[Federal Register Volume 63, Number 138 (Monday, July 20, 1998)]
[Notices]
[Pages 38866-38868]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-19182]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40196; File No. SR-CHX-98-01]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1 by The Chicago Stock Exchange, Incorporated 
Relating to the Stopping of Market and Marketable Limit Orders

July 13, 1998.

I. Background

    On January 16, 1998, the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') a proposed rule change relating to the 
stopping of market and marketable limit orders pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ On 
February 12, 1998, the Exchange filed amendment No. 1 with the 
Commission.\2\ The proposed rule change, as amended, was published for 
comment in Securities Exchange Act Release No. 39956 (May 5, 1998), 63 
FR 26233 (May 12, 1998). No comments were received on the proposal. For 
the reasons discussed below, the Commission is approving the proposed 
rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ See letter from David T. Rusoff, Foley & Lardner, to Gail A. 
Marshall, Division of Market Regulation, Commission, dated February 
12, 1998.
    \3\ This approval includes a technical amendment that the 
Commission received which deleted an inappropriate reference in the 
proposed rule text. Article XX, Rule 37(b)(10) should not have 
referenced automatic executions under Article XX, Rule 37(b)(7). See 
letter David T. Rusoff, Foley & Lardner, to Gail A. Marshall, 
Division of Market Regulation, Commission, dated July 13, 1998.
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II. Description of the Proposal

    The Exchange proposes to amend Article XX, Rule 37(b) relating to 
the stopping of market orders and marketable limit orders in the 
Midwest Automated Execution System (``MAX System''). The purpose of the 
proposed rule change is to amend CHX rules relating to ``stopped'' 
orders \4\ in the MAX System \5\ (i) to permit specialists to stop a 
marketable limit order \6\ if the order is not immediately executed, 
and (ii) to automate the stopping of certain market orders that are not 
automatically executed.
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    \4\ See CHX Manual, Art. XX, Rule 28 regarding member liability 
for stopped orders.
    \5\ The MAX System provides an automated delivery and, in 
certain cases, execution facility for orders that are eligible for 
execution under Article XX, Rule 37(a), and in certain other orders. 
See CHX Manual, Art. XX, Rule 37(b).
    \6\ For purposes of this filing, a marketable limit order is a 
limit order that is marketable when entered into the MAX System, 
i.e., the limit price of the order is at or past (higher for a buy 
order or lower for a sell order) the relevant side of the ITS BBO at 
the time the order is received in the MAX System. If the ITS BBO 
subsequently moves away from the limit price (i.e., if the limit 
price is lower than the ITS best offer for a buy order or higher 
than the ITS best bid for a sell order) after receipt of the order 
but before execution of the order, the order will still be 
considered a marketable limit order for purposes of pending auto-
stop. Conversely, if a limit order is not marketable when received 
by the MAX System, the order will not be considered a marketable 
limit order for purposes of pending auto-stop, even if the ITS BBO 
subsequently becomes equal to or past the limit price of the order.
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    Under the Exchange's BEST Rule, Exchange specialists are required 
to guarantee executions of all agency \7\ market and limit orders for 
Dual Trading System issues \8\ from 100 shares up to and including 2099 
shares. Subject to the requirements of the short sale rule, market 
orders in Dual Trading System issues must be executed at a price equal 
to or better than the Intermarket Trading System (``ITS'') best bid or 
offer (``BBO''), up to the size associated with the ITS BBO. Limit 
orders 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 or the broker 
and specialist agree to a specific volume related to, or other criteria 
for, requiring an execution.\9\
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    \7\ 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.
    \8\ 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 the American Stock Exchange.
    \9\ It is the responsibility of the specialist to be able to 
demonstrate that the order would not have been executed had it been 
routed to the other market. This is often accomplished by sending a 
``marker'' order to the primary market.
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    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.\10\ 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 the MAX System that is greater 
than the specialist's auto-acceptance threshold, a specialist may 
cancel the order within one minute of it being entered into the MAX 
System. If the order is not canceled by the specialist, the order is 
designated as an open order.\11\ If the order-entry firm sends an order 
through the MAX System 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

[[Page 38867]]

difference must remain as an open order. If the order-entry firm sends 
an order through the MAX System that is less than or equal to the auto-
execution threshold, the order is executed automatically, unless an 
exception applies.\12\
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    \10\ A MAX order fits under the BEST parameters must be executed 
pursuant to BEST Rules via the MAX System. (See Art. XX, Rule 37(a) 
for BEST Rules). While the BEST Rules do not apply if the order is 
outside the BEST parameters, MAX System handling rules are still 
applicable. (See Art. XX, Rule 37(b) for MAX System handling rules)
    \11\ If an oversized market or limit order is received by the 
specialist, he will either reject the order immediately or display 
it immediately, in accordance with CHX Article XX, Rule 7 and the 
SEC's recently adopted 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 will check with 
the order entry broker to determine the validity of the oversized 
order. During the one 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.
    \12\ See CHX Article XX Rule 37(b)(6) and (7).
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    The MAX Rules currently provide several exceptions to automatic 
execution, even for orders that are less than or equal to the auto-
exeuction threshold. First, unless a professional order is received 
with a ``Z'' designator, it is not automatically executed, regardless 
of size. Second, all market orders for Dual Trading System issues 
received through the MAX System that would result in an out of range 
\13\ execution are deemed to be received with a request to 
``stop.''\14\ Stopped orders for Dual Trading System issues are not 
automatically executed in the usual course (i.e.,  pursuant to Rule 
37(b)(6)), but are placed in the open order file.\15\ The order sending 
firm then receives a ``UR Stopped'' message. The specialist is then 
required to include the order in its quote by bidding (if it is an 
order to buy) or offering (if it is an order to sell) the shares at one 
minimum variation better than the current market, in an effort to 
obtain price improvement for the order. Third, the MAX System will not 
automatically execute a market order or marketable limit order if the 
size associated with the ITS BBO, for Dual Trading System issues, is 
less than the size of the market or marketable limit order.\16\
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    \13\ ``Out of range'' means either higher or lower than the 
range in which the security has traded on the primary market during 
a particular trading day.
    \14\ See CHX Manual, Art. XX, Rule 37(b)(11).
    \15\ See CHX Manual, Art. XX, Rule 37(b)(2).
    \16\ See CHX Manual, Art. XX, rule 37(b)(12).
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    Currently, the MAX System has no functionality to automatically 
``stop'' marketable limit orders; only market orders are stopped, and 
then only for Dual Trading System issues if the order would result in 
out of range execution or the size of the order is greater than the 
size associated with the ITS BBO.\17\ Consequently, if a marketable 
limit order is not immediately executed (e.g., it is out of range, the 
order is greater than the size associated with the ITS BBO, etc.), it 
is merely added to the open order book. No message is sent to the order 
sending firm until the order is executed. The same is true for market 
orders that are not automatically stopped and are not automatically 
executed.
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    \17\ See CHX Manual, Art. XX, Rule 37(b)(10) and (11). While 
makret orders may also be stopped under the Exchange's Enhanced 
SuperMAX program, these orders are not subject to this filing.
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    Because no message is sent to the order sending firm, the firm is 
uncertain as to the current status of its order. As a result, as stated 
above, the puprose of the proposed rule change is (i) to permit 
specialist to stop a marketable limit order, and (ii) to automate the 
stopping of certain market orders. Once stopped, the order sending firm 
will then receive a stopped message, rather than being unsure as to the 
current status of the order, as is currently the case.
    Specifically, the CHX is proposing to amend Article XX, Rule 37 
(b)(10) to provide that all MAX market orders that are from 100 up to 
and including 599 shares (or such higher amount determined by a 
specialist on a stock by stock basis) that are not automatically 
executed in the normal course pursuant to Rule 37(b)(6) (i.e., because 
there is insufficient size associated with the ITS BBO, because the 
order would result in an out of range execution, because the order is a 
professional order and the specialist has not yet decided whether to 
accept the order, or because of any other reason permitted under CHX 
rules) will be identified as a ``pending auto stop'' order.\18\
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    \18\ While both agency and professional orders will be eligible 
to be ``pending auto-stop'' orders, all or none orders, odd-lot 
orders, fill or kill orders, immediate or cancel orders, orders that 
are or will be stopped under the Enhanced SuperMAX program, and 
other orders that cannot be entered into the MAX System (i.e., not 
held orders, sell short exempt orders and special settlement orders) 
will not be eligible to be ``pending auto stop'' orders.
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    These orders will retain their ``pending auto-stop'' status for 30 
seconds. At the end of this 30 second period, the MAX System will 
automatically stop the order and send a ``UR Stopped'' message to the 
order sending firm, unless, before the end of the 30 second period, the 
order is executed, canceled, manually stopped by the specialist or 
``put on hold.'' If any of these events occur, the ``pending auto-
stop'' status will be removed from the order and the order will not 
automatically be stopped.\19\ If an order is ``put on hold, the CHX's 
existing rules for the order will apply. If the order is stopped, the 
stop price will be the ITS BBO at the time the order is received in the 
MAX System. Furthermore, if the order is stopped after the ``pending 
auto-stop'' period, the entire order will be stopped.
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    \19\ As is the case for all features of the MAX System, in 
unusual trading conditions, this feature of MAX can be de-activated 
(in its entirety or on an issue by issue basis) with the approval of 
two members of the Exchange's Committee on Floor Procedure or 
designated member of the Exchange staff who would have authority to 
set execution prices. See CHX Article XX, Rule 37(b)(8).
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    The change to Rule 37(b)(10) to stop the entire order will result 
in better guarantees for the order than are required by existing CHX 
Rules. For example, professional orders are currently not guaranteed an 
execution under the BEST Rule. Under this change, eligible professional 
market orders will not be guaranteed an execution at the stopped price. 
Additionally, pursuant to Article XX, Rule 28, a stopped order 
constitutes a guarantee that the order will be executed at the stopped 
price or better. However, under existing rules, if the size of the 
order is greater than the size of the ITS BBO in existence when the 
order is received, there is merely no automatic execution of the order, 
the order does not have to be ``stopped.'' Moreover, even if the order 
is ``stopped'' under Rule 28 only that portion of the order that is 
less than or equal to the size of the ITS BBO is stopped. The portion 
of the order that exceeds the ITS BBO is not stopped. As proposed, the 
entire size of the order (up to 599 shares) would be automatically 
stopped after the seeond delay unless an exception applies.
    The Exchange believes that the 30 second delay between the time the 
order is entered and the time the order is stopped is appropriate. The 
30 seconds will give the specialist an opportunity to review the order 
to determine whether a stop is appropriate under the circumstances.
    The ``pending auto-stop'' feature of the MAX System will operate 
from 8:45 a.m. until 2:57 p.m. Thus, only orders entered into the MAX 
System after 8:45 a.m. but before 2:57 p.m. will be eligible to be 
``pending auto-stop'' orders.
    In addition to adding the new ``pending auto stop'' order to the 
MAX System the CHX is proposing changes to the MAX System that would 
permit a specialist to manually ``stop'' a marketable limit order, 
regardless of size.

III. Discussion

    The Commission believes that the proposed rule change is consistent 
with the Act and the rules and regulations thereunder applicable to the 
Exchange, and, in particular with Section 6(b)(5),\20\ which requires 
that the rules of an exchange be designed, among other things, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and, in

[[Page 38868]]

general, to protect investors and the public interest.
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    \20\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposal to add the functionality 
to the MAX System to automatically stop unexecuted market orders and 
marketable limit orders will provide investors additional benefits. 
First, specialists will now have the ability to automatically stop 
marketable limit order which provides investors with improved 
opportunities for price improvement on these orders. Second, investors 
trading in Dual Trading System issues will be provided with more 
certainty as to the status of their orders because the auto-stop 
feature results in a message being sent to the order sending firm 
notifying that firm that the order has been stopped.\21\ Third, 
investors may receive improved executions on their orders because, once 
auto-stopped, the entire order (up to 599 shares) in Dual Trading 
System issues will now be guaranteed an execution at the stopped price, 
regardless of whether it is an eligible professional market order or an 
order greater than the size of the ITS BBO.
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    \21\ The stopped price will be the price at the time the order 
was received in the MAX System, consistent with CHX Rules for 
stopped orders.
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    The Commission believes that the proposed 30 second ``pending auto-
stop'' period prior to the order being automatically stopped was 
designed to provide specialists with an opportunity to determine the 
best course for the order, consistent with best execution principles, 
whether that be executing the order, manually stopping the order, 
canceling the order, or putting the order on hold.\22\ The Commission, 
however, expects the Exchange, as it gains experience with the auto-
stop feature, to review whether the ``pending auto-stop'' period should 
be less than 30 seconds. In addition, the Commission anticipates that 
the Exchange will surveil to determine that specialists are not eluding 
the auto-stop feature, and thereby the benefits to investors, by 
routinely putting orders on hold or canceling them.
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    \22\ If an order is ``put on hold,'' the existing CHX Rules on 
order handling apply.
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange. In addition, 
in approving this rule, the Commission notes that it has also 
considered the proposed rule's impact on efficiency, competition, and 
capital formation.\23\
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    \23\ 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (CHX-98-01) be, and hereby is, 
approved.

    \24\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 15 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-19182 Filed 7-17-98; 8:45 am]
BILLING CODE 8010-01-M