[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] ======================================================================= ----------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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\ --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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\ --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \12\15 U.S.C. 78f(b) and 78k(b) (1988). \13\17 CFR 240.11b-1 (1991). --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \14\See supra, note 4. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \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''). --------------------------------------------------------------------------- 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\ --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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\ --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- 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. --------------------------------------------------------------------------- \21\15 U.S.C. Sec. 78s(b)(2) (1988). For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\22\ --------------------------------------------------------------------------- \22\17 CFR 200.30-3(a)(12) (1991). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-20719 Filed 8-23-94; 8:45 am] BILLING CODE 8010-01-M