[Federal Register Volume 77, Number 174 (Friday, September 7, 2012)]
[Notices]
[Pages 55257-55265]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-22059]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67772; File No. SR-C2-2012-024]
Self-Regulatory Organizations; C2 Options Exchange, Incorporated;
Notice of Filing of a Proposed Rule Change to Adopt a Designated
Primary Market-Maker Program
August 31, 2012.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on August 21, 2012, C2 Options Exchange, Incorporated (the
``Exchange'' or ``C2'') filed with the Securities and Exchange
Commission (the ``Commission'') the proposed rule change as described
in Items I and II below, which Items have been prepared by the
Exchange. The Commission is publishing this notice to solicit comments
on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to adopt a Designated Primary Market-Maker
(``DPM'') program. The text of the proposed rule change is available on
the Exchange's Web site (http://www.c2exchange.com/Legal/), at the
Exchange's Office of the Secretary, at the Commission's Web site
(http://www.sec.gov), and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
The proposed rule change proposes to adopt a DPM program.\3\ The
Exchange believes the DPM program will encourage deeper liquidity in
allocated classes by imposing obligations on DPMs to attract order flow
to the Exchange in allocated securities and to quote competitively.
These proposed Rules also impose special eligibility requirements and
market performance standards on DPMs. As specialists, DPMs will receive
a trade participation right in their allocated classes in exchange for
their heightened responsibilities.
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\3\ The proposed rules are based generally on the rules
governing the DPM program on Chicago Board Options Exchange,
Incorporated (``CBOE''), excluding among other things certain
provisions that are inapplicable to C2 (such as provisions related
to floor trading and CBOE-specific provisions) as well as other
provisions that are outdated. See CBOE Rules 6.45A(a)(ii)(2) and
(iii), 6.45B(a)(i)(2) and (iii), 8.80, 8.83-8.91, 8.95, and
17.50(g)(14). See Item 8 of the Form 19b-4 for a discussion of the
differences between the proposed Rules and the corresponding CBOE
rules.
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DPM Program
Rule 1.1--Definition of DPM 4
The proposed rule change amends Rule 1.1 to adopt a definition of
the term ``Designated Primary Market-Maker'', which is used throughout
the proposed DPM Rules. A DPM is a Participant \5\ organization that is
approved by the Exchange to function in allocated securities as a
Market-Maker and is subject to obligations under proposed Rule 8.17.
The purpose of requiring that a DPM be an organization is to ensure
that each DPM has a formal organizational structure in place to govern
the manner in which it will operate as a DPM. The Exchange believes it
is essential that it have the sole authority to approve a Participant
organization to act as a DPM to ensure that the Participant
organization satisfies the eligibility requirements set forth in
proposed Rule 8.14 and the financial requirements set forth in proposed
Rule 8.18, and can otherwise meet the obligations and responsibilities
of a DPM set forth in proposed Rule 8.17.
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\4\ See CBOE Rule 8.80(a).
\5\ A ``Participant'' is an Exchange-recognized holder of a
Trading Permit, which is an Exchange-issued permit that confers the
ability to transact on the Exchange. See Rule 1.1.
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Rule 8.14--Approval to Act as a DPM 6
Proposed Rule 8.14 addresses the DPM approval process. To act as a
DPM, a Participant must file an application with the Exchange on such
forms as the Exchange may prescribe. The Exchange will determine the
appropriate number of approved DPMs. The Exchange will make each DPM
approval from among the DPM applications on file with the Exchange,
based on the Exchange's judgment as to which applicant is best able to
perform the functions of a DPM. The factors the Exchange may consider
when making this selection include, but are not limited to, any one or
more of the following:
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\6\ See CBOE Rules 8.83, 8.88, and 8.89.
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(1) Adequacy of capital;
(2) operational capacity;
(3) trading experience of and observance of generally accepted
standards of conduct by the applicant and its associated persons;
(4) regulatory history of and history of adherence to Exchange
Rules by the applicant and its associated persons; and
(5) willingness and ability of the applicant and its associated
persons to promote the Exchange as a marketplace.
The following are some examples of the many ways in which the
Exchange may consider these factors:
In considering adequacy of capital of an applicant, the
Exchange may look at whether the applicant meets the financial
requirements set forth in proposed Rule 8.18 and whether it otherwise
has the resources to meet the heightened responsibilities.
In considering operational capacity of an applicant, the
Exchange may look to criteria such as the number of Market-Makers or
personnel and the ability to process order flow in determining whether
it would be able to satisfy the DPM obligations in an efficient manner.
[[Page 55258]]
In considering trading experience of and observance of
generally accepted standards of conduct by the applicant and its
associated persons, the Exchange may look at the applicant's and its
associated persons' history at the Exchange or in the industry, the
trading volume of the applicant and its associated persons, and market
performance reviews in determining whether the applicant would be able
to meet the DPM market performance standards.
In considering the regulatory history of and history of
adherence to Exchange Rules by the applicant and its associated
persons, the Exchange may look to whether the applicant or its
associated persons have been found to have violated Exchange rules or
have been subject to any enforcement proceedings in determining whether
the applicant and its associated persons would comply with obligations
imposed by the DPM Rules and other Rules of the Exchange, as well as
federal securities laws and regulations.
In considering willingness and ability of the applicant
and its associated persons to promote the Exchange as a marketplace,
the Exchange may look at whether the applicant has engaged (or how it
intends to engage) in activities such as assisting in meeting and
educating market participants, maintaining communications with
Participants in order to be responsive to suggestions and complaints,
and responding to suggestions and complaints in determining whether the
applicant could bring order flow to the Exchange.
These are the primary factors that the Exchange believes are
necessary for it to consider when determining whether a DPM applicant
is able to meet the DPM obligations, responsibilities, and market
performance standards imposed by the proposed DPM Rules. Given that the
Exchange may limit the number of approved DPMs, it is important that
the Exchange can reasonably determine that the Participants it approves
to act as DPMs will increase liquidity and quote competitively in order
to attract order flow as intended by the proposed DPM program.
Each applicant for approval as a DPM will have an opportunity to
present any matter that it wishes the Exchange to consider in
conjunction with the approval decision. The Exchange may require that a
presentation be solely or partially in writing, and may require the
submission of additional information from the applicant or its
associated persons. Formal rules of evidence will not apply to these
proceedings. This opportunity will allow a DPM applicant to ensure that
the Exchange considers all information that the DPM applicant deems
relevant, in addition to the standard information described by the
factors above that the Exchange reviews. The Exchange believes the
presentation of this information, in addition to the information
requested by the Exchange, will result in fair and fully informed
decisions by the Exchange during the DPM approval process.
In selecting an applicant for approval as a DPM, the Exchange may
place one or more conditions on the approval, including but not limited
to conditions concerning the capital or operations of or persons
associated with the DPM applicant, and the number or type of securities
that may be allocated to the applicant. Depending on the circumstances
surrounding a specific DPM applicant, the Exchange believes it is
necessary to have the ability to impose conditions on the specific DPM
approval in addition to the obligations otherwise imposed by the DPM
Rules as an additional means to ensure that the DPM applicant is able
to adequately perform the DPM functions.
Each DPM will retain its approval to act as a DPM for one year,
unless the Exchange relieves the DPM of its approval and obligations to
act as a DPM or earlier terminates the DPM's approval to act as a DPM
pursuant to proposed Rule 8.20. After each one-year term, a DPM may
file an application with the Exchange to renew its approval to act as a
DPM on forms prescribed by the Exchange, which renewal application the
Exchange may approve or disapprove in its sole discretion in the same
manner and based on the same factors set forth in proposed Rule 8.14(b)
through (d), and any other factors the Exchange deems relevant
(including an evaluation of the extent to which the DPM has satisfied
its obligations under proposed Rule 8.17). Because the proposed rule
change provides that the Exchange will determine the appropriate number
of approved DPMs in a class, the Exchange believes that having
temporary DPM appointments will provide all Participants with regular
opportunities to be selected as DPMs by the Exchange rather than allow
certain Participants to have perpetual DPM appointments.
If the Exchange terminates or otherwise limits its approval for a
Participant to act as a DPM, the Exchange may do one or both of the
following: (1) Approve a DPM on an interim basis, pending the final
approval of a new DPM; and (2) allocate on an interim basis to another
DPM(s) the securities that were allocated to the affected DPM, pending
a final allocation of the securities pursuant to proposed Rule 8.15 (as
described below). Neither an interim approval nor allocation will be
viewed as a prejudgment with respect to the final approval or
allocation. Interim approvals and allocations will provide
uninterrupted DPM quoting in appointed classes and prevent any reduced
liquidity in those classes that could otherwise result from a
termination, condition, or limit on a DPM's approval or allocation.
Proposed Rule 8.14(g) provides that DPM appointments may not be
sold, assigned, or otherwise transferred without prior written approval
of the Exchange. This provision clarifies that only the Exchange may
authorize a firm to act as a DPM, which will allow the Exchange to
ensure that a Participant is qualified to adequately perform DPM
functions and fulfill its obligations and responsibilities as a DPM
under the proposed DPM Rules.
Rule 8.15--Allocation of Securities to DPMs 7
Proposed Rule 8.15 sets forth the manner in which the Exchange will
allocate securities to DPMs. Proposed Rule 8.15(a) provides that the
Exchange will determine for each security traded on the Exchange
whether the security should be allocated to a DPM and, if so, to which
DPM the security should be allocated. The proposed rule change could
produce additional quotation volume in classes that are allocated to
DPMs. The Exchange maintains a rigorous capacity planning program that
monitors system performance and projected capacity demands and, as a
general matter, considers the potential system capacity impact of all
new initiatives. The Exchange has analyzed the potential for additional
quote traffic resulting from the addition of DPMs and has concluded
that the Exchange has sufficient system capacity to handle those
additional quotes without degrading the performance of its systems. The
Exchange also notes that any additional quote traffic will be limited,
as the Exchange may allocate securities to DPMs on a class-by-class
basis as opposed to allocating all classes to DPMs. Ultimately, the
Exchange believes that it has the necessary systems capacity to
allocate option classes to DPMs as described in this proposed rule
change. The Exchange will monitor quoting volume associated with DPMs
and its effect on C2's systems.
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\7\ See CBOE Rule 8.95.
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Proposed Rule 8.15(b) describes the criteria that the Exchange may
consider in making allocation determinations.
[[Page 55259]]
The factors the Exchange may consider when making these determinations
include, but are not limited to, any one or more of the following:
Performance, volume, capacity, market performance commitments,
operational factors, efficiency, competitiveness, environment in which
the security will be traded, expressed preferences of issuers, and
recommendations of any Exchange committees. The following are some
examples of the many ways in which these criteria may be applied:
In considering performance, the Exchange may look at the
market performance ranking of the applicable DPMs, as established by
market performance reviews that are conducted by the Exchange.
In considering volume, the Exchange may look at the
anticipated trading volume of the security and the trading volume
attributable to the applicable DPMs in determining which DPMs would be
best able to handle the additional volume.
In considering capacity, operational factors, and
efficiency, the Exchange may look to criteria such as the number of
Market-Makers or DPM personnel, the ability to process order flow, and
the amount of DPM capital in determining which DPMs would be best able
to handle additional securities.
In considering marketing performance commitments, the
Exchange may look at the pledges a DPM has made with respect to how
narrow its bid-ask spreads will be and the number of contracts for
which it will honor its disseminated market quotations beyond what is
required by Exchange Rules.
In considering competitiveness, the Exchange may look at
percentage of volume attributable to a DPM in allocated securities that
are multiply listed.
In considering the environment in which the security will
be traded, the Exchange may seek a proportionate distribution of
securities between the Market-Maker system and the DPM system and
across different DPMs.
In considering expressed preferences of issuers, the
Exchange may consider the views of the issuer of a security traded on
the Exchange with respect to the allocation of that security or to the
licensor of an index on which an index option is based with respect to
the allocation of that index option.
The Exchange may consider the recommendation of any
Exchange committees, particularly those that evaluate DPM market
performance.
Proposed Rule 8.15(c) provides that the Exchange may remove an
allocation and reallocate the applicable security during a DPM's term
if the DPM fails to adhere to any market performance commitments made
by the DPM in connection with receiving the allocation. The Exchange
typically requests that DPMs make market performance commitments as
part of their applications to receive allocations of particular
securities. As described above, these commitments may relate to pledges
to keep bid-ask spreads within a particular width or to make
disseminated quotes firm for a designated number of contracts beyond
what is required by Exchange Rules. Proposed Rule 8.15(c) permits the
Exchange to remove an allocation if these commitments are not met,
which the Exchange believes will incentive [sic] DPMs to abide by these
commitments. The Exchange believes these types of commitments will be
instrumental in causing DPMs to quote more competitively.
Proposed Rule 8.15(c) also provides that the Exchange may change an
allocation determination if it concludes that doing so is in the best
interests of the Exchange based on operational factors or efficiency.
For example, if, due to market conditions, trading volume in a security
greatly increased over a very short time frame and the DPM allocated
that security could not handle the additional order flow, the Exchange
may deem it necessary to reallocate the security to another DPM with
the capacity to do so. This provision will allow the Exchange to ensure
that there is sufficient liquidity during trading hours in the
allocated option classes.
Proposed Rule 8.15(d) provides that prior to taking any action to
remove an allocation, the Exchange will generally give the DPM prior
notice of the contemplated action and an opportunity to be heard
concerning the action. The only exception to this requirement would be
in those unusual situations when expeditious action is required due to
extreme market volatility or some other situation requiring emergency
action. Specifically, except when expeditious action is required,
proposed Rule 8.15(d) requires that prior to taking any action to
remove an allocation, the Exchange must notify the DPM involved of the
reasons the Exchange is considering taking the contemplated action, and
will either convene one or more informal meetings with the DPM to
discuss the matter, or provide the DPM with the opportunity to submit a
written statement to the Exchange concerning the matter. Due to the
informal nature of the meetings provided for under proposed Rule
8.15(d) and in order to encourage constructive communication between
the Exchange and the affected DPM at those meetings, ordinarily neither
counsel for the Exchange nor counsel for the DPM will be invited to
attend these meetings and no verbatim record of the meetings will be
kept.
As with any decision made by the Exchange, any person adversely
affected by a decision made by the Exchange to remove an allocation may
appeal the decision to the Exchange under Chapter 19 of the Exchange
Rules. The appeal procedures in Chapter 19 provide for the right to a
formal hearing concerning any such decision and for the right to be
accompanied, represented, and advised by counsel at all stages of the
proceeding. In addition, any decision of the Exchange's Appeals
Committee may be appealed to the Board of Directors pursuant to CBOE
Rule 19.5 (which is incorporated into the Exchange Rules). The Exchange
believes these hearing and appeal procedures will provide DPMs with
appropriate due process with respect to decisions made regarding their
DPM allocations and will promote a fair and fully informed decision-
making process.
Proposed Rule 8.15(e) provides that the allocation of a security to
a DPM does not convey ownership rights in the allocation or in the
order flow associated with the allocation. Proposed Rule 8.15(e) is
intended to make clear that DPMs may not buy, sell, or otherwise
transfer an allocation and that, instead, the Exchange has the sole
authority to determine allocations. As discussed above, DPM
appointments may only be transferred with Exchange approval pursuant to
proposed Rule 8.14(g).
Proposed Rule 8.15(f) provides that in allocating and reallocating
securities to DPMs, the Exchange will act in accordance with any
limitation or restriction on the allocation of securities that is
established pursuant to another Exchange Rule. For example, the
Exchange may take remedial action against a DPM for failure to satisfy
minimum market performance standards, and such action may involve a
restriction related to the allocation of securities to that DPM.
Similarly, the Exchange may place restrictions on a DPM's ability to
receive or retain allocations of securities pursuant to various
provisions of these proposed Rules, including as a condition of
appointment as a DPM (proposed Rule 8.14(d)), due to failure to perform
DPM functions (proposed Rule 8.20(a)(2)), or due to a material
financial or operational change (proposed Rule 8.20)(a)(1)). Proposed
Rule 8.15(f) is intended to make clear that the
[[Page 55260]]
Exchange must act in accordance with any of these restrictions in
making allocation determinations.
Proposed Rule 8.15, Interpretation and Policy .01 generally
provides that the Exchange may reallocate a security at the end of a
DPM's one-year term, in the event that the security is removed pursuant
to another Exchange Rule from the DPM to which the security has been
allocated, or in the event that for some other reason the DPM to which
the security has been allocated no longer retains the allocation. For
example, at the end of a DPM's term, the Exchange may allocate the
security to the same DPM again (if the DPM applied for its appointment
to be renewed and the Exchange approved the renewal application), to
another DPM, or to no DPM. As another example, as described above, the
Exchange may take remedial actions against DPMs in specified
circumstances, including the removal of an allocation. Proposed Rule
8.15, Interpretation and Policy .01 is intended to clarify that in the
event the Exchange removes an allocation pursuant to Exchange Rules,
the Exchange will reallocate the security pursuant to proposed Rule
8.15. The only exception to this provision is that the Exchange is
authorized pursuant to proposed Rule 8.14(f) to allocate to an interim
DPM on a temporary basis a security that is removed from another DPM
until the Exchange has made a final allocation of the security. As with
several other proposed Rules, this provision is intended allow the
Exchange to ensure that there is sufficient liquidity in allocated
classes despite changing circumstances.
Rule 8.16--Conditions on the Allocation of Securities to DPMs \8\
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\8\ See CBOE Rule 8.84.
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Proposed Rule 8.16 allows the Exchange to establish (1)
restrictions applicable to all DPMs on the concentration of securities
allocable to a single DPM and to affiliated DPMs and (2) minimum
eligibility standards applicable to all DPMs, which must be satisfied
in order for a DPM to receive allocations of securities, including but
not limited to standards relating to adequacy of capital and
operational capacity (including number of personnel). Among the reasons
for granting the Exchange the authority to limit the concentration of
securities allocable to a single DPM and to affiliated DPMs is to
promote competition in the Exchange's market and to help ensure that no
DPM or group of affiliated DPMs is allocated such a large number of
securities that it would be difficult for the Exchange to quickly
reallocate those securities to other DPMs or Market-Makers in the event
that for some reason the DPM or group of affiliated DPMs were no longer
able to perform in that capacity. Among the reasons for granting the
Exchange the authority to establish minimum eligibility standards for
DPMs to receive allocations of securities is to help ensure that a DPM
has the financial and operational ability to handle additional
allocations of securities and meet its DPM obligations with respect to
those securities. Similarly, the Exchange may utilize this proposed
Rule to establish specific minimum market performance standards that
must be satisfied by DPMs in order to receive allocations of securities
so that a DPM that is not performing adequately with respect to the
securities that have already been allocated to the DPM is not allocated
additional securities.
Rule 8.17--DPM Obligations \9\
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\9\ See CBOE Rule 8.85.
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Proposed Rule 8.17 describes the obligations of a DPM. Proposed
Rule 8.17(a) includes the general obligation with respect to each of
its allocated securities to fulfill all of the obligations of a Market-
Maker under Exchange Rules in addition to the requirements set forth in
this proposed Rule.\10\ Proposed Rule 8.17(a) requires each DPM:
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\10\ To the extent there is any inconsistency between the
specific obligations of a DPM set forth in proposed Rule 8.17 and
the general obligations of a Market-Maker under the Exchange Rules,
proposed Rule 8.17 will govern.
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(1) To provide continuous quotes in at least the lesser of 99% of
the non-adjusted option series (as defined in Rule 8.5(a)(1)) or 100%
of the non-adjusted option series minus one call-put pair of each
option class allocated to it, with the term ``call-put pair'' referring
to one call and one put that cover the same underlying instrument and
have the same expiration date and exercise price, and assure that its
disseminated market quotations are accurate; \11\
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\11\ For purposes of this provision, ``continuous'' means 90% of
the time. If a technical failure or limitation of the System
prevents a DPM from maintaining, or from communicating to the
Exchange, timely and accurate quotes in a series, the duration of
such failure will not be considered in determining whether that that
[sic] DPM has satisfied the 99% quoting standard with respect to the
series.
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(2) to assure that each of its displayed market quotations are for
the number of contracts required by Rule 8.6(a), ``Market-Maker Firm
Quotes'';
(3) to segregate in a manner prescribed by the Exchange (a) all
transactions consummated by the DPM in securities allocated to the DPM
and (b) any other transactions consummated by or on behalf of the DPM
that are related to the DPM's DPM business; \12\
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\12\ This will permit the Exchange to monitor each DPM's trading
positions in order to ensure that the DPM is in compliance with the
financial and other requirements that are applicable DPMs.
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(4) to not initiate a transaction for the DPM's own account that
would result in putting into effect any stop or stop limit order that
may be in the Book \13\ and when the DPM guarantees that the stop or
stop limit order will be executed at the same price as the electing
transaction; \14\ and
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\13\ The term ``Book'' means the electronic book of buy and sell
orders and quotes maintained by the System. The ``System'' is the
automated trading system used by the Exchange for the trading of
options contracts. See Rule 1.1.
\14\ These restrictions apply to stop or stop limit orders only
if the terms of such orders are visible to the DPM or if such orders
are handled by the DPM.
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(5) to ensure that a trading rotation is initiated promptly
following the opening of the underlying security (or promptly after
8:30 a.m. Central Time in an index class) in accordance with Rule 6.11
in 100% of the series of each allocated class by entering opening
quotes as necessary.
Proposed Rule 8.17(b) provides that a DPM may not represent
discretionary orders as an agent in its allocated classes.
Proposed Rule 8.17(c) lists additional obligations of a DPM,
including that a DPM must:
(1) Resolve disputes relating to transactions in the securities
allocated to the DPM, subject to Exchange official review, upon the
request of any party to the dispute;
(2) make competitive markets on the Exchange and otherwise promote
the Exchange in a manner that is likely to enhance the ability of the
Exchange to compete successfully for order flow in the classes it
trades;
(3) promptly inform the Exchange of any material change in the
financial or operational condition of the DPM;
(4) supervise all persons associated with the DPM to assure
compliance with the Exchange Rules;
(5) segregate in a manner prescribed by the Exchange the DPM's
business and activities as a DPM from the DPM's other business and
activities; \15\ and
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\15\ This requirement will help reduce the risk that a DPM's
financial integrity will be adversely impacted by financial losses
that may be incurred by the DPM in connection with its other
businesses and activities.
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(6) continue to act as a DPM and to fulfill all of the DPM's
obligations as a DPM until its DPM appointment has lapsed, the Exchange
relieves the DPM
[[Page 55261]]
of its approval and obligations to act as a DPM, or the Exchange
terminates the DPM's approval to act as a DPM pursuant to proposed Rule
8.20.
Proposed Rule 8.17(d) provides that each person associated with a
DPM will be obligated to comply with the provisions of proposed Rule
8.17(a) through (c) when acting on behalf of the DPM.
Proposed Rule 8.17(e) provides that each DPM must hold the number
of Trading Permits as may be necessary based on the aggregate
``registration cost'' for the classes allocated to the DPM. Each
Trading Permit held by the DPM has a registration cost of 1.0.\16\ For
example, if the Exchange allocates to a DPM classes with an aggregate
registration cost of 1.6, the DPM would be required to hold two Trading
Permits. The Exchange may change at any time the registration cost of
any option class; upon any such change, each DPM will be required to
hold the appropriate number of Trading Permits reflecting the revised
registration costs of the classes that have been allocated to it.
Additionally, a DPM is required to hold the appropriate number of
Trading Permits at the time a new option class is allocated to it
pursuant to proposed Rule 8.16 begins trading.
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\16\ Rule 8.2(d) lists the registration costs for the classes of
securities on the Exchange.
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In the event a Participant approved as a DPM is also approved to
act as a Market-Maker and has excess Trading Permit capacity above the
aggregate registration cost for the classes allocated to it as the DPM,
the Participant may utilize the excess Trading Permit capacity to quote
in an appropriate number of classes in the capacity of a Market-Maker.
For example, if the DPM has been allocated a number of option classes
with an aggregate registration cost of 1.6, the Participant could
request an appointment as a Market-Maker in any combination of option
classes whose aggregate registration cost does not exceed 0.40. The
Participant will not function as a DPM in any of these additional
classes. In the event the Participant utilizes any excess Trading
Permit capacity to quote in some additional classes as a Market-Maker,
it must comply with the provisions of Rule 8.2.
Rule 8.17, Interpretation and Policy .01 clarifies that willingness
of a DPM to promote the Exchange as a marketplace includes assisting in
meeting and educating Participants (and taking the time for travel
related thereto), maintaining communications with Participants in order
to be responsive to suggestions and complaints, responding to
suggestions and complaints, and other like activities.
The Exchange believes that these obligations will result in
additional liquidity and competitive quoting in the allocated classes
on C2's market, which could ultimately lead to additional order flow
directed to the Exchange. The Exchange believes that these obligations
will strengthen its market and are reasonable given the benefits
conferred upon DPMs in exchange for these heightened obligations in the
form of a participation entitlement, as discussed further below.
Rule 8.18--DPM Financial Requirements \17\
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\17\ See CBOE Rule 8.86.
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Proposed Rule 8.18 requires each DPM to maintain net liquidating
equity in its DPM account of not less than $100,000. It also requires
each DPM to maintain net capital sufficient to comply with the
requirements of Rule 15c3-1 under the Act and requires each DPM that is
a Clearing Participant \18\ also to maintain net capital sufficient to
comply with the requirements of The Options Clearing Corporation.
Additionally, proposed Rule 8.18 requires DPMs to maintain net
liquidating equity in their DPM accounts in conformity with any
guidelines as the Exchange may establish from time to time. The
Exchange expects to draft and use DPM financial guidelines in
connection with the process for allocating securities to DPMs, and
proposed Rule 8.18 would permit the Exchange to implement and enforce
these guidelines as DPM financial requirements under Exchange Rules.
The Exchange will announce these guidelines to Participants by
Regulatory Circular. Although there are other rules that already
subject DPMs to these financial requirements (and all Market-Makers
must comply with the Act requirements applicable to specialists,
including financial requirements), the Exchange believes that it is
worthwhile to also include these requirements in proposed Rule 8.18 so
that the proposed DPM Rules are more informative and complete.
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\18\ A ``Clearing Participant'' means a Permit Holder that has
been admitted to membership in The Options Clearing Corporation
(``OCC'') pursuant to the provisions of OCC rules. A ``Permit
Holder'' means the Exchange recognized holder of a Trading Permit. A
Permit Holder is also known as a Trading Permit Holder under the
Exchange's Bylaws. Permit Holders are deemed ``members'' under the
Act. See Rule 1.1.
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Rule 8.19--Participation Entitlement of DPMs \19\
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\19\ See CBOE Rule 8.90 [sic].
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Rule 6.12 sets forth how the System prioritizes orders for
execution purposes. Rule 6.12(a)(3) provides that the Exchange may
prioritize orders using a price-time priority with primary priority for
public customers and secondary priority for certain trade participation
rights. Proposed Rule 8.19 grants to DPMs a trade participation right.
Proposed Rule 8.19(a) gives the Exchange authority to determine the
appropriate participation right for DPMs by providing that the
Exchange, subject to review by the Exchange Board of Directors, may
establish from time to time a participation entitlement formula that is
applicable to all DPMs.
Proposed Rule 8.19(b)(1) provides that: (1) A DPM will be entitled
to a participation entitlement only if quoting at the best bid or offer
disseminated on the Exchange (``BBO''); (2) a DPM may not be allocated
a total quantity greater than the quantity that the DPM is quoting at
the BBO; and (3) the participation entitlement is based on the number
of contracts remaining after all public customer orders in the Book at
the BBO have been satisfied.
Proposed Rule 8.19(b)(2) provides that the collective DPM
participation entitlement shall be: 50% when there is one Market-Maker
also quoting at the BBO and 40% when there are two or more Market-
Makers also quoting at the BBO. If only the DPM is quoting at the BBO
(with no Market-Makers quoting at the BBO), the participation
entitlement will not be applicable and the allocation procedures under
Rule 6.12 will apply.
Proposed Rule 8.19(b)(3) provides that a DPM will not receive its
participation entitlement in trades for which a Preferred Market-Maker
(``PMM'') already received a participation entitlement pursuant to Rule
8.13, based on the priority determination made by the Exchange under
Rule 6.12. This provision clarifies that only one trade participation
right may be applied to the same trade (see the discussion of the
proposed rule change to Rule 6.12(a) below). For example, if the
Exchange has activated both a PMM participation right and DPM
participation right in a class and determines under Rule 6.12 that a
PMM has higher priority than a DPM, and a PMM receives its
participation entitlement for a trade, then a DPM may not receive its
participation entitlement for that trade.
Proposed Rule 8.19, Interpretation and Policy .01 provides that the
Exchange may also establish a lower
[[Page 55262]]
DPM participation rate on a product-by-product basis for newly listed
products or products that are being allocated to a DPM for the first
time. The Exchange will announce any lower participation rate to
Participants by Regulatory Circular.
The Exchange believes that DPMs will play an important role in
providing additional liquidity and more price competition because of
the obligations imposed on DPMs by the proposed Rules, as discussed
above. The Exchange also believes that the proposed participation
entitlement, which DPMs may receive only when quoting at the best
price, is an appropriate reward for DPMs' satisfaction of their DPM
obligations, particularly given the overall benefit to the Exchange's
market and customers that the additional DPM liquidity will create.
Further, the Exchange believes that the limited percentage of the
participation entitlement still provides other market participants with
opportunities to be allocated a significant number of contracts in
trades in which a DPM receives its participation entitlement.
Similarly, the Exchange believes it is appropriate to only allow a PMM
or DPM to receive its participation entitlement for a trade to further
ensure that these opportunities are available to other market
participants in classes with a DPM or PMM. While the Exchange believes
that DPMs will add liquidity to the benefit of the market and
customers, it is still important for all market participations to
engage in price competition on the Exchange. This participation
entitlement is part of the Exchange's careful balancing of the rewards
and obligations of all types of Exchange Participants, which is part of
the overall market structure designed to encourage vigorous price
competition among Market-Makers, while still maximizing the benefits or
price competition resulting from the entry of customer and non-customer
orders, while encouraging Participants to provide market depth.
Rule 8.20--Termination, Conditioning, or Limiting Approval to Act as a
DPM \20\
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\20\ See CBOE Rule 8.90.
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Proposed Rule 8.20 governs the termination, conditioning, and
limiting of approval to act as a DPM. Rule 8.20(a) provides that the
Exchange may terminate, place conditions upon, or limit a Participant's
approval to act as a DPM if the Participant: (1) Incurs a material
financial or operational; (2) fails to comply with any requirements
under Exchange Rules regarding DPM obligations and responsibilities; or
(3) is no longer eligible to act as DPM or be allocated a particular
security or securities. Proposed Rule 8.20(a) also provides that before
the Exchange may take any action to terminate, condition, or otherwise
limit a Participant's approval to act as a DPM, the Participant will be
given notice of such possible action and an opportunity to present any
matter that it wishes the Exchange to consider in determining whether
to take such action. These proceedings will be conducted in the same
manner as the Exchange proceedings concerning DPM approvals described
above.
Proposed Rule 8.20(b) provides an exception to this provision,
which grants authority to the Exchange to immediately terminate,
condition, or otherwise limit a Participant's approval to act as a DPM
if the DPM incurs a material financial or operational warranting
immediate action or if the DPM fails to comply with any of the
financial requirements applicable to DPMs.
In addition, proposed Rule 8.20(c) provides that limiting a
Participant's approval to act as a DPM may include, among other things,
limiting or withdrawing a DPM's participation entitlement and
withdrawing a DPM's right to act as DPM in one or more of its allocated
securities.
As discussed above, it is important for the Exchange to have the
sole authority to approve a Participant to act as a DPM (and allocate
securities to a DPM) to ensure that the Participant is able to satisfy
DPM obligations and perform DPM functions. Similarly, the Exchange
needs authority to terminate, condition, or limit a DPM's approval when
necessary to incentive DPMs to meet their DPM obligations and
responsibilities in order to continue to receive the corresponding DPM
benefits provided for in the proposed DPM Rules. In addition, if any of
the circumstances set forth in proposed Rule 8.20(a) occurs, the
Exchange's authority to terminate, condition, or limit a DPM's
approval, and appoint another DPM if necessary (in the interim or
permanently as discussed above), is essential to provide for
uninterrupted DPM quoting in appointed classes and prevent any reduced
liquidity in the DPM's allocated class that could otherwise result
under these circumstances.
Proposed Rule 8.20(d) provides that if a Participant's approval to
act as a DPM is terminated, conditioned, or otherwise limited by the
Exchange pursuant to proposed Rule 8.20, the Participant may appeal
that decision to the Appeals Committee under Chapter 19. Additionally,
as is described above, these appeal procedures provide for the right to
a formal Appeals Committee hearing concerning any such decision, and
the decision of the Appeals Committee may be appealed to the Board of
Directors. The advanced notice and appeal procedures are intended to
ensure that DPMs receive appropriate due process with respect to their
approvals to act as DPMs, as discussed above.
Rule 8.21--Limitations on Dealings of DPMs and Affiliated Persons of
DPMs \21\
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\21\ See CBOE Rule 8.91.
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Proposed Rule 8.21 provides that a DPM must maintain information
barriers that are reasonably designed to prevent the misuse of
material, non-public information with any affiliates that may conduct a
brokerage business in option classes allocated to the DPM or act as a
specialist or market-maker in any security underlying options allocated
to the DPM, and otherwise comply with the requirements of CBOE Rule
4.18 (which is incorporated into the Exchange Rules) regarding the
misuse of material non-public information. A DPM must provide its
information barriers to the Exchange and obtain prior written approval.
This provision is meant to prevent a Participant's non-DPM businesses
from obtaining any benefits as a result of the Participant's status as
a DPM.
Rule 6.12--Order Execution and Priority \22\
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\22\ See CBOE Rules 6.45A(a)(ii)(2) and (iii) and 6.45B(a)(i)(2)
and (iii).
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The proposed rule change amends Rule 6.12 to ensure that the
Exchange's order execution and priority rule contemplates a
participation entitlement for DPMs. The proposed rule change provides
that both PMMs and DPMs may be granted participation rights up to the
applicable participation right percentage designated in Rule 8.13 and
8.19, respectively. The Exchange may activate more than one trade
participation right for an option class (including at different
priority sequences), however in no case may more than one trade
participation right be applied on the same trade.\23\ The
[[Page 55263]]
proposed rule change provides that, like for PMMs, (1) a DPM's order or
quote must be at the best price on the Exchange; (2) a DPM may not be
allocated a total quantity greater than the quantity that it is quoting
(including orders not part of quotes) at that price; (3) in
establishing the counterparties to a particular trade, the DPM's
participation right must be first counted against its highest priority
bids or offers; and (4) the DPM's participation right will only apply
to any remaining balance of an order once all higher priorities are
satisfied.
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\23\ For example, the Exchange may activate both the PMM trade
participation right of Rule 8.13 and the DPM trade participation
right of Rule 8.20, along with other priorities that are allowed
under Rule 6.12(a)(3), for an option class at the following priority
levels: Public customer has first priority, Market Turner (see Rule
6.12(b)(1)) has second priority, PMM participation right has third
priority, and DPM participation right has fourth priority. If a
PMM's participation right is applied to a trade, then the DPM's
participation right cannot be applied to that trade, and the trade
would be allocated as follows: First to any public customers, second
to the Market Turner, third to the PMM's participation right, and
the remainder to other orders in price-time priority. However, if a
PMM's participation right was not applied to the trade, then the
DPM's participation right could be applied to the trade, and the
trade would be allocated as follows: First to any public customers,
second to the Market Turner, third to the DPM's participation right,
and the remainder to other orders in price-time priority.
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The proposed rule change also amends Rule 6.12 to add paragraph
(b)(2), which will provide for an additional priority overlay for small
orders that can be applied to each of the three matching algorithms. If
the small order priority overlay is in effect for an option class,\24\
then the following would apply:
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\24\ As set forth in Rule 6.12(b), the Exchange may determine to
apply, on a series-by-series basis, any additional priority overlays
in subparagraph (b) in a sequence determined by the Exchange.
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Orders for five contracts or fewer will be executed first
by the DPM that is appointed to the option class; provided, however,
that, on a quarterly basis, the Exchange will evaluate what percentage
of the volume executed on the Exchange (excluding volume resulting from
the execution of orders in C2's Automated Improvement Mechanism
(``AIM'')--see Rule 6.51) is comprised of orders for five contracts or
fewer executed by DPMs, and will reduce the size of the orders included
in this provision if this percentage is over 40%.
This procedure will only apply to the allocation of
executions among non-customer orders and Market-Maker quotes existing
in the Book at the time the Exchange receives the order. No market
participant will be allocated any portion of an execution unless it has
an existing interest at the execution price. Moreover, no market
participant will be able to execute a greater number of contracts than
is associated with the price of its existing interest. As a result, the
small order preference contained in this allocation procedure will not
be a guarantee; the DPM (1) must be quoting at the execution price to
receive an allocation of any size, and (2) cannot execute a greater
number of contracts than the size that is associated with its quote.
If a PMM is not quoting at a price equal to the national
best bid or offer (the ``NBBO'') at the time a preferred order is
received, the allocation procedure for small orders described above
will be applied to the execution of the preferred order (i.e., it will
be executed first by the DPM). If a PMM is quoting at the NBBO at the
time the preferred order is received, the allocation procedure in place
for all other sized orders in the class will be applied to the
execution of the preferred order, except that any Market Turner status
will not apply (e.g., if the default matching algorithm is price-time
with a public customer and participation entitlement overlay, the order
will execute first against any public customer orders, then the PMM
would receive its participation entitlement, then the remaining balance
would be allocated on a price-time basis).
The small order priority overlay will only be applicable
to automatic executions and will not be applicable to any auctions.\25\
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\25\ In addition to AIM, C2 has various electronic auctions that
are described under Rules 6.14, ``Simple Auction Liaison,'' and
6.52, ``Solicitation Auction Mechanism.'' Each of these auctions
generally allocates executions pursuant to the matching algorithm in
effect for the options class with certain exceptions noted in the
respective rules.
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Lastly, like the existing priority overlays, the small order
priority overlay is optional. The Exchange will announce all
determinations under this Rule by Regulatory Circular.
As described above, the Exchange believes that because DPMs will
have unique obligations to the C2 market,\26\ they should be provided
with certain participation rights. Under the proposed DPM Rules in this
filing, if the DPM is one of the Participants with a quote at the best
price, the participation entitlement will generally equal to 50% when
there is one Market-Maker also quoting at the BBO or 40% when there are
two or more Market-Makers also quoting at the BBO.\27\ This proposed
priority overly [sic] will make available an allocation procedure that
provides that the DPM has precedence to execute orders of five
contracts or fewer. The Exchange believes that this small order
priority overlay will not necessarily result in a significant portion
of the Exchange's volume being executed by the DPM. As stated above,
the DPM would execute against these small orders only if it is quoting
at the best price, and only for the number of contracts associated with
its quotation. Nevertheless, the Exchange will evaluate what percentage
of the volume executed on the Exchange is comprised of orders for five
contracts or fewer executed by DPMs, and will reduce the size of the
orders included in this provision if this percentage is over 40%.
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\26\ See proposed Rule 8.17, ``DPM Obligations.''
\27\ See proposed amendment to Rule 6.12(a) and proposed Rule
8.19, ``Participation Entitlement of DPMs.''
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C2 considered this small order priority overlay as part of its
balancing of DPM obligations and benefits described above and believes
this priority overlay, which includes participation rights for DPMs
only when they are quoting at the best price, helps strike an
appropriate balance of these obligations and benefits.
Other Changes
Rule 1.1--Definitions
The proposed rule change amends Rule 1.1 to define the term ``BBO''
as the best bid or offer disseminated on the Exchange. The Exchange
proposes to include this definition to clarify its meaning in the
Exchange Rules because the term is used throughout the proposed DPM
Rules as well as other Exchange Rules.
Rule 17.50--Minor Rule Violation Plan \28\
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\28\ See CBOE Rule 17.50(g)(14).
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The proposed rule change also amends Rule 17.50(g)(14) to add DPM
quoting obligations to the Exchange's Minor Rule Violation Plan
(``MRVP'') provision regarding C2 Market-Maker quoting obligations.
This will allow the Exchange to impose sanctions upon DPMs for failing
to meet their quoting obligations pursuant to the MRVP, as it does for
Market-Makers and PMMs. C2 believes these violations are suitable for
inclusion in the MRVP because they are generally technical in nature,
allowing C2 to carry out its regulatory responsibilities more quickly
and efficiently with respect to Market-Maker quoting obligations. For
violations of DPM's quoting obligations, the Exchange may assess fines
ranging from $2,000 to $4,000 for a first offense and $4,000 to $5,000
for a second offense, and may assess a fine of $5,000 or refer to C2's
Business Conduct Committee any subsequent offenses. The Exchange notes
that these fine amounts are the same as the amounts currently imposed
on Market-Makers for violations of their quoting obligations under the
MRVP.
C2 will maintain internal guidelines that dictate the sanctions
that will be imposed for a particular violation (based on the degree of
the violation). As with all other violations in C2's MRVP, C2
[[Page 55264]]
will retain the ability to refer a violation of DPM quoting obligations
to its Business Conduct Committee should the circumstances warrant this
referral.
2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Act and the rules and regulations thereunder applicable to the
Exchange and, in particular, the requirements of Section 6(b) of the
Act.\29\ Specifically, the Exchange believes the proposed rule change
is consistent with the Section 6(b)(5) \30\ requirements that the rules
of an exchange be designed to promote just and equitable principles of
trade, to prevent fraudulent and manipulative acts, to remove
impediments to and to perfect the mechanism for a free and open market
and a national market system, and, in general, to protect investors and
the public interest.
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\29\ 15 U.S.C. 78f(b).
\30\ 15 U.S.C. 78f(b)(5).
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In particular, the Exchange believes that adopting a DPM program
will protect investors and the public interest, because it will help
generate greater order flow for the Exchange in appointed classes and
provide additional incentives for DPMs to trade with that order flow,
which in turn adds depth and liquidity to C2's market and ultimately
benefits all market participants. The Exchange believes this deeper
liquidity will make C2 more competitive with other markets that trade
those classes, which will also help remove impediments to and perfect
the mechanism for a free and open market.
Additionally, the Exchange believes that adopting a DPM program
will promote just and equitable principles of trade, as it will require
DPMs to assist in the maintenance of a fair and orderly market, as
reasonably practicable, and maintain net capital consistent with
federal requirements for market-makers. These proposed Rules impose
many obligations on DPMs, including continuous two-sided quoting
obligations, which will ensure that DPMs provide significant liquidity
in their allocated classes to the benefit of all C2 market
participants, and operational capacity requirements, which will ensure
that DPMs are capable of carrying out their obligations, as well as
eligibility requirements and market performance standards. The proposed
Rules also allow the Exchange to impose conditions on DPMs or their
allocations to further ensure that DPMs are providing appropriate depth
and liquidity in their allocated classes.
In light of these obligations, the Exchange also proposed to
provide DPMs with the benefit of a participation entitlement that may
receive higher priority for trades than other Participants, subject to
the requirements set forth in proposed Rule 8.19(b)(1), as well as a
small order priority overlay, subject to the requirements set forth in
proposed Rule 6.12(b)(2). While these trade priorities may reduce the
number of contracts that other Participants may execute in trades in
which the DPM participation entitlement, or small order priority
overlay is applied, the Exchange believes this fact is outweighed by
the benefit of the additional liquidity and more competitive pricing
that DPMs will provide to the market in their appointed classes,
ultimately resulting in a net benefit to Exchange customers. These
trade priorities are part of the balancing of C2's overall market
structure, which is designed to encourage vigorous price competition
between Market-Makers on the Exchange, as well as maximize the benefits
of price competition resulting from the entry of customer and non-
customer orders, while encouraging Participants to provide market
depth. Therefore, the Exchange believes the obligations proposed to be
imposed on DPMs are offset by the benefits proposed to be conferred
upon DPMs.
In addition, the Exchange believes that the approval and allocation
procedures and policies will ensure that Participants are approved to
act as DPMs and securities traded on the Exchange are allocated in an
equitable manner, and that all DPMs will have a fair opportunity for
approvals and allocations based on established criteria and procedures.
The proposed rules that give the Exchange the authority to terminate,
limit, or condition DPM approvals or reallocate securities will allow
the Exchange to ensure that its market maintains an uninterrupted high
level of liquidity for customers in allocated classes, even when
unusual or changing market circumstances exist. Further, the Exchange
believes that the advanced notice provisions and appeal procedures that
the proposed rules put in place for all determinations made by the
Exchange with respect to DPM approvals and allocations, including
termination and reallocation decisions, are reasonable procedures that
will create a fair and equitable decision-making process with respect
to DPMs.
The Exchange believes the proposed rule change to add violations of
DPM quoting obligation to C2's MRVP will strengthen C2's ability to
carry out its regulatory responsibilities as a self-regulatory
organization pursuant to the Act and reinforce its surveillance and
enforcement functions.
The Exchange believes that adding the definition of BBO to the
Rules protects investors and the public interest, as it clarifies the
meaning of this term, which is used throughout the proposed DPM Rules
and other Exchange Rules, for investors.
Finally, the Exchange believes that the proposed rule change is
consistent with the requirements of the Act because, as the Exchange
notes above, the proposed requirements for DPMs are based primarily on
existing requirements for DPMs on another exchange (CBOE).
B. Self-Regulatory Organization's Statement on Burden on Competition
C2 does not believe that the proposed rule change will impose any
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange neither solicited nor received comments on the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove the proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change 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 email to [email protected]. Please include
File No. SR-C2-2012-024 on the subject line.
[[Page 55265]]
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File No. SR-C2-2012-024. This file
number should be included on the subject line if email 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 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 Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE., Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing also will be available for inspection
and copying at the principal office of C2. 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-C2-2012-024 and should be submitted on or
before September 28, 2012.
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\31\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\31\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-22059 Filed 9-6-12; 8:45 am]
BILLING CODE 8011-01-P