[Federal Register Volume 67, Number 56 (Friday, March 22, 2002)]
[Notices]
[Pages 13386-13388]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-6938]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45584; File No. SR-CHX-2002-05]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Requesting Permanent 
Approval of Pilot Rules Relating to the Securities Industry Transition 
to Decimal Pricing

March 18, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on March 1, 2002, the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``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 Exchange requests permanent approval of pilot rule changes 
amending certain CHX rules that were impacted by the securities 
industry transition to a decimal pricing environment, including the 
Exchange's crossing rule. The two pilots containing these rule changes 
are due to expire on April 15, 2002. The text of the proposed rule 
change is available at the Commission and at the CHX.

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 regarding 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.

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

1. Purpose
    The Exchange requests permanent approval of pilot rule changes 
amending certain CHX rules that were impacted by the securities 
industry transition to a decimal pricing environment, including the 
Exchange's crossing rule. The two pilots containing these rule changes 
are due to expire on April 15, 2002. The CHX is not proposing any 
substantive changes to the pilots.
    On August 24, 2000, the Commission approved, on a pilot basis 
through February 28, 2001, changes proposed by the Exchange to amend 
certain CHX rules that would be impacted by the securities industry 
transition to a decimal pricing environment.\3\ By a series of 
subsequent submissions, each pilot was extended to April 15, 2002.\4\ 
The Exchange now requests permanent approval of the current pilots, 
effective as of April 15, 2002.
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    \3\ These changes were proposed in two separate CHX submissions, 
the second of which dealt solely with decimal-related changes to the 
Exchange's crossing rule, Article XX, Rule 23, See Securities 
Exchange Act Release No. 43204 (August 24, 2000), 64 FR 53065 
(August 31, 2000) (SR-CHX-00-22) (approving changes to various CHX 
rules on a pilot basis (``Omnibus Decimal Pilot'')); see also 
Securities Exchange Act Release No. 43203 (August 24, 2000), 65 FR 
53067 (August 31, 2000) (SR-CHX-00-13) approving changes to the CHX 
crossing rule on a pilot basis (``Crossing Rule Decimal Pilot'')).
    \4\ See Securities Exchange Act Release No. 42964 (February 16, 
2000) 66 FR 11621 (February 26, 2001) (File No. SR-CHX-2001-03) 
(extending Omnibus Decimal Pilot through July 9, 2001); 44488 (June 
28, 2001), 66 FR 35684 (July 6, 2001) (SR-CHX-2001-13) (extending 
Omnibus Decimal Pilot through November 5, 2001); 45059 (November 15, 
2001), 66 FR 58453 (November 21, 2001) (SR-CHX-2001-20) (extending 
Omnibus Decimal Pilot through January 14, 2002), and 45481 (February 
27, 2002), 67 FR 10244 (March 6, 2002) (SR-CHX-2002-01) (extending 
Omnibus Decimal Pilot through April 15, 2002; see also, Securities 
Exchange Act Release Nos. 44000 (February 23, 2001) (66 FR 13361 
(March 5, 2001) (extending Crossing Rule Decimal Pilot through July 
9, 2001), 45010 (November 1, 2001), 66 FR 56585 (November 8, 2001) 
(SR-CHX-2001-22) (extending Crossing Rule Decimal Pilot through 
January 14, 2002), and 45482 (February 27, 2002), 67 FR 10243 (March 
6, 2002) (SR-CHX-2002-03) (extending Crossing Rule Decimal Pilot 
through April 15, 2002).
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    The Ominbus Decimal Pilot: The Omnibus Decimal Pilot for which the 
Exchange seeks permanent approval amended certain provisions of Article 
XX, Rule 37 of the Exchange's rules, which were impacted by the 
securities industry transition to a decimal pricing environment. 
Specifically, the Exchange proposes permanent approval of changes to 
Article XX, Rule 37 which (1) Allow specialists to elect, on an issue 
by issue basis, to either manually

[[Page 13387]]

or automatically execute limit orders when a trade-through occurs in 
the primary market; (2) remove the ``pending auto-stop'' functionality 
from the Exchange's systems; and (3) allow a specialist, on an issue by 
issue basis, to establish an auto execution guarantee that is not 
dependent on the ITS Best Bid or Offer (``ITS BBO'') or National Best 
Bid or Offer (``NBBO'') size. The Exchange believes that decimal 
pricing is likely to continue to affect the CHX trading environment, 
and the interaction between the CHX and the national market system, in 
a manner that necessitates permanent approval of these pilot rule 
changes, which are designed to minimize the adverse impact of 
decimalization on trading operations.\5\
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    \5\ This submission does not concern ``typographical'' 
amendments to CHX rules, where the sole change that was proposed by 
the Exchange was the substitution of a decimal price increment for 
the fractional price increment set forth in certain CHX rules. The 
proposed ``typographical'' amendments were the subject of a separate 
submission previously approved by the Commission on a permanent 
basis. See Securities Exchange Act Release No. 43256 (September 6, 
2000), 65 FR 55659 (September 14, 2000) (SR-CHX-00-25).
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    Manual or Automatic Execution of Limit Orders When a Trade-Through 
Occurs. The Exchange proposes to amend permanently Article XX, Rule 
37(b)(6) to allow a specialist to elect, on an issue by issue basis, to 
either manually or automatically execute limit orders when a trade-
through occurs in the primary market. The pre-pilot version of the rule 
provided that agency limit orders (that were not marketable when 
entered into the Exchange's MAX automatic execution system) would 
automatically be filled at the limit price when there was a price 
penetration of the limit price in the primary market for the subject 
security. Under the pilot rule, automatic execution of such limit 
orders is no longer mandated. A CHX specialist may elect to provide for 
automatic execution of agency limit orders at the limit price when 
there is a price penetration of the limit price in the primary market 
for the subject security or securities. The obligation to fill the 
order at the limit price remains the same under either election. The 
Exchange believes that this pilot rule reasonably addresses the impact 
that the decimal pricing environment has had on the national market 
system, where the number of small orders executed at multiple price 
levels has increased the number of inadvertent trade throughs that 
would otherwise lead to unwarranted automated executions of large 
orders in a CHX specialist's limit order book, exposing the specialist 
to substantially increased liability in the decimal pricing 
environment.
    Removal of the Pending Auto-Stop Functionality. For similar 
reasons, the Exchange proposes to amend permanently Article XX, Rule 
37(b)(10) to eliminate the Exchange's ``pending auto-stop'' function. 
Under the pre-pilot rule, all agency market orders from 100 to 599 
shares that were not automatically executed, because, among other 
things, the order size exceeded the quantity at the ITS BBO, were 
designated as ``pending auto-stop orders.'' Such orders were stopped, 
and due an execution at the ITS BBO thirty seconds after entry into the 
Exchange's MAX system, unless the order had been canceled, executed, 
manually stopped, or put on hold during such thirty second period. Once 
an order was stopped, a text message to that effect was automatically 
sent to the order-sending firm.
    The Exchange believes that this feature is not practicable in the 
decimal pricing environment, given the dramatic increases in quote 
traffic and the systems issues associated with generating 
administrative notifications regarding pending auto-stop. Additionally, 
quoting in decimals has significantly increased stock price points and, 
as a result, decreased the quantities associated with the ITS BBO price 
point and increased the rate of change in the ITS BBO price point. Both 
of these factors reduce a specialist's ability to offset the pending 
auto-stop guarantee. Under these circumstances, the Exchange believes 
it would be imprudent to continue to provide such a guarantee.
    Changes Relating to Relationship Between Automatic Execution 
Guarantee and BBO Size. The rationale set forth above relating to the 
decrease in the quantities associated with the BBO price point also 
supports permanent approval of the Exchange's pilot rule change 
permitting CHX specialists to designate automatic execution guarantee 
levels that are not dependent on the BBO. Under the pre-pilot version 
of the CHX rule,\6\ an order was not eligible for automatic execution 
on the Exchange if the order was larger than the then-current BBO size. 
Given the post-decimalization decreased quantities at each price point, 
the pre-pilot version of the rule would effect a corresponding decrease 
in the number of orders eligible for automatic execution on the 
Exchange. To accommodate customer demand for automatic execution, the 
Exchange believes that permanent approval of the pilot rule is 
necessary. The pilot rule permits a CHX specialist to designate, on an 
issue-by-issue basis, automatic execution guarantees that exceed the 
BBO size. Such an election is strictly voluntary and thus does not 
operate to increase the exposure of any specialist who desires to 
maintain the protections of the existing rule.
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    \6\ Art. XX, Rule 37(b)(11).
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    The Crossing Rule Decimal Pilot: The Exchange also proposes 
permanent approval of the pilot rule change to Article XX, Rule 23 of 
the Exchange's rules, which governs participation in crossing 
transactions in Nasdaq/NM securities effected on the floor of the 
Exchange Crossing transactions represent a significant component of 
Exchange volume. Under the pre-pilot rule, if a floor broker presents a 
crossing transaction, another member was able to participate, or 
``break up,'' the transaction, by offering (after presentation of the 
proposed crossing transaction) to better one side of the transaction by 
the minimum price variation. The floor broker was then effectively 
prevented from consummating the transaction as a ``clean cross,'' which 
often operated to the detriment of the floor broker's customer(s).\7\ 
In instances where the minimum price variation is relatively small, it 
is very inexpensive for a member to break up crossing transactions in 
this manner.
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    \7\ According to the Exchange, some institutional customers 
prefer executing large crossing transactions at a single price and 
are willing to forego the opportunity to achieve the piecemeal price 
improvement that might result from the breakup of the cross 
transaction by another Exchange member. Of course, the floor broker 
will still retain the ability to present both sides of the order at 
the post if the customers so desire.
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    Given the post-decimalization transition to a minimum price 
variation of only $.01, the floor broker community, and other CHX 
members, remain concerned that much of the crossing business (and 
corresponding Exchange volume) will evaporate if the pilot rule is not 
amended on a permanent basis to preclude breaking up crossing 
transactions in the manner described above.
    Under the pilot rule (which was developed by the Exchange's 
Decimalization Subcommittee and Floor Broker Tech Subcommittee to 
strike a balance of interests of those members who are impacted by 
crossing transactions), a floor broker is permitted to consummate 
crossing transactions without interference by any specialist or market 
maker if, prior to presenting the cross transaction, the floor broker 
first requests a quote for the subject

[[Page 13388]]

security.\8\ These requests will place the specialist and other market 
makers on notice that the floor broker is intending to ``cross'' within 
the bid-offer spread. This arrangement is intended to ensure that a 
specialist or market maker retains the opportunity to better the cross 
price by updating their quote, but will preclude them from breaking up 
a cross transaction after the cross transaction is presented.
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    \8\ These updated quotes are not directed solely to the floor 
broker. Anyone at the post may respond to the updated quotes.
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2. Statutory Basis
    The CHX believes the proposal is consistent with the requirements 
of the Act and the rules and regulations thereunder that are applicable 
to a national securities exchange, and, in particular, with the 
requirements of section 6(b).\9\ The CHX believes the proposal is 
consistent with section 6(b)(5) of the Act \10\ in that it is designed 
to promote just and equitable principles of trade, 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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    \9\ 15 U.S.C. 78(f)(b).
    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any inappropriate burden on competition.

I. 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 CHX consents, the Commission will:
    (A) by order approve the 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 proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., 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-2002-05 and should be 
submitted by April 12, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)912).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-6938 Filed 3-21-02; 8:45 am]
BILLING CODE 8010-01-P