[Federal Register: December 9, 2002 (Volume 67, Number 236)]
[Notices]
[Page 72988-72990]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr09de02-127]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46935; File No. SR-CBOE-2002-27]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving Proposed Rule Change and Amendments No. 1 and 2
Thereto by the Chicago Board Options Exchange, Inc. Relating to
Permanent Approval of the 100 Spoke RAES Wheel Pilot Program and
Elimination of the ``Vacation Penalty''
December 2, 2002.
I. Introduction
On May 24, 2002, the Chicago Board Options Exchange, Inc. (``CBOE''
or ``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposal to amend its rules to eliminate the pilot
program and make permanent the 100 Spoke RAES Wheel System. The CBOE
further proposed to modify the calculation of the participation
distribution for market makers participating on the 100 Spoke RAES
Wheel by eliminating the ``vacation penalty.'' On July 17, 2002, the
Exchange filed Amendment No. 1 to the proposed rule change.\3\ On
September 26, 2002, the Exchange filed Amendment No. 2 to the proposed
rule change.\4\ On October 17, 2002, the Commission published the
proposed rule change and Amendments No. 1 and 2 in the Federal
Register.\5\ The Commission received no comments on the proposal. This
order approves the proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from Nancy L. Nielsen, Director of Arbitration
and Assistant Secretary, CBOE, to Nancy Sanow, Assistant Director,
Division of Market Regulation, Commission, dated July 16, 2002
(``Amendment No. 1'').
\4\ See Letter from Madge M. Hamilton, Legal Division, CBOE, to
Nancy Sanow, Assistant Director, Division of Market Regulation,
Commission, dated September 26, 2002 (``Amendment No. 2'').
\5\ See Securities Exchange Act Release No. 46683 (October 17,
2002), 67 FR 65384 (October 24, 2002).
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II. Description of the Proposal
On May 25, 2000, the Commission approved, on a pilot basis, the
Exchange's proposal to amend Rule 6.8 to provide the appropriate Floor
Procedure Committee (``FPC'') with a third choice for apportioning RAES
trades among participating market makers, the 100 Spoke RAES Wheel.\6\
In those classes where the 100 Spoke RAES Wheel is employed, the
allocation of RAES trades to participating market makers is
commensurate with the distribution of in-person agency market-maker
trades for non-RAES trades in that class. The pilot program has been
extended five times, most recently until November 28, 2002.\7\
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\6\ Securities Exchange Act Release No. 42824 (May 25, 2000), 65
FR 37442 (June 14, 2000). RAES is the Exchange's automatic execution
system for public customer market or marketable limit orders of less
than a certain size.
\7\ Securities Exchange Act Release No. 46644 (October 10, 2002)
(pilot program extended until November 28, 2002) (SR-CBOE-2002-60);
Securities Exchange Act Release No. 46149 (June 28, 2002), 67 FR
45161 (July 8, 2002) (pilot program extended until September 28,
2002) (SR-CBOE-2002-34); Securities Exchange Act Release No. 45230
(January 3, 2002), 67 FR 1380 (January 10, 2002) (pilot program
extended until June 28, 2002) (SR-CBOE-2001-68); Securities Exchange
Act Release No. 44749 (August 28, 2001), 66 FR 46487 (September 5,
2001) (pilot program extended until December 28, 2001) (SR-CBOE-
2001-47); Securities Exchange Act Release No. 44020 (February 28,
2001), 66 FR 13985 (March 8, 2001) (pilot program extended until
August 28, 2001) (SR-CBOE-01-07).
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[[Page 72989]]
Under the 100 Spoke RAES Wheel, RAES orders are assigned to market
makers according to the percentage of their in-person agency contracts
(excluding RAES contracts) traded in that class compared to the in-
person agency contracts (excluding RAES contracts) of all of the market
makers traded during the review period. Agency contracts are any
contracts represented by an agent (booked orders and orders represented
by brokers) and do not include contracts traded between market makers
in person in the trading crowd. A particular market maker's entitlement
will change based upon the percentage of agency contracts that market-
maker traded in the review period. For example, if a particular market
maker traded 10% of all the in-person agency contracts (excluding RAES
contracts) of class ABC for a particular review period, then that
market maker would be assigned 10% of the RAES contracts during the
next trading period. The review period is determined by the appropriate
FPC.
The RAES Wheel can be envisioned as having a number of spokes, each
generally representing one percent of the total participation of all
market makers in the class. Thus, a market maker generally will be
assigned one spoke for each one percent of his or her market maker
participation during the review period. If the spoke size is one and
all market makers who traded in-person agency contracts in that option
class during the review period are logged onto RAES, and no other
market makers are logged on, the RAES Wheel would consist of 100
spokes, representing 100 percent of all market maker activity during
the review period. The appropriate FPC may establish a larger spoke
size. Setting the spoke size to five contracts, for example, would
redefine the RAES Wheel for a particular option class as a Wheel of 500
contracts. A larger Wheel would mean the Wheel would not revolve as
quickly through the logged on market makers, but a larger Wheel would
not change the participation percentage of the individual market
makers.
A wedge is the maximum number of spokes that may be consecutively
assigned at any one time to a market maker during a rotation of the
RAES Wheel. The purpose of the wedge is to break up the distribution of
contracts into smaller groupings to reduce the exposure of any one
market maker to market risk. If the size of the wedge is smaller than
the number of spokes to which a particular market maker may be entitled
based on his or her participation percentage, then that market maker
would receive one or more additional assignments during one revolution
of the RAES Wheel. For example, in the case where one spoke is equal to
one contract and the market maker's participation percentage is 15
percent (15 percent of 100 spokes) and the wedge size is ten, that
market maker first would be assigned ten contracts on the RAES Wheel
and then five contracts at a different place on the RAES during the
same revolution of the RAES Wheel. The wedge size is variable at the
discretion of the appropriate FPC and may be established at different
levels for different classes, or at the same level for all classes.
In its filing, the Exchange represented that the 100 Spoke RAES
Wheel has worked as anticipated by providing an efficient and effective
alternative allocation method for assigning RAES trades. The Exchange
further represented that, in those classes where the 100 Spoke RAES
Wheel is employed, the distribution of RAES trades is essentially
identical to the distribution of in-person agency market maker trades
on non-RAES trades in that class during the relevant review period.
The Exchange also clarified the calculation of the participation
distribution for market makers participating on the 100 Spoke RAES
Wheel.\8\ Specifically, the applicable review period would be adjusted
to account for vacations by market makers. CBOE indicated that without
this revision, if a market maker takes even a single trading day off
over the two-week review period, the market maker is allocated a number
of spokes that is less than the market-maker's average daily percentage
of the trading volume, resulting in a ``vacation penalty.'' Thus,
rather than a maximum review period of two weeks, as provided in the
current rule, the review period will be a maximum of 10 trading days,
i.e., last ten days in which the market maker had trading activity,
subject to the condition that the review period cannot extend back more
than 30 calendar days (in order to assure that the review period is not
based on stale activity). Under the proposed rule, the trading days
within the review period may be non-consecutive trading days, and the
percentage allocation will be calculated at the conclusion of each
trading day and will be applied to the 100 Spoke RAES Wheel
distribution on the following trading day.
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\8\ See Amendment No. 1, supra n. 3.
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Further, CBOE explained that, in calculating the review period, the
10 trading days used to compute one market maker's RAES participation
distribution may be a different 10 trading days than another market
maker signed onto RAES in the same trading crowd, and that the 10-day
review periods of individual market makers may overlap.\9\ In addition,
CBOE clarified that the individual market makers have no discretion
over which 10 trading days will be used in the calculation. The
proposed rule change permits the appropriate FPC to set a review period
not to exceed 10 trading days.\10\ Once the appropriate FPC has set the
number of days to be used in the calculation of the market maker's
participation distribution, the Exchange looks back that number of
trading days to calculate each market maker's participation right.
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\9\ See Amendment No. 2, supra n. 4. As noted above, the review
period of a maximum of 10 trading days (i.e., the last ten days in
which the market maker had trading activity) cannot extend back more
than 30 calendar days.
\10\ The Exchange represents that under the proposed rule
change, as amended, all market makers' review periods will be of
equal size, regardless of whether the Exchange may look at different
underlying time periods to ascertain the most recent days of trading
activity for a specific market maker. Telephone conference among
Madge Hamilton, Legal Division, CBOE, Nancy Sanow, Assistant
Director, Division of Market Regulation, Commission, and Geoffrey
Pemble, Special Counsel, Division of Market Regulation, Commission
(November 26, 2002).
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CBOE further noted that, under the proposed rule, the Exchange will
conduct the calculation for the market maker participation distribution
at the conclusion of each trading day and apply the market makers' RAES
participation distribution to the following trading day. CBOE further
explained that, since the calculation of the participation distribution
is done at the end of each trading day, the 10 day review period for
each market maker will be done on a rolling basis, i.e., each time the
calculation is conducted, the non-RAES agency trading volume for the
current day, if any, is added to the 10 day review period, and the non-
RAES agency trading volume for the oldest day used for the previous
day's calculation is deleted. According to CBOE, this calculation
encourages market makers to actively trade every day, since each day's
trading activity will have an effect on the market maker's RAES
participation distribution for the next trading day.\11\ Finally,
[[Page 72990]]
CBOE noted the formula for determining market maker participation
percentage on the 100 Spoke RAES Wheel. CBOE explained that in order to
calculate a market maker's participation percentage, the ``non-RAES
agency trading volume'' for a given market maker is divided by the
``total volume,'' i.e., the sum of the volume of the non-RAES agency
trades for all traders in a particular options class (which is
determined by adding together the trading volume for each market maker
and DPM during his or her relevant review period).
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\11\ Any market maker that logs on the system during a
particular review period will be guaranteed to receive an
entitlement during that review period of no less than 1 percent of
RAES contracts, or one ``spoke.'' The minimum entitlement applies to
any market maker in a particular option class who logs on RAES
during a given review period. Thus, new market makers who have not
yet had time to acquire market share on the trading floor will be
allocated a single spoke if they log on RAES during the first review
period they traded that class on the Exchange floor. Telephone
conference among Madge Hamilton, Legal Division, CBOE, Nancy Sanow,
Assistant Director, Division of Market Regulation, Commission, and
Geoffrey Pemble, Special Counsel, Division of Market Regulation,
Commission (November 26, 2002).
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III. Discussion
After careful review, the Commission finds that implementation of
the proposed rule change, as amended, is consistent with the
requirements of Section 6 of the Act \12\ and the rules and regulations
thereunder applicable to a national securities exchange.\13\
Specifically, the Commission believes that the proposal, as amended, is
consistent with Sections 6(b)(5) and 6(b)(8) of the Act.\14\ Section
6(b)(5) requires, among other things, 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 facilitate
transactions in securities, to remove impediments to and perfect the
mechanisms of a free and open market and a national market system, and,
in general, to protect investors and the public interest.\15\ Section
6(b)(5) also requires that those rules not be designed to permit unfair
discrimination between customers, issuers, brokers, or dealers. Section
6(b)(8) of the Act requires that the rules of an exchange not impose
any burden on competition not necessary or appropriate in furtherance
of the purposes of the Act.
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\12\ 15 U.S.C. 78f.
\13\ 15 U.S.C. 78f(b)(5).
\14\ 15 U.S.C. 78f(b)(5) and (b)(8).
\15\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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As the Commission stated in its original approval order for the 100
Spoke RAES Wheel as a pilot program, the Commission believes that
CBOE's implementation of the 100 Spoke RAES Wheel system as a pilot
program was an important step forward, as it rewarded those market
makers who consistently execute a greater portion of agency orders in
the trading crowd, rather than randomly assigning contracts to all
market makers logged on RAES. Although the 100 Spoke RAES Wheel does
not reward a market maker for improving the Exchange's displayed
quotation, it does reward the market maker for providing liquidity to
orders in the trading crowd by linking the market maker's percentage of
RAES contracts to the percentage of agency contracts it executed in the
trading crowd.
Unlike the two means of allocation that were used exclusively prior
to the 100 Spoke RAES Wheel pilot program, under which the size of the
order assigned to a particular market maker is determined randomly,\16\
the 100 Spoke RAES Wheel more closely allocates the percentage of
contracts that a particular market maker can receive on a single
revolution of the Wheel to the percentage of in-person agency contacts
(excluding RAES contracts) traded on CBOE by that market maker. With
the 100 Spoke RAES Wheel, market makers have a greater incentive to
compete effectively for orders in the crowd, and this, in turn, should
benefit investors and promote the public interest.
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\16\ Under Variable RAES, the market maker has some flexibility
in limiting the extent of its exposure during each revolution of the
Wheel.
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The Commission reiterates that implementation of the 100 Spoke RAES
Wheel will have no effect on the prices offered to customers. Under
CBOE Rule 6.8(d)(i), RAES automatically provides to each retail
customer order its execution price, generally determined by the
prevailing market quote at the time of the order's entry into the
system. The 100 Spoke RAES Wheel merely provides for a different
contract allocation system than currently exists for automatic
execution of small retail orders.
The proposed rule change also will eliminate the ``vacation
penalty'' that resulted under the original rule when a market maker was
absent for one or more days. Under the proposed rule change, as
amended, the review period will be the period not in excess of 10
trading days, i.e., last ten days in which the market maker had trading
activity, subject to the condition that the review period cannot extend
back more than 30 calendar days (in order to assure that the review
period is not based on stale activity). In addition, the Commission
notes that under the proposal, all market maker's review periods will
be of equal size, regardless of whether the Exchange may look at
different underlying time periods to ascertain the most recent days of
trading activity for a specific market maker. The Commission finds that
these changes relating to the ``vacation penalty'' are consistent with
the Act.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change, as amended (SR-CBOE-2002-27) is
approved on a permanent basis.
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\17\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-31018 Filed 12-6-02; 8:45 am]
BILLING CODE 8010-01-P