[Federal Register Volume 59, Number 47 (Thursday, March 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5476]


[[Page Unknown]]

[Federal Register: March 10, 1994]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33708; File No. SR-MSE-93-05]

 

Self-Regulatory Organizations; Midwest Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Amendment No. 1 to Proposed 
Rule Change and Notice of Filing and Order Granting Accelerated 
Approval to Amendment No. 2 to Proposed Rule Change Relating to Agency 
Crosses Between the Disseminated Exchange Market

March 3, 1994.

I. Introduction

    On March 2, 1993, the Midwest Stock Exchange, Inc. (``MSE,'' 
``Exchange'' or ``Chicago Stock Exchange'')\1\ submitted to the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\2\ and rule 19b-4 thereunder,\3\ a proposed rule change 
relating to the execution of agency cross transactions at a price 
between the disseminated Exchange market. On December 10, 1993, the MSE 
submitted to the Commission Amendment No. 1 to the proposed rule change 
in order to summarize and respond to a comment letter it received in 
opposition to this proposal.\4\ On February 16, 1994, the MSE submitted 
Amendment No. 2 to the proposed rule change to specify that the 
proposal only applies to block trades and to clarify the Exchange's 
position regarding specialist participation in cross transactions.\5\
---------------------------------------------------------------------------

    \1\As of July 8, 1993, the MSE changed its name to the Chicago 
Stock Exchange, Inc. (``CHX''). See Securities Exchange Act Release 
Nos. 32488 (June 18, 1993), 58 FR 34284 (June 24, 1993) (File No. 
SR-MSE-93-13) (immediate effectiveness of proposed rule change to 
amend the MSE's Certificate of Incorporation and Constitution to 
effect a name change); and 32489 (June 18, 1993), 58 FR 34285 (June 
24, 1993) (File No. SR-MSE-93-16) (immediate effectiveness of 
proposed rule change to make conforming changes to the MSE Rules.)
    \2\15 U.S.C. 78s(b)(1) (1988).
    \3\17 CFR 240.19b-4 (1991).
    \4\See letter from David T. Rusoff, Foley & Lardner, to Beth A. 
Stekler, Attorney, Division of Market Regulation, SEC, dated 
December 9, 1993 (``Amendment No. 1'').
    \5\See letter from David T. Rusoff, Foley & Lardner, to Sharon 
Lawson, Assistant Director, Division of Market Regulation, SEC, 
dated February 15, 1994 (``Amendment No. 2'').
---------------------------------------------------------------------------

    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 33500 (January 21, 1994), 59 FR 4128 (January 
28, 1994). One comment letter was received on the proposal.\6\ This 
order approves the proposed rule change, including both amendments.
---------------------------------------------------------------------------

    \6\See letter from Robert Hill, Vice President, The Chicago 
Corporation, to the Executive Committee, MSE, dated October 20, 1992 
(``Hill comment letter''). The Hill comment letter was forwarded to 
the Commission as part of Amendment No. 1, supra, note 4.
---------------------------------------------------------------------------

II. Description of the Proposal

    Article XX, Rule 23 of the Exchange's rules outlines the current 
method for the execution of cross transactions on the MSE.\7\ Under 
that rule (in conjunction with the MSE's priority rule), a member or 
member organization effecting a cross transaction first must assure 
that all existing bids or offers, at or better than the cross price, 
are filled at their limits.\8\ Thereafter, the member or member 
organization must publicly announce both sides of the cross; the 
member's offer must be higher than its bid by at least the minimum 
variation permitted for that security.\9\ Rule 23 then allows the 
member or member organization to execute the cross transaction at its 
bid or offer. Under this method, however, another member can ``break 
up'' the cross, by trading with either the bid or offer side of the 
transaction when it is presented to the crowd. According to the 
Exchange, the ability of the specialist, in particular, to participate 
in a cross transaction decreases the likelihood of the order sending 
firm receiving an immediate execution.
---------------------------------------------------------------------------

    \7\In a cross transaction, a member or member organization that 
holds an order to buy and an order to sell an equivalent amount of 
the same security wishes to execute the orders against each other. 
Because it already holds both sides of the trade, the member does 
not want the orders to interact with other market interest.
    \8\As a general matter, the bid/offer entered at the best price 
(i.e., the highest bid or the lowest offer) is entitled to priority 
over bids/offers at inferior prices; similarly, the first bid/offer 
clearly established at a given price is entitled to priority over 
other bids/offers at the same price. See Article XX, rules 15-18 of 
the MSE Rules.
    \9\Article XX, Rule 22 of the MSE Rules sets forth the minimum 
variation permitted for securities traded on the Exchange.
---------------------------------------------------------------------------

    The Exchange proposes to add a new Interpretation and Policy .01 to 
Rule 23. Specifically, the proposed interpretation will require that 
the MSE specialist refrain from interfering with a floor-brokered 
agency cross,\10\ of 10,000 shares or more,\11\ at a cross price 
between the disseminated Exchange market.\12\ Even if the above 
requirement precludes specialist participation, once a cross is 
executed, the specialist nevertheless will be obligated, as under 
current rules, to satisfy all book orders with priority at the cross 
price. In contrast, the MSE proposal will allow the specialist to 
participate in a block agency cross if he or she has a disseminated bid 
or offer at the cross price, regardless of the size thereof.\13\ 
Finally, the MSE has clarified that a specialist who is willing to 
provide one side of the cross with a better price will have the 
opportunity to do so.\14\
---------------------------------------------------------------------------

    \10\For purposes of this proposal, the Exchange has defined the 
term ``agency cross'' as a cross where neither the order to buy nor 
the order to sell is for the account of any member or member 
organization (i.e., including, but not limited to, the member or 
member organization executing the cross). Telephone conversation 
between David T. Rusoff, Foley & Lardner, and Beth A. Stekler, 
Attorney, Division of Market Regulation, SEC, on January 5, 1994.
    \11\The proposed interpretation will not apply to crosses of 
less than 10,000 shares. According to the Exchange, the current 
rules, see supra notes 7-9 and accompanying text, will continue to 
govern the execution of, and specialist participation in, crosses 
that fall below the MSE's 10,000 share size threshold for block 
trades. Telephone conversation between David T. Rusoff, Foley & 
Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on February 18, 1994.
    \12\However, the specialist will be allowed to participate if 
the member presenting the cross previously solicited his or her 
assistance in consummating any part of the transaction.
    \13\In particular, the Exchange has indicated that a specialist 
who is displaying a bid or offer at the cross price will be allowed 
to participate at that price, even in a size greater than his or her 
quotation. Telephone conversation between David T. Rusoff, Foley & 
Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on December 20, 1993.
    \14\See Amendment No. 2, supra, note 5.
---------------------------------------------------------------------------

    The MSE states that the purpose of the proposed rule change is to 
increase the possibility of immediate execution of agency crosses on 
the Exchange when the cross price is between the disseminated MSE 
market. The Exchange believes that the proposed rule change is 
consistent with section 6(b)(5) of the Act, in that it is designed to 
promote just and equitable principles of trade, to remove impediments 
to and to perfect the mechanism of a free and open market and a 
national market system, and, in general, to protect investors and the 
public interest.

III. Comments Received and MSE Response

    One comment letter on the proposed rule change, from a MSE 
specialist, was received by the Exchange and forwarded to the 
Commission.\15\ In his letter, the commentator recommends that the MSE 
proposal be disapproved and raises several arguments, as discussed 
below, in support of his position.
---------------------------------------------------------------------------

    \15\See Hill comment letter, supra, note 6.
---------------------------------------------------------------------------

    First, the commentator states that the MSE's rules have always 
provided for the protection of customer orders, no matter how small, 
and claims that this proposal represents a significant philosophical 
change from that stance. The commentator fears that this will undermine 
the Exchange's leverage in arguing for increased protection and 
participation of public orders.
    The letter also suggests that a new policy is not necessary at this 
time. In the commentator's opinion, most instances where crosses are 
broken up occur for legitimate reasons, and, while there may be 
problems with certain specialists, overall brokers believe that the 
current rules are adequate. Moreover, the commentator contends that the 
Exchange does not have much to gain, except for ``window dressing 
trades,'' from the proposed rule change. To this end, the commentator 
states that the Exchange will receive little in the way of additional 
transaction fees or CTA revenue.
    In addition, the commentator argues that the proposed 
interpretation makes no allowance for human slowness and asks what will 
happen in busy markets. The commentator notes that a public order which 
has come in to the MSE specialist, but has not yet been reflected in 
his or her quote, cannot participate in a cross; the letter implies 
that this result is contrary to the type of business an exchange (as 
opposed to a crossing network) wants to encourage. In addition, the 
commentator suggests that the new policy will be susceptible to abuse 
because the MSE cannot determine, on an immediate basis, whether a 
particular transaction is really an agency cross. His letter predicts 
that monitoring ``after the fact'' will have a negative impact on the 
Exchange's ability to attract business.
    Finally, the commentator expresses concern that this proposal will 
reduce the natural tension between specialist and broker that allows 
for efficiency in the marketplace. The commentator argues that the 
Exchange should be encouraging more orders and less crosses. From his 
perspective, liquidity is based on the flow of orders into the price 
discovery network, and, accordingly, it is not in the Exchange's 
interest to facilitate what he describes as passively priced orders 
that trade without interaction.
    The MSE responded to the issues raised by the specialist's comment 
letter.\16\ In its response, the MSE asserts that the proposed rule 
change will not interfere with the execution of public orders on the 
specialist's book. According to the Exchange, customer orders will 
continue to be protected under its proposal, because the specialist 
will be required to fill limit orders at the cross price, even if they 
are not displayed due to the specialist's oversight. In the Exchange's 
view, this requirement also should encourage specialists to be more 
efficient in representing customer orders and to quote their true 
market.
---------------------------------------------------------------------------

    \16\See Amendment No. 1, supra, note 4.
---------------------------------------------------------------------------

    Second, the MSE disputes the commentator's assessment of the costs 
and benefits of the proposed rule change. The MSE believes that its new 
policy will encourage more institutional trades to be routed to the 
Exchange floor; whether this will result in more revenue is described 
as a ``secondary consideration.'' In conclusion, the MSE states that 
its proposal will create a more attractive marketplace for 
institutional orders, without sacrificing traditional agency auction 
market principles.
    In addition, the MSE does not agree with the commentator that the 
potential for abuse (i.e., by not having an agency order on both sides 
of the trade) is a valid argument against adopting the proposed 
interpretation in the first place. The Exchange states that many of its 
present rules cannot be monitored for compliance on an immediate basis, 
and pledges to take appropriate action if it finds that members are 
abusing this rule.
    Finally, according to the MSE, the proposed rule change will not 
reduce the possibility of order interaction on the floor. The Exchange 
notes that a specialist who is not displaying his or her market at the 
cross price (and who has not previously been solicited for help) will 
be the only one who cannot participate in a cross transaction. This 
proposal will not affect the requirement that both sides of the cross 
be announced publicly and/or the ability of other interest in the crowd 
to participate. In fact, the MSE contends that, as a result of this 
policy, more orders could be routed to the Exchange floor and could 
take part in the auction process.

IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of sections 6(b) and P11(a).\17\ In 
particular, the Commission believes that the proposed rule change is 
consistent with the section 6(b)(5) requirement that the rules of an 
exchange be designed to promote just and equitable principles of trade, 
to prevent fraudulent and manipulative acts and, in general, to protect 
investors and the public interest; and with the section 6(b)(8) 
requirement that the rules of an exchange not impose any unnecessary 
burden on competition. The Commission also believes that the proposed 
rule change does not operate in a manner inconsistent with the 
traditional auction market principle of customer priority, as embodied 
in section 11(a) of the Act.
---------------------------------------------------------------------------

    \17\15 U.S.C. 78f(b) (1988).
---------------------------------------------------------------------------

    After careful review of the comments received as well as the 
applicable statutory provisions, the Commission has concluded that the 
proposed rule change should further competition among the exchanges, as 
well as between exchanges and other markets, and should increase the 
opportunities for the efficient execution of cross transactions. In the 
past, the Commission has recognized the competition that exists between 
the various markets for order flow, and especially for block business. 
Several exchanges recently have received Commission approval to amend 
their rules, on the grounds that exchange rules may hinder members' 
ability to execute a cross transaction without interference and thus 
may place an exchange at a competitive disadvantage.\18\
---------------------------------------------------------------------------

    \18\See, e.g., Securities Exchange Act Release Nos. 27205 
(August 31, 1989), 54 FR 37180 (September 7, 1989) (File No. SR-
Phlx-89-17) (approving Philadelphia Stock Exchange (``Phlx'') 
proposal to prohibit members from interfering, with either side of 
an agency cross or the customer side of a facilitation cross, by 
buying or selling for their own account at the cross price; except 
that a specialist can participate to the extent of a publicly 
disseminated bid or offer at that price, or to better the price); 
31343 (October 21, 1992), 57 FR 48645 (October 27, 1992) (File No. 
SR-NYSE-90-39) (approving New York Stock Exchange (``NYSE'') ``clean 
cross'' proposal to allow members to execute agency crosses of 
25,000 shares or more, at a price at or within the prevailing 
quotation, without interference, irrespective of any pre-existing 
bids or offers at the cross price; however, the cross can be broken 
up at a better price); and 33391 (December 28, 1993, 59 FR 336 
(January 4, 1994) (File No. SR-PSE-91-11) (approving Pacific Stock 
Exchange (``PSE'') proposal to prohibit specialists from 
participating for their own account on either side of an agency 
cross, or the customer side of a facilitation cross, at a price 
within the disseminated PSE market; except that a specialist can 
participate to better the price).
---------------------------------------------------------------------------

    In response to today's competitive market environment, the MSE has 
proposed to add a new requirement that a specialist's proprietary bid 
or offer must yield to a block agency cross at a cross price between 
the prevailing Exchange quotation. The MSE's new policy, however, will 
allow a specialist who has a disseminated bid or offer at the cross 
price to participate at that price. On balance, the Commission believes 
that the proposal will clarify the roles of various market participants 
and assure that, under routine circumstances, crosses are executed in a 
fair and orderly manner, without disadvantaging public customer orders. 
For instance, the Commission has determined that, for a regional 
exchange like the MSE, a size threshold of 10,000 shares is not 
unreasonable. Similarly, specialists will be protected from yielding 
priority if they have exposed themselves to market risk at the cross 
price. Accordingly, the Commission finds that the proposed rule change 
should improve the MSE's ability to compete for block business and 
potentially could enhance the depth and liquidity of the Exchange 
market.\19\
---------------------------------------------------------------------------

    \19\The Commission appreciates all the exchanges' competitive 
concerns with respect to the facilitation of cross transactions and, 
at the same time, continues to emphasize the importance of adherence 
with traditional auction market principles.
---------------------------------------------------------------------------

    In terms of auction market principles, the Commission believes that 
the proposed rule change strikes an appropriate balance between the 
competing needs of various customer orders represented for execution on 
the MSE and the proprietary trading operations of Exchange members and 
member organizations, including specialists. The Commission notes that 
the MSE's new policy only applies to crosses between the disseminated 
Exchange market. Accordingly, a member effecting a cross transaction at 
the prevailing bid or offer will, consistent with current rules, be 
required to obtain priority over all existing limit orders at that 
price.\20\ In the event that an order on the specialist's book has not 
been displayed in the quote but has time priority, the MSE proposal 
guarantees that, after an order is effected at its price (pursuant to 
rule 23 or otherwise), that limit order will be filled, even if the 
specialist is precluded from interfering with the cross on its behalf. 
Thus the Commission has concluded that the MSE proposal adheres to the 
auction market principles of time and price priority and that this 
method for the execution of crosses (and, in particular, the priority 
granted to block agency crosses) will not disadvantage existing 
orders.\21\ In fact, limit orders on the MSE which coincide with the 
cross price could benefit from being assured of receiving an execution 
at that price.
---------------------------------------------------------------------------

    \20\See supra, note 8.
    \21\In this regard, the MSE proposal contrasts favorably with 
other rule changes approved by the Commission, such as the NYSE's 
clean cross proposal, see supra note 18.
---------------------------------------------------------------------------

    Furthermore, the Commission finds that the MSE proposal does not 
restrict the opportunity for customer orders to receive price 
improvement. To this end, rule 23 will allow the specialist to 
participate in a cross transaction to provide one side with a better 
price, notwithstanding any other provisions of this rule.\22\ In 
addition, under the proposed rule change, it is still possible for 
interest in the trading crowd, including an order for the principal 
account of a member, to break up the cross and improve the price.
---------------------------------------------------------------------------

    \22\See Amendment No. 2, supra, note 5.
---------------------------------------------------------------------------

    The Commission also believes that the MSE proposal would not grant 
priority, parity or precedence to the order of a member in a manner 
inconsistent with section 11(a)(1)(G) of the Act or SEC rule 11a1-
1(T)(a)(3) thereunder.\23\ For purposes of this proposed rule change, 
the MSE has defined the term ``agency cross'' as a cross where neither 
the order to buy nor the order to sell is for the account of a member 
or member organization. Because the definition of ``agency cross'' 
excludes (and, thus, does not grant priority to) an order for the 
account of the broker effecting the cross transaction or an associated 
person thereof,\24\ the Commission is satisfied that the proposed rule 
change complies with section 11(a).
---------------------------------------------------------------------------

    \23\17 CFR 240.11a1-1(T)(a)(3).
    \24\Telephone conversation between David T. Rusoff, Foley & 
Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on March 3, 1994.
---------------------------------------------------------------------------

    The Commission does not agree with the commentator that this 
proposed rule change represents a significant philosophical change from 
the MSE's traditional stance of customer protection. As discussed 
above, the Exchange will continue to afford time and price protection 
to orders on the specialist's book.\25\ In the Commission's opinion, 
this proposal contains adequate safeguards to ensure that public 
customers are not disadvantaged.
---------------------------------------------------------------------------

    \25\See supra, notes 20-21 and accompanying text.
---------------------------------------------------------------------------

    In addition, the Commission finds that the Exchange has advanced a 
satisfactory rationale for its new policy. The MSE believes that the 
specialist's ability to participate in a cross transaction decreases 
the likelihood of the order sending firm receiving an immediate 
execution. Conversely, the MSE argues that minimizing such interference 
will make the Exchange a more attractive marketplace for institutional 
orders (regardless of the effect on Exchange revenues). In the absence 
of a finding that this proposal is inconsistent with the Act, which the 
Commission cannot make at this time, the Commission is willing, in 
these circumstances, to defer to the MSE's judgment about the need for 
and the potential gains from the proposed rule change.
    The Commission also believes that the means the exchange has chosen 
to accomplish its goals are not unreasonable, despite the potential for 
abuse identified by the commentator. In reaching that conclusion, the 
Commission placed great weight on the MSE's assurances that its current 
surveillance methods (especially, the existence of an audit trail) are 
capable of determining, in a relatively prompt fashion, whether a 
particular transaction was really an agency cross.\26\ The Exchange, 
moreover, has pledged to take appropriate action to remedy any 
instances of noncompliance. Based on the above, the Commission is 
satisfied that existing surveillance procedures will detect, as well as 
deter, abuse of the rule. Where appropriate, the Commission expects the 
Exchange to take prompt action to discipline members that fail to 
comply with the agency cross requirement.
---------------------------------------------------------------------------

    \26\Telephone conversation between David T. Rusoff, Foley & 
Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on February 24, 1994.
---------------------------------------------------------------------------

    Finally, the Commission does not believe that the MSE proposal will 
significantly reduce order interaction on the floor of the Exchange. As 
discussed above, only a MSE specialist who does not have a displayed 
bid or offer at the cross price must refrain from participating in a 
cross transaction at that price.
    The specialist, however, will be allowed to participate at a better 
price; and other interest in the trading crowd will not be subject to a 
comparable yielding requirement.\27\ In the context of other rule 
changes that have been approved by the Commission,\28\ the limited 
scope of the yielding requirement and the protection afforded book 
orders at the cross price, the Commission does not expect that the MSE 
proposal will substantially impair the price discovery network and/or 
market liquidity.
---------------------------------------------------------------------------

    \27\See supra, note 22 and accompanying text.
    \28\See supra, note 18.
---------------------------------------------------------------------------

    The Commission finds good cause for approving Amendment No. 2 prior 
to the thirtieth day after the date of publication of notice of filing 
thereof. Amendment No. 2 merely delineates the scope of the original 
filing and clarifies the intent of certain language used therein. 
Finally, the interpretation the MSE proposes to adopt is substantially 
similar to the rules of several other exchanges that were published in 
the Federal Register for the full comment period and were approved by 
the Commission.\29\
---------------------------------------------------------------------------

    \29\No comments were received in connection with the rule 
changes submitted by the Phlx and PSE, which, as discussed above, 
see supra note 18, are substantially similar to the interpretation 
proposed herein.
---------------------------------------------------------------------------

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2 to the proposed rule change. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street 
NW., Washington, DC 20549. Copies of the submission, all subsequent 
amendments, all written statements with respect to the proposed rule 
change that are filed with the Commission, and all written 
communications relating to Amendment No. 2 between the Commission and 
any persons, other than those that may be withheld from the public in 
accordance with the provisions of 5 U.S.C. 552, will be available for 
inspection and copying in the Commission's Public Reference Section, 
450 Fifth Street NW., Washington, DC 20549. Copies of such filing will 
also be available at the principal office of the Chicago Stock 
Exchange, All submissions should refer to File No. SR-MSE-93-05 and 
should be submitted by March 30, 1994.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-MSE-93-05), including 
Amendments No. 1 and No. 2, is approved.


    \30\15 U.S.C. 78s(b)(2) (1988).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
---------------------------------------------------------------------------

    \31\17 CFR 200.30-3(a) (1991).
---------------------------------------------------------------------------

 Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5476 Filed 3-9-94; 8:45 am]
BILLING CODE 8010-01-M