[Federal Register Volume 65, Number 250 (Thursday, December 28, 2000)]
[Notices]
[Pages 82420-82423]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-33123]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-43750; File No. SR-CBOE-00-52]
Self-Regulatory Organizations; Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by the Chicago Board Options
Exchange, Inc., Relating to Participation Entitlements of Designated
Primary Market Makers and Time and Priority Rules
December 20, 2000.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on November 7, 2000, the Chicago Board Options Exchange, Inc. (``CBOE''
or ``Exchange''), filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the Exchange. The
proposed rule change has been filed by the CBOE as a ``non-
controversial'' rule change pursuant to Rule 19b-4(f)(6) \3\ under the
Act. The Commission is publishing this notice to solicit 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.
\3\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The CBOE is proposing to increase the participation entitlements of
Designated Primary Market Makers (``DPMs'') when only one or two market
makers are at parity with the DPM, and to clarify the operation of
various CBOE rules concerning participation entitlements, time and
priority rules, and orders represented by a DPM as agent. The text of
the proposed rule change is available at the Office of the Secretary,
CBOE, and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the CBOE included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the purposed rule change. The
text these statements may be examined at the places specified in Item
IV below. The CBOE has prepared summaries, set forth in
[[Page 82421]]
Sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
A DPM's right to participate as principal in a transaction is
generally governed by the principles of time and price priority set
forth in CBOE Rule 6.45 and applicable in general to all bids and
offers made on the Exchange.\4\ Under these principles, if a DPM is
first to respond with the best bid (offer) in response to a request for
a market from a member not acting on behalf of the DPM, the DPM is
entitled to participate up to 100% in any resulting transaction.\5\
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\4\ Certain exceptions apply, as provided in Rule 6.45.
\5\ Similarly, by the principles set forth in Rule 6.45, if a
market maker is first to respond with the best bid (offer) in
response to a request for a market, the market maker is entitled to
participate up to 100% in any resulting transaction. However, this
entitlement applies only if the market maker's bid (offer) is better
than the DPM's previously established principal bid (offer). If the
DPM had previously established its principal bid (offer) at the
price at which the transaction is to take place, the DPM entitlement
provisions of CBOE Rule 8.87 apply, as explained below. It should be
noted further that, by the terms of Rule 6.45, if the best bid
(offer) is also represented by an order in the customer limit order
book, that order will have priority over any other bid (offer) at
the trading post.
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In addition to this right, CBOE Rule 8.87 authorizes the Modified
Trading System Appointments Committee (``MTS Committee'') to establish
from time to time a participation entitlement formula for all DPMs in
the securities allocated to them, to apply even when the DPM's bid or
offer is not otherwise entitled to priority in accordance with CBOE
Rule 6.45. Rule 8.87 grants any DPM trading for its own account a right
to participate with the market makers in the trading crowd--up to the
percentage established by the MTS Committee \6\--in transactions that
occur at the DPM's previously established principal bid or offer.\7\
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\6\ As specified in rule 8.87, the extent of the entitlement is
subject to the review of the CBOE Board of Directors.
\7\ On the other hand, when a DPM and one or more market makers
all announce bids (offers) that establish the best bid (offer) at a
price at which the DPM was not previously bidding, the priority
rules apply as set forth in Rule 6.45. As such, the member who was
first to respond at the best price (be it the DPM, a market-maker,
or a floor broker) is entitled to participate up to the full amount
of the order. As further provided by Rule 6.45, after the member
with time priority has been satisfied, all other members bidding
(offering) at the best price are entitled to participate based upon
the sequence of their bids (offers). Concerning the application of
the DPM entitlement when a customer order is at the best bid
(offer), see further below.
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The CBOE's current DPM participation entitlement is 30% for all
transactions occurring at the DPM's previously established bid or
offer.\8\ The 30% entitlement is a flat rate and applies regardless of
the volume in a particular class and the number of market makers
present in the trading crowd, and regardless of whether the class if
multiply listed. The CBOE is proposing to increase its DPM
participation entitlements when there are one or two market makers at
parity with the DPM \9\ as follows:
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\8\ See Securities Exchange Act Release No. 42190 (Dec. 1,
1999), 64 FR 68706 (Dec. 8, 1999).
\9\ According to the CBOE, market makers are deemed to be ``at
parity'' with the DPM when they are bidding or offering at the DPM's
previously established bid or offer; and ``at parity'' with each
other when it is impossible to determine, in the open outcry of the
auction floor, which market maker responded first with the best bid
(offer) in response to the request for a market. Telephone
conversation between Arthur B. Reinstein and Steve Youhn, CBOE, and
Ira L. Brandriss, Division of Market Regulation, Commission, on
December 4, 2000.
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50% when there is one market maker bidding (offering) at
the DPM's previously established bid (offer); and
40% when there are two market makers at parity with the
DPM.
When there are three or more market makers at parity with the DPM,
the DPM's participation entitlement will remain unchanged at 30%.
Accordingly, the changes would only occur in those limited instances
where there are just one or two market makers at parity with the DPM,
as the case may be. As discussed in more detail below, the CBOE
proposes to issue a regulatory circular (``Regulatory Circular'') to
establish these changes.
The proposed changes will enable the CBOE to conform its
participation entitlement percentages to the entitlements established
by the rules and/or practices of the other exchanges. For example, on
the Philadelphia Stock Exchange (``Phlx''), a specialist is currently
allocated 60% of an order when one ``controlled account'' is on parity,
40% when two are on parity, and 30% when three or more are on
parity.\10\ Similarly, on the International Securities Exchange
(``ISE''), after all public customer orders have been filled, a Primary
Market Maker (``PMM'') is allocated 60% of an order if only one other
participant is quoting at the best price, 40% if two other participants
are at the best price, and 30% if more than two other participants are
at the best price.\11\ The American Stock Exchange (``Amex'') and
Pacific Exchange (``PCX'') have similar practices and provisions.\12\
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\10\ See Phlx Rule 1014(g)(ii). A ``controlled account,'' for
the purposes of the referenced rule, includes any account controlled
by or under common control with a member broker-dealer of the Phlx.
See also Phlx Rule 1014(g)(i), which incorporates additional
provisions for situations when a customer order is on parity.
\11\ See Supplementary Material .01 to ISE Rule 713. ISE rules
also state that a PMM has precedence to execute orders of five
contracts or fewer.
\12\ On the Amex, a specialist is not currently entitled by rule
to a participation guarantee. However, the Amex recently filed a
proposal to codify the specialist allocation practices that have
developed on its trading floor. The proposal would guarantee the
specialist approximately 60% of an order when one registered trader
is on parity, 40% when two to four are on parity, 30% when five to
seven are on parity, 25% when eight to fifteen are on parity, and
20% when 16 or more are on parity. See Securities Exchange Act
Release No. 42964 (June 20, 2000), 65 FR 39972 (June 28, 2000). On
the PCX, after all public customer orders in the book have been
filled, an LMM is generally guaranteed the right to participate in
50% of each transaction occurring at its disseminated quote. See PCX
Rule 6.82(d).
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The primary purpose of the DPM participation right is to provide
Exchange members with an incentive to become and remain DPMs and to
assume the additional affirmative obligations imposed on DPMs that
other members do not have. These obligations include the obligation to
be present at the trading post throughout every business day, the
obligation to participate at all times in automated execution and order
handling systems such as the Exchange's Retail Automatic Execution
System (RAES), the obligation to act as an Order Book Official and to
maintain the public order book, and the obligation to provide high
quality markets and services and to promote the Exchange as a
marketplace to customers and other market participants.
In this respect, lower DPM participation entitlements on the CBOE
make it more difficult to attract and retain qualified DPMs. This puts
the CBOE at a competitive disadvantage to those exchanges that provide
for higher guarantees. Thus, the Exchange believes that the proposed
changes to its DPM participation entitlements are necessary to promote
the CBOE's competitiveness within the exchange-traded options
marketplace.\13\
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\13\ When it first proposed the current DPM participation right,
the CBOE stated that the MTS Committee would continue to
periodically review the entitlement ``to ensure that it remains at
an appropriate level given the market environment that prevails at
the time,'' and that accordingly, the Exchange might propose further
changes to the DPM participation entitlement in the future. See
Securities Exchange Act Release No. 41904 (Sept. 22, 1999), 64 FR
52813 (Sept. 30, 1999).
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The CBOE notes that the proposed changes will not affect the
priority currently afforded to public customers in the execution of
their option orders. The Exchange will continue to apply the DPM
participation entitlement only to that portion of the order that
remains
[[Page 82422]]
after all public customer orders have been filled. This applies to
customer orders in the book as well as those represented in the crowd.
Thus, CBOE's DPM participation entitlement will continue to benefit
customers by allowing them to receive full executions of their orders
before a DPM can assert its participation entitlement.
As mentioned above, to effect the changes to the DPM participation
entitlement level, the CBOE proposes to issue a new regulatory
circular. The CBOE further believes that it would be beneficial to its
membership if, for ease of access, the Exchange were to combine a
discussion of the provisions referencing priority and DPM participation
entitlements into one circular. Currently, in order to determine
whether and to what extent a DPM is entitled to participate in a
transaction, market participants must first reference Rule 6.45 and the
corresponding, previously issued circulars to determine whether the
principles of time and price priority are applicable. Next, they must
refer to the most recent circular addressing DPM participation
entitlements to determine whether these entitlements apply and at what
level. By combining the relevant provisions of these previously issued
circulars and the new changes into one comprehensive circular, CBOE
believes that its membership will be in a better position to access
this important information more quickly and efficiently.
The first section of the Regulatory Circular, ``Price and Time
Priority,'' contains a brief summary of the price and time priority
principles contained in CBOE Rule 6.45. The second section of the
Regulatory Circular, ``DPM Participation Right,'' establishes and
describes the participation percentages discussed in this proposal. As
such, it explains when a DPM is entitled to a participation entitlement
and, if so entitled, under what circumstances a 30%, 40%, or 50%
participation entitlement is appropriate.
This section further clarifies a long-held CBOE interpretation that
a DPM's participation entitlement is applicable to all securities
traded by a DPM, which includes options as well as non-option
securities traded pursuant to Chapter XXX of CBOE's Rules. Rule 8.87(b)
states that, with respect to the DPM entitlement, a DPM has the right
to participate for its own account ``in securities allocated to the
DPM.'' The circular makes clear that the term ``securities'' is not
restricted to options only and, therefore, that the participation
entitlement extends to non-option securities traded on the CBOE.
The third section of Regulatory Circular, ``Agency Orders,'' is an
amplification of the principle that public customer orders, whether in
the book or in the trading crowd, take priority over a DPM's
participation right. As such, this section clearly states that a DPM's
participation right is applicable only to that portion of an order that
remains after public customer orders have been filled. The proposed
circular also contains an example illustrating these principles:
Assume there is an order in the book to buy 150 contracts at $3, a
price that represents the national best bid. The DPM's previously
established principal bid is $3 and there are two market makers in the
crowd each bidding at $3. If a floor broker enters the crowd with a
market order to sell 300 contracts, the order in the book receives full
execution of 150 contracts at $3. Thereafter, because the market
makers' bids are at parity with the DPM's previously established
principal bid, the DPM is entitled to a participation right of 40% with
respect to the remaining 150 contracts of the market order. Therefore,
the DPM receives 40% of the remaining 150 contracts at $3, or 60
contracts. The two market makers in the crowd each receive 45 contracts
at $3.
The fourth section of the Regulatory Circular, ``Orders in the
Order Book,'' is primarily a restatement of time priority principles
contained in CBOE Rule 6.45 as applied to the Order Book. The first
sentence clarifies that because a DPM's previously established
principal bid (offer) could not have been equal to the book, a DPM
cannot participate with a market maker that was first to buy the book
offer (sell to the book bid). The next sentence explains the operation
of this principle in the context of crossed orders. Currently, when the
AutoQuote system bid or offer would cross a booked order, AutoQuote
will not adjust until the booked order trades. Thus, when a market
maker trades with the booked order in this instance, a DPM is not
entitled to participate because its previously established best bid or
offer could not have matched the book. This section clarifies that this
is the case even if the operation of AutoQuote may have prevented the
DPM's quote from automatically adjusting to match the book offer (bid).
The last section of the Regulatory Circular, ``Orders Represented
by a DPM as Agent,'' establishes that, because of its knowledge of
orders it represents as agent, a DPM Designee acting on behalf of the
DPM's market maker account cannot be deemed first to respond to the
request for a market from another person acting on behalf of the DPM in
performing the DPM's agency function. This is designed to prevent a DPM
from using knowledge of orders it represents as agent in order to trade
ahead of other market participants. This section clarifies that other
market participants must have the opportunity to act upon the order
represented by the DPM as agent before the DPM's principal account can
transact with that agency order.
However, a DPM Designee acting on behalf of the DPM's principal
trading account may be the first to make a bid (offer) at a particular
price with respect to a previously displayed resting order in the book
or a previously represented resting order held by a DPM Designee acting
as floor broker.
2. Statutory Basis
The CBOE believes that the proposed rule change will improve the
operation of the DPM trading system by making the DPM participation
entitlement more equitable for members while retaining the incentive
for members to become and remain DPMs. Accordingly, the Exchange
believes that the proposed rule change is consistent with Section 6(b)
of the Act,\14\ in general, and furthers the objectives of Section
6(b)(5) of the Act,\15\ in particular, in that it is designed to remove
impediments to and perfect the mechanism of a free and open market.
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\14\ 15 U.S.C. 78f(b).
\15\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The CBOE does not believe that the proposed rule change will impose
any burden on competition not necessary or appropriate in furtherance
of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
The foregoing proposed rule change has become effective pursuant to
Section 19(b)(3)(A) of the Act \16\ and Rule 19b-4(f)(6) thereunder
\17\ because the proposed rule change (1) does not significantly affect
the protection of
[[Page 82423]]
investors or the public interest; (2) does not impose any significant
burden on competition; and (3) by its terms does not become operative
before 30 days from the date on which it was filed, and the CBOE
provided the Commission with written notice of its intent to file the
proposed rule change at least five days prior to the filing date.
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\16\ 15 U.S.C. 78s(b)(3)(A).
\17\ 17 CFR 240.19b-4(f)(6).
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At any time within 60 days of the filing of such proposed rule
change, the Commission may summarily abrogate such rule change if it
appears to the Commission that such action is necessary or appropriate
in the public interest, for the protection of investors, or otherwise
in furtherance of the purposes of the Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether it is 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-00-52 and should be
submitted by January 18, 2001.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
Margaret H. McFarland,
Deputy Secretary.
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\18\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 00-33123 Filed 12-27-00; 8:45 am]
BILLING CODE 3010-01-M