[Federal Register Volume 61, Number 2 (Wednesday, January 3, 1996)]
[Notices]
[Pages 199-202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-00020]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36635; File No. SR-CBOE-95-52]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the Chicago Board Options Exchange, Incorporated Relating to
the Suspension of the Ten Contract Firm Quote Requirement During Fast
Markets
December 22, 1996.
I. Introduction
On September 5, 1995, the Chicago Board Options Exchange,
Incorporated (``CBOE'' or ``Exchange'') filed a proposed rule change
with 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\ to
amend CBOE Rules 8.51, 6.6 and 6.20 Interpretation .09 to: (i) Remove
the pilot status of Rule 8.51; (ii) conform Rule 8.51 to the existing
practice of permitting, but not requiring, Floor Officials to suspend
the ten contract firm quote requirement of Rule 8.51(a) during a fast
market; (iii) expand the group of persons with authority to grant
suspensions, exemptions or exceptions to Rule 8.51 (currently only the
Market Performance Committee) to any two Floor Officials, (iv) specify
that when a fast market is declared any two Floor Officials have the
power to suspend the firm quote requirement of Rule 8.51 and turn off
the Retail Automatic Execution System (``RAES''); (v) allow the senior
person then in charge of the Exchange's Control Room to suspend the ten
contract firm quote requirement under certain circumstances; and (vi)
amend Rule 6.20 Interpretation .09 to clarify the instances
[[Page 200]]
where a member of the Market Performance Committee may perform the
functions of a Floor Official.
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19(b)-4.
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Notice of the proposal was published for comment and appeared in
the Federal Register on October 25, 1995.\3\ The Commission received
one comment letter concerning the proposed rule change.\4\ This order
approves the Exchange's proposal.
\3\ See Securities Exchange Act Release No. 36391 (October 18,
1995), 60 FR 54737.
\4\ The Security Traders Association (``STA'') supports the
proposal to codify the Exchange's authority to suspend the ten
contract firm quote requirement during a fast market because it will
permit the market to react promptly to systems malfunctions, events
in the market, or other circumstances which interfere with the
Exchange's ability to disseminate current and accurate quotes. The
STA believes that a self-regulatory organization must have the power
and authority to modify, within limits, any technological or
operational procedure immediately upon determining that it does not
fulfill its intended purpose. See Letter from William R. Rothe,
Chairman, and John L. Watson, III, President, STA, to Jonathan G.
Katz, Secretary, Commission; dated November 15, 1995 (``Comment
Letter'').
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II. Description of the Proposal
The purposes of the proposal are: (1) To approve Rule 8.51 (``ten
contract firm quote requirement'') on a permanent basis, removing the
current pilot program designation, (2) to conform Rule 8.51 to the
existing practice of permitting, but not requiring, Floor Officials to
suspend the ten contract firm quote requirement of Rule 8.15(a) during
a fast market, (3) to expand the group of persons with authority to
grant suspension, exemptions, or exceptions to the firm quote
requirement from the Market Performance Committee members to any two
Floor Officials, (4) to specify that when a fast market is declared
pursuant to Rule 6.6, two Floor Officials have the power to suspend the
firm quote requirement of Rule 8.51 and turn off RAES, (5) grant the
senior person then in charge of the Exchange's Control Room the
authority to suspend the ten contract firm quote requirement, if there
is a system malfunction that affects the Exchange's ability to
disseminate or update market quotes, and (6) to amend Rule 6.20
Interpretation .09 to clarify that the instances where a member of the
Market Performance Committee may perform the functions of a Floor
Official include enforcing policies and acting pursuant to rules
related to RAES, fast markets, and the ten contract firm quote
requirement.
Rule 8.51(a) requires a trading crowd to sell (buy) at least ten
contracts at the offer (bid) which is displayed when a buy (sell)
customer order reaches the trading crowd. Initially, this rule was
adopted as an Exchange pilot program to be monitored and enforced by
the Exchange's Market Performance Committee.\5\ The ten contract firm
quote requirement has been in effect since 1989, and the Exchange
believes it is now time to remove the designation as a pilot program.
The Exchange believes that the ten contract firm quote requirement has
been beneficial to investors and has provided greater liquidity to the
markets by requiring that the orders of non-broker dealer customer be
filled for at least ten contracts at the displayed quote price. The
Exchange further represents that trading crowds are aware of the
requirements of Rule 8.51 and have generally been able to meet its
requirements.\6\
\5\ See Securities Exchange Act Release No. 26924 (June 13,
1989), 54 FR 26284 (June 22, 1989).
\6\ See Letter from Michael Meyer, Attorney, Schiff Hardin &
Waite, to John Ayanian, Attorney, Office of Market Supervision
(``OMS''), Division of Market Regulation (``Market Regulation''),
Commission, dated December 14, 1995 (``CBOE Letter'').
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Rule 8.51(a)(2) currently provides that the ten contract firm quote
requirement will be in effect unless a fast market has been declared.
Although not presently explicit in the rules, it is current practice
not to automatically suspend this requirement when a fast market has
been declared. The Exchange proposes to amend Rule 8.51(a)(2) and add
Interpretation .07 to clarify that the ten contract firm quote
requirement in paragraph (a) of Rule 8.51 is not automatically
suspended when a fast market is declared. Instead, Interpretation .07
would provide that any two Floor Officials have the power, but are not
required, to suspend this requirement when a fast market has been
declared.
CBOE believes the interests of a fair and orderly market are better
served when the rules allow Exchange officials the discretion to
evaluate market conditions and circumstances and to exercise their
judgment as to whether the ten contract firm quote requirement should
be suspended in a fast market. This permits the firm quote requirement
to remain in place for the benefit of non-broker dealer customers even
when a fast market has been declared, except in those specific
instances where two Floor Officials have determined that the ten
contract firm quote requirement should be suspended.
As set forth in Interpretation .09 to Rule 6.20, members of the
Market Performance Committee may perform the functions of Floor
Officials for the purpose of enforcing trading conduct policies. As
Rule 8.51 is presently written, only the Market Performance Committee
or Market Performance Committee members acting as Floor Officials may
grant exemptions from, or make exceptions to, Rule 8.51. CBOE believes
Floor Officials from the Floor Officials Committee are also qualified
to make decisions regarding exemptions from, and exceptions to Rule
8.51. CBOE sees no reason to limit this power to members of the Market
Performance Committee. CBOE also believes that the power to suspend
Rule 8.51 once a fast market is declared should be granted to any two
Floor Officials, whether they are members of the Market Performance
Committee or members of the Floor Officials Committee.
CBOE's proposal would grant equal power to members of the Floor
Officials Committee and members of the Market Performance Committee to
act under Rule 8.51 regarding suspensions, exceptions to or exemptions
from the firm quote requirement. It is important for a timely decision
to be made once a fast market has been declared or other situations
have arisen which warrant the suspension of the firm quote requirement,
or an exemption or exception to this requirement. CBOE believes that it
could be detrimental to a fair and orderly market to delay action until
a member of the Market Performance Committee could be found to make
such a decision when members of the Floor Officials Committee might
already be present at the trading post. To implement CBOE's intention
that any two Floor Officials may make decisions under Rule 8.51,
including members of the Market Performance Committee acting as Floor
Officials and members of the Floor Officials Committee, the proposal
would amend Rule 6.20, Interpretation .09, amend Rule 8.51(a)(3), and
add Interpretation .06 to Rule 8.51. In addition, the proposal would
amend Rule 8.51 to clarify that in deciding whether to grant a
suspension, exception to or exemption from the firm quote requirement,
Floor Officials consider whether to do so would be in the interest of a
fair and orderly market.
Because Rule 8.51 requires that Exchange market makers honor non-
broker dealer customer orders at the displayed quote for up to ten
contracts, it is important that the displayed market quote be accurate.
Otherwise, market makers would be forced to trade ten contracts at an
inaccurate or ``stale'' quote price. Therefore, if there is a system
malfunction or other circumstance which interferes with the Exchange's
ability to disseminate the then current and accurate quote, it is
important for the Exchange to be able to act quickly to suspend the
market
[[Page 201]]
maker's obligations under Rule 8.51 until the difficulty is resolved.
To implement such a quick response, the proposal would further amend
Rule 8.51 to grant to the senior person then in charge of the
Exchange's Control Room the authority to suspend the ten contract firm
quote requirement contained in Rule 8.51(a) if there is a system
malfunction or other circumstance that affects the Exchange's ability
to disseminate or update market quotes. After exercising such
authority, the senior person would need to immediately seek approval of
two Floor Officials, who would be empowered to confirm or overrule the
suspension.
It is important for the Control Room to have this power to suspend
the firm quote requirement, since the Control Room would most likely
learn of the system malfunction before Floor Officials or other
Exchange staff. Consequently, the Control Room could act in a timely
manner to prevent market makers from having to trade at ``stale''
market quotes. If the Control Room does invoke its power to suspend the
firm quote requirement, then the Control Room would disseminate a
message notifying the public that the displayed quotes are not firm
because of a data dissemination problem. This would inform non-broker
dealer customers that their orders would not necessarily be filled at
that displayed bid or offer. Once the system malfunction has been
corrected and the market quotes have been updated, either the senior
person then in charge of the Exchange's Control Room or two Floor
Officials would be required to end the suspension of the firm quote
requirement.
As it is presently written, Rule 6.6(b) provides that the two Floor
Officials declaring a fast market have the power to take a number of
specified actions and more generally to take such other actions as are
deemed necessary in the interest of maintaining a fair and orderly
market. When a fast market has been declared, pursuant to these general
powers, Floor Officials will often, in the interest of maintaining a
fair and orderly market, suspend the ten contract firm quote
requirement of Rule 8.51. This decision to suspend the firm quote
requirement is made often during a fast market because the displayed
quote is not current or accurate due to the influx of orders or other
unusual circumstances. Therefore, market makers should not be forced to
trade ten contracts at an inaccurate quote. In order to notify members
and the public that, during a fast market, Floor Officials may suspend
the firm quote requirements, CBOE proposes to specify in Rule 6.6(b)
that when a fast market is declared, Floor Officials have the power to
suspend the ten contract firm quote requirement of Rule 8.51.
For the same reasons, after a fast market declaration, another
action Floor Officials may take in the interest of maintaining a fair
and orderly market is to turn off RAES. 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 prevailing market quote
for an offer and a sell order will sell at the prevailing market quote
for the bid. A market maker who has signed on as a participant in RAES
will be designated as a contra-broker on the trade. Trades are assigned
to these participating market makers on a rotating basis. Therefore, by
agreeing to participate in RAES, a market maker is automatically
assigned trades based on the prevailing market quote that is then being
disseminated. Consequently, it is important for the prevailing market
quote to be accurate, because otherwise market makers participating in
RAES may be assigned trades at prices other than the actual prevailing
market quote. During a fast market, often the influx of orders is
greatly increased or other unusual circumstances exist that affect the
accuracy of the prevailing market quote. For this reason, Floor
Officials, acting under the general powers of Rule 6.6(b), may turn off
RAES to prevent market makers from being assigned trades based on
inaccurate market quotes. In order to notify members and the public
that such action may be taken in a fast market, CBOE proposes to amend
Rule 6.6 to specify that Floor Officials have the power to turn off
RAES after a fast market has been declared.
If RAES is turned off because of the circumstances described above,
the orders that would have been routed to RAES will be automatically
re-outed to either the Public Automated Routing System (``PAR'')
workstation \7\ or floor broker printer in the trading crowd, or to the
appropriate member firm booth. Where the order is re-routed will depend
upon parameters set by member firms for their customers' orders prior
to entering the orders onto RAES.\8\
\7\ A PAR workstation is an automated, computer-based
workstation that provides users with the ability to execute trades,
transmit trade reports, and enter other data and commands at the
touch of a screen, thereby eliminating the delay inherent in a
keyboard-based system. Telephone conversation between Anthony
Montesano, Manager, Trading Operations, CBOE, and John Ayanian,
Attorney, OMS, Market Regulation, Commission, on December 21, 1995.
\8\ According to CBOE, when determining order parameters for
routing purposes, the member firms look to (1) the size of the
order, (2) whether the series is on RAES, and (3) whether it is a
market order or an immediately executable limit order. Telephone
conversation between Edward Joyce, CBOE, and John Ayanian, OMS,
Market Regulation, Commission, on December 21, 1995.
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Furthermore, as Rule 6.6(b) is presently written, it could be
interpreted that only the same two Floor Officials who declared the
fast market have the power to take the other actions specified in Rule
6.6(b). CBOE's practice has been that any two Floor Officials have the
powers specified in Rule 6.6(b), not just the specific two individuals
who declared the fast market. Therefore, CBOE proposes an amendment to
Rule 6.6(b) to clarify that any two Floor Officials have the powers
specified in 6.6(b).
CBOE believes that members of the Market Performance Committee, who
perform Floor Officials functions, as well as Floor Officials who are
members of the Floor Officials Committee, are equally qualified to make
decisions regarding Rule 6.6. To clarify that members of the Market
Performance Committee may also act pursuant to Rule 6.6, the proposal
would amend Rule 6.20 Interpretation .09 to specify that the Floor
Official functions that Market Performance Committee members may
perform include acting pursuant to rules related to fast markets and
RAES. Again, when circumstances arise which might require the
declaration of a fast market, it is important for timely decisions to
be made regarding the declaration of a fast market and other related
decisions specified in Rule 6.6. CBOE believes that it would be
detrimental to a fair and orderly market to delay action until a Floor
Official from the Floor Officials Committee is found to make such
decisions when members of the Market Performance Committee might
already be present at the trading post.
The Exchange believes that the proposal is consistent with and
furthers the objectives of Section 6(b)(5) of the Act, in that the
proposal is designed to perfect the mechanisms of a free and open
market and to protect investors and the public interest by: (1)
Enabling any two Floor Officials to evaluate and consider market
conditions and circumstances in determining whether to suspend the firm
quote requirement of Rule 8.51 during a fast market; (2) clarifying the
powers of Market Performance Committee members and specifying the
powers Floor Officials may invoke during a fast market; and (3)
[[Page 202]]
granting certain authority to the senior person then in charge of the
Control Room to suspend the firm quote requirement when there has been
a system malfunction affecting the dissemination or updating of quotes.
The Exchange also believes that the entire proposal is consistent
with Section 6(b) of the Act in general and furthers the objectives of
Section 6(b)(5) in particular in that it is designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of change, to foster cooperation and coordination
with persons engaged in facilitating transactions in securities, and to
remove impediments to and perfect the mechanism of a free and open
market and a national market system.
III. Commission Finding and Conclusions
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, and, in
particular, the requirements of Section 6(b)(5) of the Act.\9\
Specifically, the Commission finds that the Exchange's proposal strikes
a reasonable balance between the Commission's mandates under Section
6(b)(5) to remove impediments to and perfect the mechanism of a free
and open market and a national market system, while protecting
investors and the public interest.
\9\ 15 U.S.C. 78f(b)(5).
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For purposes of the CBOE's proposal to permanently approve the ten
contract firm quote pilot program, the Commission reasserts its initial
position regarding the benefits of the rule on the CBOE.\10\
Specifically, the permanent approval of the ten contract firm quote
requirement rule is consistent with Section 6(b)(5) of the Act in that
the rule results in improved market quality and better market maker
performance than would otherwise occur. The ten contract firm quote
requirement should continue to result in better executions of small
customer orders by ensuring greater depth of CBOE options markets.
\10\ See Securities Exchange Act Release No. 26924 (June 13,
1989), 54 FR 26284 (June 22, 1989).
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The Commission also believes that the ten contract firm quote
requirement encourages market makers to become more competitive in
making size markets, thereby facilitating transactions in securities,
contributing to a more free and open market, and improving the quality
of the CBOE's public customers' options markets.
The Commission also believes that it is appropriate for the
Exchange to conform its rules to the current practice not to
automatically suspend the ten contract firm quote requirement when a
fast market has been declared.\11\ Accordingly, the Commission believes
that it is appropriate to add Interpretation .07 to Rule 8.51 to grant
any two Floor Officials the authority, but not require them, to suspend
the ten contract firm quote requirement during a fast market. The
Commission agrees with the CBOE that, during a fast market, Exchange
officials should have the discretion to evaluate market conditions and
circumstances and to exercise their judgment as to whether the ten
contract firm quote requirement should be suspended. Both amended Rule
8.51(a)(2) and proposed Interpretation .07 to Rule 8.51 adequately
address these issues and should help minimize adverse impact on non-
broker dealer customers during a fast market when two Floor Officials
determine that market conditions and circumstances do not warrant such
action.
\11\ See CBOE Rule 8.51(a)(2).
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The Commission also believes it is appropriate to allow the
Exchange to allow any two Floor Officials, including members of the
Market Performance Committee acting as Floor Officials and members of
the Floor Officials Committee, to grant suspensions, exemptions, or
exceptions to the ten contract firm quote requirement under Rule 8.51.
Specifically, proposed rule change will (i) allow members of the Market
Performance Committee to retain authority to grant exemptions from, or
to suspend, the ten contract firm quote requirement under Rule 8.51,
and grant Floor Officials that same authority; and (ii) clarify that
the authority of Market Performance Committee members under
Interpretation .09 under Rule 6.20 includes enforcing policies and
acting pursuant to rules related to RAES and fast markets.\12\ The
Commission believes that the Exchange adequately addresses these issues
by amending (1) Rule 8.51(a)(3), (2) Interpretation .06 to Rule 8.51,
(3) Interpretation .09 to Rule 6.20, and (4) Rule 6.6(b)(iv) as set
forth above in Section II.
\12\ See CBOE Letter, supra note 6.
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In regard to RAES orders during a fast market, the Commission
believes that it is appropriate to grant any two Floor Officials,
pursuant to proposed Rule 6.6(b) (v), the express authority to turn off
RAES after a fast market declaration if in the interest of maintaining
a fair and orderly market. Floor Officials have the general authority
to turn off RAES during unusual market conditions pursuant to current
Rule 6.6(b)(v). Current Rule 6.6 (b)(v) allows Floor Officials to
``[t]ake such other actions as are deemed necessary in the interest of
maintaining a fair and orderly market.'' The Commission agrees with the
Exchange that by expressly granting its Floor Official the discretion
to turn off RAES during a fast market, Exchange members and the public
will be properly notified that such action may be taken when a fast
market has been declared.
The Commission also believes that it is appropriate to allow the
senior person then in charge of the Exchange's Control Room the
authority to suspend the ten contract firm quote requirement if there
is a systems malfunction or other circumstance that affects the
Exchange's ability to disseminate or update market quotes. The type of
circumstances that might impair the Exchange's ability to disseminate
or update market quotes in a timely and accurate manner, include, but
are not limited to, outages of the Exchange's autoquote system,
communication disruptions between the Exchange and the Processor for
the Options Price Reporting Authority, and the unavailability of market
data from the underlying market and the CBOE.\13\ The Commission notes
that the proposed rule change requires the senior person in charge of
the Exchange's Control Room to immediately seek approval from two Floor
Officials after exercising such authority. The Commission believes that
this proposed rule change provides a reasonable mechanism for the CBOE
to suspend the market maker's obligations under Rule 8.51 when the
Exchange is unable to disseminate the then current and accurate quote.
\13\ See CBOE Letter, supra note 6.
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It is therefore ordered, pursuant to section 19(b) (2) of the
Act,\14\ that the proposed rule change (File No. SR-CBOE-95-52) is
approved.
\14\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
\15\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-00020 Filed 1-2-96; 8:45 am]
BILLING CODE 8010-01-M
