[Federal Register Volume 65, Number 230 (Wednesday, November 29, 2000)]
[Notices]
[Pages 71161-71164]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30375]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43600; File No. SR-CHX-00-34]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Relating to Its 
Market Program and Floor Trading Operations

November 21, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 23, 2000, the Chicago Stock Exchange, Incorporated 
(``Exchange'' or ``CHX'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the CHX. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CHX proposes to amend its rules relating to its market maker 
program and to its floor trading operations. Specifically, the Exchange 
proposes to amend the following: (i) CHX Rules 8, 9 and 10 under 
Article XXXIV; (ii) Interpretations and Policies of CHX Rule 7 under 
Article XX; (iii) CHX Rule 10 under Article XX; and (iv) paragraph 
(b)(12) of CHX Rule 37 under Article XX.
    Below is the text of the proposed rule change. Proposed new 
language is in italics and proposed deletions are in brackets.
* * * * *

ARTICLE XX

Regular Trading Sessions

* * * * *

Recognized Quotations

RULE 7. No change to text.

Interpretations and Policies:

    .01  Specialists shall input their current markets and sizes to the 
quotation system [through the key terminal or the mark sense terminal] 
at the post or utilize Exchange systems that provide automated 
generation of quotations. These quotations shall be firm as to both 
price and size unless exempted under one of the conditions specified in 
paragraphs .06-.09 of this Rule.
    .02  In respect to Dual Trading System issues specialists utilizing 
the Auto Quote mode are prohibited from disseminating a bid and/or 
offer more than $0.10 (for issues trading in decimals) or \1/8\ point 
(for issues trading in fractions) away from the best ITS market.
    .03  Market [M]makers and floor brokers, while at the post, shall 
provide to the specialist for input to the quotation system their bids 
and/or offers which better the current Exchange market. These bids and/
or offers, and any modification or withdrawal of these bids and/or 
offers, must be provided to the specialist through a written quotation 
ticket or in any other format agreed upon by the specialist and the 
market maker or floor broker. The specialist must input to the 
quotation system any bid and/or offer which betters the current 
Exchange market. For purposes of this rule, a bid or offer will better 
the current Exchange market if it improves the price of the current bid 
or offer or if it causes the specialist to change the existing Exchange 
quotation. [Such quotations shall remain in force until the market 
maker leaves the post.] Market maker and floor broker quotations and 
accompanying sizes shall be firm unless exempted under one of the 
conditions specified in paragraphs .06-.09 of this Rule.
    Market makers and floor brokers, while at the post, may provide to 
the specialist their orders to buy or sell securities. The specialist 
must include these orders in the book to the extent required by 
Exchange Rules. These orders, and any modification or cancellation of 
these orders, must be provided to the specialist through a written 
order ticket or in any other format agreed upon by the specialist and 
the market maker or floor broker. These orders will remain in effect 
until cancelled or until they otherwise expire by their terms. If a 
market or floor broker transfers possession of an order to a 
specialist, the specialist is responsible for disseminating any 
required quotations relating to that order.
    [.04  Floor Brokers, while at the post, shall input to the 
quotation system those bids or offers which better the current Exchange 
market, unless the bid or offer is cancelled or withdrawn if not 
executed immediately. If a floor broker transfers possession of an 
order to a specialist, the requirement for input to the quotation 
system becomes the obligation of the specialist. When a floor broker 
who retains possession of an order leaves the post he must withdraw his 
bid or offer from the quotation system. Quotations and accompanying 
sizes shall be firm until withdrawn unless exempted under one of the 
conditions specified in paragraphs .06-.09 of this Rule.]
* * * * *

Manner of Bidding and Offering

    RULE 10. Bids and offers to be effective must be [audibly] made at 
the post and shall remain in full force until the person making the bid 
or offer shall [audibly] withdraw the bid or offer [announce that he is 
out of the market or until he leaves the post].
Interpretations and Policies:
    .01  Although there may be a certain amount of negotiation by voice 
away from the post, every trade must be consummated at the post.
    Amended Jan. 15, 1997.
    .02  Clearing the Post.
    Policy. All orders received by floor brokers or originated by 
market makers on the floor of the Exchange and Exposable Orders, as 
that term is defined below, received by specialists on the floor of the 
Exchange must effectively clear the post before the orders may be 
routed to another market, either via the ITS System or through the use 
of alternative means.
    Floor brokers who receive an order on the floor have a fiduciary 
responsibility to seek a best price execution for such order. This 
responsibility includes clearing of the Exchange's post prior to 
routing an order to another market so that other buying and selling 
interest at the post can be checked for a potential execution that may 
be as good as or better than the execution available in another market.
    Market makers, in certain circumstances, are required to provide 
depth and liquidity to the Exchange market, among other things. 
Exchange Rules require that all market maker transactions constitute a 
course of dealings reasonably calculated to contribute to the 
maintenance of a fair and orderly market. In so doing, market makers 
must adhere to traditional agency/auction market principles on the 
floor. Transactions by Exchange market makers on other exchanges or in 
other markets which fail to clear the Exchange post do not constitute 
such a course of dealings.
    Specialists have an ongoing requirement to provide depth and 
liquidity to the Exchange market by maintaining liquid continuous two-
sided markets on the Exchange floor and insuring that those markets are 
fair, orderly and efficient in the public interest. To meet those 
requirements, specialists must adhere to traditional agency/auction 
market principles on the

[[Page 71162]]

floor. Among other things, these principles require that a specialist 
not route all or any part of an Exposable Order to another market, 
either via the ITS System or through the use of alternative means, 
until the specialist has first exposed the portion of the order that he 
intends to route elsewhere to any market makers and floor brokers at 
the post. An Exposable Order is all or any part of an order for more 
than 100 shares that is either (i) a market order or (ii) a limit order 
that is at or better than the ITS BBO or NBBO. Transactions by Exchange 
specialists on other exchanges or in other markets which fail to clear 
the Exchange post in the manner required by this Interpretation do not 
constitute a course of dealings that fulfills a specialist's obligation 
to insure that markets are fair, orderly and efficient in the public 
interest.
    Notwithstanding the above, it is understood that on occasion a 
customer will insist on special handling for a particular order that 
would preclude it from clearing the post on the Exchange floor. For 
example, a customer might request that a specific order be given a 
primary market execution. These situations must be documented and 
reported to the Exchange. Customer directives for special handling of 
all orders in a particular stock or all stocks, however, will not be 
considered as exceptions to the clearing the post policy.
    All executions resulting from bids and offers reflected on Instinet 
terminals residents on the Exchange floor constitute ``orders'' which 
are ``communicated'' to the Exchange floor. Therefore, all orders 
resulting from interest reflected on Instinet terminals on the Exchange 
floor must be handled as any other order communicated to the floor. All 
such orders must be presented to the post during normal trading hours. 
All trades between Instinet and Exchange floor members are Exchange 
trades and must be executed on the Exchange.
    Method of Clearing the Post. Subject to Article XX, Rule 11 
relating to cabinet securities, the Exchange's clearing the post policy 
requires the floor broker or market maker to be physically present at 
the post. A market maker, after requesting the specialist's market 
quote, must bid or offer the price and size of his intended interest at 
the post. A floor broker must clear the post by requesting a market 
quote from the specialist. When required by these rules to clear the 
post, a specialist must do so by bidding or offering, at the post, the 
price and size of his intended interest.
* * * * *

Guaranteed Execution System and Midwest Automated Execution System

* * * * *
RULE 37.
* * * * *
    (b)
* * * * *
    (12) Automated Execution of Limit Orders.
    A Specialist may voluntarily choose to activate a feature of MAX 
that automatically executes limit orders on a specialist's book that 
are at or less than the specialist's auto acceptance level at the limit 
price after both of the following conditions are met: (1) The issue is 
trading at the limit price in the primary market, and (2) enough 
transactions in the issue are executed in the primary market at prices 
which are equal to the limit price of the order such that the size 
associated with such transactions are, in aggregate, equal to or 
greater than the sum of (a) the size displayed at the limit price in 
the primary market when the limit order was entered on the specialist's 
book, plus (b) the size of the limit order. This feature can be 
activated on a stock-by-stock basis only. Once activated, it must 
remain activated for a minimum of five trading days and can only be 
deactivated on a certain day (to be determined by the Exchange from 
time to time) each month.
* * * * *

ARTICLE XXXIV

Registered Market Makers--Equity Floor

* * * * *

Joint Participation

    RULE 8. (a) Orders Eligible for Joint Participation. Registered 
market makers are entitled to participate with the specialist in any 
round lot order in the specialist's book that is greater in size than a 
specialist's auto-acceptance threshold for that security. When 
requested by a specialist or floor broker to make a market with respect 
to any other order, a registered market maker is also entitled to 
participate in that order with the specialist or floor broker.
    (b) Extent of Joint Participation. When the bids or offers of one 
or more registered market makers are equal in price to those of the 
specialist with respect to the orders described above, the registered 
market maker or market makers as a group are entitled to participate in 
the transactions effected on those orders [thereon] to the extent of 
[one-third] 40% of the total shares involved (excluding those needed to 
satisfy public orders).
    When the bids or offers of one or more registered market makers are 
better in price than those of the specialist, the registered market 
maker or market makers as a group are entitled to the entire 
transaction.

Interpretations and Policies:

    .01  No change to text.

Openings

    RULE 9. Registered market makers as a group are entitled to 
participate in opening a security on the Exchange to the extent of 
[one-third] 40% of the net imbalance (excluding specialist 
participation) of purchase and sale orders on the Exchange.

Public Outcry

    RULE 10. No specialist [or market maker] shall effect a transaction 
for his own account with respect to any order greater in size than his 
auto-acceptance threshold for that security until the specialist has 
first exposed that order to any market makers and floor brokers at the 
post. Nothing in this Rule prevents specialists from exposing, to any 
market makers and floor brokers at the post, any order that is equal or 
smaller in size than his auto-acceptance threshold. [unless the 
presence of the other side of that transaction had been audibly 
announced at the post.]
    No market maker shall effect a transaction for his own account with 
respect to any order until the market maker has first exposed that 
order to the specialist and any market makers or floor brokers at the 
post.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the CHX included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CHX has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

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A. Self-Regulatory Organization's Statements of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to modify the CHX's 
market maker program (``Program'') and to make certain changes to 
reflect technical enhancements to the CHX's trading operations.
    Changes to the Market Maker Program. The Program was originally 
designed to provide supplemental liquidity to specialists on the CHX by 
permitting auxiliary market makers to trade for their own accounts on 
the floor of the CHX. Currently, the CHX market makers are required to 
fulfill certain market-making obligations, and in return are granted a 
one-third participation right in shares presented to the specialist for 
purchase or sale.
    The CHX is engaged in an examination of how to reconfigure its 
operations in order to compete in a technologically driven marketplace 
that has begun to face competition from electronic communication 
networks (``ECNs'') and the NASDAQ Stock Market, Inc. (``NASDAQ'') in 
listed stocks. As part of this evaluation, the CHX recognized that it 
needs to continue to increase the automation of its trading operations 
and address the role of floor traders on the CHX, especially market 
makers that do not contribute substantially to the liquidity of the 
Exchange.
    The CHX's evaluation included an analysis of trading by market 
makers. This analysis found that market makers rarely supply liquidity 
outside of several exchange-traded funds (``ETFs''). Specifically, 
market makers participate in less than 0.83% of trade volume outside of 
ETFs. For ETFs, especially the NASDAQ 100 Depository Receipts, market 
makers often participate in trades of 5,000 shares or greater. They 
accounted for 17% of the share volume of four ETFs during a sample 
period examined by the CHX (but only 2.4% of the trade volume in these 
issues), and a significant portion of the 17% of share volume involved 
market makers trading with brokers who were filling customer orders for 
large transactions.
    In light of the data, the CHX explored several approaches to 
address market maker activity. One approach would have eliminated 
market makers because their activity is limited almost entirely to 
participating in large ETF transactions. In response to concerns by 
some members about eliminating market makers and the liquidity they 
provide to large, brokered orders, the CHX decided to focus on 
encouraging market maker participation in large orders and stimulating 
increased quote competition for small orders.
    This proposed rule change would implement the CHX's modification of 
market maker obligations. Under the proposed rule change, registered 
market makers would be entitled to participate with the specialist in 
any round lot order in the specialist's book that is greater in size 
than the specialist's auto-acceptance threshold for a given security. 
For these orders, if the bids or offers of one or more registered 
market makers are equal to those of the specialist, the registered 
market maker or market makers as a group would be entitled to 
participate in forty percent of the total shares involved (excluding 
the shares needed to satisfy public orders).\3\ Prior to effecting a 
transaction for its own account, a specialist must expose any order 
greater than its auto-acceptance size to market makers and floor 
brokers at the post. Furthermore, when the bids or offers of one or 
more market makers are better than those of the specialist, the market 
maker or market makers as a group would be entitled to participate 
fully in the transaction without the specialist.
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    \3\ This participation right is an increase from the current 
one-third participation right. The new participation level would 
also apply to openings as provided by Rule 9, Article.
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    With respect to orders at or less than the specialist's auto-
acceptance threshold, the specialist could still request market maker 
interaction, in which event the market maker would be entitled to 
participate in that order. In addition, a specialist must request such 
interaction if the specialist chooses not to fill an order within the 
auto-acceptance parameters. A floor broker or specialist can also 
request market maker participation in a floor broker order. Market 
makers in these situations would also be entitled to participate in 
forty percent of the trade.
    Under the proposed rules, market makers and floor brokers must 
continue to provide the specialist with their bids and/or offers that 
better the current CHX market. The specialist must input these bids and 
offers to the quotation system. Market makers and floor brokers may 
also provide their orders to buy or sell securities to the specialist, 
in which event the specialist must include these orders in the book as 
required by the CHX rules.
    The proposed rule change limits market makers' ability to 
participate in small sized orders unless they improve the CHX quote, 
but offers them increased participation rights for larger sized orders 
and for those orders for which their participation is requested by a 
specialist. As a whole, the CHX believes that the proposed rule change 
does not alter the Program significantly, other than for small sized 
orders, which have not been subject to much market maker participation 
in the past.
    The intent of the proposed rule change is to stimulate market 
makers to continue to provide liquidity for larger orders by increasing 
their participation rights for those orders. Similarly, the proposed 
rule change could increase quote competition on the CHX in smaller size 
orders by creating incentives for market makers to improve the 
specialist's quote. As discussed above, a market maker who improves the 
specialist's quote would be entitled to participate in the entire 
transaction. This is a change from the current rules which allows 
market makers to receive one-third participation for merely matching a 
specialist's quote. The new rule would force market makers to improve 
the quote to participate in a trade, but reward such improvement by 
providing a greater participation right to the market maker. CHX 
believes that this proposed rule change is consistent with the recent 
SEC proposals to strengthen quote competition.\4\ The proposed rule 
change thus has the potential to benefit retail investors whose orders 
are usually executed automatically based on the national best bid or 
offer (``NBBO'') because market makers would have an incentive to 
narrow spreads in order to participate in the entire order.
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    \4\ See Securities Exchange Act Release No. 43084 (July 28, 
2000), 65 FR 48406 (August 8, 2000) (Proposing Release on Disclosure 
of Order Routing and Execution Practices discussing the need to 
strengthen quote competition). See also Securities Exchange Act 
Release No. 43590 (November 17, 2000).
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    Modifications to Trading Floor Operations Rules. The proposed rule 
change also makes several changes to floor procedure to incorporate the 
use of existing technology on the Exchange floor. The change to 
Interpretation .01 to CHX Rule 7 of Article XX reflects the replacement 
of key terminals and mark sense terminals with other Exchange systems 
and the use of Exchange auto-quote systems.\5\ The change to 
Interpretation .03 to CHX Rule 7 of Article XX is intended to reduce 
disputes as to whether market makers and floor brokers properly 
vocalized their bids and offers for input into the

[[Page 71164]]

Exchange's quotation system. The proposal would require bids or offers 
that better the Exchange market \6\ to be provided to the specialist 
via written ticket, or by any other form agreed upon by the specialist 
and market maker or floor broker. The proposed rule change also 
contains a similar requirement for limit orders left with the 
specialist by market makers or floor brokers.
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    \5\ A similar change to this Interpretation has also been 
proposed in SR-CHX-99-18 (filed September 24, 1999), a filing which 
was primarily designed to modify the CHX's description of its limit 
order display rule (Article XX, Rule 7, Interpretation and Policy 
.05).
    \6\ To better the market, the quote would have to improve the 
CHX quote by one quoting increment, or otherwise cause the 
specialist to change the existing CHX quotation. Currently, Article 
XX, Rule 7, Interpretation .05 requires a specialist to input any 
bids or offers that increase the size that has been bid or offered 
at the current price. The CHX has proposed an amendment to this 
provision in SR-CHX-99-18, which is pending with the Commission.
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    The CHX is making a few changes to its CHX Rule 10 of Article XX. 
The first change would reflect the changes made to CHX Rule 7 of 
Article XX by removing the audibalization requirement. Because bids and 
offers will have to be provided to the specialist for input into the 
Exchange's quotation system, the audibalization requirement is no 
longer necessary. The proposed rule change also adds language to 
require specialists to adhere to agency/auction market principles. 
Among other things, specialists are required to clear the post of 
exposable orders they received on the floor.\7\ Thus, a specialist 
would not be permitted to route exposable orders to another market 
until the specialist has first exposed the portion of the order that he 
intends to route to another market to market makers and floor brokers 
at the post. The intent of the proposed rule change is to extend to 
specialists the requirement of clearing the post that now applies to 
orders received by floor brokers and market makers on the floor of the 
Exchange. The CHX believes it is consistent with exchange auction 
market principles to require all market orders and marketable or 
displayable limit orders received by the specialist to have the 
opportunity to interact with other interest on the Exchange floor 
before being routed to another market.
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    \7\ An exposable order will be defined in the proposed rule 
change as ``all or any part of an order for more than 100 shares 
that is either (i) a market order or (ii) a limit order that is at 
or better than the ITS best bid or offer or the national best bid or 
offer.''
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    Finally, the CHX is proposing to amend CHX Rule 37 of Article XX to 
limit the automtic execution feature of MAX, the Exchange's automatic 
execution system, for limit orders at or less than the specialist's 
auto acceptance level. Currently, if a specialist chooses to activate 
the limit order auto-ex feature, he must do so for all limit orders on 
the book regardless of size. By allowng the specialist to automatically 
execute these limit orders only when the orders are of a size at or 
less than his auto acceptance level, the specialist will be required to 
present larger orders to the crowd as required by the new market maker 
participation rules. Of course, specialists will still be obligated to 
exercise care and diligence to provide quality executions to manually 
handled limit orders if the two conditions of paragraph (b)(12) of CHX 
Rule 37 of Article XX are triggered by executions in the primary 
market.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6 \8\ and Section 11 \9\ of the Act. The proposal furthers the 
objectives of Section 6(b)(5) \10\ of the Act in particular in that it 
should promote just and equitable principles of trade, serve to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and protect investors and the public 
interest. The proposal is also consistent with Rule 11b-1 \11\ of the 
Act because it is designed to require specialists and market makers to 
assist in the maintenance of a fair and orderly market.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78k.
    \10\ 15 U.S.C. 78f(b)(5).
    \11\ 17 CFR 240.11b-1.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change does not impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The CHX believes that the 
proposed rule change will enhance competition on the Exchange by 
providing an incentive for the CHX market makers to aggressively 
compete on quotes.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CHX. All submissions should refer to File No. SR-CHX-00-34 and should 
be submitted by December 20, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-30375 Filed 11-28-00; 8:45 am]
BILLING CODE 8010-01-M