
[Federal Register: January 5, 2010 (Volume 75, Number 2)]
[Notices]               
[Page 502-504]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05ja10-157]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61259; File No. SR-CBOE-2009-025]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change, as Modified by 
Amendment No. 1, Related to the Simple Auction Liaison (SAL)

December 30, 2009.

I. Introduction

    On May 4, 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 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend CBOE Rule 6.13A to 
revise the Designated Primary Market-Maker (``DPM'')/Lead Market-Maker 
(``LMM'') participation entitlement formula that is applicable to 
Simple Auction Liaison (``SAL'') executions in Hybrid 3.0 classes on a 
one-year pilot basis. On November 13, 2009, CBOE filed Amendment No. 1 
to the proposed rule change, which replaced the original filing in its 
entirety. The proposed rule change, as modified by Amendment No. 1, was 
published for comment in the Federal Register on November 24, 2009.\3\ 
The Commission received no comment letters on the proposal. This order 
approves the proposed rule change, 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\ Securities Exchange Act Release No. 61024 (November 18, 
2009), 74 FR 61395.
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II. Description of the Proposal

    CBOE Rule 6.13A governs the operation of the Exchange's SAL system. 
SAL is a feature within CBOE's Hybrid System that auctions marketable 
orders for price improvement over the national best bid or offer 
(``NBBO''). For Hybrid 3.0 Classes in which SAL is activated,\4\ the 
Exchange determines, on a class-by-class basis, which electronic 
matching algorithm from CBOE Rule 6.45B shall apply to SAL executions 
(e.g., pro-rata, price-time, UMA priority with public customer, 
participation entitlement and/or market turner priority overlays).\5\
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    \4\ Currently, SPX (options on the S&P 500 Index) is the only 
Hybrid 3.0 class. Telephone call between Angelo Evangelou, Assistant 
General Counsel, CBOE, and Sara Hawkins, Special Counsel, Division 
of Trading and Markets, Commission, on December 14, 2009.
    \5\ See CBOE Rule 6.13A, Interpretation .04(ii).
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    The Exchange also may establish, on a class-by-class basis, a DPM/
LMM participation entitlement that is applicable only to SAL 
executions.\6\ Pursuant to CBOE Rules 8.15B and 8.87, the participation 
entitlement generally is 50% when there is one other Market-Maker also 
quoting at the best bid/offer on the Exchange, 40% when there are two 
Market-Makers also quoting at the best bid/offer on the Exchange, and 
30% when there are three or more Market-Makers also quoting at the best 
bid/offer on the Exchange. In addition, the participation entitlement 
must be in compliance with Rule 6.45B(a)(i)(2).\7\ In relevant part, 
Rule 6.45B(a)(i)(2) provides that the DPM or LMM may not be allocated a 
total quantity greater than the quantity that it is quoting (including 
orders not part of quotes) at that price.\8\ Further, if pro-rata 
priority is in effect and the DPM or LMM's allocation of an order 
pursuant to its participation entitlement is greater than its 
percentage share of quotes/orders at the best price at the time that 
the participation

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entitlement is granted (the ``pro-rata share''), the DPM or LMM shall 
not receive any further allocation of that order.\9\ The rule also 
provides that the participation entitlement shall not be in effect 
unless public customer priority is in effect in a priority sequence 
ahead of the participation entitlement and then the participation 
entitlement shall only apply to any remaining balance.\10\ In addition, 
responses to SAL auctions are capped to the size of the Agency Order 
for allocation purposes pursuant to Rule 6.13A.\11\
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    \6\ Id.
    \7\ Id.
    \8\ See CBOE Rule 6.45B(a)(i)(2)(B).
    \9\ Id.
    \10\ See CBOE Rule 6.45B(a)(i)(2)(D). CBOE Rule 6.45B(a)(i)(2) 
also provides that, to be entitled to their participation 
entitlement, the DPM/LMM's order and/or quote must be at the best 
price on the Exchange. For purposes of SAL executions, the Exchange 
noted that it interprets this to mean that the DPM/LMM must be at 
the best price at both the start and the conclusion of the SAL 
auction.
    \11\ See Notice, supra note 3, for an example of an allocation 
of a SAL order.
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    The Exchange is now proposing to modify the DPM/LMM entitlement 
when the pro-rata algorithm is in effect for SAL in selected Hybrid 3.0 
classes as part of a pilot program that will operate on a one-year 
basis. For such pro-rata classes, after all public customer orders in 
the book at the best bid/offer and the DPM/LMM participation 
entitlement have been satisfied, the DPM/LMM shall be eligible to 
participate in any remaining balance on a pro-rata basis (regardless of 
whether its participation entitlement is greater than its pro-rata 
share).\12\
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    \12\ See Notice, supra note 3, for an example of an allocation 
of a SAL order under the proposed rule change.
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    As part of the pilot program, on a quarterly basis the Exchange 
will evaluate the number of SAL executions in each pilot class where 
the DPM/LMM participation entitlement was applied and the allocation 
was greater than what it would have been under the pre-pilot allocation 
algorithm. The Exchange will reduce the DPM/LMM participation 
entitlement for the class if the number of SAL executions that exceeded 
the benchmark is more than 1% of the total number of SAL executions in 
the class evaluated during the quarter. This evaluation will be based 
on a random sampling of three days for each month in each quarter. The 
``benchmark'' will be 60% where there is one Market-Maker also quoting 
at the best bid/offer on the Exchange; 40% where there are two Market-
Makers also quoting at the best bid/offer on the Exchange; and 40% 
where there are three or more Market-Makers also quoting at the best 
bid/offer on the Exchange. The benchmark percentages, which in some 
instances are greater than CBOE's DPM/LMM participation entitlement 
percentages contained in Rules 8.15B and 8.87, are based on the market-
maker participation entitlement percentages that are available on other 
options exchanges.\13\ During the pilot, the Exchange will submit a 
quarterly report containing certain data related to this evaluation to 
the Commission.\14\
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    \13\ See, e.g., International Securities Exchange Rule 
7.13.01(b) (provides a 60% participation right if there is only one 
other Professional Order or market maker quotation at the best 
price) and NYSE Arca, Inc. Rule 6.76A(a)(1)(A)(i) (provides a 40% 
participation right regardless of the number of other market 
participants at the best price).
    \14\ See Notice, supra note 3, for further detail on the data to 
be provided in the reports submitted to the Commission. Such data 
will be provided by CBOE on a confidential basis.
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III. Discussion and Findings

    The Commission finds that the proposed rule change, as modified by 
Amendment No. 1, 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 has closely scrutinized proposals which would 
provide participation entitlements to specialists or market makers or 
would increase any such existing entitlements.\17\ The Commission has 
recognized that such entitlements to specialists, market makers, or 
other members that ``lock up'' a certain portion of each affected order 
reduce the number of contracts for which other members and market 
participants can compete.\18\ Eventually, if particular exchange 
members ``lock up'' a large share of customer orders, competing members 
would have less incentive to compete by offering better prices on an 
exchange and competition could diminish. As a result, the disseminated 
quotations, and the other trading interest available on a market, could 
deteriorate, ultimately harming investors.\19\
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    \17\ See Securities Exchange Act Release No. 49068 (January 13, 
2004), 69 FR 2775 (January 20, 2004) (establishing trading rules for 
the Boston Options Exchange Facility) and Securities Exchange Act 
Release No. 42455 (February 24, 2000), 65 FR 11388, 11395 (March 2, 
2000) (order approving the registration of the International 
Securities Exchange LLC as a national securities exchange).
    \18\ Id.
    \19\ Id.
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    As noted, CBOE's proposal will permit DPMs and LMMs to execute a 
larger share of a SAL order than under the current allocation 
algorithm, as DPMs and LMMs will now be permitted to receive their DPM/
LMM participation entitlement as well as a pro-rata share of the 
remaining balance on an order (after all public customer orders in the 
book at the best bid/offer and the DPM/LMM participation entitlement 
have been satisfied). However, the Commission believes that any 
potential concerns regarding the increased allocation to DPMs/LMMs, as 
discussed above, are mitigated by the terms and conditions of the pilot 
program. Specifically, during the pilot program, the Exchange will be 
required to closely monitor a random sampling of the SAL executions and 
evaluate executions in which the DPM/LMM allocation is greater than 
what it would have been under the previous allocation algorithm. These 
SAL executions will be evaluated against a ``benchmark'' that is based 
on market-maker participation entitlement percentages that have been 
approved by the Commission for other options exchanges.\20\ If the 
number of SAL executions that exceeds the benchmark amounts to more 
than 1% of the total number of SAL executions in the class evaluated 
during the quarter, the Exchange must reduce the DPM/LMM participation 
entitlement for that class. As such, the Commission believes that the 
proposal will permit only DPM/LMM allocations that are generally 
consistent with the level of participation entitlement that the 
Commission has previously approved for other options exchanges.
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    \20\ See supra note 13. Specifically, the ``benchmark'' will be 
60% where there is one Market-Maker also quoting at the best bid/
offer on the Exchange; 40% where there are two Market-Makers also 
quoting at the best bid/offer on the Exchange; and 40% where there 
are three or more Market-Makers also quoting at the best bid/offer 
on the Exchange.
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    Further, the Exchange will submit quarterly reports to the 
Commission providing data on SAL executions evaluated during the 
relevant time period. In evaluating the pilot program, the Commission 
will consider, among other things, how often the allocation percentage 
exceeds the benchmark and by what amount. The Commission will closely 
scrutinize the pilot program to ensure that the DPM/LMM allocations 
under the proposed rule change are

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generally in line with the maximum participation entitlement 
percentages that the Commission has previously approved.
    For these reasons, the Commission finds that the proposed rule 
change is consistent with the Act.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-CBOE-2009-025), as modified 
by Amendment No. 1, be, and hereby is, approved.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-31345 Filed 1-4-10; 8:45 am]

BILLING CODE 8011-01-P
