[Federal Register Volume 65, Number 206 (Tuesday, October 24, 2000)]
[Notices]
[Pages 63660-63662]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-27240]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43443; File No. SR-CHX-00-20]


Self-Regulatory Organizations Chicago Stock Exchange, Inc.; Order 
Granting Approval of Proposed Rule Change and Amendment No. 1 by the 
Chicago Stock Exchange, Incorporated Relating to Automatic Execution of 
Orders for Nasdaq/NM Securities

October 13, 2000.

I. Introduction

    On June 9, 2000, 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 relating to the automatic 
execution of orders for Nasdaq/NM Securities. On August 18, 2000, the 
Exchange filed Amendment No. 1, to the proposed rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Paul O'Kelly, Executive Vice President, CHX, 
to Katherine England, Assistant Director, Division of Market 
Regulation, Commission, dated August 15, 2000. (``Amendment No. 
1''). In Amendment No. 1, the Exchange clarified how specialists 
would utilize the proposed enhanced liquidity function, and deleted 
a portion of the proposed rule text that would have permitted a 
specialist to switch to manual execution mode in unusual trading 
situations after, among other things, seeking relief from a member 
of the Exchange. Under the amended version of the rule, a specialist 
must seek relief from two floor officials.

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[[Page 63661]]

    The proposed rule change, including Amendment No. 1, was published 
for comment in the Federal Register on August 30, 2000.\4\ No comments 
were received on the proposal. This order approves the proposal.
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    \4\ Securities Exchange Release No. 43199 August 23, 2000), 65 
FR 52802.
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II. Description of Proposal

    In its proposed rule change, the Exchange seeks to amend the CHX 
rules governing automatic execution sequences and algorithms relating 
to the trading of Nasdaq/NM Securities on the Exchange.\5\ The Exchange 
has represented that the proposed changes are intended to bring the CHX 
rules in line with the practices that currently exist in the Nasdaq 
market with respect to the trading of Nasdaq/NM Securities.\6\
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    \5\ See CHX Article XX, rules 37 and 43.
    \6\ See NASD Notices to Members 99-11 and 99-12 (February, 
1999)(discussing NASD member firm order execution practices, 
particularly during periods of significant market volatility).
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    CHX Article XX, Rule 37, describes among other things, the 
circumstances under which orders must be accepted and guaranteed an 
execution at the national best bid or offer (the ``BEST Rule''). CHX 
Rule 37 also describes a specialist's ability to set a parameter (the 
auto-execution threshold) that identifies (by size) which orders 
guaranteed a fill under the BEST Rule will be automatically executed.
    The proposed rule change would allow specialists to reduce the 
minimum auto-execution threshold from 1,000 shares to 300 shares for 
each security in which the specialist makes a market. It would not 
change specialists' obligations under the BEST Rule.\7\ In other words, 
specialists could choose to obligate themselves to automatically 
execute only those orders for 300 shares or less. Under these 
circumstances, specialists would still be required, however, to 
guarantee execution at the national best bid or offer (``NBBO'') for 
orders up to the size associated with the NBBO.
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    \7\ The CHX has represented that reduction of the minimum auto-
execution threshold is intended to limit the exposure of Nasdaq/NM 
specialists in the case of highly-volatile Nasdaq/NM Securities. The 
Exchange anticipates, however, that for the majority of Nasdaq/NM 
Securities, specialists will voluntarily remain at the 1000-share 
auto-execution threshold.
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    Further, under the proposed rule, if a specialist at the NBBO 
chooses to set the auto-execution threshold at 300 shares, and an order 
for 1,000 shares is entered, the specialist must automatically execute 
300 shares (the size of his bid or offer). The portion of the order 
that exceeds 300 shares (in this example, 700 shares) shall be treated 
as an open order, and must be manually executed at the NBBO.
    The proposed rule also would permit specialists to choose to 
provide an enhanced execution guarantee for orders by setting a new 
parameter called an ``enhanced liquidity quantity.'' The enhanced 
liquidity quantity, as the name implies, would permit a specialist to 
raise its automatic execution threshold to a size greater than 300 
shares. If a specialist chooses to utilize this parameter, orders would 
be automatically executed up to the enhanced liquidity quantity 
designated by the specialist.\8\ The specialist can designate an 
enhanced liquidity quantity on a stock by stock basis.
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    \8\ See Amendment No. 1, supra note 3.
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    Lastly, the proposed rule provides new guidelines for Nasdaq/NM 
specialists that want to switch from automatic execution mode to a 
manual execution mode when unusual trading conditions exist. The 
proposed rule would define the term ``unusual trading conditions'' to 
include the existence of large order imbalances and/or significant 
price volatility. the rule would require that upon switching to manual 
execution mode based on the existence of unusual trading conditions, a 
specialist must: (1) Document the basis for election of manual 
execution mode; (2) disclose to its customers the differences in 
procedures from normal market conditions and the circumstances under 
which the specialist generally may activate manual execution mode; and 
(3) seek permission to switch to manual execution mode for two floor 
officials.\9\
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    \9\ See Amendment No. 1, supra note 3.
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\10\ In particular, the Commission believes that the proposed 
rule change is consistent with the requirements of Section 6(b)(5) of 
the Act \11\ in that it is designed to promote just an equitable 
principles of trade, to facilitate transactions in securities, to 
remove impediments to 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.
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    \10\ In approving this rule proposal, the Commission notes that 
it has also considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78s(b)(5).
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    The Commission believes that it is appropriate for the Exchange to 
allow specialist flexibility in determining the size of orders that 
they will guarantee receive automatic executions. Automatic execution 
systems help specialists meet the demands of high trade volume in the 
Nasdaq market, and competitive pressures to provide fast, efficient 
executions. The Commission recognizes that there are conditions under 
which specialists are not willing to provide automatic executions. 
During extreme market conditions, where there are large order 
imbalances or significant private volatility, guarantees of automatic 
executions for large orders subject specialists to a high degree of 
risk. The proposed rule change offered by the CHX is designed to 
mitigate that risk.
    By giving specialists the option of lowering the size of orders 
that they must guarantee an automatic execution from 1,000 shares to 
300 shares, the Commission believes the Exchange is providing 
specialists with an acceptable way to limit their exposure. The CHX has 
represented that reduction of the minimum auto-execution threshold is 
intended to limit the exposure of Nasdaq/NM specialists in the case of 
highly-volatile Nasdaq/NM Securities. The Exchange has stated that it 
anticipates that for the majority of Nasdaq/NM Securities, specialists 
will voluntarily remain at the 1,000-share auto-execution threshold.
    In reviewing this proposal, the Commission considered it important 
that while a specialist may lower the size of orders that are 
guaranteed automatic execution to 300 shares, under the proposed rule 
change a specialist must still provide an execution at the NBBO for all 
orders of 1,000 shares or less pursuant to the Exchange's Best Rule. 
Further, the proposed rule provides that in the case of orders larger 
than a specialist's automatic execution threshold, the specialist must 
provide an automatic execution up to the specialist's threshold, with 
the remainder of the order sent for manual execution. In this way, the 
Exchange is providing investors with some opportunity for a guaranteed 
automatic execution, while at the same time, protecting the specialist 
from unreasonable risk.
    The Commission also finds that the Exchange's proposal to allow 
specialists to designate an ``enhanced liquidity quantity'' will give 
specialists an appropriate level of flexibility in determining what 
size orders they want to guarantee automatic executions. If a 
specialist chooses to offer automatic executions to orders greater than 
his or

[[Page 63662]]

her automatic execution threshold, he or she may do so using this 
function.
    Next, the Commission believes that the Exchange's proposal to allow 
Nasdaq/NM specialists to switch from automatic execution mode to a 
manual execution mode in the event of unusual trading situations if 
they comply with certain requirements will also provide specialists 
with adequate protection in the event of large order imbalances and/or 
significant price volatility, or other unusual trading situations.\12\ 
The proposed rule requires that upon switching to manual execution mode 
based on the existence of unusual trading conditions, a specialist 
must: (1) document the basis for election of manual execution mode; (2) 
disclose to its customers the differences in procedures from normal 
market conditions and the circumstances under which the specialist 
generally may activate manual execution mode; and (3) seek permission 
to switch to manual execution mode from two floor officials. The 
Commission believes the proposed rule adequately balances the concern 
that specialists not be required to offer automatic executions under 
truly unusual circumstances with the concern that investors who 
reasonably except to receive an automatic execution pursuant to 
Exchange rules and policies actually receive an automatic execution. 
The Commission believes that with the aforementioned requirements prior 
to switching from automatic to manual executions, both specialists and 
investors will be protected in the event of unusual market conditions.
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    \12\ The Commission expects the Exchange to keep records of 
instances when specialists are permitted to switch to a manual 
execution mode so that the Exchange and the Commission can monitor 
the use of this option.
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IV. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CHX-00-20) is approved.
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    \13\ 15 U.S.C. 78f(b)(2).

    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. 00-27240 Filed 10-23-00; 8:45 am]
BILLING CODE 8010-01-M