register on May 4, 2011.\3\ The Commission received four
comments on the proposal.\4\ CBOE submitted a comment response letter
on June 6, 2011.\5\ This order grants approval of the proposed rule
change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 64354 (April 27,
2011), 76 FR 25392 (``Notice'').
\4\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Martin Galivan, dated May 4, 2011(``Galivan Letter''); Ron
March, dated May 4, 2011 (``March Letter''); Jesse L. Stamer, dated
May 8, 2011 (``Stamer Letter''); and Michael J. Simon, Secretary,
International Securities Exchange (``ISE''), dated May 27, 2011
(``ISE Letter'').
\5\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Jennifer M. Lamie, Assistant General Counsel, CBOE, dated June
6, 2011 (``CBOE Response Letter'').
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II. Description of the Proposal
CBOE proposes to amend CBOE Rule 6.53 to adopt rules related to a
new QCC Order type that will be available to CBOE Trading Permit
Holders (``TPHs'').\6\ CBOE Rule 6.53 would permit QCC Orders to be
submitted electronically from either on or off the floor through the
CBOE Hybrid Trading System. The QCC Order would permit a TPH to cross
the options leg(s) of a qualified contingent trade (``QCT'') \7\ in a
Regulation NMS stock, on CBOE immediately without exposure if the order
is: (i) For at least 1,000 contracts; (ii) is part of a QCT; \8\ (iii)
is executed at a price at least equal to the national best bid or offer
(``NBBO''); and (iv) there are no public customer orders resting in the
Exchange's electronic book at the same price. Specifically, the QCC
Order type would permit TPHs to provide their customers a net price for
the stock-option trade, and then allow the TPH to execute the options
leg(s) of the trade on CBOE at a price at least equal to the NBBO while
using the QCT exemption to effect the trade in the
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equities leg at a price necessary to achieve the net price.\9\ The
Exchange would not permit the options component(s) of a QCC Order to
trade through the NBBO.
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\6\ In the Notice, the Exchange states that the proposal will
permit CBOE to remain competitive with ISE, which has a QCC Order
type that is submitted from off the floor, and other options
exchanges that may adopt a similar order type. See Notice, supra
note 3, at 25393.
\7\ The Commission has granted an exemption for QCTs that meet
certain requirements from Rule 611(a) of Regulation NMS, 17 CFR
242.611(a). See Securities Exchange Act Release No. 57620 (April 4,
2008), 73 FR 19271 (April 9, 2008) (``QCT Release,'' which
supersedes a release initially granting the QCT exemption,
Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR
52829 (September 7, 2006) (``Original QCT Release'')).
\8\ CBOE is proposing to define a qualified contingent cross
trade substantively identical to the Commission's definition in the
QCT Release. A qualified contingent cross trade must meet the
following conditions: (i) At least one component must be an NMS
stock, as defined in Rule 600 of Regulation NMS, 17 CFR 242.600;
(ii) all components must be effected with a product or price
contingency that either has been agreed to by all the respective
counterparties or arranged for by a broker-dealer as principal or
agent; (iii) the execution of one component must be contingent upon
the execution of all other components at or near the same time; (iv)
the specific relationship between the component orders (e.g., the
spread between the prices of the component orders) is determined by
the time the contingent order is placed; (v) the component orders
must bear a derivative relationship to one another, represent
different classes of shares of the same issuer, or involve the
securities of participants in mergers or with intentions to merge
that have been announced or cancelled; and (vi) the transaction must
be fully hedged (without regard to any prior existing position) as a
result of other components of the contingent trade. Consistent with
the QCT Release, TPHs would be required to demonstrate that the
transaction is fully hedged using reasonable risk-valuation
methodologies. See QCT Release, supra note 7, at footnote 9.
\9\ CBOE represented that it will adopt policies and procedures
to ensure that TPHs use the QCC Order properly and require TPHs to
properly mark all QCC Orders as such. Additionally, CBOE will
implement an examination and surveillance program to assess TPH
compliance with the requirements applicable to QCC Orders, including
the requirement that the stock leg of the transaction be executed at
or near the same time as the options leg.
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III. Comment Letters
Four commenters raised objections to the proposal.\10\ One
commenter expressed the concern that the QCC Order would prohibit
potential price improvement because such order may trade on the
Exchange immediately without exposure.\11\ The commenter was also
concerned that the proposal may promote internalization of order flow
to the benefit of a few select firms.\12\ Another commenter stated that
the proposal may decrease liquidity in the market and was concerned
that public customer orders may get traded through.\13\ Further, a
commenter suggested that the proposal would create an uneven playing
field in the market to the benefit of large institutional customers and
detriment of small individual investors.
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\10\ See note 4, supra.
\11\ See Galivan Letter.
\12\ See Galivan Letter.
\13\ See Stamer Letter.
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Another commenter questioned the ability of a floor-based exchange
to verify that there is not a customer order on the book at the price
as a QCC order at the time of execution.\14\ The commenter argued that
in an electronic trading environment, an exchange's systems can
automatically determine if there is a customer order on the book before
a QCC order is executed.\15\ The commenter stated that how this
function would be performed on a floor-based exchange should be
clarified, as well as what the time of execution would be for a floor-
based trade.\16\ The commenter argued that ``[a]llowing a QCC to be
implemented in a non-automated environment without a systemic check of
whether there is a customer order on the book at the time of execution
would effectively eliminate the protections guaranteed in an all
electronic trading environment, thus returning [the exchanges] to the
unequal competitive environment from which the ISE's QCC proposal
originated.'' \17\
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\14\ See ISE Letter.
\15\ Id.
\16\ Id.
\17\ Id.
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In its letter, CBOE responded to the issues raised in the ISE
Letter and explained that, even when QCC Orders are submitted for
execution from the floor, they are submitted electronically and that
these orders would not be represented in ``open outcry.'' \18\ CBOE
also clarified that the time of execution of a QCC Order would not vary
depending on whether the order is submitted from on the floor or off
the floor and that the execution would occur when the QCC Order is
submitted to the CBOE Hybrid Trading System.\19\
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\18\ See CBOE Response Letter, supra note 5.
\19\ Id.
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IV. Discussion and Commission's Findings
The Commission has carefully reviewed the proposed rule change, the
comments received, and finds that it is consistent with the
requirements of Section 6(b) of the Act.\20\ Specifically, the
Commission finds that the proposal is consistent with Sections 6(b)(5)
\21\ and 6(b)(8),\22\ which require, among other things, that the rules
of a national securities exchange be designed to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest and that the
rules of an exchange do no impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act. In
addition, the Commission finds that the proposed rule change is
consistent with Section 11A(a)(1)(C) of the Act,\23\ in which Congress
found that it is in the public interest and appropriate for the
protection of investors and the maintenance of fair and orderly markets
to assure, among other things, the economically efficient execution of
securities transactions.
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\20\ 15 U.S.C. 78f(b). In approving this proposed rule change,
the Commission has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
\21\ 15 U.S.C. 78f(b)(5).
\22\ 15 U.S.C. 78f(b)(8).
\23\ 15 U.S.C. 78k-1(a)(1)(C).
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The Commission believes that the proposed rule change, which would
permit a clean cross of the options leg of a subset of qualified
contingent trades, is appropriate and consistent with the Act.\24\ The
Commission believes that this order type may facilitate the execution
of qualified contingent trades, which the Commission found to be
beneficial to the market as a whole by contributing to the efficient
functioning of the securities markets and the price discovery
process.\25\ The QCC Order would provide assurance to parties to stock-
option qualified contingent trades that their hedge would be maintained
by allowing the options component to be executed as a clean cross.
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\24\ See also Securities Exchange Act Release No. 63955
(February 24, 2011), 76 FR 11533 (March 2, 2011) (SR-ISE-2010-73)
(``ISE QCC Approval'').
\25\ See Original QCT Release, supra note 7.
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While the Commission believes that order exposure is generally
beneficial to options markets in that it provides an incentive to
options market maker to provide liquidity and therefore plays an
important role in ensuring competition and price discovery in the
options markets, it also has recognized that contingent trades can be
``useful trading tools for investors and other market participants,
particularly those who trade the securities of issuers involved in
mergers, different classes of shares of the same issuers, convertible
securities, and equity derivatives such as options [italics added],''
\26\ and that ``[t]hose who engage in contingent trades can benefit the
market as a whole by studying the relationships between prices of such
securities and executing contingent trades when they believe such
relationships are out of line with what they believe to be fair
value.'' \27\ As such, the Commission stated that the transactions that
meet the specified requirements of the NMS QCT Exemption could be of
benefit to the market as a whole, contributing to the efficient
functioning of the securities markets and the price discovery
process.\28\
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\26\ See id. at 52830-52831.
\27\ Id.
\28\ See QCT Release, supra note 7 at 19273.
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Thus, in light of the benefits provided by both the requirement for
exposure as well as by qualified contingent trades such as QCC Orders,
the Commission must weigh the relative merits of both for the options
markets.\29\ The Commission believes that the proposal, in requiring a
QCC Order be: (1) Part of a qualified contingent trade under Regulation
NMS; (2) for at least 1,000 contracts; (3) executed at a price at or
between the NBBO; and (4) cancelled if there is a public customer on
the electronic book, strikes an appropriate balance for the options
market in that it is narrowly drawn and establishes a limited exception
to the general principle of exposure and retains the general principle
of customer priority in the options markets. Furthermore, not
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only must a QCC Order be part of a qualified contingent trade by
satisfying each of the six underlying requirements of the NMS QCT
Exemption, the requirement that a QCC Order be for a minimum size of
1,000 contracts provides another limit to its use by ensuring only
transactions of significant size may avail themselves of this order
type.\30\
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\29\ The Commission notes that it has previously permitted the
crossing of two public customer orders, for which no exposure is
required on ISE and CBOE. See CBOE Rule 6.74A.09 and ISE Rule 715(i)
and 721.
\30\ The Commission notes that the requirement that clean
crosses be of a certain minimum size is not unique to the QCC Order.
See, e.g., NSX 11.12(d), which requires, among other things, that a
Clean Cross be for at least 5,000 shares and have an aggregate value
of at least $100,000.
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The Commission notes that, under CBOE's proposal, QCC Orders may be
submitted electronically from either on or off the floor through the
CBOE Hybrid Trading System. CBOE has represented that to effect
proprietary orders, including QCC Orders, electronically from on the
floor of the Exchange, members must qualify for an exemption from
Section 11(a)(1) of the Act,\31\ which concerns proprietary trading on
an exchange by an exchange member. Among other exemptions, common
exemptions include: An exemption for transactions by broker dealers
acting in the capacity of a market maker under Section 11(a)(1)(A);
\32\ the ``G'' exemption for yielding priority to non-members under
Section 11(a)(1)(G) of the Act and Rule 11a1-1(T) thereunder; \33\ and
the ``effect vs. execute'' exemption under Rule 11a2-2(T) under the
Act.\34\ The Exchange recognized in its filing that, consistent with
existing Exchange rules for effecting proprietary orders from on the
floor of the Exchange, TPHs effecting QCC Orders and relying on the
``G'' exemption would be required to yield priority to any interest,
not just public customer orders, in the electronic book at the same
price to ensure that non-member interest is protected.\35\
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\31\ 15 U.S.C. 78k(a)(1). Generally, Section 11(a)(1) of the Act
restricts any member of a national securities exchange from
effecting any transaction on such exchange for: (i) The member's own
account, (ii) the account of a person associated with the member, or
(iii) an account over which the member or a person associated with
the member exercises discretion, unless a specific exemption is
available.
\32\ 15 U.S.C. 78k(a)(1)(A).
\33\ 15 U.S.C. 78k(a)(1)(G) and 17 CFR 240.11a1-1(T).
\34\ 17 CFR 240.11a2-2(T).
\35\ See, e.g., Securities Exchange Act Release No. 59546 (March
10, 2009), 74 FR 11144 (March 16, 2009) (SR-CBOE-2009-016) and CBOE
Regulatory Circular RG09-35 (providing guidance on the application
of Section 11(a)(1) and certain of the exemptions, as well as the
application of the ``G'' exemption and the Effect vs. Execute
exemption to trading on the Hybrid Trading System).
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In approving a similar order type for ISE, the Commission
considered the issues raised in the Galivan Letter, March Letter, and
Stamer Letter, and found that ISE's QCC order type was consistent with
the requirements of the Act and the rules and regulations
thereunder.\36\ In addition, the Commission believes that CBOE's
response letter clarified the questions raised by ISE in the ISE
Letter.
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\36\ See ISE QCC Approval, supra note 24.
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For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with Section 6(b)(5) \37\ and 6(b)(8) \38\ of
the Act. Further, the Commission finds that the proposed rule change is
consistent with Section 11A(a)(1)(C) of the Act.\39\
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\37\ 15 U.S.C. 78f(b)(5).
\38\ 15 U.S.C. 78f(b)(8).
\39\ 15 U.S.C. 78k-1(a)(1)(C).
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\40\ that the proposed rule change (SR-CBOE-2011-041) be, and it
hereby is, approved.
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\40\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\41\
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\41\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-15058 Filed 6-16-11; 8:45 am]
BILLING CODE 8011-01-P