

[Federal Register: October 18, 2005 (Volume 70, Number 200)]
[Notices]               
[Page 60586-60590]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18oc05-131]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52577; File No. SR-CBOE-2005-60]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change and Amendment 
No. 1 Thereto Relating to an Automated Improvement Mechanism

October 7, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 5, 2005, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been substantially 
prepared by the CBOE. On September 2, 2005, the Exchange filed 
Amendment No. 1 to the proposed rule change.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19-4.
    \3\ Amendment No. 1 superseded and replaced the proposed rule 
filing in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend its rules to adopt an electronic 
price improvement mechanism. Below is the text of the proposed rule 
change. Proposed new language is italicized.
* * * * *

Chicago Board Options Exchange, Incorporated Rules

* * * * *

Rule 6.74A Automated Improvement Mechanism (``AIM'')

    Notwithstanding the provisions of Rule 6.74, a member that 
represents agency orders may electronically execute an order it 
represents as agent (``Agency Order'') against principal interest or 
against a solicited order provided it submits the Agency Order for 
electronic execution into the AIM auction (``Auction'') pursuant to 
this Rule.
    (a) Auction Eligibility Requirements. A member (the ``Initiating 
Member'') may initiate an Auction provided all of the following are 
met:

[[Page 60587]]

    (1) the Agency Order is in a class designated as eligible for AIM 
Auctions as determined by the appropriate Floor Procedure Committee and 
within the designated Auction order eligibility size parameters as such 
size parameters are determined by the appropriate Floor Procedure 
Committee;
    (2) if the Agency Order is for 50 contracts or more, the Initiating 
member must stop the entire Agency Order as principal or with a 
solicited order at the better of the NBBO or the Agency Order's limit 
price (if the order is a limit order);
    (3) if the Agency Order is for less than 50 contracts, the 
Initiating member must stop the entire Agency Order as principal or 
with a solicited order at the better of (A) the NBBO price improved by 
one minimum price improvement increment, which increment shall be 
determined by the Exchange but may not be smaller than one cent; or (B) 
the Agency Order's limit price (if the order is a limit order); and
    (4) at least three (3) Market-Makers are quoting in the relevant 
series.
    (b) Auction Process. Only one Auction may be ongoing at any given 
time in a series and Auctions in the same series may not queue or 
overlap in any manner. The Auction may not be cancelled and shall 
proceed as follows:
    (1) Auction Period and Request for Responses (RFRs).
    (A) To initiate the Auction, the Initiating Member must mark the 
Agency Order for Auction processing, and specify (i) a single price at 
which it seeks to cross the Agency Order (with principal interest or a 
solicited order) (a ``single-price submission''), or (ii) that it is 
willing to automatically match as principal the price and size of all 
Auction responses (``auto-match'') in which case the Agency Order will 
be stopped at the NBBO (if 50 contracts or greater) or one cent/one 
minimum increment better than the NBBO (if less than 50 contracts). 
Once the Initiating Member has submitted an Agency Order for processing 
pursuant to this subparagraph, such submission may not be modified or 
cancelled.
    (B) When the Exchange receives a properly designated Agency Order 
for Auction processing, a Request for Responses (``RFR'') detailing the 
side and size of the order will be sent to all members that have 
elected to receive RFRs.
    (C) The RFR will last for a random time period determined by the 
system that shall not be less than 3 seconds and shall not exceed 5 
seconds.
    (D) Each Market-Maker with an appointment in the relevant option 
class may submit responses to the RFR (specifying prices and sizes). 
Such responses cannot cross the disseminated Exchange quote on the 
opposite side of the market.
    (E) Floor Brokers may submit responses to the RFR (specifying 
prices and sizes) only on behalf of orders resting at the top of the 
Exchange's book (resting at the BBO) opposite the Agency Order. Such 
responses cannot cross the disseminated Exchange quote on the opposite 
side of the market, and may not exceed the size of the booked order 
being represented.
    (F) RFR responses shall not be visible to other Auction 
participants, and shall not be disseminated to OPRA.
    (G) The minimum price increment for RFR responses and for an 
Initiating Member's single price submission shall not be smaller than 
the minimum price improvement increment established pursuant to 
subparagraph (a)(3)(A) above.
    (H) An RFR response size at any given price point may not exceed 
the size of the Agency Order.
    (I) RFR responses may be modified or cancelled.
    (2) Conclusion of Auction. The Auction shall conclude at the sooner 
of (A) through (E) below with the Agency Order executing pursuant to 
paragraph (3) below.
    (A) The end of the RFR period;
    (B) Upon receipt by the Hybrid System of an unrelated order (in the 
same series as the Agency Order) that is marketable against either the 
Exchange's disseminated quote (when such quote is the NBBO) or the RFR 
responses;
    (C) Upon receipt by the Hybrid System of an unrelated limit order 
(in the same series as the Agency Order and on the opposite side of the 
market as the Agency Order) that improves any RFR response;
    (D) Any time an RFR response matches the Exchange's disseminated 
quote on the opposite side of the market from the RFR responses; or
    (E) Any time there is a quote lock on the Exchange pursuant to Rule 
6.45A(d).
    (3) Order Allocation. At the conclusion of the Auction, the Agency 
Order will be allocated at the best price(s) pursuant to the matching 
algorithm in effect for the class subject to the following:
    (A) Such best prices may include non-Auction quotes and orders.
    (B) Public customer orders in the book shall have priority.
    (C) No participation entitlement shall apply to orders executed 
pursuant to this Rule.
    (D) If an unrelated market or marketable limit order on the 
opposite side of the market as the Agency Order was received during the 
Auction and ended the Auction, such unrelated order shall trade against 
the Agency Order at the midpoint of the best RFR response and the NBBO 
on the other side of the market from the RFR responses (rounded towards 
the disseminated quote when necessary).
    (E) If an unrelated non-marketable limit order on the opposite side 
of the market as the Agency Order was received during the Auction and 
ended the Auction, such unrelated order shall trade against the Agency 
Order at the midpoint of the best RFR response and the unrelated 
order's limit price (rounded towards the unrelated order's limit price 
when necessary).
    (F) If the best price equals the Initiating Member's single-price 
submission, the Initiating Member's single-price submission shall be 
allocated the greater of one contract or 40% of the order. However, if 
only one Market-Maker matches the Initiating Member's single price 
submission then the Initiating Member shall be allocated 50% of the 
order.
    (G) If the Initiating Member selected the auto-match option of the 
Auction, the Initiating Member shall be allocated its full size at each 
price point until a price point is reached where the balance of the 
order can be fully executed. At such price point, the Initiating Member 
shall be allocated the greater of one contract or 40% of the remainder 
of the order.
    (H) If the Auction does not result in price improvement over the 
Exchange's disseminated price at the time the Auction began, resting 
unchanged quotes or orders that were disseminated at the best price 
before the Auction began shall have priority after any public customer 
order priority and the Initiating Member's priority (40%) have been 
satisfied. Any unexecuted balance on the Agency Order shall be 
allocated to RFR responses provided that those RFR responses will be 
capped to the size of the unexecuted balance and that the Initiating 
Member may not participate on any such balance unless the Agency Order 
would otherwise go unfilled.
    (I) If the final Auction price locks a customer order in the book 
on the same side of the market as the Agency Order, then, unless there 
is sufficient size in the Auction responses to execute both the Agency 
Order and the booked customer order (in which case they will both 
execute at the final Auction price), the Agency Order will execute 
against the RFR responses at one minimum RFR response increment worse 
than the final Auction price against the Auction participants that 
submitted the final Auction price and any balance shall

[[Page 60588]]

trade against the customer order in the book at such order's limit 
price.
    If an unexecuted balance remains on the Auction responses after the 
Agency Order has been executed and such balance could trade against any 
unrelated order(s) that caused the Auction to conclude, then the RFR 
balance will trade against the unrelated order(s).

* * * Interpretations and Policies:

    .01 The Auction may be used only where there is a genuine intention 
to execute a bona fide transaction.
    .02 A pattern or practice of submitting unrelated orders that cause 
an Auction to conclude before the end of the RFR period will be deemed 
conduct inconsistent with just and equitable principles of trade and a 
violation of Rule 4.1. It will also be deemed conduct inconsistent with 
just and equitable principles of trade and a violation of Rule 4.1 to 
engage in a pattern of conduct where the Initiating Member breaks-up an 
Agency Order into separate orders for two (2) or fewer contracts for 
the purpose of gaining a higher allocation percentage than the 
Initiating Member would have otherwise received in accordance with the 
allocation procedures contained in subparagraph (b)(3) above.
    .03 Initially, and for at least a Pilot Period expiring on July 18, 
2006, there will be no minimum size requirement for orders to be 
eligible for the Auction. During this Pilot Period, the Exchange will 
submit certain data, periodically as required by the Commission, to 
provide supporting evidence that, among other things, there is 
meaningful competition for all size orders and that there is an active 
and liquid market functioning on the Exchange outside of the Auction 
mechanism. Any data which is submitted to the Commission will be 
provided on a confidential basis.
    .04 Any solicited orders submitted by the Initiating Member to 
trade against the Agency Order may not be for the account of a Market-
Maker assigned to the option class.
    .05 Any determinations made by the Exchange pursuant to this Rule 
such as eligible classes, order size parameters and the minimum price 
increment for RFR responses shall be communicated in a Regulatory 
Circular.
    .06 Subparagraph (b)(2)(E) of this rule will be effective for a 
Pilot Period until July 18, 2006. During the Pilot Period, the Exchange 
will submit certain data relating to the frequency with which early 
termination of the Auction occurs pursuant to this provision as well as 
any other provision, and also the frequency with which early 
termination pursuant to this provision results in favorable pricing for 
the Agency Order.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CBOE has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to establish an Automated Improvement 
Mechanism (``AIM'') that would electronically auction certain orders 
for price improvement. Under the AIM process, a member (``Initiating 
Member'') that represents agency orders may submit an order it 
represents as agent (``Agency Order'') along with a second order (a 
principal order or a solicited order for the same amount as the Agency 
Order) into the AIM auction where other participants could compete with 
the Initiating Member's second order to execute against the Agency 
Order.
    When submitting an Agency Order into the AIM auction, the 
Initiating Member must also submit a contra-side second order for the 
same size as the Agency Order. This second order guarantees that the 
Agency Order will receive an execution (i.e., it acts as a stop).\4\ 
Once an AIM auction has commenced, it cannot be cancelled by the 
Initiating Member. The Initiating Member may enter the second order in 
one of two formats: (1) a specified single price, or (2) a non-price 
specific commitment to match as principal the price and size of all 
auction responses that are received during the auction. In this case, 
the Initiating Member would have no control over the match price.
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    \4\ In connection with the stop of the Agency Order, the 
following shall apply: if (1) the Agency Order is for less than 50 
contracts, the Initiating Member must stop the entire Agency Order 
as principal or with a solicited order at the better of (A) the 
national best bid or offer (``NBBO'') price improved by one minimum 
price improvement increment, which increment shall be determined by 
the Exchange but may not be smaller than one cent; or (B) the Agency 
Order's limit price (if the order is a limit order); and (2) if the 
Agency Order is for 50 contracts or more, the Initiating Member must 
stop the entire Agency Order as principal or with a solicited order 
at the better of the NBBO or the Agency Order's limit price (if the 
order is a limit order).
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    Upon receipt of an Agency Order (and second order), the Exchange 
would commence the AIM auction by issuing a request for responses 
(``RFR'') detailing the side and size of the Agency Order.\5\ The RFR 
response period (i.e., the auction) would last for a random time period 
(calculated by the Exchange system) that shall not be less than 3 
seconds and shall not exceed 5 seconds. During that period any Market-
Maker with an appointment in the class as well as any Floor Broker on 
behalf of orders resting at the top of the Exchange's book opposite the 
Agency Order may submit RFR responses (including multiple responses). 
These responses must specify price and size and may not cross the 
Exchange's quote on the opposite side of the market. All RFR responses 
are ``blind,'' that is, they are not visible to any other participants. 
CBOE believes this aspect of the auction will encourage more aggressive 
quoting and superior price improvement. RFR responses may be modified 
or cancelled so long as they are modified or cancelled before the 
conclusion of the random RFR response period. Lastly, the RFR response 
minimum price increment may be set by the Exchange at no less than one 
cent.
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    \5\ Each RFR would be sent to all members electing to receive 
RFRs (i.e., those members who have established the necessary systems 
connectivity to receive RFRs). Thus, such election to receive RFRs 
would not be on a case-by-case basis. Only members specified in 
proposed CBOE Rule 6.74A(b)(1)(D) and (E) may submit responses.
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    Normally, the auction ends at the conclusion of the random RFR 
response timer (3 to 5 seconds),\6\ however, the proposal provides that 
certain other events would end the auction prior to the conclusion of 
the RFR timer. These events are: (1) receipt by the Hybrid System of an 
unrelated order, in the same series as the Agency Order, that is 
marketable against the Exchange's disseminated quote (when such quote 
is the NBBO) or the RFR responses, (2) receipt by the Hybrid System of 
an unrelated non-marketable limit order, in the same series as the 
Agency Order and on the opposite side of the market as the Agency 
Order, that improves any RFR response, (3) any time an RFR response 
matches the Exchange's disseminated quote on the opposite side of the 
market, and (4) pursuant to a pilot program that will expire on July 
18, 2006, any time there is a Market-Maker to Market-Maker quote lock 
on the

[[Page 60589]]

Exchange (in accordance with CBOE Rule 6.45A(d)).\7\
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    \6\ CBOE represents that this random time period would be 
determined solely by the Exchange system.
    \7\ In connection with this pilot program, the Exchange would 
provide the Commission data (on a confidential basis) regarding the 
frequency with which early termination of the Auction occurs 
pursuant to this provision as well as any other provision, and also 
the frequency with which early termination pursuant to this 
provision results in favorable pricing for the Agency Order. 
Proposed Interpretation .06 to Proposed CBOE Rule 6.74A.
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    At the conclusion of the auction, the Agency Order would be 
allocated in accordance with applicable matching algorithm rules in 
effect for such class subject to the following provisions. First, no 
participation entitlement would apply with respect to an AIM execution. 
Second, public customer orders in the book would have priority. Third, 
if an unrelated market order or marketable limit order on the opposite 
side of the market as the Agency Order was received during the auction 
and ended the auction, such unrelated order would trade against the 
Agency Order at the midpoint of the best RFR response and the NBBO on 
the other side of the market (rounded towards the disseminated quote 
when necessary).\8\ Fourth, if an unrelated non-marketable limit order 
on the opposite side of the market as the Agency Order was received 
during the auction and ended the auction, such unrelated limit order 
would trade against the Agency Order at the midpoint of the best RFR 
response and the unrelated order's limit price (rounded towards the 
unrelated order's limit price when necessary).\9\ Fifth, if the best 
price equals the Initiating Member's single-price submission, the 
Initiating Member's single-price submission would be allocated the 
greater of one contract or 40% of the order. However, if only one 
Market-Maker matches the Initiating Member's single price submission 
then the Initiating Member would be allocated 50% of the order. Sixth, 
if the Initiating Member selected the auto-match option of the auction, 
the Initiating Member would be allocated its full size at each price 
point until a price point is reached where the balance of the order can 
be fully executed. At such price point, the Initiating Member would be 
allocated the greater of one contract or 40% of the remainder of the 
order. Seventh, if the auction does not result in price improvement 
over the Exchange's disseminated price at the time the auction began, 
resting unchanged quotes or orders that were disseminated at the best 
price before the auction began would have priority after any public 
customer order priority and the Initiating Member's priority (40%) have 
been satisfied. Any unexecuted balance on the Agency Order would be 
allocated to RFR responses pursuant to the matching algorithm except 
that the responses would be capped to the size of the unexecuted 
balance and the Initiating Member may not participate on any such 
balance unless the Agency Order would otherwise go unfilled. Eight, if 
the final auction price locks a customer order in the book on the same 
side of the market as the Agency Order, then, unless there is 
sufficient size in the auction responses to execute both the Agency 
Order and the booked customer order (in which case they will both 
execute at the final auction price), the Agency Order would execute 
against the RFR responses at one minimum RFR response increment worse 
than the final Auction price against the auction participants that 
submitted the final auction price and any balance would trade against 
the customer order in the book at such order's limit price.
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    \8\ For example, if an AIM auction is underway for an Agency 
Order to buy and the CBOE quote (as well as the NBBO) is 1-1.15 with 
the RFR responses at 1.12 and an unrelated market order to sell is 
received by the Exchange, the unrelated order would execute against 
the Agency Order at 1.06 (the midpoint of the best RFR responses and 
the NBBO).
    \9\ For example, using the same scenario as above except the 
unrelated order is a non-marketable limit order to sell at 1.10, the 
unrelated order would execute against the Agency Order at 1.11 (the 
midpoint of the best RFR responses and the unrelated order's limit 
price).
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    If an unexecuted balance remains on the auction responses after the 
Agency Order has been executed and such balance could trade against any 
unrelated order(s) that caused the Auction to conclude, then the RFR 
balance would trade against the unrelated order(s). CBOE believes this 
is a benefit to the market in that excess auction liquidity would be 
available to orders other than the Agency Order.
    Lastly, the Exchange proposes certain interpretations and policies. 
First, the auction may be used only where there is a genuine intention 
to execute a bona fide transaction. Second, a pattern or practice of 
submitting unrelated orders that cause an auction to conclude before 
the end of the RFR period would be deemed conduct inconsistent with 
just and equitable principles of trade and a violation of CBOE Rule 4.1 
and other Exchange Rules. Third, initially, and for at least a Pilot 
Period expiring on July 18, 2006, there would be no minimum size 
requirement for orders to be eligible for the auction. During this 
Pilot Period, the Exchange would submit certain data, periodically as 
required by the Commission, to provide supporting evidence that, among 
other things, there is meaningful competition for all size orders and 
that there is an active and liquid market functioning on the Exchange 
outside of the Auction mechanism. Any data which is submitted to the 
Commission would be provided on a confidential basis. Fourth, any 
solicited orders submitted by the Initiating Member to trade against 
the Agency Order may not be for the account of a Market-Maker assigned 
to the option class. Fifth, any determinations made by the Exchange 
pursuant to the proposed rule such as eligible classes, order size 
parameters and the minimum price increment for RFR responses would be 
communicated in a Regulatory Circular. Finally, proposed CBOE Rule 
6.74A(b)(2)(E), which would end the auction because of a lock on the 
CBOE market, would operate as a pilot program until July 18, 2006.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act \10\ in general and furthers the objectives of 
Section 6(b)(5) of the Act \11\ in particular in that it is designed to 
remove impediments to and perfect the mechanism for a free and open 
market and a national market system, and, in general, to protect 
investors and the public interest. In particular, the Exchange believes 
that the proposal would provide an opportunity for customers to receive 
price improvement on their orders.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    This proposed rule change does not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or

[[Page 60590]]

    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-CBOE-2005-60 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-CBOE-2005-60. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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 in 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 comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CBOE-2005-60 and should be submitted on or before 
November 8, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E5-5728 Filed 10-17-05; 8:45 am]

BILLING CODE 8010-01-P
