[Federal Register Volume 63, Number 65 (Monday, April 6, 1998)]
[Notices]
[Pages 16840-16841]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-8925]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39803; File No. SR-CHX-97-32]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Relating to the 
Acceptance of Oversized Orders in the MAX System

March 25, 1998.

I. Introduction

    On December 9, 1997, the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') pursuant to Section 19(b)(1) of the 
Securities Act of 1934 (``Act''),\1\ a proposed rule change which was 
subsequently amended on January 9, 1998. The proposed rule change to 
amend the Exchange's rules relating to the entry and acceptance of 
oversized orders received through the MAX System was published for 
comment in the Federal Register on February 11, 1998.\2\ No comments 
were received on the proposal. For the reasons discussed below, the 
Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 39615 (February 3, 
1998).
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II. Description of the Proposal

    Under the Exchange's BEST Rule, Exchange specialists are required 
to guarantee executions of all agency \3\ market and limit orders for 
Dual Trading System issues \4\ from 100 shares up to and including 2099 
shares. Subject to the requirements of the short sale rule, market 
orders must be executed on the basis of the Intermarket Trading 
System's (``ITS'') best bid or offer (``BBO''). Limit order must be 
executed at their limit price or better when: (1) the ITS BBO at the 
limit price has been exhausted in the primary market; (2) there has 
been a price penetration of the limit in the primary market (generally 
known as a trade-through of a CHX limit order); or (3) the issue is 
trading at the limit price on the primary market unless it can be 
demonstrated that the order would not have been executed if it had been 
transmitted to the primary market \5\ or the broker and specialist 
agree to a specific volume related to, or other criteria for, requiring 
an execution.
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    \3\ The term ``agency order'' means an order for the account of 
a customer, but does not include professional orders as defined in 
CHX, Art. XXX, Rule 2, interpretation and policy .04. That Rule 
defines a ``professional order'' as any order for the account of a 
broker-dealer, or any account in which a broker-dealer or an 
associated person of a broker-dealer has any direct or indirect 
interest.
    \4\ Dual Trading System Issues are issues that are traded on the 
CHX, either through listing on the CHX or pursuant to unlisted 
trading privileges, and are also listed on either the New York Stock 
Exchange or American Stock Exchange.
    \5\ The CHX specialist has the burden to demonstrate that the 
order would not have been executed had it been routed to the primary 
market. The Commission notes that this is often accomplished by 
sending a ``marker'' order to the primary market. See also CHX 
Article XX, Rule 37(b)(12).
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    As stated above, the Exchange's MAX System provides for the 
automatic execution of orders that are eligible for execution under the 
Exchange's BEST Rule and certain other orders.\6\ The MAX System has 
two size parameters which must be designated by the specialist on a 
stock-by-stock basis. For Dual Trading System issues, the specialist 
must set the auto-execution threshold at 1099 shares or greater and the 
auto-acceptance threshold at 2099 shares or greater. In no event may 
the auto-acceptance threshold be less than the auto-execution 
threshold. If the order-entry firm sends an order through MAX that is 
less than or equal to the auto-execution threshold, the order is 
executed automatically, unless an exception applies. If the order-entry 
firm sends an order through MAX that is less than the auto-acceptance 
threshold but greater than the auto-execution threshold, the order is 
not available for automatic execution but is designated in the open 
order book. A specialist may manually execute any portion of the order; 
the difference must remain as an open order.
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    \6\ A MAX order that fits under the BEST parameters must be 
executed pursuant to BEST Rules via the MAX system. If the order is 
outside the BEST parameters, the BEST Rules do not apply, but MAX 
system handling rules do apply.
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    Under the current MAX rules, if the order-entry firm sends an order 
through the MAX System that is greater than the specialist's auto-
acceptance threshold, a specialist may cancel the order within three 
minutes of it being entered into MAX. If not canceled by the 
specialist, the order is designated as an open order.\7\ The Exchange 
proposed to change the way that these oversized orders are handled.
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    \7\ Under current rules, if an oversized market or limit order 
is received by the specialist, he must either reject the order 
immediately or immediately display it in accordance with CHX rules 
and the Commission's Order Execution Rules (Securities Exchange Act 
Release No. 37619A (Sept. 6, 1996), 61 FR 48290 (Sept. 12, 1996)). 
If the order is displayed, the specialist must check with the order 
entry broker to determine the validity of the oversized order. 
During the three minute period, the specialist can cancel the order 
and return it to the order entry firm, but until it is canceled the 
displayed order is eligible for execution.
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    First, the Exchange proposed to amend Rule 37(b)(1) of Article XX 
to

[[Page 16841]]

change the amount of time in which the specialist can cancel the 
oversized order. Rather than the current three minute window, the 
Exchange proposed to reduce this time period to one minute. If the 
specialist has not canceled the order in the one minute period, the 
order will be designated as an open order.
    Second, the Exchange proposed to add interpretation and policy .06 
to Rule 37 to specifically describe how oversized orders are to be 
handled during the one minute period in which the specialist can cancel 
the order. The interpretation will provide that if the oversized order 
is an agency limit order, the order must immediately be reflected in 
the specialist's quote in accordance with CHX rules.\8\ Additionally, 
during the one minute window, the order must receive ``post 
protection.'' This means that while the BEST Rule will not apply during 
this period, the specialist must allow the order to interact with other 
orders received by the specialist at the post, using the same priority 
and precedence rules that apply to other orders received at the post.
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    \8\ Article XX, Rule 7 of the CHX rules requires every limit 
order that is priced at or better than the specialist's quote to be 
included in the specialist's quote, subject to certain exceptions.
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    Finally, during the one minute window, the specialist must notify 
the order sending firm's MAX floor broker representative if the 
specialist determines to cancel the order.

III. Discussion

    The Commission believes that the proposed rule change is consistent 
with the Act and the rules and regulations thereunder applicable to a 
national securities exchange, and, in particular, with Section 6(b)(5) 
which requires that the rules of an exchange be designed to promote 
just and equitable principles of trade, to remove impediments and to 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public 
interest.\9\
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    \9\ 15 U.S.C. 78f(b)(5).
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    The Exchange's proposal reduces the amount of time that a CHX 
specialist has to reject an order that is larger than the auto-
acceptance threshold thereby reducing an impediment to a free and open 
market. The Commission believes that this will benefit investors 
because the firm sending the order to the CHX specialist will be more 
certain of the ultimate status of the order and will no longer have to 
wait three minutes to determine if the order was being accepted or 
rejected by the specialist.
    The Commission believes that it is necessary to impose specific 
duties on the CHX specialist during the one minute window to ensure 
that orders are handled consistent with best execution principles. The 
Commission believes that the Exchange's proposed interpretation and 
policy .06 to Rule 37 will benefit investors because it clarifies the 
obligations of the CHX specialist during the one minute period in which 
the specialist can cancel the order. For example, customer limit orders 
that are received by the CHX specialist must be displayed immediately, 
in accordance with the Commission's Limit Order Display Rule \10\ and 
the Exchange's limit order rule,\11\ even when the size of the limit 
order is in excess of the auto-acceptance threshold. In addition, under 
the proposed interpretation and policy .06 to Rule 37, CHX specialists 
are obligated to give orders in excess of the auto-acceptance threshold 
post protection during the one minute window, allowing them to interact 
with other orders received by the specialist at the post.
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    \10\ 17 CFR 240.11Ac1-4.
    \11\ CHX Article XX, Rule 7.
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    The Commission also believes that reducing the time frame from 
three minutes to one minute is an appropriate first step given the many 
improvements in technology since the three minute window was 
established. The Commission expects the Exchange to continue to 
evaluate further reductions as technology advances and causes the one 
minute window to be too long a period of time.

IV. Conclusion

    For the foregoing reasons, the Commission believes that the 
proposed rule change is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5).\12\
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    \12\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CHX-97-32) be, and hereby 
is, approved.

    \13\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-8925 Filed 4-3-98; 8:45 am]
BILLING CODE 8010-01-M