

[Federal Register: November 23, 2007 (Volume 72, Number 225)]
[Notices]               
[Page 65776-65784]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23no07-112]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56792; File No. SR-CBOE-2006-99]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Amendment Nos. 2 and 3 to Proposed Rule Change 
Relating to FLEX Options Trading and Order Granting Accelerated 
Approval to Proposed Rule Change as Amended

November 15, 2007.

I. Introduction

    On November 27, 2006, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (``Commission''), pursuant to section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change providing for the trading of 
Flexible Exchange (``FLEX'') Options on a new electronic platform, and 
to make certain corresponding revisions to its existing open-outcry 
FLEX rules. On August 17, 2007, CBOE filed Amendment No. 1 to the 
proposed rule change. On August 30, 2007, the proposed rule change, as 
amended, was published for comment in the Federal Register.\3\ No 
comments were received on the proposal. On November 7, 2007 and 
November 15, 2007, CBOE filed Amendment Nos. 2 and 3, respectively, to 
the proposed rule change.\4\ This notice and order solicits comments 
from interested persons on Amendment Nos. 2 and 3 and grants 
accelerated approval to the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 56311 (August 23, 2007), 
72 FR 50133.
    \4\ See infra Section II(D).
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II. Description of Proposal

    FLEX Options provide investors with the ability to customize basic 
option features including size, expiration date, exercise style, and 
certain exercise prices. Currently, Exchange members may trade FLEX 
Options in open outcry. Markets are created when a member submits a 
request for quotes (``RFQ'') to the crowd. This system is referred to 
herein as the ``FLEX RFQ System.'' The Exchange has proposed an 
alternate framework for trading FLEX Options using a ``hybrid'' 
platform, which will incorporate both open outcry and electronic 
trading functionality (referred to herein as the ``FLEX Hybrid Trading 
System'' or the ``System''). Some key features of the new FLEX Hybrid 
Trading System are the following:
     Method of Operation: Transactions can take place through 
either an open-outcry RFQ process similar to the existing FLEX RFQ 
System or a new, Internet- and API-based electronic trading platform. 
Currently, the FLEX RFQ System does not provide for a book, and quotes 
and orders expire at the conclusion of the RFQ process. By contrast, 
the new System may allow FLEX Orders to be entered and trade via an 
electronic book (the ``Book''). The Exchange would determine on a 
class-by-class basis whether to make a Book available.\5\
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    \5\ See Rule 24B.5(b)(1).
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     Access: CBOE members seeking to use the new System must 
apply to and be approved by the Exchange. Approved members are 
collectively referred to as ``FLEX Traders.'' In addition, non-members 
that meet certain conditions may be offered ``sponsored access'' to the 
new System.
     Market-Maker Participation: As with the existing FLEX 
rules, there are two types of FLEX Market-Makers: FLEX Appointed 
Market-Makers and FLEX Qualified Market-Makers. The responsibilities 
and obligations of FLEX Market-Makers on the new System, and changes to 
the corresponding rules of

[[Page 65777]]

the existing FLEX RFQ System, are discussed further below.

Detailed Summary of Proposed Rule Change

A. Proposed FLEX Hybrid Trading System Rules (Chapter XXIVB)

    The rules governing the existing FLEX RFQ System are contained, and 
will continue to be maintained, in Chapter XXIVA of the Exchange rules. 
The proposed rules governing the new FLEX Hybrid Trading System are 
found in proposed Chapter XXIVB. The Exchange currently intends to 
maintain and operate both systems and will determine which system to 
use on a class-by-class basis. These determinations will be announced 
to the membership via regulatory circular. This rule further explains 
that Chapters I through XIX and XXIV of the Exchange rules apply to the 
new System, except as otherwise indicated. If the rules in Chapter 
XXIVB are inconsistent with other Exchange rules, the rules in Chapter 
XXIVB take precedence in relation to the trading of FLEX Options on the 
new System.
1. Definitions (Proposed Rule 24B.1)
    Proposed Rule 24B.1, Definitions, corresponds with existing Rule 
24A.1 but contains several new definitions necessary to accommodate the 
new System. For example, the term ``FLEX Hybrid Trading System'' means 
the Exchange's trading platform that allows FLEX Traders to submit 
RFQs, FLEX Quotes, and FLEX Orders. A ``FLEX Quote'' is a bid or offer 
entered by a FLEX Market-Maker or an order to purchase or sell entered 
by a FLEX Trader, in either case in response to an RFQ. A ``FLEX 
Order'' is a bid or offer entered by a FLEX Market-Maker or an order to 
purchase or sell entered by a FLEX Trader, in either case into the 
Book.
    Proposed Rule 24B.1 also defines several terms relating to the RFQ 
process. The ``Submitting Member'' is the FLEX Trader who initiates the 
RFQ or who enters a FLEX Order into the Book. The ``RFQ Response 
Period'' is the period during which FLEX Traders may provide FLEX 
Quotes in response to an RFQ. The ``RFQ Reaction Period'' is the period 
during which the Submitting Member determines whether to accept or 
reject the RFQ Market.\6\ The ``RFQ Market'' consists of the FLEX 
Quotes entered in response to an RFQ and FLEX Orders resting in the 
Book. An ``RFQ Order'' is an order to buy or an order to sell entered 
by the Submitting Member during the RFQ Reaction Period.
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    \6\ See proposed Rule 24B.1(u) (as modified by Amendment No. 3).
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    Proposed Rule 24B.1 also identifies certain trade conditions that 
can be placed on an RFQ Order or FLEX Order, such as fill-or-kill, all-
or-none, minimum fill, ``lots of,'' and hedge. FLEX Orders except for 
fill-or-kill orders would be designated by the System as day orders 
and, if unexecuted, would be canceled at the close of each trade day. 
An RFQ may include a hedge or ``Intent to Cross'' trade condition, 
discussed more fully below. Hedge and Intent to Cross trade conditions 
will be disclosed on the System.
2. Terms of FLEX Options (Proposed Rule 24B.4)
    Proposed Rule 24B.4, Terms of FLEX Options, is similar to existing 
Rule 24A.4. Both rules set forth the variable terms of FLEX Options 
(such as the underlying security or index, put or call type, exercise 
style, expiration date, and exercise price). Other terms are not 
variable and are the same as those that apply to Non-FLEX Options. Both 
rules set forth the information required from a member who initiates an 
RFQ, such as the type and form of quote sought, any trade conditions, 
and the length of the RFQ Response Period.\7\
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    \7\ The length of the RFQ Response Period is defined by the 
Submitting Member but must fall within the time ranges established 
by the appropriate Procedure Committee on a class-by-class basis. 
The period cannot be less than three seconds. See proposed Rule 
24B.4(a)(3)(iii).
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    Proposed Rule 24B.4 lists additional contract and transaction 
specifications for RFQs, FLEX Quotes, FLEX Orders, and RFQ Orders. 
These specifications pertain in part to maximum expiration terms and 
second to minimum value size requirements. The maximum expiration terms 
are the same as in the existing FLEX rules.\8\ The minimum value size 
specifications are substantially similar to those in Rule 24A.4, though 
additional language has been added to clarify the minimum value size 
requirements for FLEX Orders entered in the Book. There are additional 
special terms for FLEX Index Options \9\ and FLEX Equity Options,\10\ 
which correspond to provisions in existing Rule 24A.4.
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    \8\ For FLEX Equity Options, the maximum term is generally three 
years, although the Submitting Member may request up to five years. 
For FLEX Index Options, the maximum term is generally five years, 
although a Submitting Member may request up to ten years. See 
existing Rule 24A.4(a)(4); proposed Rule 24B.4(a)(5).
    \9\ See proposed Rule 24B.4(b).
    \10\ See proposed Rule 24B.4(c). For example, settlement of a 
FLEX Equity Option shall be by physical delivery of the underlying 
security.
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3. FLEX Trading Procedures and Principles (Proposed Rule 24B.5)
    On the new System, there will be no trading rotations in FLEX 
Options, either at the open or the close.\11\ Instead, trading will 
result from RFQs submitted through the System or in open outcry, or 
from transactions on the Book.
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    \11\ See proposed Rule 24B.3.
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(a) Electronic RFQ Process
    Upon receipt of an RFQ in proper form, the System will cause the 
terms and specifications of the RFQ to be communicated to all FLEX 
Traders. Any FLEX Trader, including the Submitting Member, may then 
enter a FLEX Quote during the RFQ Response Period. Any FLEX Quote or 
FLEX Order may be entered, modified, or withdrawn at any point during 
the RFQ Response Period.\12\ The System will dynamically calculate and 
disseminate to all FLEX Traders the RFQ Market.\13\
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    \12\ However, a FLEX Appointed Market-Maker must meet certain 
FLEX Quote maintenance obligations. See proposed Rule 
24B.5(a)(1)(ii)(B).
    \13\ See proposed Rule 24B.5(a)(1)(ii)(C) (as modified by 
Amendment No. 2).
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    Following the RFQ Response Period, the Submitting Member may trade 
against the RFQ Market during the RFQ Reaction Period. The length of 
this period will be established by the appropriate Procedure Committee 
on a class-by-class basis and will not be more than five minutes.\14\ 
Failure of the Submitting Member to trade against the RFQ Market before 
expiration of the RFQ Reaction Period would equate to a rejection. 
During the RFQ Reaction Period: (1) FLEX Traders can continue to enter, 
modify, or withdraw FLEX Quotes and FLEX Orders; (2) FLEX Orders that 
are entered or modified during the RFQ Response and Reaction Periods 
will be treated the same as FLEX Quotes for purposes of the priority 
allocation; and (3) the System will dynamically calculate and 
disseminate to all FLEX Traders the RFQ Market given the current FLEX 
Quotes and resting FLEX Orders.\15\
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    \14\ The Exchange originally proposed to cap the RFQ Reaction 
Period at 30 seconds. In Amendment No. 2, the Exchange proposed to 
increase the maximum period to five minutes ``to address feedback 
received from members and potential users that the RFQ Reaction 
Period should be lengthened to provide Submitting Members with 
additional time to assess an RFQ Market, determine whether to accept 
or reject it, and process a response accordingly.''
    \15\ See proposed Rule 24B.5(a)(1)(iii)(B)(II) (as modified by 
Amendment No. 2).
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    The Submitting Member may decline to trade against the RFQ Market 
by canceling the RFQ or letting it expire. If the Submitting Member 
chooses to trade but has not indicated an Intent to Cross,

[[Page 65778]]

he or she may enter an RFQ Order to trade with one side of the RFQ 
Market (but not both). The Submitting Member's RFQ Order will be 
eligible to trade with FLEX Quotes and FLEX Orders at a single price 
that will leave bids and offers which cannot trade with each other (the 
``BBO clearing price''). In determining the priority of FLEX Quotes and 
FLEX Orders, the System gives priority to those priced better than the 
BBO clearing price, then to FLEX Quotes and FLEX Orders at the BBO 
clearing price. Priority among FLEX Quotes and FLEX Orders at the BBO 
clearing price is as follows: (1) any FLEX Quotes that are subject to a 
FLEX Appointed Market-Maker participation entitlement; (2) FLEX Orders 
resting in the Book, based on the Book priority algorithm; (3) FLEX 
Quotes for the account of public customers and non-member broker-
dealers based on time priority; and (4) all other FLEX Quotes based on 
time priority.
    If the RFQ Market is locked or crossed, priority among FLEX Quotes 
and FLEX Orders at the BBO clearing price and on the same side as the 
RFQ Order is as follows: (1) FLEX Orders in the Book, based on the Book 
priority algorithm; (2) if applicable, an RFQ Order for the account of 
a public customer or non-member broker-dealer, then any FLEX Quote that 
is subject to a FLEX Appointed Market-Maker participation entitlement; 
(3) FLEX Quotes for the account of public customers and non-member 
broker-dealers, based on time priority; (4) if applicable, an RFQ Order 
for the account of a member, then any FLEX Quote that is subject to a 
FLEX Appointed Market-Maker participation entitlement; and (5) all 
other FLEX Quotes, based on time priority. The System will enter any 
remaining balance of the incoming RFQ Order in the Book (if available), 
unless the Submitting Member has indicated that the balance of the RFQ 
Order is to be automatically canceled if it is not traded.
    If the Submitting Member has indicated an ``Intent to Cross'' in 
its RFQ request, the Submitting Member may receive a crossing 
participation entitlement if one has been established in that class by 
the appropriate Procedure Committee, and if the RFQ Order entered by 
the Submitting Member during the RFQ Reaction Period matches or 
improves the BBO clearing price. The RFQ Order will be eligible to 
trade with FLEX Quotes and FLEX Orders at the BBO clearing price giving 
priority to the FLEX Quotes and FLEX Orders priced better than the BBO 
clearing price, then to FLEX Quotes and FLEX Orders at the BBO clearing 
price. Priority among multiple FLEX Quotes and FLEX Orders at the BBO 
clearing price is as follows: (1) FLEX Orders in the Book, based on the 
Book priority algorithm; (2) FLEX Quotes for the account of public 
customers and non-member broker-dealers, based on time priority; (3) 
the crossing participation entitlement; (4) any FLEX Quotes that are 
subject to a FLEX Appointed Market-Maker participation entitlement; 
\16\ and (5) then all other FLEX Quotes, based on time priority.
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    \16\ The crossing participation entitlement and the FLEX 
Appointed Market-Maker entitlement together may not exceed a certain 
percentage of the original order. See proposed Rule 
24B.5(d)(2)(i)(A)-(B).
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    If a Book is available in that class, the System would enter any 
remaining balance of the incoming RFQ Order in the Book and treat it 
the same as other FLEX Orders. If there is no Book available, the 
System will expose any remaining balance of the incoming RFQ Order so 
other FLEX Traders can trade against it. After the remaining balance of 
the RFQ Order has been exposed for at least the Crossing Exposure 
Period,\17\ the Submitting Member may enter a contra-side order to 
trade all or any portion of the remaining balance.\18\
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    \17\ The length of this Crossing Exposure Period shall be 
determined by the appropriate Procedure Committee on a class-by-
class basis and shall not be less than three seconds. See proposed 
Rule 24B.5(a)(1)(iii)(D)(IV).
    \18\ The Submitting Member must, however, enter a contra-side 
order when necessary to satisfy applicable minimum value size 
requirements. See id.
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    If the Submitting Member rejects the RFQ Market or to the extent 
the RFQ Market size exceeds the Submitting Member's size, the System 
automatically would execute any remaining FLEX Quotes and FLEX Orders 
that are marketable against each other at the BBO clearing price. Then, 
if a Book is available, any remaining balance of any FLEX Quote would 
be automatically entered into the Book unless the FLEX Trader who 
entered it had indicated that the FLEX Quote is to be automatically 
canceled if not traded. If no Book is available, any remaining balance 
of the FLEX Quotes will be automatically canceled at the conclusion of 
the RFQ Reaction Period.\19\
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    \19\ See proposed Rule 24B.5(a)(1)(F).
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(b) Open-Outcry RFQ Process

    To initiate a FLEX transaction using the open-outcry RFQ process 
under proposed Rule 24B.5, a Submitting Member would submit an RFQ to a 
FLEX Official. The Submitting Member would then immediately announce 
the terms and specifications of the RFQ to the crowd. FLEX Traders 
present in the crowd may respond orally with FLEX Quotes during the RFQ 
Response Period. A FLEX Trader could enter, modify, or withdraw its 
FLEX Quote at any point during the RFQ Response Period. At the 
expiration of the RFQ Response Period, the Submitting Member would 
identify the BBO (considering responsive FLEX Quotes and, if 
applicable, FLEX Orders resting in the Book) and announce the BBO to 
the crowd.
    If the Submitting Member does not indicate an Intent to Cross or 
act as principal with respect to any part of the trade, the Submitting 
Member may submit an agency RFQ Order to trade against the RFQ Market. 
If the Submitting Member rejects the BBO or is given a BBO for less 
than the entire size requested, the FLEX Traders in the crowd other 
than the Submitting Member would have an opportunity to match or 
improve the BBO during a BBO Improvement Interval. At the expiration of 
any BBO Improvement Interval, the Submitting Member must promptly 
accept or reject the BBO.
    If the Submitting Member indicates an Intent to Cross or act as 
principal with respect to any part of the trade, acceptance of the 
displayed BBO would be automatically delayed until the expiration of 
the BBO Improvement Interval. Prior to the BBO Improvement Interval, 
the Submitting Member must announce to the crowd the price at which it 
expects to trade. In these circumstances, the Submitting Member may 
participate with all other FLEX Traders present in the crowd in 
attempting to improve or match the BBO during the BBO Improvement 
Interval. At the expiration of the BBO Improvement Interval, the 
Submitting Member could trade against the BBO or reject it.
    If the Submitting Member rejects the BBO after an RFQ Response 
Period or BBO Improvement Interval, or the BBO size exceeds the FLEX 
transaction size indicated in the RFQ, FLEX Traders present in the 
crowd could accept the unfilled balance of the BBO. Such acceptance 
must occur by public outcry immediately following the Submitting 
Member's rejection of the BBO or any BBO Improvement Interval, or the 
Submitting Member's trade that does not exhaust the full size of the 
BBO.
    The highest bid (lowest offer) would have priority. Among bids 
(offers) at the same price, priority generally is as follows: (1) The 
crossing participation entitlement, if the Submitting Member has 
indicated an Intent to Cross and an entitlement is available in that 
class; (2)

[[Page 65779]]

any FLEX Quote subject to a FLEX Appointed Market-Maker participation 
entitlement; (3) all other FLEX Quotes, in the sequence in which they 
are entered; \20\ and (4) FLEX Orders resting in the Book, based on the 
Book priority algorithm. However, if a member is relying on the ``G'' 
exception to section 11(a) of the Act,\21\ the member's bid (offer) 
must yield to any bid (offer) at the same price on the Book and all 
other bids (offers) that have priority over the Book. If a Submitting 
Member is asserting a crossing participation entitlement on behalf of a 
proprietary account of a member relying on the ``G'' exception and a 
FLEX Appointed Market-Maker is also asserting a participation 
entitlement, the Submitting Member's crossing participation entitlement 
combined with any guaranteed participation for FLEX Appointed Market-
Makers shall not exceed 40% of the original order.
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    \20\ If two or more best bids (offers) are submitted in open 
outcry at the same time and same price or if the Submitting Member 
cannot reasonably determine the sequence in which they were made, 
priority would be apportioned equally among those open-outcry bids 
(offers). See proposed Rule 24B.5(a)(2)(v)(A)(III) (as modified by 
Amendment No. 2).
    \21\ 15 U.S.C. 78k(a)(1)(G).
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    The proposed open-outcry RFQ process is similar to the existing 
process, with a few distinctions. Under the new System, the Submitting 
Member is responsible for announcing the terms and specifications of 
the RFQ to the crowd, receiving responsive FLEX Quotes, and at the 
conclusion of the RFQ Response Period announcing the BBO to the crowd. 
Under the existing process, the FLEX Post Official communicates the RFQ 
to the crowd over facilities maintained by the Exchange, responsive 
FLEX Quotes may be entered at the post, and the BBO is visibly 
displayed at the post and over the network.\22\ The proposed priority 
algorithm takes into consideration the Book, which does not exist 
currently, and provides that two bids submitted in open outcry at the 
same time and same price will be apportioned equally, as compared to 
the existing practice of affording priority to FLEX Appointed or 
Qualified Market-Makers.\23\
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    \22\ Compare proposed Rules 24B.5(a)(2)(i)(B), (ii)(A), and 
(ii)(B) to existing Rule 24A.5(a)(ii), (b)(i), and (b)(iii).
    \23\ Compare proposed Rules 24B.5(a)(2)(v) and (d) to existing 
Rules 24A.5(e) and (f).
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(c) The FLEX Book and FLEX Orders

    The Exchange may determine to make a FLEX Book available on a 
class-by-class basis. If a Book has been enabled, a Submitting Member 
may enter a FLEX Order if it satisfies the applicable minimum value 
size requirements and the FLEX Order is in compliance with section 
11(a) of the Act. A FLEX Order submitted on behalf of the proprietary 
account of a member relying on the ``G'' exception to Section 11(a) may 
be entered only to hit the Book and may not rest in the Book.\24\
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    \24\ See proposed Rule 24B.5(b)(2)(ii).
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    FLEX Orders in the Book are ranked and matched based on price/time 
priority. However, if a FLEX Appointed Market-Maker is quoting at the 
best bid (offer) and a FLEX Appointed Market-Maker participation 
entitlement has been established, then priority at the same price is as 
follows: (1) Any FLEX Orders for the account of public customer ranked 
ahead of the FLEX Appointed Market-Maker; (2) any FLEX Orders subject 
to a FLEX Appointed Market-Maker entitlement; and (3) all other FLEX 
Orders, based on time priority.\25\
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    \25\ See proposed Rule 24B.5(b)(2)(iii).
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    A Submitting Member may not execute as principal against a FLEX 
Order on the Book that it represents as agent unless: (1) The 
Submitting Member has been bidding or offering for at least the 
Crossing Exposure Period before receiving the agency FLEX Order that is 
executable against such bid or offer; \26\ or (2) the agency FLEX Order 
is first subject to an RFQ and the agency FLEX Order (or any remaining 
balance not executed during the RFQ Reaction Period) is exposed on the 
System for at least the Crossing Exposure Period.\27\ A Submitting 
Member may not execute a solicited order against a FLEX Order that the 
Submitting Member is representing as agent unless the agency FLEX Order 
is first subject to any RFQ and the agency FLEX Order (or any remaining 
balance not executed during the RFQ Reaction Period) is exposed on the 
System for at least the Crossing Exposure Period.\28\ The Crossing 
Exposure Period referenced in the above provisions will be established 
by the appropriate Procedure Committee on a class-by-class basis and 
will not be less than three seconds.\29\
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    \26\ See proposed Rule 24B.5(b)(3)(i)(B).
    \27\ See proposed Rule 24B.5(b)(3)(i)(A) (as modified by 
Amendment No. 2).
    \38\ See proposed Rule 24B.5(b)(3)(ii) (as modified by Amendment 
No. 2).
    \26\ See proposed Rule 24B.5(b)(3)(iii) (added by Amendment No. 
2).
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(d) Creation of Binding Contracts

    Proposed Rule 24B.5(c) provides that acceptance of any bid or offer 
creates a binding contract under Rule 6.48. This provision is the same 
as in existing Rule 24A.5(d) and applies to both RFQ and Book 
transactions.

(e) Guarantees

    For FLEX Equity Options, the Exchange's appropriate Procedure 
Committee may determine on a class-by-class basis to establish a 
crossing participation entitlement for facilitations and/or 
solicitations with respect to open-outcry and/or electronic trades. The 
entitlement percentage may not exceed 40% of the original order.\30\ If 
the Submitting Member matches or improves the BBO or BBO clearing 
price, as applicable, the Submitting Member would have priority to 
execute the contra-side of the order up to the crossing participation 
entitlement percentage. The appropriate Procedure Committee similarly 
may determine on a class-by-class basis to establish a crossing 
participation entitlement for FLEX Index Options, which may not exceed 
40% of the trade. With respect to FLEX Index Options, if the Submitting 
Member matches or improves the BBO or BBO clearing price, as 
applicable, the Submitting Member would have priority to execute the 
contra-side of the order up to the largest of: (1) The crossing 
entitlement percentage; (2) a proportional share of the trade; (3) $1 
million underlying equivalent value; or (4) the remaining underlying 
equivalent value on a closing transactions valued at less than $1 
million.\31\
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    \30\ See proposed Rule 24B.5(d)(2)(i)(A).
    \31\ See proposed Rule 24B.5(d)(2)(i)(B). In the FLEX RFQ System 
rules, the crossing participation entitlement for transactions in 
FLEX Index Options is currently 20%, and there are similar 
provisions for FLEX Index Options that could permit an entitlement 
of greater than 40% in certain cases. See existing Rule 
24A.5(e)(iii)(B).
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    In the past, the establishment of FLEX Appointed Market-Maker 
entitlements were the subject of separate rule filings.\32\ In lieu of 
submitting separate rule filings, the Exchange has now proposed to 
include specific parameters within the rule text, similar to its rules 
respecting crossing participation entitlements and market-maker 
participation entitlements for Non-FLEX Options.\33\ Henceforth, the 
appropriate Procedure Committee may establish a participation 
entitlement for FLEX Appointed Market-Makers on a class-by-class basis 
with respect to open-outcry RFQs, electronic RFQs, and/or Book 
transactions. Any such entitlement shall: (1) Be divided equally by the 
number of FLEX Appointed Market-Makers quoting at the BBO or BBO

[[Page 65780]]

clearing price, as applicable; (2) collectively be no more than: (a) 
50% of the remaining order when one other FLEX Market-Maker is quoting 
at the same price, (b) 40% when two other FLEX Market-Makers are 
quoting at the same price, and (c) 30% when three or more FLEX Market-
Makers are quoting at the same price; and (3) when combined with any 
Submitting Member's crossing participation entitlement, shall not 
exceed 40% of the size of the original order.\34\ Pronouncements 
regarding the applicable participation entitlements must be announced 
to the membership via regulatory circular.
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    \32\ See Rule 24A.5(e)(iv); Securities Exchange Act Release No. 
45934 (May 15, 2002), 67 FR 36276 (May 23, 2002) (SR-CBOE-2002-09).
    \33\ See, e.g., Rule 8.87, Participation Entitlement of DPMs and 
e-DPMs (providing for a DPM/e-DPM participation entitlement after 
all public customer orders are satisfied).
    \34\ See proposed Rule 24B.5(d)(2)(ii).
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(f) Solicited Orders

    A Submitting Member trading in open outcry may not cross an order 
that he or she is holding with an order that he or she solicited from a 
FLEX Market-Maker who is then in the trading crowd, except in 
accordance with CBOE Rule 6.55, Multiple Representation Prohibited. A 
Submitting Member utilizing the electronic System may not cross an 
order that he or she is holding with: (1) a solicited order for a FLEX 
Market-Maker's individual or joint account; or (2) a solicited order 
initiated by the FLEX Market-Maker for an account in which the FLEX 
Market-Maker has an interest, unless the FLEX Market-Maker refrains 
from participating on the same trade.\35\
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    \35\ See proposed Rule 24B.5(d)(2)(i)(C).
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(g) FLEX Standard Minimum Increments

    The applicable increments for FLEX Index Options will be identical 
to the increments in the existing FLEX rules, which permit decimal bids 
and offers in the designated currency that meet or exceed certain 
minimum parameters.\36\ For example, the minimum increment in U.S. 
dollars is $0.01 (or such other minimum as the appropriate Procedure 
Committee may set from time to time to ensure fair and orderly 
markets). The applicable increments for FLEX Equity Options will be 
determined by the appropriate Procedure Committee on a class-by-class 
basis, but may not be smaller than $0.01. This represents a change from 
the existing FLEX rules, under which the trading increments applicable 
to FLEX Equity Options are the same as those applicable to Non-FLEX 
Equity Options (i.e., $0.10 for simple bids and offers in series quoted 
at or above $3 a contract, $0.05 for simple bids and offers in series 
quoted below $3 a contract, and $0.01 for series quoted in the penny 
pilot program \37\).
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    \36\ See existing Rule 24A.5(g) (which is proposed to be 
renumbered as Rule 24A.5(f)); proposed Rule 24B.5(e).
    \37\ See CBOE Rule 6.42.
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4. FLEX Market-Maker Appointments and Obligations (Proposed Rule 24B.9)
    Under the rules for the new System, the Exchange will appoint two 
or more FLEX Qualified Market-Makers to each FLEX Index Option class 
and settlement currency, and two or more FLEX Qualified Market-Makers 
to each FLEX Equity Option class. In making such appointments and in 
taking other action with respect to FLEX Qualified Market-Makers, the 
Exchange shall take into account the factors enumerated in, and shall 
refer to the requirements of, existing CBOE Rule 8.3, Appointment of 
Market-Makers. As a condition to receiving and maintaining a FLEX 
Qualified Market-Maker appointment in a FLEX Index Option (FLEX Equity 
Option), the FLEX Qualified Market-Maker must maintain an appointment 
in one or more Non-FLEX Index Option classes (Non-FLEX Equity Option 
classes). The Non-FLEX Option class need not include the FLEX Option 
class's underlying index or security.
    Notwithstanding the above, the appropriate Market Performance 
Committee may determine to solicit applications and appoint: (1) One or 
more FLEX Appointed Market-Makers in addition to appointing FLEX 
Qualified Market-Makers to such classes; or (2) two or more FLEX 
Appointed Market-Makers in lieu of appointed FLEX Qualified Market-
Makers. Thus, under this revised structure applicable to both 
platforms, a FLEX Option class could be structured as a FLEX Qualified 
Market-Maker-only crowd with at least two participants, a mixed FLEX 
Qualified/Appointed Market-Maker crowd with at least three 
participants, or a FLEX Appointed Market-Maker-only crowd with at least 
two participants.
    A FLEX Appointed Market-Maker must provide a FLEX Quote in response 
to any open-outcry RFQ in a class of FLEX Options to which it is 
appointed and trades in open outcry.\38\ In addition, a FLEX Appointed 
Market-Maker must provide FLEX Quotes in response to a designated 
percentage of electronic RFQs, such percentage to be determined by the 
appropriate Procedure Committee and not less than 80%.\39\ Although a 
FLEX Qualified Market-Maker need not enter a FLEX Quote in response to 
an RFQ in a class of FLEX Options to which it is appointed,\40\ the 
FLEX Qualified Market-Maker (like the FLEX Appointed Market-Maker) must 
submit a FLEX Quote if called upon by a FLEX Official, including when 
no FLEX Quotes are submitted in response to a specific RFQ.\41\
---------------------------------------------------------------------------

    \38\ See proposed Rule 24B.9(c)(i).
    \39\ See proposed Rule 24B.4(a)(5)(iv).
    \40\ See proposed Rule 24B.9(c).
    \41\ See proposed Rule 24B.9(d).
---------------------------------------------------------------------------

5. FLEX Officials (Proposed Rule 24B.14)
    Existing FLEX Rule 24A.12 provides that a FLEX Post Official is 
responsible for: (1) Reviewing the conformity of RFQs and FLEX Quotes 
to the terms and specifications contained in Rule 24A.4; (2) posting 
RFQs for dissemination; (3) determining the BBO; (4) ensuring that 
contracts are executed in conformance with the priority principles set 
forth in Rule 24A.5(e); (5) calling for Indicative FLEX Quotes in 
accordance with the requirements of Rule 24A.12(c); and (6) calling 
upon FLEX Qualified Market-Makers to provide FLEX Quotes in specific 
classes of FLEX Equity Options as provided in Rule 24A.9(c).\42\
---------------------------------------------------------------------------

    \42\ See existing Rule 24A.12(b).
---------------------------------------------------------------------------

    Proposed Rule 24B.14, FLEX Official, corresponds with existing Rule 
24A.12 and describes the functions of a FLEX Official for the new 
System. The FLEX Official would continue to be responsible for 
reviewing the conformity of open-outcry RFQs to the applicable terms 
and specifications in proposed Rule 24B.4. However, because open-outcry 
FLEX Quotes will now be provided to the Submitting Member, the FLEX 
Official is no longer responsible for reviewing them for conformity to 
the applicable terms and specifications or for determining the BBO. In 
addition, a FLEX Official may nullify a FLEX transaction, whether 
electronic or open-outcry, if he or she determines that it does not 
conform to the terms of proposed Rules 24B.4 or 24B.5. As noted above, 
a FLEX Official may call upon FLEX Market-Makers, whether Qualified or 
Appointed to a given class, to provide FLEX Quotes in certain 
circumstances, as provided in proposed Rule 24B.9.
    A FLEX Official may be an employee of the Exchange or an 
independent contractor. The Exchange may designate other qualified 
employees or independent contractors to assist the FLEX Official as the 
need arises.\43\
---------------------------------------------------------------------------

    \43\ See proposed Rule 24B.14(a).
---------------------------------------------------------------------------

6. Position and Exercise Limits
    Proposed Rules 24B.7, Position Limits and Reporting Requirements, 
and 24B.8, Exercise Limits, are modeled after existing Rules 24A.7 and 
24A.8. However, the Exchange is proposing to make certain revisions to 
existing Rules

[[Page 65781]]

24A.7 and 24A.8, and to include the same language in proposed Rules 
24B.7 and 24B.8, relating to the applicable position and exercise 
limits for FLEX Index Options and the aggregation of certain FLEX and 
non-FLEX positions. The Exchange has proposed changes to Rule 24A.7 to 
conform the language of that rule to reflect changes that were recently 
approved by the Commission in a separate proposed rule change.\44\
---------------------------------------------------------------------------

    \44\ See Securities Exchange Act Release No. 56350 (September 4 
2007), 72 FR 51878 (September 11, 2007) (SR-CBOE-2007-79).
---------------------------------------------------------------------------

    In addition, the proposal would amend Rule 24A.7 to establish new 
position limits for certain industry-based FLEX Index Option classes:
    1. No more than four times the applicable position limits 
established pursuant to Rule 24.4A for FLEX Options on: (a) The Dow 
Jones Transportation Average or the Dow Jones Utility Average; or (b) 
an industry-based index that is not a ``narrow-based security index,'' 
as defined under Section 3(a)(55)(B) of the Act.\45\
---------------------------------------------------------------------------

    \45\ 15 U.S.C. 78c(a)(55)(B).
---------------------------------------------------------------------------

    2. For all other industry-based FLEX Index Option classes, no more 
than one times the applicable number of Non-FLEX Index Option contracts 
(whether long or short) of the put class and the call class on the same 
side of the market, as determined on the basis of the position limits 
established pursuant to Rule 24.4A, Position Limits for Industry Index 
Options.
    The proposal also would amend Rule 24A.7 to provide that position 
limits for a micro narrow-based FLEX Index Option class shall not 
exceed one times the applicable number of Non-FLEX Index Option 
contracts (whether long or short) of the put class and the call class 
on the same side of the market, as determined on the basis of the 
position limits established pursuant to Rule 24.4B, Position Limits for 
Options on Micro Narrow-Based Indexes As Defined Under Rule 24.2(d). 
Finally, new language to Rule 24A.7 would provide that, except as 
otherwise provided, the position limit for a broad-based FLEX Index 
Option class may not exceed 200,000 contracts on the same side of the 
market. Proposed Rule 24B.7 replicates amended Rule 24A.7 in the rules 
applying to the new System.
    Both rules would contain new language requiring that positions in 
FLEX Options must be aggregated with positions in Non-FLEX Options in 
certain circumstances:
     QIX Options: Commencing at the close of trading two 
business days prior to the last trading day of the calendar, positions 
in FLEX Index Options having an exercise settlement value determined by 
the level of the index at the close of trading on the last trading day 
before expiration shall be aggregated with positions in Quarterly Index 
(QIX) Options on the same index with the same expiration and shall be 
subject to the position limits set forth in Rule 24.4, 24.4A, or 24.4B, 
as applicable.
     Weekly Options: Commencing at the close of trading two 
business days prior to the last trading day of the week, positions in 
FLEX Options that are cash-settled \46\ shall be aggregated with 
positions in Short Term Option Series on the same underlying index with 
the same means for determining exercise settlement value (e.g., opening 
or closing prices of the underlying index) with the same expiration and 
shall be subject to the position limits set forth in Rule 24.4, 24.4A, 
24.4B or 29.5, as applicable.
---------------------------------------------------------------------------

    \46\ FLEX Index Options and FLEX Credit Default Options are cash 
settled. FLEX Equity Options are settled by physical delivery. See 
existing Rules 24A.4(b)(4) and (c)(3) and 29.19; see also proposed 
Rules 24B.4(b)(4) and (c)(3).
---------------------------------------------------------------------------

    Proposed Rule 24B.8 replicates existing Rule 24A.8 regarding 
exercise limits. Both rules generally provide that the exercise limit 
for a FLEX Index Option is equivalent to the position limit. Both rules 
also set forth certain minimum value size requirements for exercises of 
FLEX Equity Options and FLEX Index Options.
    In an earlier proposed rule change, CBOE represented that, when it 
files a proposed rule change to list and trade a new Non-FLEX Index 
Option, it also would propose to list and trade the FLEX Index Options 
in the same filing and include proposed position and exercise 
limits.\47\ Because the maximum FLEX Index Option position and exercise 
limits will now be explicitly set out in Rules 24A.7, 24A.8, 24B.7, and 
24B.8, the Exchange seeks to eliminate this earlier commitment.
---------------------------------------------------------------------------

    \47\ See Securities Exchange Act Release No. 43108 (August 2, 
2000), 65 FR 48770 (August 9, 2000) (SR-CBOE-00-26) (immediately 
effective proposal providing for the listing and trading of FLEX 
Options on all indices that underlie Non-FLEX Options listed and 
traded by the Exchange).
---------------------------------------------------------------------------

7. Financial Requirements
    Under the proposal, a FLEX Index Market-Maker may not effect a FLEX 
Index Option transaction unless it has demonstrated to the satisfaction 
of the Exchange that the net liquidating equity maintained in the FLEX 
Appointed Market-Maker's individual or joint accounts with any one 
clearing member in which transactions in FLEX Index Options will be 
conducted is at least $100,000.\48\ In addition, a FLEX Index Appointed 
Market-Maker is required to maintain at least $1 million net 
liquidating equity and/or $1 million net capital, as applicable.\49\ A 
FLEX Index Appointed Market-Maker or its clearing member must 
immediately inform the Exchange whenever the FLEX Index Appointed 
Market-Maker fails to be in compliance with any of the above 
requirements. FLEX Market-Makers and floor brokers must file letters of 
guarantee accepting financial responsibility for all FLEX transactions 
they make.\50\ These provisions parallel existing Rules 24A.13, 24A.14, 
and 24A.15 that apply to the FLEX RFQ System.
---------------------------------------------------------------------------

    \48\ See proposed Rule 24B.11.
    \49\ See proposed Rule 24B.12.
    \50\ See proposed Rule 24B.13.
---------------------------------------------------------------------------

8. Other Rules for New System
    Other rules in proposed Chapter XXIVB are the same as, or closely 
modeled after, the existing rules of the FLEX RFQ System. Proposed 
Rules 24B.2, Hours of Trading; 24B.3, Trading Rotations; 24B.10, 
Related Securities; 24B.15, Nonavailability of RAES; and 24B.16, 
Inapplicability of Split Price and Accommodation Liquidation Rules, are 
identical to Rules 24A.2, 24A.3, 24A.11, 24A.16, and 24A.17, 
respectively. Proposed Rules 24B.6, Discretionary Transactions, and 
24B.13, Letter of Guarantee or Authorization are virtually identical to 
Rules 24A.6 and 24A.15, respectively, except for non-substantive 
grammatical changes. Proposed Rules 24B.11, FLEX Index Appointed 
Market-Maker Account Equity, and 24B.12, FLEX Index Appointed Market-
Maker Financial Requirements, are virtually identical to Rules 24A.13 
and 24A.14, respectively, except that revisions are being made to 
clarify that these rules apply only to FLEX Appointed Market-Makers in 
FLEX Index Options.\51\
---------------------------------------------------------------------------

    \51\ The special account equity and financial requirements under 
existing Rules 24A.13 and 24A.14 apply only to FLEX Appointed 
Market-Makers, who currently are appointed only to FLEX Index Option 
classes and currently are subject to certain heightened minimum 
value size requirements under Rule 24A.4(a)(4)(iv). Given the 
proposed changes to the FLEX Market-Maker appointments discussed 
above, which would allow for the appointment of a FLEX Equity 
Appointed Market-Maker, proposed Rules 24B.11 and 24B.12 make clear 
that these special account equity and financial requirements would 
apply only to FLEX Appointed Market-Makers in FLEX Index Options 
(who would continue to be subject to the heightened minimum value 
size requirements under proposed Rule 24B.4(a)(5)(iv)) and not FLEX 
Appointed Market-Makers in FLEX Equity Options (who would not be 
subject to heightened minimum value size requirements). The Exchange 
has proposed corresponding changes to existing Rules 24A.13 and 
24A.14.

---------------------------------------------------------------------------

[[Page 65782]]

B. Changes to Existing FLEX Rules

    The Exchange is proposing various changes to the existing FLEX 
rules to conform them to the corresponding new System rules. In 
addition, the term ``Indicative FLEX Quote'' in Rule 24A.1 and a 
related reference in Rule 24A.12 are being deleted. Indicative FLEX 
Quotes are non-binding indications of the market that were periodically 
supplied by FLEX Market-Makers and displayed on the FLEX communication 
network. This functionality is no longer utilized, so these references 
in Rules 24A.1 and 24A.12 are being deleted.
    The Exchange is also proposing to increase the crossing 
participation entitlement percentage available on the FLEX RFQ System. 
Currently, the Submitting Member may obtain a crossing participation 
entitlement of 25% of the incoming order for a FLEX Equity Option or 
20% of the incoming order for a FLEX Index Option.\52\ Under the 
proposal, the appropriate Procedure Committee could determine on a 
class-by-class basis whether to establish a crossing participation 
entitlement for facilitations and/or solicitations and the applicable 
crossing participation entitlement percentage, which may not exceed 40% 
of the incoming order.\53\ These revisions would make the crossing 
participation entitlements equivalent on the FLEX RFQ System and the 
FLEX Hybrid Trading System.
---------------------------------------------------------------------------

    \52\ See Rule 24A.5(e)(iii)(A)-(B). Other existing provisions 
could allow the Submitting Member to receive in excess of 20% of an 
incoming order for a FLEX Index Option. See Rule 24A.5(e)(iii)(B).
    \53\ See proposed Rule 24A.5(e)(iii)(A)-(B).
---------------------------------------------------------------------------

C. Other Changes to CBOE Rules

    The Exchange is proposing to allow sponsored access to the new 
System. Under proposed Rule 6.20A, a CBOE member (``Sponsoring 
Member'') may provide a non-member (``Sponsored User'') with electronic 
access to the System. The proposed rule outlines the requirements that 
Sponsored Users and Sponsoring Members are required to meet prior to 
engaging in a sponsorship arrangement. A Sponsored User may be a 
person, such as an institutional investor, who has entered into a 
sponsorship arrangement with a Sponsoring Member for purposes of 
entering orders on the System. This would include entering and 
responding to electronic RFQs and entering FLEX Orders into the Book. A 
Sponsored User may utilize the System only if authorized in advance by 
one or more Sponsoring Members in accordance with the provisions of 
proposed Rule 6.20A.

D. Amendment Nos. 2 and 3

    In Amendment No. 2, the Exchange made the following changes to the 
proposal:
     In proposed Rule 24B.5(a)(1), modifying the procedures 
that apply during the electronic RFQ Reaction Period to: (i) Permit 
FLEX Quotes and FLEX Orders to be entered, modified, or canceled during 
the RFQ Reaction Period; (ii) increase the maximum RFQ Reaction Period 
from the proposed 30 seconds to five minutes; (iii) provide that, if 
the Submitting Member enters a FLEX Quote during the RFQ Reaction 
Period, the Submitting Member must be bidding (offering) for at least 
the Crossing Exposure Period prior to entering an RFQ Order; and (iv) 
provide that the RFQ Market is dynamically updated during both the RFQ 
Response and RFQ Reaction Periods;
     Also in proposed Rule 24B.5(a)(2), modifying the open-
outcry priority provisions to clarify the Exchange's original intent 
that, after the application of any participation entitlements, all 
other FLEX Quotes submitted in response to an open-outcry RFQ have 
priority based on the sequence in which those FLEX Quotes are made in 
open outcry and, to the extent two or more best bid (offer) FLEX Quotes 
are submitted in open outcry at the same time and same price (or the 
Submitting Member cannot reasonably determine the sequence), priority 
will be apportioned equally;
     In proposed Rule 24B.5(b), modifying the Book crossing 
provisions to clarify the Exchange's original intent that an agency 
FLEX Order must first be subject to an RFQ and the agency FLEX Order 
(or any remaining balance not executed during the RFQ Reaction Period) 
must also be exposed on the System for at least the Crossing Exposure 
Period prior to entering a contra-side principal or solicitation order 
that is executable against the agency FLEX Order. Previously, the 
proposed rule text had simply indicated that the agency FLEX Order must 
first be subject to an RFQ;
     Updating the text of Rules 24A.7 and 24A.8, as well as 
proposed Rules 24B.7 and 24B.8, to reflect unrelated changes that have 
been approved in a separate rule filing \54\ and to make certain non-
substantive corrections;
---------------------------------------------------------------------------

    \54\ See Securities Exchange Act Release No. 56350 (September 4, 
2007), 72 FR 51878 (September 11, 2007) (SR-CBOE-2007-79).
---------------------------------------------------------------------------

     Inserting corresponding changes to the discussion sections 
of the Form 19b-4 and the Exhibit 1 Federal Register notice to reflect 
the above-noted changes;
     Providing information regarding its plans respecting 
dissemination of FLEX data via the Options Price Reporting Authority 
(``OPRA''). Specifically, with respect to price reporting, the Exchange 
currently plans to continue disseminating via OPRA information 
regarding executed FLEX transactions. However, the Exchange currently 
does not plan to disseminate via OPRA information respecting pending 
electronic and open-outcry RFQs or information on resting orders in the 
Book; and
     Submitting as part of Exhibit 5 the text of the Sponsored 
User Agreement form that the Exchange proposes to use in connection 
with proposed Rule 6.20A.
    In Amendment No. 3, the Exchange made the following changes to the 
proposal:
     Revising the text of Rule 24B.1(u), RFQ Reaction Period, 
to reflect that during this time a Submitting Member determines whether 
to accept or reject the RFQ Market, which consists of both FLEX Quotes 
and FLEX Orders; and
     Correcting the text of proposed Rule 24B.5(a)(2)(iii) that 
was submitted as part of Amendment No. 2.

III. Discussion

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities exchange.\55\ In particular, the Commission finds that the 
proposal is consistent with section 6(b)(5) of the Act,\56\ which 
requires that the rules of an exchange be designed, among other things, 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. The 
Commission also finds that the proposal is consistent with section 
11A(a)(1)(C) of the Act,\57\ which sets forth Congress's findings that 
it is in the public interest and appropriate for the protection of 
investors and the maintenance of fair and orderly markets to assure, 
among other things, economically efficient execution of securities 
transactions; fair competition among brokers and dealers, among 
exchange markets, and between exchange markets and markets other than 
exchange markets; and the

[[Page 65783]]

practicability of brokers executing investors' orders in the best 
market. The Commission generally believes that an exchange furthers 
these principles when developing products and trading functionality 
that compete with the over-the-counter markets. This order approves the 
amended proposal in its entirety, although only certain aspects of the 
proposed rule change are discussed below.
---------------------------------------------------------------------------

    \55\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \56\ 15 U.S.C. 78f(b)(5).
    \57\ 15 U.S.C. 78k-1(a)(1)(C).
---------------------------------------------------------------------------

A. Execution Algorithm and Priority and Allocation Rules

1. Electronic Trading
    The Commission believes that the priority and allocation rules for 
electronic trading on the new System are reasonable and consistent with 
the Act. These rules generally provide for allocation pursuant to 
price/time priority, with some allowance for market-maker and crossing 
participation guarantees. The proposed guarantees appear reasonably 
designed to balance incentives for providing liquidity in the FLEX 
market (in the case of the market-maker entitlement) and for bringing 
trades to the Exchange (in the case of the crossing participation 
entitlement) with incentives for all other market participants to quote 
competitively.
    The Commission also believes that the priority and allocation rules 
for electronic FLEX trading are consistent with section 11(a) of the 
Act.\58\ The Commission believes, however, that neither a Submitting 
Member who trades against an electronic RFQ Market nor any other FLEX 
Trader who itself submits an RFQ Quote electronically qualifies for the 
``effect-versus-execute'' exception to section 11(a).\59\ Nevertheless, 
the Commission believes that other exceptions may apply. FLEX Market-
Makers qualify for the market-maker exception. With respect to non-
market-maker members, the new System appears reasonably designed to 
cause RFQ Quotes constituting the RFQ Market and the RFQ Order that 
trades against the RFQ Market to yield to non-member interest, 
consistent with the ``G'' exception.\60\
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78k(a). Section 11(a)(1) prohibits a member of a 
national securities exchange from effecting transactions on that 
exchange for its own account, the account of an associated person, 
or an account over which it or its associated person exercises 
discretion unless an exception applies.
    \59\ 17 CFR 240.11a2-2(T).
    \60\ See 15 U.S.C. 78k(a)(1)(G) (setting forth all requirements 
for the ``G'' exception).
---------------------------------------------------------------------------

2. Open-Outcry Trading on New System
    The Commission believes that the priority and allocation rules for 
open-outcry trading on the new System are reasonable and consistent 
with the Act. These provisions are generally modeled on the priority 
and allocation rules of the existing FLEX RFQ System, which were 
previously found by the Commission to be consistent with the Act.\61\ 
There is one significant difference, however, the addition of an 
electronic Book. Generally, an order resting on the Book will be filled 
only after all FLEX Quotes submitted in open outcry, even if the order 
was booked before the RFQ began and any oral responses to the RFQ were 
submitted.\62\ The Commission generally believes that displayed limit 
orders of public customers must be able to compete freely and openly 
for executions on an equitable basis. However, with a highly customized 
product such as FLEX Options, there are likely to be few booked orders. 
Therefore, solely with respect to the FLEX Hybrid Trading System, the 
Commission believes at the present time that it is appropriate to 
approve CBOE's proposal to allow FLEX Quotes submitted in response to 
an open-outcry RFQ to have priority over same priced bids (offers) on 
the Book.\63\ The Commission also notes that an open-outcry FLEX Quote 
must yield to the Book and all other bids (offers) that have priority 
over the Book if the member entering the FLEX Quote is relying on the 
``G'' exception to Section 11(a) of the Act.\64\
---------------------------------------------------------------------------

    \61\ See Securities Exchange Act Release No. 31920 (February 24, 
1993), 58 FR 12280 (March 3, 1993) SR-CBOE-92-17).
    \62\ See proposed Rule 24B.5(a)(2)(v)(A).
    \63\ If circumstances change and the FLEX Book becomes 
frequently used, the Commission may revisit this issue.
    \64\ See proposed Rule 24B.5(a)(2)(v)(B).
---------------------------------------------------------------------------

3. Orders on the Book
    If the Exchange enables an electronic Book in a FLEX Option class, 
any transaction involving a booked order must comply with section 11(a) 
of the Act. If a FLEX Trader cannot avail itself of any other 
exception, it must rely on the ``G'' exception, which requires, among 
other things, that a member order yield to a non-member order at the 
same price, even if the member order has time priority. The new System 
has not been programmed to cause a member order on the Book to yield to 
a later-arriving non-member order at the same price, although proposed 
Rule 24B.5(b)(2)(ii) prohibits a member order that is relying on the 
``G'' exemption from resting on the Book. The Commission believes that 
a member may rely on the ``G'' exception if it sends an order to the 
Book and then cancels it immediately if it is not executed in full.
4. Changes to Allocation Rules of FLEX RFQ System
    CBOE has proposed certain changes to its allocation rules under the 
existing FLEX RFQ System. Under the proposal, a FLEX Appointed Market-
Maker will have priority over a FLEX Qualified Market-Maker when the 
two submit orders at the same time and same price. The Commission 
believes that this is consistent with the Act in light of the greater 
quoting obligations of the FLEX Appointed Market-Maker. CBOE also is 
proposing to increase the percentages of an incoming order that can be 
reserved for a crossing guarantee or FLEX Appointed Market-Maker 
participation entitlement.\65\ These percentages appear reasonably 
designed to balance incentives for providing liquidity with incentives 
for all other market participants to quote competitively.
---------------------------------------------------------------------------

    \65\ See proposed Rule 24A.5(e)(iii)-(iv).
---------------------------------------------------------------------------

5. Best Execution
    The proposed rules do not explicitly require an RFQ Trader to trade 
against an RFQ Market. The Commission reminds RFQ Traders that the duty 
of best execution requires them to assess the quality of competing 
markets to ensure that a customer order is directed to the market 
providing the most advantageous terms for the customer. If a Submitting 
Member declines to trade a customer order against an RFQ Market and 
subsequently facilitates the customer order at a price inferior to the 
RFQ Market, there would be a presumption that the Submitting Member did 
not fulfill its best execution obligation.

B. Market-Maker Benefits and Obligations

    The Commission believes that the balance of benefits and 
obligations of FLEX Market-Makers under the rules for the new System is 
consistent with the Act. A FLEX Appointed Market-Maker must provide a 
FLEX Quote in response to any open-outcry RFQ in a class of FLEX 
Options to which it is appointed and trading in open outcry.\66\ In 
addition, the FLEX Appointed Market-Maker must provide FLEX Quotes in 
response to a designated percentage of electronic RFQs, such percentage 
to be determined by the appropriate Procedure Committee and not less 
than 80%.\67\ Although a FLEX Qualified Market-Maker need not enter a 
FLEX Quote in response to an RFQ in its assigned class,\68\ the FLEX 
Qualified

[[Page 65784]]

Market-Maker (like the FLEX Appointed Market-Maker) must submit a FLEX 
Quote if called upon by a FLEX Official, including when no FLEX Quotes 
are submitted in response to a specific RFQ.\69\ FLEX Appointed Market-
Makers may be awarded a participation entitlement, noted above. Both 
FLEX Market-Makers qualify for the market-maker exception to section 
11(a) of the Act.
---------------------------------------------------------------------------

    \66\ See proposed Rule 24B.9(c)(i).
    \67\ See proposed Rule 24B.4(a)(5)(iv).
    \68\ See proposed Rule 24B.9(c).
    \69\ See proposed Rule 24B.9(d).
---------------------------------------------------------------------------

C. Position and Exercise Limits

    The Commission believes that the proposed position and exercise 
limits in FLEX Options are reasonable and consistent with the Act. They 
appear reasonably designed to prevent a member from establishing an 
imprudent position in FLEX Options. Moreover, the Commission believes 
that these rules are reasonably designed to prevent a FLEX Trader from 
using FLEX Options to evade the position limits applicable to 
comparable Non-FLEX Options. In view of the explicit standards for 
position and exercise limits set forth in Rules 24A.7, 24A.8, 24B.7, 
and 24B.8, the Commission believes it is reasonable to relieve the 
Exchange of the obligation to propose new position and exercise limits 
for FLEX Options whenever it lists and trades a comparable non-FLEX 
product.

D. Sponsored Access

    The Commission believes that the proposed sponsored access 
provisions are reasonable and consistent with the Act. The Commission 
notes that these provisions are substantially similar to those of 
another exchange, which previously were approved by the Commission.\70\ 
The Exchange has proposed to offer sponsored access only to the new 
FLEX Hybrid Trading System, not to open-outcry FLEX trading or to other 
Exchange trading facilities. If the Exchange in the future would seek 
to offer sponsored access to its other trading facilities, it would 
have to file a proposed rule change pursuant to section 19(b) of the 
Act.
---------------------------------------------------------------------------

    \70\ See NYSE Arca Equities Rule 7.29; Securities Exchange Act 
Release No. 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) 
(SR-PCX-00-25) (approving proposal to establish Archipelago Exchange 
as the equities trading facility of the Pacific Exchange).
---------------------------------------------------------------------------

E. Acceleration

    The Commission finds good cause for approving the proposal, as 
modified by Amendment Nos. 2 and 3, prior to the thirtieth day after 
the date of publication of notice of the amended proposal in the 
Federal Register. Amendment Nos. 2 and 3 made only minor changes to the 
overall proposal, which was subject to a notice-and-comment period. 
Because no comments were received, the Commission believes that good 
cause exists to grant accelerated approval and thereby allow the 
Exchange to implement the proposal without further delay.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 2 and 3, including whether it 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-2006-99 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-2006-99. 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, 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 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-2006-99 and should be 
submitted on or before December 14, 2007.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\71\ that the proposed rule change (SR-CBOE-2006-99), as amended, 
is approved.
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    \71\ 15 U.S.C. 78s(b)(2).
    \72\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\72\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-22779 Filed 11-21-07; 8:45 am]

BILLING CODE 8011-01-P
