[Federal Register Volume 63, Number 85 (Monday, May 4, 1998)]
[Notices]
[Pages 24578-24580]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-11746]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39923; File No. SR-CBOE-97-50]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval to Amendment Nos. 1 and 2 to Proposed Rule Change
by the Chicago Board Options Exchange, Inc., Relating to ``Go Along''
Orders
April 27, 1998.
Introduction
On September 25, 1997,\1\ 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'') \2\ and Rule 19b-4
thereunder,\3\ a proposed rule change to issue a regulatory circular
which would establish the representation of ``go along'' orders on the
floor of the Exchange as a violation of just and equitable principles
of trade pursuant to Exchange Rule 4.1.
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\1\ The Exchange originally submitted this proposal as SR-CBOE-
96-67 on November 11, 1996, and withdrew it at the request of the
Commission on February 18, 1997.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
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The proposed rule change, together with the substance of the
proposal, was published for comment in Securities Exchange Act Release
No. 39261 (October 20, 1997) 62 FR 55663 (October 27, 1998). One
comment letter was receive in response to the proposal.\4\ The Exchange
subsequently filed Amendment Nos. 1 and 2 to the proposed rule change
on January 20, 1998 and February 10, 1998, respectively.\5\
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\4\ See letter and attachment from Trent Cutler, TSC Partners,
L.P., to Jonathan Katz, Secretary, Commission, dated January 7,
1998.
\5\ Amendment No. 1 clarifies the definition of ``go-along''
orders in the regulatory circular that the Exchange expects to issue
to its members. Amendment No. 1 deletes ``generally'' from the first
sentence of the circular entitled ``Definition of Go Along Orders.''
In addition, Amendment No. 1 clarifies the definition by explaining
there are two elements that an instruction to a floor broker must
meet before those instructions make an order a ``go along'' order.
First, the floor broker must be instructed to bid or offer when one
or more participant in the trading crowd are bidding or offering.
Second, the floor broker must be instructed to bid or offer at the
price established by the other participants in the trading crowd.
Furthermore, the Exchange is proposing to add a sentence to make
clear that the prohibition against ``go along'' orders is not
intended to prohibit a floor broker from properly exercising
discretion in the representation of an order. Amendment No. 2
further clarifies the definition of ``go along'' order to state that
the floor broker must be instructed to bid (offer) on a contract
only when particular market-makers in the trading crowd are bidding
(offering) on that contract, that the floor broker must be
instructed to bid (offer) at the prices established by such market-
makers in the trading crowd. Amendment No. 2 also amends the last
sentence the last sentence of the first paragraph of the definition
section to state that the prohibition against ``go along'' orders
prevents a floor broker from accepting a specific instruction to
trade ``in a manner that mimics the trading behavior of one or more
market makers.'' See letters from Timothy H. Thompson, Senior
Attorney, CBOE, to Michael Walinskas, Senior Special Counsel, Market
Regulation, Commission, dated January 16, 1998 (``Amendment No. 1'')
and February 9, 1998 (``Amendment No. 2'').
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II. Background and Description
The purpose of the proposed rule change is to prohibit floor
brokers from representing or executing ``go along'' orders (as further
described below) on the floor of the Exchange. The Exchange will
consider the representation or execution of such orders an act
inconsistent with just and equitable principles of trade pursuant to
Exchange Rule 4.1. The Exchange proposes to set forth the prohibition
against the representation of ``go along'' orders in a regulatory
circular describing the types of conduct which would be considered to
be violative of just and equitable principles of trade. The proposed
regulatory circular will state the following:
Definition of ``Go Along'' Orders
A ``go along'' order, or a ``not held with the crowd'' order, is an
order that instructs a floor broker to bid or offer (as appropriate for
the type of order) on a contract only (i) when a particular market-
makers in the trading crowd are bidding or offering on the contract and
(ii) at the price or prices established by such market-makers in the
trading crowd. The prohibition of ``go along'' orders does not limit a
floor broker's use of discretion in representing an order on behalf of
a customer. Instead, the prohibition is intended to prohibit a floor
broker from accepting a specific instruction to trade in a manner that
mimics the trading behavior of one or more market-makers.
Generally, customers submitting ``go along'' orders to floor
brokers will specify whether the order is to buy or sell, the number of
contracts, the series, and the strike price. Typically, the floor
broker will be instructed to buy when
[[Page 24579]]
the majority of the market-makers participating on a trade are buying
or to sell the majority of the market-makers participating on a trade
are selling. Similarly, a floor broker may be instructed to buy when a
particular market-maker (or combination of market-makers) is buying
(selling) on a trade. ``Go along'' orders can be entered from off the
floor of the Exchange and can be concealed at the complete discretion
of the customer. CBOE represents that ``go along'' orders often are
placed by market-making firms as a side business, by upstairs broker-
dealers who want to participate in ``market making,'' and by
specialists on other exchanges, who are attempting to receive the
benefits of market-making without assuming the affirmative obligations
to provide markets. These orders are entered in both multiply-traded
and singly listed option classes.
Rationale for the Prohibition
The CBOE believes that the proliferation of ``go along'' orders
interferes with the risk-reward trade-off of Exchange market-making.
``Go along'' order participants, according to CBOE, generally are
professional traders that are attempting to accept the rewards of
market making without accepting any of the risks. In addition, CBOE
does not believe these orders provide any incremental liquidity or
price discovery because market participants entering ``go along''
orders are merely trading at a price and size at which market-makers
are willing to trade. ``Go along'' order participants, as customers,
however, are not obliged to fulfill the affirmative market-making
obligations of market-makers and their activity is not necessarily
subject to Commission or Exchange oversight.
III. Summary of Comments
The Commission received one comment letter opposing the proposed
rule change from members of the Pacific Exchange, Inc. (``PCX'').\6\
The commenters argue that the proposed rule change, by prohibiting
orders ``that don't match the trading crowd as long as the broker has
discretion'' makes this a rule restricting discretionary orders, which
is much broader than a rule restricting ``go along'' orders. The
commenters state that the rule is attempting to reduce competitive
forces on the trading floor, which would reduce liquidity and pricing
efficiency for all market participants, which, in turn damages the
Exchange's long-term competitive position.
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\6\ See supra note 3.
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IV. Discussion
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, with the requirements of Section 6(b)(5) \7\ that the rules
of the Exchange 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.\8\
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\7\ 15 U.S.C. 78f(b)(5).
\8\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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The Commission finds that it is reasonable for CBOE to prohibit
floor brokers from accepting ``go along'' orders. CBOE has determined
that the use of ``go along'' orders is an abusive trading practice
whereby professional traders, including market-makers, attempt to mimic
the trading pattern of particular market-makers. More specifically,
CBOE believes that the proliferation of ``go along'' order use could
seriously threaten its market-maker system, by reducing market-maker
trading opportunities. ``Go along'' orders often obtain parity with the
bid/offer of the market-maker(s) they are designed to trade along with,
thereby diluting market-maker participation in these affected trades.
In essence, traders submitting ``go along'' orders are attempting to
achieve the same time and place advantage held by market-makers on the
floor. However, market-makers, in return for their time and place
advantage, are subject to affirmative and negative market-making
obligations.\9\ While it is certainly possible that market-makers on
CBOE's floor can mimic the trading behavior of other market-makers,
they are required to make an active market while present in a
particular trading crowd.\10\ Customers submitting ``go along'' orders,
by contrast, have no market-making responsibilities, and therefore,
should not be afforded benefits derived from the special time and place
benefits that are unique to market-makers.
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\9\ See CBOE Rules 8.7; 8.15 (Lead Market-Makers and
Supplemental Market-Makers); and 8.16 (RAES Eligibility in Option
Classes Other Than DJX). See also Securities Exchange Act Release
Nos. 28021 (May 16, 1990), 55 FR 21131 (May 22, 1990) (``* * * the
Commission notes that the position of options market makers on the
floor provides them substantial time and place advantages over other
market participants.'') and 21008 (June 1, 1984), 49 FR 23721 (June
7, 1984) (``In return for assuming these obligations to the
marketplace, market makers are permitted to trade on the floor of
the exchange, thus being provided significant ``time and place'' as
well as margin credit (``exempt credit'') advantages over other
market participants.'').
\10\ CBOE Rule 8.7(b) and phone conversation between Timothy H.
Thompson, Senior Attorney, CBOE, and Michael Walinskas, Deputy
Associate Director, Market Regulation, Commission, on April 24,
1998.
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Notwithstanding the appropriate basis for prohibiting ``go along''
orders, restrictions on abusive trading practices must be carefully
crafted so as not to restrict trading beyond that necessary to curb the
identified abuse.\11\ In this regard, the Commission emphasizes that
CBOE's proposed restriction is narrowly tailored to apply only in the
specific instance where a customer instructs a floor broker to bid (or
offer) on a contract when particular market-makers are bidding or
offering, at the price or prices established by such market-makers. The
prohibition against ``go along'' orders does not limit any category of
market participant from access to CBOE markets and does not impair
market participants from effecting legitimate trading strategies,
including obtaining the best available price. The proposed rule change
also does not prohibit a floor broker from accepting an order that
directs him or her to buy (or sell) along with the trend of the crowd.
If given such instructions, a floor broker may, in his or her own
expert judgment, trade in a manner that mimics the behavior of one or
more market-makers.
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\11\ Cf. Amex intra-day trading restriction. See Securities
Exchange Act Release No. 34363 (July 13, 1994), 59 FR 36808 (July
19, 1994).
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The comment letter objected to original language in the definition
of ``go along'' order that stated ``Such an order is prohibited even if
the bid or offer does not match exactly the price established by the
other participants in the trading crowd as long as the customer has
given the broker discretion to determine what to bid or offer based
upon the prices established by the other participants.'' The Commission
notes that the Exchange has eliminated this provision. The Commission
also notes, as discussed more fully above, that the prohibition of ``go
along'' orders does not limit a floor broker's discretion, but instead
prohibits a customer from giving a floor broker specific instructions
to trade in a particular manner.
The Commission finds good cause to approve Amendment Nos. 1 and 2
to the proposed rule change prior to the thirtieth day after the date
of publication of notice of filing thereof in the Federal Register.
Amendment Nos. 1 and 2 both clarify the definition of ``go along''
order to narrowly outline the boundaries of the restriction and to
ensure that the prohibition against ``go
[[Page 24580]]
along'' orders does not prohibit a floor broker from properly
exercising discretion in the representation of an order or prevent
market participants from effecting legitimate trading strategies. In
addition, the proposed rule change was published for the full comment
period and Amendment Nos. 1 and 2 do not substantively change the
proposal. Accordingly, the Commission believes that it is consistent
with Section 6(b)(5) of the Act to approve Amendment Nos. 1 and 2 to
the proposal on an accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1 and 2 to the rule proposal,
including whether Amendment Nos. 1 and 2 are consistent with the Act.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. 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 at the Commission's Public
Reference Room. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
submissions should refer to File No. SR-CBOE-97-50 and should be
submitted by May 26, 1998.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\12\ that the proposed rule change (SR-CBOE-97-50), including
Amendment Nos. 1 and 2, is approved.
\12\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\13\
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\13\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-11746 Filed 5-1-98; 8:45 am]
BILLING CODE 8010-01-M
