[Federal Register Volume 59, Number 163 (Wednesday, August 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20719]


[[Page Unknown]]

[Federal Register: August 24, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34538; File No. SR-CHX-94-07]

August 17, 1994.

 

Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Approving Proposed Rule Change Relating to Utilization of Exempt 
Credit by Market Makers.

    On March 15, 1994, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Interpretation and 
Policy .01 to Article XXXIV, Rule 17, which governs utilization of 
exempt credit\3\ by market makers.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
    \3\As used herein, exempt credit means good faith margin, as 
defined under Regulation T of the Board of Governors of the Federal 
Reserve System. See infra, note 5.
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    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 34256 (June 24, 1994), 59 FR 33805 (June 30, 
1994). No comments were received on the proposal. This order approves 
the proposed rule change.
    Under Article XXXIV, Rule 17, Exchange members registered as equity 
market makers\4\ are deemed to be specialists for purposes of the Act 
and thus may obtain exempt credit to finance their market maker 
transactions.\6\ To qualify for exempt credit financing, Interpretation 
and Policy .01 to Rule 17 imposes a minimum participation requirement. 
Specifically, 50% of the quarterly share volume which creates or 
increases a position in a market maker account must result from 
transactions consummated on the Exchange (``50% volume test''). Market 
makers who satisfy the 50% volume test are entitled to good faith 
margin only for transactions initiated on the floor\7\ where the 
position was established as the direct result of bona fide equity 
market maker activity.\8\
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    \4\Registered market makers must engage in a course of dealings 
reasonably calculated to contribute to the maintenance of fair and 
orderly market, and shall not enter into transactions or make bids 
or offers inconsistent with such a course of dealings. See Article 
XXXIV, Rule 1. After approval of their registration, market makers 
are assigned particular securities; 50% of their quarterly share 
volume must be in issues to which they are assigned. See 
Interpretation and Policy .01 to Article XXXIV, Rule 3. At the 
request of a floor broker, a registered market maker must make a bid 
or offer in an assigned security or must accept and guarantee 
execution of an agency order for 100 shares. See Article XXXIV, Rule 
2 and Interpretation and Policy .02 to Rule 17.
    \5\Under Regulation T, a creditor may extend good faith margin 
for any long or short position in a security in which a specialist 
makes a market. See 12 CFR 220.12(b)(3). Regulation T defines ``good 
faith margin'' as the amount of margin which a creditor, exercising 
sound credit judgment, would customarily require for a specified 
security position and which is established without regard to the 
customer's other assets or securities positions held in connection 
with unrelated transactions. See 12 CFR 220.2(k). See also Article 
X, Rule 3(c)(6)(A) of the CHX Rules. Good faith margin does not 
mean, however, that no margin deposit is required. See, e.g., letter 
from Michael A. Macchiaroli, Assistant Director, Division of Market 
Regulation, SEC, to Mary L. Bender, First Vice President, Division 
of Regulatory Services, Chicago Board Options Exchange, dated June 
2, 1992.
    \6\For further discussion of restrictions on market maker 
transactions, see infra notes 7-8 and accompanying text. Market 
makers receive ``customer'' margin treatment for all other 
transactions. See Article X, Rule 3 of the CHX Rules.
    \7\Interpretation and Policy .01 prohibits the use of exempt 
credit where market maker orders are routed to the floor from 
locations off the floor.
    \8\Pursuant to the CHX rules, positions resulting from options 
exercises and assignments do not qualify for exempt credit 
treatment.
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    The Exchange proposes to amend this interpretation to revise the 
means by which market makers can satisfy their minimum participation 
requirement. under the proposed rule change, orders that are initiated 
on the Exchange floor but are sent to another market for execution 
through the Intermarket Trading System (``ITS'')\9\ will count, along 
with transactions consummated on the CHX, towards the 50% volume test. 
As under current rules, a market maker must ``clear the post''\10\ 
before routing an ITS commitment to another market. The CHX proposal 
will not affect the existing restrictions on those transactions by a 
market maker which may qualify for exempt credit treatment.\11\
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    \9\The CHX has clarified that orders initiated on the Exchange 
floor that are sent to another market for execution through any 
means other than ITS (e.g., through terminals with direct access to 
such other market's systems) will not count toward the 50% volume 
test. Telephone conversation between David T. Rusoff, Attorney, 
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on August 2, 1994.
    \10\Specifically, before sending an order initiated on the 
Exchange floor to another market, the market maker must (1) request 
the specialist's quote and (2) make a bid or offer at the post for 
the price and size of his or her intended interest. Failure to clear 
the post properly may result in violation of just and equitable 
principles of trade and in subsequent disciplinary action. See 
Securities Exchange Act Release No. 28638 (November 21, 1990), 55 FR 
4973 (November 30, 1990) (File No. SR-MSE-90-07).
    \11\See supra, notes 7-8 and accompanying text.
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    The CHX 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 perfect the 
mechanism of a free and open market and a national market system and, 
in general, to protect investors and the public interest.
    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 11(b).\12\ In 
particular, the Commission believes the proposal is consistent with the 
Section 6(b)(5) requirements 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. The Commission also believes that the proposed 
rule change is consistent with the requirement of Section 11(b) and 
Rule 11b-1 thereunder\13\ that specialist (i.e., market maker) 
transactions must contribute to the maintenance of fair and orderly 
markets.
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    \12\15 U.S.C. 78f(b) and 78k(b) (1988).
    \13\17 CFR 240.11b-1 (1991).
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    The Commission believes that registered market makers on the 
Exchange can serve an important function to the extent that they add 
supplemental depth and liquidity to the equity market. Under the CHX 
rules, market makers are subject to both affirmative and negative 
obligations\14\ and, in return, are accorded certain privileges, 
including exempt credit financing. For that reason, it is critical that 
only those members who are engaged in bona fide equity market maker 
activity qualify for favorable margin treatment under the Act. The 
Exchange's 50% volume test represents an adequate means to ensure that 
the margin rules are not circumvented and that CHX market maker 
activity is consistent with the maintenance of fair and orderly 
markets.
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    \14\See supra, note 4.
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    After careful review, the Commission has concluded that the 
proposed rule change, if appropriately utilized,\15\ should continue to 
ensure that the purposes behind the Exchange's minimum participation 
requirement are met while, at the same time, potentially improving the 
quality of the CHX's markets. The Commission agrees with the Exchange 
that a market maker who initiates an order on the floor and clears the 
post\16\ should not be penalized if there is no interest in the crowd 
or on the limit order book against which the market maker's order can 
be executed and if the specialist does not accept that order for 
placement in the book.\17\ The Commission finds that it is reasonable 
for the CHX to assume that a member who makes a good faith effort to 
participate as dealer on the Exchange floor, as described above, is 
engaged in bona fide equity market maker activity, although the 
transaction ultimately can be consummated only by exposing the member's 
order to all interest in the national market system.
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    \15\See infra, note 19 and accompanying text.
    \16\See supra, note 10 and accompanying text.
    \17\The CHX rules require the specialist to accept and guarantee 
execution of agency orders for up to 2,099 shares. See Article XX, 
Rule 37. According to the Exchange, however, specialists are not 
required to accept a professional order that does not better their 
market. Telephone conversation between David T. Rusoff, Attorney, 
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on August 2, 1994. See also Article XXX, Rule 2 
(defining the term ``professional order'').
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    Moreover, to the extent that the Exchange's current interpretation 
of its 50% volume test may represent a disincentive for members to 
register as market makers, particularly in less liquid issues, the 
proposed rule change should encourage more dealer participation. This, 
in turn, could add depth and liquidity to the market for CHX traded 
securities.
    For the above reasons, the Commission believes that the proposed 
rule change will help to ensure that market maker transactions continue 
to contribute to the maintenance of fair and orderly markets while, at 
the same time, facilitating dealer participation. In reaching that 
conclusion, the Commission has relied on the Exchange's representation 
that it has the capability to determine whether market makers clear the 
post before routing an order to another market, and to distinguish ITS 
orders from other orders initiated on the floor.\18\ The Commission 
requests that the Exchange monitor how market makers satisfy their 
minimum participation requirement and, in particular, what percentage 
of the relevant transactions are consummated on the CHX. If the 
Exchange finds that ITS orders constitute a substantial portion of the 
orders counted towards satisfying the 50% volume test, the Commission 
would question whether those members actually are engaged in bona fide 
equity market maker activity entitled to exempt credit and would expect 
the Exchange to take appropriate action to respond to the Commission's 
concerns.\19\
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    \18\Telephone conversation between David T. Rusoff, Attorney, 
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulations, SEC, on August 2, 1994.
    \19\The CHX plans to issue a notice to its membership describing 
the rule change, including the Commission's concerns about the 
appropriate use of ITS orders to satisfy the 50% volume test for the 
extension of exempt credit. Telephone conversation between David T. 
Rusoff, Attorney, Foley & Lardner, and Beth A. Stekler, Attorney, 
Division of Market Regulation, SEC, on August 16, 1994.
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    Finally, the Commission notes that the staff of the Board of 
Governors of the Federal Reserve System (``Federal Reserve Board'') has 
raised no objection to the Commission's approval of the proposal based 
on the Commission's belief that, pursuant to the 50% volume test, as 
amended, CHX market maker transactions will continue to contribute to 
the maintenance of a fair and orderly market and are consistent with 
the obligations of a specialist under Section 11 of the Act.\20\
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    \20\Telephone conversation between Scott Holz, Senior Attorney, 
Division of Banking Supervision and Regulation, Federal Reserve 
Board, and Beth A. Stekler, Attorney, Division of Market Regulation, 
SEC, on June 23, 1994.
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    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-CHX-94-07) is approved.
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    \21\15 U.S.C. Sec. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20719 Filed 8-23-94; 8:45 am]
BILLING CODE 8010-01-M