

[Federal Register: November 29, 2005 (Volume 70, Number 228)]
[Notices]               
[Page 71565-71568]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29no05-107]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52823; File No. SR-CBOE-2005-90]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change To Adopt a 
Simple Auction Liaison System To Auction Qualifying Marketable Orders 
for Potential Price Improvement

November 22, 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 October 26, 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

[[Page 71566]]

prepared by CBOE. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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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 a Simple Auction 
Liaison (``SAL'') system to auction qualifying inbound orders for 
potential price improvement. Below is the text of the proposed rule 
change. Proposed new language is in italics.

Chicago Board Options Exchange, Incorporated

Rules

* * * * *
Rule 6.13. CBOE Hybrid System's Automatic Execution Feature
    (a) No change.
    (b) Automatic Execution
    (i) Eligibility: Orders eligible for automatic execution through 
the CBOE Hybrid System may be automatically executed in accordance with 
the provisions of this Rule or in accordance with Rule 6.13A for 
classes that have been designated for auction price improvement. This 
section governs automatic executions and split-price automatic 
executions. The automatic execution and allocation of orders or quotes 
submitted by market participants also is governed by Rules 6.45A(c) and 
(d).
    (ii)-(iv) No change.
    (c)-(e) No change.
* * * * *

Rule 6.13A Simple Auction Liaison (SAL)

    This Rule governs the operation of the SAL system. SAL is a feature 
within the Hybrid System that auctions marketable orders for price 
improvement over the NBBO.
    (a) SAL Eligibility. The Exchange, with input from the appropriate 
Floor Procedure Committee, shall designate the eligible order size, 
eligible order type, eligible order origin code (i.e. public customer 
orders, non-market maker broker-dealer orders, and market maker broker-
dealer orders), and classes in which SAL shall be activated. For such 
classes, SAL shall automatically initiate an auction process for any 
order that is eligible for automatic execution by the Hybrid System 
pursuant to Rule 6.13 (``Agency Order''), except when the Exchange's 
disseminated quotation contains one or more resting limit orders and 
does not contain sufficient Market-Maker quotation size to satisfy the 
entire Agency Order.
    (b) SAL Auction. Prior to commencing the auction, SAL shall stop 
the Agency Order at the NBBO against Market-Maker quotations displayed 
at the NBBO on the opposite side of the market as the Agency Order. SAL 
will not allow such quotations to move to an inferior price or size 
throughout the duration of the auction. The auction will last for a 
period of time not to exceed two (2) seconds as determined by the 
Exchange on a class-by-class basis. Auction responses may be submitted 
by Market-Makers with an appointment in the relevant option class and 
Members acting as agent for orders resting at the top of the Exchange's 
book opposite the Agency Order. With respect to responses, the 
following shall apply:
    (i) Responses shall not be visible to other auction participants 
and shall not be disseminated to OPRA.
    (ii) Responses may be submitted in one-cent increments.
    (iii) Multiple responses are allowed.
    (iv) Responses may be cancelled.
    (v) Responses cannot cross the Exchange's disseminated quotation on 
the opposite side of the market.
    (c) Allocation of Agency Orders. Agency Orders may be executed at 
multiple prices and shall be executed in two rounds per price point as 
follows:
    (i) First Round Allocation. The Agency Order shall first be 
allocated at the prevailing price (the ``First Allocation Round'') 
between all parties that represented the Exchange's NBBO quotation at 
the time the auction commenced (``Original Quoters'') up to the size of 
such quotation. During the First Allocation Round, the following shall 
apply:
    (1) the Agency Order shall be allocated pursuant to the matching 
algorithm in effect for the class pursuant to Rules 6.45A or 6.45B as 
appropriate;
    (2) An Original Quoter may only participate in a First Round 
Allocation at each execution price up to its size at the NBBO at the 
time the auction commenced; and
    (3) If the applicable matching algorithm includes a participation 
entitlement, then Market-Makers that qualify for a participation 
entitlement at the NBBO price will receive a participation entitlement 
if they match the executing auction price(s).
    (ii) Second Allocation Round. If an Agency Order is not fully 
executed during the First Allocation Round at a particular price point, 
then a Second Allocation Round shall occur. During this round, all 
responses received during the auction at the prevailing auction price 
that were not eligible for the First Allocation Round shall participate 
in accordance with the matching algorithm in effect for the class, and 
the size of such responses shall be capped to the size of the Agency 
Order for allocation purposes. There shall be no participation right 
during the Second Allocation Round.
    (d) Early Termination of Auction. The auction will terminate early 
under the following circumstances:
    (i) If the Hybrid System receives an unrelated non-marketable limit 
order on the opposite side of the market from the Agency Order that 
improves any auction responses, the unrelated order will trade (after 
any responses that were priced better than the unrelated order have 
traded) to the fullest extent possible at the midpoint of the best 
remaining auction response and the unrelated order's limit price 
(rounded towards the unrelated order's limit price when necessary).
    (ii) If the Hybrid System receives an unrelated market or 
marketable limit order on the opposite side of the market from the 
Agency Order, such unrelated order will trade to the fullest extent 
possible at the midpoint of the best auction response and the NBBO on 
the opposite side of the market from the auction responses (rounded 
towards the disseminated quote when necessary).
    (iii) If the Hybrid System receives an unrelated order on the same 
side of the market as the Agency Order that is marketable against the 
NBBO, then the auction shall conclude and the Agency Order shall trade 
against the prevailing responses in accordance with subparagraph (c) 
above.
    (iv) Any time there is a quote lock on the Exchange pursuant to 
Rule 6.45A(d).
    (v) Any time a response matches the Exchange's disseminated quote 
on the opposite side of the market from the response.

. . . Interpretations and Policies

    .01 A pattern or practice of submitting unrelated orders that cause 
an exposure period to conclude early will be deemed conduct 
inconsistent with just and equitable principles of trade and a 
violation of Rule 4.1 and other Exchange Rules.
    .02 Disseminating information regarding auctioned orders to third 
parties will be deemed conduct inconsistent with just and equitable 
principles of trade and a violation of Rule 4.1 and other Exchange 
Rules.
* * * * *

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

[[Page 71567]]

the purpose of and basis for the proposal and discussed any comments it 
received on the proposal. The text of these statements may be examined 
at the places specified in Item IV below. 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 purpose of the proposed rule change is to implement SAL, a 
price improvement auction system for qualifying inbound orders. SAL is 
a feature within CBOE's Hybrid System that auctions marketable orders 
for price improvement over the National Best Bid or Offer (``NBBO''). 
Thus, orders that would otherwise be automatically executed at CBOE's 
NBBO market will be exposed to a brief auction in penny increments for 
potential price improvement. SAL would not auction an order if CBOE 
were not the NBBO market at the time the order was received. As 
proposed, the Exchange would designate the eligible order size (e.g., 
all orders under 100 contracts), eligible order type (e.g., non-
contingency orders), eligible order origin code (e.g., public customer 
orders, non-market maker broker-dealer orders, and market maker broker-
dealer orders), and classes in which SAL shall be activated.
    For eligible classes, SAL shall automatically initiate an auction 
process for any qualifying order (``Agency Order'') that is eligible 
for automatic execution by the Hybrid System except when the Exchange's 
disseminated quotation contains one or more resting limit orders and 
does not contain sufficient quotation size from CBOE Market-Makers to 
satisfy the entire Agency Order. The reason SAL requires sufficient 
Market-Maker quote size in the NBBO quote to initiate a SAL auction is 
because SAL stops the Agency Order against the Market-Maker quotes. If 
CBOE's NBBO price consisted only of resting limit orders, SAL could not 
stop the Agency Order against such limit orders because the limit 
orders might be cancelled prior to the conclusion of the auction.
    As mentioned above, SAL stops the Agency Order at the NBBO against 
Market-Maker quotations displayed at the NBBO on the opposite side of 
the market as the Agency Order. In connection with this stop, SAL will 
not allow such quotations to move to an inferior price or size 
throughout the duration of the auction. The auction will last for a 
period of time not to exceed two (2) seconds as determined by the 
Exchange. Auction responses may be submitted by Market-Makers with an 
appointment in the relevant option class and by CBOE Members acting as 
agent for orders resting at the top of the Exchange's book opposite the 
Agency Order. With respect to responses, the following shall apply: (i) 
Responses shall not be visible to other auction participants and shall 
not be disseminated to the Options Price Reporting Authority; (ii) 
responses may be submitted in one-cent increments (and not less than 
one-cent increments); (iii) multiple responses are allowed; (iv) 
responses may be cancelled prior to the conclusion of the auction; and 
(v) responses cannot cross the Exchange's disseminated quotation on the 
opposite side of the market.
    At the conclusion of the auction period, the Agency Order will be 
executed at the best auction response prices and may be executed at 
multiple prices if necessary. The allocation of the execution of the 
Agency Order shall occur in two rounds at each price point. 
Participation in the first round (the ``First Allocation Round'') is 
limited to those that constituted the Exchange's NBBO quote (on the 
side of the market opposite the Agency Order) at the time the SAL 
auction commenced (``Original Quoters''). This is to encourage 
aggressive quoting and reward those that set the NBBO market. During 
the First Allocation Round, the following shall apply: (i) The Agency 
Order shall be allocated pursuant to the matching algorithm in effect 
for the class under Rules 6.45A or 6.45B as appropriate; (ii) Original 
Quoters may only participate in a First Allocation Round at each 
execution price up to their respective size at the NBBO at the time the 
auction commenced; and (iii) if the applicable matching algorithm 
includes a participation entitlement, then Market-Makers that qualified 
for a participation entitlement at the NBBO price will receive a 
participation entitlement in a First Allocation Round if they match the 
execution price for that round.
    If an Agency Order is not fully executed during the First 
Allocation Round, then a second round (``Second Allocation Round'') 
shall occur. During this round, all responses received during the 
auction at the execution price of the immediately preceding First 
Allocation Round that were not eligible for that preceding round shall 
participate in accordance with the matching algorithm in effect for the 
class. The size of such responses shall be limited to the size of the 
Agency Order for allocation purposes. There is no participation right 
during the Second Allocation Round.
    The following is an example of a SAL auction: The CBOE market of 
1.00-1.10 is the NBBO. The 1.10 offer is for 300 contracts and is 
comprised of Market-Maker A for 100 contracts, Market-Maker B for 100 
contracts and Market-Maker C for 100 contracts. A qualifying order is 
received to buy 100 contracts at 1.10. Instead of automatically 
executing the order at 1.10, SAL will auction the order. Assume the 
auction timer is set to one second. At the conclusion of the one-second 
auction, the following responses were received: Market-Maker A at 1.07 
for 10 contracts and at 1.08 for 40 contracts; Market-Maker B at 1.08 
for 40 contracts and at 1.09 for 100 contracts; and Market-Maker X at 
1.07 for 10 contracts and at 1.08 for 100 contracts. The execution of 
the Agency order will proceed as follows: 10 contracts get filled at 
1.07 against Market-Maker A, who is an Original Quoter; 10 contracts 
get filled at 1.07 against Market-Maker X, who is not an Original 
Quoter; and the remaining 80 contracts get filled against Market-Makers 
A and B (40 each) at 1.08. Market-Maker X does not participate at 1.08 
since it is not an Original Quoter.
    The following situations will cause the auction to conclude early. 
First, if the Hybrid System receives an unrelated non-marketable limit 
order on the opposite side of the market from the Agency Order that 
improves any auction responses, the auction will conclude and the 
unrelated order will trade (after any responses that were priced better 
than the unrelated order have traded) to the fullest extent possible at 
the midpoint of the best remaining auction response and the unrelated 
order's limit price (rounded towards the unrelated order's limit price 
when necessary). This will allow both the unrelated order and the 
Agency Order to obtain price improvement. Second, if the Hybrid System 
receives an unrelated market or marketable limit order on the opposite 
side of the market from the Agency Order, the auction will conclude and 
the unrelated order will trade to the fullest extent possible at the 
midpoint of the best auction response and the NBBO on the opposite side 
of the market from the auction responses (rounded towards the 
disseminated quote when necessary). This also provides price 
improvement to both orders. Third, if the Hybrid System receives an 
unrelated order on the same side of the market as the Agency Order that 
is marketable against the NBBO, then the auction will conclude and the 
Agency Order will

[[Page 71568]]

trade against the responses at the highest price points. Fourth, the 
auction will conclude early any time there is a quote lock on the 
Exchange pursuant to Rule 6.45A(d). Fifth, the auction will conclude 
early any time a response matches the Exchange's disseminated quote on 
the opposite side of the market from the response.
    Lastly, the Exchange seeks to adopt provisions providing that a 
pattern or practice of submitting unrelated orders that cause an 
auction to conclude early and disseminating information regarding such 
orders to third parties will be deemed conduct inconsistent with just 
and equitable principles of trade and a violation of CBOE Rule 4.1 and, 
potentially, other Exchange Rules.

2. Statutory Basis

    The Exchange believes the proposed rule change is consistent with 
section 6(b) of the Act \3\ in general and furthers the objectives of 
section 6(b)(5) \4\ in particular in that by swiftly providing 
potential price improvement over the NBBO to qualifying inbound orders, 
it should promote just and equitable principles of trade, serve to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and protect investors and the 
public interest.
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    \3\ 15 U.S.C. 78f(b).
    \4\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change would 
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
    (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 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-2005-90 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-2005-90. 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 the filing also will be available for 
inspection and copying at the principal office of CBOE. 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-2005-90 and should be 
submitted on or before December 20, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-6656 Filed 11-28-05; 8:45 am]

BILLING CODE 8010-01-P
