
[Federal Register: August 11, 2008 (Volume 73, Number 155)]
[Notices]               
[Page 46650-46653]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11au08-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58296; File No. SR-CBOE-2008-30]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change Relating to the 
Hybrid Opening System

August 4, 2008.

I. Introduction

    On June 5, 2008, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') 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 to revise its Hybrid Opening 
System (``HOSS'') procedures to allow the Hybrid Agency Liaison 
(``HAL'') functionality to be available on the openings in designated 
classes. The proposed rule change was published for comment in the 
Federal Register on June 30, 2008.\3\ The Commission received no 
comments regarding the proposal. This order approves the proposed rule 
change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 57997 (June 20, 
2008), 73 FR 36939.
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II. Description of the Proposal

    CBOE Rule 6.2B, ``Hybrid Opening System (``HOSS''),'' sets forth 
procedures for opening trading rotations for series trading on the CBOE 
Hybrid Trading System (``Hybrid''). The current HOSS method for opening 
chooses a single ``market clearing'' price that will leave unexecuted 
those bids and offers that cannot trade with each other.\4\ However, 
one or more series of a class may not open if one of the following 
conditions is met: (1) No opening quote that complies with the legal 
width quote requirements of Rule 8.7(b)(iv) has been entered by at 
least one Market Maker appointed to the class (or by the Designated 
Primary Market-Maker or

[[Page 46651]]

Lead Market-Maker, if applicable for the particular class) (the 
``opening quote condition''); (2) the opening price is not within an 
acceptable range (as applicable for the particular class) compared to 
the lowest quote offer and the highest quote bid (the ``acceptable 
opening range condition''); or (3) the opening trade would leave a 
market order imbalance (i.e., there are more market orders to buy or to 
sell for the particular series than can be satisfied by the limit 
orders, quotes and market orders on the opposite side) (``market order 
imbalance condition'').
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    \4\ In determining the priority of orders and quotes to be 
traded, HOSS gives priority to market orders first, then to limit 
orders and quotes whose price is better than the opening price, and 
then to resting orders and quotes at the opening price. See Rule 
6.2B(c)(iv).
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    Under the current HOSS procedures, if the opening quote condition 
or acceptable opening range condition is present, the senior official 
in the Exchange's control room may authorize the opening of the 
affected series where necessary to ensure a fair and orderly market. If 
the acceptable opening range condition is present, HOSS will not open 
the series but will send a notification to market participants 
indicating the reason. If the market order imbalance condition is 
present, a notification will be sent to market participants indicating 
the size and direction (buy or sell) of the market order imbalance. 
HOSS will not open the series until the condition causing the delay is 
satisfied. HOSS will repeat the process until the series is open.\5\
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    \5\ See CBOE Rule 6.2B(f).
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    CBOE proposes to amend the current HOSS procedures in CBOE Rule 
6.2B to permit HAL functionality to be available on the openings in 
designated classes. HAL is a system for automated handling of 
electronically received orders that are not automatically executed upon 
receipt by Hybrid.\6\ Under the proposed rule change, the Exchange 
could designate the classes in which HAL would be activated for HOSS 
openings. For such designated classes, additional steps would be 
automatically taken using HAL functionality to address the opening 
quote, acceptable opening range, and market order imbalance conditions, 
as well as to address instances where CBOE's opening trade would be at 
a price that is not the current national best bid or offer (the ``NBBO 
condition'').
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    \6\ See CBOE Rule 6.14 (governing the operation of HAL).
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    In particular, CBOE proposes that for classes where HAL is 
activated for HOSS openings, the following procedures would apply if 
one of the following conditions is met:
    (1) If the opening quote condition is present, HOSS would check to 
see if there is an NBBO quote on another market that falls within the 
acceptable opening range. If such an NBBO quote is present, the series 
would open and expose the marketable order(s) at the NBBO price. If 
such an NBBO quote is not present, HOSS would not open the series and 
would send a notification to market participants indicating the reason.
    (2) If the acceptable opening range condition is present, HOSS 
would match orders and quotes to the extent possible at a single 
clearing price \7\ within the acceptable opening range and then expose 
the remaining marketable order(s) at the widest price point within the 
acceptable opening range or the NBBO price, whichever is better.
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    \7\ In determining the priority of orders and quotes to be 
traded on the opening trade or through the subsequent exposure 
process, HOSS would give priority to public customer market orders 
first (with multiple orders ranked based on time priority), then to 
non-public customer market orders second (with multiple orders being 
ranked based on time priority), then to limit orders and quotes 
whose price is better than the opening price (with multiple orders 
and quotes being ranked in accordance with the allocation algorithm 
in effect for the option class pursuant to CBOE Rule 6.45A, 
``Priority and Allocation of Equity Option Trades on the CBOE Hybrid 
System,'' or 6.45B, ``Priority and Allocation of Trades in Index 
Options and Options on ETFs on the CBOE Hybrid System),'' and then 
to limit orders and quotes at the opening price (with multiple 
orders and quotes being ranked in accordance with the allocation 
algorithm in effect for the option class pursuant to Rule 6.45A or 
6.45B). See proposed Interpretation and Policy .03(c)(i) to Rule 
6.2B.
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    (3) If the market order imbalance condition is present, HOSS would 
match orders and quotes to the extent possible at a single clearing 
price and then expose the remaining marketable order(s) at the widest 
price point within the acceptable opening range or the NBBO price, 
whichever is better.
    (4) If the NBBO condition is present, HOSS would match orders and 
quotes to the extent possible at a single clearing price within the 
acceptable opening range or the NBBO price, whichever is better, and 
then expose the remaining marketable order(s) at the NBBO price.
    The order exposure process in each of the above would be conducted 
pursuant to Rule 6.14, ``Hybrid Agency Liaison (HAL).'' Under the HAL 
process, marketable orders would be electronically exposed to all 
Market-Makers appointed to the relevant option class if not executed at 
a single clearing price.\8\ For HOSS openings where HAL is used, this 
exposure period would afford Market-Makers appointed to the class an 
opportunity to match the widest price point within the opening range or 
the NBBO price, whichever is better. If at least one Market-Maker 
committed to trade any portion of the exposed marketable order(s) 
during the exposure period, the exposure period would end and an 
allocation period would commence. The Exchange would determine on a 
class-by-class basis the applicable exposure period (which would not 
exceed 1.5 seconds) and allocation period (which, when combined with 
the designated exposure period time--as opposed to an exposure period 
that is terminated early \9\--would not exceed a total of 3 seconds) 
that would be applicable where HAL is activated for HOSS openings.
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    \8\ On an intra-day basis, orders are normally exposed through 
HAL to Market-Makers appointed to the relevant option class as well 
as members acting as agent for orders at the top of CBOE's book 
(``Qualifying Members'') in the relevant series. See CBOE Rule 
6.14(b). For HOSS openings where HAL is used, the exposure to 
Qualifying Members would not be applicable because there would not 
be an established ``top of CBOE's book'' at the time. As part of a 
separate rule filing, the Exchange recently modified Rule 6.14 to 
permit electronic exposure of HAL orders on a class-by-class basis 
to all members that elect to receive HAL messages (not just Market-
Makers appointed to the relevant option class and Qualifying 
Members) and to permit such members to participate in the HAL 
process. See Securities Exchange Act Release No. 57837 (May 20, 
2008), 73 FR 30431 (May 27, 2008) (SR-CBOE-2008-46). In classes 
where all members that elect to receive HAL messages are eligible to 
participate in the HAL process for a particular class on an intra-
day basis, all such members would also be eligible to participate in 
any HAL process that occurs as part of the HOSS opening in that 
class.
    \9\ In addition to the receipt of a response to trade any 
portion of the exposed order(s), the exposure period would also 
terminate early under the circumstances described in CBOE Rule 
6.14(d).
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    At the conclusion of the allocation period, the order(s) would be 
filled in accordance with the allocation algorithm in effect for the 
class pursuant to Rule 6.45A or 6.45B. There would be no participation 
entitlement applicable to exposed orders, and response sizes are 
limited to the size of the exposed order for allocation purposes. If no 
responses are received or if there remains an unexecuted marketable 
order (or portion thereof), then the balance of the order would be 
booked if it is a limit order that is not marketable or processed in 
accordance with CBOE Rule 6.14(b)(i)-(ii).\10\ In addition, for all 
classes, any remaining balance of opening contingency orders not 
executed via HAL on the opening would be automatically cancelled.\11\ 
For single list classes, any remaining balance of

[[Page 46652]]

marketable orders (other than opening contingency orders) not executed 
via HAL on the opening would route as determined by the Exchange on a 
class-by-class basis to PAR, BART, or at the order entry firm's 
discretion to the order entry firm's booth printer.\12\
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    \10\ With respect to new proposed HAL exposure period, 
``Exchange Initial BBO'' in CBOE Rule 6.14(i)-(ii) means the best 
bid (or offer) that exists in the system at the time the auction 
begins. This takes into account orders and quotes on the relevant 
side of the market that exist in the system at that time (including 
orders and quotes that may have been entered up until the beginning 
of the HAL auction). See e-mail from Jennifer Lamie, Assistant 
General Counsel, CBOE, to Sara Gillis, Special Counsel, Division, 
Commission, dated June 19, 2008.
    \11\ See proposed CBOE Rule 6.2B, Interpretation .03(c)(ii).
    \12\ See proposed CBOE Rule 6.2B, Interpretation .03(c)(ii).
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    The Exchange also notes that all transactions executed via HOSS, 
including through the new proposed HAL exposure period, must be in 
compliance with Section 11(a) of the Act \13\ and the rules promulgated 
thereunder. In this regard, the Exchange states that it believes that 
orders for proprietary accounts submitted into HOSS, including any such 
orders submitted as a response through the proposed HAL exposure 
period, would qualify for an exception under Rule 11a2-2(T).\14\
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    \13\ 15 U.S.C. 78k(a).
    \14\ 17 CFR 240.11a2-2(T).
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange.\15\ 
Specifically, the Commission finds that the proposal is consistent with 
section 6(b)(5) of the Act,\16\ which requires, among other things, 
that the rules of a national securities exchange be designed to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public interest.
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    \15\ 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).
    \16\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change will reduce 
delays in the opening of a series where the opening quote, acceptable 
opening range, and market order imbalance conditions (collectively, 
``opening conditions'') currently would cause the Exchange to delay the 
opening of a series until the condition causing the delay is satisfied. 
Under the current HOSS procedures, the Exchange must undertake a manual 
process when one of the opening conditions exits, which includes 
notifying members of the existence of one of the opening conditions and 
waiting for the condition(s) to be remedied. The proposed rule change 
would automate the process for addressing the opening conditions by 
allowing the HAL functionality to be enabled on the openings in 
designated classes. Specifically, rather than preventing a series from 
opening, the Exchange's system will match orders and quotes to the 
extent possible and then expose the remaining marketable orders to HAL. 
The Commission believes that this may enhance the efficiency of HOSS 
opening rotations because it will allow the opening conditions to be 
addressed more quickly through the automated HAL process, as well as 
address NBBO condition scenarios where the Exchange's opening trade 
might occur at a price inferior to an away market.
    Section 11(a)(1) of the Act \17\ 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 
(collectively, ``covered accounts'') unless an exception applies. Rule 
11a2-2(T) under the Act, known as the ``effect versus execute'' rule, 
provides exchange members with an exemption from the section 11(a)(1) 
prohibition. Rule 11a2-2(T) permits an exchange member, subject to 
certain conditions, to effect transactions for covered accounts by 
arranging for an unaffiliated member to execute the transactions on the 
exchange. To comply with Rule 11a2-2(T)'s conditions, a member (i) must 
transmit the order from off the exchange floor; (ii) may not 
participate in the execution of the transaction once it has been 
transmitted to the member performing the execution; \18\ (iii) may not 
be affiliated with the executing member; and (iv) with respect to an 
account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in 
connection with effecting the transaction except as provided in the 
Rule.
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    \17\ 15 U.S.C. 78k(a).
    \18\ The member may, however, participate in clearing and 
settling the transaction.
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    The Rule's first condition is that orders for covered accounts must 
be transmitted from off the exchange floor. The HOSS system receives 
orders electronically through remote terminals or computer-to-computer 
interfaces.\19\ In the context of other automated trading systems, the 
Commission has found that the off-floor transmission requirement is met 
if a covered account order is transmitted from a remote location 
directly to an exchange's floor by electronic means.\20\ Since HOSS 
receives orders electronically through remote terminals or computer-to-
computer interfaces, the Commission believes that such orders satisfy 
the off-floor transmission requirement. However, the Commission notes 
that to the extent a member submits an order for a covered account into 
HOSS from on the floor of the Exchange, such an order would not meet 
this requirement.
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    \19\ See e-mail from Jennifer Lamie, Assistant General Counsel, 
CBOE, to Sara Gillis, Special Counsel, Division of Trading and 
Markets, Commission, dated July 31, 2008.
    \20\ See, e.g., Securities Exchange Act Release Nos. 57478 
(March 12, 2008), 73 FR 14521 (March 18, 2008) (order approving The 
NASDAQ Options Market as an options exchange facility of The NASDAQ 
Stock Market (``Nasdaq'')); 53128 (January 13, 2006), 71 FR 3550 
(January 23, 2006) (order approving Nasdaq's application to register 
as a national securities exchange); 49068 (January 13, 2004), 69 FR 
2775 (January 20, 2004) (order approving the Boston Options Exchange 
as an options trading facility of the Boston Stock Exchange); 44983 
(October 25, 2001), 66 FR 55225 (November 1, 2001) (order approving 
Archipelago Exchange as electronic trading facility of the Pacific 
Exchange (``PCX'')); 29237 (May 24, 1991), 56 FR 24853 (May 31, 
1991) (regarding the New York Stock Exchange's (``NYSE'') Off-Hours 
Trading Facility); 15533 (January 29, 1979), 44 FR 6084 (January 31, 
1979) (regarding the American Stock Exchange (``Amex'') Post 
Execution Reporting System, the Amex Switching System, the 
Intermarket Trading System, the Multiple Dealer Trading Facility of 
the Cincinnati Stock Exchange, the PCX Communications and Execution 
System, and the Philadelphia Stock Exchange's Automated 
Communications and Execution System (``1979 Release'')); and 14563 
(March 14, 1978), 43 FR 11542 (March 17, 1978) (regarding the NYSE's 
Designated Order Turnaround System (``1978 Release'')).
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    Second, the Rule requires that the member not participate in the 
execution of its order. CBOE represented that no Exchange member is 
able to acquire control or influence over the result or timing of an 
order's execution through HOSS. According to CBOE, the execution of a 
member's order through HOSS, including the subsequent HAL exposure, is 
determined solely by automated processing and execution by computerized 
systems.\21\ Accordingly, the Commission believes that a member does 
not participate in the execution of an order submitted to HOSS.
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    \21\ The member may cancel or modify the order, or modify the 
instruction for executing the order. The Commission has stated that 
the non-participation requirement is satisfied under such 
circumstances so long as such modifications or cancellations are 
also transmitted from off the floor. See 1978 Release, supra note 20 
(stating that the ``non-participation requirement does not prevent 
initiating members from canceling or modifying orders (or the 
instructions pursuant to which the initiating member wishes orders 
to be executed) after the orders have been transmitted to the 
executing member, provided that any such instructions are also 
transmitted from off the floor.'') Thus, the Commission notes that 
if such orders are cancelled or modified from on the floor of the 
Exchange, such orders would not meet this requirement of Rule 11a2-
2(T).
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    Third, Rule 11a2-2(T) requires that the order be executed by an 
exchange member who is unaffiliated with the

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member initiating the order. The Commission has stated that this 
requirement is satisfied when automated exchange facilities are used, 
as long as the design of these systems ensures that members do not 
possess any special or unique trading advantages in handling their 
orders after transmitting them to the exchange.\22\ CBOE has 
represented that the design of HOSS, including the new HAL exposure 
period, ensures that no member has any special or unique trading 
advantage in the handling of its orders after transmitting its orders 
to the Exchange and is designed to prevent any Exchange members from 
gaining any time or place advantages. Based on CBOE's representation, 
the Commission believes that HOSS, as amended herein, satisfies this 
requirement.
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    \22\ In considering the operation of automated execution systems 
operated by an exchange, the Commission noted that while there is 
not an independent executing exchange member, the execution of an 
order is automatic once it has been transmitted into the systems. 
Because the design of these systems ensures that members do not 
possess any special or unique trading advantages in handling their 
orders after transmitting them to the exchange, the Commission has 
stated that executions obtained through these systems satisfy the 
independent execution requirement of Rule 11a2-2(T). See 1979 
Release, supra note 20.
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    Fourth, in the case of a transaction effected for an account with 
respect to which the initiating member or an associated person thereof 
exercises investment discretion, neither the initiating member nor any 
associated person thereof may retain any compensation in connection 
with effecting the transaction, unless the person authorized to 
transact business for the account has expressly provided otherwise by 
written contract referring to section 11(a) of the Act and Rule 11a2-
2(T).\23\ CBOE represents that members trading for covered accounts 
over which they exercise investment discretion must comply with this 
condition in order to rely on the rule's exemption.\24\
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    \23\ 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written 
contract to retain compensation, in connection with effecting 
transactions for covered accounts over which such member or 
associated persons thereof exercises investment discretion, to 
furnish at least annually to the person authorized to transact 
business for the account a statement setting forth the total amount 
of compensation retained by the member in connection with effecting 
transactions for the account during the period covered by the 
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra 
note 20 (stating ``[t]he contractual and disclosure requirements are 
designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such 
arrangements are suitable to their interests'').
    \24\ See e-mail from Jennifer Lamie, Assistant General Counsel, 
CBOE, to Sara Gillis, Special Counsel, Division of Trading and 
Markets, Commission, dated July 31, 2008.
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    Accordingly, for the reasons stated above, the Commission finds 
that the proposed rule change is consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-CBOE-2008-30) is approved.
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    \25\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-18368 Filed 8-8-08; 8:45 am]

BILLING CODE 8010-01-P
