01-3003. Self-Regulatory Organizations; Chicago Board Options Exchange, Inc.; International Securities Exchange, LLC; Order Approving Proposed Rule Changes Relating to an Interim Intermarket Linkage

January 30, 2001.

I. Introduction

On November 15, 2000, the Chicago Board Options Exchange, Inc. (“CBOE”) and the International Securities Exchange LLC (“ISE”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] proposals to adopt rules providing for the implementation of “interim linkages” with other option exchanges. On December 13, 2000, the CBOE and ISE (collectively “Exchanges”) each submitted amendments to their rule proposals.^[3] On December 19, 2000, the Exchanges' rule proposals were published for comment in the Federal Register.^[4] The Commission did not receive comments on either the CBOE or the ISE proposals. This order approves the CBOE and the ISE proposed rule changes, as amended.

II. Description of the Proposed Rule Changes

The CBOE and ISE propose to implement certain aspects of an intermarket options linkage on an “interim” basis.^[5] The Exchanges represent that this interim linkage would utilize existing order types to facilitate the sending and receiving of order flow between CBOE market makers and ISE market makers and their counterparts on the other options exchanges as an interim step towards development of a “permanent” linkage.^[6]

The Exchanges represent that all of the options exchanges continue to work towards implementation of a permanent linkage, which likely will include contracting with a third party to build a linkage infrastructure. According to the Exchanges, because the implementation of a permanent linkage is expected to take a significant amount of time, the options exchanges have proposed implementing an “interim” linkage. An interim linkage would use the existing market infrastructure to route orders between market makers on the participating exchanges in a more efficient manner. The Exchanges propose that the interim linkage would be in effect on a pilot basis until January 31, 2002.^[7]

The interim linkage would require the participating exchanges to open their automated customer execution systems, on a limited basis, to market maker orders. Specifically, market makers would be able to designate certain orders as “customer” orders, and thus, would receive automatic execution of those orders on participating exchanges.

The proposals would authorize the CBOE and the ISE to implement bilateral or multilateral interim arrangements with the other options exchanges to provide for equal access between market makers on the respective exchanges. The Exchanges represent that the initial arrangements would allow ISE Primary Market Makers (“PPMs”), CBOE Designated Primary Market Makers (“DPMs”), and their equivalents on the other exchanges,^[8] when they are holding customer orders, to send orders reflecting the customer orders to another market for execution when such other market has a better quote. Such orders would be limited in size to the lesser of the size of the two markets' “firm” quotes for customer orders. The Exchanges expect that the interim linkage may expand to include limited access for pure principal orders, for orders of no more than 10 contracts.

Under the Exchanges' proposals, all interim linkage orders must be “immediate or cancel”,^[9] and a market maker can send a linkage order only when the other (receiving) market is displaying the best national bid or offer and the sending market is displaying an inferior price. The Exchanges represent that this will allow a market maker to access the better price for its customer. In addition, if the interim linkage includes principal orders, it would allow market makers to attempt to “clear” another market displaying a superior quote. Further, the Exchanges represent that they will implement heightened surveillance procedures to help ensure that their market makers send only properly qualified orders through the interim linkage.

DPM and PMM participation in the interim linkage would be voluntary under the terms of the proposals. Only when a DPM or PMM and its equivalent on another exchange believe that this form of mutual access would be advantageous would the exchanges employ the interim linkage procedures. The Exchanges represent that the interim linkage will benefit investors and will provide useful experience that will help the Exchanges in implementing the permanent linkage.

III. Discussion

After careful review, the Commission finds that the CBOE and the ISE proposed rule changes are consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange ^[10] and, in particular, the requirements of Section 6 of the Act.^[11] Among other provisions, Section 6(b)(5) of the Act requires that the rules of an exchange be designed to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating securities transactions; remove impediments to and perfect the mechanism of a free and open market and a national market system; and protect investors and the public interest.

The Commission notes that developing and fully implementing a permanent intermarket linkage may take a significant amount of time. According to the Exchanges, the interim linkage will be introduced on a voluntary basis, to allow participating exchanges to route customer orders to an away market that is displaying the best available price in a multiply-traded options class. The Commission believes that this interim linkage should enable customers to benefit from the Exchanges' immediate ability to use their existing market infrastructure to route their orders between market makers on the participating exchanges in a more efficient manner.^[12]

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[13] that the proposed rule changes (SR-CBOE-00-58 and SR-ISE-00-15) are approved, as amended, on a pilot basis until January 31, 2002.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[14]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See letters from Timothy Thompson, Assistant General Counsel, Legal Department, CBOE, and from Michael Simon, Senior Vice President and General Counsel, ISE, to Nancy Sanow, Assistant Director, Division of Market Regulation, Commission, dated December 12, 2000 and December 11, 2000, respectively.

4.  See Securities Exchange Act Release Nos. 43745 (December 19, 2000), 65 FR 82418 (File No. SR-CBOE-0058) and 43743 (December 19, 2000), 65 FR 82426 (File No. SR-ISE-0015).

5.  Under the proposal, the interim linkage would be for a pilot period expiring on January 31, 2002.

6.  On July 28, 2000, the Commission approved a linkage plan that now includes all five options exchanges. See Securities Exchange Act Release Nos. 43086 (July 28, 2000), 65 FR 48023 (August 4, 2000); 43573 (November 16, 2000), 65 FR 70851 (November 28, 2000); and 43574 (November 16, 2000), 65 FR 70850 (November 28, 2000).

7.  See supra note 3.

8.  Specialists on other exchanges would be permitted to use the interim linkage after filing appropriate rules with the Commission and executing agreements with the participating exchanges.

9.  Thus, interim linkage orders could not be placed on an exchange's limit order book.

10.  The Commission has considered the proposed rules' impact on efficiency, competition and capital formation. 15 U.S.C. 78c(f).

11.  15 U.S.C. 78f(b)(5).

12.  Id.

13.  15 U.S.C. 78s(b)(2).

14.  17 CFR 200.30-3(a)(12).