[Federal Register Volume 61, Number 252 (Tuesday, December 31, 1996)]
[Notices]
[Pages 69127-69129]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-33270]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38082; File No. SR-CHX-96-27]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Relating to 
Permanent Approval of Its Pilot Program for Automatic Execution of 
Limit Orders

December 24, 1996.

I. Introduction

    On October 15, 1996, 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 seeking permanent approval of its 
system enhancement relating to the automatic execution of non-
marketable limit orders.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    Notice of the proposed rule change, together with the substance of 
the proposal, was provided by issuance of a release,\3\ and by 
publication in the Federal Register.\4\ No comments were received. This 
order approves the proposed rule change.
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    \3\ See Securities Exchange Act Release No. 37946, November 13, 
1996.
    \4\ See 61 FR 59263, November 21, 1996.
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II. Description of the Proposal

    The rule change approved today provides permanent approval of the 
Exchange's system enhancement relating to the automatic execution of 
non-marketable limit orders. On July 12, 1995, the Commission approved 
this system enhancement on a pilot basis, with an expiration date of 
July 31, 1996.\5\ The pilot program was extended in a subsequent 
Commission approval order and is currently scheduled to expire on 
December 31, 1996.\6\ In the Pilot Approval Order, as amended by the 
Pilot Extension Order, the Commission requested that the CHX provide a 
report to the Commission, by August 31, 1996, describing its experience 
with the pilot program. This report has been submitted to the 
Commission.
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    \5\ See Securities Exchange Act Release No. 35962 (July 12, 
1995), 60 FR 37115 (July 19, 1995) (File No. SR-CHX-95-11) (``Pilot 
Approval Order'').
    \6\ See Securities Exchange Act Release No. 37442 (July 16, 
1996), 61 FR 38491 (July 24, 1996) (File No. SR-CHX-96-18) (``Pilot 
Extension Order'').
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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 execute automatically non-
marketable limit orders \7\ on the specialist's book. Auto-Ex operates 
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. The Auto-Ex System 
begins comparing CHX-entered limit orders when the order's limit price 
equals the bid (for a limit order to buy) or offer (for a limit order 
to sell) quoted in the primary market.\8\ Thereafter, the Auto-Ex 
system keeps track of all prints in the primary market and 
automatically executes the limit order once the required size prints in 
the primary market.\9\ As additional limit orders at the same price are 
received by the specialist, comparisons are made and entered based upon 
the shares ahead of those limit orders at the time of receipt, 
including shares ahead on the CHX. The Auto-Ex feature does not permit 
a limit order to be filled out of sequence.
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    \7\ 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. 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.
    \8\ 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 which is disseminated with the \1/8\ bid is the size 
against which the limit order is compared for Auto-Ex purposes.
    \9\ 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 CHX 
order. The Auto-Ex will automatically execute the entire CHX limit 
5,000 shares offered, meaning there are 5,000 shares ahead of the 
order after 7,000 shares print at \1/2\ or better 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 executes limit orders in accordance with 
existing CHX

[[Page 69128]]

rules.\10\ Auto-Ex is available for all dually traded issues; however, 
specialists are permitted to choose Auto-Ex on an issue by issue 
basis.\11\ Generally, however, Auto-Ex has been used by specialists for 
issues which, based on experience, have demonstrated reliable and 
accurate quotes in the primary market. Limit orders not subject to 
Auto-Ex will be ``flagged'' with a prompt to alert the specialist that 
a fill may be due. The proposal to establish an Auto-Ex feature applies 
only to non-marketable limit orders. It is not applicable to marketable 
limit orders or to market orders.
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    \10\ Further, the Exchange has stated that the recent adoption 
of the Order Execution Obligations (Securities Exchange Act Release 
No. 37619 (August 29, 1996), 61 FR 48290 (September 12, 1996)) will 
have no impact or effect on the proposed rule change. See Letter 
from J. Craig Long, Foley & Lardner to Janice Mitnick, Division of 
Market Regulation, SEC, dated November 8, 1996.
    \11\ The CHX will limit a specialist's ability to activate and 
deactivate Auto-Ex by: (1) only permitting a specialist to 
deactivate Auto-Ex on a certain day each month, which is determined 
from time to time by the Exchange; and (2) requiring that issues 
remain on Auto-Ex for a minimum of five trading days.
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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 only automates the manner in which limit orders are filled. The 
Exchange 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

    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.\12\ 
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.
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    \12\ 15 U.S.C. 78f(b).
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    In the Pilot Approval Order, the Commission noted several items to 
be addressed prior to implementation of the pilot on a permanent basis. 
The Commission sought clarification regarding the basis upon which 
issues would be added and removed from Auto-Ex. The Commission also 
requested clarification that manually-executed limit orders and Auto-Ex 
limit orders receive an identical quality of execution. Finally, the 
Commission expressed an interest regarding the length of time between a 
print in the primary market and the resulting fill on CHX for both 
issues included in Auto-Ex and those issues not included in Auto-Ex.
    In order to address the items noted by the Commission, the Exchange 
submitted a report summarizing data gathered during the pilot 
period.\13\ The Exchange stated that during the reporting period, five 
of the 348 issues participating in the pilot were removed. Of those 
issues removed, three had been added to the pilot in error \14\ and two 
were removed at the specialist's request due to a high volume of 
activity on the primary market. According to the report submitted by 
the Exchange, specialists seem to be biased against including issues in 
Auto-Ex which generate large size orders. The Exchange stated that it 
believes this bias is due to the fact that the maximum quote size that 
CQS can disseminate is 99,900. For example, if a specialist on the 
primary market has a limit order on the book for 400,000, only 99,900 
appears on the CHX system. Therefore, once the CHX system registered 
the execution of 99,900 shares on the primary market, executions would 
occur on Auto-Ex while more than 300,000 in limit orders still remained 
in the primary market limit order book. Further, these executions would 
occur when CHX rules did not yet require the order to be filled.\15\ 
Therefore, to avoid automatic executions when an order fill was not yet 
required, some specialists for issues which generated larger size 
orders requested that those issues be removed from Auto-Ex.
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    \13\ The report includes data gathered from April 7, 1996 
through July 25, 1996. Phone conversation between David Rusoff, 
Foley & Lardner and Janice Mitnick, SEC on December 16, 1996.
    \14\ In one case, a stock ticker symbol was incorrectly entered. 
The other two errors resulted from outdated information. Generally, 
firms participating in the pilot requested that the Exchange include 
all of their specialists in the pilot. One error resulted from the 
addition of an issue marketed by a specialist who had was no longer 
with the firm requesting participation in AutoEx. Additionally, if a 
specialist chose to participate in AutoEx, the specialist usually 
placed all of his or her stocks in the pilot. One error resulted 
from the fact that the specialist who chose to participate AutoEx 
was no longer a market maker in the erroneously added stock. Phone 
conversation between David Rusoff, Foley & Lardner and Janice 
Mitnick, SEC on December 16, 1996.
    \15\ See CHX Article XX, Rule 37(a)(3)(c).
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    The Exchange reported that the length of time between a print in 
the primary market and an Auto-Ex was less than one second. Further, 
according to the Exchange report, the length of time between a print in 
the primary market and a manual CHX order fill averaged 11.623 minutes. 
The Exchange stated in the report that fifty percent of the manually 
filled orders are executed in 1\1/2\ minutes or less. Although the 
submitted data appears to suggest that the execution of some manually-
executed limit orders was delayed for several hours, the Exchange has 
confirmed that these orders were not executed late; rather, the prompt 
to execute was actually premature due to the fact that an order of more 
than 99,900 shares (in the primary market) was ahead of the CHX 
order.\16\
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    \16\ See Id.
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    The Commission believes that the Exchange reports adequately 
addresses the potential issues identified by the Commission in the 
Pilot Approval Order. Specifically, the Commission finds that the 
report indicates that issues participating in Auto-Ex during the pilot 
period were added and removed in a fair and non-discriminatory manner. 
Further the Commission finds that it does not appear that the method of 
selection of issues for participation in Auto-Ex raised concerns 
regarding manipulation.

[[Page 69129]]

The only factor noted in the report which created a bias regarding the 
issues selected for inclusion in Auto-Ex appears to be the result of 
the size limitations of the CQS. As discussed above in detail, the size 
limitation of CQS, combined with issues which generate large orders, 
could result in fills being generated on Auto-Ex before the CHX rules 
require a fill to occur. Finally, the Commission finds that the report 
data indicates that executions on Auto-Ex are timely, occurring in 1\1/
2\ minutes or less, and, in most cases, faster than manual executions 
for issues not included on Auto-Ex. As discussed above, the Commission 
believes that the proposed rule change should result in prompt 
execution of non-marketable limit orders and reduce errors caused by 
manual execution of limit orders that are entitled to primary market 
protection, especially during periods of heavy trading volume.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-CHX-96-27) is approved.
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    \17\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-33270 Filed 12-30-96; 8:45 am]
BILLING CODE 8010-01-M