[Federal Register Volume 61, Number 110 (Thursday, June 6, 1996)]
[Notices]
[Pages 28917-28922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14177]



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

[[Page 28918]]


SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37255; File No. SR-CHX-95-25]


Self-Regulatory Organizations; Chicago Stock Exchange, 
Incorporated; Order Granting Approval to Proposed Rule Change, 
Including Amendment Nos. 1, 2, 3, and 4, Relating to the Establishment 
of a Minor Rule Violation Procedure and Reporting Plan

May 30, 1996.

I. Introduction

    On October 11, 1995, the Chicago Stock Exchange, Incorporated 
(``CHX`' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Sections 19(b)(1) 
and 19(d)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and 
Rules 19b-4 and 19d-1(c)(2) thereunder,\2\ a proposed rule change to 
establish a minor rule violation procedure.\3\ On December 8, 1995, the 
Exchange submitted to the Commission Amendment No. 1 to the proposed 
rule change.\4\ The original filing, as amended by Amendment No. 1, was 
published for comment in Securities Exchange Act Release No. 36576 
(December 12, 1995), 60 FR 65362 (December 19, 1995). On January 17, 
1996 the Exchange submitted to the Commission Amendment No. 2 to the 
proposed rule change, on March 5, 1996 the Exchange submitted Amendment 
No. 3 to the proposed rule change, and on April 17, 1996 the Exchange 
submitted Amendment No. 4 to the proposed rule change.\5\ Amendment 
Nos. 2, 3, and 4 were published for comment in Securities Exchange Act 
Release No. 37140 (April 23, 1996), 61 FR 19107 (April 30, 1996). The 
Commission received two comment letters on the proposal.\6\ This order 
approves the proposed rule change, including amendment Nos. 1, 2, 3, 
and 4, and the Exchange's proposed minor rule violation reporting 
plan.\7\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1) and (d)(1).
    \2\ 17 CFR 240.19b-4 and 240.19d-1(c)(2).
    \3\ The Exchange has submitted to the SEC concurrently with the 
proposed rule change a minor rule violation reporting plan in 
accordance with Rule 19d-1(c)(2) under the Act. See Letter from 
David Rusoff, Attorney, Foley & Lardner; to Glen Barrentine, SEC, 
dated October 6, 1995.
    \4\ See Letter from David T. Rusoff, Attorney, Foley & Lardner, 
to Glen Barrentine, SEC, dated December 8, 1995 (``Amendment No. 
1'').
    \5\ See Letter from David T. Rusoff, Attorney, Foley & Lardner, 
to Jon Kroeper, Attorney, SEC, dated January 12, 1996 (``Amendment 
No. 2''); Letter from David T. Rusoff, Attorney, Foley & Lardner, to 
Glen Barrentine, SEC, dated March 3, 1996 (``Amendment No. 3''); and 
Letter from David T. Rusoff, Attorney, Foley & Lardner, to John 
Kroeper, Attorney, SEC, dated April 17, 1996 (``Amendment No. 4''). 
Amendment No. 2 added a number of clarifications to the proposal, 
amended the Recommended Fine Schedule, and revised the proposed 
minor rule violation reporting plan to provide a method for 
modifying the list of rule violations that constitute minor rule 
violations under the reporting plan. Amendment No. 3 revised the 
proposal by removing the President of the CHX from any role in the 
imposition or setting aside of fines under the proposal and further 
amended the Recommended Fine Schedule. Amendment No. 3 also revised 
the proposed rule change and reporting plan by removing seven rule 
violations from the list of rule violations that would be designated 
minor rule violations under the proposal and reporting plan and 
clarified the operation of four other rules on such list. Amendment 
No. 4 revised the proposal to provide for the imposition of a fine 
under the proposal in the event the Staff disagrees with the Minor 
Rule Violation Panel's recommendation that the Exchange commence a 
formal disciplinary proceeding, and amended language from Amendment 
No. 2 in light of changes to the proposal contained in Amendment No. 
3.
    \6\ See Letter from C. Philip Curely, Attorney, Robinson Curely 
& Clayton, P.C., to Margaret H. McFarland, Deputy Secretary, SEC, 
dated January 5, 1996 (``Comment Letter No. 1''); Letter from C. 
Philip Curely, Attorney, Robinson Curley & Clayton, P.C., to 
Jonathan G. Katz, Secretary, SEC, dated March 7, 1996 (``Comment 
Letter No. 2''). See infra Section III, for a discussion of Comment 
Letter Nos. 1 and 2.
    \7\ In Securities Exchange Act Release No. 21013 (June 1, 1984), 
49 FR 23828 (June 8, 1984), the SEC adopted amendments to paragraph 
(c) of Rule 19d-1 to allow self-regulatory organizations (``SROs'') 
to submit for SEC approval plans for the abbreviated reporting of 
minor disciplinary infractions. Under the amendments, any 
disciplinary action taken by a self-regulatory organization against 
any person for violation of a rule of the self-regulatory 
organization that has been designated as a minor rule violation 
pursuant to a plan filed with the SEC shall not be considered 
``final'' for purposes of Section 19(d)(1) of the Act if the 
sanction imposed consists of a fine not exceeding $2,500 and the 
sanctioned person has not sought an adjudication, including a 
hearing, or otherwise exhausted his or her administrative remedies 
with respect to the matter.
    The SEC has approved minor disciplinary rule plans by virtually 
every stock exchange and the National Association of Securities 
Dealers, Inc. See, e.q., Securities Exchange Act Release No. 21918 
(April 3, 1985), 50 FR 14068 (April 9, 1985) (File No. 4-260) 
(Amex); Securities Exchange Act Release No. 22415 (September 17, 
1985), 50 FR 38600 (September 23, 1985) (File No. 4-284) (NYSE); 
Securities Exchange Act Release No. 22654 (November 21, 1985), 50 FR 
48853 (November 27, 1985) (File No. 4-285) (PSE); Securities 
Exchange Act Release No. 32383 (May 28, 1993), 58 FR 31768 (June 4, 
1993) (SR-NASD-93-06).
---------------------------------------------------------------------------

II. Description

    The Exchange proposes to adopt, as Article XII, Rule 9 of the CHX 
rules,\8\ a minor rule violation procedure (``Procedure'') that 
authorizes the Exchange, in lieu of commencing disciplinary proceeding, 
to impose a fine, not to exceed $2,500, on any member, member 
organization, associated person or registered or non-registered 
employee of a member or member organization for any violation of an 
Exchange rule which the Exchange determines to be minor in nature. The 
Committee on Floor Procedure will have the same authority for 
violations relating to decorum on the Exchange trading floor. The 
Procedure specifically states that the Committee on Floor Procedure and 
the Panel shall not, collectively, impose more than one fine pursuant 
to the Procedure relating to the same underlying violation and 
incident.
---------------------------------------------------------------------------

    \8\ The proposed rule change also renumbers existing CHX Article 
XII, Rule 9 to Article XII, Rule 10. See Amendment No. 1, supra note 
4.
---------------------------------------------------------------------------

    If the fine is to be imposed by the Exchange (as opposed to the 
Committee on Floor Procedure) the fine shall be imposed in accordance 
with the method set forth in paragraph (b) of the Procedure. 
Specifically, prior to imposing the fine, the staff of the Exchange 
shall present the facts supporting such violative conduct to a Minor 
Rule Violation Panel (``Panel''), which shall consist of three floor 
members (one member of the Committee on Floor Procedure, one member of 
the Committee's Rules Subcommittee, and one member not on the Committee 
or any of its subcommittees) appointed by the President of the 
Exchange. The Panel then is authorized either to impose the fine, 
reject the staff's recommendation, or recommend that the Exchange 
commence a formal disciplinary proceeding under Article XII of the CHX 
rules. In the event that the Panel recommends that the Exchange 
commence a formal disciplinary proceeding, the staff shall either issue 
a report to the President, in accordance with Article XII, Rule 1(a), 
recommending that formal changes be brought, or advise the Panel that 
the staff will not recommend that the Exchange commence a formal 
disciplinary proceeding. If the staff decides not to recommend the 
commencement of a formal disciplinary proceeding, the Panel is required 
to impose a fine in accordance with the provisions of the Procedure.
    If a fine is to be imposed under the Procedure, the Exchange will 
serve a written statement on the person against whom a fine is imposed 
setting forth the rule violated, the act or omission constituting the 
violation, the fine imposed and the date of imposition, the date the 
fine must be paid and the date by which such determination must be 
contested, such date to be not less than 15 days after the date of 
service of the written statement.
    If the person against whom a fine is imposed pursuant to the 
Procedure chooses not to contest the matter and pays the fine, he or 
she waives his or her right to a disciplinary proceeding under Article 
XII of the Exchange's rules and any right to review or appeal (to the 
extent such right would otherwise exist under current Exchange rules). 
Alternatively, any person may chose to

[[Page 28919]]

contest a fine by submitting a written answer, at which point the 
matter becomes a ``disciplinary proceeding'' subject to the applicable 
provisions of Article XII, including all disciplinary sanctions 
available thereunder (except for contests of a fine by the Committee on 
Floor Procedure, which will be subject to the provisions of Article 
XII, Rule 3).\9\
---------------------------------------------------------------------------

    \9\ Any fine imposed under the Procedure that is contested may 
be publicly reported by the Exchange to the same extent that CHX 
disciplinary proceedings may be publicly reported. See CHX Rules, 
Article XII, Rule 9 (Pending Proceedings).
---------------------------------------------------------------------------

    Under the Procedure, the Exchange will periodically prepare and 
announce to its members and member organizations a list of Exchange 
rules and policies as to which the Exchange may impose fines pursuant 
to the Procedure as well as the fines that may be imposed for their 
violation.\10\ The Procedure, however, expressly states that the 
Exchange is not required to impose a fine under the Procedure with 
respect to any violation of any rule included on such list. In 
addition, whenever the Exchange determines that a rule violation is not 
minor in nature, it has the discretion to commence disciplinary 
proceedings under Article XII of the CHX rules.
---------------------------------------------------------------------------

    \10\ The Exchange will file with the SEC, for its approval 
pursuant to Section 19(b) of the Act and Rule 19b-4 thereunder, any 
proposed additions to, deletions from, or other modifications to 
either the list of rule violations set forth in Article XII, Rule 9 
that are deemed to be minor rule violations or the related 
Recommended Fine Schedule.
    As part of the proposed rule filing, the Exchange has submitted 
a Recommended Fine Schedule which contains recommended dollar 
amounts for the first, second, third and subsequent violations, as 
calculated on a twelve-month rolling basis, of a rule designated as 
a minor rule violation in the Procedure and Plan. With one 
exception, the recommended dollar amounts are as follows: First 
Violation--$100; Second Violation--$500; Third and Subsequent 
Violation--$1,000. For violations of Article XI, Rule 4 (Financial 
and Operational Reports) the recommended fines will be those 
currently set forth in Interpretation and Policy .02 to such rule 
(i.e., 1-30 days late--$100; 31-60 days late--$200; 61-90 days 
late--$400).
---------------------------------------------------------------------------

    The Exchange also proposes to adopt, pursuant to Section 19(d)(1) 
of the Act and Rule 19d-1(c)(2) thereunder, a minor rule violation 
reporting plan (``Plan''). Under its Plan, the Exchange designates 
certain specified rule violations as minor rule violations \11\ and 
requests that it be relieved of the current reporting requirement of 
Rule 19d-1(c)(1) under the Act regarding such violations, provided it 
gives notice of such violations to the Commission on a quarterly 
basis.\12\ The Plan, however, would not cover any fine imposed pursuant 
to the Procedure that is contested. Such violations and fines would 
continue to be reported as they occur.
---------------------------------------------------------------------------

    \11\ The Plan provides that the Exchange may make additions to, 
deletions from, or other modifications to the list of rule 
violations that constitute minor rule violations under the Plan. 
Rule 19d-1(c)(2) under the Act requires that the SEC approve by 
order, after appropriate notice of the terms of substance of the 
filing or a description of the subjects and issues involved and 
opportunity for interested persons to submit written comment, any 
amendment to an exchange's minor rule violation reporting plan 
submitted under such rule. In this regard, the Plan provides that 
every filing of a proposed rule change by the Exchange pursuant to 
Section 19(b) of the Act and Rule 19b-4 thereunder that adds to, 
deletes from or otherwise modifies the list of rule violations 
contained in Article XII, Rule 9(h) of the CHX rules for which the 
Article XII, Rule 9 Procedure may be used will be deemed a request 
by the Exchange for SEC approval to modify the list of CHX rules 
that are designated minor rule violations for purposes of the 
Exchange's reporting plan pursuant to Rule 19d-1(c)(2) under the 
Act.
    \12\ The Exchange's quarterly report to the SEC will include: 
the CHX's internal file number for the case, the name of the 
individual and/or organization, the nature of the violation, the 
specific rule provision violated, the fine imposed, the number of 
times the rule violation has occurred, and the date of disposition.
---------------------------------------------------------------------------

    The Exchange has proposed a list of rule and policy violations that 
would be designated minor rule violations in both its Procedure and 
Plan: \13\ (1) Acquisition of Membership by General or Limited Partner 
(Article II, Rule 1); (2) General Partners Bound by Rules of Exchange 
(Article II, Rule 4); (3) Notice of Death or Retirement of Partner 
(Article II, Rule 9); (4) Filing and Approval of Articles of 
Incorporation (Article III, Rule 4); (5) Authorization of Officers to 
Act (Article III, Rule 5); (6) Officers, Directors and Principal 
Stockholders (Article III, Rule 6); (7) Death or Retirement of 
Registrant Member (Article III, Rule 11); (8) Records of Orders 
Transmitted (Article IX, Rule 78); (9) Dealing in Stocks on Put, Call, 
Straddle or Option (Article IX, Rule 15); (10) Record of Margin Calls 
and Receipt of Margin (Article X, Rule 2); (11) Record of Orders 
(Article XX, Rule 24); (12) Written Reports of Transactions (Article 
XXX, Rule 5); (13) Record of Orders (Article XXX, Rule 11); \14\ (14) 
Financial Operational Reports (Article XI, Rule 4); (15) Notification 
of Change in Bond Coverage (Article XI, Rule 6); (16) Filing 
Requirements on Change of Examining Authority (Article XI, Rule 7); 
(17) Submission of Evaluation of Co-Specialists Survey (Article VIII, 
Rule 11); (18) Failure to Issue Intermarket Trading System (``ITS'') 
Pre-Opening Notification (Article XX, Rule 39); (19) Failure to Comply 
with ITS Trade-Through, Locked Markets and Block Trade Rules (Article 
XX, Rule 40); (20) Failure to Comply with 50% Requirement (Article 
XXXIV, Rule 3); (21) Failure to Comply with Public Outcry Rule (Article 
XXXIV, Rule 10); (22) Violation of Class A Decorum Rules (Article XII, 
Rule 3, Interpretation and Policy .01); (23) Violation of Class B 
Decorum Rules (Article XII, Rule 3, Interpretation and Policy .01); 
(24) Failure to Clear the Post (Article XX, Rule 10); (25) Failure to 
Comply with Cabinet Securities Provision (Article XX, Rule 11); \15\ 
(26) Failure to Comply with Minimum Fractional Changes (Article XX, 
Rule 22); (27) Failure to Comply with ``Stopped'' Order Rule (Article 
XX, Rule 28); (28) Improper Use of ``SOLD'' Designator (Article VIII, 
Rule 7); (29) Trading Ahead of Customer Orders (Article XXX, Rule 2); 
\16\ and (30) Violation of Preference Solely on Competitive Basis Rule 
(Article XXX, Rule 3).\17\
---------------------------------------------------------------------------

    \13\ In Amendment No. 3, the Exchange removed seven violations 
from the list of violations it proposed to add to its Procedure and 
Plan.
    \14\ The only violation of this rule that may be considered a 
minor rule violation is a failure of a specialist to properly time-
stamp an order ticket entrusted to him or it.
    \15\ The provision of this rule that may be considered a minor 
rule violation is the provision that states that although oral bids 
and offers in securities in the cabinet are permitted, they cannot 
conflict with bids and offers resident in the cabinet. A violation 
of this provision would occur if a floor broker fails to ``clear the 
cabinet'' (i.e., fails to satisfy bids or offers in the cabinet) 
before effecting an agency cross in a cabinet security at the same 
price or a price worse than the price of the bid or offer resident 
in the cabinet.
    \16\ The only portion of this rule that is considered a minor 
rule violation is the prohibition on a specialist trading for his or 
its own account ahead of customer orders on the specialist's book.
    \17\ The only violation of this rule that may be considered a 
minor rule violation is a specialist's failure to fill an incoming 
ITS commitment to the fullest extent possible based on orders in the 
specialist's book.
---------------------------------------------------------------------------

III. Comments

    The Commission received two comment letters on the proposal from 
Robinson Curely & Clayton, P.C.\18\ In response, the Exchange filed 
Amendment No. 3 to the proposal and a reply letter.\19\ The following 
is a summary of the arguments raised in the comment letters, and the 
Exchange's response thereto.
---------------------------------------------------------------------------

    \18\ See Comment Letter Nos. 1 and 2, supra note 6.
    \19\ See Amendment No. 3, supra note 5; Letter from George T. 
Simon, Attorney, Foley & Lardner, to Jonathan G. Katz, Secretary, 
SEC, dated March 4, 1996.
---------------------------------------------------------------------------

    First, in Comment Letter Nos. 1 and 2 the commenter argues that the 
proposal gives too much discretion to the Exchange's staff with regard 
to the disposition of alleged violations of CHX rules and does not 
provide any guidelines as to whether a formal disciplinary proceeding 
or the Procedure should be utilized in any particular situation. In 
this regard, the

[[Page 28920]]

commenter argues that the staff could elect to initiate a formal 
disciplinary proceeding (with the potential for the imposition of a 
severe penalty and attendant publicity) if it was to its ``advantage'' 
to do so, or utilize the Procedure in order to spare a presumably 
favored offender such treatment. The Exchange contends that the 
discretion given to its staff under the Procedure is the same 
prosecutorial discretion currently given to the staff in deciding 
whether to bring disciplinary charges and approved by the Commission 
for use by other SROs in their minor rule violation procedures. 
Moreover, the CHX argues that because all fines imposed under the 
Procedure must be approved by the Panel, the Procedure gives less 
discretion to the CHX staff than that granted under the procedures 
utilized by other exchanges, which allow their staffs to unilaterally 
assess such fines.\20\
---------------------------------------------------------------------------

    \20\ See, e.g., NYSE Rule 476A, Amex Rule 590, and BSE Chapter 
XVIII, Section 4.
---------------------------------------------------------------------------

    Second, in Comment Letter No. 1 the commenter argued that the 
Procedure, as originally proposed, also placed too much discretion in 
the hands of the CHX's President.\21\ Furthermore, the commenter 
contended that the interaction of the President's role under the 
Exchange's existing formal disciplinary procedures and the Procedure, 
as originally proposed, would create an ``unsound result'' in a 
situation where the President disregarded the Panel's recommendation 
that the Exchange initiate a formal disciplinary action and imposed a 
fine under the Procedure. If the alleged violator contested the 
imposition of such a fine, the matter would become a formal 
disciplinary proceeding. Under Article XII, Rule 5(b) of the CHX rules, 
the President imposes the final judgment in each formal disciplinary 
proceeding.\22\ The commenter claimed that in such situations the 
President would, in effect, sit as ``trial judge and appeals court.'' 
In response, the CHX stated that this concern was resolved by Amendment 
No. 3, which removed the President from any role in the Procedure; 
however, the Exchange also disputed the commenter's characterization of 
the President's role in the Procedure, as originally filed.
---------------------------------------------------------------------------

    \21\ Under the Procedure, as originally proposed, if the Panel 
recommended that the Exchange commence a formal disciplinary 
proceeding in a matter brought before it, the staff would issue a 
report to the President pursuant to Article XII, Rule 1(a), either 
recommending that formal charges be brought or that the President 
impose a sanction in accordance with the Procedure. The President 
then would have had the discretion to: (i) direct the staff to 
prefer written charges, (ii) reject the recommendation to prefer 
written charges, or (iii) impose a fine under the Procedure. See 
Securities Exchange Act Release No. 36576 (December 12, 1995), 60 FR 
65362 (December 19, 1995).
    \22\ Subject to review by the Judiciary Committee, Executive 
Committee and the Board of Governors. See CHX Rules, Article XII, 
Rule 6.
---------------------------------------------------------------------------

    Third, in Comment Letter Nos. 1 and 2 the commenter contends that 
because any contest of a fine imposed under the Procedure converts the 
matter into a formal disciplinary proceeding with the potential for the 
imposition of more severe sanctions, the Procedure imposes a ``chilling 
effect'' on a member's ability to contest such a fine.\23\ The CHX 
asserts in response that in approving the minor rule violation 
procedures of other exchanges, the Commission has determined that such 
procedures are consistent with the Act.
---------------------------------------------------------------------------

    \23\ In Comment Letter No. 2, the commenter suggested that a 
means to avoid such a ``chilling effect'' would be to allow the 
Exchange not to impose a more severe sanction in a disciplinary 
proceeding arising out of a contested minor rule violation than the 
fine originally imposed under the Procedure.
---------------------------------------------------------------------------

    Finally, the commenter questioned the need for the adoption of a 
minor rule violation procedure by the Exchange, given the existence of 
the summary procedure for minor infractions of CHX rules found in 
Article XII, Rule 2.\24\ The Exchange responded by submitting that the 
Article XII, Rule 2 summary procedure has not been designated for use 
in conjunction with a minor rule violation reporting plan. As a result, 
any summary action taken under Rule 2(a) is a ``final disciplinary 
action,'' which is subject to the immediate reporting requirements of 
Rule 19d-1 under the Act.
---------------------------------------------------------------------------

    \24\ Under CHX Rules, Article XII, Rule 2(a), if in the 
President's judgment it appears from the staff's report filed 
pursuant to Rule 1(a) that an alleged violator has committed a minor 
infraction of the CHX Constitution or rules, the President may 
summarily censure and/or impose a fine of up to $500 against such 
violator. The President's decision may be appealed to the Executive 
Committee of the Exchange, whose decision shall be final.
---------------------------------------------------------------------------

IV. Discussion

    After careful consideration of the Comment Letters and the 
Exchange's response thereto, the Commission has decided to approve the 
Exchange's Procedure and Plan. For the reasons discussed below, the 
Commission finds that the proposed rule change and minor rule violation 
reporting plan are 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) 
(1), (6), and (7), 6(d)(1) and 19(d) of the Act.\25\
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78f (b)(1), (b)(6), and (b)(7); 78f(d)(1); and 
78s(d).
---------------------------------------------------------------------------

A. Proposed Minor Rule Violation Procedure

    The proposal is consistent with the Section 6(b)(6) requirement 
that the rules of an exchange provide that its members and persons 
associated with its members shall be appropriately disciplined for 
violation of the rules of the exchange. In this regard, the Commission 
believes that the proposal will provide a procedure whereby member 
organizations can be appropriately disciplined in those instances when 
a rule violation is technical and objective or minor in nature, but a 
sanction more serious than a warning or cautionary letter is 
appropriate. Furthermore, because the Procedure provides procedural 
rights to the person fined and permits a disciplined person to request 
a full disciplinary hearing on the matter, the proposal provides fair 
procedure for the disciplining of members and persons associated with 
members consistent with Sections 6(b)(7) and 6(d)(1) of the Act.
    The Commission also believes that the proposal provides an 
alternate means by which to deter violations of the CHX rules included 
in the Procedure, thus furthering the Section 6(b)(1) requirement that 
an exchange have the ability to enforce compliance by its members and 
persons associated with its members with the Act and the rules of the 
exchange. An exchange's ability to enforce effectively compliance by 
its members and member organizations with Commission and exchange rules 
is central to its self-regulatory functions. Inclusion of a rule in an 
exchange's minor rule violation procedure and reporting plan should not 
be interpreted to mean that it is an unimportant rule. On the contrary, 
the Commission recognizes that inclusion of rules under a minor rule 
violation procedure and reporting plan not only can reduce reporting 
burdens of an SRO but also can make its disciplinary system more 
efficient in prosecuting violations of such rules.\26\
---------------------------------------------------------------------------

    \26\ Relatedly, the SEC also believes that the CHX proposal to 
create a new Minor Rule Violation Panel to review specified minor 
rule violations should help to make its disciplinary system more 
efficient in prosecuting violations of these rules.
---------------------------------------------------------------------------

    The Commission finds that of the 37 rules that the CHX has proposed 
to designate as minor rule violations in its Procedure and Plan, 28 
already have been approved by the Commission for inclusion in the minor 
rule violation procedures and reporting plans of other exchanges.\27\ 
As violations of these 28

[[Page 28921]]

rules are amenable to quick, objective determinations of compliance and 
are readily adjudicated, the Commission finds that they are appropriate 
for inclusion in the CHX's Procedure. The Commission also finds that, 
for the following reasons, the other nine rules proposed to be 
designated as minor rule violations are appropriate for inclusion in 
the CHX's Procedure.
---------------------------------------------------------------------------

    \27\ Compare list of proposed minor rule violations in CHX 
Procedure and Plan (see supra text following footnote 13 for such 
list), with lists of minor rule violations contained in NYSE Rule 
476, Amex Rule 590, and PSE Rule 10.13.
---------------------------------------------------------------------------

    Notification of Change in Bond Coverage (Article XI, Rule 6) 
requires members to file with the Exchange any changes in their 
fidelity bond coverage. Filing Requirements on Change of Examining 
Authority (Article XI, Rule 7) requires members to file with the 
Exchange upon their withdrawal from membership in another national 
securities exchange or registered securities association that is the 
member's designated examining authority. These rules are essentially 
administrative reporting requirements whose violation is both 
objectively determinable and readily adjudicated, making them suitable 
for inclusion in the Exchange's Procedure.
    Failure to Comply with 50% Requirement (Article XXXIV, Rule 3) 
requires that 50% of a CHX market maker's quarterly share volume must 
be in issues to which he or she is assigned.\28\ Failure to Comply with 
Minimum Fractional Changes (Article XX, Rule 22) requires that bids and 
offers in a security may not be made at a less variation than that set 
in the rule.\29\ A minor rule violation of Written Reports of 
Transactions (Article XXX, Rule 5) would occur, for example, if a 
specialist failed to supply a report of a transaction that was not 
effected through the Exchange's MAX System.\30\ As with the rules 
discussed in the previous paragraph, violations of these rules lend 
themselves to quick, objective determination and adjudication. 
Accordingly, these rules are appropriate for inclusion in the 
Exchange's Procedure.
---------------------------------------------------------------------------

    \28\ The Commission notes that it already has approved for use 
in the Philadelphia Stock Exchange, Inc.'s minor rule violation and 
reporting plan an analogous rule that pertains to registered options 
traders (``ROTs''). See Securities Exchange Act Release No. 23491 
(August 1, 1986), 51 FR 28469 (August 7, 1986) (File No. 4-289). 
Specifically, Phlx Option Floor procedure Advice B-3 requires, among 
other things, that at least 50% of each ROT's trading activity in 
each quarter must be in assigned options.
    \29\ E.g., for every security priced above $1.00, no less than a 
\1/8\ per $1.00 variation is permissible.
    \30\ Telephone conversation between David Rusoff, Attorney, 
Foley & Lardner; Daniel Liberti, Manager, Market Regulation, and 
Rick Ose, Market Regulation, CHX; and Glen Barrentine and Jon 
Kroeper, SEC, on February 28, 1996.
---------------------------------------------------------------------------

    The remaining four violations are concerned directly with the 
handling and execution of orders entered with Exchange members. A minor 
rule violation of Failure to Comply with Cabinet Securities Provision 
(Article XX, Rule 11) would occur if a member fails to satisfy bids or 
offers already resident in the cabinet before effecting an agency cross 
in a cabinet security at the same or worse price than that of a bid or 
offer in the cabinet.\31\ The portion of Violation of Preference Solely 
on Competitive Basis Rule (Article XXX, Rule 3) subject to the 
Exchange's Procedure is a specialist's failure to fill an incoming ITS 
commitment to the fullest extent possible based on orders in the 
specialist's book.\32\ Failure to Comply with Public Outcry Rule 
(Article XXXIV, Rule 10) and Failure to Clear the Post (Article XX, 
Rule 10) provide that market makers and floor brokers must audibly bid 
or offer their orders at the post before sending the order to another 
market or effecting an agency cross, as the cause may be.\33\
---------------------------------------------------------------------------

    \31\ See supra note 15.
    \32\ See supra note 17.
    \33\ See Amendment No. 3, supra note 5.
---------------------------------------------------------------------------

    Although these four rules involve more substantive matters than the 
rules concerning reporting requirements, violations of these rules 
should not involve the complicated factual and interpretive issues that 
are present in matters that require the initiation of formal 
disciplinary proceedings. Moreover, the Exchange has represented to the 
Commission that member non-compliance with these four rules is readily 
determinable through the use of its surveillance mechanisms.\34\ The 
Commission believes that aggressive enforcement of these rules under 
the Procedure should benefit investors by improving order interaction 
on the Exchange, while furthering member compliance with the Exchange's 
trading rules. Specifically, floor brokers and market makers more 
likely will be encouraged to clear the post or the cabinet before 
effecting agency crosses or off-the-Floor transactions, thus providing 
a greater opportunity for the execution of orders against those already 
resident either with the specialist or in the cabinet. Also, 
specialists will be provided with an additional incentive to fill 
incoming ITS commitments to their stated amount, leading to the more 
prompt execution of orders on the specialist's book.
---------------------------------------------------------------------------

    \34\ The Exchange's floor staff can determine whether the 
cabinet securities provision has been violated through a comparison 
of executions in such securities with orders resident in the book. 
Violations of precedence to orders in the book can be determined 
through a comparison of ITS commitments, executions thereof on the 
Exchange, and subsequent specialist executions. Telephone 
conversation between David T. Rusoff, Attorney, Foley & Lardner, and 
Jon Kroeper, Attorney, SEC, dated May 24, 1996. Violations of the 
two provisions concerning clearing the post can be determined by 
discerning whether the floor broker or market maker's order ticket 
was stamped with the distinctive identifier of the time stamp 
machine at the specialist's post, or through a conversation with the 
specialist in question. For a more complete discussion of the 
determination of clearing the post violations, see Amendment No. 3, 
supra note 5.
---------------------------------------------------------------------------

    Although a violation of these four rules and a number of the other 
rules contained in the Exchange's Procedure are designed to provide 
important investor safeguards,\35\ a particular violation of such rules 
may or may not rise to the level which would justify a formal 
disciplinary proceeding. Therefore, the Commission believes that 
including such rules in the Procedure, in light of the Exchange's 
discretion to bring a formal disciplinary hearing for any violation of 
such rules, should enhance, rather than reduce, the Exchange's 
enforcement capabilities regarding these rules in cases where 
initiation of a formal disciplinary proceeding may be more costly and 
time consuming in view of the minor nature of the particular violation, 
if not the category of violation.
---------------------------------------------------------------------------

    \35\ E.g., Trading Ahead of Customer Orders (Article XXX, Rule 
2) and Failure to Comply with ``Stopped'' Order Rule (Article XX, 
Rule 28).
---------------------------------------------------------------------------

    In conclusion, the Commission believes that the Procedure will 
provide a more effective means of deterrence for the rules the Exchange 
proposes to include in its Procedure than would the alternative of 
written letters of caution for lesser violations of such rules. 
Accordingly, the Commission notes that the CHX retains the discretion 
to bring a formal disciplinary proceeding for violations of any of the 
rules listed in the Procedure. The Commission expects the CHX to do so 
when appropriate for the particular violation(s) involved, as in the 
cases of an egregious violation or habitual offender.

B. Comments on the Minor Rule Violation Procedure

    For the reasons discussed below, the Commission believes that the 
Procedure, as amended, adequately addresses the concerns raised by the 
commenter. First, the Commission does not believe that the Procedure 
grants undue discretion to the staff of the Exchange in the disposition 
of alleged violations of CHX rules, nor that it provides inadequate 
guidelines as to the staff's exercise of such discretion. As the 
Exchange stated in its response to the Comment Letters, the addition of 
the

[[Page 28922]]

Procedure gives its staff the same prosecutorial discretion as that 
approved by the Commission for use by other SROs in their minor rule 
violation procedures. In addition, the Procedure limits the staff's 
discretion by requiring that the Panel impose all fines against alleged 
violators. Moreover, as has been noted above, the Procedure is to be 
utilized in situations where a rule violation is technical and 
objective or minor in nature; the Commission expects that the Exchange 
will resolve more serious violations of such rules through the use of 
formal disciplinary proceeding. The Comment Letters make the related 
argument that the availability of the Procedure opens the possibility 
that the Exchange could abuse its discretion and utilize either the 
Procedure or full disciplinary proceedings depending upon the identity 
of the alleged violator. The Commission believes that this concern is 
alleviated by the Commission's ability to review the disciplinary 
actions taken by the Exchange through both the CHX's formal reporting 
under Rule 19d-1 and proposed quarterly reporting under the Plan, and 
as part of the Commission's regular oversight inspections of the 
Exchange.
    Second, the Commission notes that the commenter's concern that the 
roles of the CHX's President, under the Exchange's existing 
disciplinary procedures and the Procedure, as originally filed, would 
create an unsound result has been rendered moot by the removal in 
Amendment No. 3 of any role on the part of the President in the 
imposition of fines under the Procedure.
    Third, the commenter argues that because any contest of a fine 
imposed under the Procedure converts the matter into a formal 
disciplinary proceeding with the potential for the imposition of more 
severe sanctions, the Procedure imposes a chilling effect on a member's 
ability to contest such a fine. The Commission believes that the 
commenter's argument is misplaced. The availability of a minor rule 
violation procedure benefits not only an exchange, for the reasons 
noted above, but alleged violators of rules deemed minor rule 
violations as well. In having the ability to pay a fine assessed under 
a minor rule violation procedure instead of being subject to the 
initiation of formal disciplinary procedures as a matter of course, an 
alleged violator has the opportunity to avoid the expenditure of time 
and resources, as well as the attendant publicity, that a formal 
disciplinary proceeding may entail. An alleged violator receives these 
benefits while retaining his or her due process rights to contest the 
charges in a formal disciplinary proceeding.
    As for the commenter's suggestion that the Exchange could prevent 
such a ``chilling effect'' by amending the proposed rule change to 
provide that no more severe sanction could be imposed in any formal 
disciplinary proceeding arising out of a contest of a minor rule 
violation fine than that originally imposed under the Procedure, the 
Commission believes that such a provision would limit unduly the 
Exchange's discretion to impose what it believed were appropriate 
sanctions as a result of the findings it made with regard to a matter 
in a formal disciplinary proceeding.\36\
---------------------------------------------------------------------------

    \36\ Specifically, in the context of a formal disciplinary 
proceeding the Exchange has the ability to discipline its members 
and any persons associated with a member ``by expulsion, suspension, 
limitation of activities, functions, and operations, fine, censure, 
being suspended or barred from being associated with a member or any 
other fitting sanction.'' See CHX Rules, Article XII, Rule 8(a). As 
the Panel may only impose monetary fines under the Procedure, the 
commenter's proposal could restrict the Exchange to imposing such 
fines in formal disciplinary proceedings arising out of appeals of 
minor rule violations, thus depriving the Exchange of the 
opportunity to impose what may be a more appropriate sanction in 
light of its findings in a formal hearing.
---------------------------------------------------------------------------

    Finally, the commenter questions the necessity for the Procedure 
given the existence of summary disciplinary procedures in Article XII, 
Rule 2(a) of the Exchange's rules. The Commission does not believe that 
an Exchange's ability to adopt a minor rule violation procedure and 
reporting plan should be limited by the existence of other summary 
procedures in an exchange's rules. Additionally, the Commission notes 
that the Article XII, Rule 2(a) procedure is incompatible with a minor 
rule violation reporting plan, as any proceeding under Rule 2(a) is 
considered a formal disciplinary proceeding under CHX rules, making any 
action taken under these procedures a ``final disciplinary action'' 
under Rule 19d-1, and therefore immediately reportable to the 
Commission.

C. Minor Rule Violation Reporting Plan

    In adopting Rule 19d-1, the Commission noted that the Rule was an 
attempt to balance the informational needs of the Commission against 
the reporting burdens of the SROs.\37\ In promulgating paragraph (c)(2) 
of Rule 19d-1, the Commission attempted to reduce the reporting burdens 
of the SROs by permitting, where immediate reporting was unnecessary, 
periodic reporting of minor rule violations.\38\ Any minor rule 
violation reporting plan adopted pursuant to Rule 19d-1(c)(2) is 
intended to be limited to rules which relate to areas that can be 
adjudicated quickly and objectively.
---------------------------------------------------------------------------

    \37\ See Securities Exchange Act Release No. 13726 (July 8, 
1977), 42 FR 36411 (July 14, 1977).
    \38\ See Securities Exchange Act Release No. 21013 (June 1, 
1984), 49 FR 23828 (June 8, 1984).
---------------------------------------------------------------------------

    The Commission believes that the rules proposed to be deemed minor 
rule violations under the Exchange's Plan meet this criteria for the 
same reasons as noted above with regard to the rules proposed for 
inclusion in its Procedure.\39\ Violations of these rules are amenable 
to quick and objective determinations of compliance. Efficient and 
equitable enforcement of violations of these CHX rules should not 
entail the complicated factual and interpretive inquiries associated 
with more sophisticated Exchange disciplinary actions. Therefore, it is 
reasonable for these rules to be included in such an abbreviated 
periodic reporting plan.\40\ In addition, the Commission finds that the 
format proposed by the Exchange to make its quarterly report of 
violations to the Commission under the Plan is identical, in all 
material respects, to the minor rule violation reporting plans approved 
by the Commission for use by other exchanges, and thus in compliance 
with the requirements of Rule 19d-1(c)(2) under the Act.
---------------------------------------------------------------------------

    \39\ See supra Section IV.A.
    \40\ Although the CHX Board of Governors makes the initial 
determination of whether an Exchange rule violation is ``minor'' for 
purposes of inclusion in new Article XII, Rule 9 and the Plan, this 
determination is subject to SEC review pursuant to Sections 19 
(b)(1) and (d)(1) of the Act and Rules 19b-4 and 19d-1(c)(2) 
thereunder. The SEC notes that Article XII, Rule 9 fines in excess 
of $2500 are not considered assessed pursuant to the Plan and, 
accordingly, must be reported on an immediate basis to the SEC under 
Section 19(d)(1) of the Act and Rule 19d-1 thereunder.
---------------------------------------------------------------------------

V. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act 
\41\ and Rule 19d-1(c)(2) thereunder, that the proposed rule change 
(SR-CHX-95-25) and minor rule violation reporting plan of the Exchange 
is approved.

    \41\ 15 U.S.C. 78s(b)(2)
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\42\
---------------------------------------------------------------------------

    \42\ 17 CFR 200.30-3(a)(12) and (a)(44).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 96-14177 Filed 6-5 -96; 8:45 am]
BILLING CODE 8010-01-M