Tower Trading, L.P.

SECURITIES EXCHANGE ACT OF 1934
Rel. No.47537 / March 19, 2003

Admin. Proc. File No. 3-10359

ORDER SETTING ASIDE FINAL ACTION

On the basis of the Commission's opinion issued this day, it is,

ORDERED, that the final action taken by the Chicago Board Options Exchange, Inc. against Tower Trading, L.P. ("Tower"), terminating Tower's appointment as a Designated Primary Market-Maker be, and it hereby is, set aside.

By the Commission.

Jonathan G. Katz
Secretary

Footnotes

¹See former CBOE Rule 8.80(c) (1999). See current CBOE Rules 8.80 through 8.91 (2000). The CBOE Rules involved in this proceeding were amended in 2000. Where relevant, we distinguish between the then-applicable former CBOE Rule and its current version.

²See former CBOE Rule 8.80 (1999).

³ The Committee is composed of eleven members, the vice-chairman of CBOE, the chairman of the market performance committee, and nine individuals elected by the CBOE membership. See former CBOE Rule 8.80(b) (1999).

⁴See former CBOE Rule 8.80 (1999). See current CBOE Rules 8.80 through 8.91 (2000).

⁵See former CBOE Rule 8.60 (1997).

⁶See id.

⁷See former CBOE Rule 8.60(b) (1997) (The appropriate CBOE committee "shall presume a failure to meet minimum performance standards as to all members of a trading crowd if the trading crowd is rated in the bottom 10% of trading crowds" based on the results of a periodic questionnaire.).

⁸See former CBOE Rule 8.60(e) (1997). These provisions are substantially incorporated into current CBOE Rule 8.60(d)(2000).

⁹ In denying this request, Kaminsky, on behalf of the Committee, informed Tower that it would not be permitted access to the evaluations in order to "preserve the confidentiality of the surveys, and in accordance with exchange policy...."

¹⁰ Kaminsky indicated that the Committee received this feedback "over the past months" preceding the hearing.

¹¹ Pursuant to CBOE's review process, in order to avoid "unduly and inappropriately" burdening the Board, a de novo review of the Committee's decision is not conducted. Rather, the Board "will affirm the [Committee's] decision unless the [Committee] is found to have acted without basis, clearly erroneously, or arbitrarily and capriciously." Order Approving CBOE Proposed Rule Change, Securities Exchange Act Rel. No. 24008 (Jan. 16, 1987), 37 SEC Docket 882, 883.

¹² 51 S.E.C. 261 (1992).

¹³ 15 U.S.C. § 78s(d).

¹⁴ 15 U.S.C. § 78s(d)(1). Section 19(d)(1) provides that, if a self regulatory organization ("SRO") "prohibits or limits any person in respect to access to services offered" by that SRO, it must promptly file a notice of such action with the Commission.

¹⁵See Commission Rule of Practice 421(b), 17 C.F.R. § 201.421(b) ("The Commission may at any time prior to issuance of its decision raise or consider any matter that it deems material, whether or not raised by the parties."). Cf., e.g., Andrus v. Charlestone Stone Prods. Co., 436 U.S. 604, 607 n.6 (1978) ("Although the question of the District Court's subject-matter jurisdiction was not raised in this Court or apparently in either court below, we have an obligation to consider the question sua sponte.").

¹⁶ 15 U.S.C. § 78s(d). See also Post X-17, 51 S.E.C. at 264. Exchange Act Section 19(d) also provides for review of denial of membership or participation in an SRO to any applicant. As in Post X-17, neither of these bases is applicable in this case. See id. at 264 n.11.

¹⁷ Pub.L.No. 94-29, § 16, 89 Stat. 97 (1975).

¹⁸ For a discussion of the Commission's historical authority to review SRO actions, see generally Notice of Proposed Rules, Exchange Act Rel. No. 19969 (July 21, 1983), 28 SEC Docket 470.

¹⁹ S. Rep. No. 93-13 (1973).

²⁰ Industry Report, at 151, 171-80.

²¹Id. at 214.

²²William Higgins, Exchange Act Rel. No. 22877 (Feb. 7, 1986), 35 SEC Docket 12, 14 n.22 (citing Senate Comm. on Banking, Housing and Urb. Affs., Report to Accompany S. 249; Securities Acts Amendments of 1975, S. Rep. No. 94-75, at 26 (1975), reprintedin 1975 U.S.C.C.A.N. 179 ("Senate Report")).

²³ Senate Report at 24.

²⁴Post X-17, 51 S.E.C. at 266 (citing the following: Exchange Act Rel. No. 25681 (May 8, 1988), 40 SEC Docket 1525; Exchange Act Rel. No. 25611 (Apr. 22, 1988), 40 SEC Docket 1315; Exchange Act Rel. No. 24008 (Jan. 16, 1987), 37 SEC Docket 882; Exchange Act Rel. No. 15827 (May 15, 1979), 17 SEC Docket 589).

²⁵Id. at 266 (citations omitted). Cf. Exchange Act Rule 19d-1(c), 17 C.F.R. § 240.19d-1 (Reallocation of securities by exchange due to poor performance is not included within the rule's definition of "final disciplinary action."); see also Exchange Act Section 19(e)(1)(A), 15 U.S.C. § 78s(e)(1)(A) (specifying that in reviewing an SRO disciplinary sanction, the Commission is to determine whether the aggrieved person violated the Exchange Act, the Commission's rules and regulations thereunder, or the SRO's rules).

²⁶See Order Approving CBOE Proposed Rule Change, Exchange Act Rel. No. 24008 (Jan. 16, 1987), 37 SEC Docket 882 n.5 (In order to remedy deficient trading crowd performance, the Committee "will have the authority to take other related remedial measures in appropriate cases, including restricting a marketmaker's registration and appointments....")(emphasis added).

²⁷ 51 S.E.C. at 267. However, we expressly reserved the question "whether any SRO determination to reallocate a security pursuant to a program to evaluate and improve market maker or specialist performance is reviewable by us as a denial or limitation of access to services." Id. at 267.

²⁸Id. at 262.

²⁹Id.

³⁰Id. at 263. In authorizing Pacific's evaluation program, the Commission stated that Pacific's program was "substantially similar to the CBOE program, which ha[d] been in operation for over a year" at the time that the Pacific program was approved. See Order Approving Pacific Proposed Rule Change, Exchange Act Rel. No. 25611 (Apr. 22, 1988), 40 SEC Docket 1315, 1316.

³¹ The questionnaire was "substantially similar to the questionnaire used by the CBOE in its trading crowd evaluation program." 40 SEC Docket at 1315 n.5.

³²Post X-17, 51 S.E.C. at 263.

³³Id. at 261.

³⁴Id. at 266-67.

³⁵Id. at 267.

³⁶ Senate Report at 24.

³⁷ Rule Change Relating to Participation Entitlements of DPMs, Exchange Act Rel. No. 43750 (Dec. 20, 2000), 73 SEC Docket 3819, 3820.

³⁸ Order Approving CBOE Proposed Rule Change, Exchange Act Rel. No. 42190 (Dec. 1, 1999), 71 SEC Docket 503. See former CBOE Rule 8.80(c)(7)(ii) (1999) ("In executing transactions for his own account as a market-maker, the DPM shall have a right to participate pro rata with the trading crowd in trades that take place at the DPM's principal bid or offer."); current CBOE Rule 8.87(b) (2000) (DPM has right to participate).

³⁹ 73 SEC Docket, supra, at 3820. An example of a DPM's guaranteed participation is as follows:

Assume there is an order in the book to buy 150 contracts at $3, a price that represents the national best bid. The DPM's previously established principal bid is $3 and there are two market makers in the crowd each bidding at $3. If a floor broker enters the crowd with a market order to sell 300 contracts, the order in the book receives full execution of 150 contracts at $3. Thereafter, because the market makers' bids are at parity with the DPM's previously established principal bid, the DPM is entitled to a participation right of 40% with respect to the remaining 150 contracts of the market order. Therefore, the DPM receives 40% of the remaining 150 contracts at $3, or 60 contracts. The two market makers in the crowd each receive 45 contracts at $3.

Id. at 3821.

⁴⁰Id. at 3820; 71 SEC Docket, supra, at 503.

⁴¹ Section 19(f) of the Exchange Act, 15 U.S.C. § 78s(f). See, e.g., Jacob Adoni, Exchange Act Rel. No. 41813 (Aug. 31, 1999), 70 SEC Docket 1496, 1499.

⁴² Section 19(f) of the Exchange Act, 15 U.S.C. § 78s(f). See, e.g., Eli Boggs Combs, 52 S.E.C. 737, 739 (1996).

⁴³ Kaminsky also responded to post-hearing requests on behalf of the Committee, and issued the Committee's written decision under his signature as chairman.

⁴⁴ Dempsey, the only other Committee hearing witness, was also presented to testify in his "capacity solely as a floor official and as vice chairman of that committee." Nonetheless, Dempsey also testified as a fact witness, relating an incident involving Tower and Dempsey's firm that resulted in Dempsey filing a floor officials report with CBOE.

⁴⁵ 15 U.S.C. § 78f(b)(7).

⁴⁶Steven P. Sanders, 53 S.E.C. 889, 906 & n.35 (1998) (quoting David A. Gingras, 50 S.E.C. 1286, 1292 (1992); citing Austin Municipal Sec., Inc. v. NASD, 757 F.2d 676, 689 (1985); Stratton Oakmont, Inc., 52 S.E.C. 1170 (1997); Daniel C. Adams, 47 S.E.C. 919, 922 (1983); Richard W. Perkins, 47 S.E.C. 847, 849-50 (1982)).

While the Sanders decision recognizes the general principle that an SRO may combine prosecutorial and adjudicatory functions without offending notions of due process, it also specifically notes that the SRO in that case, the National Association of Securities Dealers, Inc., has modified its procedures such that the members of a hearing panel are not responsible for investigating possible misconduct or instituting disciplinary proceedings. Sanders, 53 S.E.C. at 906, n.35.

⁴⁷Scattered Corp., 53 S.E.C. 948, 967 (1998).

⁴⁸Sumner B. Cotzin, 45 S.E.C. 575, 581 (1974).

⁴⁹Cf. Cinderella Career and Finishing Schools, Inc. v. FTC, 425 F.2d 583 (D.C. Cir. 1970) (Even though FTC chairman's vote in pending appeal was not necessary for a majority, by giving a speech wherein it appeared that he had prejudged an issue in the appeal, chairman should have recused himself because there was no way of measuring the influence of the chairman upon the other commissioners' votes.).

The record is silent whether Kaminsky considered recusing himself from the hearing. We note, however, that recusal was a procedure familiar to the Committee and available to Kaminsky. In fact, the record reflects, without elaboration, that another Committee member "recused himself from the hearing." See CBOE Regulatory Circular RG96-81 (Sept. 12, 1996) (Standards applicable to committee members include recusal standards and recusal "is ordinarily appropriate" where any reason "could cause the committee member to be unable to decide the matter fairly and impartially.").

⁵⁰See, e.g., Scattered Corp., 53 S.E.C. at 958 (Where separation of litigation and adjudicatory "functions are not scrupulously observed, courts do not hesitate to stop an agency from proceeding.") (citing Amos Treat & Co. v. SEC, 306 F.2d 260, 265 (D.C. Cir. 1962)); Matter of Krishna Yemmanur, 447 N.W.2d 525, 527 (S.D. 1989) (State medical board that sanctioned doctor based, in part, on testimony from board member, did not deny doctor fair and impartial hearing because witness disqualified himself from the board "so as to participate only in the prosecutorial role, and not the adjudicatory role."); Administrative Procedure Act, 5 U.S.C. § 554(d) (2000) (employee who presides at agency hearing and renders decision shall not be responsible to or subject to the supervision or direction of an employee engaged in the agency's investigative or prosecutorial functions); Commission Rule of Practice 121, 17 C.F.R. § 201.121 (any Commission employee engaged in performance of investigative or prosecutorial functions in a proceeding may not participate or advise in the decision in that proceeding, except as a witness or counsel). See generally, Judith K. Meierhenry, The Due Process Right to an Unbiased Adjudicator in Administrative Proceedings, 36 S.D. L. Rev. 551 (1991) (analyzing four categories of adjudicator bias).

⁵¹See, e.g., Tyler v. Swenson, 427 F.2d 412, 415-16 (8th Cir. 1970) (presiding trial judge is not competent witness; duties as judge are not compatible with duties as witness since judge would have to pass upon competency of his own testimony and, as a witness, might be regarded as partisan and subject to embarrassing conflicts with counsel); Fed. R. Evid. 605 ("The judge presiding at trial may not testify in that trial as a witness. No objection need be made in order to preserve the point.").

⁵²Cf. Scattered Corp., 53 S.E.C. at 962 (fairness of proceeding impaired where decision-maker had ex parte communications or had taken an adversarial position against one of the parties) (citing Grolier Inc. v. FTC, 615 F.2d 1215, 1220 (9th Cir. 1980); Trans World Airlines, Inc. v. Civil Aeronautics Bd., 254 F.2d 90, 91 (D.C. Cir. 1958)).

⁵³ Tower implicitly argues that, even if survey anonymity is permissible, it should have been allowed to inspect the questionnaires, as the identity of a survey respondent is not disclosed on the questionnaire form.

⁵⁴ The Committee also relied upon summary numerical compila-tions derived from the surveys. The summaries ranked Tower's performance by comparing its average score in four categories (market quality, crowd competition, multiple listing competition, and ethical standards and administra-tion) with the mean score of the entire trading floor. The summaries indicated that Tower's performance was rated at the bottom of all DPMs and that its average scores were below the trading floor mean scores in every category.

⁵⁵ Tower argues that neither CBOE's rules relating to the evaluation surveys nor the Commission's order approving those rules provides for keeping confidential any aspect of the questionnaires. CBOE asserts that the Commission, in approving CBOE's rules, sanctioned confidentiality for the surveys.

We have never imposed confidentiality as a requirement of the evaluation program. In 1987, when the Commission approved CBOE's use of evaluation surveys, we did not require that the surveys, or the identities of those completing the surveys, be confidential. Rather, we specifically stated in our approval order that in any formal hearing the "rights of confrontation and rights to counsel will apply." See Order Approving CBOE Proposed Rule Change, Exchange Act Rel. No. 24008 (Jan. 16, 1987), 37 SEC Docket 882. Likewise, the Commission's order approving on a permanent basis CBOE's use of evaluation surveys did not provide for survey confidentiality. See Order Approving Proposed Rule Change Relating to Evaluation of Trading Crowd Performance, Exchange Act Rel. No. 28012 (May 14, 1990), 46 SEC Docket 372.

In our most recent order approving a change to CBOE Rule 8.60, we again approved the use of an evaluation survey, cautioning CBOE that we considered "it essential that a Market Participant be fully cognizant of the factors that may bear upon the Committee's evaluation, particularly if that evaluation could result in remedial action by the Committee." The rule filing on which this order was based did not specify that the surveys would be confidential. See Order Approving Proposed Rule Change Relating to the Evaluation of Trading Crowd Performance, Exchange Act Rel. No. 43756 (Dec. 20, 2000), 73 SEC Docket 3833, 3836.

⁵⁶Cf., e.g., Order Approving New York Stock Exchange Proposed Rule Change, Exchange Act Rel. No. 15827 (May 15, 1979), 17 SEC Docket 589, 591 (in order for specialist to make a defensive presentation in a hearing to review its performance, "any material made available to the [NYSE Committee] during the course of any such proceeding will also be made available to the specialist in a timely fashion"). This opinion should not be read to suggest that conducting surveys on a confidential basis is itself problematic.

⁵⁷Cf. id. at 591, n.12 ("Neither the [NYSE Committee] nor an affected specialist (or such person's counsel) would be given access to individual questionnaires or have the right to ascertain the identity of and to examine those floor members whose responses precipitated a [review] proceeding.") (emphasis added).

⁵⁸ Our decision here is narrow, relating only to the procedure employed by CBOE to conduct its hearing. While we are constrained by Exchange Act Section 19(f) to set aside CBOE's action terminating Tower's DPM appointment, our order should not be read to suggest that CBOE is precluded from terminating Tower's appointment, following a fair hearing process, if such action is warranted. Cf. Eli Boggs Combs, 52 S.E.C. at 739 & n.9 (set aside order is narrow and SRO is not prohibited from exercising disqualification authority). Further, we note that Tower did not seek a stay of CBOE's action pending our resolution of Tower's appeal. We understand that Tower's DPM appointment has been terminated and the options classes previously allocated to Tower have been reallocated. Accordingly, CBOE may be unable to reallocate certain option classes back to Tower.

⁵⁹ We have considered all of the parties' procedural contentions. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views expressed in this opinion.