Chicago Board Options Exchange, Incorporated

February 14, 2003

Via Facsimile and Federal Express

Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: Securities Exchange Act Release No. 47186; File No. SR-BSE-2002-15

Dear Mr. Katz:

The Chicago Board Options Exchange, Incorporated ("CBOE") hereby submits its comments on the captioned Boston Stock Exchange ("BSE") rule change filing which proposes to allow an entity called the Boston Options Exchange Group, LLC ("BOX, LLC") to operate an automated electronic system for the trading of standardized equity options. This system, which would be regulated by another entity called Boston Options Exchange Regulation, LLC ("BOXR"), would be called the Boston Options Exchange (the "BOX").

As will be fully discussed in this letter, CBOE believes that the BOX proposal is wholly inconsistent with fundamental requirements of the Securities Exchange Act of 1934 ("Exchange Act"). It proposes nothing more than an internalization mechanism in which order providing firms will be able to avoid exposing their customer orders to meaningful price discovery in a manner completely contrary to the notion of an exchange auction market. Further, although the BOX would be a new options exchange, it is not filing an application to register as a national securities exchange under Section 6 of the Exchange Act. Instead, the BOX principals are using the BSE's existing exchange registration to implement the BOX exchange through the routine rule change filing process in order to avoid addressing the requirements of the Exchange Act applicable to the registration of an exchange. CBOE questions the appropriateness and legality of proposing what is essentially a new options exchange that is owned by an undisclosed consortium of entities through a mere rule change filing. Lastly, CBOE notes that the release and filing are inadequate as a basis for public comment or Securities and Exchange Commission ("Commission") approval because they do not describe many of the most basic aspects of the operation and regulation of the proposed exchange.

This letter addresses CBOE's general concerns with the proposal. Under the Exchange Act, the Commission is charged with determining whether approval of the rule filing would be consistent with the requirements of the Exchange Act. In addition to the fact that we believe BOX should be filing an exchange application, for the reasons presented below, CBOE believes that the rule filing is not consistent with the Exchange Act and that it should not be approved. Indeed, it will remain fundamentally flawed until it has been amended and supplemented to address a number of serious deficiencies (including the elimination of its internalization mechanism) and after there is another more serious opportunity for public comment on subsequent amendments.

A. Structure of BOX and Its Status as a National Securities Exchange.

CBOE finds what little information is available about the BOX ownership structure to be ambiguous, at best. More importantly, the general lack of information in this regard makes it impossible to comment meaningfully on the proposal and makes the filing materially deficient.1 After scrutinizing the release and filing, this much is certain: (1) BOX is constantly referred to as an exchange, but it is not an exchange; (2) BSE proposes to establish rules for BOX as a facility of the BSE even though BSE will not be directly involved in operating or regulating the BOX facility; (3) BOX would be operated by BOX, LLC; (4) the founding members of BOX, LLC are Interactive Brokers Group, LLC (a broker-dealer), the Bourse de Montreal, Inc. (a foreign exchange), and the BSE (a regional stock exchange apparently eager to "rent out" its registration as a securities exchange); (5) it is not clear if there are other members of BOX, LLC; (6) it is not clear what the ownership percentages are for BOX, LLC (e.g. does BSE own two percent?); (7) it is not clear how BOX, LLC's profits and losses are allocated; (8) BSE intends to delegate its regulatory oversight responsibilities for BOX to BOXR; (9) it is not clear how BOXR will be run or whether it will have its own employees; and (10) more information will be made available in a "Delegation Plan" that will be filed as a separate proposed rule change at some point in the future.

Starting with the very name "Boston Options Exchange" and continuing throughout the description contained in its filing, BSE bases its proposal on the erroneous assumption that BOX may be treated as a national securities exchange even though it has not and will not apply to be registered as an exchange. This flaw goes to the very heart of the BSE proposal (which might more accurately be called the BOX, LLC proposal fronted by BSE), and it is one more reason why the proposal cannot and should not be approved. Confusion as to the status of BOX runs throughout the filing. In many places BOX is characterized as a "facility" of BSE, as if repeating this fiction enough times will somehow make it true.2 In fact, BOX isn't even owned by BSE but is instead owned by a completely separate entity, BOX, LLC. While some unspecified interest in this entity is apparently owned by BSE, it is also owned by at least two other "founding members", one of which is a non-U.S. person, and presumably is or will also be owned by other persons not described in the filing. It would seem to be relevant to know if the owners of the BOX are firms that stand to benefit from the internalization mechanism proposed by the filing. In other places, the filing speaks as if BOX is an exchange with its own members and rules, ("BOX would have only one class of members...."; "An Options Participant: (1) must agree to be bound by ... the BOX Rules...."). And in still other places the filing speaks as if Options Participants on BOX will be members of BSE ("With the introduction of BOX, the BSE intends to change its membership rules...."; "[A]ll Options Participants must make application to, and be approved by, the BSE as Options Participants").

When it comes to describing what entity is responsible for operating and regulating the "sort-of exchange" that is BOX, the filing is equally confusing. In one place the filing states, "BOX, LLC would operate BOX ...." Elsewhere the filing states, "...the BSE would maintain responsibility for all regulatory functions related to [BOX]" and "...the BSE would conduct all necessary surveillance of the operation of and trading on BOX." But the filing also states that the BSE intends to delegate authority for "regulatory functions related to [BOX] such as surveillance and compliance" pursuant to a "Delegation Plan" that is not part of the filing. Apparently, the sponsors of BOX do not believe that a description of how and by whom this new exchange will be regulated needs to be included in the filing. Finally, and incomprehensively, the filing states that, "BOX, LLC would be responsible for the business of [BOX] to the extent those activities are not inconsistent with the regulatory and oversight functions of the BSE." All of this makes our head spin, and suggests to us that this proposal in its present form is not close to being in shape to be published for comment, much less approved.

Our point is not simply one of semantics or that the filing is demonstrably inadequate. Instead, because the BOX, LLC proposes to create a new exchange market for options without obtaining a separate exchange registration for that market, it attempts to avoid addressing such critical issues under the Exchange Act as how the new exchange will be governed, including what will be the role of the owners of BOX, LLC, of members of BOX, of members of BSE, of the BSE board of directors, and of BOX's own board (if there will be such a body) in the governance of BOX and of BOXR; what safeguards will be in place to assure that the interests of the private owners of BOX, LLC in maximizing the value of their investment will not compromise the regulation of BOX; what special safeguards are required by virtue of the non-U.S. status of at least one of the owners of BOX, LLC in order to assure that the Commission has adequate jurisdiction over BOX and its controlling persons; and other similar issues. On the other hand, if BOX is required to apply for registration as a national securities exchange, as we believe it must, all of these issues will have to be presented to the Commission for resolution, and fully vetted for public comment, before the registration of BOX could be approved. This is how other new and proposed options exchanges have satisfied the requirements of the Exchange Act (we refer specifically to the International Securities Exchange ("ISE") and to what we understand is Eurex's proposal to create a new options exchange in the U.S.), and nothing less should be required of BOX and its sponsors.

We are surprised that the BOX proposal was published for comment in its present form, and we urge the Commission not to act on this proposal unless and until it has been substantially revised to include an application for the registration of this separately owned and operated new options exchange as a national securities exchange under the Exchange Act. Unless this is done, every future sponsor of a new exchange will be able to circumvent the entire process of preparing and submitting to the Commission an application for the registration of the new exchange as a national securities exchange under the Exchange Act and thereby avoid having to demonstrate how the requirements of that Act will be satisfied, simply by finding an existing exchange that is willing to "front" the application by allowing the new exchange to be described as its "facility" (regardless of who or what may be the true owners and operators of the new exchange), and then to delegate regulatory responsibility over the new exchange in some unspecified manner. This is the approach taken by the sponsors of BOX. It completely eviscerates the safeguards of the Exchange Act (and the pervasive regulation by the Commission of the options industry for the past thirty years) that have served to protect investors for almost seventy years, and it is completely inconsistent with the current urgent need to restore investor confidence in our nation's securities markets.

B. BOX Price Improvement Period.

The proposed Price Improvement Period ("PIP") is perhaps the most troubling, controversial, and potentially harmful aspect of the proposed BOX trading system. Unfortunately, it is the heart of the BOX platform (an overwhelming majority of the filing is spent describing the PIP process), and it appears to be the sole reason the BOX principals are proposing to establish this new options exchange. As described in the release, the PIP allows order flow providers ("OFPs") to internalize orders in penny increments as long as the facilitation price is at least a penny better than the National Best Bid or Offer ("NBBO"). Only certain BOX market makers and the facilitating OFP can improve in these penny increments and only they can see the pending facilitation (these "Improvement Orders" are not disseminated through OPRA to other market participants), which is subject to a paltry three-second "exposure" period. Thus, the proposed "price discovery" process is limited to a select group of BOX participants and only for a three-second period. In fact, unrelated customer orders submitted to BOX that are marketable against the invisible penny-better prices will not be allowed to trade with such better prices (i.e. the better prices are only for the internalized customer order). As discussed in more detail below, the process is designed to enable OFPs to internalize customer orders without any real exposure to the marketplace, and in a manner that is inconsistent with the objectives of the Commission's Firm Quote Rule (Rule 11Ac1-1).

BOX proposes no minimum contract amount for use of the PIP. Instead BOX proposes an 18-month pilot period providing for no minimum contract amount.3 Also, subject to certain conditions, the facilitating OFP can be entitled to trade with 40% of the Customer Order4 and in some cases a qualifying market maker (referred to as the Market Maker Prime) that was quoting at the NBBO at the time the facilitation order was entered can be entitled to 1/3 of the remaining quantity after the OFP firm has internalized 40% of the order.

Because the PIP is the central component of the filing, CBOE will address our concerns with the PIP process in sub-categories.

1. PIP is all About Internalization. Bluntly stated, the PIP was crafted by the BOX creators to facilitate the internalization of options orders by order flow providers without the "friction" of price discovery and the exposure of orders to the marketplace. To CBOE's disappointment, internalization and its related practice payment for order flow are becoming increasingly prevalent in the listed options markets. Indeed, the conflict-ridden and potentially harmful consequences of internalization and payment for order flow appear to also be of great concern to the Commission as evidenced by Chairman Harvey Pitt's January 24, 2003 letter to CBOE and other options exchanges regarding these practices. In his letter, Chairman Pitt notes that "internalization practices and the current exchange-sponsored payment for order flow programs not only create a significant conflict of interest for agents, but also may discourage the display of aggressively priced quotes." He further urges CBOE, and presumably the other options exchanges, to eliminate any rules that provide members guarantees in connection with the internalization of customer order flow.

CBOE has previously expressed its concerns with internalization practices to the Commission urging the Commission to take action to stem the growth of internalization.5 We are encouraged that the Commission is also seemingly alarmed by the detrimental effects of internalization.6 To approve the BOX internalization platform would fly in the face of repeated concerns expressed by the Commission and numerous market participants, including CBOE. Further, approval of the BOX platform would essentially signify the Commission's full-fledged endorsement of this dubious practice and would open the gates for broker-dealers with agency responsibilities to flagrantly abandon the employment of best execution principles.

2. The Penny Improvement Period and One-Cent Increments. The BSE states in the filing that the BOX intends to trade in minimum trading increments of five (5) cents for options trading below $3.00, and ten (10) cents for options trading at $3.00 or higher.7 All BOX participants would be allowed to trade in such increments. However, only a select group of BOX participants would be allowed to trade in one (1) cent increments during the PIP process. The OFP and market makers that are appointed in the subject option class8 will be allowed to conduct a secret three-second auction in trading increments that BOX chooses to not make available to the rest of the BOX participants. This means BOX would not be disseminating the best bids and offers communicated by BOX participants as required by Commission Rule 11Ac1-1. Such lack of disclosure is harmful to the markets (in that it does not allow other customers and participants access to such bids/offers) and to unwitting customers whose orders are being internalized.

Further, CBOE believes BOX is discriminating among its participants by allowing certain participants to trade in increments that are not available to others BOX participants, namely public customers. Such discrimination is in clear contravention of the Exchange Act, and the BOX filing provides no explanation whatsoever as to how this aspect of the PIP has any benefit to public customer orders that are: (i) resident on the BOX book; (ii) marketable against a penny-better OFP or market maker quote; and/or (iii) internalized in a secret auction in which other market participants (who might be inclined to price improve in a meaningful trading increment) cannot see the auction unfolding and cannot even improve in the less significant one-cent increments. CBOE urges the Commission to recognize that the one-cent increment aspect of the PIP is merely BOX's attempt at disguising internalization as some form of price improvement for customers.

3. The PIP Participants. As mentioned above, the only participants that will be able to see or participate in any given PIP are the OFP initiating the PIP and any BOX market makers that are appointed in the subject option class. To the extent there are BOX market makers quoting at the NBBO at the time an OFP submits a Customer Order into the PIP (on the opposite side of the Customer Order), the first such market maker (the one with time priority) is called the Market Maker Prime.

If the OFP is quoting at the best price at the conclusion of the PIP process, it will be entitled to 40% of the Customer Order.9 If the Market Maker Prime is quoting at the best price at the conclusion of the PIP, the Market Maker Prime will be entitled to 1/3 of the remaining quantity of the Customer Order10 (after the OFP's 40% is taken, if applicable).11 Thus, even though there may be multiple public customer orders priced at the NBBO in the BOX order book with time priority over the Market Maker Prime at the time the PIP is initiated, such public customer orders (or any non-market maker participants for that matter) will not be allowed to compete in penny increments and will not see the PIP auction process. CBOE believes this is patently unfair to market participants who might not only be willing to price improve, but who have true price/time priority (including ahead of any Market Maker Prime) at the time the PIP is initiated, and in contravention of Section 6(b)(5) of the Exchange Act. Surely, BOX is reluctant to allow for a "Customer Prime" because it would interfere with the unimpeded internalization that is the core of BOX's proposed operation.

Equally troubling is the fact that the OFP can also be the Market Maker Prime. Thus, even if an OFP is forced to "compete" with market makers during the PIP, the OFP, if it were also the Market Maker Prime (a very possible scenario), would be guaranteed at least 60% of the Customer Order as long as it finished the PIP at the best price. Given that this is all supposed to happen in three-seconds, CBOE expects that the OFP will usually be quoting at the best price at the conclusion of the PIP. Thus, this thinly-veiled form of internalization not only disadvantages customers, but it blocks critical liquidity from the market to the financial betterment of OFPs.

4. Excessive Guarantees. The Commission has for some time maintained a 40% cap on the portion of a crossed options order that can be "locked-up" by any given exchange's market participants collectively. Despite the fact that the Commission has expressed concerns with such guarantees, the BOX now proposes to establish a 60% guarantee as part of its PIP process. As described in the filing, if at the end of the "vigorous" and secret three-second price discovery period the OFP and the Market Maker Prime are both quoting at the secret best price, the OFP will take 40% of the Customer Order and the Market Maker Prime will take 1/3 of what is left (or 20% of the original order). This would establish a new 60% standard in the face of Commission, Congressional, and industry concerns over internalization guarantees that are potentially anti-competitive and laden with conflict. BOX fails to explain why this new standard is appropriate or consistent with the Exchange Act and how it addresses Commission concerns.

5. Three Seconds. A three-second price discovery period is woefully inadequate. BSE postures that three-seconds "is enough time for a vigorous, multi-round, electronic price improvement auction among the BOX Market Makers and the OFP who initiates the PIP, and yet is not so long that it is economically infeasible for OFPs to be firm to the Customer for at least a penny better..."12 CBOE believes three-seconds is certainly not enough time for a meaningful electronic price discovery exposure period.

By proposing to establish a three-second exposure period (that is invisible to most), the BOX proposal profoundly increases the likelihood that other market participants will not be able to respond quickly enough to provide price improvement. This is unacceptable under applicable federal securities laws, both because it will deprive individual orders of opportunities for true price discovery, and because it will enable OFPs to internalize and direct their order flow to an extent the Commission has never previously condoned. The CBOE respectfully submits that allowing an exposure requirement of three-seconds would represent a radical departure from the fundamental principles of an auction marketplace that will preclude BOX participants from ensuring true price improvement and best executions through competitive bidding for customer orders. This loss of competitive bidding would contravene the BSE's presumed responsibilities as a national securities exchange to promulgate rules that "protect investors" and do not "permit unfair discrimination" among customers, brokers and dealers.13

The Commission has, in our view, wrongly permitted a ten-second minimum exposure period for the facilitation of orders.14 Nevertheless, in doing so, the Commission clearly rejected a five-second exposure period that was initially proposed. We and others expressed serious doubts about the adequacy of a ten-second exposure period, and worried that such a brief exposure period would be the prelude to an eventual elimination of any exposure period by an electronic exchange under the guise of "efficiency." A three-second standard is so brief as to be tantamount to an elimination of order exposure. It would most certainly pave the way for the frictionless non-stop internalization of customer orders. Moreover, given the fact that option classes could have as few as one market maker on BOX (not to be confused with a Designated Primary Market-Maker or a specialist who have a significantly higher level of affirmative obligations) and that no other participants may compete in the PIP process, it is likely that the meager three-second time period will allow the initiating OFP to internalize 100% of the vast majority of orders it submits into the PIP process.

Additionally, CBOE strongly objects to BOX's conclusion that the economic feasibility of OFPs internalizing orders is paramount to customer orders being exposed to the true market for potential price improvement. An OFP is an agent. The OFP has certain best execution obligations that it must meet in handling customer orders. Those obligations do not include trying to internalize as many customer orders as possible in a manner that is economically beneficial for the OFP. Our understanding of agency law is that the agent owes its highest fiduciary obligation to its customer - we fail to see how the structure of this system is designed to facilitate the agent's responsibility to its customer. To the contrary, it "boxes" out the ability to fulfill best execution obligations. In fact, BOX rules are admittedly crafted to "minimize the market risk borne by OFPs."15 BOX fails to explain why any protections need to be afforded to OFPs that seek to internalize customer orders for which they have a best execution obligation.

6. Firm Bids/Offers. BOX states that all prices are firm during the PIP process.16 This is false. BOX Improvement Orders (the penny increment price improvement orders that are the crux of the PIP process) are only firm for the Customer Order that the OFP is trying to internalize. All other orders, including non-broker dealer customer orders, are not allowed to trade with Improvement Orders. Such a structure would seemingly allow for unlimited continuous violations of BOX's own rules (Chapter VI, Section 6(c)(i)). For example, an OFP seeks to internalize a Customer market order to buy 100 contracts. The national best offer is 2.75. The OFP initiates a PIP and creates a 2.74 improvement offer. Two seconds later three BOX market makers join the OFP at 2.74, each for 100 contracts (for a total of 400 contracts at 2.74). Before the 3 second period concludes, BOX receives an unrelated market order to buy 10 contracts. Pursuant to BOX rules, this concludes the PIP and the Customer Order for 100 contracts is executed at 2.74 but the unrelated order is not allowed to trade at 2.74 despite the fact that 300 contracts were offered at 2.74 at the time the unrelated order was received by the BOX system (all Improvement Orders that don't trade with the pending Customer Order are cancelled). CBOE does not understand how this would not be in direct violation of BOX rules and firm quote principles.

7. NBBO Guarantee. BOX states that "Customer Orders are guaranteed a locked-in trade at a price at least a penny better than the NBBO."17 However, BOX does not explain what happens if during the PIP, an "away" exchange establishes a new NBBO at a price that is superior to the final Improvement Price. In fast moving options markets, this is a likely scenario, and the fact that BOX makes no effort to explain how such a scenario would be handled is yet another indication as to why the filing is so fundamentally deficient.

8. Lack of Incentive to Quote Aggressively. There is very little incentive for OFPs and BOX market makers to quote aggressively on BOX. This is a multi-faceted problem. First, BOX market makers hardly have an incentive to generally quote in an aggressive manner if an OFP can essentially internalize orders in three-seconds at a penny better than the NBBO. Chairman Pitt's comments seem to support this contention. Second, there is little incentive for the OFP to price improve aggressively during a PIP because, as previously noted (and as detailed in the eight overly-simplistic examples provided in the filing), the OFP's 40% guarantee applies so long as an unexecuted portion of the Customer Order remains- even if the OFP were not quoting at the best price at the conclusion of the PIP. Thus, the OFP (and sometimes the Market Maker Prime) is likely to get a guaranteed percentage of the Customer Order even if it doesn't compete and match the best Improvement Order (or an unrelated better-priced order).

C. Linkage and a National Market System.

As previously mentioned, BOX fails to explain how it intends to handle orders that are marketable against an away NBBO exchange. It is highly likely that marketable orders could be routed to BOX while it is not the NBBO. The filing makes absolutely no mention of what will happen to those orders or who will handle those orders. Indeed, the BOX structure does not employ a DPM or specialist-type entity that is a designated agent for such orders. BOX should be required to describe how it intends to handle orders when BOX is not the NBBO.

A related area in which the filing is glaringly deficient is how BOX intends to operate in connection with the intermarket options linkage that began on January 31, 2003. The Options Intermarket Linkage Plan ("Plan") governing the linkage and its implementation has been publicly available for years (including on the Commission's website). Nevertheless, BOX only states that BSE intends to file more proposed rule changes to join the Plan. No indication is given as to how BOX could even structurally operate within the requirements of the Plan. For example, the Plan contemplates qualifying market makers on Participant exchanges transmitting Principal Acting as Agent Orders ("PA Orders") to an away NBBO exchange. Such orders are meant to reflect the terms of an unexecuted underlying public customer order in the custody of a market maker and must be sent for the principal account of a market maker.

By its own terms, the BOX's proposed structure does not seem to comply with the most basic requirements of the Plan, because, as proposed, BOX market makers are not charged with acting as agent for public customer orders. In certain respects, the options linkage is causing significant change to the manner in which options exchanges execute customer orders. For BOX to propose a market model that does not address how it will integrate into and operate in this linked environment is another indication that BOX's sole focus is developing an internalization mechanism without regard for public customers in the BOX market and on other markets.

D. BOX Market Makers.

There is conflicting information available about BOX market maker obligations. For example, Chapter VI, Section 5(a)(i) states, in pertinent part, that "During trading hours, a Market Maker must maintain a continuous, two-sided market in those option classes in which the Market Maker is registered to trade..." However, Section 6(d) provides that "a Market Maker must enter continuous quotations for the options classes to which it is at least eighty percent (80%) of the options series, for at least ninety percent (90%) of the classes to which the market maker is appointed." These provisions seem in direct conflict. Further, Section 5(a)(viii) provides that market makers should "maintain active markets in all classes in which the Market Maker is appointed for a period of at least six months." Does this mean that all quoting obligations (or any obligations for that matter) no longer apply after six months? It is unclear from the filing.

The BOX website18 (which contains more information about BOX than does the BSE rule filing) provides that "BOX will conduct random reviews of each Market Maker's quotes throughout the trading session. Within a given class for which he is appointed Market Maker, the BOX Market Maker must present a valid bid and offer quote pair for a minimum percentage of the individual observations conducted by BOX." If BOX market makers are required to continuously provide a two-sided market during trading hours, shouldn't the minimum percentage referenced above be 100%?

The BOX website also mentions other market maker obligations that are not in the proposed BOX rules. For example, it states that "BOX market makers are obligated to respond to all Request for Quote (RFQ) messages on their appointed classes where they are not posting a current valid market for the option instrument for which the RFQ is issued." CBOE believes that BOX must clarify what the true market maker obligations will be, and that BOX should be required to include an accurate description of all such obligations in the BOX rules. In fact, CBOE can find no references to RFQs in the proposed BOX rules. It seems an RFQ process should be thoroughly described in the rules.

Last, the proposed BOX rules provide that a BOX market maker may be appointed to all option classes traded on BOX.19 CBOE is concerned that this capability may be used by BOX market makers to receive preferential margin treatment, and dealer status for tax purposes, for transactions in one or more classes when such transactions were merely casual and not truly characteristic of "market making" as has been long established in the options markets.

E. Deficient Options Margin/Sales Practice Rules.

Not surprisingly, the BOX proposal does not contain options margin rules. Since BOX proposes to establish a new options exchange, it should be required to at least propose to adopt such rules. Further, the proposed BOX rules do not contain any sort of anti money laundering compliance program requirements, something the Commission insisted CBOE and other options exchanges adopt. Also, the proposed BOX rules do not contain provisions requiring BOX to review and approve an application of a BOX Options Participant to conduct a public customer business. These deficiencies only punctuate the fact that the BOX proposal is so incomplete that it should be disapproved.


The CBOE has grave concerns about the BOX proposal. The operation of the BOX is designed to permit virtually unimpeded internalization and would lead to a dangerous mutation of the options markets into a fragmented system of separate internalization mechanisms. Such a structure would serve the interests of professionals, not customers, and would undermine the integrity of the options markets. We urge the Commission to disapprove the proposal as filed. In addition, the filing is so deficient in material respects that it cannot possibly be considered by the Commission in its present state. At a minimum, BSE should be required to supplement or amend the filing to fill in the gaping holes and commenters should be given another opportunity to submit comments.

CBOE would be glad to discuss these comments with individual members of the Commission and its staff. Any questions regarding this letter should be directed to Joanne Moffic-Silver, General Counsel & Corporate Secretary, at 312-786-7462, Angelo Evangelou, Senior Attorney, at 312-786-7464, or the undersigned.


William J. Brodsky

cc: Chairman Harvey L. Pitt
Commissioner Cynthia A. Glassman
Commissioner Harvey J. Goldschmid
Commissioner Paul S. Atkins
Commissioner Roel C. Campos
Annette Nazareth, Director, Division of Market Regulation
Lori Richards, Director, Office of Compliance Inspections and Examinations
Robert L.D. Colby, Deputy Director, Division of Market Regulation
Elizabeth King, Associate Director, Division of Market Regulation
Deborah Flynn, Assistant Director, Division Market Regulation

1 Interestingly, BOX's proposed registration process for a market maker applicant would involve a review of, among other things, the applicant's capital, operations, personnel, and technical resources. Yet, BOX does not deem it necessary to include such information about itself in seeking approval of this rule filing.
2 CBOE recognizes that the Commission previously approved a Pacific Exchange ("PCX") rule filing to establish the Archipelago Exchange as the Equities Trading Facility of PCX Equities, Inc. While CBOE does not believe such approval was appropriate, it is clearly distinguishable from the BOX proposal, in that, among other things, the PCX was already a stock exchange trading equity securities and wanted to modify its existing equity operation whereas the BSE does not trade options and is not itself proposing to trade options.
3 See Proposed BOX Chapter V, Section 18 (Supplementary Material).
4 BOX defines Customer Order as an order of a Broker-Dealer or a Public Customer. See proposed BOX Chapter I, Section 1(a)(20).
5 Most recently, in a February 10, 2003 letter from William J. Brodsky to Chairman Harvey Pitt.
6 In fact, the Commission has expressed concern with internalization practices for some time. For example, in a November 4, 1999 speech, then Chairman Arthur Levitt stated "I worry that best execution may be compromised by payment for order flow, internalization, and certain other practices that can present conflicts between the interests of brokers and their customers." More recently, in a written response to the U.S. Senate, Chairman-Designate William Donaldson stated "Like payment for order flow, internalization can discourage markets from competing on the basis of price and pose a conflict of interest for broker-dealers."
7 See proposed BOX Chapter V, Section 6.
8 It seems from the filing, that it is entirely possible for an option class listed on BOX to have only one market maker appointed to it.
9 See proposed BOX Chapter V, Section 18(f)(i).
10 See proposed BOX Chapter V, Section 19(c).
11 Both of these guarantees apply even if the OFP and Market Maker Prime are not at the ultimate best price. The guarantees apply even at inferior prices as long as any unexecuted quantity of the Customer Order remains.
12 See page 3068 of the release.
13 Exchange Act of 1934 Section 6(b)(5), 15 U.S.C. §78f(b)(5).
14 See ISE Rule 716.
15 See page 3068 of the release.
16 See page 3068 of the release.
17 See page 3067 of the release.
19 See proposed BOX Chapter VI, Section 4(a).