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Spoofing, Surveillance and Supervision

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February 24, 2006

Critics Charge BOX Sneaks Peaks

By Peter Chapman

The Boston Options Exchange (BOX) is under fire for ignoring one of its own rules.

Citadel Derivatives Group, the BOX's second largest market maker, and the International Securities Exchange, a competitor, have complained to the Securities and Exchange Commission about deceptive practices at the BOX.

BOX's rules state that the identity of all order senders will remain anonymous until clearing or in the case of errors. But that rule is apparently not enforced when it comes to orders directed to specific market makers for price improvement.

"BOX's original price improvement rules were very explicit in saying order senders' identities would remain anonymous," says Citadel chief executive Matt Andresen. "It has come to light that they were not operating that way."

Andresen and the ISE claim the practice allows BOX market makers to "cherry pick" the least risky and most profitable orders they receive through the "directed order" process. Those deemed too risky or less profitable can be shunted into the BOX's general auction market.

Citadel, in fact, in a comment letter, claims that the largest market maker at the BOX and one the exchange's largest equity owners "refuses to price improve any of Citadel's orders."

Timber Hill, sources say, is the largest market maker at the BOX.

The lack of anonymity facilitates unfair discrimination, BOX's critics claim, and is detrimental to the health of the overall options market. At the BOX, orders that receive price improvement account for approximately 25 percent of all orders.

The BOX, which began operations in February 2004, is seeking to change its rules to formally eliminate anonymity on directed orders. It filed a rule change with the SEC in December.

The exchange claims the move will "clarify the information contained in a directed order. This clarification will allow options participants to make better informed decisions in determining when and how to use the directed order process."

Citadel and the ISE have asked the SEC to reject the filing. In addition, the ISE, to stay competitive with the BOX, has eliminated anonymity on its directed orders.