[Federal Register Volume 65, Number 114 (Tuesday, June 13, 2000)]
[Notices]
[Pages 37191-37196]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14850]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42870; File No. SR-CBOE-97-37]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving Proposed Rule Change and Notice of Filing and
Order Granting Accelerated Approval of Amendment Nos. 1, 2, 3, 4 and 5
to the Proposed Rule Change Relating to Eligibility Requirements for
Participation on the RAES System
May 31, 2000.
I. Introduction
On August 6, 1997, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'' or ``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 amend its Retail Automatic
Execution System (``RAES'') eligibility requirements for market makers.
The proposed rule change was published in the Federal Register on
August 20, 1997.\3\ The Commission received three comment letters on
the proposed rule change.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Exchange Act Release No. 38928 (August 12, 1997), 62 FR
44296.
\4\ Letters from James I. Gelbort to the Commissioners, SEC,
dated September 7, 1997 (``Gelbort Letter''); Scott Kilrea,
President, Letco, Lee E. Tenzer Trading Company, to Jonathan G.
Katz, Secretary, SEC, dated February 20, 1998 (``Letco Letter No.
1''); and Scott Kilrea, President Letco, Lee E. Tenzer Trading
Company, et al, to Heather Seidal, Division of Market Regulation
(``Division''), SEC, dated August 7, 1998 (``Letco Letter No. 2'').
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On July 23, 1998, the CBOE submitted Amendment No. 1 to the
proposed rule change. \5\ On September 28, 1999, the CBOE submitted
Amendment No. 2 to the proposed rule change.\6\ On December 8, 1999,
the CBOE submitted Amendment No. 3 to the proposed rule change.\7\ On
March 22, 2000, the CBOE submitted Amendment No. 4 to the proposed rule
change.\8\ Finally, on May 19, 2000, the CBOE submitted
[[Page 37192]]
Amendment No. 5 to the proposed rule change.\9\
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\5\ Letter from Timothy H. Thompson, Director, Regulatory
Affairs, Legal Department, CBOE, to Heather Seidel, Division, SEC,
dated July 22, 1998 (``Amendment No. 1''). In Amendment No. 1, the
Exchange amended the proposal by establishing a floor percentage
that may be set by the Market Performance Committee (``MPC'') that
limits a market maker's total transactions and contract volume
executed on RAES. The CBOE also proposed that the market maker
percentages should be established and calculated on a quarterly
basis. Amendment No. 1 contained guidelines to be used by the MPC
when determining whether to exempt market maker activity on one or
more trading days during the applicable calendar quarter and
guidelines for the exercise of discretion by the MPC pursuant to
Interpretation .01 of the proposed rule change, which permits the
MPC to apply the eligibility requirements to fewer than all classes
traded at a particular trading station. Finally, the CBOE responded
to issues raised in Letco Letter No. 1 (see supra note 4).
\6\ Letter from Timothy Thompson, Director, Regulatory Affairs,
Legal Department, CBOE, to Richard Strasser, Division, SEC, dated
September 23, 1999 (``Amendment No. 2''). In Amendment No. 2, the
CBOE amended the proposal to limit its application to those options
classes identified by the Exchange as having market makers that
trade an inordinate percentage of their transactions on RAES. The
Exchange also reiterated its belief that the proposed rule language
afforded protections against potential discrimination by the MPC
when it determines which trading days to exempt from the percentage
calculations because the MPC will not know the identity of market
makers from the data it reviews. Finally, the Exchange responded to
issues raised in Letco Letter No. 2 (see supra note 4).
\7\ Letter from Stephanie C. Mullins, Attorney, CBOE, to Kelly
Riley, Division, SEC, dated December 7, 1999 (``Amendment No. 3'').
In Amendment No. 3, the CBOE amended the proposed rule change to
provide an exemption from the proposed RAES percentage requirements
for designated primary market makers (``DPMs'') and their designees,
when acting in the capacity as a DPM in an option class.
\8\ Letter from Timothy Thompson, Director, Regulatory Affairs,
Legal Department, CBOE, to Kelly Riley, Division, SEC, dated March
21, 2000 (``Amendment No. 4''). In Amendment No. 4, the CBOE
corrected rule language submitted in Amendment No. 3, which failed
to reflect the revisions proposed in Amendment No. 2.
\9\ Letter from Timothy Thompson, Director, Regulatory Affairs,
Legal Department, CBOE to Kelly Riley, Division, SEC, dated May 18,
2000 (``Amendment No. 5''). In Amendment No. 5, the CBOE amended the
proposed language of Interpretation .01 of Rule 8.16. Specifically,
Interpretation .01 is proposed to contain factors to be considered
by the MPC when it determines whether to impose the percentage
requirements on a particular options class. Further, the Exchange
deleted factors proposed in Amendment No. 1, which were to be used
by the MPC to determine whether to exempt an options class from the
percentage requirements. However, because the proposal, as amended
in Amendment No. 2, is no longer proposed to be implemented floor
wide but only applied to specific options classes that have been
identified by the MPC as having market makers that are not actively
fulfilling their market making obligations, the deleted factors were
no longer necessary.
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This order approves the proposed rule change, as amended. The
Commission is also soliciting comment on Amendment Nos. 1, 2, 3, 4 and
5 to the proposed rule change from interested persons.
II. Description of the Proposal
The CBOE proposes to establish two additional eligibility
requirements that market makers must satisfy to be eligible to
participate in the RAES system.\10\ The Exchange also proposes to
clarify that CBOE Rule 8.16 applies to RAES eligibility in all CBOE
options except options on the Standard & Poor's 100 Stock index
(``OEX''), options on the Standard & Poor's 500 Stock Index (``SPX'')
and options on the Dow Jones Industrial Average (``DJX''), which have
separate RAES rules.
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\10\ RAES is the Exchange's automatic execution system for small
(generally less than 50 contracts) public customer market or
marketable limit orders. When RAES receives an order, the system
automatically will attach to the order its execution price,
determined by the prevailing market quote at the time of the order's
entry into the system. A buy order will pay the offer; a sell order
will sell at the bid. An eligible market maker who is signed onto
RAES at the time the order is received will be designated to trade
with the public customer at the assigned price.
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The Exchange proposes to implement a limit on the percentage of a
market maker's overall trades, both in terms of total transactions and
contract volume, that a market maker may transact on RAES during a
quarterly period. The proposed eligibility requirements, however, will
not apply to DPMs.\11\ The eligibility requirements have two distinct
parts, both of which must be satisfied. First, a market maker's RAES
transactions may not exceed a maximum percentage of his or her total
transactions for a calendar quarter. Second, a market maker's contract
volume resulting from his or her RAES transactions must not exceed a
maximum percentage of his or her overall contract volume during a
calendar quarter.
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\11\ See Amendment No. 3.
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These percentages will be determined by the MPC. The MPC's
authority to determine the applicable percentages, however, will be
limited so that neither of the percentages may be set at less than
fifteen percent. In other words, the MPC may not establish a maximum
RAES transaction or contact volume percentage under fifteen percent.
Further, the MPC will only implement these eligibility requirements
on those options classes that have been identified as having market
makers that are not actively fulfilling their market making
obligations.\12\ If the MPC determines to implement the eligibility
requirements on an options class, a regulatory circular will be issued
setting forth the applicable percentages and the effective date for the
application of the percentages before the beginning of the quarterly
period.
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\12\ See Amendment No. 2.
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The MPC will have the authority to implement the eligibility
requirements on those options classes that it identifies as having
market makers that are not actively fulfilling their market making
obligations on the floor of the Exchange. The factors to be considered
by the MPC when determining whether to apply the percentage
requirements include complaints from floor brokers or other market
makers; the results of routine market performance surveys; data
concerning the percentage of RAES trades performed by a particular
market maker or market maker trading crowd; or any other factor that
the MPC deems relevant.\13\
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\13\ See Amendment No. 5.
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At the end of each quarter, the market maker transaction and volume
percentages will be calculated. The MPC will have the authority to
exempt from the percentage tabulations certain trading days. When
determining which days to exempt, however, the MPC will not be privy to
individual market maker identities. It will consider whether a
particular day experienced an unusually high percentage of RAES trades
compared to normal trading days and any other relevant factors.
Generally, the MPC will exempt market maker activity for any option
class on days where the percentage of RAES trades out of total trades
exceeds the requirement set for the class by the MPC.
If a market maker is found to be in violation of the eligibility
requirements, he or she may be determined ineligible to participate on
RAES. In addition, a market maker may be subject to disciplinary or
other remedial action by the MPC under paragraph (d) of Rule 8.16.
Market makers, pursuant to Chapters XIX and XVII, as applicable, may
appeal such actions taken by the MPC.\14\
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\14\ The Exchange also noted that the MPC might determine to
require an ineligible market maker to participate in RAES if there
is inadequate participation in a particular options class. See CBOE
Rule 8.16(c).
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III. Summary of Comments
The Commission received three comment letters from two commenters
on the proposed rule change.\15\ One commenter stated that he believed
that the proposed rule change was unnecessary.\16\ The other commenter,
while generally supporting the underlying motivation of the proposed
rule change, questioned its application on DPMs \17\ and requested that
approval of the proposal be postponed until the ramifications on DPMs
could be resolved.\18\ The Exchange submitted to the Commission a
letter in response to the issues raised by one commenter.\19\ In
addition, the Exchange addressed the issues raised in the comment
letters in Amendment Nos. 1, 2, and 3. The following discussion
summarizes the issues raised by the commenters and the Exchange's
response.
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\15\ See supra note 4.
\16\ See Gelbort Letter.
\17\ See Letco Letter No. 1.
\18\ See Letco Letter No. 2.
\19\ Letter from Charles J. Henry, President and Chief Operating
Officer, CBOE to Jonathan G. Katz, Secretary, SEC, dated October 31,
1997 (``Response Letter''). The Response Letter addressed the issues
raised in the Gelbort Letter.
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1. Gelbort Letter
In his comment letter, Mr. Gelbort questioned the appropriateness
of the proposed rule change and suggested that current Exchange rules
should be able to sufficiently address the concerns described by the
Exchange relating to market makers who fail to adequately fulfill their
market making obligations. Specifically, Mr. Gelbort suggested that by
filing the proposal the Exchange implied that it had been unable to
enforce the provisions of CBOE Rule 8.7.\20\ Mr. Gelbort stated that he
believed that other current Exchange rules, if employed effectively,
could adequately address the problems identified by the Exchange. For
example, according to Mr. Gelbort, CBOE Rule 8.2(a) provides
[[Page 37193]]
the Exchange with the authority to deny market maker registration for
insufficient ability. In addition, according to Mr. Gelbort, CBOE Rule
8.2(b) permits the MPC to suspend or terminate market maker
registrations for incompetence. Further, Mr. Gelbort stated, CBOE Rule
8.3 permits the MPC to suspend or terminate market maker appointments
when the interests of a fair and orderly market are served. Finally,
Mr. Gelbort described the authority granted to the MPC in CBOE 8.60 to
hold informal meetings or hearings that may result in remedial actions
against market makers and the disciplinary proceedings that the
Exchange may institute under Chapter XVII of its rules.
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\20\ CBOE Rule 8.7 sets forth the obligations of market makers.
Pursuant to CBOE Rule 8.7, market makers are required, among other
things, to execute transactions that constitute a course of dealings
that are reasonably calculated to contribute to the maintenance of a
fair and orderly market. Specifically, market makers are required,
among other things, to compete with other market makers to improve
markets, to make markets, to update market quotations in response to
changed market conditions and to price options contracts fairly.
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Mr. Gelbort also suggested that the proposed rule change might
create inequities associated with its administration. Specifically, Mr.
Gelbort raised concerns about the broad authority sought by the
Exchange and questioned the apparent lack of numerical limits. Mr.
Gelbort pointed out that the broad authority could result in the
proposed rule being applied to exclude certain market makers in an
arbitrary manner. He also questioned whether the proposed rule could be
applied differently to market makers and DPMs.\21\ In addition, Mr.
Gelbort suggested that because the Exchange has the authority to compel
market maker participation on RAES whenever a market maker is present
in the crowd during an expiration cycle after the market maker has
signed on to RAES once,\22\ that market makers would not be able to
self-regulate his or her own RAES trading percentage. Further, Mr.
Gelbort stated that the proposed rule would not encourage compliance
with the marekt making obligations of CBOE Rule 8.7 in all classes
allocated to a crowd.
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\21\ As discussed above, DPMs have been specifically exempted
from operation of the rule. See Amendment No. 3.
\22\ See CBOE Rule 8.16(b).
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Mr. Gelbort also questioned the effect of changing the phrase from
``in that trading crowd'' to ``at the trading station'' in proposed
Rule 8.16(a)(iv). Mr. Gelbort expressed concern that his change in
language could allow a future MPC to interpret the phrase as
prohibiting market makers standing in one part of the crowd from
trading or participating on RAES in all classes allocated to the crowd.
According to Mr. Gelbort, some DPMs arrange their stations to make it
difficult for all market makers to trade in all of the classes
allocated to the station and he questioned the significance of the
language change.
Finally, Mr. Gelbort stated that he believed that the proposed rule
change is anticompetitive because he believes it condones disregard for
the affirmative market making obligations and because it arbitrarily
restricts the number of market makers who may choose to interact with
RAES-eligible orders. Further, he believed that the Exchange should
clarify the problems sought to be addressed by the proposal and to
determine whether current Exchange rules adequately address these
problems. If, however, the Exchange finds that the proposal is the best
gauge for market maker performance, Mr. Gelbort believes that
persistent non-compliance should be met with sanctions stronger than
exclusion from RAES.
The Exchange responded to Mr. Gelbort's comments in its Response
Letter.\23\ The following summarizes the Response Letter.
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\23\ See supra note 19.
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The Exchange expressed its strong disagreement with Mr. Gelbort's
suggestion that is proposal was an indication of its inability to
enforce CBOE Rule 8.7. According to the Exchange, the proposal should
not be read to suggest that it lacks the ability to enforce compliance
with CBOE Rule 8.7, but should be considered as an additional incentive
for market makers to meet their market making obligations. The Exchange
explained that it utilizes a number of current rules to ensure
compliance by its market makers. For example, the Exchange stated that
it conducts semi-annual crowd evaluations pursuant to CBOE Rule 8.60
during which the MPC speaks to each member of a trading crowd to
explain the obligations of market makers. These reviews have led to
some trading crowds being restricted in new product allocations and
have led to referrals to the Department of Market Regulation for
appropriate action when it appears that individual market makers are
performing below standard.
The Exchange also stated that it evaluates the performance of
individual market makers. The Exchange reviews, on a quarterly basis,
whether a market maker is complying with the trading volume
requirements of Interpretation .03 of CBOE Rule 8.7.\24\ The Exchange
stated that the MPC takes progressive remedial actions against market
makers for violations of these provisions. In conjunction with the
MPC's review, the Department of Market Regulation reviews the 80
percent in-person requirement.\25\ According to the Exchange, these
reviews seek to ensure that market makers trade in the appointed
options. If a market maker is not performing, remedial actions may be
taken.
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\24\ Interpretation .03A of CBOE Rule 8.7 requires a market
maker to transact 75 percent of his or her total contract volume in
options classes to which he or she has been appointed.
Interpretation .03B of CBOE Rule 8.7 requires a market maker to
execute at least 25 percent of his or her total transactions in
person, and not through the use of orders, provided, however, that
for any calendar quarter in which a market maker receives market
maker treatment of off-floor orders, the market maker must execute
in person, and not through the use of orders, 80 percent of his or
her total transactions.
\25\ Id.
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Moreover, according to the Exchange, applications of potential
market makers are reviewed. The Exchange's Membership Committee reviews
all market maker applications, pursuant to CBOE Rule 8.2(a) and Chapter
III of the Exchange's rules. All market maker applicants must
successfully complete an examination that measures competence and
qualifications. Further, all applicants must attend educational
training.
In response to Mr. Gelbort's assertion that the proposal may be
inequitably administered because of the broad authority of the MPC to
set applicable percentages, the Exchange stated that this flexibility
was necessary because the MPC does not yet have experience with setting
such limitations. Further, the Exchange believes that the flexibility
will enable the MPC to apply appropriate to each class and to exempt
trading days as necessary. The Exchange stated that the administration
of the rule would not be arbitrary because the same percentages for a
particular class will apply to all market makers. Moreover, members
economically aggrieved by any MPC decision will be able to appeal such
decision pursuant to Chapter XIX of the Exchange's rules.
The Exchange disagreed with Mr. Gelbort's assertion that market
makers will be unable to effectively regulate their percentage of RAES
trades. While it is true that a market maker is obligated to log on to
RAES in specified circumstances, which prevents the market maker from
regulating the number of his or her RAES trades, the Exchange believes
that a market maker can regulate the number of non-RAES trades by
making competitive markets and aggressively competing for order flow.
Thus, the Exchange believes that market makers can regulate the
percentage of his or her RAES trades by monitoring his or her non-RAES
trades. Moreover, the Exchange states that the MPC's authority to
exempt certain
[[Page 37194]]
trading days should prevent market makers from failing to satisfy the
tests due to unusual market conditions.
In response to Mr. Gelbort's assertion that the proposal would not
encourage compliance with the obligation imposed on market makers to
make markets in all series of options classes at the trading station,
the Exchange states the proposal was not intended for such a purpose.
According to the Exchange, the proposed rule change was not meant to
encourage compliance with this market maker obligation and that other
Exchange rule serve this purpose.
Regarding the proposed change in language from ``in the trading
crowd'' to ``at the trading station,'' the Exchange states the terms
``station'' and ``trading crowd'' are synonymous, pursuant to
Interpretation .01 to CBOE Rule 8.8. Thus, a future MPC could not
change this Interpretation without first submitting a proposed rule
change to the Commission for approval.
The Exchange believes that the proposal should provide market
makers with an incentive to compete when they are signed onto RAES
because failure to actively fulfill their market obligations under CBOE
Rule 8.7 could lead to sanctions. The Exchange believes that the
proposal complements the other objectives tests to ensure that a market
maker fulfills his Rule 8.7 obligations. Further, the Exchange does not
believe that the proposal will limit the number of market makers who
will be able to actively engage in making markets in their appointed
classes. Rather, the Exchange believes that the proposal encourages
compliance with CBOE Rule 8.7 and promotes active competition among
market makers.
Finally, the Exchange agrees with Mr. Gelbort's observation that
persistent non-compliance with the proposal should be met with a
stronger sanction than expulsion from RAES. According to the Exchange,
suspension from RAES is only one of the alternative sanctions that may
be imposed pursuant to proposed paragraph (d) of CBOE Rule 8.16.
Specifically, if a member repeatedly violates the proposed rule, the
MPC may refer the violations to the Department of Market Regulation for
an investigation of the market maker's compliance with CBOE Rule 8.7
generally.
2. Letco Letters
Letco submitted two letters to the Commission in response to the
proposed rule change.\26\ In both letters, Letco expressed concern
about some of the administrative applications of the proposal.
Specifically, the commenter questioned the application of the proposal
with respect to DPMs. As discussed above, subsequent to these comment
letters, the Exchange amended the proposal to exempt DPMs from the
proposal rule.\27\ Thus, the commenter's concerns regarding DPMs are
moot.
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\26\ See Letco Letter Nos. 1 and 2, supra note 4.
\27\ See Amendment No. 3.
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IV. Discussion
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
exchange.\28\ In particular, the Commission finds that the proposal is
consistent with the requirements of Section 6(b)(5) \29\ of the Act,
which requires, among other things, that the rules of an exchange be
designed to promote just and equitable principals 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.
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\28\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\29\ 15 U.S.C. 78f(b)(5).
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Currently, CBOE Rule 8.16 does not contain any eligibility
requirements for participating on RAES that is related to a market
maker's trading activity. The Exchange stated that it had learned that
some market makers on the floor have relied on their RAES participation
to derive a large percentage of their profits and have not been
affirmatively fulfilling their market making obligations as set forth
in CBOE Rule 8.7. The Exchange explained that RAES was never intended
to be a substitute to the normal operation of a traditional market
making business. However, it became apparent to the Exchange that
participation on RAES had led some market makers to cease to perform
their obligations under CBOE 8.7.
To address these problems, the Exchange developed the proposed
eligibility requirements. With these requirements, the Exchange seeks
to ensure that market makers affirmatively make markets in their
allocated classes. The proposal seeks to prevent market makers from
relying on order flow from RAES without actively seeking order flow on
the floor of the Exchange.
Pursuant to CBOE Rule 8.7, market makers have specified obligations
that must be fulfilled. Generally, market makers are required to enter
into transactions that constitute a course of dealings ``reasonably
calculated to contribute to the maintenance of a fair and orderly
market.'' Further, market makers are obligated to continuously engage
in dealing for their own accounts when a lack of price continuity
exists or when there is a temporary disparity between supply and demand
for a particular contract, or when a temporary distortion of the price
relationships exists between options contracts of the same class. In
addition, market makers are specifically required to: (i) complete with
other market makers to improve markets; (ii) make markets, which will
be honored to a reasonable number of contracts in all series of options
classes at the trading post; (iii) update market quotations in response
to changed market conditions; and (iv) price options contracts fairly,
within certain perimeters.
As described above, market makers have many important obligations
that create a viable marketplace for options contracts, and perform
functions that contribute to fair and orderly markets, as well as to
liquidity. If market makers are not actively performing these
obligations, the integrity of the marketplace is compromised. Customers
expect that when they send an order to the CBOE floor that it will be
treated in a manner consistent with the requirements of the CBOE rules,
and when market makers fail to fulfill their obligations, customers can
be negatively impacted.
If market makers are failing to fulfill their obligations as the
Exchange described, the market for those securities can be adversely
affected because there is not competition from all of the market makers
in the trading crowd. This lack of total involvement by the crowd could
lead to inferior pricing of customer orders, and could affect
liquidity. Moreover, customer orders may be executed in a less timely
manner.
Thus, the Commission is satisfied that the proposal addresses these
concerns in a manner that is consistent with the Act. Under the
proposal, in a particular calendar quarter market makers will be
limited in the proportion of RAES transactions that may make up their
total transactions and total contract volume. As proposed, the MPC may
determine for a particular options class to limit each market maker's
transactions and contract volume attributed to trades on RAES to a
maximum percentage of each market maker's total transactions and
contract volume. The MPC will determine two percentages, one will
establish a maximum percentage of a market maker's total transactions
for the quarter that may be derived from RAES transactions; the other
will establish the
[[Page 37195]]
maximum contract volume that may be derived from a market maker's RAES
transactions. Neither of these percentages may be less than 15 percent.
The Commission believes that these percentages should encourage
market makers to actively fulfill their market making obligations. A
market maker allocated options that are subject to these percentages
requirements is more likely to participate in the floor market because
its passive participation by signing onto RAES will be limited based on
the market maker's non-RAES transactions. In this way, the proposed
rule should act as an incentive to market makers to fulfill their
obligations because those who fail to keep their RAES percentage within
the maximum percentages will be subject to sanctions, including
suspension of RAES participation.
The Commission is satisfied with the 15 percent floor that has been
established in the rule. This provision limits the discretion of the
MPC by preventing the MPC from establishing percentages that may be too
low, and recognizes the importance of technology in Exchange
operations. Today, a large amount of orders are routed to RAES for
automatic execution.\30\ Thus, an unduly restrictive percentage may
have unintended consequences that compromise order flow and trading
operations. This floor percentage is intended to strike a balance
between establishing reasonable percentages to encourage market-makers
to fulfill their obligations on the floor while also recognizing the
amount of order flow that is routed to the RAES system for execution.
The Commission expects that the Exchange will monitor the percentages
established by the MPC to ensure that this balance is preserved.
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\30\ According to the Exchange, approximately 34% of its order
executions take place in RAES.
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The proposal will only be implemented in those options classes that
the Exchange has identified as having market makers that are not
actively fulfilling their market making obligations. The Commission
believes that this limitation is appropriate and consistent with the
Act. There would not be any reason to impose such limitations on market
makers who are already actively making markets in their allocated
options classes. This proposal provides the MPC with a remedial measure
that can be imposed when a problem is identified.
The MPC will have the authority to determine the options classes in
which market makers will be subject to the percentage limitations. In
determining whether to impose the percentage requirements on a
particular options classes, the MPC will consider factors such as
complaints from floor brokers or other market makers that certain
market makers performance surveys, data concerning the percentage of
RAES trades performed by particular market makers, and other relevant
factors. The Commission believes that these factors provide the MPC
with the appropriate amount of discretion. Because the MPC will
consider only relevant data, the limitations on the proportion of RAES
trades to a market maker's total trades should only be applied to those
options classes that are experiencing market maker problems. The
Commission believes that this discretion should provide the MPC with
flexibility to implement the eligibility requirements where needed,
while also preventing the implementation of these requirements in
classes that do not have such a need.
The MPC, at the end of each quarter, will have the authority to
exclude from the percentage calculations trading days that may have
experienced an unusually high percentage of RAES transactions when
compared to normal trading days. In making this decision, the MPC,
however, will not be able to identify individual market makers. Thus,
the MPC will not be able to make these decisions based on any market
maker's identity or volume. This anonymity should help to ensure that
the process of excluding days is fair.
As described above, the Commission received three comment letters
from two commenters regarding the proposal. The Commission believes
that the Exchange adequately addressed the commenters concerns.
Specifically, the Commission believes that the proposal does not
reflect upon the Exchange's ability to enforce its market making
obligations. Rather, the Commission believes that the proposal should
enhance the existing regulatory structure of the Exchange. In addition,
the Commission is satisfied with the Exchange's assertion that its
rules already specifically define the terms ``in that trading crowd''
and ``at the trading station'' as synonymous, and the Commission
further agrees that such definitions could only be amended by a rule
change approved by the Commission.
The Commission disagrees with Mr. Gelbort's assertion that the
proposal is anticompetitive because it condones disregard for
affirmative market making obligations and because it arbitrarily
restricts the number of market makers that may interact with RAES-
eligible orders. On the contrary, the Commission believes that the
proposal should encourage market makers to vigorously make markets in
their appointed classes. Moreover, the Commission does not believe that
the proposal arbitrarily restricts the number of RAES-eligible market
makers that may interact with RAES transactions because all market
makers will be able to continue to interact with RAES orders so long as
their businesses do not place an over-reliance on RAES transactions to
the detriment of the business on the floor. Market makers that fulfill
their market making obligations on the floor, as well as in RAES,
should not be prevented from participating in either trading forum.
Finally, as discussed above both commenters expressed concerns
about how the proposal would apply to DPMs. The Exchange has addressed
these concerns by exempting DPMs from operation of the rule. DPMs have
additional responsibilities along with making markets, such as
maintaining the book, participating at all times in automated execution
and order handling systems, and responding to competitive developments
in areas of market quality and customer service.\31\ Thus, a DPM is
unable to rely primarily on RAES trades to operate profitably.
Therefore, imposing the eligibility requirements on DPMs would be
unwarranted.
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\31\ See CBOE Rules 8.80 and 8.81.
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The Commission finds good cause to accelerate approval of Amendment
Nos. 1, 2, 3, 4 and 5 to the proposed rule change prior to the
thirtieth day after the date of publication of notice thereof in the
Federal Register.
In Amendment No. 1, the Exchange proposed to prohibit the MPC from
requiring that market makers' transaction or contract volume from RAES
executions be less than 15 percent of their total transaction or
contract volume. By placing a floor on the percentage of a market
maker's total transaction and contract volume that it must execute
otherwise than on RAES, the Commission believes that the changes
proposed in Amendment No. 1 preclude the MPC from establishing
eligibility requirements that could actually harm the operations of the
floor and the business of the market makers. The Exchange also proposed
to apply these market makers eligibility requirements on a quarterly
basis. Finally, the Exchange proposed two sets of guidelines for the
MPC. The first set of guidelines will be used by the MPC to determine
which days to exclude from the eligibility calculations. The Commission
believes that these proposed guidelines strengthen the proposal by
preventing the MPC from
[[Page 37196]]
considering inappropriate information that could lead to uneven or
potentially discriminatory application of the eligibility requirements.
The second set of guidelines set forth the factors to be considered by
the MPC, pursuant to Interpretation .01, in determining whether to
apply the eligibility requirements to fewer than all the option classes
traded at a trading station. The second set of guidelines was
eliminated by the CBOE in a subsequent amendment.\32\
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\32\ See Amendment No.5
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The Commission believes that the proposals in Amendment No. 1
enhance the proposed rule change. For these reasons the Commission
believes that good cause exists, consistent with Section 6(b)(5) \33\
and Section 19(b) \34\ of the Act, to accelerate approval of Amendment
No. 1 to the proposed rule change.
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\33\ 15 U.S.C. 78f(b)(5).
\34\ 15 U.S.C. 78s(b).
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In Amendment No. 2, the Exchange proposed to limit the application
of the proposed rule to options classes identified as having market
makers that trade an inordinate percentage of their trades on RAES. The
Commission believes that allowing the Exchange to limit application of
the proposal to only certain options classes will reduce the potential
for undue burdens to be placed on those options classes that are
trading without problems and that have market makers that are actively
fulfilling their market making obligations. In addition, the Exchange
further explained why it believes that its proposal sufficiently
protects against the MPC discriminating against or in favor of any
parties when exercising its discretion to exclude certain days from the
percentage calculations. The Commission is satisfied that the proposal
prevents the MPC from applying the eligibility requirements in a
discriminatory fashion. In particular, the Commission believes that,
because the data upon which the MPC will base its decision to exclude
certain days from the calculation of the eligibility requirement will
not identify individual market makers, the MPC will not be able to make
such decisions based upon the businesses of the individual market
makers on those days. For these reasons, the Commission believes that
Amendment No. 2 is consistent with the Act and that good cause exists
to accelerate its approval.
The Commission believes that good cause exists, pursuant to Section
6(b)(5) \35\ and Section 19(b) \36\ of the Act, to accelerate approval
of Amendment No. 3 to the proposed rule change. In Amendment No. 3, the
Exchange proposed to exempt DPMs from the eligibility requirements. The
Commission believes that in light of the additional responsibilities
that DPMs must fulfill and due to the fact that these additional
responsibilities are required by specific CBOE rules, that it is
reasonable to exempt DPMs from the eligibility requirements.
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\35\ 15 U.S.C. 78f(b)(5).
\36\ 15 U.S.C. 78S(b).
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The Commission believes that good cause exists, pursuant to Section
6(b)(5) \37\ and Section 19(b) \38\ of the Act, to accelerate approval
of Amendment No. 4 to the proposed rule change. Amendment No. 4 was
technical in nature and only sought to correct the proposed rule
language submitted in Amendment No. 3 to make it consistent with the
proposed rule language submitted in Amendment No. 2.
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\37\ 15 U.S.C 78f(b)(5).
\38\ 15 U.S.C. 78s.
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Finally, in Amendment No. 5, the Exchange deleted proposed factors
that were no longer applicable after the submission of Amendment No. 2.
Specifically, in Amendment No. 2, the Exchange proposed to only apply
the percentage requirements to those options classes that had a
demonstrated need for the limitations. The factors the Exchange
proposes to delete in Amendment No. 5 were to be used by the MPC to
determine if options classes should be exempt from the percentage
requirements. Because the proposal now only applies the percentage
requirements to those options classes with a demonstrated need, these
factors are no longer appropriate. In addition, the Exchange proposed
to add factors to be used by the MPC to determine which options classes
should be subject to the percentage requirements. The Commission
believes that the factors, as described above, provide the Exchange
with appropriate discretion to determine which options should be
subject to the limitations. Therefore, the Commission believes that
good cause exists, pursuant to Section 6(b)(5) \39\ and Section 19(b)
\40\ of the Act, to accelerate approval of Amendment No. 5.
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\39\ 15 U.S.C. 78f(b)(5).
\40\ 15 U.S.C. 78s(b).
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V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1, 2, 3, 4, and 5, including
whether Amendment Nos. 1, 2, 3, 4 and 5 are consistent with the Act.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW, Washington, DC 20549-0609. Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying in the Commission's Public
Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the CBOE. All
submissions should refer to File No. SR-CBOE-97-37 and should be
submitted by July 5, 2000.
VI. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\41\ that the amended proposed rule change (SR-CBOE-97-37) is
approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\42\
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\41\ 15 U.S.C. 78s(b)(2)
\42\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14850 Filed 6-12-00; 8:45 am]
BILLING CODE 8010-01-M