[Federal Register Volume 70, Number 9 (Thursday, January 13, 2005)]
[Notices]
[Pages 2436-2439]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-128]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-50996; File No. SR-CBOE-2004-77]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Chicago Board Options Exchange, Inc., Relating to the
Systematizing of Orders in Connection With the Requirement To Design
and Implement a Consolidated Options Audit Trail System
January 7, 2005.
I. Introduction
On November 24, 2004, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') filed with the Securities Exchange
Commission (``SEC'' or ``Commission''), pursuant to section 19(b)(1) of
the Securities Exchange Act
[[Page 2437]]
of 1934 (the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule
change to amend its rules relating to the systematization of orders in
connection with the requirement to design and implement a consolidated
options audit trail system (``COATS''). The proposed rule change was
published for notice and comment in the Federal Register on December 6,
2004.\3\ The Commission received 2 comment letters on the proposed rule
change.\4\ 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. 50755 (November 30,
2004), 69 FR 70482.
\4\ See e-mail from Brian Meister, CBOE Floor Broker, O'Connor
and Co., LLC, dated December 26, 2004 and Richard T. Marneris, CBOE
Floor Broker, dated December 21, 2004.
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II. Background
The proposed rule change is intended to fulfill certain of the
undertakings contained in an order issued by the Commission relating to
the settlement of an enforcement action against the American Stock
Exchange LLC, CBOE, Pacific Exchange, Inc., and Philadelphia Stock
Exchange, Inc. (collectively ``Options Exchanges'') for failure to
comply with their own rules and to enforce compliance with their own
rules by their members and persons associated with their members \5\ as
is required by section 19(g) of the Act.\6\ The Order found that the
Options Exchanges impaired the operations of the options market by: (i)
Following a course of conduct under which they refrained from multiply
listing a large number of options; and (ii) inadequately discharging
their obligations as self-regulatory organizations by failing
adequately to enforce compliance with (a) certain of their rules,
including order handling rules, that promote competition as well as
investor protection, and (b) certain of the rules prohibiting
anticompetitive conduct, such as harassment, intimidation, refusals to
deal and retaliation directed at market participants who sought to act
competitively. In addition, the Commission found that the Options
Exchanges failed to enforce compliance with their trade reporting
rules, which promote transparency of the market and facilitate
surveillance and enforcement of other exchange rules and the Federal
securities laws.
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\5\ See Order Instituting Public Administrative Proceedings
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934,
Making Findings and Imposing Sanctions, Securities Exchange Act
Release No. 43268 (September 11, 2000) and Administrative Proceeding
File 3-10282 (the ``Order'').
\6\ 15 U.S.C. 78s(g).
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As part of the Order, the Options Exchanges agreed to, and were
ordered to comply with, a variety of undertakings. Among other things,
they agreed to, and were ordered to, design and implement COATS to
enable the Options Exchanges to reconstruct markets promptly,
effectively surveil them and enforce order handling, firm quote,
trading reporting and other rules. The Options Exchanges were required
to complete this undertaking in five phases. The Options Exchanges have
completed the first four phases. The final phase of the undertaking to
implement COATS requires that each exchange incorporate into its audit
trail all non-electronic orders. This proposed rule change addresses
that aspect of the undertaking.
III. Description of Proposed Rule Change
To assure that all non-electronic orders are incorporated into
COATS for Phase V, the CBOE proposes to amend CBOE Rule 6.24, which
currently requires orders to be in written form. The proposed rule
change generally would require that each order, change to an order, or
cancellation of an order transmitted to the Exchange be
``systematized,'' in a format approved by the Exchange, either before
it is sent to the Exchange or contemporaneously upon receipt on the
floor of the Exchange, and prior to representation of the order.
CBOE proposes that each order, change to an order, or cancellation
of an order may be systematized in one of two ways. First, if an order,
change to an order, or cancellation of an order is sent electronically
to the Exchange, would be considered to be systematized. Second, if an
order, change to an order, or cancellation of an order that is sent to
the Exchange non-electronically is input electronically into the
Exchange's systems contemporaneously upon receipt on the Exchange and
prior to representation, it would be considered to be systematized. The
requirement would proposed to commence on January 10, 2005. With
respect to non-electronic orders received in the S&P 100 index option
class (OEX), the S&P 500 index option class (SPX), and the European-
style S&P 100 index option class (XEO), however, CBOE proposes that the
requirement to systematize orders prior to representation would
commence on March 28, 2005.
Although the proposed rule change generally requires that each
order be systematized prior to representation, the Exchange proposes to
treat market and marketable orders differently than other orders so
that marketable orders may be represented immediately in the
marketplace. Specifically, with respect to non-electronic market and
marketable orders sent to the Exchange, CBOE proposes to provide that
the member responsible for systematizing the order must input into the
Exchange's systems the following specific information with respect to a
market or marketable order prior to the representation of the order:
(i) The option symbol; (ii) the expiration month; (iii) the expiration
year; (iv) the strike price; (v) buy or sell; (vi) call or put; (vii)
the number of contracts; and (viii) the Clearing Member. Any additional
information with respect to the order would be inputted into the
Exchange's systems contemporaneously thereafter, which may occur after
the representation and execution of the order.
CBOE also proposes to amend Interpretation .04 to CBOE Rule 6.73,
to make explicit that a broker's responsibility to immediately and
continuously represent market and marketable orders would be subject to
the requirement that each order must be systematized prior to
representation.
In proposed new subparagraph (a)(4) of CBOE Rule 6.24, the Exchange
proposes that in the event of a malfunction or disruption of the
Exchange's systems such that a member is unable to systematize an
order, the member or member organization would be required to use paper
trade tickets to record order information during the time period that
the malfunction or disruption occurs. Upon the cessation of the
malfunction or disruption, the member would be required to immediately
resume systematizing orders. In addition, the member would be required
to exert best efforts to input electronically into the Exchange's
systems all relevant order information received during the time period
when there was a malfunction or disruption of the Exchange's systems as
soon as possible, and in any event would be required to input such data
electronically into the Exchange's systems not later than the close of
business on the day that the malfunction or disruption ceases.
The Exchange proposes to keep the current Interpretation and Policy
.02(a) of CBOE Rule 6.24, which permits the use of hand signal
communications on the floor to, among other things, initiate an order,
cancel an order or to change material terms of an order. However, the
Exchange proposes to clarify that any initiation, cancellation, or
change of an order relayed to a floor broker through the use of hand
signals also must be
[[Page 2438]]
systematized upon receipt in accordance with paragraph (a) of CBOE Rule
6.24. The proposed rule change also deletes paragraph (b) of
Interpretation .02 as paragraph (a) of that interpretation is being
amended to delete the reference to exempt classes.
The Exchange proposes to add a new Interpretation and Policy .04 to
CBOE Rule 6.24, which states that accommodation liquidations as defined
in CBOE Rule 6.54 are exempted from the systematization requirement.
However, the Exchange commits to maintain quotation, order and
transaction information for accommodation liquidations in the same
format as the COATS data is maintained, and will make such information
available to the SEC upon request.
The Exchange also proposes to add a new Interpretation and Policy
.05 to CBOE Rule 6.24, which states that FLEX options, as described in
Chapter 24A of the Exchange's rules, are exempt from the requirements
of the Rule. However, the Exchange commits to maintain as part of its
audit trail quotation, order and transaction information for FLEX
options in a form and manner that is substantially similar to the form
and manner as the COATS data is maintained, and will make such
information available to the SEC upon request.
The Exchange proposes to include a new Interpretation .06 to CBOE
Rule 6.24, which provides that any proprietary system approved by the
Exchange on the Exchange's trading floor that receives orders would be
considered an Exchange system for purposes of paragraph (a)(1) of this
Rule. This proposed rule would require that any proprietary system
approved by the Exchange must comply with the requirements of COATS.
Finally, the Exchange has proposed a new Interpretation .07 to CBOE
Rule 6.24, which would require that each order transmitted by a Market-
Maker while on the floor, including any cancellation of or change to
such order, must be systematized in accordance with the procedures
described in Paragraph (a) and (b) of this Rule, as applicable.
Currently, paragraph (d) of CBOE Rule 6.24 requires that each order
transmitted by a Market-Maker while on the floor, including any
cancellation of or change to such order, must be recorded legibly in a
written form that has been approved by the Exchange, and must be time
stamped immediately prior to its transmission. The new proposed
interpretation thus would require that each order transmitted by a
Market-Maker while on the floor, including any cancellation of or
change to such order, be systematized in accordance with CBOE Rule
6.24.
IV. Summary of Comments
The Commission received comment letters from 2 CBOE floor brokers
opposing the systematization prior to representation of an order
requirement.\7\ Both commenters were concerned that this requirement
might harm customers by delaying the execution and possibly causing the
customer orders to lose the market.
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\7\ See supra Note 4.
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V. Discussion
After careful consideration, the Commission finds that the proposed
rule change is consistent with the Act and the rules and regulations
thereunder applicable to a national securities exchange. In particular
the Commission finds that the proposed rule change is consistent with
section 6(b)(5) of the Act,\8\ which requires among other things, that
the Exchange's rules be designed to promote just and equitable
principles of trade, to remove impediments and to perfect the mechanism
of a free and open market and a national market system, and in general,
to protect investors and the public interest.\9\
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\8\ 8 15 U.S.C. 78f(b)(5).
\9\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition and capital
formation. 15 U.S.C. 78c(f).
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The Commission believes that the rules as proposed should allow the
Exchange to comply with its obligations under the Order in that they
will result in the creation of an audit trail that incorporates manual
orders sent to CBOE. Specifically, the proposed rules will require that
each order, change to an order, or cancellation of an order must be
systematized prior to representation.
With respect to market and marketable orders, the Exchange proposes
to require that floor brokers must enter only eight order data elements
into the Exchange's systems prior to representation. These elements
are: (i) The option symbol; (ii) the expiration month; (iii) the
expiration year; (iv) the strike price; (v) buy or sell; (vi) call or
put; (vii) the number of contracts; and (viii) the Clearing Member. The
Exchange represents that limiting the number of elements that must be
entered prior to representation will permit marketable orders to be
represented immediately in the marketplace as customers expect and as
members representing those orders are obligated to do. The Commission
notes that two commenters expressed concern that the requirement to
systematize certain information prior to representation would harm
investors.\10\ The Commission notes, however, that only a limited
amount of information about an order would be required to be
systematized prior to representation under the proposal. Moreover, the
Commission believes that the order elements proposed to be captured for
market and marketable orders should be sufficient to distinguish one
order from another order that a member may receive at or about the same
time to ensure an accurate audit trail. Therefore, the Commission
believes that it is appropriate and consistent with the goals of
investor protection to permit the capture of only the above-referenced
order data elements prior to representation for market and marketable
orders.
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\10\ See supra note 4.
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The Commission also believes that the Exchange's plan for recording
order details in the event of a systems outage or malfunction is
reasonable. In the event of a systems outage or malfunction, floor
brokers would revert to the use of trade tickets and would record on
those tickets the times that various events occur in the life of the
order. Further, the Exchange would ensure that the information recorded
on trade tickets is entered into the Exchange's electronic systems in a
timely manner so that it can be incorporated into the electronic audit
trail.
The Commission notes that the Exchange has acknowledged the need
for effective and proactive surveillance for activities such as trading
ahead and front-running in connection with the creation of its audit
trail. The Exchange represents that it currently conducts automated
surveillance for such activities and will incorporate a review of order
systemization as part of such surveillance. The Exchange also states
that it intends to implement supplementary surveillance and examination
programs related to the systemization of orders requirement promptly
after this requirement is instituted, which are designed to address,
among other things, trading ahead and front-running. The Commission
views effective surveillance as critical to the integrity of COATS and
expects that the Exchange will inform the Commission of any problems it
encounters in conducting effective surveillance.
[[Page 2439]]
VI. Conclusion
For all of the aforementioned reasons, 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.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\11\ that the proposed rule change (SR-CBOE-2004-77) is approved.
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\11\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-128 Filed 1-12-05; 8:45 am]
BILLING CODE 8010-01-P