01-3042. Self-Regulatory Organizations; Order Approving Proposed Rule Change by the Chicago Board Options Exchange, Inc. Relating to Permanent Approval of Live Ammo to RAES

January 30, 2001.

I. Introduction

On November 8, 2000, 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 adopt the rule governing the execution of orders on the live ammo screen on a permanent basis. On December 11, 2000, the proposal was published in the Federal Register.^[3] The Commission did not receive any comments on the proposed rule change. This order approves the proposed rule change.

II. Background

The CBOE originally proposed to amend its Rule 7.4, which governs the execution of orders by order book officials (“OBOs”) or designated primary market makers' (“DPMs”) book staff, to permit the electronic execution of certain orders on the live ammo screen, in June 1998 (“Original Proposal”).^[4] The Commission approved the Original Proposal on a pilot basis on February 2, 2000,^[5] which was scheduled to expire on October 30, 2000. On October 26, 2000, the CBOE submitted a proposed rule change, pursuant to Section 19(b)(3)(A) of the Act,^[6] to extend the pilot until December 15, 2000.^[7] On December 7, 2000, the CBOE submitted a proposed rule change, pursuant to Section 19(b)(3)(A) of the Act,^[8] to extend the pilot until January 31, 2001.^[9]

In addition, on July 14, 2000, the CBOE submitted a related proposed rule change, pursuant to Section 19(b)(3)(A) of the Act,^[10] to implement a systems change to its Order Routing System (“ORS”) to provide for the automatic rerouting of cancel replace orders.^[11]

III. Description of the Proposal

The live ammo screen, which is an undisplayed portion of the CBOE's electronic customer limit order book, known as the Electronic Book or EBook, receives for further processing orders that are market orders or limit orders that improve the market. An order may be routed to the live ammo screen under a number of circumstances. First, market orders that are received through the Exchange's order shoe ^[12] that are manually booked are automatically routed to the live ammo screen. Second, limit orders that better the quote that are received through the order shoe and that are manually booked are automatically routed to the live ammo screen. Third, limit orders that better the quote and that are routed directly to the EBook when the routing parameters have been set at “0” are automatically sent to the live ammo screen.^[13] Finally, marketable limit orders that are electronically booked from a floor broker's PAR workstation are automatically routed to the live ammo screen.^[14]

The Original Proposal, which CBOE proposes to implement on a permanent basis, permits OBOs or DPMs, as the case may be, to designate certain orders on the live ammo screen to be electronically executed against market makers standing in the crowd, i.e., the live ammo to RAES feature of the live ammo screen.^[15] The live ammo to RAES feature of the live ammo screen permits an OBO (or DPM) to send RAES-eligible orders on the live ammo screen to RAES for automatic execution.^[16] The OBO (or DPM) may select all or any portion of the orders displayed on the live ammo page to be routed to RAES.^[17] Selected RAES-eligible orders are routed based on time priority, pursuant to CBOE Rule 6.45. Orders that are not RAES-eligible must be manually represented in the crowd by the OBO (or DPM) or sent to the EBook, if book eligible.^[18]

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.^[19] In particular, the Commission finds that the proposed rule change is consistent with the requirements of Section 6(b)(5) of the Act,^[20] which provides, among other things, that the rules of an exchange be designed to promote just and equitable principals of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, and processing information with respect to, and facilitating transactions in securities, and to remove impediments to and perfect the mechanism of a free and open market, and in general to protect investors and the public interest.

The Commission continues to believe that the live ammo to RAES feature should help in providing timely executions of orders on the live ammo screens of the CBOE's EBook. In absence of this feature, an OBO (or DPM) will be again required to manually represent each order on the live ammo screen in the crowd. As discussed in the Original Order, during periods of high volume or volatility, the OBO (or DPM) may be unable to manually represent these live ammo orders in a timely fashion, which could result in investors' orders receiving inferior executions.^[21] The live ammo to RAES feature enables an OBO (or DPM) to address live ammo orders and provide for their execution faster than would occur if each order had to be individually represented in the crowd by the OBO (or DPM). Thus, the Commission believes that it is in the public interest for the live ammo to RAES feature to be implemented on a permanent basis.

In the Original Order, the Commission expressed concern that the use of the live ammo screen may disadvantage customer orders. Specifically, the Commission stated that it expected the Exchange to make systems enhancements to ensure that a maximum number of customer orders in the CBOE system are matched against each other. The Commission continues to encourage the CBOE to develop systems enhancements to ensure that a maximum number of customer orders in the CBOE system are matched against one another. However, the Commission believes that, in the meantime, the live ammo to RAES feature should provide investors with enhanced executions and should be implemented on a permanent basis.

In addition, the Commission directed the Exchange to develop systems enhancements to ensure that when there are no opportunities for the matching of customer orders in the CBOE-system, RAES-eligible orders will be routed directly to RAES without the interim step of appearing first on the live ammo screen. In response to this directive, the Exchange proposed the ORS Modification, which will permit cancel replace orders to be rerouted through the ORS without having to be sent to the live ammo screen. The Commission notes that, according to the Exchange, the majority of orders that were sent to the live ammo screen were cancel replace orders. Therefore, the Commission is encouraged by the new ORS Modification and its impact on the ability of customer orders to be routed directly through the ORS without having the interim step of first going to the live ammo screen. That having been said, however, the Commission urges the Exchange to continue to consider other systems modifications to address those orders that continue to be routed to the live ammo screen.

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[22] that the proposed rule change (SR-CBOE-00-53) is approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[23]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  Securities Exchange Act Release No. 43646 (November 30, 2000), 65 FR 77403.

4.  Securities Exchange Act Release No. 40283 (July 30, 1998), 63 FR 42085 (August 6, 1998).

5.  Securities Exchange Act Release No. 42379, 65 FR 6665 (February 10, 2000) (“Original Order”).

6.  15 U.S.C. 78s(b)(3)(A).

7.  Securities Exchange Act Release No. 43499 (October 31, 2000), 65 FR 67023 (November 8, 2000).

8.  15 U.S.C. 78s(b)(3)(A).

9.  Securities Exchange Act Release No. 43727 (December 14, 2000), 65 FR 80968 (December 22, 2000).

10.  15 U.S.C. 78s(b)(3)(A).

11.  Securities Exchange Act Release No. 43185 (August 21, 2000), 65 FR 51884 (August 25, 2000) (“ORES Modification”). The ORS Modification will permit the processing of a cancel replace order for an order residing on the EBook by routing the replace order through the ORS as a new order, after the cancel portion has been completed. The replace order, as with any new incoming order, may be eligible for execution in the Retail Automatic Execution system (“RAES”), crossing with other EBook orders through the Automated Book Priority system, routing directly to the EBook (automatically updating the quote if it improves the market), or routing to the Public Automated Routing (“PAR”) terminal or Booth Automated Routing terminal for price improvement. According to the Exchange, the ORS Modification was implemented on January 24, 2001. Telephone call between Jamie Galvin, CBOE and Kelly Riley, Division of Market Regulation, SEC, on January 30, 2001.

12.  The order shoe is where orders are manually held, i.e. where paper order tickets are actually placed at the trading post.

13.  The “0” parameter is an order routing parameter that may be implemented under high volume situations to route all limit orders to the EBook.

14.  At the time of the Original Proposal, approximately 90 percent of orders routed to the live ammo screen were cancel replace orders. According to the CBOE, the ORS Modification should significantly reduce the amount of orders routed to the live ammo screen. See note 11, supra.

15.  Prior to the Original Proposal, an OBO or DPM, acting in his or her capacity as an OBO, represented in the trading crowd each order that resided on the live ammo screen.

16.  Orders selected for automatic execution must satisfy RAES requirements. Currently, RAES accepts market and marketable limit orders that meet the applicable size requirements.

17.  A live ammo screen page may contain up to sixteen orders.

18.  A “book all” button permits the OBO (or DPM) to send all book eligible orders on the live ammo screen to the EBook.

19.  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).

20.  15 U.S.C. 78f(b)(5).

21.  See note 5, supra. In the Original Order, the Commission also noted that delayed execution of customer orders may implicate a broker-dealer's best execution responsibilities. See letter from Arthur Levitt, Chairman, SEC, to Michael Kelly, President, First Options of Chicago, Inc., dated April 13, 1999.

22.  15 U.S.C. 78s(b)(2).

23.  17 CFR 200.30-3(a)(12).