00-29707. Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Chicago Board Options Exchange, Inc. Relating to Participation Rights in Crossing Transactions

November 9, 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 August 29, 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 Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The CBOE is proposing certain changes to provisions of its rule that governs the participation rights of firms crossing orders. The text of the proposed rule change is set forth below. Additions are italicized and deletions are bracketed.

* * * * *

Chicago Board Options Exchange, Inc., Rules, Chapter VII, Section D: Floor Brokers, “Crossing” Orders, Rule 6.74

(a)-(c) No change.

(d) Notwithstanding the provisions of paragraphs (a) and (b) of this Rule, when a Floor Broker holds an equity option order of the eligible order size or greater (“original order”), the Floor Broker is entitled to cross a certain percentage of the order with other [customer] orders [from the same firm from which the original order originated (“originating firm] that he is holding or in the case of a public customer order with a facilitation order of the originating firm (i.e., the firm from which the original customer order originated). The appropriate Floor Procedure Committee may determine, on a class by class basis the eligible size for an order that may be transacted pursuant to this paragraph (d), however, the eligible order size may not be less than 50 contracts. In accordance with his responsibilities for due diligence, a Floor Broker representing an order of the eligible order size or greater which he wishes to cross shall request bids and offer for such option series and make all persons in the trading crowd, including the Order Book Official, aware of his request.

(i)-(vii) No change.

* * * Interpretations and Policies:

No change.

* * * * *

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 and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these 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 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. Background. The Commission recently approved a change to Exchange Rule 6.74 to provide a participation right that entitles member firms to cross a certain percentage of each order they send to the floor.^[3]

Specifically, the rule change provided that after the Floor Broker representing an order (“original order”) has requested and received a market from the trading crowd, if the trade takes place at that market, the Floor Broker is entitled to cross 20% of the contracts remaining in the original order with another order from the same firm from which the original order originated.^[4] The participation right applies only after all public customer orders in the book and represented in the crowd at the time the market was established have been satisfied.

If the trade takes place at a price between the best bid and offer provided by the crowd then, after public customer orders are satisfied, the Floor Broker will be entitled to cross 40% of the contracts remaining in the original order.

b. Proposed Changes. The Exchange is proposing to make two changes to Rule 6.74(d). The first change would make clear that the rule includes the situation where a Floor Broker is seeking to cross a solicited order against the original customer order. The second change would allow the Floor Broker representing the original customer order to solicit the order to trade against it even if that Floor Broker is not a nominee of the originating firm.

(i) Application of the rule to solicited orders. The Exchange states that its recently approved rule governing participation rights in cross trades was clearly intended to allow the member firm to receive its participation right when seeking to cross either a solicited order or a facilitation order against the original customer order.

The Exchange states that this is indicted by the rule language itself, which refers to “other customer orders” that a Floor Broker may be seeking to cross against the original order, in addition to—and as distinct from—“facilitation orders.” ^[5] The Exchange states that there would have been no reason to distinguish between these types of orders if the rule was intended to allow the member firm to receive its participation right only when facilitating a customer order. The Exchange additionally points out that paragraph (d)(vi) of the rule specifically indicates that a Floor Broker might be holding either a solicited or facilitation order.^[6]

Finally, the CBOE notes that in letter that amended the original proposal of Rule 6.74(d), in response to questions from the Commission's staff about what type of entity might be solicited to trade against the original order pursuant to the rule, the Exchange stated that the “member firm may solicit a broker-dealer, a public customer, or any other source from which the firm expects to be able to find additional liquidity and a better price.” ^[7]

Nonetheless, the CBOE states, a few members of the Exchange have questioned whether the rule was in fact intended to allow the member firm to receive a participation right by trading a solicited order against the original customer order. These members have based their uncertainty on the text of Rule 6.74(d), which states that “the Floor Broker is entitled to cross a certain percentage of the order with other customer orders from the same firm from which the original order originated (‘originating firm’) that he is holding.” (emphasis added)

These members believe that the term “customer” could be read to mean either a public customer (i.e., a non-broker-dealer) or a client with which the firm has had a longstanding relationship. According to the Exchange, however, the aforementioned amendment letter demonstrates that the term “customer” was not intended to be read so restrictively. Consequently, the Exchange is now proposing to delete the term “customer” from this portion of the rule to make clear that the solicited order may come from any source.^[8]

(ii) The Floor Broker may solicit the order. As currently written, the cross participation rule provides that the Floor Broker may cross the original customer order with other “orders from the same firm from which the original order originated (originating firm).” As such, if the Floor Broker who is representing the order is not a nominee of the originating firm but works for a firm that has been given the order to execute (“executing firm”), the Floor Broker or the executing firm would not be entitled to obtain the cross participation entitlement with respect to any order that the Floor Broker or executing firm had solicited.

After considering the implications of this restriction, the Exchange has determined to amend the rule so that the Floor Broker's participation entitlement is not limited to orders from the originating firm only. The proposed rule change would permit the Floor Broker who is not a nominee of the originating firm to himself solicit orders, with the aim of expanding the pool of potential liquidity providers who will be able to participate in the price improvement process that the Exchange believes is encouraged by this rule.

To permit the Floor Broker who is not a nominee of the originating firm to solicit orders that will receive the benefit of the cross participation entitlement, the Exchange is proposing to delete the phrase that states that the order must be “from the same firm from which the original order originated (‘originating firm’).”

2. Statutory Basis

The Exchange believes that the proposed rule change is consistent with and furthers the objectives of section 6(b)(5) ^[9] of the Act in that it is designed to remove impediments to a free and open market and protecting investors and the public interest.

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.

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

Within 35 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 CBOE consents, the Commission will:

(A) By order approve 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 arguments concerning the foregoing, including whether the proposed rule change 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 the filing will also be available for inspection and copying at the principal offices of the CBOE. All submissions should refer to File No. SR-CBOE-00-43 and should be submitted by December 12, 2000.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.¹⁰

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See Securities Exchange Act Release No. 42835 (May 26, 2000), 65 FR 35683 (June 5, 2000) (File No. SR-CBOE-99-10).

4.  The rule applies equally to a case where the second order is provided by the firm from its own proprietary account, in which case the second order is referred to as a “facilitation order.” See id.

5.  Paragraph (d) of Rule 6.74 states that “the Floor Broker is entitled to cross a certain percentage of the order with other customer orders from the same firm from which the original order originated (‘originating firm’) that he is holding or in the case of a public customer order with a facilitation order of the originating firm.”

6.  Paragraph (d)(vi) states: “A Floor Broker who is holding a customer order and either a facilitation or solicited order and who makes a request for a market will be deemed to be representing both the customer order and either the facilitation order or solicited order, so that the customer order and the other order will also have priority over all other orders that were not being represented in the trading crowd at the time the market was established.”

7.  Letter from Timothy Thompson, Director-Regulatory Affairs, Legal Department, CBOE, to Nancy Sanow, Division of Market Regulation (“Division”), the Commission, dated April 10, 2000 (Amendment No. 2 to File No. SR-CBOE-99-10) (“amendment letter”).

8.  For instance, as clarified by the proposed rule change, the participation right would apply equally when the Floor Broker seeks to cross the original order with an order solicited from a market maker. Telephone conversation between Timothy Thompson, Director-Regulatory Affairs, Legal Department, CBOE, and Ira L. Brandriss, Attorney, Division, the Commission, on September 21, 2000.

9.  15 U.S.C. 78f(b)(5).

10.  17 CFR 200.30-3(a)(12).