
[Federal Register Volume 76, Number 117 (Friday, June 17, 2011)]
[Notices]
[Pages 35491-35493]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-15058]


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SECURITIES AND EXCHANGE COMMISSION

Release No. 34-64653; File No. SR-CBOE-2011-041


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Granting Approval of Proposed Rule Change Establishing 
Qualified Contingent Cross Orders

June 13, 2011.

I. Introduction

    On April 18, 2011, the Chicago Board Options Exchange, Inc. 
(``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 establish qualified contingent 
cross orders (``QCC Order''). The proposed rule change was published in 
the Federal Register on May 4, 2011.\3\ The Commission received four 
comments on the proposal.\4\ CBOE submitted a comment response letter 
on June 6, 2011.\5\ This order grants approval of 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. 64354 (April 27, 
2011), 76 FR 25392 (``Notice'').
    \4\ See Letters to Elizabeth M. Murphy, Secretary, Commission, 
from Martin Galivan, dated May 4, 2011(``Galivan Letter''); Ron 
March, dated May 4, 2011 (``March Letter''); Jesse L. Stamer, dated 
May 8, 2011 (``Stamer Letter''); and Michael J. Simon, Secretary, 
International Securities Exchange (``ISE''), dated May 27, 2011 
(``ISE Letter'').
    \5\ See Letter to Elizabeth M. Murphy, Secretary, Commission, 
from Jennifer M. Lamie, Assistant General Counsel, CBOE, dated June 
6, 2011 (``CBOE Response Letter'').
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II. Description of the Proposal

    CBOE proposes to amend CBOE Rule 6.53 to adopt rules related to a 
new QCC Order type that will be available to CBOE Trading Permit 
Holders (``TPHs'').\6\ CBOE Rule 6.53 would permit QCC Orders to be 
submitted electronically from either on or off the floor through the 
CBOE Hybrid Trading System. The QCC Order would permit a TPH to cross 
the options leg(s) of a qualified contingent trade (``QCT'') \7\ in a 
Regulation NMS stock, on CBOE immediately without exposure if the order 
is: (i) For at least 1,000 contracts; (ii) is part of a QCT; \8\ (iii) 
is executed at a price at least equal to the national best bid or offer 
(``NBBO''); and (iv) there are no public customer orders resting in the 
Exchange's electronic book at the same price. Specifically, the QCC 
Order type would permit TPHs to provide their customers a net price for 
the stock-option trade, and then allow the TPH to execute the options 
leg(s) of the trade on CBOE at a price at least equal to the NBBO while 
using the QCT exemption to effect the trade in the

[[Page 35492]]

equities leg at a price necessary to achieve the net price.\9\ The 
Exchange would not permit the options component(s) of a QCC Order to 
trade through the NBBO.
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    \6\ In the Notice, the Exchange states that the proposal will 
permit CBOE to remain competitive with ISE, which has a QCC Order 
type that is submitted from off the floor, and other options 
exchanges that may adopt a similar order type. See Notice, supra 
note 3, at 25393.
    \7\ The Commission has granted an exemption for QCTs that meet 
certain requirements from Rule 611(a) of Regulation NMS, 17 CFR 
242.611(a). See Securities Exchange Act Release No. 57620 (April 4, 
2008), 73 FR 19271 (April 9, 2008) (``QCT Release,'' which 
supersedes a release initially granting the QCT exemption, 
Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR 
52829 (September 7, 2006) (``Original QCT Release'')).
    \8\ CBOE is proposing to define a qualified contingent cross 
trade substantively identical to the Commission's definition in the 
QCT Release. A qualified contingent cross trade must meet the 
following conditions: (i) At least one component must be an NMS 
stock, as defined in Rule 600 of Regulation NMS, 17 CFR 242.600; 
(ii) all components must be effected with a product or price 
contingency that either has been agreed to by all the respective 
counterparties or arranged for by a broker-dealer as principal or 
agent; (iii) the execution of one component must be contingent upon 
the execution of all other components at or near the same time; (iv) 
the specific relationship between the component orders (e.g., the 
spread between the prices of the component orders) is determined by 
the time the contingent order is placed; (v) the component orders 
must bear a derivative relationship to one another, represent 
different classes of shares of the same issuer, or involve the 
securities of participants in mergers or with intentions to merge 
that have been announced or cancelled; and (vi) the transaction must 
be fully hedged (without regard to any prior existing position) as a 
result of other components of the contingent trade. Consistent with 
the QCT Release, TPHs would be required to demonstrate that the 
transaction is fully hedged using reasonable risk-valuation 
methodologies. See QCT Release, supra note 7, at footnote 9.
    \9\ CBOE represented that it will adopt policies and procedures 
to ensure that TPHs use the QCC Order properly and require TPHs to 
properly mark all QCC Orders as such. Additionally, CBOE will 
implement an examination and surveillance program to assess TPH 
compliance with the requirements applicable to QCC Orders, including 
the requirement that the stock leg of the transaction be executed at 
or near the same time as the options leg.
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III. Comment Letters

    Four commenters raised objections to the proposal.\10\ One 
commenter expressed the concern that the QCC Order would prohibit 
potential price improvement because such order may trade on the 
Exchange immediately without exposure.\11\ The commenter was also 
concerned that the proposal may promote internalization of order flow 
to the benefit of a few select firms.\12\ Another commenter stated that 
the proposal may decrease liquidity in the market and was concerned 
that public customer orders may get traded through.\13\ Further, a 
commenter suggested that the proposal would create an uneven playing 
field in the market to the benefit of large institutional customers and 
detriment of small individual investors.
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    \10\ See note 4, supra.
    \11\ See Galivan Letter.
    \12\ See Galivan Letter.
    \13\ See Stamer Letter.
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    Another commenter questioned the ability of a floor-based exchange 
to verify that there is not a customer order on the book at the price 
as a QCC order at the time of execution.\14\ The commenter argued that 
in an electronic trading environment, an exchange's systems can 
automatically determine if there is a customer order on the book before 
a QCC order is executed.\15\ The commenter stated that how this 
function would be performed on a floor-based exchange should be 
clarified, as well as what the time of execution would be for a floor-
based trade.\16\ The commenter argued that ``[a]llowing a QCC to be 
implemented in a non-automated environment without a systemic check of 
whether there is a customer order on the book at the time of execution 
would effectively eliminate the protections guaranteed in an all 
electronic trading environment, thus returning [the exchanges] to the 
unequal competitive environment from which the ISE's QCC proposal 
originated.'' \17\
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    \14\ See ISE Letter.
    \15\ Id.
    \16\ Id.
    \17\ Id.
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    In its letter, CBOE responded to the issues raised in the ISE 
Letter and explained that, even when QCC Orders are submitted for 
execution from the floor, they are submitted electronically and that 
these orders would not be represented in ``open outcry.'' \18\ CBOE 
also clarified that the time of execution of a QCC Order would not vary 
depending on whether the order is submitted from on the floor or off 
the floor and that the execution would occur when the QCC Order is 
submitted to the CBOE Hybrid Trading System.\19\
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    \18\ See CBOE Response Letter, supra note 5.
    \19\ Id.
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IV. Discussion and Commission's Findings

    The Commission has carefully reviewed the proposed rule change, the 
comments received, and finds that it is consistent with the 
requirements of Section 6(b) of the Act.\20\ Specifically, the 
Commission finds that the proposal is consistent with Sections 6(b)(5) 
\21\ and 6(b)(8),\22\ which require, 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 and that the 
rules of an exchange do no impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act. In 
addition, the Commission finds that the proposed rule change is 
consistent with Section 11A(a)(1)(C) of the Act,\23\ in which Congress 
found 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, the economically efficient execution of 
securities transactions.
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    \20\ 15 U.S.C. 78f(b). 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).
    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78f(b)(8).
    \23\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission believes that the proposed rule change, which would 
permit a clean cross of the options leg of a subset of qualified 
contingent trades, is appropriate and consistent with the Act.\24\ The 
Commission believes that this order type may facilitate the execution 
of qualified contingent trades, which the Commission found to be 
beneficial to the market as a whole by contributing to the efficient 
functioning of the securities markets and the price discovery 
process.\25\ The QCC Order would provide assurance to parties to stock-
option qualified contingent trades that their hedge would be maintained 
by allowing the options component to be executed as a clean cross.
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    \24\ See also Securities Exchange Act Release No. 63955 
(February 24, 2011), 76 FR 11533 (March 2, 2011) (SR-ISE-2010-73) 
(``ISE QCC Approval'').
    \25\ See Original QCT Release, supra note 7.
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    While the Commission believes that order exposure is generally 
beneficial to options markets in that it provides an incentive to 
options market maker to provide liquidity and therefore plays an 
important role in ensuring competition and price discovery in the 
options markets, it also has recognized that contingent trades can be 
``useful trading tools for investors and other market participants, 
particularly those who trade the securities of issuers involved in 
mergers, different classes of shares of the same issuers, convertible 
securities, and equity derivatives such as options [italics added],'' 
\26\ and that ``[t]hose who engage in contingent trades can benefit the 
market as a whole by studying the relationships between prices of such 
securities and executing contingent trades when they believe such 
relationships are out of line with what they believe to be fair 
value.'' \27\ As such, the Commission stated that the transactions that 
meet the specified requirements of the NMS QCT Exemption could be of 
benefit to the market as a whole, contributing to the efficient 
functioning of the securities markets and the price discovery 
process.\28\
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    \26\ See id. at 52830-52831.
    \27\ Id.
    \28\ See QCT Release, supra note 7 at 19273.
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    Thus, in light of the benefits provided by both the requirement for 
exposure as well as by qualified contingent trades such as QCC Orders, 
the Commission must weigh the relative merits of both for the options 
markets.\29\ The Commission believes that the proposal, in requiring a 
QCC Order be: (1) Part of a qualified contingent trade under Regulation 
NMS; (2) for at least 1,000 contracts; (3) executed at a price at or 
between the NBBO; and (4) cancelled if there is a public customer on 
the electronic book, strikes an appropriate balance for the options 
market in that it is narrowly drawn and establishes a limited exception 
to the general principle of exposure and retains the general principle 
of customer priority in the options markets. Furthermore, not

[[Page 35493]]

only must a QCC Order be part of a qualified contingent trade by 
satisfying each of the six underlying requirements of the NMS QCT 
Exemption, the requirement that a QCC Order be for a minimum size of 
1,000 contracts provides another limit to its use by ensuring only 
transactions of significant size may avail themselves of this order 
type.\30\
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    \29\ The Commission notes that it has previously permitted the 
crossing of two public customer orders, for which no exposure is 
required on ISE and CBOE. See CBOE Rule 6.74A.09 and ISE Rule 715(i) 
and 721.
    \30\ The Commission notes that the requirement that clean 
crosses be of a certain minimum size is not unique to the QCC Order. 
See, e.g., NSX 11.12(d), which requires, among other things, that a 
Clean Cross be for at least 5,000 shares and have an aggregate value 
of at least $100,000.
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    The Commission notes that, under CBOE's proposal, QCC Orders may be 
submitted electronically from either on or off the floor through the 
CBOE Hybrid Trading System. CBOE has represented that to effect 
proprietary orders, including QCC Orders, electronically from on the 
floor of the Exchange, members must qualify for an exemption from 
Section 11(a)(1) of the Act,\31\ which concerns proprietary trading on 
an exchange by an exchange member. Among other exemptions, common 
exemptions include: An exemption for transactions by broker dealers 
acting in the capacity of a market maker under Section 11(a)(1)(A); 
\32\ the ``G'' exemption for yielding priority to non-members under 
Section 11(a)(1)(G) of the Act and Rule 11a1-1(T) thereunder; \33\ and 
the ``effect vs. execute'' exemption under Rule 11a2-2(T) under the 
Act.\34\ The Exchange recognized in its filing that, consistent with 
existing Exchange rules for effecting proprietary orders from on the 
floor of the Exchange, TPHs effecting QCC Orders and relying on the 
``G'' exemption would be required to yield priority to any interest, 
not just public customer orders, in the electronic book at the same 
price to ensure that non-member interest is protected.\35\
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    \31\ 15 U.S.C. 78k(a)(1). Generally, Section 11(a)(1) of the Act 
restricts any member of a national securities exchange from 
effecting any transaction on such exchange for: (i) The member's own 
account, (ii) the account of a person associated with the member, or 
(iii) an account over which the member or a person associated with 
the member exercises discretion, unless a specific exemption is 
available.
    \32\ 15 U.S.C. 78k(a)(1)(A).
    \33\ 15 U.S.C. 78k(a)(1)(G) and 17 CFR 240.11a1-1(T).
    \34\ 17 CFR 240.11a2-2(T).
    \35\ See, e.g., Securities Exchange Act Release No. 59546 (March 
10, 2009), 74 FR 11144 (March 16, 2009) (SR-CBOE-2009-016) and CBOE 
Regulatory Circular RG09-35 (providing guidance on the application 
of Section 11(a)(1) and certain of the exemptions, as well as the 
application of the ``G'' exemption and the Effect vs. Execute 
exemption to trading on the Hybrid Trading System).
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    In approving a similar order type for ISE, the Commission 
considered the issues raised in the Galivan Letter, March Letter, and 
Stamer Letter, and found that ISE's QCC order type was consistent with 
the requirements of the Act and the rules and regulations 
thereunder.\36\ In addition, the Commission believes that CBOE's 
response letter clarified the questions raised by ISE in the ISE 
Letter.
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    \36\ See ISE QCC Approval, supra note 24.
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    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) \37\ and 6(b)(8) \38\ of 
the Act. Further, the Commission finds that the proposed rule change is 
consistent with Section 11A(a)(1)(C) of the Act.\39\
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    \37\ 15 U.S.C. 78f(b)(5).
    \38\ 15 U.S.C. 78f(b)(8).
    \39\ 15 U.S.C. 78k-1(a)(1)(C).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\40\ that the proposed rule change (SR-CBOE-2011-041) be, and it 
hereby is, approved.
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    \40\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\41\
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    \41\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-15058 Filed 6-16-11; 8:45 am]
BILLING CODE 8011-01-P


