02-12984. Self-Regulatory Organizations; Order Approving Proposed Rule Change by the Chicago Board Options Exchange, Inc. Relating to the Allocation of Orders for Lead Market-Makers and Supplemental Market-Makers Logged On to the Exchange's Rapid ...

May 15, 2002.

I. Introduction

On February 15, 2002, the Chicago Board Options Exchange, Inc. (“CBOE” or “Exchange”) submitted to 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] a proposed rule change relating to the allocation of orders for Lead Market-Makers (“LMMs”) and Supplemental Market-Makers (“SMMs”) logged on to the Exchange's Rapid Opening System (“ROS”). On March 15, 2002 and March 22, 2002, CBOE submitted Amendment Nos. 1 and 2, respectively, to the proposed rule change. The proposed rule change and Amendment Nos. 1 and 2 were published for comment in the Federal Register on April 2, 2002.^[3] The Commission received no comments on the proposed rule change. This order approves the proposed rule change.

II. Description of Proposal

CBOE is proposing changes to Interpretation and Policies .01 of CBOE Rule 6.2A (“Interpretation .01”), relating to the allocation of orders for LMMs and SMMs logged onto ROS.^[4] The proposed rule change was filed by the CBOE pursuant to subparagraph IV.B.j. of the Commission's Order of September 11, 2000, which requires that respondent options exchanges adopt new, or amend existing, rules to make express any practice or procedure “whereby market makers trading any particular option class determine by agreement * * * the allocation of orders in that option class.” ^[5]

Currently, Interpretation .01 limits the use of ROS to LMMs and SMMs in S&P 100 (“OEX”) Options. The proposed rule change would establish that ROS may be used by LMMs and SMMs appointed pursuant to CBOE Rule 8.15 to conduct rotations in any options class. The proposed rule change would also clarify that despite CBOE Rule 6.2A(b), which assigns ROS contracts to trade to participating market-makers, ROS contracts to trade will be assigned only to the LMMs and SMMs logged onto ROS in crowds to which LMMs and SMMs are appointed.

The proposed rule change would also permit the appropriate Floor Procedure Committee to establish a participation right for the LMM who determines the formula for generating automatically updated market quotations during the trading day and provides the primary quote feed for an option class during the current expiration month. This participation right would apply only to ROS contracts to trade, and would be subject to the following conditions: (1) The LMM would receive this participation right only during the time it is actually providing the primary quote feed for an option class; and (2) the LMM must log onto ROS the minimum number of times established by the appropriate Floor Procedure Committee.

As part of the proposed rule change, the CBOE also submitted the draft text of a Regulatory Circular that would establish a specific entitlement formula for qualifying LMMs, and would be used by the appropriate Floor Procedure Committee to adopt the participation entitlement. The formula provides for participation entitlements that range from 34 percent to 40 percent for the LMM providing the primary quote feed, depending on the total number of appointed LMMs and SMMs in the option, when the number is three or more. If the number is two, each of the two will be assigned an equal portion of ROS contracts, and if there is only one, all ROS contracts to trade will be assigned to the appointed LMM or SMM.^[6]

In explaining the purpose of the participation guarantee, the CBOE stated that it has introduced a vendor quote program in OEX to replace the Autoquote system. The vendor system accepts a quote stream from a firm's proprietary quote system and then sends this quote information to the Trading Support System to be disseminated as market quotes. The CBOE believes that the LMM that provides the primary quote feed for an option class during the current expiration cycle provides a valuable service that ensures that the quotes are being updated in timely fashion to reflect the current state of the market.

III. Discussion

After careful consideration, the Commission has determined to approve the proposed rule change.^[7] For the reasons discussed below, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, with Section 6(b)(5) of the Act.^[8]

In the Commission's view, it is reasonable to expand the use of ROS to all options classes in which LMMs and SMMs conduct rotations. The Commission also believes that it is reasonable to assign ROS contracts to trade only to the LMMs and SMMs logged onto ROS in crowds in which LMMs and SMMs are appointed. The Commission notes that when Interpretation .01 was first adopted to permit the use of ROS under the LMM system (at the time, for OEX options), the CBOE stated that ROS was not meant to supplant the LMM system, which the Exchange believed had added accountability to openings, but to be used as a tool by the LMM to facilitate openings.^[9]

The Commission further believes that it is reasonable to grant a participation entitlement to the LMMs who provide the primary quote feed for an option class during an option cycle is reasonable, in view of the service such LMMs provide. The Commission notes that the proposed entitlement would never be greater than 40 percent. The Commission has found with respect to participation guarantees in other contexts that 40 percent is not inconsistent with statutory standards of competition and free and open markets.^[10]

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[11] that the proposed rule change (SR-CBOE-2002-10) be, and hereby is, approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[12]

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. 45640 (March 25, 2002), 67 FR 15644 (April 2, 2002) (“Notice”).

4.  ROS is the Exchange's automated system for opening classes of options at the beginning of the trading day or for re-opening classes of options during the trading day. See CBOE Rule 6.2A.

5.  See Order Instituting Public Administrative Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions. Securities Exchange Act Release No. 43268 (September 11, 2000).

6.  The Exchange has stated that changes to this Regulatory Circular, including changes to a participation entitlement formula, will be submitted to the Commission pursuant to Section 19(b) of the Exchange Act. See Notice.

7.  In approving this proposed rule change, the Commission has considered its impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

8.  15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the rules of an exchange, among other things, be designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers.

9.  See Securities Exchange Act Release No. 4366 (December 4, 2000), 65 FR 77943 (December 13, 2000). The CBOE also stated at the time that “to the extent that market-makers want to participate in the opening of a series in which they do not hold LMM or SMM appointments, they will continue to be able to transmit written non-cancelable proprietary and market-makers orders to the LMM in the appropriate zone ten minutes prior to the opening of trading, pursuant to the terms of Interpretation .02 to CBOE Rule 24.13.” Id.

10.  See, e.g., Securities Exchange Act Release Nos. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000) at 11398; and 43100 (July 31, 2000), 65 FR 48778 (August 9, 2000) at notes 96-99 and accompanying text.

11.  15 U.S.C. 78s(b)(2).

12.  17 CFR 200.30-3(a)(12).