

[Federal Register: December 15, 2005 (Volume 70, Number 240)]
[Notices]               
[Page 74388-74392]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15de05-104]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52928; File No. SR-CBOE-2005-89]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Notice of Filing of a Proposed Rule Change and Amendment No. 1 
Thereto Relating to the Adoption of a Hybrid Agency Liaison System for 
Automated Handling of Inbound Orders That Are Not Automatically 
Executed

December 8, 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 27, 2005, the Chicago Board Options Exchange, Inc. (``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 
Exchange. CBOE filed Amendment No. 1 to the proposed rule change on 
December 7, 2005.\3\ The Commission is publishing this notice to 
solicit comment 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 240.19b-4.
    \3\ Amendment No. 1 replaced the original filing in its 
entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend its rules to adopt a Hybrid Agency Liaison 
(``HAL'') system for automated handling of inbound orders. The text of 
the proposed rule change is set forth below. Proposed new language is 
in italics.

Chicago Board Options Exchange, Incorporated

Rules

* * * * *

[[Page 74389]]

Rule 6.13. CBOE Hybrid System's Automatic Execution Feature

    (a) No change.
    (b) Automatic Execution
    (i)-(iii) No change.
    (iv) Executions at NBBO: Eligible orders in classes that are 
multiply traded will not be automatically executed on CBOE at prices 
that are inferior to the NBBO and instead shall route to HAL, the PAR 
workstation in the trading crowd or, at the order entry firm's 
discretion, to BART. Eligible orders received while the CBOE market is 
locked (e.g., $1.00 bid--$1.00 offered) shall be eligible for automatic 
execution at CBOE's disseminated quote, provided that the disseminated 
quote is not inferior to the NBBO.
    (c)-(e) No change.
* * * * *

Rule 6.14 Hybrid Agency Liaison (HAL)

    This Rule governs the operation of the HAL system. HAL is a feature 
within the Hybrid System that provides automated order handling in 
designated Hybrid option classes for qualifying electronic orders that 
are not automatically executed by the Hybrid System.
    (a) HAL Eligibility. The Exchange, with input from the appropriate 
Floor Procedure Committee, shall designate the classes in which HAL 
shall be activated. For such classes, HAL shall automatically process 
upon receipt, as set forth in subparagraph (b) below, market and limit 
orders under the following circumstances:
    (i) Market orders or limit orders that are marketable against the 
Exchange's disseminated quotation while that quotation is not the NBBO;
    (ii) Limit orders that would improve the Exchange's disseminated 
quotation and that are marketable against quotations disseminated by 
other exchanges that are participants in the Intermarket Options 
Linkage; and
    (iii) Limit orders that would improve the Exchange's disseminated 
quotation.
    (b) HAL Order Handling. Orders that are received by HAL pursuant to 
subparagraph (a) above shall immediately upon receipt be electronically 
exposed to all Market-Makers appointed to the relevant option class as 
well as all members acting as agent for orders at the top of the 
Exchange's book (``Qualifying Members'') in the relevant option series. 
The exposure shall be for a period of time determined by the Exchange 
on a class-by-class basis, with input from the appropriate Floor 
Procedure Committee, which period of time shall not exceed 1.5 seconds. 
If during the exposure period, a Market-Maker or Qualifying Member (on 
behalf of the order it is representing) commits to trade with any 
portion of the order, then the exposure period shall end (the Exchange 
will disseminate a last sale report for the quantity committed to) and 
an allocation period shall commence (with additional last sale reports 
being immediately disseminated for any additional portions of the order 
that are committed to during this period). At no point will HAL execute 
an order, or any portion of an order, if such execution would cause a 
trade-through. The allocation period shall be a period of time 
determined by the Exchange on a class-by-class basis, with input from 
the appropriate Floor Procedure Committee, which period of time, when 
combined with the designated exposure period time (as opposed to an 
exposure period that is terminated early), shall not exceed a total of 
three (3) seconds. Allocation of the order shall be pursuant to 
subparagraph (c) below. If no responses are received during the 
exposure period or if there remains an unexecuted portion of an order 
at the conclusion of the allocation period, then the order (the 
``Remaining Order'') shall be processed as follows:
    (i) If the Remaining Order is for the account of a public customer 
and is marketable against another exchange that is a participant in the 
Intermarket Options Linkage, then HAL shall route a P/A Order on behalf 
of the Remaining Order through the Linkage and any resulting execution 
of the P/A Order shall be allocated to the Remaining Order. If the P/A 
Order cannot be transmitted from the Exchange because the price of the 
P/A Order (or a better price) is no longer available on any market, 
then HAL shall, pursuant to normal order allocation processing, execute 
the Remaining Order against the Exchange's quote (provided such 
execution would not cause a trade-through) including, if appropriate, 
at the Exchange's BBO at the time the order was received by HAL 
(``Exchange Initial BBO'') against the Market-Makers that constituted 
the Exchange Initial BBO;
    (ii) If the Remaining Order is marketable against another exchange 
that is a participant in the Intermarket Options Linkage but is not for 
the account of a public customer, then HAL, when the system is enabled, 
shall route a Principal Order on behalf of the Remaining Order through 
the Linkage and any resulting execution of the Principal Order shall be 
allocated to the Remaining Order. If the Principal Order cannot be 
transmitted from the Exchange because the price of the Principal Order 
(or a better price) is no longer available on any market, then HAL 
shall, pursuant to normal order allocation processing, execute the 
Remaining Order against the Exchange's quote (provided such execution 
would not cause a trade-through) including, if appropriate, at the 
Exchange Initial BBO at the time the order was received by HAL against 
the Market-Makers that constituted the Exchange Initial BBO. Until the 
HAL system is enabled to route Principal Orders, the Remaining Order 
shall route to PAR;
    (iii) If the Remaining Order is not marketable (either on the 
Exchange or another exchange) it shall be entered into the Hybrid book 
for dissemination.
    (c) Allocation of Exposed Orders. Each Market-Maker or Qualifying 
Member that submits an order or quote to trade with an order during the 
exposure or allocation periods shall be entitled to receive an 
allocation of the order in accordance with the allocation algorithm in 
effect for the option class pursuant to Rule 6.45A or 6.45B. There is 
no participation entitlement applicable to exposed orders, and response 
sizes are limited to the size of the exposed order for allocation 
purposes.
    (d) Early Termination of Exposure Period. In addition to the 
receipt of a response to trade any portion of the exposed order, the 
exposure period will also terminate early under the following 
circumstances:
    (i) If during the exposure period the Hybrid System receives an 
unrelated order on the opposite side of the market from the exposed 
order that could trade against the exposed order at the prevailing NBBO 
price, then the orders will trade. However, the exposure period shall 
not terminate for any quantity that remains on the exposed order after 
such trade;
    (ii) If during the exposure period the Hybrid System receives an 
unrelated order on the same side of the market as the exposed order 
that is priced equal to or better than the exposed order, then the 
exposure period shall terminate and the exposed order shall be 
processed in accordance with subparagraph (b) (i), (ii) or (iii), as 
appropriate;
    (iii) If during the exposure of an order that is marketable against 
the Exchange Initial BBO, a Market-Maker attempts to move its quote to 
a price that is inferior to the Exchange Initial BBO, then the exposure 
period shall terminate and the exposed order shall be processed in 
accordance with subparagraph (b) (i) or (ii), as appropriate.
    (e) Early Termination of Allocation Period.
    (i) If HAL is in the allocation stage of processing an order that 
has not been

[[Page 74390]]

fully executed (i.e. all responses that have been received to that 
point cannot fully execute the order) and the Hybrid System receives an 
unrelated order on the opposite side of the market from the order that 
could trade against the order at the prevailing NBBO price, then the 
orders will trade. However, the allocation period shall not terminate 
with respect to any portion of the HAL order that did not execute 
against the unrelated order;
    (ii) If HAL is in the allocation stage of processing an order that 
has not been fully executed (i.e. all responses that have been received 
to that point cannot fully execute the order) and the Hybrid System 
receives an unrelated order on the same side of the market as the 
order, then the allocation period shall terminate for the unexecuted 
portion of the order and the unexecuted portion of the order shall be 
processed in accordance with subparagraph (b) (i), (ii) or (iii), as 
appropriate;
    (iii) If HAL is in the allocation stage of processing an order that 
is marketable against the Exchange Initial BBO and a Market-Maker 
attempts to move its quote to a price that is inferior to the Exchange 
Initial BBO while any portion of the order remains unexecuted (i.e. all 
responses that have been received to that point cannot fully execute 
the order), then the allocation period shall terminate and the 
unexecuted portion of the order shall be processed in accordance with 
subparagraph (b) (i) or (ii), as appropriate.
    * * * 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 exposed 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 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 HAL, a new 
order handling system for option classes trading on CBOE's Hybrid 
System (``Hybrid''). Hybrid provides electronic executions for orders 
that are marketable against the Exchange's quote when it is priced at 
the National Best Bid or Offer (``NBBO''). The entire process for those 
orders is automated; however, many electronically-received orders that 
are not automatically executed upon receipt by the Hybrid System 
(usually because CBOE's disseminated quote is not the NBBO) are routed 
to a PAR terminal for manual handling. Proposed CBOE Rule 6.14 is meant 
to automate the process of handling most orders that would otherwise go 
to PAR.
    Currently, if the Exchange receives a marketable order when its 
disseminated quote is not the NBBO, the order routes to PAR where it 
must be selected by the PAR Official (there may be multiple orders on 
PAR at the same time) and then represented to the trading crowd in 
open-outcry. The order is represented to determine if any trading crowd 
members are willing to step up and match the NBBO price available on 
another exchange. If there is interest in the crowd to match the NBBO, 
then the order will be manually filled. If there is no interest in 
matching the NBBO price, an order will be generated and transmitted via 
the Intermarket Option Linkage (``Linkage'') to the NBBO market on 
behalf of the order on PAR. If the Linkage order is filled, that fill 
will be transferred to the order on PAR. While all of this is done 
relatively quickly, the HAL system would automate this process and 
reduce the timing to a matter of seconds (in no case more than three 
seconds). The following is an explanation of how HAL would work.
    HAL would only be available for classes trading on Hybrid. The 
Exchange, with input from the appropriate Floor Procedure Committee, 
would designate the Hybrid classes for which HAL would be activated. 
For those classes, HAL would process (i) market orders or limit orders 
that are marketable against CBOE's disseminated quote while that quote 
is not the NBBO; (ii) limit orders that would improve the Exchange's 
disseminated quote and that are marketable against quotes disseminated 
by other exchanges that are participants in the Plan for the Purpose of 
Creating and Operating an Intermarket Options Linkage (``Linkage 
Plan''); and (iii) limit orders that are not marketable against the 
NBBO but that would improve CBOE's disseminated quote. These orders 
would be electronically exposed (flashed) to all Market-Makers 
appointed to the relevant option class as well as to all members acting 
as agent for orders at the top of the Exchange's book in the relevant 
option series (``Qualifying Members'').\4\ Like with open outcry, this 
flash would afford crowd members an opportunity to match the away NBBO 
price.
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    \4\ Of course, eligible recipients of these ``flash'' messages 
may need to undertake some programming modifications in order to 
receive and respond to these messages. The Exchange will not require 
those programming changes.
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    HAL's first step in flashing an order would be to gauge if there is 
any interest from any Market-Maker or Qualifying Member in matching the 
away NBBO price, or, in the case of a limit order that improves CBOE's 
quote but is not marketable, in filling the order instead of booking 
it. This step is called the exposure period. The exposure would be for 
a period of time determined by the Exchange on a class-by-class basis, 
with input from the appropriate Floor Procedure Committee, which period 
of time would not exceed 1.5 seconds. If during the exposure period, a 
Market-Maker or Qualifying Member (on behalf of the order it is 
representing) commits to trade with any portion of the order, then the 
exposure period would end (with a last sale report being issued for the 
quantity that was traded) and an allocation period would begin.
    The allocation period affords other participants that were 
attempting to trade with the exposed order a chance to participate in 
the execution of the order. The allocation period would be a period of 
time determined by the Exchange on a class-by-class basis, with input 
from the appropriate Floor Procedure Committee, which period of time, 
when combined with the designated exposure period time (as opposed to 
an exposure period that is terminated early), would not exceed a total 
of three seconds. For example, if the exposure period is set to 1.5 
seconds, the allocation period cannot exceed 1.5 seconds. If the 
exposure period is set for one second, the allocation period cannot 
exceed two seconds. Of course, in that case the Exchange could 
determine to set the allocation period at one second or anything less 
than two seconds (i.e., the

[[Page 74391]]

entire HAL process does not have to equal three seconds). Further, if 
an exposure period for a given order is terminated early, the ``unused 
balance'' of the exposure period is not added to the allocation period.
    Exposed orders would be allocated at the conclusion of the 
allocation period in accordance with the allocation algorithm in effect 
for the option class pursuant to CBOE Rule 6.45A or 6.45B. There is no 
participation entitlement applicable to exposed orders, and response 
sizes are limited to the size of the exposed order for allocation 
purposes.
    If no responses are received during the exposure period or if there 
remains an unexecuted portion of an order at the conclusion of the 
allocation period, then the order (the ``Remaining Order'') would be 
booked if it is a limit order that is not marketable, or processed in 
one of the following two ways, based on whether the order is for the 
account of a public customer. First, if the Remaining Order is for the 
account of a public customer and is marketable against another exchange 
that is a participant in the Linkage Plan, then HAL would route a 
Principal Acting as Agent Linkage Order (``P/A Order'') on behalf of 
the Remaining Order through the Linkage and any resulting execution of 
the P/A Order would be allocated to the Remaining Order. Second, if the 
Remaining Order is marketable against another exchange that is a 
participant in the Linkage Plan but is not for the account of a public 
customer, then HAL, when the system is enabled, would route a Principal 
Linkage Order (``P Order'') on behalf of the Remaining Order through 
the Linkage, and any resulting execution of the P Order would be 
allocated to the Remaining Order.\5\ Until the HAL system is enabled to 
route P Orders, the Remaining Order would route to PAR.
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    \5\ When routing Linkage orders (whether P or P/A), the Exchange 
may choose to route only up to the available size at the NBBO as 
allowable under the ``trade and ship'' process of the Linkage Plan.
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    In either of these situations, if the Linkage order cannot be 
transmitted from the Exchange because the price of the Linkage order 
(or a better price) is no longer available on any market, then HAL 
would, pursuant to normal order allocation processing, execute the 
Remaining Order against the Exchange's quote (provided such execution 
would not cause a trade-through), including, if appropriate, at the 
Exchange's best bid or offer at the time the order was received by HAL 
(``Exchange Initial BBO'') against the Market-Makers that constituted 
the Exchange Initial BBO. HAL would effect executions against Market-
Makers at the Exchange Initial BBO by preventing Market-Makers from 
moving Exchange Initial BBO quotes to inferior prices until a HAL order 
has been executed on CBOE or routed through Linkage.
    The Exchange notes that, in addition to the receipt of a response 
to trade any portion of the exposed order, the exposure period would 
terminate early under the following circumstances. First, if during the 
exposure period the Hybrid System received an unrelated order on the 
opposite side of the market from the exposed order that could trade 
against the exposed order at the prevailing NBBO price, then the orders 
would trade. However, the exposure period would not terminate if a 
quantity remains on the exposed order after such trade. Second, if 
during the exposure period the Hybrid System received an unrelated 
order on the same side of the market as the exposed order that was 
priced equal to or better than the exposed order, then the exposure 
period would terminate and the exposed order would be processed in the 
same manner as an exposed order for which no response to trade was 
received during the full exposure period--i.e., routed through the 
Linkage or booked, in accordance with proposed CBOE Rule 6.14(b)(i), 
(ii), or (iii), as appropriate. Third, if during the exposure of an 
order that is marketable against the Exchange Initial BBO a Market-
Maker attempted to move its quote to a price that was inferior to the 
Exchange Initial BBO, then the exposure period would terminate and the 
exposed order would be processed in the same manner as an exposed order 
for which no response to trade was received during the full exposure 
period. Meanwhile, the Exchange would not permit any Market-Maker 
quotes to move to an inferior price until the exposed order was routed 
through Linkage or, if necessary, executed against Market-Makers at the 
Exchange Initial BBO.
    Similarly, if HAL were in the allocation stage of processing an 
order that has not been fully executed (i.e., an order that was 
partially ``hit'' during the exposure period and for which all 
responses received to that point could not fully execute the order), 
the allocation period would terminate early under the following 
circumstances. First, if the Hybrid System received an unrelated order 
on the opposite side of the market from the HAL order that could trade 
against the HAL order at the prevailing NBBO price, then the orders 
would trade. However, the allocation period would not terminate with 
respect to any quantity that did not execute against the unrelated 
order. Second, if the Hybrid System received an unrelated order on the 
same side of the market as the HAL order, then the allocation period 
would terminate for the unexecuted portion of the order and the 
unexecuted portion of the order would be processed in the same manner 
as an exposed order for which no response to trade was received during 
the full exposure period--i.e., routed through the Linkage or booked, 
in accordance with proposed CBOE Rule 6.14(b)(i), (ii), or (iii), as 
appropriate. Third, if HAL were in the allocation stage of an order 
that is marketable against the Exchange Initial BBO and a Market-Maker 
attempted to move its quote to a price that was inferior to the 
Exchange Initial BBO while any portion of the order remained unexecuted 
(i.e., all responses that have been received to that point cannot fully 
execute the order), then the allocation period would terminate and the 
unexecuted portion of the order would be processed in the same manner 
as an exposed order for which no response to trade was received during 
the full exposure period.
    Finally, the Exchange proposes that a pattern or practice of 
submitting unrelated orders that cause an exposure period to conclude 
early and disseminating information regarding exposed orders to third 
parties would be deemed conduct inconsistent with just and equitable 
principles of trade and a violation of CBOE Rule 4.1 and other Exchange 
Rules.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act \6\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act \7\ in particular, in that 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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    \6\ 15 U.S.C. 78f(b).
    \7\ 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.

[[Page 74392]]

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 Exchange 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, 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-2005-89 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-9303.
    All submissions should refer to File Number SR-CBOE-2005-89. 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-2005-89 and should be submitted on or before 
January 5, 2006.
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    \8\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
Jonathan G. Katz,
Secretary.
[FR Doc. E5-7370 Filed 12-14-05; 8:45 am]

BILLING CODE 8010-01-P
