[Federal Register Volume 64, Number 24 (Friday, February 5, 1999)]
[Notices]
[Pages 5844-5846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-2736]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40998; File No. SR-CHX-98-27]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to Crossing 
Orders of 25,000 Shares or More

January 29, 1999.

I. Introduction

    On November 5, 1998, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change relating to crossing 
orders of 25,000 shares or more.
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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 December 15, 1998.\3\ No comments were received on the 
proposal. This order approves the proposal.
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    \3\ See Exchange Act Release No. 40758 (December 8, 1998), 63 FR 
69125
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II. Description of the Proposal

    The Exchange's general auction market procedures are codified in 
CHX Article XX, Rule 16, which provides for the manner in which bids 
and offers at the same price will be sequenced for execution. A member 
who makes the first bid or offer at a particular price has ``priority'' 
at that price, which means that the member is the first one in the 
market to be entitled to receive an execution at that price. If no 
member can claim priority, all members who are bidding or offering at a 
particular price are deemed to be on ``parity'' with each other, or 
equivalent in status.\4\ Unlike the rules of certain other 
exchanges,\5\ however, the CHX does not currently permit bids and 
offers that have parity to obtain precedence based on size (a so-called 
``size-out'' rule).\6\ In addition, unlike some other exchanges,\7\ the 
CHX does not currently have a ``clean cross'' rule (as an exception to 
the normal priority rules) that would permit a member to cross a large 
block of stock, without the cross being broken up, by permitting the 
cross to obtain priority over all other existing bids and offers at the 
same price, regardless of the size of such bids or offers.\8\
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    \4\ Members are on parity with each other when two or more bids 
or offers are announced simultaneously, or after a trade takes place 
leaving several bids or offers unfilled at the same price as the 
executed trade. See CHX Art. XX, Rule 16 (b) and (c).
    \5\ See New York Stock Exchange (``NYSE'') Rule 72 and similar 
Philadelphia Stock Exchange and Boston Stock Exchange rules. The 
American Stock Exchange (``Amex'') has a modified version of a 
``size out'' rule for crosses of 25,000 shares or more. See Amex 
Rule 126(g), commentary .01 and .02.
    \6\ Under a typical size-out rule, the priority of existing bids 
and offers are first removed by means of a sale so that all bids and 
offers are on parity. Then, a person desiring to execute a cross can 
usually do so by claiming precedence based on size, so long as the 
size of the cross is greater than any other single bid or offer at 
that price.
    \7\ See, e.g., NYSE Rule 72(g) which gives priority to an agency 
cross transaction of 25,000 shares or more that is executed at or 
within the prevailing quotation, without regard to the size or price 
of existing bids or offers on the floor. Other members can typically 
interact with the cross only by bettering one side of the cross, and 
even then, can only do so after satisfying all other existing bids 
or offers at that price. The Pacific Exchange, Inc. (``PCX'') and 
Amex have similar crossing rules.
    \8\ While the CHX does have a crossing rule, Article XX, Rule 
23, this rule only permits crosses between (and not at) the CHX 
disseminated market. Thus, under current rules, assuming a 
specialist has properly reflected all limit orders from his book in 
his quote, the crossing rule does not have any effect on the 
Exchange's general priority, parity and precedence rules because all 
crosses must be at a better price than the disseminated market. 
Therefore, they are entitled to priority because of price (and not 
because of a special priority rule giving certain crosses priority 
over other bids and offers).
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    The purpose of the proposed rule filing is to add new 
interpretation and policy .02 to Article XX, Rule 23, to allow a member 
or member organization that has an order to buy and an order to sell 
25,000 shares or more of the same security to cross those orders at a 
price that is at or within the prevailing quotation, without the 
transaction being broken up at the cross price so long as (i) the size 
of the proposed cross transaction is of a size that is greater than the 
aggregate size of all interest communicated on the Exchange floor at 
that price at the time of the proposed cross, and (ii) neither side of 
the cross is for the account of the executing member or member 
organization.
    As is the case for cross transactions that are permitted under 
existing CHX rules, prior to effecting the cross under the new 
proposal, the member will be required to make a public bid and offer on 
behalf of both sides of the cross.\9\ The offer must be made at a price 
which is higher than the bid by the minimum trading variation permitted 
for the security. Under the Proposal, another member may trade with 
either the bid or offer side of the cross transaction only to provide a 
price which is better than the cross price as to all or part of the bid 
or offer. A member who is providing a better price to one side of the 
cross transaction must trade with all other market interest having 
priority at that price before trading with any part of the cross 
transaction.
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    \9\ See CHX Art. XX, Rule 23.
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    Because the proposal provides that the bid or offer of the member 
desiring to execute the cross would be entitled to priority at such 
price (over pre-existing bids and offers at that price) only if the 
size of the cross is greater than the aggregate size of all interest 
communicated on the Exchange floor (which includes the specialist's bid 
or offer--including any limit order reflected in such quote--and any 
communicated interest of floor brokers or market makers standing in the 
crowd), the proposed rule is more akin to a size-out rule than a 
special priority rule.
    The difference between the CHX proposal and the size-out rules 
contained on other exchanges is that the priority of earlier bids and 
offers will not have to be removed, by means of a sale, before 
effecting the cross. In addition, a cross transaction effected in 
accord with the CHX proposal does not affect the priority of existing 
orders in a specialist's book, and once the cross is executed, the 
priority (based on time rather than size) shall remain as it was before 
the execution of the cross transaction. In this sense, the proposal 
does have some attributes of a special priority rule. However, unlike 
the special priority afforded certain crosses on other exchanges, which 
are reported to the tape as ``stopped stock,'' cross transactions 
effected under the proposed rule will be reported to the tape without a 
``tape designator.''
    The CHX proposal limits the types of orders eligible to be crossed. 
Specifically, as stated above, no part of the cross can include an 
order for the account of the executing member or member organization. 
Under the proposal, only customer orders of a floor broker (i.e., 
orders in which the floor broker acts as agent) can be included in the 
cross. For purposes of this proposal, the term customer order includes 
professional orders not for the account of the executing member (i.e., 
orders for the accounts of broker-dealers and other members or member 
organizations communicated from off the floor).
    The proposal is intended to facilitate the execution of certain 
cross

[[Page 5845]]

transactions on the CHX. The Exchange asserts that confining the 
proposed size threshold to block size orders of 25,000 shares or more 
will limit the effects of the rule primarily to actively traded, liquid 
securities.
    The CHX further believes that the proposal, as drafted, furthers 
the important auction market principle of price improvement by allowing 
another member, under certain conditions, to trade with either the bid 
or offer side of the cross transaction to provide a price that is 
better than the proposed cross price.
    Finally, the Exchange believes that limiting the proposal to 
crosses not involving principal transactions of the executing broker 
(i.e., limiting the proposal to orders in which the floor broker is 
acting as agent), is consistent with Section 11(a)(1)(G) of the Act 
\10\ as well as portions of other crossing rules at other exchanges. 
For example, in approving a crossing rule for the PCX, the Commission 
stated that it ``believes that the [PCX] proposal would not grant 
priority, parity or precedence to the order of a member in a manner 
inconsistent with Section 11(a)(1)(G) of the Act or Rule 11a1-
1(T)(a)(3) thereunder.'' \11\ The PCX proposal defined customer to 
include any order that the broker represents in an agency capacity, 
including a professional order that is not for an account associated 
with the executing broker. The Commission concluded that because ``this 
definition of customer order excludes, and thus does not grant priority 
to, an order for an account over which the broker or an associated 
person of the broker exercises investment discretion, the Commission is 
satisfied that the proposed rule change complies with Section 11(a).'' 
\12\
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    \10\ 15 U.S.C. 78k(a)(1)(G).
    \11\ See Exchange Act Release No. 33391 (December 28, 1993), 59 
FR 336 (January 4, 1994) (order approving SR-PSE-91-11). The PCX 
changed its name in 1997 from Pacific Stock Exchange to Pacific 
Exchange.
    \12\ Id.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act \13\ and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Sections 6(b) and 11A of the 
Act.\14\ Specifically, the Commission believes that the proposed rule 
change does not impose any burden on competition not necessary or 
appropriate in furtherance of the Act and 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.\15\ The Commission also believes that the proposed rule 
change is consistent with Section 11A of the Act,\16\ in that it will 
enable the CHX to better compete with the other exchanges markets.
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    \13\ In reviewing this proposal, the Commission has considered 
the proposal's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \14\ 15 U.S.C. 78f(b) and 78k-1.
    \15\ 15 U.S.C. 78f(b)(5).
    \16\ 15 U.S.C. 78k-1(a)(1)(C)(ii).
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    The Commission believes that the proposed rule change should 
enhance CHX's ability to compete for block business and could enhance 
the depth and liquidity of CHX's market. That said, the Commission also 
believes that limiting the proposed size threshold to block-size orders 
of 25,000 shares or more should limit the effects of the rule primarily 
to actively traded, liquid securities.
    The Commission believes that the proposed rule change should 
increase the opportunities for the efficient execution of block-sized 
agency cross transactions. Specifically, the proposed rule change 
should facilitate the ability of CHX members to execute block agency 
transactions on the CHX by giving such orders priority over orders at 
or within the prevailing quotation.
    The Commission notes that the proposed rule change also preserves 
the auction market principle of price improvement by prohibiting the 
cross transaction from being broken up unless a member is willing to 
provide price improvement to the cross price (either all or part of 
such bid or offer). The proposal also preserves the principle of 
priority by requiring that a member who breaks up a cross by providing 
a better price must first satisfy all existing market interest having 
priority at that better price before trading with any part of the 
cross.
    The Commission recognizes that approval of the clean cross proposal 
could disadvantage smaller orders with time priority which are on the 
book, or in the trading crowd, as the same price as the cross 
transaction. The Commission, however, believes that the proposal 
restricts sufficiently the circumstances in which members may execute 
clean cross transactions on the Exchange. In particular, the Commission 
believes that the share size threshold of 25,000 shares or more should 
help ensure that the clean cross proposal will apply primarily to large 
block-sized orders where the depth of the prevailing bid or offer may 
be less likely to satisfy either side of the clean cross. In addition, 
the proposal is limited to agency orders only and, therefore, it should 
not give any special advantage to members, member organizations, and 
non-member broker-dealers in their proprietary trading.
    The Commission notes that similar rules are in place at the Amex, 
NYSE, and PCX.\17\ The rules of the Amex, NYSE, and PCX, like the CHX 
proposal, give priority to agency cross transactions of 25,000 shares 
or more and permit such crosses to be broken up only if price 
improvement will result therefrom. The Commission notes, however, that 
the CHX's proposed rule is more restrictive than the rules of the Amex, 
NYSE, or PCX in that it allows for an agency block-sized cross 
transaction to occur without being broken up at the cross price as long 
as the size of the proposed cross transaction is of a size greater than 
the aggregate size of all interest communicated on the Exchange Floor 
at that price at the time of the cross.
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    \17\ See Amex Rule 126(g), Commentary .02; NYSE Rule 
72(b)(Priority of Agency Cross Transactions); PCX Rule 5.14(b), 
Commentary .05.
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    Finally, the Commission believes that because the CHX proposal is 
limited to crosses not involving principal transactions of the 
executing broker (i.e., limited to orders in which the floor broker 
acts as agent) it would not grant priority, parity or precedence to the 
order of a member inconsistent with Section 11(a)(1)(G) of the Act \18\ 
or Exchange Act Rule 11a1-1(T)(a)(3) thereunder.\19\ For purposes of 
the proposed rule change, the CHX has defined the term ``customer 
order'' as an order that a broker represents in an agency capacity, 
including a professional order that is not for an account associated 
with the executing broker. Because the definition of ``customer order'' 
excludes (and, thus does not grant priority to) an order for an account 
over which the broker or an associated person of the broker exercises 
investment discretion, the Commission is satisfied that the proposed 
rule change complies with Section 11(a) of the Act.
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    \18\ 15 U.S.C. 78k(a)(1)(G).
    \19\ 17 C.F.R. 240.11a1-1(T)(a)(3).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-CHX-98-27) is approved.
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    \20\ 15 U.S.C. 78s(b)(2).

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[[Page 5846]]

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-2736 Filed 2-4-99; 8:45 am]
BILLING CODE 8010-01-M