[Federal Register: February 10, 2006 (Volume 71, Number 28)]
[Notices]
[Page 7089-7095]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10fe06-127]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-53222; File No. SR-CBOE-2005-60]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Granting Approval of Proposed Rule Change and
Amendment No. 1 Thereto and Notice of Filing and Order Granting
Accelerated Approval to Amendment No. 2 to the Proposed Rule Change
Relating to an Automated Improvement Mechanism
February 3, 2006.
I. Introduction
On August 5, 2005, 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 adopt an electronic price
improvement mechanism. On September 2, 2005, the Exchange filed
Amendment No. 1 to the proposed rule change.\3\ The proposed rule
change, as amended, was published for comment in the Federal Register
on October 18, 2005.\4\ On October 12, 2005, the Exchange filed
Amendment No. 2 to the proposed rule change.\5\ The Commission received
two comment letters with respect to the amended proposal,\6\ and on
December 2, 2005, the Exchange filed its response to the comment
letters.\7\ This order approves the proposed rule change as amended by
Amendment No. 1, notices and solicits comments on Amendment No. 2, and
grants accelerated approval to Amendment No. 2.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Amendment No. 1 superseded and replaced the proposed rule
filing in its entirety.
\4\ See Securities Exchange Act Release No. 52577 (October 7,
2005), 70 FR 60586.
\5\ In Amendment No. 2, the CBOE proposes to amend proposed CBOE
Rule 6.74A(b)(1)(E) so that members, not floor brokers, may submit
RFR responses on behalf of customer orders resting at the top of the
Exchange book. Amendment No. 2 also would amend proposed CBOE Rule
6.74A.06 with respect to information that the Exchange may provide
to the Commission regarding a pilot program that would end on July
18, 2006.
\6\ See letters to Jonathan G. Katz, Secretary, Commission, from
Matthew B. Hinerfeld, Managing Director & Deputy General Counsel,
Citadel Investment Group, LLC on behalf of Citadel Derivatives Group
LLC (``Citadel''), dated November 8, 2005 (``Citadel Letter'') and
from Annah Y. Kim, Chief Regulatory Officer, Boston Options Exchange
Regulation (``BOX''), dated November 10, 2005 (``BOX Letter'').
Citadel also commented on the American Stock Exchange LLC's
(``Amex'') proposal to implement the Amex New Trading Environment
Price Improvement Auction (``PIA'') (File No. SR-Amex-2004-107).
This Order and Notice does not address the Amex proposal. A
discussion of the comment letters is provided in section III below.
\7\ See letter from Angelo Evangelou, Managing Senior Attorney,
Legal Division, CBOE, to Jonathan G. Katz, Secretary, Commission,
dated December 2, 2005 (``Response Letter'').
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II. Description of the Proposal
The Exchange proposes to establish an electronic auction system
(Automated Improvement Mechanism or ``AIM''), which would expose
certain orders electronically in an auction to provide such orders with
the opportunity to receive an execution at an improved price.
The AIM auction is available only for orders that an Exchange
member represents as an agent (``Agency Order''). To initiate the
electronic auction, the Exchange member (``Initiating Member'') who
represents an Agency Order would submit the Agency Order and a second
order for the same size as the Agency Order (on the opposite side of
the Agency Order) into the auction. If the Agency Order is for less
than 50 contracts, the Initiating Member must stop the entire Agency
Order as principal or with a solicited order at the better of (A) the
national best bid or offer (``NBBO'') price improved by one minimum
price improvement increment, which increment shall be determined by the
Exchange but may not be smaller than one cent or (B) the Agency Order's
limit price (if the Agency Order is a limit order). If the Agency Order
is for 50 contracts or more, the Initiating Member must stop the entire
Agency Order as principal or with a solicited order at the better of
the NBBO or the Agency Order's limit price (if the Agency Order is a
limit order). Thereafter, other Exchange participants would compete
with the Initiating Member's second order to execute against the Agency
Order. The second order submitted by the Initiating Member could be an
order for the principal account of the Initiating Member (``principal
order'') or an order solicited by the Initiating Member to trade with
another member or a non-member customer or broker-dealer (``solicited
order'').\8\ Under the proposal, the Initiating Member may enter the
second order in one of two formats: (1) At a specified single price or
(2) with a non-price specific commitment to match as principal the
price and size of all auction responses (``Auto-Match''). If the
Initiating Member enters the second order with Auto-Match, then the
Initiating Member would not have control over the prices at which it
receives an allocation at the conclusion of the auction. After the
commencement of an auction, the Initiating Member would not be able to
cancel the auction.
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\8\ See CBOE Rule 6.9 for a definition of solicited order.
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Upon receipt of an Agency Order and the second order, the Exchange
would commence the auction by issuing a request for responses (``RFR'')
detailing the side and size of the Agency Order.\9\ The auction would
last for a random time period, from 3 seconds to 5 seconds, determined
by the Exchange's system. During such time period, any Exchange market
maker with an appointment in the options class may submit RFR responses
(including multiple responses). In addition, any Exchange member acting
as an agent for customer orders resting at the top of the Exchange's
book opposite the Agency Order, may submit RFR responses on behalf of
such customer orders (such RFR responses may not exceed the size of the
customer orders).\10\ The RFR responses must specify price and size,
and may not cross the Exchange's quote on the opposite side of the
market as the Agency Order. All RFR responses would be ``blind,'' i.e.,
the RFR responses would not be visible to any other participants in the
auction. Under the proposal, market makers may modify or cancel RFR
responses prior to the conclusion of the auction. The Exchange may set
the RFR response minimum price increment at no less than one cent.
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\9\ The Exchange would send each RFR to all members electing to
receive RFRs (i.e., those members who have established the necessary
systems connectivity to receive RFRs). Thus, an Exchange member's
election to receive RFRs would not be on an auction-by-auction
basis.
\10\ See Amendment No. 2, supra note 5.
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Normally, the auction would end at the conclusion of the random 3
seconds
[[Page 7090]]
to 5 seconds time period. However, under the proposal, the following
events could prematurely end the auction: (1) If the Exchange Hybrid
System receives an unrelated order in the same series as the Agency
Order and such unrelated order is marketable against the Exchange's
disseminated quote (when the quote is the NBBO) or the RFR responses;
(2) if the Exchange Hybrid System receives an unrelated non-marketable
limit order in the same series and on the opposite side of the market
as the Agency Order that improves any RFR response; (3) any time an RFR
response matches the Exchange's disseminated quote on the opposite side
of the market; or (4) pursuant to a pilot program that would expire on
July 18, 2006, any time there is a market maker to market maker quote
lock on the Exchange in accordance with CBOE Rule 6.45A(d).\11\
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\11\ In connection with this pilot program, pursuant to proposed
CBOE Rule 6.74A.06, the Exchange would provide the Commission data
(on a confidential basis) regarding the frequency of early
terminations of the auction, and also the frequency of early
terminations pursuant to this provision that result in favorable
pricing for the Agency Order. See Amendment No. 2, supra note 5.
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At the conclusion of the auction, the Agency Order would be
allocated in accordance with applicable matching algorithm rules in
effect for such option class subject to the following provisions.
First, no participation entitlement would apply with respect to an AIM
execution. Second, public customer orders in the Exchange book would
have priority. Third, if the Exchange received an unrelated market
order or marketable limit order on the opposite side of the Agency
Order which prematurely ended the auction, such unrelated order would
trade against the Agency Order at the midpoint of the best RFR response
and the NBBO on the other side of the market (rounded towards the
disseminated quote when necessary).\12\ Fourth, if the Exchange
received an unrelated non-marketable limit order on the opposite side
of the Agency Order which prematurely ended the auction, such unrelated
limit order would trade against the Agency Order at the midpoint of the
best RFR response and the unrelated order's limit price (rounded
towards the unrelated order's limit price when necessary).\13\ Fifth,
if the best price equals the Initiating Member's single-price
submission, the Initiating Member's single-price submission would be
allocated the greater of one contract or 40% of the order. However, if
only one market maker matches the Initiating Member's single price
submission, then the Initiating Member would be allocated 50% of the
order. Sixth, if the Initiating Member selected Auto-Match for the
second order, then the Initiating Member would be allocated its full
size at each price point until a price point is reached where the
balance of the order can be fully executed. At such price point, the
Initiating Member would be allocated the greater of one contract or 40%
of the remainder of the order. Seventh, if the auction does not result
in price improvement over the Exchange's disseminated price at the
commencement of the auction, resting unchanged quotes or orders that
were disseminated at the best price before the auction started would
have priority, after any public customer order priority and the
Initiating Member's priority (40%) have been satisfied. Any unexecuted
balance on the Agency Order would be allocated to RFR responses
pursuant to the matching algorithm except that the RFR responses would
be capped to the size of the unexecuted balance and the Initiating
Member may not participate on any such balance unless the Agency Order
would otherwise go unfilled. Finally, if the final auction price locks
a customer order on the book on the same side as the Agency Order, then
unless there is sufficient size in the RFR responses to execute both
the Agency Order and the booked customer order (in which case they
would both execute at the final auction price), the Agency Order would
execute against the RFR responses at one minimum RFR response increment
worse than the final Auction price against the auction participants
that submitted the final auction price, and any balance would trade
against the customer order in the book at such order's limit price.
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\12\ For example, if an auction is underway for an Agency Order
to buy and the CBOE quote (as well as the NBBO) is 1-1.15, with the
RFRs at 1.12 and an unrelated market order to sell is received by
the Exchange, the unrelated order would execute against the Agency
Order at 1.06 (the midpoint of the best RFRs and the NBBO on the
other side of the market, i.e., the best bid).
\13\ For example, using the same scenario as above except the
unrelated order is a non-marketable limit order to sell at 1.10, the
unrelated order would execute against the Agency Order at 1.11 (the
midpoint of the best RFRs (1.12) and the unrelated order's limit
price (1.10)).
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If an unexecuted balance remains on the RFR responses after the
Agency Order has been executed and such balance could trade against any
unrelated order(s) that caused the auction to conclude, then the RFR
response balance would trade against the unrelated order(s).
The CBOE proposes several interpretations and policies to proposed
CBOE Rule 6.74A. First, an Initiating Member would be permitted to use
the auction only when there is a genuine intention to execute a bona
fide transaction. Second, a pattern or practice of submitting unrelated
orders that cause an auction to prematurely conclude would be deemed
conduct inconsistent with just and equitable principles of trade and a
violation of CBOE Rule 4.1 and other Exchange Rules. Third, initially,
and during a Pilot Period, which would end on July 18, 2006, there
would be no minimum size requirement for orders to be eligible for the
auction. During this Pilot Period, the Exchange would submit on a
confidential basis certain data, periodically as required by the
Commission, to provide supporting evidence that, among other things,
there is meaningful competition for all size orders and that there is
an active and liquid market functioning on the Exchange outside of the
auction mechanism. Fourth, any solicited orders submitted by the
Initiating Member to trade against the Agency Order would not be
permitted to be for the account of a market maker assigned to the
option class. Fifth, the Exchange would communicate any Exchange
determinations pursuant to the proposed rule such as eligible classes,
order size parameters, and the minimum price increment for RFR
responses, in a Regulatory Circular. Finally, proposed CBOE Rule
6.74A(b)(2)(E), which would end the auction due to a lock on the CBOE
market, would operate as a pilot program until July 18, 2006.
III. Discussion and Commission Findings
After careful review of the amended proposal and consideration of
the comment letters and the Response Letter, the Commission finds that
the proposed rule change, as amended, to establish rules for the
implementation of the AIM auction, is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange \14\ and, in particular, the requirements
of section 6 of the Act.\15\ Specifically, as discussed in detail
below, the Commission finds that the proposal is consistent with
section 6(b)(5) of the Act,\16\ which requires, in part, that the rules
of an exchange be designed to prevent fraudulent and manipulative acts
and practices, to promote just and equitable principles of trade, to
foster cooperation
[[Page 7091]]
and coordination with persons engaged in regulating, clearing,
settling, and processing information with respect to, and facilitating
transactions in securities, 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. Section
6(b)(5) of the Act \17\ also requires that the rules of an exchange not
be designed to permit unfair discrimination among customers, issuers,
brokers, or dealers.
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\14\ In approving this proposal, the Commission has considered
the proposed rule change's impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
\15\ 15 U.S.C. 78f.
\16\ 15 U.S.C. 78f(b)(5).
\17\ Id.
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The Commission believes that approving the Exchange's proposal to
establish the AIM should confer benefits to the public by increasing
competition between and among the options exchanges, resulting in
better prices and executions for investors. The Commission also
believes that access to the AIM auction for those who may wish to
compete for an Agency Order should be sufficient to provide
opportunities for a meaningful, competitive auction. The Commission
therefore finds that for the reasons discussed below, the Exchange's
proposal is consistent with the Act.
A. Internalization
In its comment letter, Citadel asks the Commission to reject the
proposal because the AIM auction and other similar auctions encourage
internalization, which Citadel believes would hinder price discovery
and harm investors with worse prices.\18\ Citadel states that these
auctions harm the options markets and investors by hindering price
discovery, discouraging aggressive quoting, eliminating substantial
price improvement by diminishing the ability of customers to interact
with one another; and undercutting customer limit orders.\19\
Therefore, Citadel urges the Commission to reevaluate the auctions
currently in operation \20\ and determine whether such auctions should
operate.\21\
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\18\ See Citadel Letter, supra note 6, at p.1.
\19\ Id. at pp. 3-4.
\20\ Id. at p. 6. The Boston Options Exchange (``BOX''), a
trading facility of the Boston Stock Exchange, Incorporated
(``BSE''), operates an auction known as the PIP, see Securities
Exchange Act Release No. 49068 (January 13, 2004), 69 FR 2775
(January 20, 2004) (Order approving SR-BSE-2002-15 to establish
trading rules for the BOX facility (``BOX Order'')), and the
International Securities Exchange, Inc. (``ISE'') operates an
auction known as the PIM, see Securities Exchange Act Release No.
50819 (December 8, 2004), 69 FR 75093 (December 15, 2004) (Order
approving SR-ISE-2003-06 to adopt rules for the PIM).
\21\ See Citadel Letter, supra note 6, at p.1.
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In the Response Letter, the Exchange states that it should be
allowed to adopt the AIM auction for competitive reasons, since other
options exchanges have similar auctions, and if the Commission were to
take any actions with respect to these auctions, such actions should
affect the options exchanges equally at the same time.\22\
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\22\ See Response Letter, supra note 7, at pp. 1-2.
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After considering the Citadel Letter and the Response Letter, the
Commission believes that the Citadel Letter does not raise any novel
regulatory concerns that would preclude the approval of the proposed
rule change. The Commission believes that the proposed CBOE AIM auction
provides limitations on internalization comparable to the other
exchanges' rules that guarantee members the right to internalize their
customers' orders. Specifically, like the auction rules previously
approved by the Commission, the proposed AIM rules require the
Initiating Member to expose the Agency Order in the auction before the
Initiating Member may trade with the Agency Order.
B. Solicitation Process
Proposed CBOE Rule 6.74A permits a member that represents an Agency
Order to execute that Agency Order in the AIM auction against principal
interest or against a solicited order. BOX argues that the proposal
should define how the Initiating Member solicits the other side of the
Agency Order. BOX contends that the proposed rules need to clarify the
parameters for a market maker and the Initiating Member's ability to
access customer information that may be derived from solicited orders
and agency orders. BOX notes that the Commission required BOX to codify
procedural protections on BOX's Directed Order process (which it termed
its version of a solicitation process), and BOX believes that it would
be placed at a competitive advantage if the Commission does not require
CBOE to adopt similar procedural protections. Finally, BOX notes that
brokers in the options industry generally limit solicitation of large
customer orders (e.g., greater than 300 contracts). BOX believes that
the Exchange should clarify why the proposal would permit solicitation
of orders of all sizes, particularly for orders of less than 50
contracts.\23\
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\23\ See BOX Letter, supra note 6, at pp. 4-5.
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In the Response Letter, the Exchange notes that solicited orders
are processed on the floor of all floor-based options exchanges. The
Exchange contends that ISE's PIM is identical to the proposed rule
change in that the PIM auction rules allow the initiating member to
pair the agency order with a facilitation order or a solicitation
order. Further, CBOE notes that ISE's rules do not contain elaborate
procedures regarding the solicitation process. The Exchange further
notes that unlike the BOX Directed Order process, the AIM proposal
provides that solicited orders submitted by the Initiating Member may
not be for the account of a market maker assigned to the option class.
Thus, the CBOE contends that any comparison between the AIM auction and
BOX's Directed Order process is not relevant. Finally, with respect to
the size of a solicited order, the Exchange believes that unless other
options exchanges adopt size limits, it would be inappropriate for the
Commission to require that the CBOE impose such size limitations on
solicited orders for the AIM auction.\24\
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\24\ See Response Letter, supra note 7, at pp. 4-5.
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The Commission believes that the proposal regarding solicitation
process is sufficiently clear. The Commission notes that CBOE Rule 6.9
limits solicitation from members or non-member customers or broker-
dealers.\25\ In addition, CBOE Rule 4.1 prohibits members from engaging
in acts or practices inconsistent with just and equitable principles of
trade.\26\ The Commission further notes that CBOE has proposed an
additional limitation in CBOE Rule 6.74A.04 that would require that any
solicited orders submitted by the Initiating Member to trade against
the Agency Order not be for the account of a Market-Maker assigned to
the option class. The Commission believes that these provisions should
permit members to solicit, in advance, the other side of an order,
while providing for adequate disclosure of such orders to limit
manipulation and abuse.
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\25\ CBOE Rule 6.9.
\26\ CBOE Rule 4.1.
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C. Competition in the AIM
Proposed CBOE Rule 6.74A(a)(4) would require that there be at least
three Market Makers quoting in a relevant series at the time an
Initiating Member submits its Agency Order into the AIM.\27\ The
Commission believes that this requirement should improve the
opportunity for an Agency Order to be exposed to a competitive
auction.\28\
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\27\ See also ISE Rule 723(b)(1) and BOX Rules Chapter V, Sec.
18(e).
\28\ See BOX Order, supra note 20.
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BOX questions how public customers may participate in the RFR.\29\
The Exchange proposes to clarify in Amendment No. 2 that members acting
as agent for orders resting at the top of the Exchange's book opposite
the Agency Order may submit responses to
[[Page 7092]]
the RFR on behalf of such orders.\30\ In its Response Letter, the
Exchange further explains that at the time customer orders are
submitted to the member representing such orders, the member and the
customer would discuss price improvement parameters, and the CBOE
member representing customer orders would actually represent those
customer orders during an AIM auction.\31\ Based on the Exchange's
representations, the Commission believes that public customer access to
the AIM auction should be comparable to customers' access to open
outcry auctions on the current floor-based exchanges.
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\29\ See BOX Letter, supra note 6, at p. 5.
\30\ See Amendment No. 2, supra note 5.
\31\ See Response Letter, supra note 7, at p. 5.
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D. Duration of the AIM
The CBOE proposes that the duration of each RFR period be for a
random time period determined by the system that would not be less than
3 seconds and would not exceed 5 seconds.\32\ The Commission believes
that a RFR period between 3 and 5 seconds randomly determined by the
Exchange's system should afford electronic crowds sufficient time to
respond to, and compete for, Agency Orders submitted by an Initiating
Member. The Commission expects that electronic systems should be
readily available to CBOE members to allow them to respond to the RFR
broadcasts.
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\32\ The AIM would end prior to the expiration of the RFR period
under certain circumstances. See proposed CBOE Rule 6.74A(b)(2) and
discussion in text accompanying notes 33-35.
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E. Termination of Auction by Unrelated Orders
As proposed, the AIM would end prematurely under certain
circumstances: \33\ (1) If the Exchange Hybrid System receives an
unrelated order in the same series as the Agency Order and such
unrelated order is marketable against the Exchange's disseminated quote
(when the quote is the NBBO) or the RFR responses; (2) if the Exchange
Hybrid System receives an unrelated non-marketable limit order in the
same series as the Agency Order and on the opposite side of the market
as the Agency Order that improves any RFR response; (3) any time an RFR
response matches the Exchange's disseminated quote on the opposite side
of the market; or (4) pursuant to a pilot program that would expire on
July 18, 2006, any time there is a market maker to market maker quote
lock on the Exchange in accordance with CBOE Rule 6.45A(d).
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\33\ With respect to the same series, no AIM auction will run
simultaneously with another AIM auction, nor will AIM auctions be
permitted to queue or overlap in any manner. See proposed CBOE Rule
6.74A(b).
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BOX argues that the termination of the auction by an unrelated non-
marketable limit order in the same series as the Agency Order and on
the opposite side of the market could expose the AIM auction to
manipulation. BOX believes the proposal is unclear as to why such
orders should terminate the auction, unless they are for the full size
of the Agency Order; BOX notes that other similar auction systems, such
as the systems of BOX and ISE, treat such orders as price improvement
orders and argues that categorizing such orders as price improvement
orders would increase the number of RFR responses and maximize price
improvement potential in the AIM auction.\34\
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\34\ See BOX Letter, supra note 6, at p. 3.
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In the Response Letter, the Exchange asserts that both the
unrelated non-marketable limit order and the Agency Order should be
provided with price improvement (rather than the Agency Order only as
provided in the BOX PIP and ISE PIM). The Exchange agreed with BOX that
early termination of the auction for the purpose of manipulating the
market would be inappropriate, and noted that according to proposed
CBOE Rule 6.74.02, a pattern of submitting unrelated orders to end the
auction prematurely would be a violation of Exchange rules and would be
deemed conduct inconsistent with just and equitable principles of
trade.\35\
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\35\ See Response Letter, supra note 7, pp. 3-4.
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The Commission believes that the treatment of unrelated non-
marketable orders on the opposite side of the Agency Order is
consistent with the requirements of the Act. The Exchange's proposal
provides that the unrelated order and the Agency Order would receive
price improvement, and the Commission believes that allowing both
orders to be eligible for price improvement should benefit investors
and customers. In addition, the Exchange's proposed interpretation
would prohibit Exchange members from deliberately submitting orders to
end the AIM auction prematurely. The Commission, however, expects the
Exchange to analyze the impact of unrelated orders on the AIM auction
to ensure that Agency Orders are not being deprived of a full
opportunity for price improvement by the premature conclusion of an AIM
auction.
F. Allocation at the Conclusion of the Auction
1. Order Matching Allocation Algorithms
At the conclusion of the auction, the Agency Order would be
allocated in accordance with applicable matching algorithm rules in
effect for such class subject to certain conditions.\36\ BOX notes that
proposed CBOE Rule 6.74A(b)(3) does not specify the matching algorithm
as to how orders will be allocated,\37\ and in its Response Letter, the
Exchange has clarified that the matching algorithms are defined in CBOE
Rule 6.45A for equity options and CBOE Rule 6.45B for index
options.\38\ The Commission believes that the matching algorithm set
forth in these rules is sufficiently clear regarding how orders are to
be allocated in the AIM auction.
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\36\ See proposed CBOE Rule 6.74A(b)(3). The Commission notes
that to be consistent with the requirements of section 11(a) of the
Exchange Act, 15 U.S.C. 78k(a), and Rule 11a1-1(T) under the Act, 17
CFR 240.11a1-1(T), Exchange Members must yield priority in the AIM
auction to all non-Member orders, unless another exception to
Section 11(a) applies.
\37\ See BOX Letter, supra note 6, at p. 4.
\38\ See Response Letter, supra note 7, at pp. 3-4.
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2. Auto-Match
To initiate the electronic auction, the Initiating Member who
represents an Agency Order would submit the Agency Order and also
either specify a single-price submission to cross the Agency Order or
indicate that it is willing to automatically match as principal the
price and size of all auction responses (``Auto-Match''). If the
Initiating Member uses the Auto-Match feature, the Initiating Member
would not have control over the prices at which it receives an
allocation of the Agency Order at the conclusion of the auction.
BOX, in its comment letter, argues that the Auto-Match feature of
the AIM auction provides unfair competitive advantages to the
Initiating Member. BOX contends that since the Exchange system governs
the Auto-Match feature, it is likely to confer upon the Initiating
Member a technological advantage in the sense that the Initiating
Member would have the fastest response time to any competing RFR
responses. BOX further contends that the proposal appears to provide
the Initiating Member with an automatic ``last look'' at the best
priced RFR response, thereby guaranteeing the Initiating Member an
allocation in any auction. BOX also notes that RFR responses would not
be visible to other AIM auction participants and believes that as a
result, Exchange members would not
[[Page 7093]]
have sufficient information to make a fully informed decision to
compete for the Agency Order. Finally, BOX believes the ability of the
Initiating Member to use Auto-Match would provide the Initiating Member
an unfair advantage over customer orders and thus raise customer
priority concerns.\39\
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\39\ See BOX Letter, supra note 6, at pp. 2, 5.
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In its Response Letter, the Exchange states that a blind auction is
a key component to AIM and that a blind auction would encourage
participants to quote their best prices. The Exchange believes that in
a blind auction, there is greater incentive for participants to submit
their best prices at the outset, whereas in a non-blind auction,
participants would need to submit only the minimal amount of
improvement. Because AIM is a blind auction, the Exchange adds, it
sought to propose a means by which the Initiating Member could still
receive a guaranteed participation, i.e., Auto-Match, similar to other
mini-auctions, like BOX's PIP. CBOE notes that since PIP is not a blind
auction, the initiating member could always configure its system to
match the best response. Further, CBOE points out that under the terms
of its proposal, when the Initiating Member selects Auto-Match prior to
the start of the auction, the available liquidity would be doubled and
pricing would be completely out of the Initiating Member's control.
Finally, the Exchange states that BOX's argument that Auto-Match would
provide the Initiating Member with some sort of technological advantage
(in the form of faster response time) over other participants is
misleading. The CBOE notes that once Auto-Match is selected (before the
auction), the Initiating Member does not respond at all, but instead
must honor the prices set forth in the responses received from other
participants.\40\
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\40\ See Response Letter, supra note 7, at pp. 2-3.
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The Commission believes that the Auto-Match feature of the AIM
auction would not unfairly discriminate against other AIM participants.
The Commission disagrees that a blind auction would necessarily deprive
auction participants with information necessary to submit RFR
responses. When the AIM system receives an Agency Order, the Exchange
would submit a RFR to all participating members detailing the side and
size of the Agency Order. RFR responses would not be visible to any of
the auction participants, including the Initiating Member.
Finally, the Commission believes that an Initiating Member's use of
Auto-Match would not have customer priority issues, since the proposal
provides that public customer orders in the book must have
priority.\41\ At the same time, because the Auto-Match feature is
offered only to the Initiating Member and would provide the Initiating
Member with a guaranteed participation, the Commission believes it is
essential that the Exchange provide data on the frequency of use of
Auto-Match and its effect on price improvement to permit the Commission
to monitor the impact of the proposed rule change on the competitive
process.\42\
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\41\ See proposed CBOE rule 6.74A(b)(3)(B).
\42\ See Section II.G.
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G. Price Improvement versus Facilitation
As discussed above, an Initiating Member who submits an Agency
Order into the AIM auction must ``stop'' the Agency Order as follows:
(1) If the Agency Order is for less than 50 contracts, the Initiating
Member must stop the entire Agency Order as principal or with a
solicited order at the better of (A) the NBBO price improved by one
minimum price improvement increment, which increment shall be
determined by the Exchange but may not be smaller than one cent or (B)
the Agency Order's limit price (if the Agency Order is a limit order);
or (2) if the Agency Order is for 50 contracts or more, the Initiating
Member must stop the entire Agency Order as principal or with a
solicited order at the better of the NBBO or the Agency Order's limit
price (if the Agency Order is a limit order).\43\
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\43\ See proposed CBOE Rule 6.74A(a)(2) and (3).
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BOX argues that the AIM rules should provide a minimum price
improvement over the NBBO for orders of 50 contracts or greater. BOX
noted that other auction systems such as ISE's PIM and BOX's PIP
initiate auctions for such orders with a required price improvement of
at least one cent better than the NBBO.\44\ In response, the Exchange,
however, points out that all of the options exchanges, other than BOX,
allow guaranteed facilitation participation at the NBBO for orders of
50 contracts or greater.\45\
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\44\ See BOX Letter, supra note 3.
\45\ See Response Letter, supra note 7, at p. 4.
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The Commission believes that stopping an Agency Order of 50
contracts or greater at the better of the NBBO or the Agency Order's
limit price is consistent with the requirements of the Act. The
Commission notes that it has approved rules of other options exchanges
that permit facilitation at the NBBO for orders of 50 contracts or
greater.\46\ The Commission further notes that unlike the facilitation
mechanisms of some exchanges, once the Initiating Member has submitted
an Agency Order and designated a single-price submission or auto-match
into the AIM auction, it may not modified or cancelled. Therefore, the
Agency Order submitted to the AIM auction is guaranteed an execution
price of at least the NBBO and, moreover, is given the opportunity for
price improvement beyond the NBBO.
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\46\ See e.g., Rule 6.47(b)(4) of the Pacific Exchange, Inc.,
ISE Rule 716(d).
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H. No Minimum Size Requirement for AIM
Like the BOX's PIP auction and the ISE's PIM auction, the AIM
auction would be available for orders of fewer than 50 contracts. Under
the Exchange's proposal, there would be no minimum size requirement for
orders entered into the AIM, for a pilot period expiring on July 18,
2006.\47\
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\47\ The July 18, 2006 pilot expiration date corresponds to the
expiration of a similar pilot program for the BOX's PIP, and ISE's
PIM. See BOX Rules, Chapter V, Sec. 18, Supplementary Material .01,
and ISE Rule 723, Supplementary Material .03.
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The Commission believes that the Exchange's proposal should provide
small customer orders with the opportunity for price improvement, and
is consistent with the Act. In particular, any Agency Order for less
than 50 contracts that is entered into the AIM is guaranteed an
execution at the end of the auction at a price at least a penny better
than the NBBO. The Commission will evaluate the AIM auction during the
Pilot Period to determine whether it would be beneficial to customers
and to the options market as a whole to approve any proposal requesting
permanent approval to permit orders of fewer than 50 contracts to be
submitted to the AIM auction. In addition, the Commission will examine
the data submitted by the Exchange with respect to situations in which
the AIM auction is terminated prematurely by an unrelated order. To aid
the Commission in its evaluation, the CBOE represents that it will
provide the following information each month:
(1) The number of orders of fewer than 50 contracts entered into
the AIM auction;
(2) The percentage of all orders of fewer than 50 contracts sent to
CBOE that are entered into CBOE's AIM auction;
(3) The percentage of all CBOE trades represented by orders of
fewer than 50 contracts;
(4) The percentage of all CBOE trades effected through the AIM
auction
[[Page 7094]]
represented by orders of fewer than 50 contracts;
(5) The percentage of all contracts traded on CBOE represented by
orders of fewer than 50 contracts;
(6) The percentage of all contracts effected through the AIM
auction represented by orders of fewer than 50 contracts;
(7) The spread in the option, at the time an order of fewer than 50
contracts is submitted to the AIM auction;
(8) The number of orders of 50 contracts or greater entered into
the AIM auction;
(9) The percentage of all orders of 50 contracts or greater sent to
CBOE that are entered into CBOE's AIM auction;
(10) The spread in the option, at the time an order of 50 contracts
or greater is submitted to the AIM auction;
(11) Of AIM trades for orders of fewer than 50 contracts, the
percentage done at the NBBO plus $.01, plus $.02, plus $.03, etc.;
(12) Of AIM trades for orders of 50 contracts or greater, the
percentage done at the NBBO plus $.01, plus $.02, plus $.03, etc.;
(13) The number of orders submitted by Exchange members when the
spread was $.05, $.10, $.15, etc. For each spread, specify the
percentage of contracts in orders of fewer than 50 contracts submitted
to CBOE's AIM that were traded by: (a) the Exchange member that
submitted the order to the AIM; (b) CBOE Market Makers assigned to the
class; (c) other CBOE members; (d) Public Customer Orders; and (e)
unrelated orders (orders in standard increments entered during the AIM
auction). For each spread, also specify the percentage of contracts in
orders of 50 contracts or greater submitted to CBOE's AIM that were
traded by: (a) the Exchange member that submitted the order to the AIM;
(b) CBOE Market Makers assigned to the class; (c) other CBOE members;
(d) Public Customer Orders; and (e) unrelated orders (orders in
standard increments entered during the AIM auction);
(14) The number of times that a market or marketable limit order in
the same series on the same side of the market as the Agency Order
prematurely ended the AIM auction, and the number of times such orders
were entered by the same (or affiliated) firm that initiated the AIM
auction that was terminated;
(15) The percentage of AIM early terminations due to the receipt of
a market or marketable limit order in the same series on the same side
of the market that occurred within a \1/2\ second of the start of the
AIM auction; the percentage that occurred within one second of the
start of the AIM auction; the percentage that occurred within 1\1/2\
second of the start of the AIM auction; the percentage that occurred
within 2 seconds of the start of the AIM auction; the percentage that
occurred within 2\1/2\ seconds of the AIM auction; and the average
amount of price improvement provided to the Agency Order where the AIM
auction is terminated early at each of these time periods;
(16) The number of times that a market or marketable limit order in
the same series on the opposite side of the market as the Agency Order
prematurely ended the AIM auction and at what time the unrelated order
ended the AIM auction, and the number of times such orders were entered
by the same (or affiliated) firm that initiated the AIM auction that
was terminated;
(17) The percentage of AIM auction early terminations due to the
receipt of a market or marketable limit order in the same series on the
opposite side of the market that occurred within a \1/2\ second of the
start of the AIM auction; the percentage that occurred within one
second of the start of the AIM auction; the percentage that occurred
within 1\1/2\ second of the start of the AIM auction; the percentage
that occurred within 2 seconds of the start of the AIM auction; the
percentage that occurred within 2\1/2\ seconds of the AIM auction; and
the average amount of price improvement provided to the Agency Order
where the AIM auction is terminated early at each of these time
periods;
(18) The number of times that an RFR response matching the
Exchange's disseminated quote on the opposite side of the market from
the RFR responses prematurely ended the AIM auction and at what time
the RFR response ended the AIM auction, and the number of times such
orders were entered by the same (or affiliated) firm that initiated the
AIM auction that was terminated;
(19) The percentage of AIM auction early terminations due to the
receipt of an RFR response matching the Exchange's disseminated quote
on the opposite side of the market from the RFR responses that occurred
within a \1/2\ second of the start of the AIM auction; the percentage
that occurred within one second of the start of the AIM auction; the
percentage that occurred within 1\1/2\ second of the start of the AIM
auction; the percentage that occurred within 2 seconds of the start of
the AIM auction; the percentage that occurred within 2\1/2\ seconds of
the AIM auction; and the average amount of price improvement provided
to the Agency Order where the AIM auction is terminated early at each
of these time periods;
(20) The number of times that a quote lock on the Exchange pursuant
to CBOE Rule 6.45A(d) prematurely ended the AIM auction and at what
time the quote lock ended the AIM auction, and the number of times such
orders were entered by the same (or affiliated) firm that initiated the
AIM that was terminated;
(21) With respect to a quote lock on the Exchange pursuant to CBOE
Rule 6.45A(d) that has occurred with an Agency Order to buy, the number
of times that the quote was locked at the existing best bid and the
number of times that the quote was locked at the existing best offer,
and the firm that caused the quote lock;
(22) With respect to a quote lock on the Exchange pursuant to CBOE
Rule 6.45A(d) that has occurred with an Agency Order to sell, the
number of times that the quote was locked at the existing best bid and
the number of times that the quote was locked at the existing best
offer, and the firm that caused the quote lock;
(23) The frequency with which early termination due to a quote lock
on the Exchange pursuant to CBOE Rule 6.45A(d) results in price
improvement for the Agency Order; and the average amount of price
improvement provided to the Agency Order;
(24) The average amount of price improvement provided to the Agency
Order when the AIM auction is not terminated early (i.e., runs the full
three seconds); and
(25) The percentage of all CBOE trades effected through the AIM
auction in which the Initiating Member has chosen the Auto-Match
feature, and the average amount of price improvement provided to the
Agency Order when the Initiating Member has chosen the Auto-Match
feature vs. the average amount of price improvement provided to the
Agency Order when the Initiating Member has chosen a single-price
submission.
IV. Solicitation of Comments on Amendment No. 2
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:
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 Number SR-CBOE-2005-60 on the subject line.
[[Page 7095]]
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 Number SR-CBOE-2005-60. 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. Copies of such
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 Number SR-CBOE-2005-60 and should be submitted on or before March
3, 2006.
V. Accelerated Approval of Amendment No. 2
The Commission finds good cause to approve Amendment No. 2 to the
proposed rule change prior to the thirtieth day after the amendment is
published for comment in the Federal Register pursuant to section
19(b)(2) of the Act.\48\ The revisions made to the proposed rule
change, as amended, in Amendment No. 2 clarified that Exchange members,
when acting as agent for orders resting at the top of the Exchange's
book on the other side of the Agency Order, may submit RFR responses on
behalf of such orders. In addition, Amendment No. 2 clarified that the
Exchange would submit certain data, as required by the Commission,
during the Pilot Period and information submitted by the Exchange to
the Commission would be on a confidential basis.
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\48\ 15 U.S.C. 78s(b)(2).
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The Commission believes that the proposed changes in Amendment No.
2 are necessary to the proper functioning and implementation of AIM.
The Commission believes that the proposed changes in Amendment No. 2
provide a clearer understanding of the operation of AIM and the Pilot
Period and raise no new issues of regulatory concern. For these
reasons, the Commission believes that accelerated approval of Amendment
No. 2 is appropriate. Accordingly, pursuant to section 19(b)(2) of the
Act,\49\ the Commission finds good cause exists to approve Amendment
No. 2 prior to the 30th day after notice of the Amendment is published
in the Federal Register.
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\49\ 15 U.S.C. 78s(b)(2).
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VI. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule change, as amended, is consistent with the Act and the rules and
regulations thereunder applicable to a national securities exchange,
and, in particular, with section 6(b)(5) of the Act.\50\
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\50\ 15 U.S.C. 78f(b)(5). In connection with the issuance of
this approval order, neither the Commission nor its staff is
granting any exemptive or no-action relief from the requirements of
Rule 10b-10 under the Act. 17 CFR 240.10b-10. Accordingly, a broker-
dealer executing a customer order through the AIM auction will need
to comply with all applicable requirements of that Rule.
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It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\51\ that the proposed rule change (SR-CBOE-2005-60) and Amendment
No. 1 thereto, are approved, and that Amendment No. 2 thereto is
approved on an accelerated basis, except that (1) paragraph (b)(2)(E)
of CBOE Rule 6.74A is approved on a pilot basis until July 18, 2006;
and (2) there shall be no minimum size requirement for orders entered
into the AIM, for a pilot period expiring on July 18, 2006.
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\51\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\52\
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\52\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-1836 Filed 2-9-06; 8:45 am]
BILLING CODE 8010-01-P