[Federal Register Volume 63, Number 242 (Thursday, December 17, 1998)]
[Notices]
[Pages 69699-69701]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33360]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40763; File No. SR-CHX-98-25]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to the 
Addition of an Interpretation to the Minimum Variation Rule

December 8, 1998.

I. Introduction

    On September 25, 1998, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act

[[Page 69700]]

of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ 
a proposed rule change to add an interpretation to the Minimum 
Variation Rule.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on October 23, 1998.\3\ No comments were received on the 
proposal. This order approves the proposal, as amended.\4\
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    \3\ See Exchange Act Release No. 40545 (October 13, 1998), 63 FR 
56956 (October 23, 1998).
    \4\ Amendment No. 2 makes a technical word change to the 
proposed rule change, replacing the word ``that'' with ``than'' in 
the second line of the proposed Interpretation and Policy .06 to 
Art. XX, Rule 22. Since this amendment is completely technical in 
nature, good cause for accelerated approval is not necessary. Letter 
from Kirsten M. Carlson, Counsel to the CHX, to Katherine A. 
England, Assistant Director, Division of Market Regulation, 
Commission, dated October 14, 1998.
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II. Description of the Proposal

    The CHX proposes to add Interpretation and Policy .06 to Article 
XX, Rule 22 relating to the trading by members in increments smaller 
than the minimum variation in order to match bids and offers displayed 
in other markets for the purpose of preventing Intermarket Trading 
System (``ITS'') trade-throughs.
    Over the past 18 months, a number of self regulatory organizations 
(``SROs''), including the Exchange, the Pacific Exchange, Inc. 
(``PCX''), the American Stock Exchange (``Amex''), the Nasdaq Stock 
Market (``Nasdaq''), the New York Stock Exchange (``NYSE'') and the 
Chicago Board Options Exchange (``CBOE''), have reduced the minimum 
trading and quotation increments of most equity securities to as little 
as \1/16\ of one dollar.\5\ Subsequent to the reduction to sixteenths, 
several third market makers have commenced quoting securities in 
increments smaller than those approved for trading on the exchanges on 
which the securities are listed or traded.\6\ Several exchanges have 
responded by permitting their members to execute trades in these finer 
increments under certain circumstances.\7\ Like these other exchanges, 
the CHX believes that it is important to provide its members with 
flexibility to effect transactions on the Exchange at a smaller 
increment than is set forth in its existing interpretations and 
policies (i.e., \1/16\ for most securities) for the purpose of matching 
a displayed bid or offer in another market at such smaller increment 
(i.e., \1/32\, \1/64\ or smaller) for the purpose of preventing ITS 
trade-throughs. For example, if the best bid on the Exchange is 8 and a 
bid of 8\1/32\ is displayed through ITS in another market center, the 
Exchange specialist or floor broker may execute a market or marketable 
limit order at 8\1/32\ in order to match the other market's bid. Limit 
orders entered on the Exchange, however, will continue to be priced at 
the current minimum trading increments (i.e., usually \1/16\), and 
orders priced in smaller increments will not be accepted. In addition, 
specialists will not be permitted to quote in these finer increments.
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    \5\ See Exchange Act Release Nos. 38780 (June 26, 1997), 62 FR 
36087 (July 3, 1997) (approving a PCX rule change to reduce the 
minimum quotation increment to \1/16\ for stocks); 38571 (May 5, 
1997), 62 FR 25682 (May 9, 1997) (approving an Amex proposal to 
reduce the minimum trading increment to \1/16\ for certain Amex-
listed equity securities); 38678 (May 27, 1997), 62 FR 30363 (June 
6, 1997) (approving a Nasdaq rule change to reduce the minimum 
quotation increment to \1/16\ for certain Nasdaq-listed securities); 
38897 (August 1, 1997), 62 FR 42847 (August 8, 1997) (approving a 
NYSE rule change to reduce the minimum quotation increment to \1/16\ 
for certain NYSE-listed securities); and 39159 (September 30, 1997), 
62 FR 52365 (October 9, 1997) (approving a CBOE rule change to 
reduce the minimum quotation increment to \1/16\ for stocks).
    \6\ For example, Nasdaq systems are capable of trading 
securities priced under $10 in increments as fine as \1/32\ of one 
dollar. Securities priced over $10 may be traded in increments as 
fine as \1/16\ of one dollar. As a result, the third market makers 
may trade Amex listed securities that are traded on CHX and priced 
at less than $10 in increments finer than sixteenths.
    \7\ See Exchange Act Release Nos. 40199 (July 14, 1998), 63 FR 
39336 (July 22, 1998) (approving PCX rule permitting members to 
trade in increments smaller than \1/16\, in order to match bids and 
offers displayed in other markets for the purpose of preventing ITS 
trade-throughs); and 40189 (July 10, 1998), 63 FR 38439 (July 16, 
1998) (approving Amex rule permitting members to trade in increments 
smaller than \1/16\, in order to match bids and offers displayed in 
other markets for the purpose of preventing ITS trade- throughs).
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    The proposed amendment will allow CHX traders to match prices 
disseminated by market makers that may better the CHX quote by an 
increment finer than the current minimum increment (usually \1/16\). 
Further, the proposal will enable the Exchange to match prices 
disseminated by another exchange in the event that another exchange 
were to reduce its minimum trading increment. Thus, the proposed 
amendment will assist Exchange members in fulfilling their obligation 
to obtain the best price for their customers.
    While the new interpretation would give members the extra 
flexibility that they need, the Exchange believes that a member would 
violate the spirit and intent of this new interpretation and would, 
most likely, be considered to have engaged in manipulative activity, in 
the event that the member enters an order in another market in a 
smaller variation for the express purpose of enabling such member to 
execute trades on the Exchange at such smaller increment. For example, 
if floor broker sent to a third market maker a 100 share limit order to 
buy that is priced \1/32\ or \1/64\ better than the current quote 
solely to enable the floor broker to cross a large block of stock on 
the Exchange at such better price without a specialist intervention, 
the Exchange would probably consider the floor broker to have engaged 
in manipulative activity.\8\
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    \8\ The Exchange believes this is consistent with a recent SEC 
enforcement action brought against two brothers who used the SEC's 
Limit Order Display Rule to manipulate the quote to their advantage. 
See In re Ian Fishman and Lawrence Fishman. Admin. Proc. File No. 3-
9629 (June 24, 1998). In that case, the Commission stated that the 
brothers used a limit order ``to move the public bid or offer quote, 
in order to permit [Fishman] to buy or sell a security at a price 
that otherwise would not have been available in the market,'' and 
found that such activity violated Exchange Act Rule 10b-5.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act \9\ 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.\10\ 
Specifically, the Commission believes the proposal is consistent with 
Section 6(b)(5) in that it is 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.\11\
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    \9\ In reviewing this proposal, the Commission has considered 
the proposal's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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    Recently, there has been a movement within the industry to reduce 
the minimum trading and quotation increments imposed by the various 
SROs. Last year, Amex, Nasdaq, NYSE, PCX and CBOE reduced their minimum 
increments.\12\ Currently, exchange rules provide for trading of most 
equity securities in increments as small as \1/16\ of a dollar. The CHX 
exchange represents that several third market makers have begun quoting 
securities in increments smaller than those approved for trading on the 
primary markets. The Exchange's proposed rule change will provide it 
the limited flexibility it needs to address this development and remain 
competitive with these third markets.
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    \12\ See supra, note 5.
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    The size of the minimum trading increment for securities traded 
through the facilities of the Nasdaq system is determined by the 
technical limitations of the Nasdaq system. Currently, Nasdaq systems 
are capable of trading securities priced under $10 in increments as 
fine

[[Page 69701]]

as \1/32\ of one dollar. Securities priced over $10 may be traded in 
increments as fine as \1/16\ of one dollar.\13\ As a result, the 
Commission recognizes that third market makers may trade exchange 
listed securities priced at less than $10 in increments finer than 
sixteenths. Nasdaq has informed the Commission that third market makers 
are currently posting quotes for listed securities in increments finer 
than sixteenths.\14\ The proposed amendment to CHX Article XX, Rule 22, 
will allow CHX traders to match price disseminated by third market 
makers that may better the CHX quote by an increment finer than the \1/
16\ minimum increment. In addition, the Commission notes that the 
proposal will enable the Exchange to match prices disseminated by other 
exchanges in the event that another exchange were to reduce its minimum 
trading increment.\15\ The proposal should assist Exchange members to 
fulfill their obligation to obtain the best price for their customers. 
Accordingly, the Commission finds that it is reasonable for the CHX to 
allow trading in increments finer than \1/16\ for the limited purpose 
of preventing an ITS trade-through.
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    \13\ The Commission notes that any change to the minimum 
increment for securities traded through the facilities of the Nasdaq 
system would be considered a change in an existing order-entry or 
trading system of an SRO. Accordingly, the Nasdaq would be required 
to file a proposed rule change under Section 19(b)(3)(A) of the Act 
to change its minimum increment.
    \14\ See Exchange Act Release No. 40189 (July 10, 1998), 63 FR 
38439 (July 16, 1998).
    \15\ To change its minimum increment, an exchange would be 
required to file a proposed rule change that would become 
immediately effective under Section 19(b)(3)(A).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-CHX-98-25), as amended, is 
approved.

    \16\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33360 Filed 12-16-98; 8:45 am]
BILLING CODE 8010-01-M