
[Federal Register: November 12, 2009 (Volume 74, Number 217)]
[Notices]               
[Page 58332-58334]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12no09-114]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60957; File No. SR-CBOE-2009-070]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change Relating to 
Preferred Market Makers

November 6, 2009.

I. Introduction

    On September 28, 2009, 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 (the ``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposal to amend CBOE Rule 8.13, ``Preferred Market-
Maker Program'' to establish a participation entitlement for complex 
orders designated to Preferred Market Makers and to clarify the 
operation of the Hybrid System with respect to the existing Preferred 
Market Maker participation entitlement for individual options orders. 
The proposed rule change was published for comment in the Federal 
Register on October 7, 2009.\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. 60746 (September 30, 
2009), 74 FR 51626 (``Notice'').
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II. Description of the Proposal

    The CBOE proposes to amend CBOE Rule 8.13 to: (1) Establish a 
participation entitlement for complex orders entered into the Complex 
Order Book (``COB'') or the complex order RFQ auction (``COA'') that 
are designated to a Preferred Market Maker; and (2) clarify the 
operation of the Hybrid System with respect to the Preferred Market 
Maker participation entitlement for individual options orders.

A. Participation Entitlement for Complex Orders

    Under the proposal, any Designated Primary Market Maker, Lead 
Market Maker, or Market Maker with an appointment/allocation in the 
relevant options class may be designated as a Preferred Market Maker 
for complex orders.\4\ A Preferred Market Maker must comply with the 
quoting obligations applicable to its Market Maker type under CBOE's 
rules and must provide continuous electronic quotes (as defined in CBOE 
Rule 1.1(ccc)) in at least 90% of the series of each class for which it 
receives Preferred Market Maker orders.\5\ In addition, to receive a 
participation entitlement for orders entered into the COB, the 
Preferred Market Maker must be quoting at the best net priced bid/offer 
when the order is received.\6\ For orders in a COA, the Preferred 
Market Maker must: (1) At the beginning of the auction, be quoting at 
either (A) the best bid/offer on the CBOE in at least one of the 
component series of the complex order, or (B) the best net priced bid/
offer for the complex order; and (2) be quoting at the best net priced 
bid/offer at the conclusion of the auction.\7\
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    \4\ See CBOE Rule 8.13, Interpretation and Policy .01(a).
    \5\ See CBOE Rule 8.13, Interpretation and Policy .01(c).
    \6\ See CBOE Rule 8.13, Interpretation and Policy .01(a)(ii).
    \7\ See CBOE Rule 8.13, Interpretation and Policy .01(a)(iii).
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    CBOE prohibits an order flow provider from notifying a Preferred 
Market Maker of its intention to submit a preferenced complex order so 
that the Preferred Market Maker could change its quotation to match the 
national best bid or offer (``NBBO'') immediately prior to the 
submission of the preferenced order.\8\ CBOE states that CBOE Rule 
4.18, ``Prevention of the Misuse of Material, Nonpublic Information,'' 
prohibits this misuse of material non-public information.\9\ CBOE 
represents that it will conduct surveillance for, and enforce against, 
such violations.\10\
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    \8\ See Notice, supra note 3, at note 3.
    \9\ Id.
    \10\ Id.
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    The participation entitlement for a complex order is based on the 
contracts remaining after equivalent net priced orders and quotes on 
the EBook and equivalent net priced public customer complex orders 
resting in the COB that have priority over Preferred Market Makers have 
been filled.\11\ After these orders have been filled, the participation 
entitlement for a Preferred Market Maker that satisfies the 
requirements in CBOE Rule 8.13, Interpretation and Policy .01 is: (1) 
40% when there are two or more Market Makers also quoting at the best 
net priced bid/offer execution price; and (2) 50% when there is one 
other Market Maker quoting at the best net priced bid/offer execution 
price.\12\ The participation entitlement percentages for complex orders 
are the same as the

[[Page 58333]]

participation entitlement percentages for individual options orders 
currently provided under CBOE Rule 8.13(c). If a Preferred Market Maker 
receives a participation entitlement for a complex order in the COB or 
a COA, no other participation entitlement provided in the CBOE's rules 
for complex orders will apply to the complex order.\13\
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    \11\ See CBOE Rule 8.13, Interpretation and Policy .01(b)(ii).
    \12\ See CBOE Rule 8.13, Interpretation and Policy .01(b).
    \13\ See CBOE Rule 8.13, Interpretation and Policy .01(b)(iii). 
However, if a complex order executes, in part, against a Preferred 
Market Maker's interest in the COB or the COA and, in part, against 
the Preferred Market Maker's interest in the individual series legs 
in the EBook, a Preferred Market Maker entitlement may apply on both 
the individual series legs and on the COB or COA execution. See 
Notice, supra note 3, at note 5.
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B. Clarification of the Participation Entitlement for Individual Orders

    CBOE is amending CBOE Rule 8.13(b) to more clearly reflect the 
operation of the Hybrid System with respect to Preferred Market Makers. 
Specifically, CBOE is revising CBOE Rule 8.13(b) to indicate that the 
Hybrid System is programmed so that the recipient of a Preferred Market 
Maker order will receive a participation entitlement if: (1) The 
Preferred Market Maker has an appointment/allocation in the relevant 
options class; and (2) the Preferred Market Maker is quoting at the 
CBOE's best bid or offer. CBOE is adding paragraph (d) to CBOE Rule 
8.13, which will incorporate the quoting obligations applicable to 
Preferred Market Makers that are currently set forth in CBOE Rule 
8.13(b)(iii), including the requirement that a Preferred Market Maker 
provide continuous electronic quotes, as defined in CBOE Rule 1.1(ccc), 
in at least 90% of the series of each class for which it receives 
Preferred Market Maker orders. CBOE notes that this quoting obligation, 
like other Market Maker quoting obligations, is subject to CBOE market 
performance, surveillance, and disciplinary programs to assess and 
enforce compliance.

III. Discussion and Commission Findings

    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.\14\ In 
particular, the Commission finds that the proposal is consistent with 
Section 6(b)(5) of the Act,\15\ which requires, in part, that the rules 
of a national securities exchange be designed to prevent fraudulent and 
manipulative acts and practices, 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. The proposal 
establishes a Preferred Market Maker participation entitlement for 
complex orders submitted to the COB and the COA. Under the proposal, 
the Preferred Market Maker participation entitlement percentages for 
complex orders are the same as the Preferred Market Maker participation 
entitlement percentages provided currently in CBOE Rule 8.13(c) for 
individual options orders.\16\ Because the proposal does not provide a 
participation entitlement for complex orders that is greater than the 
currently acceptable participation entitlement threshold for individual 
options orders, the Commission does not believe that the proposal will 
negatively impact quote competition for complex orders on CBOE. Under 
the proposal, the remaining portion of each complex order will still be 
allocated based on the competitive bidding of market participants.
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    \14\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78f(b)(5).
    \16\ The Commission also has approved similar participation 
entitlement percentages for individual options orders on other 
options exchanges. See, e.g., Securities Exchange Act Release Nos. 
56269 (August 15, 2007), 72 FR 47086 (August 22, 2007) (File No. SR-
Amex-2007-75) (order approving an American Stock Exchange directed 
order program that provides a 40% participation entitlement on 
directed orders) (``Amex Order''); 51759 (May 27, 2005), 70 FR 32860 
(June 6, 2005) (File No. SR-Phlx-2004-91) (order approving a 
directed order program on the Philadelphia Stock Exchange that 
allows the directed order recipient to receive a 40% participation 
entitlement on designated orders) (``Phlx Order''); and 51818 (June 
10, 2005), 70 FR 35146 (June 16, 2005) (File No. ISE-2005-18) (order 
approving a preferencing program on the International Securities 
Exchange that allows a preferenced market maker to receive a 40% 
participation entitlement on designated orders).
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    A Preferred Market Maker must satisfy certain requirements to be 
eligible for a participation entitlement in complex orders. 
Specifically, a Preferred Market Maker must comply with the quoting 
obligations applicable to its Market Maker type under the CBOE's rules 
and must provide continuous electronic quotes (as defined in CBOE Rule 
1.1(ccc)) in at least 90% of the series for each class for which it 
receives Preferred Market Maker orders.\17\ In addition, to receive a 
participation entitlement for orders entered into the COB, the 
Preferred Market Maker must be quoting at the best net priced bid/offer 
when the order is received.\18\ For orders in a COA, the Preferred 
Market Maker must: (1) At the beginning of the auction, be quoting at 
either (A) the best bid/offer on the CBOE in at least one of the 
component series of the complex order, or (B) the best net priced bid/
offer for the complex order; and (2) be quoting at the best net priced 
bid/offer at the conclusion of the auction.\19\ These quoting 
requirements are analogous to the current requirement in CBOE Rule 
8.13(b)(ii) that a Preferred Market Maker be quoting at the CBOE's best 
bid/offer to be eligible for a participation entitlement for an 
individual options order.
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    \17\ See CBOE Rule 8.13, Interpretation and Policy .01(c). This 
quoting obligation also applies currently to the Preferred Market 
Maker participation entitlement for individual options orders.
    \18\ See CBOE Rule 8.13, Interpretation and Policy .01(a)(ii).
    \19\ See CBOE Rule 8.13, Interpretation and Policy .01(a)(iii).
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    The Commission believes that it is critical that, to be eligible 
for a participation entitlement for a complex order, a Preferred Market 
Maker may not step up and match the CBOE's best bid/offer after it 
receives an order, but must be publicly quoting at the CBOE's best net 
priced bid/offer when the order is received (for orders in the COB), 
or, for orders in a COA, quoting at either the CBOE's best/bid offer 
for a least one component of a complex order or at the CBOE's best net 
priced bid/offer for the complex order at the start of the auction.\20\ 
As noted above, CBOE states that it would be a misuse of material non-
public information in violation of CBOE Rule 4.18 for an order flow 
provider to notify a Preferred Market Maker of its intention to submit 
a preferenced complex order immediately prior to sending the order to 
allow the Preferred Market Maker to modify its quotation.\21\ CBOE 
represents that it will conduct surveillance for, and enforce against, 
such violations of its rules.\22\
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    \20\ A Preferred Market Maker will not be allocated a total 
quantity greater than the quantity it is quoting at the best net 
priced bid/offer execution price. See CBOE Rule 8.13, Interpretation 
and Policy .01(b)(i).
    \21\ See notes 8 and 9, supra, and accompanying text.
    \22\ See note 10, supra, and accompanying text.
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    The Commission emphasizes that approval of this proposal does not 
affect a broker-dealer's duty of best execution. The Commission has 
discussed the duty of best execution in previous orders approving 
proposals to implement participation entitlements,\23\ and hereby 
incorporates those discussions by reference into this order.
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    \23\ See, e.g., Amex Order and Phlx Order, supra note 16; and 
Securities Exchange Act Release No. 51779 (June 2, 2005), 70 FR 
33564 (June 8, 2005) (File No. SR-CBOE-2004-71) (order approving a 
modification of the participation entitlement for Preferred 
Designated Primary Market Makers).
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    Finally, the Commission finds that the changes to CBOE Rule 8.13(b) 
are

[[Page 58334]]

consistent with the Act because they clarify the operation of the 
Hybrid System with respect to Preferred Market Maker participation 
entitlements.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (File No. SR-CBOE-2009-070) is 
approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-27258 Filed 11-10-09; 8:45 am]

BILLING CODE 8011-01-P
