

[Federal Register: July 27, 2007 (Volume 72, Number 144)]
[Notices]               
[Page 41367-41369]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27jy07-91]                         


[[Page 41367]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56114; File No. SR-CBOE-2007-81]

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

July 20, 2007.
    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 July 16, 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 set out certain parameters that 
the Exchange intends to use for determining the applicable share to be 
allocated to a Successor Reference Entity if there is a CDO contract 
adjustment due to a Succession Event.\5\ 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.
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    \5\ The terms ``applicable share,'' ``Successor Reference 
Entity,'' and ``Succession Event'' are described further below.
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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 Credit 
Default Options or CDOs, which are binary call options based on Credit 
Events \6\ in one or more debt securities of an issuer or guarantor.\7\ 
The Exchange is now proposing to amend Rule 29.4, Adjustments, in order 
to set out certain parameters that the Exchange intends to use for 
determining the applicable share to be allocated to a Successor 
Reference Entity if there is a CDO contract adjustment due to a 
Succession Event.\8\
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    \6\ 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 (other than non-recourse indebtedness) that underlie a 
CDO are referred to as the ``Relevant Obligations.'' 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 Restructuring are defined in accordance with the terms of the 
Relevant Obligation(s) and subject to certain minimum threshold 
amounts provided in Rule 29.1(c).
    \7\ See Securities Exchange Act Release No. 55871 (June 6, 
2007), 72 FR 32372 (June 12, 2007) (SR-CBOE-2006-84).
    \8\ A ``Successor Reference Entity'' and a ``Succession Event'' 
are defined in accordance with the terms of the Relevant 
Obligation(s). See Rule 29.4(a)(1)(i).
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    By way of background, the cash settlement amount for a CDO is 
generally $100,000 per contract (equal to an exercise settlement value 
of $100 multiplied by a contract multiplier of 1,000) upon automatic 
exercise if the Exchange confirms a Credit Event.\9\ If a Credit Event 
is not confirmed, the cash settlement value will be $0. Among other 
things, Rule 29.4 provides that CDO contracts will be subject to 
adjustment and replaced by one or more CDOs derived from Successor 
Reference Entities based on the applicable share of each Successor 
Reference Entity. The ``applicable share'' is a percentage amount used 
to determine the adjusted cash settlement amount and adjusted contract 
multiplier applicable to each replacement CDO.\10\ For example, if 
there are two Successor Reference Entities that each have an applicable 
share of 50%, the cash settlement amount for each replacement CDO would 
be $50,000 (equal to an exercise settlement value of $100 multiplied by 
the revised contract multiplier of 500).
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    \9\ See Rule 29.1(a).
    \10\ Every determination by the Exchange pursuant to Rule 29.4 
is within the Exchange's sole discretion, is conclusive and binding 
on all holders and sellers, and is not subject to review. See Rule 
29.4(d).
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    Currently, the rule is silent regarding the calculation of the 
applicable share. Based on feedback from potential CDO investors and in 
order to provide more clarity and certainty to such investors, the 
Exchange is proposing to codify certain parameters that it intends to 
utilize in determining the applicable share. As set out in the proposed 
revisions to the rule text, in determining the applicable share the 
Exchange, as a general rule, would allocate an equal share to each 
Successor Reference Entity that has succeeded the Reference Entity as 
issuer and guarantor of (i) at least one Relevant Obligation and (ii) 
at least 25% of the principal amount of the original Reference Entity's 
outstanding debt obligations other than non-recourse indebtedness. If 
no Successor Reference Entity satisfies the ``at least 25%'' 
requirement and the original Reference Entity does not survive 
following the Succession Event, an equal share will be allocated to the 
Successor Reference Entity(ies) that succeeded to the largest 
percentage of the original Reference Entity's outstanding debt 
obligations other than non-recourse indebtedness.\11\ These applicable 
share parameters would override any contradictory provision in the 
Relevant Obligation(s) terms. In addition, the Exchange intends to 
apply these parameters to all presently listed and any future-listed 
CDO contracts.
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    \11\ If no Successor Reference Entity satisfies the ``at least 
25%'' requirement and the original Reference Entity survives, then 
no Succession Event will be deemed to have occurred and the CDO 
contract will not be adjusted.
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    The following examples illustrate the application of the 
parameters:
     Assume a Succession Event is confirmed by the Exchange in 
a Reference Entity with $100 million outstanding in debt obligations 
and, under the terms of the Succession Event, Successor Reference 
Entity A succeeds to certain Relevant Obligations and other debt 
obligations totaling $40 million (40% of the original Reference 
Entity's outstanding debt obligations), Successor Reference Entity B 
succeeds to certain Relevant Obligations and other debt obligations 
totaling $30

[[Page 41368]]

million (30%), and Successor Reference Entity C succeeds to all other 
Relevant Obligations and other debt obligations totaling $30 million 
(30%). A CDO contract overlying Relevant Obligations on the original 
Reference Entity would be adjusted and replaced with three new CDOs, 
one each for Successor Reference Entities A, B and C, and each having 
an equal share value equivalent to 33.333%, the ``applicable share,'' 
of the original CDO contract (e.g., 33.333% of $100,000, or $33,333, 
which is equal to an exercise settlement value of $100 multiplied by 
the revised contract multiplier of 333.33).
     Assume a Succession Event is confirmed by the Exchange in 
a Reference Entity with $100 million outstanding in debt obligations 
and, under the terms of the Succession Event, Successor Reference 
Entity A succeeds to certain Relevant Obligations and other debt 
obligations totaling $45 million (45% of the original Reference 
Entity's outstanding debt obligations), Successor Reference Entity B 
succeeds to certain Relevant Obligations and other debt obligations 
totaling $40 million (40%), and Successor Reference Entity C succeeds 
to all other Relevant Obligations and other debt obligations totaling 
$15 million (15%). A CDO contract overlying Relevant Obligations on the 
original Reference Entity would be adjusted and replaced with two new 
CDOs, one each for Successor Reference Entities A and B, and each 
having an equal share value equivalent to 50% of the original CDO 
contract (e.g., 50% of $100,000, or $50,000, which is equal to an 
exercise settlement value of $100 multiplied by the revised contract 
multiplier of 500). Successor Reference Entity C's applicable share 
would be 0.
     Assume a Succession Event is confirmed by the Exchange in 
a Reference Entity with $100 million outstanding in debt obligations 
and, under the terms of the Succession Event, Successor Reference 
Entities A and B each succeed to certain Relevant Obligations and other 
debt obligations totaling $23 million each (23% of the original 
Reference Entity's outstanding debt obligations) and Successor 
Reference Entities C, D and E each succeed to certain Relevant 
Obligations and other debt obligations totaling $18 million each (18%). 
A CDO contract overlying Relevant Obligations on the original Reference 
Entity would be adjusted and replaced with two new CDOs, one each for 
Successor Reference Entities A and B, and each having an equal share 
value equivalent to 50% of the original CDO contract (e.g., 50% of 
$100,000, or $50,000, which is equal to an exercise settlement value of 
$100 multiplied by the revised contract multiplier of 500). Successor 
Reference Entities C, D and E's applicable shares would be 0.
    As indicated above, the Exchange is proposing to codify these 
parameters for determining the applicable share of each Successor 
Reference Entity based on feedback we have received thus far from 
potential CDO investors. The Exchange believes that setting forth these 
parameters would clarify how the Exchange intends to administer the 
Succession Event confirmation process, thereby affording investors 
additional clarity and certainty regarding the impact of a Succession 
Event on an outstanding CDO contract. The Exchange also understands 
that these parameters would be substantially similar to and generally 
consistent with the practice in the over-the-counter market.
    Finally, the Exchange is also proposing a non-substantive change to 
Rule 29.4. Specifically, the Exchange is substituting the phrase ``the 
adjusted cash settlement amount(s) and the adjusted contract 
multiplier(s)'' for ``adjusted unit of trading and the adjusted 
exercise price'' in paragraph (c) to be consistent with the use and 
meaning of those terms elsewhere in the rule text.
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) \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. As indicated above, the 
Exchange believes that setting forth the ``applicable share'' 
parameters would clarify how the Exchange intends to administer the 
Succession Event confirmation process, thereby affording investors 
additional clarity and certainty regarding the impact of a Succession 
Event on an outstanding CDO contract.
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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-2007-81 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-2007-81. 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

[[Page 41369]]

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, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. 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-2007-81 and should be submitted on 
or before August 17, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
Florence E. Harmon,
Deputy Secretary.
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    \15\ 17 CFR 200.30-3(a)(12).
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[FR Doc. E7-14507 Filed 7-26-07; 8:45 am]

BILLING CODE 8010-01-P
