On December 17, 2001, the Chicago Board Options Exchange, Inc. (“CBOE” or “Exchange”) submitted to the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change relating to the Exchange's AutoQuote System. The Federal Register published the proposed rule change for comment on February 12, 2002. The Commission received no comments on the proposed rule change. This order approves the proposed rule change.
II. Description of Proposal
The CBOE submitted the proposed change to Interpretation and Policy .07 to CBOE Rule 8.7 pursuant to subparagraph IV.B.j of the Commission's September 11, 2000 Order, which requires in part that certain options exchanges, including the CBOE, adopt new, or amend existing, rules to make express any practice or procedure “whereby market makers trading any particular option class determine by agreement the spreads or option prices at which they will trade any option class * * *.” The proposed amendment to Interpretation and Policy .07 to CBOE Rule 8.7 would permit market makers to coordinate in setting the components of the formula used by an automated quotation updating system, or AutoQuote.
AutoQuote is the Exchange's electronic quotation system that Start Printed Page 13384automatically monitors and updates market quotations using a mathematical formula measuring certain characteristics of the option and the underlying interest. According to the Exchange, AutoQuote provides a means to update the quotes for the tens of thousands of series the Exchange lists. AutoQuote formulas require the selection and input of the following components or variables: an option pricing calculation model, volatility, interest rate, dividend, and the measure used to represent the value of the underlying.
The proposed amendment to Interpretation and Policy .07 to CBOE Rule 8.7 would set forth a more thorough description of AutoQuote. The proposed rule change also would identify who has responsibility under Exchange rules to determine a formula for generating automatically updated market quotations. For classes of options in which a DPM is appointed, the DPM would have primary responsibility to determine the formula, which includes determining the components or variables used in the AutoQuote formula. For classes of options in which an LMM or SMM is appointed, such as the S&P 100 option class (“OEX”), the LMM or SMM would have primary responsibility to determine the formula for generating automatically updated market quotations. For classes of options in which a DPM, LMM, or SMM has not been appointed, the appropriate Exchange Committee would be permitted to appoint one or more market makers in good standing with an appointment in the particular option class (“Appointed Market-Makers”) to determine a formula for generating automatically updated market quotations, using the Exchange's AutoQuote system or a proprietary automated quotation updating system.
Although DPMs, LMMs, SMMs, and Appointed Market-Makers would have the responsibility for determining the formula for generating automatically updated market quotations, the proposed amendment to Interpretation and Policy .07 expressly would provide that the DPM, LMM, SMM, or Appointed Market-Maker may, but is not required to, consult with and/or agree with other market makers in the trading crowd in setting the components or variables of the formula. However, members of the trading crowd would not be required to provide input to the DPM, LMM, SMM, or Appointed Market-Maker about these decisions and the decision is ultimately that of the DPM, LMM, SMM or Appointed Market-Maker in the particular class.
For classes of options in which a DPM, LMM, SMM or Appointed Market-Maker does not have the responsibility to determine a formula for generating automatically updated market quotations, the market makers would be permitted to coordinate and agree upon the variables for the AutoQuote formula. In some trading crowds, one or a few market makers may take responsibility (with the crowd's approval) for updating the AutoQuote variables without seeking input on a continual basis. The CBOE believes that such market maker coordination is necessary and appropriate because an AutoQuote system is centralized and applicable to all market participants. Thus, the obligations resulting from the quotes generated by AutoQuote, such as the firm quote obligation, are imposed on the crowd as a whole. Moreover, although AutoQuote is essential to ensure that quotes are updated on the numerous series traded by the Exchange on a timely basis, individual market makers can and do compete among each other to gain a larger share of orders by verbalizing quotes that improve the AutoQuote generated quotes. These verbalized quotes by market makers override the AutoQuote generated quotes for the particular series that is the subject of the verbalized quote.
Finally, the proposed amendment to Interpretation .07 would provide that the provisions described above and set forth in the proposed amendment to Interpretation .07 would also apply to the use of automated quotation updating systems that generate indicative prices that are indications of interest and not firm quotes.
The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. Specifically, the Commission believes that the proposed rule change is consistent with the Section 6(b)(8) requirement that the rules of an exchange not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act.
The Commission believes that the proposed rule change should deter collective action, except as authorized by the Exchange's rules, by clearly establishing in the Exchange's rules the responsibilities of, and conduct permitted by, Exchange members in setting AutoQuote parameters. For instance, the proposal would permit the DPM, LMM, or SMM, or Appointed Market-Maker, as applicable, to receive input from members of the crowd in setting the parameters of the formula used to automatically update options quotations. At this time, the Commission believes it is reasonable for the Exchange's rules to permit the members of the crowd to be given a voice in setting autoquote parameters because, pursuant to the Exchange's rules, they will be obligated to execute orders at the resultant quote. In addition, the proposal codifies a more complete description of AutoQuote, which the Commission believes should protect investors and the public interest by providing important information regarding how options prices on the Exchange are derived. Moreover, the Commission notes that individual market makers can compete among each other to gain a larger share of orders and override the AutoQuote generated quotes by verbalizing quotes that improve the AutoQuote generated Start Printed Page 13385quotes, which should limit any anticompetitive effects of the proposed rule change.
The Commission notes that in its filing, the Exchange states its belief that the proposed rule change is “procompetitive” because it is necessary to provide for a fair and orderly market in the thousands of options series traded on the Exchange. While the Commission does not agree that the proposed rule change enhances competition, the Commission finds that the burden that the proposal imposes on competition is appropriate in furtherance of the purposes of the Act and, thus, is not inconsistent with the Act. Finally, the Commission finds that the proposed rule change is designed to effectively limit the circumstances in which collective action is permissible.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-CBOE-2001-64) is approved.Start Signature
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Margaret H. McFarland,
4. See Order Instituting Public Administrative Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions. Securities Exchange Act Release No. 43268 (September 11, 2000).Back to Citation
5. For purposes of this filing and the proposed interpretation, the term AutoQuote is used to refer to both the Exchange's own automatic quotation system that is offered to trading crowds to generate quotes and to proprietary automated quotation updating systems that are used by trading crowds, DPMs, LMMs, SMMs, or appointed market-makers to generate quotes in lieu of or in addition to the Exchange's own AutoQuote system.Back to Citation
6. Although the Exchange believes that AutoQuote is necessary, the Exchange notes that individual market makers can and do manually improve the quote themselves in order to gain a larger share of orders than competing market makers. In these instances, the manual quote overrides the AutoQuote for that particular series.Back to Citation
7. See CBOE Rule 8.85(a)(x).Back to Citation
8. On December 17, 2001, the CBOE filed SR-CBOE-2001-63 which amends CBOE Rule 8.15 to make explicit in the rule that the appropriate Market performance Committee (“MPC”) may appoint LMMs and SMMs to determine a formula for generating automatically updated market quotations and use the Exchange's AutoQuote system or a proprietary automated quotation updating system to update market quotations during the trading day in an options class for which a DPM has not been appointed. See Securities Exchange Act Release No. 45419 (February 7, 2002), 67 FR 6772 (February 13, 2002). The Commission is approving SR-CBOE-2001-63 simultaneously with the proposed rule change.Back to Citation
9. CBOE has always used, and the applicable CBOE rules envision, a centralized autoquote system. Although it may be technologically feasible at some point in the future to have a system that would permit each individual market-maker to have his or her own automatic quote updating capability (and although CBOE may eventually develop such a model), CBOE believes that its centralized autoquote system is essential to preserving CBOE's current model of a floor-based, open-outcry market that includes joint crowd obligations pursuant to rules that have been approved by the Commission.Back to Citation
10. Interpretation and Policy .10 to CBOE Rule 8.7 provides that “[m]arket-makers may display indicative spread prices on the websites of member organizations through a system licensed from a third party, developed by the Exchange or otherwise. Such indicative prices shall not be regarded as firm quotes, and a market-maker shall not be obligated to execute at the indicative prices spread orders that are entered into the market.“Back to Citation
11. In approving the proposal, the Commission has considered its impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).Back to Citation
13. The Commission expects the Exchange to monitor the collective actions that are undertaken pursuant to the rule change approved herein for any undesirable or inappropriate anticompetitive effects. The Commission's examination staff will monitor the Exchange's efforts in this regard.Back to Citation
[FR Doc. 02-6902 Filed 3-21-02; 8:45 am]
BILLING CODE 8010-01-P