[Federal Register Volume 60, Number 138 (Wednesday, July 19, 1995)]
[Notices]
[Pages 37115-37117]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-17730]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35962; File No. SR-CHX-95-11]


Self-Regulatory Organizations; Chicago Stock Exchange, 
Incorporated; Order Granting Approval to Proposed Rule Change Relating 
to the Automatic Execution of Limit Orders

July 12, 1995.

I. Introduction

    On March 31, 1995, the Chicago Stock Exchange, Incorporated 
(``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 establish a one-year pilot 
program \3\ for the automatic execution of non-marketable limit 
orders.\4\ The proposed rule change was published for comment in 
Securities Exchange Act Release No. 35722 (May 16, 1995), 60 FR 27358 
(May 23, 1995). No comments were received on the proposal.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ See letter from Craig Long, Foley & Lardner, to Glen 
Barrentine, Senior Counsel, Division of Market Regulation, SEC, 
dated May 4, 1995 (requesting that the rule filing be approved on a 
one-year pilot basis).
    \4\ A limit order is an order to buy or sell a stated amount of 
a security at a specified price or at a better price.
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II. Proposal

    The Exchange proposes to re-implement for a one-year pilot period a 
system enhancement that would facilitate the automatic execution of 
non-marketable limit orders in a specialist book. In 1993, the 
Commission first approved this system enhancement as a one-year pilot 

[[Page 37116]]
program.\5\ The original one-year pilot lapsed in April 1994 without 
the Exchange filing for an extension or permanent approval.

    \5\ See Securities Exchange Act Release No. 32124 (Apr. 13, 
1993), 58 FR 21325 (approving File No. SR-MSE-92-03).
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    The proposed system enhancement (``Auto-Ex'') is a feature of the 
Exchange's automated execution system (``MAX'') that CHX specialists 
may voluntarily choose to activate to automatically execute non-
marketable limit orders on a specialist's book. Auto-Ex will operate by 
comparing the size of the CHX-entered limit order against the amount of 
stock ahead of that order in the primary market when the issue is 
trading in the primary market at the limit price.\6\ The Auto-Ex system 
will begin comparing CHX-entered limit orders when the limit price 
equals the bid or offer quoted in the primary market (as the case may 
be) for the first time.\7\ Thereafter, the Auto-Ex system will keep 
track of all prints in the primary market and will automatically 
execute the limit order once sufficient size prints in the primary 
market.\8\ The Auto-Ex feature will not permit a limit order to be 
filled out of sequence; the Auto-Ex will execute additional limit 
orders at the same price by comparing those orders with shares ahead in 
the primary market and on CHX.

    \6\ In the original pilot program, the Auto-Ex was to operate by 
comparing the size of CHX-entered limit order against the amount of 
stock ahead of that order in the ``consolidated market'' rather than 
in the primary market. This change is the one modification made by 
the Exchange to the original pilot program. Telephone conversation 
with Craig Long, Foley & Lardner, and Jennifer Choi, Attorney, 
Division of Market Regulation, SEC, on April 17, 1995.
    \7\ For example, if the primary market quotation is \1/4\ bid, 
\1/2\ offered, 4,000 shares bid and 4,000 shares offered, and a CHX 
specialist receives a limit order to buy 2,000 shares for \1/8\, 
that limit order will not be compared against the amount of stock 
ahead of the order in the primary market until such time as the \1/
4\ bid is exhausted and the \1/8\ bid becomes the best bid. At that 
time, the size that is disseminated in the primary market with the 
\1/8\ bid is the size against which the limit order is compared for 
Auto-Ex purposes.
    \8\ For example, assume a CHX specialist receives an agency 
limit order to buy 2,000 shares of ABC at \1/2\. The primary market 
quotation is \1/2\ bid, \3/4\ offered, 5,000 shares bid and 5,000 
shares offered, meaning there are 5,000 shares ahead of the CHX 
order. The Auto-Ex system will automatically execute the entire CHX 
limit order after 7,000 shares print at \1/2\ in the primary market. 
However, when more than 5,000 but less than 7,000 shares print at 
\1/2\ in the primary market, the order will be flagged with a 
flashing prompt to alert the specialist that the order may be due at 
least a partial fill. See CHX Article XX, Rule 37(a) governing 
primary market protection of certain limit orders.
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    The Auto-Ex feature will execute limit orders in accordance with 
existing CHX rules.\9\ All dually traded issues are eligible for 
inclusion in Auto-Ex, but specialists will be permitted to choose the 
securities for Auto-Ex on an issue by issue basis. Once Auto-Ex is 
activated for a certain security, the feature must remain activated for 
a minimum of five trading days and can be deactivated only on a certain 
day each month, which is determined from time to time by the Exchange. 
Generally, the Exchange believes that specialists will choose to use 
Auto-Ex for issues that, based on experience, have demonstrated 
reliable and accurate quotes in the primary market.\10\ Limit orders 
not subject to Auto-Ex will be ``flagged'' with a prompt to alert the 
specialist that a fill may be due. The proposed Auto-Ex feature will 
apply only to nonmarketable limit orders \11\ and not to marketable 
limit orders or to market orders.\12\

    \9\ The CHX specialist will be the contra-side of all Auto-Ex 
trades. See Securities Exchange Act Release No. 32124 (Apr. 13, 
1993), 58 FR 21325 (approving File No. SR-MSE-92-03).
    \10\ Telephone conversation between Craig Long, Foley & Lardner, 
and Glen Barrentine and Jennifer Choi, Division of Market 
Regulation, SEC, on May 3, 1995.
    \11\ Under CHX Rule 37(b)(7), specialists generally are required 
to automatically execute nonmarketable agency limit orders at the 
limit price when there is a price penetration of the limit price in 
the primary market.
    \12\ A limit order is called ``marketable'' when the prevailing 
best offer (bid) is equal to or less (greater) than the limit buy 
(sell) order price. CHX Rule 37(b)(7) provides for the automatic 
execution at the best bid or best offer disseminated pursuant to 
Rule 11Ac1-2 (``BBO'') or better of all limit orders that are 
marketable when entered into the MAX system provided that such 
orders are of a certain size and otherwise are eligible for 
execution under CHX Rule 37(a).
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    The Exchange states that the purpose of the proposed rule change is 
to further automate the CHX's trading floor functions and to improve 
the CHX's performance in filling limit orders. By providing for 
automatic execution of limit orders in accordance with existing 
Exchange rules, the Exchange states that it is eliminating the need for 
the manual operation required of specialists in determining when and to 
what extent limit orders are due fills based on primary market prints. 
The Exchange notes that the manual effort expended by specialists in 
filling limit orders that are entitled to primary market protection is 
often time-consuming and can result in errors, particularly when there 
is heavy trading volume. The Exchange believes that the present 
proposal will, therefore, directly benefit customers because it will 
result in more timely fills while eliminating errors resulting from 
manual execution.
    The Exchange also states that the Auto-Ex feature will not change 
or amend any CHX trading rules, nor will it cause or allow limit orders 
to be filled under different parameters than under existing rules. 
Auto-Ex will only automate the manner in which limit orders are filled. 
The Exchanged states that it will continue to monitor specialist 
execution of limit orders through the Market Regulation/Surveillance 
Department. In addition, CHX specialists will continue to be 
responsible for their books to the same degree as they are now under 
the manual execution system for limit orders.

III. Discussion and Conclusion

    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) of the Act.\13\ 
Specifically, 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 believes that the proposed rule 
change to provide for the automatic execution of non-marketable limit 
orders should result in prompt execution of such orders on the Exchange 
and reduce errors caused by manual execution of limit orders that are 
entitled to primary market protection, especially during periods of 
heavy trading volume.

    \13\ 15 U.S.C. 78f(b) (1988 & Supp. v 1993).
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    As discussed above, the CHX proposal will allow specialists to 
choose which issues will be included in Auto-Ex. Although the Exchange 
has limited the specialist's discretion in deactivating the Auto-Ex 
feature once the system is activated for a particular security, the 
specialist does retain the ultimate decision of which stocks will be 
executed automatically. The Commission remains concerned with this 
aspect of the proposal even though all non-marketable limit orders 
should receive the same treatment, whether executed manually or through 
the Auto-Ex system.
    The Commission believes that it would be appropriate to allow the 
Exchange to re-implement Auto-Ex for a one-year period to afford the 
Exchange and the Commission an opportunity to monitor the operation of 
the pilot and determine its effectiveness.\14\ The 

[[Page 37117]]
Exchange should monitor the use of the system during the one-year pilot 
period and assure the Commission that manually-executed orders and 
Auto-Ex orders do not receive differential treatment. Moreover, the 
Exchange should examine the program during the pilot period to 
determine whether specialists are choosing the stocks to include in 
Auto-Ex on a discriminatory basis.

    \14\ The Exchange has indicated that the Auto-Ex system can 
become operational immediately upon the approval of the proposal. 
Telephone conversation between Craig Long, Foley & Lardner, and 
Jennifer s. Choi, Attorney, Division of Market Regulation, SEC, on 
July 5, 1995.
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    The Commission, therefore, requests that the Exchange submit a 
report to the Commission by May 31, 1996, describing its experience 
with the pilot program. At a minimum, this report should contain the 
following data gathered during the first 10-month period after the 
start-up date for Auto-Ex: (1) The total number of issues and 
specialists using Auto-Ex including their percentages in comparison to 
the Exchange's market as a whole; (2) a break down of each issue 
subject to Auto-Ex during the pilot period, including each date the 
issue was placed on Auto-Ex and removed; (3) the types of securities 
being chosen for Auto-Ex (if a pattern is discernable); and (4) whether 
any distinguishable market condition existed when an issue was placed 
on or taken off Auto-Ex. The Commission is also interested in the 
length of time between a print in the primary market and the resulting 
fill on CHX for both the issues on Auto-Ex and those issues not on 
Auto-Ex. Any requests to modify this pilot program, to extend its 
effectiveness, or to seek permanent approval for the pilot program also 
should be submitted to the Commission by May 31, 1996, as a proposed 
rule change pursuant to section 19(b) of the Act.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-CHX-95-11) is approved for a 
one-year period ending on July 31, 1996.

    \15\ U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\

    \16\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-17730 Filed 7-18-95; 8:45 am]
BILLING CODE 8010-01-M