[Federal Register Volume 59, Number 165 (Friday, August 26, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-21060]


[[Page Unknown]]

[Federal Register: August 26, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34563; File No. SR-CHX-94-15]

 

Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Granting Accelerated Approval to Proposed Rule Change and 
Amendment No. 1 to Proposed Rule Change Relating to Corporate 
Governance Issues

August 19, 1994.
    On June 23, 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 certain provisions of 
its Constitution relating to corporate governance issues. On June 30, 
1994, the Exchange submitted to the Commission Amendment No. 1 to the 
proposed rule change in order to narrow the scope of the original 
filing.\3\
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
    \3\See letter from David T. Rusoff, Attorney, Foley & Lardner, 
to Sandra Sciole, Special Counsel, Division of Market Regulation, 
SEC, dated June 29, 1994 (``Amendment No. 1'').
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    The proposed rule change, including Amendment No. 1, was published 
for comment in Securities Exchange Act Release No. 34379 (July 14, 
1994), 59 FR 37110 (July 20, 1994). No comments were received on the 
proposal. This order approves the proposed rule change on an 
accelerated basis.
    The CHX's Board of Governors (``Board'') is responsible for 
managing the business of the Exchange and is vested with all the powers 
necessary for the government of the Exchange, the regulation of the 
business conduct of members and member organizations and the promotion 
of the welfare, objects and purposes of the Exchange.\4\ Currently, the 
Board consists of twenty-four elected Governors, plus the Vice Chairman 
of the Board and the President of the Exchange.\5\ Of the twenty-four 
Governors, sixteen must be members, general partners of member firms or 
officers of member corporations (``member Governors''); and eight must 
be unaffiliated with the Exchange or any broker-dealer in securities 
(``non-member Governors'').\6\ The CHX Constitution also requires that 
nine of the sixteen member Governors be from the Chicago area, at least 
three of whom must be active on the floor of the Exchange, and that 
seven member Governors be from outside the Chicago area.\7\
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    \4\See Article III, Sec. 1 of the CHX Constitution.
    \5\See Article III, Sec. 2 of the CHX Constitution. The Chairman 
of the Board is appointed by the Board from among the elected 
Governors. Id. Since 1992, the Chairman has served in a non-
management capacity and has been primarily responsible for Board 
oversight of management performance. See Securities Exchange Act 
Release No. 31633 (December 22, 1992), 57 FR 62402 (December 30, 
1992) (File Nos. SR-MSE-92-12 and SR-MSE-92-13). The Vice Chairman 
of the Board is elected by the membership and must be active on the 
floor of the Exchange. See Art. III, Sec. 2 of the CHX Constitution. 
The Vice Chairman has the power, subject to Board approval, to 
appoint individuals to serve on certain Exchange committees. See 
Art. VI, Sec. 3 of the CHX Constitution. Finally, the President of 
the Exchange is appointed by the Board to serve at its pleasure. The 
President is the chief executive officer of the Exchange and cannot 
be a member or affiliated with a member organization during his or 
her incumbency. See Art. VI, Sec. 4 of the CHX Constitution.
    \6\See Article III, Sec. 2 of the CHX Constitution. For purposes 
of Board elections, the twenty-four Governors are divided into three 
classes, as follows: there are five member Governors and three non-
member Governors in Classes I and III; there are six member 
Governors and two non-member Governors in Class II. Id.
    \7\See Article IV, Sec. 4(b)(i) of the CHX Constitution.
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    The CHX proposes to amend its Constitution to achieve a governance 
structure under which the Exchange and its wholly-owned subsidiaries, 
the Midwest Clearing Corporation (``MCC'') and the Midwest Securities 
Trust Company (``MSTC''),\8\ will be able to operate as a single, 
coherently run business.\9\ In effect, the proposed rule change will 
enable the same individuals to serve on the Boards of the Exchange, MCC 
and MSTC.
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    \8\For discussion of corresponding amendments to the By-Laws of 
MCC and MSTC, see Securities Exchange Act Release No. 34427 (July 
21, 1994), 59 FR 38653 (July 29, 1993) (File Nos. SR-MCC-94-07 and 
SR-MSTC-94-09) (``MCC/MSTC Proposal'').
    \9\The CHX has indicated, however, that the Exchange and its 
subsidiaries will continue to be separate legal entities. Telephone 
conversation between David T. Rusoff, Attorney, Foley & Lardner, and 
Beth A. Stekler, Attorney, Division of Market Regulation, SEC, on 
August 10, 1994.
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    Under the proposed amendments to the CHX Constitution, five 
Governors will be added to the Exchange's Board, for a total of twenty-
nine elected Governors plus the Vice Chairman and the President.\10\ 
The proposed rule change also will create a new category of Governor to 
represent MCC and MSTC participants in the governance process.\11\ 
Thus, upon approval and implementation of these proposals, the Board 
will include one additional non-member Governor and four Governors who 
are general partners or officers of a participant of MCC or MSTC 
(``participant Governors'').\12\
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    \10\The proposed rule change will not affect the powers of the 
CHX Board, see supra note 4 and accompanying text, or the method of 
selection and duties of the Exchange's senior officers. See supra 
note 5.
    \11\The Exchange has proposed conforming changes to other 
Constitutional provisions in order to reflect the creation of the 
new participant Governor category. See, e.g., Article IV, Sec. 5 
(``Limitation on Service'') and Sec. 7 (``Nominations by Members'').
    \12\The five new Governors will be divided among the three 
classes, see supra note 6, as follows: there will be one participant 
Governor in Classes I and II, and two participant Governors in Class 
III; the additional non-member Governor will be placed in Class II.
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    In terms of their qualifications, participant Governors must have 
securities clearance and/or settlement expertise, background or 
responsibilities. To ensure that floor members are not over-represented 
on the Board, the Exchange has stated that management will use its best 
efforts to ensure that the newly created participant Governor positions 
will not initially or thereafter be filled by floor members.\13\
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    \13\In the event that a floor member is elected to fill a 
participant Governor position, the Exchange has stated that it will 
promptly notify the Commission. In addition, if the Exchange's best 
efforts do not succeed in ensuring that floor members do not fill 
participant Governor positions, the Exchange is committed to revisit 
this issue. See letter from David T. Rusoff, Attorney, Foley & 
Lardner, to Sharon Lawson, Assistant Director, Division of Market 
Regulation, SEC, dated July 8, 1994 (``July 8 Letter'').
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    Finally, the Exchange proposes to allow a participant Governor to 
be re-categorized as a member Governor, or a member Governor to be re-
categorized as a participant Governor, so long as both positions are 
within the same class.\14\ The proposed rule change will provide this 
increased flexibility only if the Governor being recategorized 
otherwise meets the qualifications for his or her new position.
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    \14\See supra, notes 6 and 14. According to the Exchange, the 
President will recommend and the Board (or Executive Committee) must 
approve the recategorization of a Governor. The CHX has stated that, 
after initial implementation of the proposed rule change, the 
recategorization provision mainly will be used to help fill 
vacancies on the Board. Telephone conversation between David T. 
Rusoff, Attorney, Foley & Lardner, and Beth A. Stekler, Attorney, 
Division of Market Regulation, SEC, on August 17, 1994. A 
recategorization will not affect the qualifications for serving in a 
given Board position or the length of the Governor's term.
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    According to the CHX, 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 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 Section 6(b).\15\ In particular, 
the Commission believes the proposal is consistent with Sections 
6(b)(1), 6(b)(3) and 6(b)(5) of the Act. Section 6(b)(1) of the Act 
requires that an exchange be organized and have the capacity to carry 
out the purposes of the Act and to comply, and to enforce compliance by 
its members and persons associated with its members, with the Act, the 
rules and regulations thereunder and the rules of the exchange. Section 
6(b)(3) of the Act requires that the rules of an exchange assure the 
fair representation of its members in the selection of its directors 
and administration of its affairs and provide that one or more 
directors represent issuers and investors and not be associated with a 
member of the exchange or a broker-dealer. Finally, Section 6(b)(5) of 
the Act requires, among other things, that the rules of an exchange be 
designed, in general, to protect investors and the public interest.
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    \15\15 U.S.C. 78f(b) (1988).
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    In the Commission's opinion, changes in the composition of the 
board of governors of a national securities exchange typically raise 
difficult regulatory issues, due to the board's special role and 
responsibilities in managing the business of an exchange and in 
ensuring that the exchange fulfills its obligations under the Act.\16\ 
Accordingly, before the Commission can approve a proposed board 
reorganization, the Commission must be satisfied that all exchange 
constituencies, including the public, are fairly represented in its 
governance.\17\
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    \16\For discussion of the powers of the CHX Board, see supra, 
notes 4-5 and accompanying text.
    \17\The Commission previously has indicated that allowing a 
single constituency to dominate exchange governance may be 
inconsistent with the requirements of the Act. See, e.g., Securities 
Exchange Act Release No. 22058 (May 21, 1985), 50 FR 23090 (May 30, 
1985) (File Nos. SR-CBOE-84-15 and SR-CBOE-84-16) (disapproving 
proposed rule change to increase the minimum number of floor 
directors on the Board of the Chicago Board Options Exchange 
(``CBOE'') and approving proposed rule change to provide for 
election of a floor member to be the CBOE's Executive Committee 
Chairman) (``CBOE Order''). See also Securities Exchange Act Release 
Nos. 31633 (December 22, 1992), 57 FR 62402 (December 30, 1992) 
(File Nos. SR-MSE-92-12 and SR-MSE-92-13) (approving proposed rule 
change to increase diversity of representation on the Exchange's 
Nominating Committee, Executive Committee and Audit Committee, to 
limit the position of Vice Chairman to floor members and to revise 
the duties of the Exchange's other senior officers) (``1992 Exchange 
Order''); and 33901 (April 12, 1994), 59 FR 18586 (April 19, 1994) 
(File No. SR-CHX-93-28) (approving proposed rule change to provide, 
among other things, more flexibility in the appointment of Governors 
to the Executive and Finance Committees).
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    After careful review, the Commission believes that the CHX proposal 
should allow the Exchange and its subsidiaries to operate more 
efficiently. In addition, the Commission has concluded that the 
proposed rule change strikes an appropriate balance between the various 
constituencies of the CHX\18\ and, therefore, is consistent with the 
Act's requirements. The Commission's reasons for reaching these 
conclusions are set forth in more detail below.
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    \18\For purposes of this order, the Commission has limited its 
discussion to the adequacy of representation of Exchange 
constituencies (i.e., the public, floor members and ``upstairs'' 
members). For further discussion of the adequacy of representation 
of participants, see MCC/MSTC Proposal, supra note 8.
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    The Commission recognizes that the CHX and its clearing corporation 
and trust company subsidiaries generally are viewed as parts of one 
``Exchange complex.'' Among other things, the CHX, MCC and MSTC share 
certain facilities, systems and financial services.\19\ Under the 
current governance structure, however, the CHX has found that having 
different Governors serve on the Board of each organization can 
complicate strategic planning for the ``complex'' and may create 
certain inefficiencies in the development and implementation of 
policy.\20\ In order to address these issues, the proposed rule change 
will enable the same individuals to serve on the Board of the CHX and 
its subsidiaries.\21\ The Commission therefore believes that the CHX 
proposal should foster greater coordination in decision making among 
the Exchange, MCC and MSTC.
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    \19\Telephone conversation between David T. Rusoff, Attorney, 
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on August 17, 1994.
    \20\Id.
    \21\As noted above, however, the exchange, the clearing 
corporation and the trust company will continue to be separate legal 
entities and to hold separate Board meetings. See supra, note 9.
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    More importantly for purposes of the Act's requirements, the 
Commission finds that the new Board will continue to be representative 
of the CHX and its various constituencies.\22\ Specifically, the 
Commission has concluded that, as a practical matter, the proposed rule 
change should maintain existing levels of public participation on the 
CHX Board and should prevent floor domination of the governance of the 
Exchange.\23\
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    \22\As noted above, see supra note 18, the Commission's analysis 
herein is limited to the impact of the proposed rule change on the 
relative representation of the public, floor members and 
``upstairs'' members on the CHX Board.
    \23\Prior Commission decisions regarding corporate governance, 
see supra note 17, largely have turned on these principles. See, 
e.g., CBOE Order and 1992 Exchange Order.
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    First, although the Commission would be concerned by a significant 
increase in the proportion of securities professionals on an exchange's 
board, the Commission does not believe that the CHX proposal favors 
professionals at the expense of the public. The Commission notes that 
the CHX Board presently consists of sixteen member (i.e., industry) 
Governors and eight non-members (i.e., public) Governors. As amended, 
four participant Governors and one non-member Governor will be added to 
the Board, for a total of twenty industry and nine public 
representatives. On that basis, the Commission agrees with the 
Exchange's argument that the proposed rule change will, in effect, 
maintain the current balance between those constituencies.\24\ The 
Commission therefore finds that the CHX proposal is consistent with the 
fair representation and the protection of investors and the public 
interest.
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    \24\Under the proposed reorganization, public Governors will 
constitute 31% of the CHX Board, as opposed to 33% of the existing 
Board, which is a minor change.
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    Similarly, based on certain commitments made by the CHX, the 
Commission is satisfied that the proposed rule change will not be used 
as an indirect means to achieve floor domination of the Board. The 
Commission recognizes that many MCC or MSTC participants are also CHX 
members and, in that capacity, may be active on the floor of the 
Exchange. Due to the Commission's long-standing concerns, Exchange 
management has committed to use its best efforts to ensure that the 
participant Governor positions will not be filled by floor members upon 
implementation of the proposed rule change or in the future.\25\ The 
Commission believes that these commitments should be sufficient to 
prevent floor members' interests from being over-represented in the 
governance of the Exchange. Finally, although the proposal will allow 
Governors to be recategorized, the Commission expects the CHX to 
exercise its discretion in a manner which is consistent with the above 
commitments.\26\ On the conditions set forth above, the Commission is 
satisfied that the Board composition should be sufficiently diverse for 
it to carry out its obligations under the Act.
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    \25\See July 8 letter, supra, note 13. In the event that a floor 
member is elected to fill a participant Governor position, the 
Exchange has stated that it will promptly notify the Commission. In 
addition, if the Exchange's best efforts do not succeed in ensuring 
that floor members do not fill participant Governor position, the 
Exchange is committed to revisit this issue. Id.
    \26\According to the CHX, because both positions must be in the 
same class, see supra note 14, the recategorization of a Governor 
will not affect (i.e., increase or decrease) the length of his or 
her term. Telephone conversation between David T. Rusoff, Attorney, 
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market 
Regulation, SEC, on August 18, 1994. If the Board fills a vacancy 
among the Governors, however, that individual only serves until the 
next annual election meeting. See Art. III, Sec. 1 of the CHX 
Constitution. If a recategorization creates a vacancy and that 
vacancy is filled by the Board, the Exchange membership will retain 
the right to elect a Governor to serve the remainder of that term.
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    The Commission finds good cause for approving the proposed rule 
change, including Amendment No. 1, prior to the thirtieth day after the 
date of publication of the notice of filing thereof. The CHX proposal 
is designed to achieve a more coherent governance structure while 
maintaining fair representation of Exchange constituencies and 
protecting investors and the public interest. Accelerated approval 
thereof will allow these benefits to be realized as soon as possible. 
In addition, the proposed rule change was published in the Federal 
Register for the full statutory period and no comments were received on 
any aspect of the proposal.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CHX-94-15), including 
Amendment No. 1, is approved on an accelerated basis.

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    \27\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\17 CFR 200.30-3(a)(12) (1992).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-21060 Filed 2-25-94; 8:45 am]
BILLING CODE 8010-01-M