[Federal Register Volume 64, Number 179 (Thursday, September 16, 1999)]
[Notices]
[Pages 50313-50315]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-24115]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41821; File No. SR-CBOE-99-17]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval of Amendment No. 3 to Proposed Rule Change by the
Chicago Board Options Exchange, Inc. Relating to the Operation of the
Retail Automatic Execution System
September 1, 1999.
I. Introduction
On April 16, 1999, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') 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 amending the CBOE's rules
governing the operation of its Retail Automatic Execution System
(``RAES''). The proposal increases the maximum order sizes of certain
RAES-eligible options and authorizes the appropriate Floor Procedure
Committees (``FPCs'') of the Exchange to change current procedures
governing assignment and price improvement of RAES orders. On May 21,
1999, the CBOE filed with the Commission Amendment No. 1 to the
proposal.\3\ Notice of the proposal was published in the Federal
Register on June 17, 1999.\4\ The Commission received no comments on
the proposal. On August 23, 1999, the CBOE filed Amendment No. 2 to the
proposal,\5\ on August 31, 1999, the CBOE filed Amendment No. 3 to the
proposal.\6\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, the CBOE clarified issues relating to
implementation of the new RAES order assignment procedures. See
letter from Timothy Thompson, Director, Regulatory Affairs, CBEO, to
Gordon Fuller, Special Counsel, Division of Market Regulation, SEC,
dated May 20, 1999.
\4\ See Securities Exchange Act Release No. 41501 (June 9,
1999), 64 FR 32568.
\5\ Amendment No. 2 is described below. See letter from
Christopher R. Hill, Attorney, CBOE, to Michael Walinskas, Associate
Director, Division of Market Regulation, SEC, dated August 23, 1999.
\6\ Amendment No. 3 is described below. See letter from Timothy
Thompson, Director, Regulatory Affairs, CBOE, to Gordon Fuller,
Special Counsel, Division of Market Regulation, SEC, dated August
31, 1999.
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II. Description of the Proposal
a. Summary
This filing does four things. First, it increases from 20 to 50
contracts the maximum size of orders for equity options and certain
classes of index options eligible to be executed through RAES.\7\
Second, it authorizes the appropriate FPCs to implement a new RAES
order assignment procedure called ``Variable RAES'' (described below)
for some or all classes of CBOE options. Third, it allows the
appropriate FPCs to authorize automatic RAES ``step-ups'' for price
differentials greater than the one ``tick'' differential currently
specified in the rules.\8\ Fourth, it makes editorial revisions to
clarify or update current RAES rules.
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\7\ The proposal also effects a minor increase (from 99
contracts to 100 contracts) in the maximum size of RAES orders for
options on two indices--the S&P 500 Index and the Nasdaq 100 Index--
to bring those size maximums into conformity with size maximums for
other index options and interest rate options. See infra note 11.
\8\ ``Step-ups'' refers to the ability to improve the price at
which an order is executed on RAES to match a better price in
another market.
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b. Previous Partial Approval
The Commission previously granted accelerated approval to a portion
of this rule filing. Specifically, on August 23, 1999, the Commission
approved Amendment No. 2, which permitted the CBOE to immediately
implement Variable RAES in five stocks that are dually listed on both
the Philadelphia stock Exchange (``Phlx'') and the CBOE.\9\ Amendment
No. 2 was filed in tandem with a related rule proposal, SR-CBOE-99-47,
which increased the maximum RAES order size from 20 to 50 contracts in
options on those five stocks only.\10\ SR-CBOE-99-47 became effective
on August 23, 1999. The Commission granted immediate approval of
Amendment No. 2 to enable Variable RAES to be used on August 23, when
the new order size maximum on the five dually traded options went into
effect.
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\9\ Those stocks are Dell Computer Corporation (``DLQ''),
International Business Machines (``IBM''), Johnson & Johnson
(``JNJ''), Coca-Cola (``KO''), and Ford Motor Company (``F'').
Securities Exchange Act Release No. 41782 (August 23, 1999), 64 FR
47881 (September 1, 1999).
\10\ Securities Exchange Act Release No. 41823 (September 1,
1999).
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c. Order Size Increase
Formerly, the maximum size of RAES-eligible orders was 20 contracts
for all classes of equity options (other than the five dually traded
classes noted above), all classes of sector index options and all other
classes of index options (except options on the S&P 500 Index, the
Nasdaq 100 Index, the Dow Jones Industrial Average, and interest rate
options).\11\ This proposed rule change
[[Page 50314]]
increases the maximum order size for these options classes to 50
contracts. Increasing the RAES eligibility maximum to 50 contracts for
these classes of options does not, however, automatically permit orders
up to this size to be entered into RAES. Instead, the actual maximum
RAES eligibility size will be established by the appropriate FPC of the
CBOE, which may maintain the maximum for particular classes at levels
below the 50-contract maximum.
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\11\ The RAES eligibility maximum was formerly 99 contracts for
options on the S&P 500 Index and the Nasdaq 100 Index, and 100
contracts for options on the DJIA and interest rate options. To
simplify the administration of RAES and eliminate confusion, this
proposal makes the RAES eligibility maximums 100 contracts for these
four classes of options. See Rule 6.8(e). One hundred contracts is
also the RAES eligibility maximum for options on the Dow Jones High
Yield Select 10 Index. See Securities Exchange Act Release No. 41509
(June 10, 1999), 64 FR 32906 (June 18, 1999) (approving increase in
RAES order size limit from 20 contracts to 100 contracts).
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Under existing Interpretation and Policy .01 under Rule 6.8, the
appropriate FPC may increase the size of RAES-eligible orders for
multiply-traded equity options to match the size of orders in options
of the same class that are eligible for entry into the automated
execution system of any other options exchange, subject to filing
notice of the increase under Section 19(b)(3)(A) of the Act.\12\ The
CBOE nonetheless believes the FPC should be able to permit up to 50
contracts to be eligible for RAES in response to the perceived needs of
the market without regard to automatic execution limits on other
exchanges. The CBOE also seeks greater flexibility in competing for
order flow with other exchanges that have 50-contract maximum
eligibility levels for their own automatic execution systems, since the
CBOE will not be limited to responding to increases in automatic
execution eligibility levels initiated by the other exchanges. CBOE
represents that its systems capacity is sufficient to accommodate the
increased number of automatic executions anticipated to result from
implementation of the proposal.
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\12\ 15 U.S.C. 78s(b)(3)(A).
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d. Variable RAES
The proposed rule change authorizes the appropriate FPCs to
implement Variable RAES for some or all classes of CBOE options. Under
former procedures, RAES orders were randomly assigned to market makers,
and each market maker had to buy or sell the entire order assigned to
him or her. By contrast, Variable RAES will enable each market marker
to designate a maximum number of contracts he or she is willing to buy
or sell when a RAES order is assigned to that market maker. No market
maker, however, will be able to designate a maximum that is less than a
stated minimum number of contracts per assignment established by the
appropriate FPC. In determining appropriate minimum execution levels,
the FPC must take into account whether market makers have sufficient
capital to fill an order that size.
If the number of contracts in a RAES order is less than or equal to
the market maker's specified limit, the market maker will be obligated
to buy or sell all of the contracts in the order, and the next RAES
order will be assigned to the next market maker on the RAES assignment
rotation. If the number of contracts in an order exceeds the specified
limit, the market maker will be obligated to buy or sell the number of
contracts equal to the specified limit. The remainder of the order will
be assigned to the next market maker on the RAES assignment rotation,
who will likewise be obligated to buy or sell the number of remaining
unassigned contracts in the order up to that market maker's limit. The
assignment rotation will continue in this manner until all of the
contracts in the order have been assigned to one or more market makers,
even if this requires more than one assignment to the same market maker
as the assignment rotation continues.
Variable RAES will apply to all classes of options eligible for
entry into RAES. CBOE represents that Variable RAES will be implemented
following the effectiveness of this proposed rule change, and will be
described in a circular to be distributed to the membership prior to
that time. If the appropriate FPC decides to implement a different RAES
order assignment procedure, CBOE will file a proposed rule change with
the Commission pursuant to Section 19(b)(1) of the Act and Rule 19b-4
thereunder.
e. Increase in Automation Step-Up Increment
Finally, the proposed rule change authorizes the appropriate FPC to
establish a ``step-up amount'' for purposes of the automatic step-up
procedure of Interpretation and Policy .02 under Rule 6.8 that is
greater than the minimum quote interval (``tick'') for that class of
option under rule 6.42. The automatic step-up procedure formerly stated
that in designated classes of multiple-traded options, if the
Exchange's best bid or offer is inferior to the bid or offer in another
market by no more than one tick, an order in RAES will be automatically
excluded at the better bid or offer. The proposal enables the
appropriate FPC to establish price differentials greater than one tick
at which orders will be automatically executed in RAES in order to
match better bids or offers in other markets.
f. Amendment No. 3
Amendment No. 3 changes the language of the RAES rules to more
clearly define the limits of the FPC's discretion to implement Variable
RAES and increase automatic step-up increments. Amendment No. 3 also
clarifies language in the RAES rules. Specifically, Amendment No. 3:
(1) Requires the appropriate FPCs to provide at least three
days' advance notice to Exchange members of the FPC's intention to
discuss an issue relating to the RAES allocation method, and to
provide members with the opportunity to give written comments, or
appear at the meeting, or both. To prevent delay the FPCs may
initially implement Variable RAES without notice and comment;
however, that initial implementation will be subject to review at
the next FPC meeting, pursuant to notice and comment procedures;
(2) Describes the criteria the FPCs will consider in setting a
minimum contract limit under Variable RAES. The Amendment explains
that the appropriate FPC will select a minimum that is not so high
as to discourage market makers from participating on RAES. On the
other hand, the appropriate FPC will choose a level high enough that
the market-makers retain the incentive to pay attention to and
update their quotes;
(3) Clarifies language that orders routed over RAES ``may be
subject to such contingencies as the appropriate [FPC] shall
approve.'' The Amendment revises this language to make clear that
the FPC may approve certain ``contingency orders'' for routing to
RAES. The FPC may consider whether the order can be easily
accommodated by RAES without substantial system changes, whether the
nature of the contingency makes it reasonable to include the order
in RAES, and whether there is customer interest in including the
order in RAES;
(4) Clarifies the term ``group'' in revised Interpretation .04
to Rule 6.8 which states that ``that first order in any group of
rerouted orders'' will be entitled to be filled at the offer (bid)
which existed at the time of the order's entry into the RAES system.
The Amendment states that ``group'' refers to orders kicked out as
the result of an instance where the prevailing market bid or offer
is equal to the best bid or offer on the Exchange's book. When the
market bid or offer changes or the booked order is traded such that
the market no longer equals the book, then the instance by which an
order will be kicked out in a particular group will have ended; and
(5) Describes the factors that would be considered by the
appropriate FPC in determining whether to increase the ``step-up''
amount beyond the minimum increment for the particular class of
options. RAES will execute orders in designated classes at the
National Best Bid or Offer (``NBBO'') if the NBBO is better than the
CBOE's best bid or offer by no more than the ``step-up amount.'' In
determining the ``step-up amount,'' the
[[Page 50315]]
appropriate FPC will consider the impact of such decision in
attracting order flow to the Exchange, the desire or need to reduce
the amount of orders rejected for manual handling to provide for a
more orderly market, and any other relevant factors.
III. 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.\13\ 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, the requirements of Section 6 of the Act.\14\
Section 6(b)(5) \15\ of the Act that the rules of an exchange must be
designed to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect to,
and facilitating securities transactions. These rules also must help to
remove impediments to and perfect the mechanism of a free and open
market.
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\13\ The Commission has considered to proposed rule's impact on
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
\14\ 15 U.S.C. 78c(f).
\15\ 15 U.S.C. 78f(b)(5).
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Moreover, the Commission finds good cause for approving Amendment
No. 3 prior to the 30th day after the date the Amendment is published
for comment in the Federal Register pursuant to Section 19(b)(2) of the
Act.\16\ Amendment No. 3 addresses the discretion of the FPCs to
implement Variable RAES and expand the automatic step-up increment, but
does not otherwise affect the operation of RAES. In view of the
immediate need of RAES market makers to limit their risk to compensate
for increased exposure to the larger RAES order sizes, the Commission
finds that acceleration of Amendment No. 3 is appropriate.
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\16\ 15 U.S.C. 78s(b)(2).
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The Commission does not object at this time to extending the
benefits available through RAES to larger-size customer orders up to 50
contracts. The Commission believes that increasing to 50 the number of
option contracts executable through RAES will enable the Exchange to
more effectively and efficiently manage increased order flow in
actively traded option classes consistent with its obligations under
the Act. In addition, this increase should bring the speed and
efficiency of automated execution to a greater number of retail orders.
The Commission also believes that the CBOE should have flexibility to
compete for order flow with other exchanges without being limited to
responding to increases in automatic execution eligibility levels
initiated by those other exchanges. The Commission notes that it has
approved similar proposals by other exchanges increasing to fifty the
maximum size of orders that may be executed automatically.\17\
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\17\ See Securities Exchange Act Release No. 36601 (December 18,
1995), 60 FR 66817 (December 26, 1995); see also Securities Exchange
Act Release No. 41823 (September 1, 1999) (SR-PCS-99-04).
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The Commission believes, based on representations by the Exchange,
that the increase will not expose RAES to risk of failure or
operational breakdown. Our approval of this increase is expressly
conditioned on CBOE's representation that its systems capacity is
sufficient to accommodate the increased number of automatic executions
anticipated to result from implementation of this proposal.
Although the Commission has a degree of comfort with respect to the
proposed increase, the Commission notes that any proposed increases
above fifty contracts may raise additional issues, including such
matters as market maker financial exposure, price improvement, and
quote dissemination. Because of these concerns, the Commission welcomes
the opportunity to review the Exchange's experience with any increase
in maximum order size to fifty contracts. If, in the future, exchanges
seek to increase order size levels above fifty contracts, this
examination will help the Commission assess whether such increases are
appropriate and, if so, whether the Commission should seek additional
assurances regarding such increases.
In addition, the Commission is persuaded that permitting the CBOE
to implement Variable RAES is appropriate. Variable RAES allows RAES
market makers to choose the level of risk they are comfortable with
(subject to minimum size requirements set by the (FPCs). Allowing
market makers to limit their risk in this way is particularly important
because the CBOE may increase the maximum size of orders eligible for
RAES from 20 to 50 contracts in many options classes, thus increasing
the potential exposure of RAES market makers to risk in those options.
In approving Variable RAES, however, the Commission emphasizes that its
approval is expressly conditioned on the CBOE's representation that the
FPCs will take market maker capitalization into account in setting the
RAES order size minimums, thus further reducing the risk market makers
and exposed to. Accordingly, the Commission finds that increasing the
maximum size of RAES orders, in conjunction with implementation of
Variable RAES, will serve to remove impediments to a free and open
market while fostering investor protection, consistent with section
6(b)(5) of the Act.
Finally, the Commission finds that allowing the FPCs to expand the
step-up limit beyond one tick for multiply traded options removes
impediments to a free and open market and protects investors consistent
with Section 6(b)(5) of the Act, by increasing the likelihood that RAES
investors will gain to superior bids and offers available in another
market.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 3, including whether it is
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, DC 20549-0609. Copies
of the submission, all subsequent amendments, all written statements
with respect to the Amendment that are filed with the Commission, and
all written communications relating to the Amendment 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 such filing will also be available for
inspection and copying at the principal office of the CBOE. All
submissions should refer to File No. SR-CBOE-99-17 and should be
submitted by October 7, 1999.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rule change (SR-CBOE-99-17) be, and hereby
is, approved; and that Amendment No. 3 is approved on an accelerated
basis.
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\18\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-24115 Filed 9-15-99; 8:45 am]
BILLING CODE 8010-01-M
