I. Introduction

On November 12, 2004, the Chicago Board Options Exchange, Inc. (“CBOE” or “Exchange”), filed with the Securities and Exchange Commission (“SEC” or “Commission”) a proposed rule change pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] to amend its rules relating to a designated primary market maker's (“DPMs”) ability to charge a brokerage commission. The proposed rule change was published for comment in the Federal Register on December 15, 2004.^[3] The Commission received two comments on the proposal.^[4] This order approves the proposed rule change.

II. Description

The CBOE proposes to clarify that DPMs cannot charge a brokerage commissions on orders for which they do not perform an agency function, by amending the CBOE's rules to specifically prohibit DPMs from charging a brokerage commission for an order, or the portion of an order, (1) for which the DPM was not the executing broker, which includes any portion of the order that is automatically executed through an Exchange system; (2) that is automatically cancelled; or (3) that is not executed, and not cancelled.

The CBOE also proposes to make a technical clarification to current CBOE Rule 8.85(b)(iv), which currently prohibits a DPM from charging a brokerage commission for an order in which the DPM acts as both principal and agent. The proposed change would clarify that a DPM can charge a brokerage commission for the part of any order for which it acts as the executing broker but not as the executing principal.

III. Summary of Comments

The Commission received two comment letters from DPMs on the Exchange regarding the proposal. One commenter, Susquehanna,^[5] stated that it does not object to the proposed rule change and that it “conceptually agree[s]” that DPMs cannot charge a brokerage commission on orders for which they do not perform an agency function. However, Susquehanna argued that Section 6(e) of the Act ^[6] prohibits the CBOE from requiring a DPM to charge zero commissions on orders for which the DPM has agency or order handling responsibilities. Accordingly, in Susquehanna's view, the CBOE should be required to expressly provide that DPMs never have any agency or order handling responsibilities towards the orders for which they are prohibited from charging a commission.

The second commenter, Citadel,^[7] supported the proposed rule change, stating that “DPMs should not be free unilaterally to impose charges for their regulatorily-mandated functions” and that “the ability to impose non-uniform charges not reflected in market maker quotes would be destructive to best execution and the Intermarket Linkage system because quotes that appear to be the NBBO [National Best Bid or Offer] may not really be the best if one must pay an extra charge to access them.” Citadel also suggested that the CBOE further clarify in the rule text that DPMs may not charge a brokerage commission for “any portion of an order for which the DPM acted in its capacity as a DPM.”

In response to Citadel's comments, the CBOE noted that a DPM is a “member organization that is approved by the Exchange to function in allocated securities as a Market-Maker * * * as a Floor Broker (as defined in Rule 6.70), and as an Order Book Official. * * * ” ^[8] In addition, since DPMs also may be Floor Brokers, the CBOE noted that most DPMs maintain brokerage staff who perform agency functions with respect to certain orders and thus such DPMs should be allowed to charge brokerage commissions on those orders, which they represent in an agency capacity. Further, the CBOE noted that the proposal clarifies that a DPM may not charge a commission for orders when it does not act as agent.

IV. Discussion

The Commission has carefully reviewed the proposed rule change, the comment letters received, and the CBOE's response, and finds that the proposed rule change is consistent with the requirements of Section 6 of the Act ^[9] and the rules and regulations thereunder applicable to a national securities exchange.^[10] In particular, the Commission finds that the proposed rule change is consistent with Sections 6(b)(5) and 6(e)(1) of the Act,^[11] because it is designed 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; and is not designed to permit unfair discrimination between customers, issuers, brokers and dealers, or to impose any schedule or fix rates of commissions, allowances, discounts, or other fees to be charged by its members. The Commission also believes that the proposed rule change is consistent with Section 11(A)(a)(1)(C) of the Act ^[12] which states that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets ( printed page 9688) to assure, among other things, economically efficient execution of securities transactions, and fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets.

The Commission believes that CBOE's proposal is reasonable because it prohibits a DPM from charging a customer a commission for an order executed without assistance or handling by the DPM or that is not executed at all. The Commission notes that Susquehanna suggested that Section 6(e)(1) of the Act ^[13] prohibits the Commission from approving a rule that limits the fees charged by DPMs with respect to orders for which DPMs have agency or order handling responsibilities. The Commission disagrees with this commenter and notes that the Commission has not viewed an SRO's limits on fees that its members may charge, even when the member is acting as agent, as inconsistent with Section 6(e) of the Act.^[14]

Section 6(e) of the Act ^[15] was adopted by Congress in 1975 to statutorily prohibit the fixed minimum commission rate system. As noted in a report of the House of Representatives, one of the purposes of the legislation was to “reverse the industry practice of charging fixed rates of commissions for transactions on the securities exchanges.” ^[16] The fixed minimum commission rate system allowed exchanges to set minimum commission rates that their members had to charge their customers, but allowed members to charge more. CBOE's proposal, by contrast, does not establish a minimum commission rate, but instead prohibits commissions in circumstances in which the DPM is not handling the order or in which the order is not executed. Accordingly, the Commission does not believe that the CBOE's proposal to limit the fees charged by DPMs constitutes fixing commissions, allowances, discounts, or other fees for purposes of Section 6(e)(1) of the Act.^[17]

In addition, CBOE's limits on fees that DPMs may charge applies only to members who choose to be DPMs on CBOE. Therefore, CBOE is not fixing fees generally; it is merely imposing a condition, which is consistent with the Act, on a member's appointment as a DPM. Finally, the Commission does not agree with Susquehanna that the CBOE must expressly provide that DPMs never have any agency obligations towards orders for which they are prohibited from charging a commission.

V. Conclusion

For the foregoing reasons, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, with Sections 6(b)(5) and 6(e)(1) of the Act.^[18]

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[19] that the proposed rule change (SR-CBOE-2004-73) is approved.