
[Federal Register: December 29, 2009 (Volume 74, Number 248)]
[Notices]               
[Page 68880-68882]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29de09-132]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61198; File No. SR-CBOE-2009-078]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of the Proposed Rule Change, as 
Modified by Amendment No. 1, Related to Professional Orders

December 17, 2009.

I. Introduction

    On October 20, 2009, the Chicago Board Options Exchange, 
Incorporated (the ``Exchange'' or ``CBOE'') filed with the Securities 
and Exchange Commission (``Commission'') a proposed rule change 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder \2\ to amend its order 
execution rules to give certain non-broker-dealer orders the same 
priority as broker-dealer orders. On November 3, 2009, the Exchange 
filed Amendment No. 1 to the proposal.\3\ The proposed rule change, as 
modified by Amendment No. 1, was published for comment in the Federal 
Register on November 12, 2009.\4\ The Commission received three comment 
letters on the proposal.\5\ This order approves the proposal, as 
modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 revised a paragraph in the Purpose section 
of the proposal relating to the application of Section 11(a) of the 
Act.
    \4\ See Securities Exchange Act Release No. 60931 (November 4, 
2009), 74 FR 58355 (November 12, 2009) (``Notice'').
    \5\ See letters from Charles B. Cox, dated November 11, 2009 
(``Cox Letter''); Richard Weinstock, dated November 24, 2009 
(``Weinstock Letter I''); and Richard Weinstock, dated December 3, 
2009 (``Weinstock Letter II'').
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II. Description of CBOE's Proposal

    CBOE proposes to adopt a new term, ``Professional,'' which would be 
defined in proposed CBOE Rule 1.1(ggg) as a person or entity that (i) 
is not a broker or dealer in securities, and (ii) places more than 390 
orders in listed options per day on average during a calendar month for 
its own beneficial account(s).\6\ The definition would state that a 
Professional will be treated in the same manner as a broker or dealer 
in securities for purposes of specified order execution rules of 
CBOE.\7\
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    \6\ The Professional designation would not be available in 
Hybrid 3.0 classes.
    \7\ Specifically, the orders of Professionals would be treated 
like broker-dealer orders for the purposes of CBOE Rules 6.2A (Rapid 
Opening System), 6.2B (Hybrid Opening System), 6.8C (Prohibition 
Against Members Functioning as Market-Makers), 6.9 (Solicited 
Transactions), 6.13A (Simple Auction Liaison), 6.13B (Penny Price 
Improvement), 6.45 (Priority of Bids and Offers--Allocation of 
Trades), 6.45A (Priority and Allocation of Equity Option Trades on 
the CBOE Hybrid System) (except that Professional orders may be 
considered public customer orders, and therefore not be subject to 
the exposure requirements for solicited broker-dealer orders, under 
Interpretation and Policy .02), 6.45B (Priority and Allocation of 
Trades in Index Options and Options on ETFs on the CBOE Hybrid 
System) (except that Professional orders may be considered public 
customer orders, and therefore not be subject to the exposure 
requirements for solicited broker-dealer orders, under 
Interpretation and Policy .02), 6.53C(c)(ii) and (d)(v) and 
6.53C.06(b) and (c) (Complex Orders on the Hybrid System), 6.74 
(Crossing Orders) (except that Professional orders may be considered 
public customer orders subject to facilitation under paragraphs (b) 
and (d)), 6.74A (Automated Improvement Mechanism) (except 
Professional orders may be considered customer Agency Orders or 
solicited orders eligible for customer-to-customer immediate crosses 
under Interpretation and Policy .09), 6.74B (Solicitation Auction 
Mechanism), 8.13 (Preferred Market-Maker Program), 8.15B 
(Participation Entitlement of LMMs), 8.87 (Participation Entitlement 
of DPMs and e-DPMs), 24.19 (Multi-Class Broad-Based Index Option 
Spread Orders), 43.1 (Matching Algorithm/Priority), 44.4 
(Obligations of SBT Market-Makers), and 44.14 (SBT DPM Obligations).
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    The use of this new term for purposes of these rules would result 
in Professionals participating in CBOE's allocation process on equal 
terms with broker-dealers--i.e., Professionals would not receive 
priority over broker-dealers in the allocation of orders on the 
Exchange. CBOE states that the proposal would not otherwise affect non-
broker-dealer individuals or entities under CBOE rules, and that, in 
particular, all public customer orders would continue to be treated 
equally for purposes of rules relating to options exchange linkage.\8\
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    \8\ See CBOE Rules 6.14A and 6.80-6.82, which relate to routing 
of orders and linkage. These rules are not included by the proposed 
rule change in the list of rules, supra, for which the Professional 
designation would apply.
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    In addition, CBOE intends to require members to indicate whether 
public customer orders are ``Professional'' orders to assure that 
orders entered on the Exchange are properly represented.\9\ To comply 
with this requirement, members would be required to review their 
customers' activity on at least a quarterly basis to determine whether 
orders that are not for the account of a broker or dealer should be 
represented as public customer orders or as Professional orders.\10\
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    \9\ CBOE has issued a regulatory circular outlining the 
procedures for the implementation of the proposal. See CBOE 
Regulatory Circular RG09-123 (November 6, 2009).
    \10\ Id.
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    The Exchange states that it intends to establish, in a separate 
rule filing, transaction fees applicable to Professionals, and that it 
would not commence the implementation of the instant proposal until 
such fees are in place.\11\
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    \11\ See Notice, supra note 4.
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III. Commission Findings and Order Granting Approval of the Proposed 
Rule Change as Modified by Amendment No. 1

    After careful consideration of the proposed rule change and the 
comments received, the Commission finds that the proposed rule change 
is consistent with the Act. Specifically, the Commission finds that the 
proposed rule change is consistent with Section 6(b) \12\ of the Act 
and the rules thereunder,\13\ and in particular with:
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    \12\ 15 U.S.C. 78f(b).
    \13\ In approving the proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
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    Section 6(b)(5) of the Act, which requires that the rules of a 
national securities exchange, among other things, be designed to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism for a free and open market

[[Page 68881]]

and a national market system, and, in general, to protect investors and 
the public interest; and not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers; \14\ 
and
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    \14\ 15 U.S.C. 78f(b)(5).
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    Section 6(b)(8) of the Act, which requires the rules of an exchange 
not to impose any burden on competition not necessary or appropriate in 
furtherance of the Act.\15\
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    \15\ 15 U.S.C. 78f(b)(8).
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    In addition, the Commission finds that the proposed rule change is 
consistent with Section 11(a) of the Act.\16\
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    \16\ 15 U.S.C. 78k(a).
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    Under the proposed rule change, public customers would be deemed 
``Professional'' and would no longer receive the priority treatment 
currently granted to all public customers, if they place orders on the 
level of frequency specified in proposed Rule 1.1(ggg). In January 
2009, the Commission approved a similar rule proposed by the 
International Securities Exchange, LLC (``ISE'') to create the category 
of ``Professional Orders,'' and to include in that category--in 
addition to the orders of broker-dealers--the orders of public 
customers who place on average more than 390 orders per day in a 
calendar month. Under the ISE rule, public customer orders that 
satisfied the criteria for Professional Orders were no longer to be 
accorded the priority granted to the orders of other public customers 
(i.e., ``Priority Customers'').\17\ While the proposed CBOE rule 
differs somewhat from the format of the ISE rule, the Commission 
believes that the CBOE proposal is comparable to the ISE rule 
pertaining to Professional Orders, which the Commission found to be 
consistent with the Act.
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    \17\ See Securities Exchange Act Release No. 59287 (January 23, 
2009), 74 FR 5694 (January 30, 2009) (``ISE Approval Order'').
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    In the ISE Approval Order, the Commission reviewed the background 
and history of customer order priority rules on national securities 
exchanges, and analyzed the role played in the shaping of these rules 
by various considerations and principles. In this regard, the 
Commission discussed the requirement of Section 6(b)(5) of the Act that 
the rules of an exchange be designed to protect investors and the 
public interest; traditional notions of customer priority in exchange 
trading; the agency obligations of exchange specialists; and the 
requirements of Section 11(a) of the Act.\18\ In approving the ISE 
proposal, the Commission articulated its view that priority for public 
customer orders is not an essential attribute of an exchange,\19\ and 
noted that in the past it has approved trading rules at options 
exchanges that do not give priority to orders of public customers that 
are priced no better than the orders of other market participants.\20\
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    \18\ ISE Approval Order, supra note 17. For a brief synopsis of 
the requirements of Section 11(a), see infra, note 21.
    \19\ See ISE Approval Order, supra note 17, at 5697.
    \20\ ISE Approval Order, supra note 17, at 5697, n. 41-44.
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    The Commission concluded in the ISE Approval Order that Section 
6(b)(5) of the Act does not require an exchange to treat the orders of 
public customers who place orders at the frequency of more than 390 
orders per day on average identically to the orders of public customers 
who do not meet that threshold. For the same reason, the Commission 
believes that the CBOE's proposed rule change is consistent with 
Section 6(b)(5) of the Act.
    With regard to Section 11(a) of the Act,\21\ the Exchange states 
that it does not believe that the proposal would affect the 
availability of the exceptions to Section 11(a) of the Act, including 
the exceptions in subparagraph (G) of Section 11(a) and in Rules 11a1-
1(T) and 11a2-2(T), as are currently available.\22\ The Commission 
concurs. For this reason, the Commission believes that the proposed 
rule change, which would permit orders of CBOE members to be executed 
under certain circumstances even if an order of a Professional is on 
CBOE's book, is consistent with the requirements of Section 11(a) of 
the Act.
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    \21\ Section 11(a) 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. Section 11(a)(1) and the rules thereunder contain 
a number of exceptions for principal transactions by members and 
their associated persons, including the exceptions in subparagraph 
(G) of Section 11(a)(1) and in Rule 11a1-1(T), as well as Rule 11a2-
2(T) under the Act, 17 CFR 240.11a2-2(T).
    \22\ See Notice, supra note 4 at n.17 and accompanying text. See 
also Securities Exchange Act Release No. 59546 (March 10, 2009), 74 
FR 11144 (March 16, 2009) (SR-CBOE-2009-016) and related CBOE 
regulatory circular, RG09-35, in which CBOE provides its members 
with information on compliance with Section 11(a)(1) when trading on 
CBOE's Hybrid System.
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    As noted above, the Commission received three comment letters from 
two commenters regarding the proposed rule change, both of whom opposed 
the proposal.\23\ The commenters believed, among other things, that the 
proposal would thwart competition \24\ and that the proposal was 
designed for that purpose.\25\ They further believed that the proposal 
would discourage and impede customers who provide valuable liquidity to 
the market and whose participation promotes price discovery.\26\ In 
addition, they argued that it is unfair to treat public customers in 
the same manner as members of the Exchange are treated, because public 
customers do not have the same marketplace advantages as members.\27\ 
One of the commenters added that the threshold of 390 orders per day 
was arbitrary and capricious and that the proposal does not make clear 
that orders placed at other exchanges are to be included in determining 
whether the 390-order threshold has been reached.\28\
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    \23\ See supra note 5.
    \24\ See Cox Letter, Weinstock Letters I and II.
    \25\ See Weinstock Letters I and II.
    \26\ See Weinstock Letters I and II. Both Weinstock Letters and 
the Cox Letter maintained that the additional liquidity provided by 
customers improves price discovery when such customers receive 
priority, particularly in the context of penny pricing.
    \27\ See, in particular, Weinstock Letter I, which pointed to 
advantages of time and place, different capital requirements, and 
the ability of market makers to quote on both sides of the market.
    \28\ See Weinstock Letter I.
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    The arguments and concerns raised by the commenters are similar to 
the arguments and concerns that were raised by commenters on the ISE 
proposal. The Commission believes, as it stated with respect to the ISE 
proposal, that these arguments and concerns do not support the 
conclusion that the proposal is inconsistent with the Act.
    The Commission believes that its views with respect to the ISE 
proposal are equally applicable to the CBOE proposal. In this regard, 
the Commission does not believe that the Act requires that the order of 
a public customer or any other market participant be granted priority. 
Historically, in developing their trading and business models, 
exchanges have adopted rules, with Commission approval, that grant 
priority to certain participants over others, in order to attract order 
flow or to create more competitive markets. However, the Act does not 
entitle any participant to priority as a right. The requirement of 
Section 6(b)(8) of the Act that the rules of an exchange not impose an 
unnecessary or inappropriate burden upon competition does not 
necessarily mandate that a Professional (as defined in the CBOE 
proposal) be granted priority at a time that a broker-dealer is not 
granted the same right. The CBOE proposal simply restores the treatment 
of persons who would be deemed Professionals to a base line where no 
special priority benefits are granted.
    The Commission agrees that public customers provide valuable 
liquidity to

[[Page 68882]]

the options markets and compete with market makers. However, the 
contribution of these participants to the market does not mean that 
their orders are entitled to priority treatment, even if--as the 
commenters argue--they would not be able to supply this liquidity 
without being granted such advantage. Market makers and broker-dealers 
also provide valuable liquidity to the marketplace and do not have 
priority.
    With respect to the contention that broker-dealers have substantial 
marketplace advantages over public customers, it should be noted that 
broker-dealers, unlike public customers, pay significant sums for 
registration and membership in self-regulatory organizations 
(``SROs''), and incur significant costs to comply, and to ensure that 
their associated persons comply, with the Act, the rules thereunder, 
and SRO rules. Moreover, persons who place options orders on the scale 
contemplated by the proposal could choose to become registered broker-
dealers and receive the same advantages.
    Regarding the contention of one commenter that the numerical 
threshold is arbitrary, the Commission believes that it is reasonable 
to establish the placement of one order every minute on average as a 
threshold to establish the level of activity, at a minimum, at which 
the Exchange believes that the incentive of priority is not warranted. 
For the same reason, the Commission does not believe that such a 
threshold is capricious.
    Finally, the Commission believes that the proposed rule change is 
clear in not distinguishing between orders placed on the CBOE and those 
placed on any other exchange, and CBOE stated that ``basing the 
standard on the number of orders that are entered in listed options for 
a beneficial account(s) assures that Professional account holders 
cannot inappropriately avoid the purpose of the rule by spreading their 
trading activity over multiple exchanges.'' \29\
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    \29\ See Notice, supra note 4.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-CBOE-2009-078), as modified 
by Amendment No. 1, be, and it hereby is, approved.
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    \30\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-30781 Filed 12-28-09; 8:45 am]

BILLING CODE 8011-01-P
