Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 2 Thereto, Regarding Penny Price Improvement, 24329-24332 [E8-9645]

Download as PDF Federal Register / Vol. 73, No. 86 / Friday, May 2, 2008 / Notices including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments SECURITIES AND EXCHANGE COMMISSION [Release No. 34–57716; File No. SR–CBOE– 2007–39] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 2 Thereto, Regarding Penny Price Improvement Paper Comments April 25, 2008. • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–BSE–2008–28. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the BSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–BSE–2008–28 and should be submitted on or before May 23, 2008. mstockstill on PROD1PC66 with NOTICES • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–BSE–2008–28 on the subject line. I. Introduction On April 24, 2007, 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 its rules regarding price improvement for options not currently quoted in one-cent increments. The proposed rule change was published for comment in the Federal Register on May 14, 2007.3 The Commission received two comment letters in response to the proposed rule change.4 On March 25, 2008, the Exchange filed Amendment No. 1 to make certain modifications to the original rule filing. On March 28, 2008, the Exchange withdrew Amendment No. 1 to the proposed rule change and simultaneously filed Amendment No. 2 to the proposal. This order provides notice of the proposed rule change, as modified by Amendment No. 2, and approves the proposed rule change, as modified by Amendment No. 2, on an accelerated basis. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.19 Florence E. Harmon, Deputy Secretary. [FR Doc. E8–9695 Filed 5–1–08; 8:45 am] BILLING CODE 8010–01–P 19 17 CFR 200.30–3(a)(12). VerDate Aug<31>2005 17:17 May 01, 2008 Jkt 214001 II. Description of the Proposal Proposed CBOE Rule 6.13B will expand the ability of Exchange users to effect transactions in penny increments in classes and/or series trading on CBOE’s Hybrid System that are not currently quoting in penny increments.5 The Exchange will designate the classes/series eligible for this penny pricing, and the penny pricing will be 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 55724 (May 8, 2007), 72 FR 27156. 4 See letter to Nancy Morris, Secretary, Commission, from John C. Nagel, Director & Associate General Counsel, Citadel, dated June 4, 2007 (‘‘Citadel Letter’’) and letter to Nancy M. Morris, Secretary, Commission, from Michael J. Simon, Secretary, International Securities Exchange, LLC, dated June 1, 2007 (‘‘ISE Letter’’). 5 Amendment No. 2 clarified that the program will not apply to Hybrid 3.0 classes. 2 17 PO 00000 Frm 00119 Fmt 4703 Sfmt 4703 24329 available electronically and in open outcry. As proposed, all limit orders or quotes electronically sent to CBOE (regardless of sender origin type) can be priced in a one-cent increment. Specifically, an Exchange Market-Maker can provide the Exchange with indications to trade in one-cent increments that improve on the Market-Maker’s disseminated quotation. Such indications of interest will be firm for all interest received by the Exchange. Further, all other users can electronically submit orders priced in one-cent increments. The Exchange will round the limit price to the nearest permissible quoted increment for display purposes, but will maintain the one-cent increment limit price for trade execution and allocation purposes.6 To the extent there is trading interest from multiple sources at the same one-cent increment price, priority will be established in the same manner as priority at a standard quoting increment (i.e., normal allocation procedures will be used). The Exchange has represented that the system will not execute an order at a price that would cause a trade-through of another options exchange. With respect to open outcry, crowd members will be able to provide price improvement in one-cent increments over the Exchange’s Best Bid or Offer (‘‘BBO’’). The Exchange has represented that any resulting trade will not cause a trade-through of another options exchange. Further, prior to executing any order in open outcry in a one-cent increment, Exchange members will be required to electronically ‘‘sweep’’ any penny pricing interest on the book that may exist.7 The ‘‘sweep’’ is designed to ensure that better-priced orders resting in one-cent increments are executed prior to the open outcry transaction and 6 For example, if the CBOE market is 1–1.20 and an order is received to buy 10 contracts at 1.08, CBOE would disseminate a 1.05 bid for 10 contracts, and any subsequent sell market order received by the Exchange would trade at 1.08 for up to 10 contracts (after that, the quote would revert back to 1–1.20). Amendment No. 2 deletes a provision in the original filing that would have allowed the Exchange to append an indicator to the OPRA quote representing the existence of penny pricing. Additionally, in Amendment No. 2, the Exchange represents that the size and price of any penny pricing will not be displayed or made available to anyone (other than the size that is added to the Exchange’s BBO to reflect the size of rounded, penny-priced orders). 7 Open outcry penny pricing generally will be available in instances where a Floor Broker is attempting to cross an order pursuant to CBOE Rule 6.74, except it will not be available in those instances where: (i) A Floor Broker is attempting to cross orders during the opening rotation in open outcry (see CBOE Rule 6.74(c)); or (ii) a Floor Broker is utilizing the Exchange’s SizeQuote Mechanism (see CBOE Rule 6.74(f)). E:\FR\FM\02MYN1.SGM 02MYN1 24330 Federal Register / Vol. 73, No. 86 / Friday, May 2, 2008 / Notices that same priced orders receive executions consistent with existing rules governing priority of orders in the Hybrid book when trading with an order represented in open outcry.8 The Exchange represents that, in activated classes/series, all users would receive the benefit of penny pricing either through the electronic submission of contra-side orders or through a Floor Broker ‘‘sweeping’’ the electronic interest prior to executing an order in open outcry, and that all market participants will have the ability to rest orders in penny increments under the program.9 The Exchange clarified in Amendment No. 2 that, to the extent penny-priced orders are received that ‘‘cross’’ one another, the second order received by the system will receive the benefit of price improvement.10 The Exchange may determine the applicability of split-price priority under CBOE Rule 6.47 to transactions effected under proposed CBOE Rule 6.13B.11 The mechanics of split-price priority in those instances will be the same as the mechanics of split-price priority in five- and ten-cent increments. The restrictions on principal transactions and solicited orders contained in Interpretations and Policies .01 and .02 under CBOE Rules 6.45A and 6.45B will continue to apply to trading in penny increments, including the three second exposure requirements. III. Discussion and Commission Findings After careful review of the proposal, as modified by Amendment No. 2, and the comment letters thereto, the Commission finds that the proposal, as modified by Amendment No. 2, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.12 In particular, the 8 See CBOE Rules 6.45A(b) and 6.45B(b). Amendment No. 2. 10 For example, if an order is received to buy at 1.08 and then an order is received to sell at 1.06, those orders will trade at 1.08—the price of the resting order. 11 Amendment No. 2 provided that the ‘‘Exchange’’ will determine if the split price provisions of Rule 6.47 apply to open outcry Penny Pricing under proposed Rule 6.13B(b), rather than the ‘‘appropriate Procedure Committee,’’ as originally proposed. The Commission notes that this change is consistent with SR–CBOE–2008–02, where the Exchange is replacing references to the ‘‘appropriate Procedure Committee’’ with references to the ‘‘Exchange’’ throughout the Exchange’s rules. 12 In approving the 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). mstockstill on PROD1PC66 with NOTICES 9 See VerDate Aug<31>2005 17:17 May 01, 2008 Jkt 214001 Commission finds that the proposal is consistent with Section 6(b)(5) of the Act,13 which requires, among other things, 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. A. Quote Rule The Commission received two comment letters in response to the proposed rule change.14 One commenter argues that the proposal would violate Rule 602 of Regulation NMS (the ‘‘Quote Rule’’) because CBOE will not disseminate its best bid or offer.15 The Quote Rule requires a national securities exchange to collect, process, and make available to vendors the best bid, the best offer, and aggregate quotation sizes for each subject security that is communicated on any national securities exchange by a responsible broker or dealer. A ‘‘bid’’ or ‘‘offer’’ is defined as ‘‘the bid price or the offer price communicated by a member of a national securities exchange or member of a national securities association to any broker or dealer, or to any customer. * * *.’’ 16 Because the non-displayed price of a penny-priced order under Rule 6.13B is sent to the Exchange, but not communicated to anyone, it is not a bid, offer, or quotation. Thus, the Quote Rule does not require this information to be disseminated. The Quote Rule also requires responsible brokers and dealers to be firm for their quotes.17 Proposed CBOE Rule 6.13B(1), which allows Market Makers to provide the Exchange with indications of interest that are superior to their own quotations in increments no smaller than one-cent, explicitly requires such indications to be firm for all interest received by the Exchange. Further, as with any other electronic order entered into CBOE’s Hybrid System, an order priced in a penny increment and rounded for display must 13 15 U.S.C. 78f(b)(5). ISE Letter and Citadel Letter, supra note 4. Both commenters expressed concern about CBOE’s proposal to append an indicator showing when there is trading interest at a price that is better than the CBOE BBO. As noted above, Amendment No. 2 deleted this aspect of the proposal. Because CBOE has proposed to eliminate the indicator, this order does not make any findings with respect to the use of an indicator. 15 See ISE Letter, supra note 4, at 2–3. 16 17 CFR 242.600(a)(8). 17 17 CFR 242.602(b)(2) and (c)(3). 14 See PO 00000 Frm 00120 Fmt 4703 Sfmt 4703 be firm under CBOE’s rules and Rule 602 of Regulation NMS.18 B. Transparency, Quote Competition, and Internalization Both commenters expressed concern about the impact of penny pricing on market quality. In particular, one commenter believes such orders would undermine transparency in the options markets and that, because the prices and sizes of such orders would not be disseminated, it would be impossible for market participants to know the true best trading interest on CBOE.19 This commenter argues that penny pricing would discourage market participants from matching or establishing a new BBO because it would be too easy for non-displayed penny orders to jump ahead of displayed orders by a penny at opportune moments.20 Another commenter expresses a concern that no one will know the actual prices communicated to the exchange, which are prices at which transactions can take place.21 This commenter expressed concern that if other options markets adopted similar order types, there would be a trading environment in which there would be no way for customers to make intelligent pricing decisions or for broker-dealers to fulfill their best execution obligations.22 Additionally, one commenter expressed the concern that hidden penny pricing will enable CBOE members to internalize their order flow without the possibility of real order interaction. This commenter argues that the purpose of the requirement that a member display a customer order and wait three seconds before trading against the order is to provide other market participants with a chance to trade with the order before the member internalizes it. The commenter argues that, because only the member that enters the penny priced order will know the true price of the order, only that member can accurately run its pricing model to determine whether it is economically viable to trade against the 18 See electronic mail between Angelo Evangelou, Assistant General Counsel, CBOE, and Johnna B. Dumler, Special Counsel, Division of Trading and Markets, Commission, on April 22, 2008. 19 See Citadel Letter, supra note 4, at 2. This commenter further believes that the concerns raised by hidden penny pricing exceed those raised by the auction facilities on other options exchanges (including the Boston Options Exchange’s PIP and the International Securities Exchange’s PIM) because penny pricing would be a fundamental component of options trading on CBOE rather than a separate auction facility operating parallel to the regular options market. Id. 20 Id. 21 See ISE Letter, supra note 4, at 3. 22 Id. E:\FR\FM\02MYN1.SGM 02MYN1 Federal Register / Vol. 73, No. 86 / Friday, May 2, 2008 / Notices mstockstill on PROD1PC66 with NOTICES order. The commenter does not believe this presents a level playing field.23 Penny priced orders will allow market participants to submit an order priced between the minimum price variation (‘‘MPV’’) that will be rounded to the nearest MPV for display. Without the ability to price orders in pennies, market participants would not be able to submit orders priced between the MPV. Instead, orders, if submitted, would be priced (and displayed) at the MPV. Thus, CBOE’s proposal will not ‘‘take away’’ transparency that would already exist. The Commission recognizes that under CBOE’s proposal, orders will not be displayed at their actual penny price. CBOE’s proposal, however, will provide investors with the opportunity to trade at a better price than would otherwise be available. The Commission believes that this opportunity for investors to receive executions inside the disseminated best bid or offer could result in better executions for investors. In response to a commenter’s concern about broker-dealers’ ability to fulfill their best execution obligations,24 as just discussed, the Commission believes that penny-priced orders likely will provide another opportunity for investors to receive executions inside the disseminated best bid or offer for a security, which could result in better executions for investors. The availability of this price improvement feature will be a factor to be considered in a broker-dealer’s best execution routing determination, similar to other factors a broker-dealer must consider in connection with its best execution obligation.25 The Commission also believes that penny-priced orders will provide market participants with an additional tool to submit trading interest to the Exchange. The ability to price orders in penny increments may serve to increase liquidity to the extent that market participants find it to be useful and result in better executions. Further, market participants may be incented to compete by putting forth their best price—priced in a penny increment—to potentially match or better any other penny-priced orders resident in the System. This may result in more aggressive, rather than less aggressive, trading interest. Moreover, the Commission believes that the ability to ‘‘fish’’ inside the displayed quote, coupled with the restriction on the market participant that initially submitted the pennypriced order from trading with that order until after three seconds has elapsed, will provide a meaningful opportunity for interaction prior to the time at which the submitting market participant can interact with the order. The Commission also notes that a market participant that would like to trade against its customer order runs the risk that the customer order, if entered in a hidden penny increment, will execute against another penny-priced order resident in the system. The Commission does not believe that the availability and use of penny-priced orders will reduce the quality or competitiveness of the options markets by increasing the level of internalization in the options markets. C. Linkage Plan One commenter expresses concern as to how hidden penny-priced orders will interact with the requirements of the Plan for the Purpose of Creating and Operating an Intermarket Options Linkage (‘‘Linkage Plan’’).26 Specifically, the commenter expresses concern that, because the existence of hidden penny orders would not be disseminated to the market, they would not trigger the obligations of other market centers to ship linkage orders to the CBOE.27 Therefore, the commenter believes that away-markets will not be able to benefit from the better prices available on the CBOE, and undisplayed orders resting on the CBOE book would not be protected from trade-throughs by away markets.28 The Linkage Plan, and SRO rules adopted pursuant to the Plan, provide trade through protection to the national best bid and offer (‘‘NBBO’’).29 The NBBO will not include the nondisplayed price of a CBOE penny-priced order under Rule 6.13B. Therefore, the non-displayed price of a penny-priced order is not subject to trade through protection under the Linkage Plan. D. Penny Pilot Program One commenter believes that the proposal will circumvent the industry efforts with respect to the Penny Pilot Program (‘‘Pilot’’) by moving to hidden penny quoting without the benefit of careful study of the data yielded in the Pilot.30 Another commenter believes 26 See 23 Id. 27 See 24 See Citadel Letter, supra note 4, at 2. Citadel Letter, supra note 4, at 2. 28 Id. ISE Letter, supra note 4, at 2. Securities Exchange Act Release No. 57478 (March 12, 2008), 73 FR 14521 (March 18, 2008) (order approving SR–NASDAQ–2007–004 and SR– NASDAQ–2007–080), at notes 130 to 134 and accompanying text. 25 See VerDate Aug<31>2005 17:17 May 01, 2008 Jkt 214001 29 The national best bid or offer is defined in the Linkage Plan as the national best bid and offer in an options series calculated by a Participant. See Section 2(19) of the Linkage Plan. 30 See Citadel Letter, supra note 4, at 1 and 3. PO 00000 Frm 00121 Fmt 4703 Sfmt 4703 24331 that the appropriate way to address penny pricing in options is through the current Penny Pilot. This commenter recommends that the Commission consider any expansion of penny quoting only through review of the experience under the Pilot.31 As discussed above, the Commission finds that CBOE’s proposal, as amended, is consistent with the Act. The Commission has previously approved proposals by options exchanges, including CBOE, to trade in penny increments.32 The Commission does not believe itis appropriate to prohibit CBOE from implementing an initiative designed to allow further limited trading, not quoting, in penny increments. The Commission finds good cause to approve the proposed rule change, as modified by Amendment No. 2, prior to the thirtieth day after the date of publication of the notice of filing of the amended proposal in the Federal Register. The substance of the proposed rule change was published in the Federal Register on May 14, 2007 for full notice and comment.33 The Commission believes that the changes proposed in Amendment No. 2 respond to concerns raised in the commenter letters and strengthen and clarify aspects of the proposal. Further, the Commission recently approved a similar proposal by another exchange that allows orders to be entered in one-cent increments, but displayed at the standard MPV.34 For these reasons, the Commission finds good cause for approving the proposed rule change, as modified by Amendment No. 2, on an accelerated basis, pursuant to Section 19(b)(2) of the Act. IV. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning Amendment No. 2, including whether Amendment No. 2 is consistent with the Act. Comments may be submitted by any of the following methods: 31 See ISE Letter, supra note 4, at 3. e.g., Securities Exchange Act Release Nos. 54229 (July 27, 2006), 71 FR 44508 August 3, 2006) (File No. SR–CBOE–2005–90) (order approving CBOE’s Simple Auction Liaison system); 50819 (December 8, 2004), 69 FR 75093 (December 15, 2004) File No. SR–ISE–2003–06) (order approving ISE’s Price Improvement Mechanism); and 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004) (order approving BOX’s Price Improvement Period). 33 See supra note 3. 34 See Securities Exchange Act Release No. 57478 (March 12, 2008), 73 FR 14521 (March 18, 2008) (order approving SR–NASDAQ–2007–004 and SR– NASDAQ–2007–080). 32 See, E:\FR\FM\02MYN1.SGM 02MYN1 24332 Federal Register / Vol. 73, No. 86 / Friday, May 2, 2008 / Notices Electronic Comments • Use the Commission’s Internet comment form http://www.sec.gov/ rules/sro.shtml; or • Send an e-mail to rulecomments@sec.gov. Please include File No. SR–CBOE–2007–39 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File No. SR–CBOE–2007–39. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site at http://www.sec.gov/ rules/sro.shtml. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File No. SR–CBOE–2007–39 and should be submitted on or before May 23, 2008. mstockstill on PROD1PC66 with NOTICES V. Conclusion For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.36 Florence E. Harmon, Deputy Secretary. [FR Doc. E8–9645 Filed 5–1–08; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–57720; File No. SR–FINRA– 2008–013] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change Relating To Amending NASD Rule 2220 (Options Communications With the Public) April 25, 2008. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on April 7, 2008, Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) (f/k/a National Association of Securities Dealers, Inc. (‘‘NASD’’)) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by FINRA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change FINRA is proposing to amend NASD Rule 2220 (Options Communications with the Public), to better address current needs for regulating options communications practices and promote consistency across the options communications rules of other selfregulatory organizations (‘‘SROs’’). Below is the text of the proposed rule change. Proposed new language is in italics; proposed deletions are in brackets. * * * * * 2200. COMMUNICATIONS WITH CUSTOMERS AND THE PUBLIC * It is therefore ordered, pursuant to Section 19(b)(2) of the Act,35 that the proposed rule change (SR–CBOE–2007– 39), as modified by Amendment No. 2, be, and hereby is, approved on an accelerated basis. * * * * 2220. Options Communications [with the Public] (a) Definitions For purposes of this Rule and any interpretation thereof: 36 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 35 15 U.S.C. 78s(b)(2). VerDate Aug<31>2005 17:17 May 01, 2008 Jkt 214001 PO 00000 Frm 00122 Fmt 4703 Sfmt 4703 (1) ‘‘Options communications’’ consist of: (A) ‘‘Advertisement.’’ Any ‘‘Advertisement’’ as defined in Rule 2210(a)(1) concerning options. [shall include any material that reaches a mass audience through public media such as newspapers, periodicals, magazines, radio, television, telephone recording, motion picture, audio or video device, telecommunications device, billboards, signs or through written sales communications to customers or the public that are not required to be accompanied or preceded by one or more current options disclosure documents.] [(2) ‘‘Educational material’’ shall include any explanatory material distributed or made generally available to customers or the public that is limited to information describing the general nature of the standardized options markets or one or more strategies.] [(3)] (B) ‘‘Sales literature.’’ Any ‘‘Sales Literature’’ as defined in Rule 2210(a)(2) concerning options including worksheet templates. [shall include any written communication (not defined as an ‘‘advertisement’’ or as ‘‘educational material’’) distributed or made generally available to customers or the public that contains any analysis, performance report, projection or recommendation with respect to options, underlying securities or market conditions, any standard forms of worksheets, or any seminar text which pertains to options and which is communicated to customers or the public at seminars, lectures or similar such events.] (C) ‘‘Correspondence.’’ Any ‘‘Correspondence’’ as defined in Rule 2211(a)(1) concerning options. (D) ‘‘Institutional sales material.’’ Any ‘‘Institutional Sales Material’’ as defined in Rule 2211(a)(2) concerning options. (E) ‘‘Public appearance.’’ Any participation in a seminar, forum (including an interactive electronic forum), radio, television or print media interview, or other public speaking activity, or the writing of a print media article, concerning options. (F) ‘‘Independently prepared reprint.’’ Any ‘‘Independently Prepared Reprint’’ as defined in Rule 2210(a)(6)(A) concerning options. (2) ‘‘Existing retail customer’’ as is defined in Rule 2211(a)(4). (3) ‘‘Standardized option’’ means any option contract issued, or subject to issuance, by The Options Clearing Corporation, that has standardized terms for the strike price, expiration date, and amount of the underlying security, and is traded on a national E:\FR\FM\02MYN1.SGM 02MYN1

Agencies

[Federal Register Volume 73, Number 86 (Friday, May 2, 2008)]
[Notices]
[Pages 24329-24332]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-9645]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57716; File No. SR-CBOE-2007-39]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Amendment No. 2 and Order Granting 
Accelerated Approval of a Proposed Rule Change, as Modified by 
Amendment No. 2 Thereto, Regarding Penny Price Improvement

April 25, 2008.

I. Introduction

    On April 24, 2007, 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 its rules regarding 
price improvement for options not currently quoted in one-cent 
increments. The proposed rule change was published for comment in the 
Federal Register on May 14, 2007.\3\ The Commission received two 
comment letters in response to the proposed rule change.\4\ On March 
25, 2008, the Exchange filed Amendment No. 1 to make certain 
modifications to the original rule filing. On March 28, 2008, the 
Exchange withdrew Amendment No. 1 to the proposed rule change and 
simultaneously filed Amendment No. 2 to the proposal. This order 
provides notice of the proposed rule change, as modified by Amendment 
No. 2, and approves the proposed rule change, as modified by Amendment 
No. 2, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 55724 (May 8, 2007), 
72 FR 27156.
    \4\ See letter to Nancy Morris, Secretary, Commission, from John 
C. Nagel, Director & Associate General Counsel, Citadel, dated June 
4, 2007 (``Citadel Letter'') and letter to Nancy M. Morris, 
Secretary, Commission, from Michael J. Simon, Secretary, 
International Securities Exchange, LLC, dated June 1, 2007 (``ISE 
Letter'').
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II. Description of the Proposal

    Proposed CBOE Rule 6.13B will expand the ability of Exchange users 
to effect transactions in penny increments in classes and/or series 
trading on CBOE's Hybrid System that are not currently quoting in penny 
increments.\5\ The Exchange will designate the classes/series eligible 
for this penny pricing, and the penny pricing will be available 
electronically and in open outcry.
---------------------------------------------------------------------------

    \5\ Amendment No. 2 clarified that the program will not apply to 
Hybrid 3.0 classes.
---------------------------------------------------------------------------

    As proposed, all limit orders or quotes electronically sent to CBOE 
(regardless of sender origin type) can be priced in a one-cent 
increment. Specifically, an Exchange Market-Maker can provide the 
Exchange with indications to trade in one-cent increments that improve 
on the Market-Maker's disseminated quotation. Such indications of 
interest will be firm for all interest received by the Exchange. 
Further, all other users can electronically submit orders priced in 
one-cent increments. The Exchange will round the limit price to the 
nearest permissible quoted increment for display purposes, but will 
maintain the one-cent increment limit price for trade execution and 
allocation purposes.\6\ To the extent there is trading interest from 
multiple sources at the same one-cent increment price, priority will be 
established in the same manner as priority at a standard quoting 
increment (i.e., normal allocation procedures will be used). The 
Exchange has represented that the system will not execute an order at a 
price that would cause a trade-through of another options exchange.
---------------------------------------------------------------------------

    \6\ For example, if the CBOE market is 1-1.20 and an order is 
received to buy 10 contracts at 1.08, CBOE would disseminate a 1.05 
bid for 10 contracts, and any subsequent sell market order received 
by the Exchange would trade at 1.08 for up to 10 contracts (after 
that, the quote would revert back to 1-1.20).
    Amendment No. 2 deletes a provision in the original filing that 
would have allowed the Exchange to append an indicator to the OPRA 
quote representing the existence of penny pricing. Additionally, in 
Amendment No. 2, the Exchange represents that the size and price of 
any penny pricing will not be displayed or made available to anyone 
(other than the size that is added to the Exchange's BBO to reflect 
the size of rounded, penny-priced orders).
---------------------------------------------------------------------------

    With respect to open outcry, crowd members will be able to provide 
price improvement in one-cent increments over the Exchange's Best Bid 
or Offer (``BBO''). The Exchange has represented that any resulting 
trade will not cause a trade-through of another options exchange. 
Further, prior to executing any order in open outcry in a one-cent 
increment, Exchange members will be required to electronically 
``sweep'' any penny pricing interest on the book that may exist.\7\ The 
``sweep'' is designed to ensure that better-priced orders resting in 
one-cent increments are executed prior to the open outcry transaction 
and

[[Page 24330]]

that same priced orders receive executions consistent with existing 
rules governing priority of orders in the Hybrid book when trading with 
an order represented in open outcry.\8\
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    \7\ Open outcry penny pricing generally will be available in 
instances where a Floor Broker is attempting to cross an order 
pursuant to CBOE Rule 6.74, except it will not be available in those 
instances where: (i) A Floor Broker is attempting to cross orders 
during the opening rotation in open outcry (see CBOE Rule 6.74(c)); 
or (ii) a Floor Broker is utilizing the Exchange's SizeQuote 
Mechanism (see CBOE Rule 6.74(f)).
    \8\ See CBOE Rules 6.45A(b) and 6.45B(b).
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    The Exchange represents that, in activated classes/series, all 
users would receive the benefit of penny pricing either through the 
electronic submission of contra-side orders or through a Floor Broker 
``sweeping'' the electronic interest prior to executing an order in 
open outcry, and that all market participants will have the ability to 
rest orders in penny increments under the program.\9\
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    \9\ See Amendment No. 2.
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    The Exchange clarified in Amendment No. 2 that, to the extent 
penny-priced orders are received that ``cross'' one another, the second 
order received by the system will receive the benefit of price 
improvement.\10\ The Exchange may determine the applicability of split-
price priority under CBOE Rule 6.47 to transactions effected under 
proposed CBOE Rule 6.13B.\11\ The mechanics of split-price priority in 
those instances will be the same as the mechanics of split-price 
priority in five- and ten-cent increments.
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    \10\ For example, if an order is received to buy at 1.08 and 
then an order is received to sell at 1.06, those orders will trade 
at 1.08--the price of the resting order.
    \11\ Amendment No. 2 provided that the ``Exchange'' will 
determine if the split price provisions of Rule 6.47 apply to open 
outcry Penny Pricing under proposed Rule 6.13B(b), rather than the 
``appropriate Procedure Committee,'' as originally proposed. The 
Commission notes that this change is consistent with SR-CBOE-2008-
02, where the Exchange is replacing references to the ``appropriate 
Procedure Committee'' with references to the ``Exchange'' throughout 
the Exchange's rules.
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    The restrictions on principal transactions and solicited orders 
contained in Interpretations and Policies .01 and .02 under CBOE Rules 
6.45A and 6.45B will continue to apply to trading in penny increments, 
including the three second exposure requirements.

III. Discussion and Commission Findings

    After careful review of the proposal, as modified by Amendment No. 
2, and the comment letters thereto, the Commission finds that the 
proposal, as modified by Amendment No. 2, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\12\ In particular, the 
Commission finds that the proposal is consistent with Section 6(b)(5) 
of the Act,\13\ which requires, among other things, 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.
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    \12\ In approving the 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).
    \13\ 15 U.S.C. 78f(b)(5).
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A. Quote Rule

    The Commission received two comment letters in response to the 
proposed rule change.\14\ One commenter argues that the proposal would 
violate Rule 602 of Regulation NMS (the ``Quote Rule'') because CBOE 
will not disseminate its best bid or offer.\15\ The Quote Rule requires 
a national securities exchange to collect, process, and make available 
to vendors the best bid, the best offer, and aggregate quotation sizes 
for each subject security that is communicated on any national 
securities exchange by a responsible broker or dealer. A ``bid'' or 
``offer'' is defined as ``the bid price or the offer price communicated 
by a member of a national securities exchange or member of a national 
securities association to any broker or dealer, or to any customer. * * 
*.'' \16\ Because the non-displayed price of a penny-priced order under 
Rule 6.13B is sent to the Exchange, but not communicated to anyone, it 
is not a bid, offer, or quotation. Thus, the Quote Rule does not 
require this information to be disseminated.
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    \14\ See ISE Letter and Citadel Letter, supra note 4. Both 
commenters expressed concern about CBOE's proposal to append an 
indicator showing when there is trading interest at a price that is 
better than the CBOE BBO. As noted above, Amendment No. 2 deleted 
this aspect of the proposal. Because CBOE has proposed to eliminate 
the indicator, this order does not make any findings with respect to 
the use of an indicator.
    \15\ See ISE Letter, supra note 4, at 2-3.
    \16\ 17 CFR 242.600(a)(8).
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    The Quote Rule also requires responsible brokers and dealers to be 
firm for their quotes.\17\ Proposed CBOE Rule 6.13B(1), which allows 
Market Makers to provide the Exchange with indications of interest that 
are superior to their own quotations in increments no smaller than one-
cent, explicitly requires such indications to be firm for all interest 
received by the Exchange. Further, as with any other electronic order 
entered into CBOE's Hybrid System, an order priced in a penny increment 
and rounded for display must be firm under CBOE's rules and Rule 602 of 
Regulation NMS.\18\
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    \17\ 17 CFR 242.602(b)(2) and (c)(3).
    \18\ See electronic mail between Angelo Evangelou, Assistant 
General Counsel, CBOE, and Johnna B. Dumler, Special Counsel, 
Division of Trading and Markets, Commission, on April 22, 2008.
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B. Transparency, Quote Competition, and Internalization

    Both commenters expressed concern about the impact of penny pricing 
on market quality. In particular, one commenter believes such orders 
would undermine transparency in the options markets and that, because 
the prices and sizes of such orders would not be disseminated, it would 
be impossible for market participants to know the true best trading 
interest on CBOE.\19\ This commenter argues that penny pricing would 
discourage market participants from matching or establishing a new BBO 
because it would be too easy for non-displayed penny orders to jump 
ahead of displayed orders by a penny at opportune moments.\20\ Another 
commenter expresses a concern that no one will know the actual prices 
communicated to the exchange, which are prices at which transactions 
can take place.\21\ This commenter expressed concern that if other 
options markets adopted similar order types, there would be a trading 
environment in which there would be no way for customers to make 
intelligent pricing decisions or for broker-dealers to fulfill their 
best execution obligations.\22\
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    \19\ See Citadel Letter, supra note 4, at 2. This commenter 
further believes that the concerns raised by hidden penny pricing 
exceed those raised by the auction facilities on other options 
exchanges (including the Boston Options Exchange's PIP and the 
International Securities Exchange's PIM) because penny pricing would 
be a fundamental component of options trading on CBOE rather than a 
separate auction facility operating parallel to the regular options 
market. Id.
    \20\ Id.
    \21\ See ISE Letter, supra note 4, at 3.
    \22\ Id.
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    Additionally, one commenter expressed the concern that hidden penny 
pricing will enable CBOE members to internalize their order flow 
without the possibility of real order interaction. This commenter 
argues that the purpose of the requirement that a member display a 
customer order and wait three seconds before trading against the order 
is to provide other market participants with a chance to trade with the 
order before the member internalizes it. The commenter argues that, 
because only the member that enters the penny priced order will know 
the true price of the order, only that member can accurately run its 
pricing model to determine whether it is economically viable to trade 
against the

[[Page 24331]]

order. The commenter does not believe this presents a level playing 
field.\23\
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    \23\ Id.
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    Penny priced orders will allow market participants to submit an 
order priced between the minimum price variation (``MPV'') that will be 
rounded to the nearest MPV for display. Without the ability to price 
orders in pennies, market participants would not be able to submit 
orders priced between the MPV. Instead, orders, if submitted, would be 
priced (and displayed) at the MPV. Thus, CBOE's proposal will not 
``take away'' transparency that would already exist. The Commission 
recognizes that under CBOE's proposal, orders will not be displayed at 
their actual penny price. CBOE's proposal, however, will provide 
investors with the opportunity to trade at a better price than would 
otherwise be available. The Commission believes that this opportunity 
for investors to receive executions inside the disseminated best bid or 
offer could result in better executions for investors.
    In response to a commenter's concern about broker-dealers' ability 
to fulfill their best execution obligations,\24\ as just discussed, the 
Commission believes that penny-priced orders likely will provide 
another opportunity for investors to receive executions inside the 
disseminated best bid or offer for a security, which could result in 
better executions for investors. The availability of this price 
improvement feature will be a factor to be considered in a broker-
dealer's best execution routing determination, similar to other factors 
a broker-dealer must consider in connection with its best execution 
obligation.\25\
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    \24\ See ISE Letter, supra note 4, at 2.
    \25\ See Securities Exchange Act Release No. 57478 (March 12, 
2008), 73 FR 14521 (March 18, 2008) (order approving SR-NASDAQ-2007-
004 and SR-NASDAQ-2007-080), at notes 130 to 134 and accompanying 
text.
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    The Commission also believes that penny-priced orders will provide 
market participants with an additional tool to submit trading interest 
to the Exchange. The ability to price orders in penny increments may 
serve to increase liquidity to the extent that market participants find 
it to be useful and result in better executions. Further, market 
participants may be incented to compete by putting forth their best 
price--priced in a penny increment--to potentially match or better any 
other penny-priced orders resident in the System. This may result in 
more aggressive, rather than less aggressive, trading interest.
    Moreover, the Commission believes that the ability to ``fish'' 
inside the displayed quote, coupled with the restriction on the market 
participant that initially submitted the penny-priced order from 
trading with that order until after three seconds has elapsed, will 
provide a meaningful opportunity for interaction prior to the time at 
which the submitting market participant can interact with the order. 
The Commission also notes that a market participant that would like to 
trade against its customer order runs the risk that the customer order, 
if entered in a hidden penny increment, will execute against another 
penny-priced order resident in the system. The Commission does not 
believe that the availability and use of penny-priced orders will 
reduce the quality or competitiveness of the options markets by 
increasing the level of internalization in the options markets.

C. Linkage Plan

    One commenter expresses concern as to how hidden penny-priced 
orders will interact with the requirements of the Plan for the Purpose 
of Creating and Operating an Intermarket Options Linkage (``Linkage 
Plan'').\26\ Specifically, the commenter expresses concern that, 
because the existence of hidden penny orders would not be disseminated 
to the market, they would not trigger the obligations of other market 
centers to ship linkage orders to the CBOE.\27\ Therefore, the 
commenter believes that away-markets will not be able to benefit from 
the better prices available on the CBOE, and undisplayed orders resting 
on the CBOE book would not be protected from trade-throughs by away 
markets.\28\
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    \26\ See Citadel Letter, supra note 4, at 2.
    \27\ See Citadel Letter, supra note 4, at 2.
    \28\ Id.
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    The Linkage Plan, and SRO rules adopted pursuant to the Plan, 
provide trade through protection to the national best bid and offer 
(``NBBO'').\29\ The NBBO will not include the non-displayed price of a 
CBOE penny-priced order under Rule 6.13B. Therefore, the non-displayed 
price of a penny-priced order is not subject to trade through 
protection under the Linkage Plan.
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    \29\ The national best bid or offer is defined in the Linkage 
Plan as the national best bid and offer in an options series 
calculated by a Participant. See Section 2(19) of the Linkage Plan.
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D. Penny Pilot Program

    One commenter believes that the proposal will circumvent the 
industry efforts with respect to the Penny Pilot Program (``Pilot'') by 
moving to hidden penny quoting without the benefit of careful study of 
the data yielded in the Pilot.\30\ Another commenter believes that the 
appropriate way to address penny pricing in options is through the 
current Penny Pilot. This commenter recommends that the Commission 
consider any expansion of penny quoting only through review of the 
experience under the Pilot.\31\ As discussed above, the Commission 
finds that CBOE's proposal, as amended, is consistent with the Act. The 
Commission has previously approved proposals by options exchanges, 
including CBOE, to trade in penny increments.\32\ The Commission does 
not believe itis appropriate to prohibit CBOE from implementing an 
initiative designed to allow further limited trading, not quoting, in 
penny increments.
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    \30\ See Citadel Letter, supra note 4, at 1 and 3.
    \31\ See ISE Letter, supra note 4, at 3.
    \32\ See, e.g., Securities Exchange Act Release Nos. 54229 (July 
27, 2006), 71 FR 44508 August 3, 2006) (File No. SR-CBOE-2005-90) 
(order approving CBOE's Simple Auction Liaison system); 50819 
(December 8, 2004), 69 FR 75093 (December 15, 2004) File No. SR-ISE-
2003-06) (order approving ISE's Price Improvement Mechanism); and 
49068 (January 13, 2004), 69 FR 2775 (January 20, 2004) (order 
approving BOX's Price Improvement Period).
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    The Commission finds good cause to approve the proposed rule 
change, as modified by Amendment No. 2, prior to the thirtieth day 
after the date of publication of the notice of filing of the amended 
proposal in the Federal Register. The substance of the proposed rule 
change was published in the Federal Register on May 14, 2007 for full 
notice and comment.\33\ The Commission believes that the changes 
proposed in Amendment No. 2 respond to concerns raised in the commenter 
letters and strengthen and clarify aspects of the proposal. Further, 
the Commission recently approved a similar proposal by another exchange 
that allows orders to be entered in one-cent increments, but displayed 
at the standard MPV.\34\ For these reasons, the Commission finds good 
cause for approving the proposed rule change, as modified by Amendment 
No. 2, on an accelerated basis, pursuant to Section 19(b)(2) of the 
Act.
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    \33\ See supra note 3.
    \34\ See Securities Exchange Act Release No. 57478 (March 12, 
2008), 73 FR 14521 (March 18, 2008) (order approving SR-NASDAQ-2007-
004 and SR-NASDAQ-2007-080).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

[[Page 24332]]

Electronic Comments

     Use the Commission's Internet comment form http://
www.sec.gov/rules/sro.shtml; or
     Send an e-mail to rule-comments@sec.gov. Please include 
File No. SR-CBOE-2007-39 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
All submissions should refer to File No. SR-CBOE-2007-39. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site at http://www.sec.gov/rules/
sro.shtml. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File No. SR-CBOE-2007-39 and should be 
submitted on or before May 23, 2008.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\35\ that the proposed rule change (SR-CBOE-2007-39), as modified 
by Amendment No. 2, be, and hereby is, approved on an accelerated 
basis.
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    \35\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\36\
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    \36\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-9645 Filed 5-1-08; 8:45 am]
BILLING CODE 8010-01-P