[Federal Register: July 22, 2008 (Volume 73, Number 141)]
[Notices]
[Page 42634-42638]
[DOCID:fr22jy08-94]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58178; File No. SR-CBOE-2008-40]

Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Approving Proposed Rule Change, as Modified by
Amendment No. 1 thereto, To Provide for the Issuance of ITPs

July 17, 2008.

I. Introduction

    On April 9, 2008, the Chicago Board Options Exchange, Incorporated
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposal to provide for the issuance of up to 50
Interim Trading Permits (``ITPs''). The proposed rule change was
published for comment in the Federal Register on April 17, 2008.\3\ The
Exchange filed Amendment No. 1 to the proposed rule change on May 20,
2008, which reflected the vote of CBOE members approving the
proposal.\4\ The Commission received two comment letters regarding the
proposal,\5\ as well as two letters from CBOE addressing the concerns
raised by the commenters.\6\ This order approves the proposed rule
change, as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 57650 (April 11,
2008), 73 FR 20989 (``Notice'').
    \4\ Amendment No. 1 is technical in nature and is therefore not
subject to notice and comment. See also General Instruction E to
Form 19b-4 (concerning completion of action by a self-regulatory
organization on a proposed rule change). In its amendment, CBOE
noted that its proposal was approved by an ``overwhelming majority''
of the CBOE members who voted thereon. CBOE also confirmed that no
further action on the part of CBOE is required in connection with
this proposed rule change.
    \5\ See Letter from Lawrence J. Blum and Michael Mondrus, to
Nancy M. Morris, Secretary, Commission, dated April 28, 2008
(``Blum/Mondrus Letter'') and Letter from Mark and Joan Andrew, to
Nancy M. Morris, Secretary, Commission, dated May 12, 2008 (``Andrew
Letter'').
    \6\ See Letter from Joanne Moffic-Silver, Executive Vice
President, General Counsel, and Corporate Secretary, CBOE, to Nancy
M. Morris, Secretary, Commission, dated May 12, 2008 (``CBOE Letter
1'') and Letter from Joanne Moffic-Silver, Executive Vice President,
General Counsel, and Corporate Secretary, CBOE, to Nancy M. Morris,
Secretary, Commission, dated May 15, 2008 (``CBOE Letter 2'').
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    The proposed rule change would allow the Exchange to issue up to 50
ITPs, which would grant to the holders thereof the same trading
privileges on the Exchange as regular transferable Exchange
memberships. Individuals and organizations that obtain ITPs would be
able to conduct their activities in a manner similar to holders of
Exchange memberships and CBOE rules that apply to the holders of
memberships would also apply to the holders of ITPs. The Exchange has
proposed the authority to issue these permits in order to address the
demand for trading access to the Exchange in the event that a shortage
exists from time to time in the number of transferable Exchange
memberships available for lease.

II. Discussion

    After careful review of the proposal, the comment letters thereto,
and the Exchange's response to comments, the Commission finds that the
proposed rule change, as amended, is consistent with the requirements
of the Act and the rules and regulations thereunder.\7\ In particular,
the Commission finds that the Exchange's proposal is consistent with
the requirements of Section 6(b)(5) of the Act,\8\ which requires that
the rules of a national securities exchange be designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest and not be designed to permit
unfair discrimination between customers, issuers, brokers, or dealers.
The Commission also finds that the Exchange's proposal is consistent
with the requirements of Section 6(b)(3) of the Act,\9\ which requires
that the rules of the exchange assure a fair representation of its
members in the selection of its directors and administration of its
affairs and provide that one or more directors shall be representative
of issuers and investors and not be associated with a member of the
exchange, broker, or dealer. The Commission also finds that the
Exchange's proposal is consistent with Section 6(b)(8) of the Act,\10\
which requires that the rules of an exchange not impose any burden on
competition that is not necessary or appropriate in furtherance of the
purposes of the Act.
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    \7\ In approving this proposed rule change, 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).
    \8\ 15 U.S.C 78f(b)(5).
    \9\ 15 U.S.C 78f(b)(3).
    \10\ 15 U.S.C 78f(b)(8).
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A. Issuances of ITPs Under Proposed Rule 3.27(b)

    The Exchange has proposed various requirements and specified
certain processes in connection with the issuance of the ITPs.
Specifically, an individual or organization would have to satisfy all
requirements and be approved for membership in the Exchange to be
eligible to apply for an ITP.\11\ The Exchange would be able to issue
one or more ITPs, subject to a

cumulative maximum total of 50, if it determines that: (1) There are
insufficient transferable Exchange memberships available for lease at
that time at a rate reasonably related to the indicative lease rate to
meet existing demand for such leases; \12\ and (2) it would be in the
interest of fair and orderly markets to provide additional trading
access under the circumstances (collectively, the ``issuance
findings'').
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    \11\ See proposed CBOE Rule 3.27(b).
    \12\ The ``indicative lease rate'' would be the highest
``clearing firm floating monthly rate'' of the Clearing Members that
assist in facilitating at least 10% of the transferable membership
leases. The ``clearing firm floating monthly rate'' would be the
floating rate that a Clearing Member designates, in connection with
transferable membership leases that the Clearing Member assisted in
facilitating, for leases that utilize that monthly rate.
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    If the Exchange determines to issue ITPs, the Exchange would
announce the number of ITPs that it would make available (limited by
the number that are available for issuance, up to a cumulative maximum
of 50), that the Exchange is taking applications for such permits, the
objective process the Exchange would follow in issuing such
permits,\13\ and the beginning and end dates during which individuals
and organizations must submit applications for such permits.\14\ To be
eligible to apply for an ITP, an individual or organization must meet
all of CBOE's requirements for membership in the Exchange and obtain
CBOE's approval for having met such requirements.\15\ CBOE is not
proposing to change any of these requirements. An individual would be
eligible to receive no more than one ITP in connection with a
particular ITP issuance, with a maximum of eight such permits for a
member organization and individuals and member organizations affiliated
with the member organization in connection with that issuance.\16\
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    \13\ The Exchange would issue the ITPs in accordance with one of
the following objective processes: (1) Random lottery, (2) order in
time, or (3) another objective process adopted pursuant to a rule
filing submitted to the Commission under Section 19(b) of the Act,
15 U.S.C. 78s(b).
    \14\ The Commission notes that although the number of permits to
be issued is limited to a maximum of 50 permits, the Exchange could
allocate ITPs in multiple issuances, each time in accordance with
one of the objective processes. For example, the Exchange could
decide to issue 10 permits by either an order-in-time process or a
random lottery process.
    \15\ See proposed CBOE Rule 3.27(b). See also, e.g., CBOE Rules
3.2 and 3.3 (setting forth qualification requirements for
individuals and member organizations, including, among other things,
that the person be registered as a broker or dealer pursuant to
Section 15 of the Act).
    \16\ See proposed CBOE Rule 3.27(b).
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    Recipients of ITPs and all of their associated persons must remain
in good standing and must pay all applicable fees, dues, assessments,
and other charges assessed against CBOE members.\17\ An ITP would be
non-transferable, except that: (1) A member organization may change the
designation of the nominee in respect of each ITP it holds, and (2) an
individual ITP holder may transfer that ITP to a member organization
with which such individual is then associated.\18\
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    \17\ See proposed CBOE Rule 3.27(f)(ii).
    \18\ See proposed CBOE Rule 3.27(g)(iii).
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    An ITP would remain in effect until the earlier of one of the
following events: (1) CBOE is converted into a stock corporation or
memberships in CBOE are converted into stock (collectively, a
``Demutualization Transaction''), (2) the holder of the ITP notifies
the Exchange in a form and manner prescribed by the Exchange that the
holder is terminating that ITP,\19\ (3) the ITP is terminated as a
result of a regulatory action by the Exchange, or (4) the Exchange
terminates all ITPs through a rule filing approved by the Commission
pursuant to Section 19(b) of the Act.\20\ In the event of a
Demutualization Transaction, holders of ITPs would be guaranteed to
receive trading permits on the same terms as holders of transferable
Exchange memberships who are eligible to receive trading permits in
connection with that transaction.\21\ The Commission notes that this
provision is designed to ensure that there is no disruption in trading
access in the event of such a Demutualization Transaction, and thus
should help to promote the fair and orderly character of the Exchange's
markets.
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    \19\ If the holder of an ITP fails to notify the Exchange that
he or she is terminating that ITP by the fifteenth day of the month,
the holder would be required to pay to the Exchange an amount equal
to the following month's monthly access fee for an ITP. See Notice,
supra note 3, 73 FR at 20991. The Exchange could reissue an ITP that
had been terminated.
    \20\ See proposed CBOE Rule 3.27(c).
    \21\ See proposed CBOE Rule 3.27(e)(ii).
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    The Commission finds that the proposed framework and methodology
that the Exchange would follow when issuing ITPs represents an
objective methodology for the allocation of trading permits in a fair
and reasonable manner and is consistent with the Act. The proposal
provides the Exchange with the ability to address, from time to time,
situations in which the demand for full trading access to the Exchange
exceeds the supply of transferable memberships available for lease. The
Commission believes that increasing the number of members in that
situation is consistent with the Act because it would promote market
liquidity and help to promote the fair and orderly character of CBOE's
markets. The Commission also believes that the limit on the number of
permits that may be obtained in any one issuance is consistent with the
Act, including Section 6(c)(4) of the Act, which permits an exchange to
limit the number of members of the exchange.\22\ The Commission
believes that the limit should help minimize the chance for any broker
or dealer to dominate any particular issuance and should provide a
broad opportunity for access to the Exchange. Finally, the Commission
notes that the additional number of permits that CBOE would have
authority to issue represents a small percentage of its 930 outstanding
memberships and is consistent with the Act, including Section 6(b)(5)
thereunder, in that it should permit the Exchange to offer additional
access where demand so warrants, and should facilitate transactions in
securities by potentially deepening the pool of liquidity available on
the Exchange. Therefore, the Commission finds that the provisions of
the proposal governing the issuance and duration of ITPs are consistent
with the requirements of the Act.
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    \22\ 15 U.S.C. 78f(c)(4).
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B. Fair Representation of ITP Holders

    The Commission finds that the proposed rule change is consistent
with Section 6(b)(3) of the Act,\23\ which requires that the rules of
the exchange assure a fair representation of its members in the
selection of its directors and administration of its affairs and
provide that one or more directors shall be representative of issuers
and investors and not be associated with a member of the exchange,
broker, or dealer. ITP holders would be members of CBOE and would have
all rights attendant thereto, except as expressly provided
otherwise.\24\
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    \23\ 15 U.S.C. 78f(b)(3).
    \24\ The Commission notes that the voting and representation
rights of ITP holders are substantively identical to the provisions
addressing the voting and representation rights provided to CBOE
Stock Exchange (``CBSX'') permit holders that the Commission
previously approved. See Securities Exchange Act Release No. 55326
(February 21, 2007), 72 FR 8816 (February 27, 2007) (order approving
File No. SR-CBOE-2006-107).
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    In particular, an ITP holder, or an officer of an ITP holder, would
be eligible to serve as an at-large director on the Board of Directors
of the Exchange (``CBOE Board'') \25\ and on any Exchange committee to
the same extent that a regular member could serve on

that committee, except as provided otherwise.\26\ Further, an ITP
holder, or an officer of an ITP holder, would be eligible to serve on
CBOE's Nominating Committee in one of the six floor member and firm
member positions on that committee, notwithstanding the fact that the
holder of an ITP would not be a regular member or an officer of a
regular member.\27\
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    \25\ See proposed Section 6.1(a) of the CBOE Constitution. The
Exchange also proposes to amend Section 6.1(a) to remove a reference
to the commencement of the classification of the Board that was
implemented in 2002, because the transition period has now passed.
    \26\ See proposed CBOE Rule 3.27(e)(i). The Commission notes
that an ITP holder would be eligible to serve on Exchange committees
that develop and/or review trading rules and would also be eligible
for appointment to the Exchange's Business Conduct Committee, whose
members are periodically appointed to conduct hearings for specific
disciplinary matters. See E-mail from Patrick Sexton, Associate
General Counsel, CBOE, to Johnna B. Dumler, Special Counsel,
Division of Trading and Markets, Commission, dated May 20, 2008.
    \27\ See proposed Section 4.1(a) of the CBOE Constitution.
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    ITP holders would have the same voting and petition rights as
holders of transferable memberships, except that they would have no
right to vote or petition concerning: (1) Issues that relate to
Exchange ownership matters, including without limitation those matters
related to demutualization, mergers, consolidations, dissolution,
liquidation, transfer, or conversion of assets of the Exchange, and (2)
matters that relate to Article Fifth(b) \28\ of CBOE's Certificate of
Incorporation.\29\ This limitation reflects the fact that ITP holders
would have no interest in the assets or property of the Exchange, and
would have no right to share in any distribution by the Exchange.\30\
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    \28\ Article Fifth(b) of CBOE's Certificate of Incorporation
provides certain rights to members of the Board of Trade of the City
of Chicago, Inc. (``CBOT'') to become members of the CBOE without
purchasing a separate CBOE membership (the ``Exercise Right'').
Pursuant to an interpretation of the Exchange that was recently
approved by the Commission, CBOE believes that the acquisition of
the CBOT by Chicago Mercantile Exchange Holdings, Inc. resulted in
no persons any longer qualifying for the Exercise Right. See
Securities Exchange Act Release No. 57159 (January 15, 2008), 73 FR
3769 (January 22, 2008) (order approving SR-CBOE-2006-106).
    \29\ See Section 2.6 of the CBOE Constitution and proposed CBOE
Rule 3.27(g)(i). Under proposed Section 1.1(b) of the CBOE
Constitution and proposed CBOE Rule 3.27(e)(i), ITP holders in good
standing would be treated the same as members, except as provided in
proposed Sections 2.1(c) and 2.6 of the CBOE Constitution, and
except for purposes of Article Fifth(b) of the Certificate of
Incorporation, Article Tenth of the Certificate of Incorporation,
proposed Section 4.1(a) of the CBOE Constitution, proposed Section
6.1(a) of the CBOE Constitution, and as may be provided in the
rules. Under Section 2.1(c) of the CBOE Constitution, an ITP holder
would have no interest in the assets or property of the Exchange and
no right to share in any distribution by the Exchange. Further,
Section 2.6 of the CBOE Constitution would grant ITP holders the
same voting and petition rights as regular members except that an
ITP holder, like a CBSX member, would not have the right to vote or
petition concerning the matters discussed above.
    \30\ See proposed Section 2.1(c) of the CBOE Constitution and
proposed CBOE Rule 3.27(g)(ii).
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C. Trading Rights of ITP Holders and Jurisdiction of the Exchange Over
ITP Holders

    A holder of an ITP would have the same trading privileges on the
Exchange as the holder of a transferable Exchange membership.\31\ Those
rights would include the right to trade on the CBSX and the trading
rights on the Exchange necessary to become a member of OneChicago, LLC.
An organization that holds an ITP or that has an ITP registered for it
in general would be treated the same as a ``member organization'' for
purposes of the rules.\32\
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    \31\ See proposed CBOE Rule 3.27(e)(i).
    \32\ See id. The Exchange notes that this provision is limited
to the rules and is subject to the conditions imposed on ITP holder
status in the CBOE Constitution and rules, including proposed
Section 1.1(b) of the Constitution and proposed Rule 3.27(e)(i).
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    Holders of ITPs would be ``members'' of the Exchange under Section
3(a)(3) of the Act.\33\ As members, ITP holders and their associated
persons would be subject to the regulatory jurisdiction of the Exchange
under the Act, and the Constitution and rules of the Exchange.\34\ In
this regard, for instance, ITPs may be suspended or revoked as a result
of a disciplinary action under the amendments proposed for Rule 17.1.
In particular, the Exchange would have the authority under proposed
Rule 2.23 to revoke an ITP if the holder fails to pay any dues, fees,
assessments, charges, fines or other amounts due to the Exchange within
six months after such payment is due. In addition, the Exchange would
have the authority under proposed Rules 16.3(c) and 16.4 to suspend or
revoke the ITP of a holder that experiences financial difficulty. The
Exchange also would have the authority under proposed Rule 17.1 to
suspend or revoke an ITP if the holder has been disciplined by the
Exchange.
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    \33\ 15 U.S.C. 78c(a)(3)(A).
    \34\ See proposed CBOE Rule 3.27(f)(i). See also 15 U.S.C.
78f(b)(6) and 15 U.S.C. 78f(c)(3). All Exchange members are required
to be registered broker dealers. See CBOE Rules 3.2(a)(ii) and
3.3(a)(ii). The Commission has jurisdiction over all broker dealers.
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    Accordingly, the Commission finds that the proposed rule change is
consistent with Section 6(b)(1) of the Act,\35\ which requires an
exchange to have the capacity to carry out the purposes of the Act and
to enforce compliance by its members and persons associated with its
members with the provisions of the Act, the rules and regulations
thereunder, and the rules of the Exchange. The Commission also finds
that the proposal is consistent with Section 6(b)(5) of the Act,\36\
which requires, among other things, that the rules of the Exchange
promote just and equitable principles of trade, remove impediments to
and perfect the mechanism of a free and open market and a national
market system, and not be designed to permit unfair discrimination
between customers, issuers, brokers, or dealers. In particular, ITP
holders would have the same trading privileges on the Exchange and
would be subject to the same regulatory jurisdiction of the Exchange as
are applicable to holders of transferable Exchange memberships.
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    \35\ 15 U.S.C. 78f(b)(1).
    \36\ 15 U.S.C. 78f(b)(5).
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D. Transfer of ITP Holders to Open Leases

    In connection with determining to issue ITPs, the Exchange sought
and received feedback from the Exchange's Lessors Committee. According
to the Exchange, some participants on that committee expressed the
concern that the issuance of ITPs potentially could have a negative
effect on the lease market for CBOE seats by reducing the demand for
leases.\37\ Further, the commenters to the proposal, while
acknowledging CBOE's need to provide additional access to the Exchange,
also expressed concern that the proposal would negatively impact the
value of existing memberships and dilute the income stream to lessors
of current memberships.\38\
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    \37\ See Notice, supra note 3, 73 FR at 20992.
    \38\ See Blum/Mondrus Letter, supra note 5. See also Andrew
Letter, supra note 5, at 1-2.
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    Specifically, in the Blum/Mondrus Letter, commenters acknowledged
CBOE's need to provide more trading access to the Exchange, but
criticized the proposed expansion of access as effecting a reduction in
the value of existing memberships and diluting the income stream to
lessors of memberships.\39\ In addition, the Blum/Mondrus Letter argued
that the Exchange's proposal to issue 50 access permits to itself would
put the Exchange in competition with seat owners, many of whom lease
their seats to others.\40\ Further, the Blum/Mondrus Letter noted that
a petition was being circulated among CBOE members to request that the
CBOE Board consider an alternate access proposal, and asked the
Commission to hold hearings on the proposal.\41\ In the Andrew Letter,
commenters similarly criticized the

mechanics of the proposed ITP program.\42\ In particular, they argued
that CBOE would be usurping the historical practice of seat owners
pricing floor access and receiving revenue therefrom.\43\
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    \39\ See Blum/Mondrus Letter, supra note 5.
    \40\ See id.
    \41\ See id.
    \42\ See Andrew Letter, supra note 5.
    \43\ See id. at 1.
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    In its response to the commenters, the Exchange noted that the CBOE
Board has explicit legal authority in Section 2.1(a) of CBOE's
Constitution to adopt the proposed permit plan.\44\ CBOE also noted
that members would have an opportunity to vote on the merits of the
plan.\45\ In Amendment No. 1 to the proposed rule change, CBOE
confirmed that it obtained both the requisite CBOE Board approval and
membership approval, and confirmed that no further action by CBOE in
connection with the proposal is necessary.\46\ As approximately 82% of
CBOE seats are currently leased,\47\ the Commission notes that members
who lease their seats had an opportunity to be heard on the proposal
and have subsequently endorsed CBOE's proposed plan.
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    \44\ See CBOE Comment Letter 1, supra note 6, at 1.
    \45\ See id.
    \46\ See Amendment No. 1, supra note 4.
    \47\ Telephone call with Arthur Reinstein, Deputy General
Counsel, CBOE, Patrick Sexton, Associate General Counsel, CBOE, Stan
Leimer, Director CBOE Membership Department, CBOE, and Richard
Holley III, Senior Special Counsel, and Johnna B. Dumler, Special
Counsel, Division of Trading and Markets, Commission, and J. Daniel
Aromi, Office of Economic Analysis, Commission, on June 11, 2008
(``June 11 Telephone Call'').
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    CBOE also noted that its members would be the ultimate
beneficiaries of the plan and any revenues generated therefrom because
they are the owners of the Exchange.\48\ CBOE further noted that it is
not unusual for an exchange to retain trading access fees, and noted
that it currently does so with respect to CBSX permits.\49\
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    \48\ See CBOE Comment Letter 1, supra note 6, at 2.
    \49\ See id.
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    In addition, CBOE proposed certain features designed to address the
concerns of lessors of CBOE memberships. To minimize any potential
negative impact on the market for leased CBOE memberships, the proposal
provides a process by which CBOE would endeavor to facilitate the
transfer of holders of ITPs to leases that become available or, if
necessary, compensate a lessor who holds an unleased seat with a
monthly payment equal to the indicative lease rate. In particular, if
the Exchange is notified by one or more lessors that they have
transferable Exchange memberships available for lease (``open leases'')
at a rate reasonably related, as determined by the Exchange in its sole
discretion, to the indicative lease rate, then the Exchange would
notify each ITP holder of the number of open leases and the names of
the lessors with those open leases. The ITP holder could contact those
lessors if the holder is interested in transferring to an open
lease.\50\ Transfer to an open lease would be entirely voluntary for
ITP holders.\51\
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    \50\ The Exchange would provide a similar notification to each
person who is a Temporary Member under Interpretation and Policy .02
of Rule 3.19, and transfer to an open lease would be entirely
voluntary. See Notice, supra note 3, 73 FR at 20992, n.16.
    \51\ See Notice, supra note 3, 73 FR at 20992.
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    If, after a reasonable period of time following the process set
forth in the paragraph above, a lessor notifies the Exchange that the
lessor continues to have an open lease, the Exchange would compensate
that lessor through a monthly payment equal to the indicative lease
rate, provided the lessor is offering for lease the transferable
membership subject to the open lease at a rate reasonably related to
the indicative lease rate, as determined by the Exchange in its sole
discretion.\52\ The lessor may, at any time thereafter, lease that
membership to any qualified individual or organization and would be
required to notify the Exchange in the event of such a lease. The
Exchange would cease compensating the lessor if it receives such a
notification or otherwise learns the lessor has leased that membership.
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    \52\ The ``indicative lease rate'' would be determined in
accordance with proposed Rule 3.27(b). See supra note 12 (further
describing the indicative lease rate). In the event that the number
of lessors receiving compensation pursuant to this provision becomes
greater than the number of outstanding ITPs, the Exchange would
compensate each such lessor on a pro-rated basis.
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    The Commission finds that the aspects of the proposal that relate
to the Exchange's intention to facilitate the transfer of ITP holders
to open leases, as well as the Exchange's proposal to compensate
lessors who hold unleased seats that are offered for lease at a market
rate when ITPs are outstanding, are consistent with the Act, including
Section 6(b)(5) thereunder.\53\ In particular, transfers of ITP holders
to an open lease would be on a voluntary basis at the option of the ITP
holder. Further, compensation to holders of CBOE transferable
memberships that are unable to lease their seats at market rates when
ITPs are outstanding is a business decision of the Exchange that does
not raise any issues under the Act.
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    \53\ 15 U.S.C. 78f(b)(5).
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    The Commission does not believe that the necessary result of CBOE's
ITP proposal is a reduction in the value of a CBOE membership or a
decrease over time in the seat lease income paid to CBOE members. To
the contrary, as CBOE provides additional trading access to the
Exchange, the result could be an increase in liquidity that in turn
increases the value of access to the Exchange. Further, the Commission
notes that the Exchange has explicit authority in its Constitution to
issue permits, and that CBOE members were informed of the proposal and
have voted decidedly in favor of it. The Commission also notes that the
Exchange currently receives trading access fees for permits to access
CBSX, and the Commission notes CBOE's point that CBOE members, as
owners of the Exchange, are the ultimate beneficiaries of the proposed
permit plan and any revenues generated in connection therewith.
    Similarly, the Commission does not believe that the proposal places
the Exchange in competition with its members. When the Exchange
determines to issue ITPs, consistent with the issuance findings, there
would be insufficient seats available for lease at a rate reasonably
related to the indicative lease rate. Thus, at the point in time of an
issuance, the Exchange generally would not be in competition with any
of its members who have open seats for lease at market rates. Further,
the Exchange's use of the indicative lease rate is designed so that the
Exchange will not issue ITPs at below-market rates. In particular, the
indicative lease rate is an objective metric that is derived from lease
rates determined by entities unaffiliated with the Exchange \54\ in
which there is a liquid market for leased seats.\55\ Further, the
Commission notes that the Exchange considers the highest of the
``clearing firm floating monthly rates'' when it establishes the
``indicative lease rate,'' which the Commission believes alleviates the
potential for any downward pressure on the market lease rate.\56\
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    \54\ See supra note 12 (further describing the indicative lease
rate).
    \55\ See Notice, supra note 3, 73 FR at 20990 (discussing the
indicative lease rate) and June 11 Telephone Call, supra note 47.
The Commission notes that, of the seats that are leased, more than
83% are currently facilitated by two clearing firms, such that the
``clearing firm floating monthly rate'' and the corresponding
``indicative lease'' rate are based on a significant and
representative portion of the overall leased seat market.
    \56\ See supra note 12 (further describing the indicative lease
rate).
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    Accordingly, the Commission does not believe that the ITP proposal
imposes any burden on competition, consistent with Section 6(b)(8) of
the

Act,\57\ that is not necessary or appropriate in furtherance of the
purposes of the Act. Specifically, the Exchange would issue ITPs,
consistent with the issuance findings, when doing so would be in the
interest of fair and orderly markets. In CBOE's judgment, therefore,
the issuance of a limited number of permits through an objective
methodology would contribute to the vitality of its market, thereby
increasing the attractiveness of CBOE's market and consequently
enhancing its value to CBOE members and other users of CBOE's
facilities. In addition, as discussed above, the Exchange has proposed
to provide compensation to holders of CBOE memberships that are unable
to lease their seats at market rates when ITPs are outstanding, which
the Commission believes would mitigate any potential burden that the
proposal might represent to lessors of CBOE memberships.
---------------------------------------------------------------------------

    \57\ 15 U.S.C 78f(b)(8).
---------------------------------------------------------------------------

    Finally, the Commission notes the desire of a commenter to have
CBOE delay the proposal and have the Commission hold hearings on the
proposal.\58\ Section 19(b)(1) of the Act \59\ requires CBOE to file
with the Commission any proposed changes to, or interpretations of, its
rules and the Commission is thereafter obligated to consider CBOE's
proposal. In this instance, given the member vote and approval, the
Commission is acting on CBOE's proposal.
---------------------------------------------------------------------------

    \58\ See Blum/Mondrus Letter, supra note 5.
    \59\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------

E. ITP Fees

    Holders of ITPs would be required to pay to the Exchange a monthly
access fee. The monthly access fee would be established and adjusted
through a proposed rule change that would be filed with the Commission
under Section 19(b) of the Act.\60\ Such fees would be due and payable
in accordance with the provisions of the Exchange fee schedule and
would be the same for all ITP holders.\61\ Commenters suggested that
CBOE provide better justification for its claim to floor access
revenue.\62\ In response, CBOE stated that, because its members own the
Exchange, they are the ultimate beneficiaries of any revenues that may
be generated by the permit plan and that the members will have an
opportunity to be heard on that aspect of the proposal when they vote
on the proposal.\63\ CBOE also noted that the commenter incorrectly
suggested that it is unusual for an exchange to set the level of and
retain trading access fees, and noted that the CBSX permit plan is
based on that model.\64\ The Commission is not today approving the
level of the monthly access fee for ITPs and notes that such fees would
be the subject of a separate proposed rule change. Nevertheless, the
Commission agrees with CBOE that it is consistent with Section 6(b)(4)
of the Act \65\ for exchanges to charge for access to their
facilities.\66\
---------------------------------------------------------------------------

    \60\ 15 U.S.C. 78s(b).
    \61\ See proposed CBOE Rule 3.27(f)(ii).
    \62\ See Andrew Letter, supra note 5, at 2.
    \63\ See CBOE Letter 2, supra note 6, at 2. On May 19, 2008, the
CBOE membership approved the ITP plan. See Amendment No. 1, supra
note 4.
    \64\ See CBOE Letter 2, supra note 6, at 2. CBOE also sought to
clarify a reference in the Andrew Letter to trading access funds
that, according to the Andrew Letter, are being held in ``escrow.''
CBOE noted that the fees to be collected under its ITP proposal
would not be held in escrow and no escrowed funds would be affected
by its proposal. See id.
    \65\ 15 U.S.C. 78f(b)(4).
    \66\ See, e.g., Securities Exchange Act Release No. 53382
(February 27, 2006), 71 FR 11251, 11268 (March 6, 2006) (SR-NYSE-
2005-77) (approving a process to determine an access fee for trading
licenses and noting that the exchange would later file a separate
proposed rule change to amend its fee schedule to establish the
price).
---------------------------------------------------------------------------

F. Conforming Rule Changes To Accommodate ITPs and Clarifying Changes
Relating to CBSX Permits

    The Exchange proposed several conforming changes in its rules to
ensure that individuals and organizations that receive ITPs can conduct
their activities in a manner similar to holders of Exchange
memberships.\67\ These changes relate to, among other things,
registration, designation of nominees, and qualifications. Other
conforming changes have been made to the rules so that certain
requirements related to the holders of memberships would apply to the
holders of ITPs. For example, CBOE would amend Rule 3.2(c) to specify
that individual ITP holders would be required to have authorized
trading functions.\68\
---------------------------------------------------------------------------

    \67\ See Notice, supra note 3, 73 FR at 20992-94 (describing
each such proposed rule change).
    \68\ See Notice, supra note 3, 73 FR at 20993.
---------------------------------------------------------------------------

    Additionally, though unrelated to the ITP proposal, CBOE also
proposed to adopt several changes to clarify how CBSX permits currently
are treated under the Certificate of Incorporation, Constitution, and
rules. These changes, which adopt certain language that is also being
proposed for ITPs, are non-substantive in nature and do not modify the
rights of the holders of such permits or materially alter the status
quo with respect to the Exchange's operation of CBSX.\69\
---------------------------------------------------------------------------

    \69\ For example, the Exchange proposes to change the
terminology in CBOE Rule 3.26(c) to note that (except as indicated
therein) CBSX permit holders are treated the ``same as'' members,
rather than being ``deemed to be'' members for purposes of the
Certificate of Incorporation, Constitution, and rules. In addition,
the Exchange is proposing to amend CBOE Rule 3.26(c) to clarify that
an organization that holds a CBSX permit or that has a CBSX permit
registered for it shall be treated the same as a ``member
organization'' for purposes of the CBOE rules. See Notice, supra
note 3, 73 FR at 20993.
---------------------------------------------------------------------------

    The Commission finds that the conforming and clarifying changes
proposed by the Exchange are consistent with the requirements of
Section 6 of the Act. In particular, the clarifying and conforming
changes are non-substantive in nature and should provide greater
clarity to market participants, including CBOE's members and CBSX
permit holders, regarding the application and operation of the
Exchange's rules.

III. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\70\ that the proposed rule change (SR-CBOE-2008-40), as modified
by Amendment No. 1 thereto, be, and hereby is approved.
---------------------------------------------------------------------------

    \70\ 15 U.S.C. 78s(b)(2).

    By the Commission.
Florence E. Harmon,
Acting Secretary.
 [FR Doc. E8-16747 Filed 7-21-08; 8:45 am]

BILLING CODE 8010-01-P


entities.\1601\ We therefore estimate the initial aggregate burden for
small entities to be 3,780 burden hours,\1602\ and the initial
aggregate cost to be $1.88 million.\1603\
---------------------------------------------------------------------------

    \1601\ See supra footnote 1426.
    \1602\ See supra footnote 1428.
    \1603\ See supra footnote 1429.
---------------------------------------------------------------------------

    Similar to delivery of the account disclosure regarding capacity
and type and scope of services, we estimate the burden for small
entities to make the initial delivery of the fee schedule to new retail
customers, at the inception of the relationship, and existing retail
customers, prior to or at the time of a recommendation, will require
approximately 0.02 hours to deliver to each retail customer.\1604\ We
therefore estimate that small entities will have an aggregate initial
burden of 106 hours, or

approximately 0.14 hours per small entity for the first year after
Regulation Best Interest is in effect.\1605\
---------------------------------------------------------------------------

    \1604\ See supra footnote 1411.
    \1605\ This estimate is based on the following calculation:
(5,281 retail customer accounts) x (0.02 hours for delivery to each
customer account) = 106 aggregate burden hours. Conversely, (106
aggregate burden hours) / (756 small entities) = 0.14 burden hours
per small entity for the first year after Regulation Best Interest
is in effect.
---------------------------------------------------------------------------

    With respect to small entities, we estimate that reviewing and
updating the fee schedule will require approximately 2 hours per year.
Based on these estimates, we estimate the recurring, aggregate,
annualized burden will be 1,512 hours for small entities.\1606\ We do
not anticipate that small entities will incur outside legal,
compliance, or consulting fees in connection with updating their
standardized fee schedule since in-house personnel would be more
knowledgeable about these facts, and we therefore do not expect
external costs associated with updating the fee schedule.
---------------------------------------------------------------------------

    \1606\ See supra footnote 1437.
---------------------------------------------------------------------------

    With respect to delivery of the amended fee schedule in the event
of a material change, we estimate that this would take place among 40%
of a small entity's retail customer accounts annually, and that small
entities will require approximately 0.02 hours to deliver the amended
fee schedule to each retail customer. We therefore estimate small
entities would incur a total annual aggregate burden of 42 hours, or
0.06 hours per small entity.\1607\
---------------------------------------------------------------------------

    \1607\ This estimate is based on the following calculation: (40%
of 5,281 retail customer accounts) x (0.02 hours) = 42 aggregate
burden hours. Conversely, (42 aggregate burden hours)/(756 small
entities) = 0.06 burden hours per small entity per year.
---------------------------------------------------------------------------

    The Commission acknowledges that the type of fee schedule may vary
greatly by small entity and therefore that the costs or burdens
associated with updating the standardized fee schedule might similarly
vary.
(3) Disclosure of All Material Facts Relating to Conflicts of Interest
Associated With the Recommendation
    We believe that many or most small entities will develop a
standardized conflict disclosure document and deliver it to their
retail customers.\1608\ For small entities, we estimate it will take
in-house counsel, on average, 5 burden hours to create the standardized
conflict disclosure document and outside counsel 5 hours to review and
revise the document. We estimate that the initial aggregate burden for
the development of a standardized disclosure document, based on an
estimated 756 small entities, will be 3,780 burden hours.\1609\ We
additionally estimate an initial cost of $2,485 per small entity,\1610\
and an aggregate initial cost of $1.88 million for all small broker-
dealers.\1611\
---------------------------------------------------------------------------

    \1608\ See supra footnote 1443.
    \1609\ See supra footnote 1444.
    \1610\ See supra footnote 1445.
    \1611\ See supra footnote 1446.
---------------------------------------------------------------------------

    We assume that small entities will deliver the standardized
conflict disclosure document to new retail customers at the inception
of the relationship, and to existing retail customers prior to or at
the time of a recommendation. We estimate that small entities will
require approximately 0.02 hours to deliver the standardized conflict
disclosure document to each retail customer.\1612\ We therefore
estimate that small entities will incur an aggregate initial burden of
106 hours, or approximately 0.14 hours per small entity for delivery of
the standardized conflict disclosure document the first year after
Regulation Best Interest is in effect.\1613\ Accordingly, the total
aggregate initial burden for small entities is estimated at 3,886
hours,\1614\ and the total aggregate initial cost is estimated at $1.88
million.\1615\
---------------------------------------------------------------------------

    \1612\ See supra footnote 1411. For purposes of this analysis,
we have assumed any initial disclosures made by the small entities
related to material conflicts of interest will be delivered
together.
    \1613\ These estimates are based on the following calculations:
(0.02 hours per customer account x 5,281 retail customer accounts) =
106 aggregate burden hours. Conversely, (106 hours)/(756 small
entities) = 0.14 burden hours per small entity for the first year
after Regulation Best Interest is in effect.
    \1614\ This estimate is based on the following calculation:
(3,780 aggregate initial burden hours for the development of a
standardized conflict disclosure document) + (106 burden hours for
delivery of the standardized conflict disclosure document) = 3,886
aggregate initial burden hours.
    \1615\ See supra footnote 1429.
---------------------------------------------------------------------------

    We believe that small entities will incur ongoing annual burdens
and costs to update the disclosure document to include newly identified
conflicts. We estimate that in-house counsel at a small entity will
require approximately 1 hour per year to update the standardized
conflict disclosure document, for an ongoing aggregate burden of
approximately 756 hours per year.\1616\ We do not anticipate that small
entities will incur outside legal, compliance, or consulting fees in
connection with updating their standardized conflict disclosure
document, since in-house personnel would presumably be more
knowledgeable about conflicts of interest.
---------------------------------------------------------------------------

    \1616\ See supra footnote 1453.
---------------------------------------------------------------------------

    With respect to ongoing delivery of the updated conflict disclosure
document, we estimate that this will take place among 40% of a small
entity's retail customer accounts annually, and that small entities
will require approximately 0.02 hours to deliver the updated conflict
disclosure document to each retail customer.\1617\ We therefore
estimate that small entities will incur an aggregate ongoing burden of
42 hours, or 0.06 burden hours per small entity per year.\1618\
---------------------------------------------------------------------------

    \1617\ See supra footnote 1455.
    \1618\ This estimate is based on the following calculation: (40%
of 5,281 retail customer accounts) x (0.02 hours) = 42 aggregate
burden hours. Conversely, (42 aggregate burden hours per year)/(756
small entities) = 0.06 hours per small entity per year.
---------------------------------------------------------------------------

2. Care Obligation
    As discussed above in Section IV.B.2, we believe that any burdens
or costs associated with the Care Obligation are accounted for in other
obligations under Regulation Best Interest, including the Disclosure
Obligation and the Record-making Obligation under Rule 17a-3(a)(35) and
Recordkeeping Obligation under Rule 17a-4(e)(5). Other costs applicable
to broker-dealers, including small entities, associated with the Care
Obligation are discussed above in Section III.C.3.b.
3. Conflict of Interest Obligation
    As described more fully above in Section IV.B.3, the Conflict of
Interest Obligation would generally include the obligation to: (1)
Update written policies and procedures to comply with Regulation Best
Interest and (2) establish mechanisms to proactively and systematically
identify and manage conflicts of interest in its business on an ongoing
or periodic basis.\1619\
---------------------------------------------------------------------------

    \1619\ See supra Section IV.B.3. For a discussion of additional
costs and burdens, as well as monetized burdens, related to the
Conflict of Interest Obligation, see supra Section III.C.4.
---------------------------------------------------------------------------

a. Written Policies and Procedures
i. Initial Costs and Burdens
    To initially comply with this obligation, we believe that small
entities would primarily rely on outside counsel to update existing
policies and procedures, as small broker-dealers generally have fewer
in-house legal and compliance personnel. We estimate that 40 hours of
outside legal counsel services would be required, for a one-time
initial cost of $19,880 per small entity,\1620\ and an aggregate
initial cost of $15.0 million for all small entities.\1621\ We also
expect that in-

house compliance would require 10 hours to review and approve the
updated policies and procedures, for an initial aggregate burden of
7,560 hours.\1622\ Therefore, we estimate the total initial aggregate
burden for small entities to be 128,160 hours \1623\ and the total
initial aggregate cost to be $25.0 million.\1624\
---------------------------------------------------------------------------

    \1620\ See supra footnote 1477.
    \1621\ See supra footnote 1478.
    \1622\ See supra footnote 1479.
    \1623\ See supra footnote 1480.
    \1624\ See supra footnote 1481.
---------------------------------------------------------------------------

    We believe that the related ongoing costs for small entities
(relating to outside counsel reviewing and updating policies and
procedures on a periodic basis) would be $2,485 annually for each small
entity,\1625\ and the projected aggregate, annual ongoing cost for
small entities (relating to outside legal counsel) would be $1.88
million.\1626\ In addition, we expect that small entities would require
five hours of outside compliance services per year to update their
policies and procedures, for an ongoing cost of $1,365 per year per
small entity,\1627\ and an aggregate ongoing cost of $1.03 million per
year.\1628\ The total aggregate, ongoing cost for small entities is
therefore projected at $2.91 million per year.\1629\
---------------------------------------------------------------------------

    \1625\ See supra footnote 1486.
    \1626\ See supra footnote 1487.
    \1627\ See supra footnote 1488.
    \1628\ See supra footnote 1489.
    \1629\ See supra footnote 1490.
---------------------------------------------------------------------------

    In addition to the costs described above, we additionally believe
small broker-dealers would incur an internal burden of approximately
five hours for an in-house compliance manager to review and approve the
updated policies and procedures per year. The ongoing, aggregate burden
for small broker-dealers would be 3,780 hours for in-house compliance
manager review per year.\1630\
---------------------------------------------------------------------------

    \1630\ See supra footnote 1491.
---------------------------------------------------------------------------

b. Identification and Management of Conflicts of Interest
    To comply with Regulation Best Interest, we expect that small
entities would modify existing technology through an outside programmer
which would require, on average, an estimated 20 hours, for an
estimated initial cost per small entity of $5,680.\1631\ We
additionally continue to project that coordination between the
programmer and the small entity's compliance manager would involve five
initial burden hours. The aggregate initial costs and burdens for small
entities for the modification of existing technology to identify
conflicts of interest would therefore be $4.29 million,\1632\ and 3,780
burden hours.\1633\
---------------------------------------------------------------------------

    \1631\ See supra footnote 1497.
    \1632\ This cost estimate is based on the following calculation:
($5,680 in outside programmer costs per broker-dealer) x (756 small
entities) = $4.29 million in aggregate initial outside programmer
costs.
    \1633\ This burden estimate is based on the following
calculation: (5 burden hours) x (756 small entities) = 3,780
aggregate initial burden hours.
---------------------------------------------------------------------------

    As a result of the changes made to the rule text of the Conflict of
Interest Obligation of Regulation Best Interest, we believe that small
entities would incur burdens to determine how to manage the conflict of
interest. We believe that small entities would require approximately 20
hours per small entity,\1634\ for an aggregate of 15,120 initial burden
hours for all small entities.\1635\ The total initial aggregate burden
for small entities for identification and management of conflicts of
interest is therefore 18,900 initial burden hours.\1636\
---------------------------------------------------------------------------

    \1634\ See supra footnotes 1501 and 1502.
    \1635\ This burden estimate is based on the following
calculation: (20 burden hours) x (756 small entities) = 15,120
aggregate initial burden hours.
    \1636\ This burden estimate is based on the following
calculation: (3,780 burden hours for modification of technology) +
(15,120 burden hours for evaluation of managing conflicts) = 18,900
total aggregate initial burden hours.
---------------------------------------------------------------------------

    To maintain compliance with the Conflict of Interest Obligation, we
believe that for purposes of this analysis, small entities would,
through the help of the business line and compliance personnel, spend
on average 10 hours \1637\ to perform an annual conflicts review using
the modified technology infrastructure.\1638\ Therefore, the aggregate
ongoing burden for an annual conflicts review, based on an estimated
756 small entities, would be approximately 7,560 burden hours per
year.\1639\ Because we assume that small entities would use in-house
personnel to identify and evaluate new, potential conflicts, we
continue to believe they would not incur additional ongoing costs.
---------------------------------------------------------------------------

    \1637\ See supra footnote 1507.
    \1638\ See supra footnote 1508.
    \1639\ This estimate is based on the following calculation: (10
hours of labor per small entity per year) x (756 small entities) =
7,560 aggregate burden hours per year.
---------------------------------------------------------------------------

c. Training
    As discussed in the Proposing Release, we expect that small
entities would develop training programs to comply with Regulation Best
Interest, including the Conflict of Interest Obligation. However, we
believe that any burdens and costs associated with a training program
would fall under the new Compliance Obligation as it would be developed
to comply with the rule as a whole, including each of the component
obligations.
    In total, to comply with the Conflict of Interest Obligation, the
Commission estimates that the total initial burdens and costs for small
entities to be 135,720 hours \1640\ and $29.29 million \1641\ and the
total ongoing burdens and costs for small entities to be 11,340 hours
\1642\ and $2.91 million.\1643\
---------------------------------------------------------------------------

    \1640\ This estimate is based on the following calculation:
(128,160 burden hours for written policies and procedures) + (7,560
burden hours for identification and management of conflicts of
interest) = 135,720 hours.
    \1641\ This estimate is based on the following calculation: ($25
million initial aggregate costs relating to written policies and
procedures) + ($4.29 million initial aggregate costs for
modification of existing technology to identify conflicts of
interest) = $29.29 million initial aggregate costs.
    \1642\ This estimate is based on the following calculation:
(3,780 burden hours for reviewing and approving the updated policies
and procedures) + (7,560 burden hours for annual conflicts review) =
11,340 initial aggregate burden hours.
    \1643\ See supra footnote 1629.
---------------------------------------------------------------------------

4. Compliance Obligation
    As discussed above, in response to comments that we should require
policies and procedures to comply with the rule as a whole, we are
adopting the Compliance Obligation.\1644\ Because we did not include
the Compliance Obligation in the Proposing Release, we did not include
costs and burdens associated with the Compliance Obligation, but have
provided a detailed explanation in Section IV.B.4 above, and a summary
below.
---------------------------------------------------------------------------

    \1644\ Section II.C.4.
---------------------------------------------------------------------------

    To comply with the Compliance Obligation, we believe that small
entities would primarily rely on outside counsel to update existing
policies and procedures, and that 20 hours of outside legal counsel
services would be required, for a one-time cost of $9,940 per small
entity,\1645\ and an aggregate initial cost of $7.5 million for all
small entities.\1646\ We also expect that in-house compliance personnel
would require 6 hours to review and approve the updated policies and
procedures, for an aggregate initial burden of 4,536 hours.\1647\
---------------------------------------------------------------------------

    \1645\ See supra footnote 1523.
    \1646\ See supra footnote 1524.
    \1647\ See supra footnote 1525.
---------------------------------------------------------------------------

    In terms of ongoing costs, we assume for purposes of this analysis
that small entities would mostly rely on outside legal counsel and
compliance consultants for review and update of their policies and
procedures, with final review and approval from an in-house compliance
manager. We estimate that outside counsel would require approximately
five hours per year to update policies and procedures, for an

annual cost of $2,485 for each small entity.\1648\ The projected
aggregate, annual ongoing cost for outside legal counsel to update
policies and procedures for small entities would be $1.88 million per
year.\1649\ In addition, we expect that a small entity would require
five hours of outside compliance services per year to update its
policies and procedures, for an ongoing cost of $1,365 per year,\1650\
and an aggregate ongoing cost of $1.03 million per year.\1651\ The
total aggregate, ongoing cost for small entities is therefore projected
at $2.91 million per year.\1652\
---------------------------------------------------------------------------

    \1648\ See supra footnote 1529.
    \1649\ See supra footnote 1530.
    \1650\ See supra footnote 1531.
    \1651\ See supra footnote 1532.
    \1652\ See supra footnote 1533.
---------------------------------------------------------------------------

a. Training
    Pursuant to the obligation to ``maintain and enforce'' written
policies and procedures, we additionally believe small entities will
develop training programs that promote compliance with Regulation Best
Interest.
    We estimate that a small entity would retain an outside systems
analyst, outside programmer, and an outside programmer analyst to
create a training module, at 20 hours, 40 hours, and 20 hours,
respectively. The total cost to develop the training module would be
approximately $20,920 per small entity,\1653\ for an aggregate initial
cost to small entities of $17.18 million.\1654\
---------------------------------------------------------------------------

    \1653\ See supra footnote 1534.
    \1654\ This estimate is based on the following calculation: (756
small entities) x ($20,920 initial costs per broker-dealer) = $15.81
million in aggregate initial costs for technology services.
---------------------------------------------------------------------------

    Additionally, we expect that the training module would require the
approval of the Chief Compliance Officer, as well as in-house counsel,
each of whom would require approximately 2 hours to review and approve
the training module. The initial aggregate burden for small entities is
therefore estimated at 3,024 initial burden hours.\1655\
---------------------------------------------------------------------------

    \1655\ This estimate is based on the following calculation: (756
small entities) x (4 initial burden hours per small entity) = 3,024
initial burden hours.
---------------------------------------------------------------------------

    In addition, small entities would incur an initial cost for
registered representatives to undergo training through the training
module. We estimate the training time at one hour per associated
person, for an aggregate initial burden of 5,094 burden hours, or an
initial burden of 6.7 hours per small entity.\1656\ The total aggregate
burden to approve the training module and implement the training
program would be 8,118 initial burden hours.\1657\
---------------------------------------------------------------------------

    \1656\ This estimate is based on the following calculation: (1
burden hour) x (5,094 registered representatives at small entities)
= 5,094 aggregate initial burden hours. Conversely, (5,094 aggregate
burden hours)/(756 small entities) = 6.7 initial burden hours per
broker-dealer.
    \1657\ This estimate is based on the following calculation:
(5,094 burden hours for training of registered representatives) +
(3,024 burden hours to approve training program) = 8,118 total
aggregate initial burden hours.
---------------------------------------------------------------------------

    For purposes of this analysis, we assume that small entities would
likely require registered representatives to repeat the training module
for Regulation Best Interest on an annual basis. The ongoing aggregate
cost for the one-hour training would be 5,094 burden hours per year, or
6.7 burden hours per small entity per year.\1658\
---------------------------------------------------------------------------

    \1658\ See supra footnote 1656.
---------------------------------------------------------------------------

    In total, for small entities to comply with the Compliance
Obligation, the Commission estimates the total initial burdens and
costs to be 12,654 hours \1659\ and $23.31 million,\1660\ and the total
ongoing burdens and costs to be 5,094 hours \1661\ and $2.91
million.\1662\
---------------------------------------------------------------------------

    \1659\ This estimate is based on the following calculation:
(4,536 initial burden hours for policies and procedures) + (8,118
initial burden hours training) = 12,654 initial burden hours to
comply with Compliance Obligation.
    \1660\ This estimate is based on the following calculation:
($7.5 million initial costs for policies and procedures) + ($15.81
million initial costs for training) = $23.31 million initial total
costs to comply with Compliance Obligation.
    \1661\ This estimate is based on the following calculation: (0
ongoing burden hours for policies and procedures) + (5,094 ongoing
burden hours for training) = 5,094 ongoing burden hours to comply
with Compliance Obligation.
    \1662\ This estimate is based on the following calculation:
($2.91 million ongoing costs for policies and procedures) + ($0
ongoing costs for training) = $2.91 million ongoing total costs to
comply with Compliance Obligation.
---------------------------------------------------------------------------

5. Record-Making and Recordkeeping Obligations
    The record-making and recordkeeping obligations will impose record-
making and recordkeeping requirements on broker-dealers with respect to
certain information collected from, or provided to, retail customers.
a. Record-Making Obligation
    As discussed above, we continue to believe that small entities will
satisfy the record-making requirements of the amendment to Rule 17a-
3(a)(35) by amending an existing account disclosure document to include
certain information.\1663\ We believe that the inclusion of this
information in an account disclosure document will require, on average,
approximately 1 hour per year for outside counsel at small entities, at
an updated average rate of $497/hour, for an annual cost of $497 for
each small entity to update an account disclosure document. The
projected initial, aggregate cost for small entities is therefore
estimated to be $375,732.\1664\ Finally, we estimate it will require an
additional 0.04 hours for the registered representative responsible for
the information (or other clerical personnel) to fill out that
information in the account disclosure document, for an approximate
total aggregate initial burden of 211 hours, or approximately 0.28
hours per small entity for the first year after the rule is in
effect.\1665\
---------------------------------------------------------------------------

    \1663\ See supra Section IV.B.5.a.i.
    \1664\ See supra footnote 1548.
    \1665\ These estimates are based on the following calculations:
(0.04 hours per customer account) x (5,281 retail customer accounts
at small entities) = 211 aggregate initial burden hours. Conversely,
(211 burden hours)/(756 small entities) = 0.28 initial burden hours
per broker-dealer.
---------------------------------------------------------------------------

    Because we have already included the costs and burdens associated
with the creation of a record to memorialize an oral disclosure, and
the delivery of the amended account disclosure document in Section
V.D.1., we need not include them in this section of the analysis.
    We do not believe that the identity of the registered
representative responsible for the retail customer's account will
change. Accordingly, we continue believe that there are no ongoing
costs and burdens associated with this record-making requirement of the
amendment to Rule 17a-3(a)(35). With respect to memorializing oral
disclosures, we estimate that this would take place among 52% of a
small entity's retail customers (and thus 52% of a registered
representative's retail customer accounts) annually.\1666\ We therefore
estimate that small entities will incur a total annual aggregate
ongoing burden of 55 hours or 0.07 hours per small entity per
year.\1667\
---------------------------------------------------------------------------

    \1666\ See supra footnote 1554.
    \1667\ (52%) x (5,281 retail customer accounts at small
entities) x (0.02 hours for recording each oral disclosure relating
to a retail customer's account) = 55 aggregate burden hours per
year. Conversely, 55 aggregate burden hours/756 small entities =
0.07 ongoing burden hours per small entity per year.
---------------------------------------------------------------------------

b. Recordkeeping Obligation
    For purposes of this analysis, we assume the following records
would likely be retained pursuant to amended Rule 17a-3(a)(35): (1)
Existing account disclosure documents; (2) comprehensive fee schedules;
(3) disclosures identifying material conflicts; and (4) memorialized
oral disclosures under the circumstances outlined in Section II.C.1,
Oral Disclosure or Disclosure After a Recommendation.
    Based on our belief that small entities will rely on existing
infrastructures to satisfy the recordkeeping obligations of Regulation
Best Interest and the amendment to Rule 17-a(4)(e)(5), we

believe the burden for small entities to add new documents or modify
existing documents to the small entity's existing retention system will
be approximately 704 burden hours for small entities, assuming a small
entity will need to upload or file each of the four account documents
discussed above for each retail customer account.\1668\ We do not
believe there will be additional internal or external costs relating to
the uploading or filing of the documents. In addition, because we have
already included the costs and burdens associated with the delivery of
the amended account opening agreement and other documents in Section
V.D.1 above, we do not include them in this section of the analysis.
---------------------------------------------------------------------------

    \1668\ This estimate is based on the following calculation: (4
documents per customer account) x (5,281 retail customer accounts at
small entities) x (2 minutes per document)/60 minutes = 704
aggregate burden hours.
---------------------------------------------------------------------------

    We estimate that the approximate ongoing burden associated with the
recordkeeping requirement of the amendment to Rule 17a-4(e)(5) is 231
burden hours per year.\1669\ We do not believe that the ongoing costs
associated with ensuring compliance with the retention schedule would
change from the current costs of ensuring compliance with existing Rule
17a-4 and as outlined above.
---------------------------------------------------------------------------

    \1669\ This estimate is based on the percentage of account
records we expect would be updated each year as described in Section
IV.B.1, supra, and the following calculation: ((40% of fee schedules
x 5,281 retail customer accounts at small entities) x (2 minutes per
document) + (40% of conflict disclosure forms x 5,281 retail
customer accounts at small entities) x (2 minutes per document) +
(20% of account opening documents x 5,281 retail customer accounts
at small entities) x (2 minutes per document)) = 10,560 minutes/60
minutes = 176 aggregate ongoing burden hours. In addition, with
respect to ongoing memorialization of the updated oral disclosures,
we estimate that this will take place among 52% of a small entity's
retail customer accounts annually. We therefore estimate that small
entities will incur an aggregate ongoing burden of 55 hours, or 0.07
burden hours per broker-dealer (calculated as follows: (52% of
updated oral disclosures x 5,281 retail customer accounts at small
entities) x (1.2 minutes per document) = 3,295 minutes/60 minutes =
55 aggregate ongoing burden hours (or 55 aggregate burden hours/756
small entities = 0.07 burden hours per small entity)). 176 hours +
55 hours = 231 total aggregate ongoing burden hours.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

    The RFA directs the Commission to consider significant alternatives
that would accomplish the stated objective, while minimizing any
significant adverse impact on small entities. As described in the
Proposing Release we considered the following alternatives for small
entities in relation to the new requirements: (1) The establishment of
differing compliance or reporting requirements or timetables that take
into account the resources available to small entities; (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements for small entities; (3) the use of performance
rather than design standards; and (4) an exemption from coverage of the
new requirements, or any part thereof, for such small entities.
    Regarding the first alternative, the Commission does not believe
that we could effectively achieve our stated objectives by establishing
different requirements applicable to broker-dealers of different sizes.
We considered adopting tiered compliance dates so that smaller broker-
dealers would have had more time to comply. However, as discussed in
Section II.E above, we believe the operational capability needed to
develop processes to comply with Regulation Best Interest is
sufficiently established by firms of all sizes and resources. The
Commission has determined, in light of the importance of the
protections afforded by Regulation Best Interest to retail customers,
that a Compliance Date of one year after the Effective Date is an
appropriate timeframe for firms to conduct the requisite operational
changes to their systems to establish internal processes to comply with
Regulation Best Interest. Further, as discussed above in Section III,
each of the component obligations in Regulation Best Interest shares
features with existing market best practices, as shaped by FINRA's
guidance on relevant rules or as described in its Report on Conflicts
of Interest.\1670\ To the extent that broker-dealer (and small entity)
practices are already aligned with the requirements of Regulation Best
Interest, the anticipated magnitude of the costs associated with a
given component of the rule will be correspondingly reduced.\1671\
---------------------------------------------------------------------------

    \1670\ See supra Section III.C.1.b.
    \1671\ See supra text following footnote 1159.
---------------------------------------------------------------------------

    As discussed above, we believe that Regulation Best Interest will
result in important investor protection benefits, and these benefits
apply to retail customers of smaller entities as well as retail
customers of large broker-dealers. For example, a primary objective of
this rulemaking is to enhance the quality of recommendations provided
by broker-dealers to retail customers, by establishing under the
Exchange Act a ``best interest'' obligation. We do not believe that the
interest of investors who are retail customers would be served by
establishing differing compliance or reporting requirements or
timetables for broker-dealers that are small entities under Regulation
Best Interest and the amendments to Rules 17a-3 and 17a-4(e)(5).
    Moreover, we continue to believe that providing an exemption or
different requirements for small entities would be inconsistent with
our goal of facilitating more consistent regulation, in recognition of
the importance for both investors and broker-dealers of having the
applicable standards for brokerage recommendations be clear,
understandable, and as consistent as possible across a brokerage
relationship (i.e., whether for retirement or non-retirement purposes)
and better aligned with other advice relationships (e.g., a
relationship with an investment adviser). Further, as discussed above,
broker-dealers are subject to regulation under the Exchange Act and the
rules of each SRO of which the broker-dealer is a member, including a
number of obligations that attach when a broker-dealer makes a
recommendation to a customer, as well as general and specific
requirements aimed at addressing certain conflicts of interest. We note
that these existing requirements do not generally distinguish between
small entities and other broker-dealers.
    For the same reasons as described in the Proposing Release, we
still do not believe that additional clarification, consolidation, or
simplification of compliance and reporting requirements would be
appropriate for small entities. We note, however, in crafting
Regulation Best Interest, we generally aimed to provide broker-dealers
flexibility in determining how to satisfy the component obligations. We
continue to believe that this flexibility reflects a general
performance-based approach, rather than design-based approach.
    As discussed in the Economic Analysis in Section III.E above, the
Commission also considered a number of alternatives as they affect all
firms, including small entities. Specifically, the Commission
considered three different options for imposing a fiduciary standard on
broker-dealers: (1) Applying the fiduciary standard under the Advisers
Act to broker-dealers; (2) adopting a ``new'' uniform fiduciary
standard of conduct applicable to both broker-dealers and investment
advisers, such as that recommended by the staff in the 913 Study, and,
or (3) adopting similar standards to what the DOL had provided under
its fiduciary rule to broker-dealers and investment advisers. The
Commission further considered requiring broker-dealers to use a
specific form for disclosure, similar to, for example, Form ADV Part II
in lieu of the flexible approach of the Disclosure Obligation, or in
the alternative, developing a disclosure-only standard,

which would require that broker-dealers satisfy only the Disclosure
Obligation of the final rule.
    We acknowledge certain commenters urged the Commission to take
additional or different regulatory actions than the approach we have
adopted, including the alternatives discussed above. We do not believe
that any rulemaking governing retail investor-advice relationships can
solve for every issue presented. After careful consideration of the
comments and additional information we have received, we believe that
Regulation Best Interest, as modified, appropriately balances the
concerns of the various commenters in a way that will best achieve the
Commission's important goals of enhancing retail investor protection
and decision making, while preserving, to the extent possible, retail
investor access (in terms of choice and cost) to differing types of
investment services and products.

VI. Statutory Authority and Text of the Rule

    Pursuant to Dodd-Frank Wall Street Reform and Consumer Protection
Act Section 913(f), Public Law 111-203, 124 Stat. 1376, 1827 (2010),
and Exchange Act sections 3, 10, 15, 15(c)(6), 15(l), 17, 23 and 36
thereof, 15 U.S.C. 78c, 78j, 78o, 78o(c)(6), 78o(l), 78q, 78w and 78mm,
the Commission is adopting Sec.  240.15l-1 and adopting amendments to
Sec.  240.17a-3 by adding new paragraph (a)(25), and to revise Sec.
240.17a-4(e)(5) of Title 17 of the Code of Federal Regulations in the
manner set forth below.

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

Text of the Rule

    In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
1. The authority citation for part 240 is amended by adding sectional
authorities for section 240.15l-1 to read as follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602,
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
    Section 240.15l-1 is also issued under Pub. L. 111-203, sec.
913, 124 Stat. 1376, 1827 (2010).
* * * * *

0
2. Add Sec.  240.15l-1 to read as follows:

Sec.  240.15l-1   Regulation Best Interest.

    (a) Best interest obligation. (1) A broker, dealer, or a natural
person who is an associated person of a broker or dealer, when making a
recommendation of any securities transaction or investment strategy
involving securities (including account recommendations) to a retail
customer, shall act in the best interest of the retail customer at the
time the recommendation is made, without placing the financial or other
interest of the broker, dealer, or natural person who is an associated
person of a broker or dealer making the recommendation ahead of the
interest of the retail customer.
    (2) The best interest obligation in paragraph (a)(1) of this
section shall be satisfied if:
    (i) Disclosure obligation. The broker, dealer, or natural person
who is an associated person of a broker or dealer, prior to or at the
time of the recommendation, provides the retail customer, in writing,
full and fair disclosure of:
    (A) All material facts relating to the scope and terms of the
relationship with the retail customer, including:
    (1) That the broker, dealer, or such natural person is acting as a
broker, dealer, or an associated person of a broker or dealer with
respect to the recommendation;
    (2) The material fees and costs that apply to the retail customer's
transactions, holdings, and accounts; and
    (3) The type and scope of services provided to the retail customer,
including any material limitations on the securities or investment
strategies involving securities that may be recommended to the retail
customer; and
    (B) All material facts relating to conflicts of interest that are
associated with the recommendation.
    (ii) Care obligation. The broker, dealer, or natural person who is
an associated person of a broker or dealer, in making the
recommendation, exercises reasonable diligence, care, and skill to:
    (A) Understand the potential risks, rewards, and costs associated
with the recommendation, and have a reasonable basis to believe that
the recommendation could be in the best interest of at least some
retail customers;
    (B) Have a reasonable basis to believe that the recommendation is
in the best interest of a particular retail customer based on that
retail customer's investment profile and the potential risks, rewards,
and costs associated with the recommendation and does not place the
financial or other interest of the broker, dealer, or such natural
person ahead of the interest of the retail customer;
    (C) Have a reasonable basis to believe that a series of recommended
transactions, even if in the retail customer's best interest when
viewed in isolation, is not excessive and is in the retail customer's
best interest when taken together in light of the retail customer's
investment profile and does not place the financial or other interest
of the broker, dealer, or such natural person making the series of
recommendations ahead of the interest of the retail customer.
    (iii) Conflict of interest obligation. The broker or dealer
establishes, maintains, and enforces written policies and procedures
reasonably designed to:
    (A) Identify and at a minimum disclose, in accordance with
paragraph (a)(2)(i) of this section, or eliminate, all conflicts of
interest associated with such recommendations;
    (B) Identify and mitigate any conflicts of interest associated with
such recommendations that create an incentive for a natural person who
is an associated person of a broker or dealer to place the interest of
the broker, dealer, or such natural person ahead of the interest of the
retail customer;
    (C)(1) Identify and disclose any material limitations placed on the
securities or investment strategies involving securities that may be
recommended to a retail customer and any conflicts of interest
associated with such limitations, in accordance with subparagraph
(a)(2)(i), and
    (2) Prevent such limitations and associated conflicts of interest
from causing the broker, dealer, or a natural person who is an
associated person of the broker or dealer to make recommendations that
place the interest of the broker, dealer, or such natural person ahead
of the interest of the retail customer; and
    (D) Identify and eliminate any sales contests, sales quotas,
bonuses, and non-cash compensation that are based on the sales of
specific securities or specific types of securities within a limited
period of time.
    (iv) Compliance obligation. In addition to the policies and
procedures

required by paragraph (a)(2)(iii) of this section, the broker or dealer
establishes, maintains, and enforces written policies and procedures
reasonably designed to achieve compliance with Regulation Best
Interest.
    (b) Definitions. Unless otherwise provided, all terms used in this
rule shall have the same meaning as in the Securities Exchange Act of
1934. In addition, the following definitions shall apply for purposes
of this section:
    (1) Retail customer means a natural person, or the legal
representative of such natural person, who:
    (i) Receives a recommendation of any securities transaction or
investment strategy involving securities from a broker, dealer, or a
natural person who is an associated person of a broker or dealer; and
    (ii) Uses the recommendation primarily for personal, family, or
household purposes.
    (2) Retail customer investment profile includes, but is not limited
to, the retail customer's age, other investments, financial situation
and needs, tax status, investment objectives, investment experience,
investment time horizon, liquidity needs, risk tolerance, and any other
information the retail customer may disclose to the broker, dealer, or
a natural person who is an associated person of a broker or dealer in
connection with a recommendation.
    (3) Conflict of interest means an interest that might incline a
broker, dealer, or a natural person who is an associated person of a
broker or dealer --consciously or unconsciously--to make a
recommendation that is not disinterested.

0
3. Amend Sec.  240.17a-3 by adding reserved paragraphs (a)(24) through
(34) and paragraph (a)(35) to read as follows:

Sec.  240.17a-3  Records to be made by certain exchange members,
brokers and dealers.

    (a) * * *
    (24)-(34) [Reserved].
    (35) For each retail customer to whom a recommendation of any
securities transaction or investment strategy involving securities is
or will be provided:
    (i) A record of all information collected from and provided to the
retail customer pursuant to Sec.  240.15l-1, as well as the identity of
each natural person who is an associated person, if any, responsible
for the account.
    (ii) For purposes of this paragraph (a)(35), the neglect, refusal,
or inability of the retail customer to provide or update any
information described in paragraph (a)(35)(i) of this section shall
excuse the broker, dealer, or associated person from obtaining that
required information.
* * * * *

0
4. Amend Sec.  240.17a-4 by revising paragraph (e)(5) to read as
follows:

Sec.  240.17a-4  Records to be preserved by certain exchange members,
brokers and dealers.

* * * * *
    (e) * * *
    (5) All account record information required pursuant to Sec.
240.17a-3(a)(17) and all records required pursuant to Sec.  240.17a-
3(a)(35), in each case until at least six years after the earlier of
the date the account was closed or the date on which the information
was collected, provided, replaced, or updated.
* * * * *

    By the Commission.

    Dated: June 5, 2019.
Vanessa Countryman,
Acting Secretary.
[FR Doc. 2019-12164 Filed 7-11-19; 8:45 am]
 BILLING CODE 8011-01-P