

[Federal Register: June 22, 2007 (Volume 72, Number 120)]
[Notices]               
[Page 34495-34498]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22jn07-93]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55919; File No. SR-CBOE-2007-62]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Immediate Effectiveness of Proposed 
Rule Change To Amend the CBOE's Rules Related to Credit Default Options

June 18, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on June 15, 2007, the Chicago Board Options Exchange, Incorporated 
( ``Exchange'' or ``CBOE'') 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 prepared 
substantially by the Exchange. The Exchange has designated the proposed 
rule change as one constituting a stated policy, practice, or 
interpretation with respect to the meaning, administration, or 
enforcement of an existing rule under Section 19(b)(3)(A)(i) of the Act 
\3\ and Rule 19b-4(f)(1) thereunder,\4\ which renders the proposal 
effective upon filing with the Commission. 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.
    \3\ 15 U.S.C. 78s(b)(3)(A)(i).
    \4\ 17 CFR 240.19b-4(f)(1).
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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 pertaining to Credit 
Default Options (``CDOs'') in order to: (i) Eliminate the requirement 
that a Market-Maker obtain a separate letter of guarantee to trade CDOs 
and the requirement that a Floor Broker obtain a separate letter of 
authorization to trade CDOs; (ii) provide that, for purposes of CDOs, 
references in the Exchange Rules to the ``appropriate committee'' shall 
be read to be the ``Exchange;'' (iii) make certain non-substantive 
clarifications with respect to the CDO provisions pertaining to 
Redemption Events; (iv) provide for the exclusion of certain debt 
securities from the definitions of ``Reference Obligation'' and 
``Relevant Obligations'' and establish certain minimum threshold 
amounts for purposes of identifying the occurrence of a ``Credit 
Event;'' and (v) modify the

[[Page 34496]]

provisions pertaining to rights and obligations of CDO holders and 
writers and certain disclaimers. The text of the proposed rule change 
is available on the Exchange's Web site (http://www.cboe.org/legal), at 

the Exchange's principal office, and at the Commission's Public 
Reference Room.

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

    In its filing with the Commission, the Exchange 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 those statements may be examined at the places specified in 
Item IV below. The Exchange 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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange recently received approval to list and trade CDOs, 
which are binary call options based on Credit Events \5\ in one or more 
debt securities of an issuer or guarantor.\6\ Before the initiation of 
trading in CDOs, the Exchange wishes to make certain changes to its new 
Chapter XXIX, which contains the rules applicable to CDOs.
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    \5\ A ``Credit Event'' occurs when a Reference Entity has a 
Failure-to-Pay Default on, any other Event of Default on, and/or a 
Restructuring of the Relevant Obligation(s). Failure-to-Pay 
Defaults, Events of Default, and Restructurings are defined in 
accordance with the terms of the Relevant Obligation(s). See CBOE 
Rule 29.1(c) and note 8, infra.
    \6\ See Securities Exchange Act Release No. 55871 (June 6, 
2007), 72 FR 32372 (June 12, 2007) (SR-CBOE-2006-84).
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    First, the Exchange is eliminating Rule 29.18, Letter of 
Authorization or Guarantee, which currently requires that: (i) No 
Market-Maker shall effect any transaction in CDOs unless one or more 
Letter(s) of Guarantee has been issued by an Exchange Clearing Member 
and filed with the Exchange accepting financial responsibility for all 
CDO transactions made by the Market-Maker; and (ii) no Floor Broker 
shall act as such in respect of CDO contracts unless a Letter of 
Authorization has been issued by an Exchange Clearing Member and filed 
with the Exchange. The Exchange is eliminating these requirements 
because they create a duplicative and unnecessary administrative burden 
since Market-Makers and Floor Brokers must already submit Letters of 
Guarantee or Authorization pursuant to Rules 8.5, Letters of Guarantee, 
and 6.72, Letters of Authorization, as applicable, and CDOs would be 
subject to such existing Letters.
    Second, the Exchange is proposing to adopt new Rule 29.18, Exchange 
Authority, which will provide that, for purposes of options that are 
subject to Chapter XXIX, references in the Exchange Rules to the 
``appropriate committee'' shall be read to be to the ``Exchange.'' \7\ 
The Exchange is proposing to make this change because it may determine 
to assign these authorities with respect to options that are subject to 
Chapter XXIX, including CDOs, to committees and/or Exchange staff. In 
making this change, the Exchange will have the flexibility to delegate 
the authorities under the rules with respect to options that are 
subject to Chapter XXIX, including CDOs, to an appropriate committee or 
appropriate Exchange staff and will not have to make a rule change 
merely, for instance, to accommodate the reassignment of any such 
authority.
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    \7\ Thus, for example, references to determinations regarding 
the applicable opening parameter settings established by the 
``appropriate Procedure Committee'' in Exchange Rule 6.2B, Hybrid 
Opening System (``HOSS''), shall be read to be by the ``Exchange.''
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    Third, the Exchange is making some non-substantive clarifications 
with respect to the provisions of Rule 29.4, Adjustments, that pertain 
to Redemption Events.\8\ Specifically, the Exchange is substituting the 
phrase ``Redemption Event'' for ``Redemption'' in three locations in 
subparagraph (a)(2) for grammatical consistency in the rule text. The 
Exchange is also inserting the phrases ``or maturity'' in subparagraph 
(a)(2)(i) and ``or matures'' in subparagraph (a)(2)(ii) in order to 
clarify that the definition of a ``Redemption Event'' includes the 
redemption or maturity of the Reference Obligation and of all other 
Relevant Obligations and, if a Reference Obligation is redeemed or 
matures but other Relevant Obligation(s) remain, a new Reference 
Obligation would be specified from among the remaining Relevant 
Obligation(s). The Exchange is also inserting language into this 
provision that clarifies that the substitution of a new Reference 
Obligation in these two particular scenarios (i.e., if the Reference 
Obligation is redeemed or matures but other Relevant Obligation(s) 
remain) would not be deemed a Redemption Event. These changes to the 
rule text simply make clear the Exchange's intent with respect to the 
impact of maturity.
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    \8\ A ``Redemption Event'' is defined in accordance with the 
terms of the Relevant Obligation(s) and includes the redemption of 
the Reference Obligation and of all other Relevant Obligations. A 
``Reference Obligation'' is a specific debt security of an issuer or 
guarantor that underlies a CDO. The set of the Reference Obligation 
and any other debt security obligation(s) of the issuer or guarantor 
that underlie a CDO are referred to as the ``Relevant Obligations.'' 
See CBOE Rules 29.1(c) and 29.4(a)(2)(i); see also proposed 
amendments to Rule 29.1(c) described below.
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    Fourth, the Exchange is proposing to clarify that non-recourse debt 
is excluded from the definitions of Reference Obligation and Relevant 
Obligations as set forth in Rule 29.1(c). The Exchange is proposing to 
exclude non-recourse indebtedness because this type of debt security is 
generally secured by collateral, which is the only asset the holder of 
debt security may look to for satisfaction to cover the defaulted 
amount. The Exchange does not intend to list and trade CDOs (and other 
types of credit products) that are based on non-recourse debt and 
therefore believes its exclusion from the definitions is appropriate. 
The Exchange also believes that exclusion of non-recourse debt is 
consistent with the purpose of CDOs to afford investors protections 
linked to the Reference Entity's creditworthiness.
    In addition, the Exchange is proposing to include a minimum 
threshold amount for purposes of identifying the occurrence of Failure-
to-Pay Defaults, Events of Default, and Restructurings. For a Failure-
to-Pay Default, the minimum failure-to-pay amount, whether individually 
or in the aggregate, shall be the greater of $750,000 or the amount 
specified in the terms of the Relevant Obligation(s). This provision 
would override any contradictory provision in the terms of the Relevant 
Obligation(s) terms regarding the minimum amount of non-payment that 
triggers a Failure-to-Pay Default. For an Event of Default or 
Restructuring, the default or restructuring (as applicable) must relate 
to a principal amount of the Relevant Obligation(s), whether 
individually or in the aggregate, that is the greater of $7.5 million 
or the amount specified in the terms of the Relevant Obligation(s). 
These provisions would override any contradictory provisions in the 
terms of the Relevant Obligation(s) regarding the minimum principal 
amount necessary to trigger an Event of Default or Restructuring. The 
Exchange believes that establishing these minimum threshold amounts is 
appropriate and will assist in the administration of the Credit Event 
confirmation process. These minimum threshold amounts are designed to 
ensure that a de minimis

[[Page 34497]]

failure-to-pay, default, or restructuring will not trigger a Credit 
Event and, thus, the Exchange believes they are in keeping with the 
purpose of CDOs to afford investors protections linked to the Reference 
Entity's creditworthiness.
    Finally, the Exchange is proposing to modify Rule 29.10, Rights and 
Obligations of Holders and Sellers, to change the title of the rule to 
Disclaimers, remove certain redundancies, and replace the disclaimer 
provision contained in the text with a provision that is more 
consistent with other existing Exchange rules. Specifically with 
respect to redundancies, the Exchange is proposing to delete paragraph 
(a) of the rule, which currently provides that, subject to certain 
other Exchange rules, the rights and obligations of holders and sellers 
of CDOs dealt in on the Exchange shall be set forth in the By-Laws and 
Rules of The Options Clearing Corporation (``OCC''). This language is 
duplicative considering Rule 5.2, Rights and Obligations of Holders and 
Sellers, contains substantively similar language. Paragraph (a) also 
currently provides that Rules 11.1, Exercise of Option Contracts, and 
11.2, Allocation of Exercise Notices, are not applicable to CDOs. The 
Exchange is proposing to delete this language because it is duplicative 
considering Rule 29.9, Determination of Credit Event, Automatic 
Exercise and Settlement.\9\ With respect to disclaimers, the Exchange 
is proposing to delete paragraph (b) of the rule, which currently 
contains disclaimer language limiting the Exchange's liability.\10\ 
This provision would be replaced with disclaimer language \11\ that the 
Exchange believes is more consistent with its other disclaimer rules 
relating to reporting authorities, including Rule 24.14, Disclaimers.
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    \9\ The reference at the end of Rule 29.9 currently provides 
that, for purpose of Chapter XXIX, Rule 29.9 replaces Rule 11.1. The 
Exchange is also proposing to amend this reference to make it clear 
that Rule 11.2 is not applicable to CDOs.
    \10\ Specifically, existing Rule 29.10(b) currently provides 
that, ``[t]he Exchange shall have no liability for damages, claims, 
losses or expenses caused by any errors, omissions or delays in 
confirming or disseminating notice of any Credit Event resulting 
from a negligent act or omission by the Exchange or any act, 
condition or cause beyond the reasonable control of the Exchange, 
including, but not limited to, an act of God; fire; flood; 
extraordinary weather conditions; war; insurrection; riot; strike; 
accident; action of government; communications or power failure; 
equipment or software malfunction; any error, omission or delay in 
the reports of transactions in one or more underlying securities.''
    \11\ Revised Rule 29.10 would provide that, ``The term 
`reporting authority' as used in this rule refers to the Exchange or 
any other entity identified by the Exchange as the `reporting 
authority' in respect of a class of [CDOs] for purposes of the By-
Laws and Rules of [OCC] and any affiliate of the Exchange or any 
such other entity. No reporting authority makes any warranty, 
express or implied, as to the results to be obtained by any person 
or entity from the use of any [CDO]. Any reporting authority hereby 
disclaims all warranties of merchantability or fitness for a 
particular purpose or use with respect to any [CDO]. Any reporting 
authority shall have no liability for any damages, claims, losses 
(including any indirect or consequential losses), expenses or 
delays, whether direct or indirect, foreseen or unforeseen, suffered 
by any person relating to any [CDO], including without limitation as 
a result of any error, omission or delay in confirming, or 
disseminating notice of, any Credit Event, any determination to 
adjust or not to adjust the terms of outstanding [CDOs], or any 
other determination with respect to [CDOs] for which it has 
responsibility under the By-Laws and Rules of [OCC].''
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Act and the rules and regulations under the Act applicable to 
national securities exchanges. Specifically, the Exchange believes the 
proposed rule change is consistent with the Section 6(b)(5) of the 
Act,\12\ which requires that the rules of an exchange be designed to 
promote just and equitable principles of trade, to prevent fraudulent 
and manipulative acts, to remove impediments to and to perfect the 
mechanism for a free and open market and a national market system, and, 
in general, to protect investors and the public interest.
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    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition 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

    The Exchange neither solicited nor received comments on the 
proposal.

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

    Because the foregoing rule change constitutes a stated policy, 
practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule, it has become 
effective pursuant to Section 19(b)(3)(A)(i) of the Act \13\ and Rule 
19b-4(f)(1) thereunder.\14\ At any time within 60 days of the filing of 
the proposed rule change, the Commission may summarily abrogate such 
rule change if it appears to the Commission that such action is 
necessary or appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the purposes of the Act.
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    \13\ 15 U.S.C. 78s(b)(3)(A)(i).
    \14\ 17 CFR 240.19b-4(f)(1).
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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-2007-62 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-CBOE-2007-62. 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 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-2007-62 and should be submitted on or before July 13, 2007.


[[Page 34498]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-12079 Filed 6-21-07; 8:45 am]

BILLING CODE 8010-01-P
