[Federal Register Volume 77, Number 2 (Wednesday, January 4, 2012)]
[Notices]
[Pages 306-312]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-33713]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66052; File No. SR-CBOE-2011-123]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Related to 
FLEX Options

December 23, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on December 20, 2011, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (the ``Commission'') the proposed rule change as 
described in Items I and II below, which Items have been prepared by 
the Exchange. The Commission is publishing this notice to solicit

[[Page 307]]

comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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Self-Regulatory Organization's Statement of the Terms of Substance of 
the Proposed Rule Change

    The Exchange is proposing to adopt certain rules pertaining to the 
electronic auction trading of Flexible Exchange Options (``FLEX 
Options'') on the Exchange's FLEX Hybrid Trading System platform.\3\ 
The text of the rule proposal is available on the Exchange's Web site 
(http://www.cboe.org/legal), at the Exchange's Office of the Secretary 
and at the Commission.
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    \3\ FLEX Options provide investors with the ability to customize 
basic option features including size, expiration date, exercise 
style, and certain exercise prices. FLEX Options can be FLEX Index 
Options or FLEX Equity Options. In addition, other products are 
permitted to be traded pursuant to the FLEX trading procedures. For 
example, credit options are eligible for trading as FLEX Options 
pursuant to the FLEX rules in Chapters XXIVA and XXIVB. See CBOE 
Rules 24A.1(e) and (f), 24A.4(b)(1) and (c)(1), 24B.1(f) and (g), 
24B.4(b)(1) and (c)(1), and 28.17. The rules governing the trading 
of FLEX Options on the FLEX Request for Quote (``RFQ'') System 
platform are contained in Chapter XXIVA. The rules governing the 
trading of FLEX Options on the FLEX Hybrid Trading System platform 
(referred to as the ``FLEX System'' or the ``System'') are contained 
in Chapter XXIVB.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of those statements may be examined at 
the places specified in Item IV below. The Exchange has prepared 
summaries, set forth in sections A, B, and C below, of the most 
significant parts of such statements.

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

1. Purpose
    The Exchange is proposing to make modified versions of the 
Automated Improvement Mechanism (``AIM'') and Solicitation Auction 
Mechanism (``SAM'')--which are currently available for non-FLEX Options 
under Rules 6.74A and 6.74B, respectively--available for FLEX Options. 
The FLEX versions of the AIM and SAM mechanisms will operate 
substantially similar to the AIM and SAM mechanisms for non-FLEX 
Options. Significant distinctions are described below.\4\
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    \4\ These distinctions are noted as compared to the existing AIM 
and SAM auction processes for non-FLEX options under Rules 6.74A and 
6.74B, respectively. The Exchange notes that it currently has two 
separate rule change filings pending that would make amendments to 
Rule 6.74A (AIM). See SR-CBOE-2011-116 and SR-CBOE-2011-117.
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Automated Improvement Mechanism
    The Exchange is proposing to establish an AIM mechanism for FLEX 
Options, which mechanism will electronically auction certain orders for 
price improvement. Under the AIM process, a FLEX Trader \5\ (referred 
to as an ``Initiating Trading Permit Holder'' or ``Initiating TPH'') 
that represents agency orders may submit an order it represents as 
agent (an ``Agency Order'') along with a second order (a principal 
order and/or solicited order(s) for the same amount as the Agency 
Order) \6\ into the AIM Auction where other FLEX Trader participants 
could compete with the Initiating TPH's second order to execute against 
the Agency Order.
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    \5\ A ``FLEX Trader'' means a FLEX-participating Trading Permit 
Holder who has been approved by the Exchange to trade on the System. 
See Rule 24B.1(l).
    \6\ Any solicited orders submitted by the Initiating TPH to 
trade against the Agency Order may not be for the account of a FLEX 
Market-Maker assigned to the option class. See proposed Rule 
24B.5A.04.
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    To be eligible, the Agency Order must be in a FLEX class designated 
as eligible for AIM Auctions and within the designated AIM Auction 
order eligibility size parameters. Such classes and size parameters 
will be determined by the Exchange and announced via circular to FLEX 
Traders. When submitting an Agency Order, an Initiating TPH must mark 
the Agency Order for AIM Auction processing and must also submit a 
contra-side second order for the same size as the Agency Order. This 
second order guarantees that the Agency Order will receive an execution 
(i.e., it acts as a stop). In connection with the stop of the Agency 
Order, the Initiating TPH must stop the entire Agency Order with the 
second order at the better of the best bid or offer (``BBO'') or the 
Agency Order's limit price.\7\ The Initiating TPH may enter the second 
order in one of two formats: (i) A specified single price at which it 
seeks to cross the Agency Order with the second order (a ``single-
priced submission''), or (ii) a non-price specific commitment for the 
second order to automatically match the price and size of all auction 
responses that are received during the auction (an ``auto-match''), in 
which case the Agency Order will be stopped at the better of the BBO or 
the Agency Order's limit price. When using the auto-match feature, the 
Initiating TPH would have no control over the ultimate match price. 
Once the Initiating TPH has submitted an Agency Order for AIM 
processing, such submission cannot be cancelled by the Initiating TPH.
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    \7\ By comparison, the AIM Auction for non-FLEX Options 
currently provides for a stop of Agency Orders for 50 contracts or 
more at the better of the national best bid or offer (``NBBO'') or 
the Agency Order's limit price (if the order is a limit order), and 
a stop of Agency Orders for less than 50 contracts at the NBBO 
improved by one minimum price increment (which is determined by the 
Exchange and may not be smaller than $0.01) or the Agency Order's 
limit price (if the order is a limit). See Rule 6.74A(a)(2)--(3). 
The FLEX provision differs in that orders of any size would be 
treated the same for purposes of the stop (i.e., there would be no 
small order provision), the stop is based on the BBO (FLEX options 
are generally not multiply-listed and are not subject to a 
consolidated quotation reporting program), and the FLEX AIM Auction 
will only process Agency Orders with limit prices (no market 
orders).
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    Upon receipt of an Agency Order (and second order), the Exchange 
would commence the AIM Auction by issuing a request for responses 
(``RFR''), detailing the side and size of the Agency Order.\8\ The 
duration of the RFR response period (i.e., the auction period) would be 
established by the Exchange on a class-by-class basis and shall not be 
less than three (3) seconds.\9\ During that period, RFR responses may 
be submitted by FLEX Traders. These responses must specify price and 
size and may not cross the Exchange's BBO on the opposite side of the 
market. All RFR responses are ``blind,'' that is they are not visible 
to any other participants.\10\ CBOE believes this aspect of the AIM 
Auction will encourage more aggressive quoting and superior price 
improvement. RFR responses may be modified or cancelled so long as they 
are modified or

[[Page 308]]

cancelled before the conclusion of the RFR response period. Lastly, the 
minimum price increment for RFR responses and for an Initiating TPH's 
single price submission shall be set by the Exchange at no less than 
one cent.
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    \8\ Each RFR would be sent to those FLEX Traders electing to 
receive RFRs (i.e., those FLEX Traders who have established the 
necessary systems connectivity to receive RFRs). Thus, such election 
to receive RFRs would not be on a case-by-case basis.
    \9\ The Exchange is proposing that the minimum RFR exposure 
period for AIM be three (3) seconds, which is consistent with the 
existing minimum exposure period for FLEX Option crossing pursuant 
to the existing FLEX crossing procedures. See Rule 24B.5(b)(3)(iii). 
By comparison, for non-FLEX Options, the minimum RFR exposure period 
for non-FLEX Options is one (1) second. See, e.g., Rule 6.45A.01 and 
.02, and Rule 6.74A(b)(1)(C).
    \10\ RFR responses will not be disseminated via the Options 
Price Reporting Authority (``OPRA''). This is consistent with the 
operation of AIM (and SAM) for non-FLEX Options. See Rules 
6.74A(b)(1)(F) and 6.74B(b)(1)(D). In addition, it is consistent 
with the operation of FLEX generally. In that regard, the Exchange 
notes that the Exchange currently disseminates via OPRA information 
regarding executed FLEX transactions. However, the Exchange 
currently does not disseminate via OPRA information respecting 
pending electronic and open outcry RFQs, or information on resting 
orders in the FLEX electronic book.
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    Normally, an AIM Auction ends at the conclusion of the RFR response 
period (which will be no less than 3 seconds). However, the proposal 
provides that the AIM Auction would end prior to the conclusion of the 
RFR response period any time an RFR response matches the BBO on the 
opposite side of the market from the RFR responses.\11\
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    \11\ This early termination provision for FLEX Options is 
consistent with the operation of AIM (and SAM) for non-FLEX Options. 
See Rules 6.74A(b)(2)(D) and 6.74B(b)(2). The Exchange notes that, 
for non-FLEX Options, additional early termination provisions apply 
that would not be applicable to FLEX Options. In particular, for 
non-FLEX Options an auction may terminate early: (i) Upon receipt by 
the Hybrid System of an unrelated order (in the same series as the 
Agency Order) that is marketable against either Exchange's 
disseminated quote (when such quote is the NBBO) or the RFR 
responses; (ii) upon receipt by the Hybrid System of an unrelated 
limit order (in the same series as the Agency Order and on the 
opposite side of the market as the Agency Order) that improves the 
RFR responses; (iii) pursuant to a pilot program, any time there is 
a quote lock on the Exchange pursuant to Rule 6.45A(d) and .06. 
Provisions (i) and (ii) above would not be applicable to FLEX 
Options because unrelated FLEX Orders may not be submitted to the 
electronic book for the duration of an AIM Auction. See proposed 
Rule 24B.5A(b). Provision (iii) above (and related pilot program 
data reporting requirements) would not be applicable to FLEX Options 
because there is no quote lock provision for FLEX Options that is 
similar to the quote lock provision applicable to non-FLEX Options 
under Rule 6.45A(d).
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    At the conclusion of the AIM Auction, the Agency Order would be 
allocated at the best price(s) and contra-side interest will be ranked 
and matched based on price-time priority,\12\ subject to the following: 
First, such best prices may include non-AIM Auction FLEX Orders (to the 
extent the Exchange has determined to make available an electronic 
book).\13\ Second, public customers and non-Trading Permit Holder 
broker-dealers RFR responses and FLEX Orders would have priority.\14\ 
Third, no FLEX Appointed Market-Maker participation entitlement \15\ 
would apply with respect to the AIM Auction. Fourth, if the best price 
equals the Initiating TPH's single-price submission, the Initiating 
TPH's single-price submission shall be allocated the greater of one 
contract or a certain percentage of the order, which percentage would 
be determined by the Exchange and may not be larger than 40%. However, 
if only one other FLEX Trader matches the Initiating TPH's single price 
submission, then the Initiating TPH may be allocated up to 50% of the 
order. Fifth, if the Initiating TPH selected the auto-match option of 
the AIM Auction, the Initiating TPH shall be allocated its full size at 
each price point until a price point is reached where the balance of 
the order can be fully executed. At such price point, the Initiating 
TPH shall be allocated the greater of one contract or a certain 
percentage of the remainder of the Agency Order, which percentage would 
be determined by the Exchange and may not be larger than 40%. Sixth, 
any remaining RFR responses and FLEX Orders will be allocated based on 
time priority.\16\ The Initiating TPH would not participate on any such 
balance unless the Agency Order would otherwise go unfilled. Finally, 
seventh, if the final AIM Auction price locks a public customer or non-
Trading Permit Holder broker-dealer order in the electronic book on the 
same side of the market as the Agency Order, then, unless there is 
sufficient size in the AIM Auction responses to execute both the Agency 
Order and the booked public customer or non-Trading Permit Holder 
broker-dealer order (in which case they will both execute at the final 
AIM Auction price), the Agency Order will execute against RFR responses 
at one minimum RFR response increment worse than the final AIM Auction 
price against the AIM Auction participants that submitted the final AIM 
Auction price and any balance shall trade against the public customer 
or non-Trading Permit Holder broker-dealer order in the book at such 
order's limit price.\17\
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    \12\ The FLEX version of the AIM Auction would only utilize a 
price-time priority allocation algorithm, subject to the conditions 
noted above. By comparison, the allocation algorithm for the non-
FLEX version of the AIM Auction is the algorithm that is in effect 
for the option class, subject to certain conditions. See Rule 
6.74A(b)(3).
    \13\ The Exchange may determine in a class-by-class basis to 
make an electronic book available in the FLEX System. See Rule 
24B.5(b). The term ``FLEX Order'' refers to (i) FLEX bids and offers 
entered by FLEX Market-Makers and (ii) orders to purchase and orders 
to sell FLEX Options entered by FLEX Traders, in each case into the 
electronic book. See Rule 24B.1(j).
    \14\ For the non-FLEX Option version of AIM, only public 
customers have priority. See Rule 6.74A(b)(3)(B). The Exchange is 
proposing to provide both public customers and non-Trading Permit 
Holder broker-dealers with the same priority for the FLEX AIM 
Auction for simplicity to be consistent with how other FLEX 
allocation algorithms currently operate. See, e.g., Rule 
24B.5(a)(1)(iii)(C) and (D). In the future, the Exchange may 
determine to modify the FLEX Option version of AIM so that only 
public customers have priority. Such a modification would be the 
subject of a separate rule filing.
    \15\ The Exchange may establish from time to time a 
participation entitlement formula that is applicable to FLEX 
Appointed Market Makers on a class-by-class basis with respect to 
open outcry RFQs, electronic RFQs and/or electronic book 
transactions. Any such FLEX Appointed Market-Maker participation 
entitlement shall: (i) Be divided equally by the number of FLEX 
Appointed Market-Makers quoting at the BBO or BBO clearing price, as 
applicable; (ii) collectively be no more than: 50% of the amount 
remaining in the order when there is one other FLEX Market-Maker 
also quoting at the same price, 40% when there are two other FLEX 
Market-Makers also quoting at the same price; and 30% when there are 
three or more FLEX Market-Makers also quoting at the same price; and 
(iii) when combined with any crossing participation entitlement, 
shall not exceed 40% of the original order. See Rule 
24B.5(d)(2)(ii).
    \16\ For the non-FLEX Option version of AIM, the allocation is 
based on the algorithm in effect for the option class. See note 12, 
supra.
    \17\ For the non-FLEX Option version of AIM, this book locking 
provision is only applicable to public customer orders resting in 
the book. The Exchange is proposing to provide both public customers 
and non-Trading Permit Holder broker-dealers with the same priority 
for the FLEX AIM Auction for simplicity to be consistent with how 
other FLEX allocation algorithms currently operate. See note 12, 
supra. The Exchange notes that, for non-FLEX Options, additional 
conditions apply that will not be applicable to FLEX Options. Those 
conditions relate to scenarios involving the following: (i) 
Unrelated orders that cause early terminations of AIM Auctions; and 
(ii) auctions that do not result in price improvement over the 
Exchange's disseminated price at the time the Auction began (in 
which case resting unchanged quotes or orders that were disseminated 
at the best price before the auction began have priority after any 
public customer order priority and the Initiating TPH's priority 
(40%) have been satisfied; any unexecuted balance on the Agency 
Order is allocated to RFR responses provided those RFR responses 
will be capped to the size of the unexecuted balance and the 
Initiating TPH may not participate on any such balance unless the 
Agency Order would otherwise go unfilled). See Rule 6.74A(b)(3)(D), 
(E) and (H). Provision (i) above would not be applicable to FLEX 
Options because unrelated FLEX Orders may not be submitted to the 
electronic book for the duration of an AIM Auction. See proposed 
Rule 24B.5A(b). Provision (ii) above is not necessary for FLEX 
Options because FLEX Options will utilize a price-time allocation 
algorithm (and, as a result, resting FLEX Orders that are 
disseminated at the best price before an AIM Auction begins will 
have priority after public customer and non-Trading Permit Holder 
broker-dealer priority and the Initiating TPH's priority (40%) have 
been satisfied by virtue of the resting FLEX Orders having time 
priority).
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    Lastly, the Exchange proposes certain interpretation and policy 
provisions applicable to the AIM Auction mechanism. First, the AIM 
Auction may only be used where there is a genuine intention to execute 
a bona fide transaction. Second, it would be deemed conduct 
inconsistent with just and equitable principles of trade and a 
violation of CBOE Rule 4.1 to engage in a patter [sic] of conduct where 
the Initiating TPH breaks-up an Agency Order into separate orders for 
two (2) or few contracts for the purpose of gaining a higher allocation 
percentage than the Initiating TPH would have otherwise received in 
accordance with the allocation procedures.\18\ Third, initially,

[[Page 309]]

and for at least a pilot period expiring on July 18, 2012, there will 
be no minimum size requirement for orders to be eligible for the AIM 
Auction. During this Pilot Period, the Exchange will submit certain 
data, periodically as required by the Commission, to provide supporting 
evidence that, among other things, there is a meaningful competition 
for all size orders and that there is an active and liquid market 
functioning on the Exchange outside of the AIM Auction. Any data which 
is submitted to the Commission will be provided on a confidential 
basis.\19\ Fourth, any solicited orders submitted by the Initiating TPH 
to trade against the Agency Order may not be for the account of a FLEX 
Market-Maker assigned to the option class.\20\ Fifth, the Exchange may 
determine on a class-by-class basis to make the AIM Auction available 
for complex orders. In such classes, complex orders may be executed 
through the AIM Auction at a net debit or net credit price provided the 
AIM Auction eligibility requirements are satisfied and the Agency Order 
is eligible for the AIM Auction considering its complex order type, 
order origin code (i.e., non-broker-dealer public customer, broker-
dealers that are not Market-Makers or specialists on an options 
exchange, and/or Market-Makers or specialists on an options exchange), 
class, and marketability as determined by the Exchange. Complex orders 
will only be eligible to trade with other complex orders through the 
AIM Auction. To the extent the Exchange determines to make an 
electronic book available for resting FLEX Orders, there will be no 
``legging'' of complex orders with FLEX Orders that may be represented 
in the individual series legs represented in the electronic book.\21\ 
Order allocation shall be the same as would be applicable for simple 
orders. In addition, the individual series legs of a complex order 
would not trade through equivalent bids (offers) in the individual 
series legs represented in the electronic book and at least one leg 
must better the corresponding bid (offer) of public customers and non-
Trading Permit Holder broker-dealers in the electronic book. Sixth, any 
determinations made by the Exchange pursuant to the proposed rule, such 
as eligible classes, order size parameters and the minimum price 
increment, would be communicated in a circular.\22\
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    \18\ The non-FLEX version of AIM contains the same prohibition. 
In addition, the non-FLEX version of AIM provides that a pattern or 
practice of submitting unrelated orders that cause an auction to 
conclude before the end of the RFR period will be deemed conduct 
inconsistent with just and equitable principles of trade and a 
violation of Rule 4.1. See Rule 6.74A.02. This ``unrelated orders'' 
provision would not be applicable to FLEX Options because unrelated 
FLEX Orders may not be submitted to the electronic book for the 
duration of an AIM Auction. See proposed Rule 24B.5A(b).
    \19\ This proposed pilot is modeled after an existing pilot for 
non-FLEX Options. The July 18, 2012 date is proposed so that the 
FLEX pilot will coincide with an existing pilot for non-FLEX 
Options. See Rule 6.74A.03.
    \20\ See note 6, supra.
    \21\ By comparison, for complex orders in non-FLEX Options 
classes, the AIM (and SAM) mechanisms permit complex orders to trade 
with the individuals series legs in the electronic book. See Rules 
6.74A.07 and 6.74B.01.
    \22\ The non-FLEX Option version of AIM also contains a 
provision for the automated customer-to-customer immediate crosses. 
See Rule 6.74A.08. The Exchange does not intend to make this 
automated crossing functionality available at this time for FLEX 
Options. If in the future the Exchange would determine to do so, it 
would be the subject of a separate rule filing.
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Solicitation Auction Mechanism
    The Exchange is also proposing to establish a SAM mechanism for 
FLEX Options, which is another mechanism that will electronically 
auction certain orders for price improvement. Under the SAM process, an 
Initiating TPH that represents agency orders may submit an Agency Order 
along with a second order (a solicited order(s) for the same amount as 
the Agency Order) \23\ into the SAM Auction where other FLEX Trader 
participants could compete with the Initiating TPH's second order to 
execute against the Agency Order. As explained in more detail below, 
the SAM mechanism is to be used for larger-sized Agency Orders that are 
to be executed against solicited orders.
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    \23\ Any solicited orders submitted by the Initiating TPH to 
trade against the Agency Order may not be for the account of a FLEX 
Market-Maker assigned to the option class. See proposed Rule 
24B.5B.03.
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    To be eligible, the Agency Order must be in a FLEX class designated 
as eligible for SAM Auctions and within the designated SAM Auction 
order eligibility size parameters determined by the Exchange (however, 
the eligible order size would not be less than 500 contracts). Such 
classes and size parameters will be determined by the Exchange and 
announced via circular to FLEX Traders. As explained in more detail 
below, each order entered into the SAM Auction would also be designated 
in the System as all-or-none (i.e., an order will be executed in its 
entirety or not at all). In addition, the second order may only be 
entered in a single-priced submission format (i.e., unlike AIM 
Auctions, there is no ``auto-match'' feature for SAM Auctions). Once 
the Initiating TPH has submitted an Agency Order for SAM processing, 
such submission cannot be cancelled by the Initiating TPH.
    Upon receipt of an Agency Order (and second order), the Exchange 
would commence the SAM Auction by issuing an RFR, detailing the price 
and size [sic] the Agency Order.\24\ The duration of the RFR response 
period (i.e., the auction period) would be established by the Exchange 
on a class-by-class basis and shall not be less than three (3) 
seconds.\25\ During that period, RFR responses may be submitted by FLEX 
Traders. These responses must specify price and size. Responses may not 
be entered for the account of an options Market-Maker from another 
options exchange. As with AIM Auctions, for SAM Auctions all RFR 
responses are ``blind.'' \26\ CBOE believes this aspect of the SAM 
Auction will encourage more aggressive quoting and superior price 
improvement. RFR responses may be modified or cancelled so long as they 
are modified or cancelled before the conclusion of the RFR response 
period. Lastly, the minimum price increment for RFR responses and for 
an Initiating TPH's single price submission shall be set by the 
Exchange at no less than one cent.
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    \24\ As with AIM Auctions, for SAM Auctions each RFR would be 
sent to those FLEX Traders electing to receive RFRs (i.e., those 
FLEX Traders who have established the necessary systems connectivity 
to receive RFRs). Thus, such election to receive RFRs would not be 
on a case-by-case basis.
    \25\ As with AIM Auctions, the Exchange is proposing that the 
minimum RFR exposure period for SAM be three (3) seconds, which is 
also consistent with the existing minimum exposure period for FLEX 
Option crossing pursuant to the existing FLEX crossing procedures. 
See Rule 24B.5(b)(3)(iii). By comparison, for non-FLEX Options, the 
minimum RFR exposure period for non-FLEX Options is one (1) second. 
See, e.g., Rule 6.45A.02, and Rule 6.74B(b)(1)(C).
    \26\ See note 10, supra.
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    Normally, a SAM Auction ends at the conclusion of the RFR response 
period (which will be no less than 3 seconds). However, as with AIM 
Auctions, the proposal provides that the SAM Auction would end prior to 
the conclusion of the RFR response period any time an RFR response 
matches the BBO on the opposite side of the market from the RFR 
responses.\27\
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    \27\ This early termination provision for FLEX Options is 
consistent with the operation of AIM and SAM for non-FLEX Options. 
As noted above, for non-FLEX Options, additional early termination 
provisions apply that would not be applicable to FLEX Options. See 
note 11, supra.
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    At the conclusion of the SAM Auction, the Agency Order would be 
executed against the second/solicited order unless there is sufficient 
size to execute the entire Agency Order at a price (or prices) that 
improves the proposed crossing price. In the case where there is one or 
more public customers or non-Trading Permit Holder broker-dealers at 
the proposed execution price on the opposite side of the Agency Order, 
the second/solicited order would be cancelled and the Agency Order 
would be executed

[[Page 310]]

against other bids (offers) if there is sufficient size at the bid 
(offer) to execute the entire size of the Agency Order (size would be 
measured considering RFR responses and resting FLEX Orders, to the 
extent the Exchange has determined to make available an electronic 
book)). If there is not sufficient size to execute the entire Agency 
Order, the proposed cross would not be executed and both the Agency 
Order and second/solicited order would be cancelled. Additionally, the 
proposed cross would not be executed and both the Agency Order and 
second/solicited order would be cancelled if the execution price would 
be inferior to the BBO.
    In the event the Agency Order is executed at an improved price(s) 
or at the proposed execution price against RFR responses and FLEX 
Orders, the allocation at a given price would be as follows: (i) RFR 
responses and FLEX Orders for the account of public customers and non-
Trading Permit Holder broker-dealers will participate in the execution 
based on time priority; (ii) any RFR responses and FLEX Orders that are 
subject to a FLEX Appointed Market-Maker participation entitlement will 
participate in the execution based on a participation entitlement 
formula specified in Rule 24B.5(d)(2)(ii); \28\ then (iii) all other 
RFR responses and FLEX Orders will participate in the execution based 
on time priority.
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    \28\ See note 15, supra.
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    Lastly, the Exchange proposes certain interpretation and policy 
provisions applicable to the SAM Auction mechanism. First, the Exchange 
is also proposing to apply the SAM Auction mechanism to complex orders. 
As proposed, the Exchange may determine on a class-by-class basis to 
make the SAM Auction available for complex orders. In such classes, 
complex orders may be executed through the SAM Auction at a net debit 
or net credit price provided the SAM Auction eligibility requirements 
are satisfied and the Agency Order is eligible for the SAM Auction 
considering its complex order type, order origin code (i.e., non-
broker-dealer public customer, broker-dealers that are not Market-
Makers or specialists on an options exchange, and/or Market-Makers or 
specialists on an options exchange), class, and marketability as 
determined by the Exchange. Complex orders will only be eligible to 
trade with other complex orders through the SAM Auction. To the extent 
the Exchange determines to make an electronic book available for 
resting FLEX Orders, there will be no ``legging'' of complex orders 
with FLEX Orders that may be represented in the individual series legs 
represented in the electronic book.\29\ Order allocation shall be the 
same as would be applicable for simple orders. In addition, the 
individual series legs of a complex order would not trade through 
equivalent bids (offers) in the individual series legs represented in 
the electronic book and at least one leg must better the corresponding 
bid (offer) of public customers and non-Trading Permit Holder broker-
dealers in the electronic book. Second, the proposed rule would also 
require Trading Permit Holders to deliver to customers a written 
document describing the terms and conditions of the SAM Auction 
mechanism prior to executing Agency Orders using the SAM Auction 
mechanism. Such written document would be required to be in a form 
approved by the Exchange.\30\ Third, the proposed rule would also 
specify that Trading Permit Holders may not use the SAM Auction 
mechanism to circumvent the Exchange's rules limiting principal order 
transactions.\31\ Additionally, the Exchange notes that for purposes of 
paragraph (e) to Rule 6.9, which paragraph prohibits anticipatory 
hedging activities prior to the entry of an order on the Exchange, the 
terms of an order would be considered ``disclosed'' to the trading 
crowd on the Exchange when the order is entered into the SAM Auction 
mechanism. Finally, fourth, any determinations made by the Exchange 
pursuant to the proposed SAM Auction rule, such as eligible classes, 
order size parameters and the minimum price increment, would be 
communicated in a circular.
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    \29\ See note 21, supra.
    \30\ This provision is the same as a provision in the SAM rule 
for non-FLEX Options. See Rule 6.74B.02. The Exchange proposes that 
the same notification used for Rule 6.74B may be used to satisfy the 
notification required under proposed Rule 24B.5B.02.
    \31\ See Rule 24B.5.
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Section 11(a)(1) of the Act
    Finally, the Exchange believes the proposed AIM and SAM Auctions 
for FLEX Options are consistent with Section 11(a)(1) of the Act \32\ 
and the rules promulgated thereunder. 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. 
Examples of common exemptions include the exemption for transactions by 
broker dealers acting in the capacity of a market maker under Section 
11(a)(1)(A),\33\ the ``G'' exemption for yielding priority to non-
members under Section 11(a)(1)(G) of the Act and Rule 11a1-1(T) 
thereunder,\34\ and ``Effect vs. Execute'' exemption under Rule 11a2-
2(T) under the Act.\35\ In this regard, we note that, Trading Permit 
Holders effecting transactions through the AIM and SAM Auctions and 
relying on the G exemption would yield priority to any public customer 
and non-TPH broker-dealer interest pursuant to the applicable 
allocation algorithms.
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    \32\ 15 U.S.C. 78k(a). Section 11(a)(1) 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 unless an exception applies.
    \33\ 15 U.S.C. 78k(a)(1)(A).
    \34\ 15 U.S.C. 78k(a)(1)(G) and 17 CFR 240.11a1-1(T).
    \35\ 17 CFR 240.11a2-2(T).
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    The Exchange also believes the proposed AIM and SAM Auctions meet 
the requirements of the Effect vs. Execution exemption under Rule 11A2-
2(T). 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 the transactions directly on the 
exchange floor. To comply with the rule's conditions, a member (i) must 
transmit the order from off the exchange floor, (ii) may not 
participate in the execution of the transaction once it has been 
transmitted to the member performing the execution,\36\ (iii) may not 
be affiliated with the executing member, and (iv) with respect to an 
account over which the member or an associated person has investment 
discretion, neither the member nor its associated person may retain any 
compensation in connection with effecting the transaction without 
express written consent from the person authorized to transact business 
for the account in accordance with the rule.
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    \36\ The member may, however, participate in clearing and 
settling the transaction.
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    Off-Floor Transmission: The requirement in Rule 11a2-2(T) for 
orders to be transmitted from off the exchange floor reflects Congress' 
intent that Section 11(a) should operate to put member money managers 
and non-member money managers on the same footing for purposes of their 
transactions for covered accounts. In considering other automated 
systems, the Commission and the staff have stated that the off-floor 
transmission requirement would be met if a covered account order is 
transmitted from off the

[[Page 311]]

floor directly to the exchange floor by electronic means.\37\ To the 
extent that orders and responses to AIM and SAM Auctions will be 
electronically submitted directly to the FLEX System from remote 
terminals, the Exchange believes the orders and responses transmitted 
for execution through AIM and SAM Auctions satisfy the off-floor 
transmission requirement.
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    \37\ See, e.g., Securities Exchange Act Release Nos. 29237 (May 
31, 1991) (regarding NYSE's Off-Hours Trading Facility); Securities 
Exchange Act Release No. 15533 (January 29, 1979) (regarding the 
Amex Post Execution Reporting System, the Amex Switching System, the 
Intermarket Trading System, the Multiple Dealer Trading Facility of 
the Cincinnati Stock Exchange, the PCX's Communications and 
Execution System, and the Phlx's Automated Communications and 
Execution System) and 14563 (March 14, 1978) (regarding the NYSE's 
Designated Order Turnaround System); see also Letter from Larry E. 
Bergmann, Senior Associate Director, Division of Market Regulation, 
SEC, to Edith Hallahan, Associate General Counsel, Phlx (March 24, 
1999) (regarding Phlx's VWAP Trading System); Letter from Catherine 
McGuire, Chief Counsel, Division of Market Regulation, SEC, to David 
E. Rosedahl, PCX (November 30, 1998) (regarding OptiMark); Letter 
from Brandon Becker, Director, Division of Market Regulation, SEC, 
to George T. Simon, Foley & Lardner (November 30, 1994) (regarding 
Chicago Match).
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    Non-Participation in Order Execution and Execution Through 
Unaffiliated Member: Rule 11a2-2(T) further provides that the exchange 
member and its associated persons may not participate in the execution 
of a transaction once the order has been transmitted to the exchange 
floor. This requirement was included to prevent members with their own 
brokers on the exchange floor from using those persons to influence or 
guide their orders' execution. This requirement does not preclude 
members from canceling or modifying orders, or from modifying the 
instructions for executing orders, after they have been transmitted to 
the floor. Such cancellations or modifications, however, also must be 
transmitted from off the exchange floor.\38\
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    \38\ Securities Exchange Act Release No. 14563 (March 14, 1978).
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    In a release discussing both the COMEX and the PACE systems, the 
Commission noted that a member relinquishes any ability to influence or 
guide the execution of its order at the time the order is transmitted 
into the systems and, although the execution is automatic, the design 
of these systems insures that members do not posses any special or 
unique trading advantages in handling orders after transmission to the 
trading floor.\39\ Similarly, orders and responses submitted to AIM and 
SAM Auctions will enter the FLEX System and be executed based on an 
established matching algorithm. To the extent that users of the AIM and 
SAM Auctions will relinquish control of their orders and responses upon 
transmission to the FLEX System, and will not be able to influence or 
guide the execution of their orders, the Exchange believes that this 
requirement is met with respect to orders and responses that are 
executed automatically through the AIM and SAM Auctions.
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    \39\ Securities Exchange Act Release No. 15533 (January 29, 
1979) at n. 25.
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    Furthermore, although Rule 11a2-2(T) contemplates having an order 
executed by an exchange member who is unaffiliated with the member 
initiating the order, the Commission has recognized that this 
requirement is not applicable when automated exchange facilities are 
used. For example, in considering the operation of COMEX and PACE, the 
Commission noted that while there is no 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 floors, the Commission has stated that executions obtained 
through these systems satisfy the independent execution requirement of 
Rule 11a2-2(T).\40\ Similarly, to the extent that the design of the AIM 
and SAM Auctions ensure that members do not possess any special or 
unique trading advantages in the handling of their orders after 
transmission, a member effecting a transaction through the AIM and SAM 
Auctions satisfies the requirement for execution through an 
unaffiliated member.
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    \40\ Id.
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    Non-Retention of Compensation for Discretionary Accounts: The 
Exchange notes that members who intend to rely on Rule 11a2-2(T) in 
connection with transactions using the AIM and SAM Auctions must comply 
with the requirements of Section (a)(2)(iv) of the rule.
2. Statutory Basis
    The proposed rule change is consistent with Section 6(b) of the 
Act,\41\ in general, and furthers the objectives of Section 6(b)(5) of 
the Act,\42\ in particular, in that it should promote just and 
equitable principles of trade, serve to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and protect investors and the public interest. In particular, 
the Exchange believes that the use of FLEX Options provide CBOE Trading 
Permit Holders and investors with additional tools to trade customized 
options in an exchange environment \43\ and greater opportunities to 
manage risk. The Exchange believes that making modified versions of the 
AIM and SAM mechanisms available for FLEX Options should serve to 
further those objectives and encourage use of FLEX Options by enhancing 
the existing processes for auctioning FLEX Orders, which should make 
the system more efficient and effective for the FLEX Option investor 
community.
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    \41\ 15 U.S.C. 78f(b).
    \42\ 15 U.S.C. 78f(b)(5).
    \43\ FLEX Options provide Trading Permit Holders and investors 
with an improved but comparable alternative to the over-the-counter 
(``OTC'') market in customized options, which can take on contract 
characteristics similar to FLEX Options but are not subject to the 
same restrictions. The Exchange believes that making these changes 
will make the FLEX Hybrid Trading System an even more attractive 
alternative when market participants consider whether to execute 
their customized options in an exchange environment or in the OTC 
market. CBOE believes market participants benefit from being able to 
trade customized options in an exchange environment in several ways, 
including, but not limited to the following: (1) Enhanced efficiency 
in initiating and closing out positions; (2) increased market 
transparency; and (3) heightened contra-party creditworthiness due 
to the role of The Options Clearing Corporation as issuer and 
guarantor of FLEX Options.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange neither solicited nor received comments on the 
proposal.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and

[[Page 312]]

arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-CBOE-2011-123 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2011-123. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of CBOE. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-CBOE-2011-123 and should be 
submitted on or before January 25, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\44\
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    \44\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-33713 Filed 1-3-12; 8:45 am]
BILLING CODE P