[Federal Register Volume 68, Number 93 (Wednesday, May 14, 2003)]
[Notices]
[Pages 25916-25917]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-11992]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47811; File No. SR-CHX-2002-20]


Self-Regulatory Organizations; Order Granting Partial Approval of 
Proposed Rule Change by the Chicago Stock Exchange, Incorporated 
Relating to Automatic Execution of Orders

May 7, 2003.

I. Introduction

    On July 11, 2002, 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 of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to allow a specialist to limit 
his aggregate auto-execution exposure.\3\ On August 13, 2002, the 
Exchange submitted Amendment No. 1 to the proposal.\4\ On August 27, 
2002, the Exchange filed Amendment No. 2 to the proposed rule 
change.\5\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In the proposed rule change, the Exchange also proposed a 
modified definition of the ``BBO Price'' and corresponding changes 
to the BEST Rule that would reflect the modified definition. The 
Commission is not approving those proposed changes in this order.
    \4\ See letter from Kathleen M. Boege, Associate General 
Counsel, CHX, to Nancy J. Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated August 9, 2002 
(``Amendment No. 1'').
    \5\ See letter from Kathleen M. Boege, Assistant General 
Counsel, CHX, to Nancy J. Sanow, Assistant Director, Division, 
Commission, dated August 23, 2002 (``Amendment No. 2'').
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    The proposed rule change was published for comment in the Federal 
Register on September 6, 2002.\6\ No comments were received on this 
aspect of the proposal.\7\ On April 25, 2003, the Exchange filed 
Amendment No. 3 to the proposed rule change.\8\ This order partially 
approves the proposed rule change.
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    \6\ See Securities Exchange Act Release No. 46436 (August 29, 
2002), 67 FR 57048.
    \7\ The Commission received one comment addressing the 
Exchange's proposed change to the definition of ``BBO price.''
    \8\ See letter from Kathleen M. Boege, Assistant General 
Counsel, CHX, to Nancy J. Sanow, Assistant Director, Division, 
Commission, dated April 24, 2003 (``Amendment No. 3''). In Amendment 
No. 3, the Exchange withdrew its request that the proposed rule 
change be approved on a pilot basis. Further, the Exchange made 
changes to the proposed definition of BBO price and requested 
partial approval of the portion of the proposed rule change dealing 
with issues other than the definition of BBO price. Because the only 
substantive changes contained in Amendment No. 3 involve this 
definition of BBO price, which the Commission is not approving in 
this order, the Commission similarly is not approving Amendment No. 
3 at this time.
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II. Description of the Proposal

    The CHX Rules provide for automatic execution of orders, i.e., 
without manual intervention by the CHX specialist, if certain 
conditions are met.\9\ Under the CHX Rules, each CHX specialist 
designates an ``auto-execution threshold'' for each issue.\10\ The 
auto-execution threshold is a number of shares, greater than 99 shares 
that the specialist is willing to execute automatically. If a 
specialist receives an order that exceeds his designated auto-execution 
threshold, the order is automatically directed into the specialist's 
book for manual execution, unless the order-sending firm has elected to 
receive partial automatic executions, in which case a portion of the 
order will automatically execute, up to the size of the auto-execution 
threshold, and the balance of the order will be placed in the 
specialist's book for manual execution.
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    \9\ See CHX Article XX, Rule 37(b)(6)(automatic execution of 
orders in listed securities); CHX Article XX, Rule 
37(b)(7)(automatic execution of orders in OTC securities).
    \10\ See CHX Article XX, Rule 37(b)(1).
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    Under the current version of the CHX Rules, a CHX specialist has 
unlimited (and the CHX believes unwarranted) auto-execution exposure, 
because a rapid succession of orders entered into the MAX system at or 
below the specialist's auto-execution threshold are due an automatic 
fill at the prevailing National Best Bid or Offer (``NBBO'') price. 
Therefore, the CHX believes that specialists may be required to provide 
more liquidity than they intend to through automatic executions.
    To resolve this issue, the Exchange has proposed to amend CHX 
Article XX, Rule 37(b)(1) to limit a specialist's unintended automatic 
execution liability by incorporating an Aggregate Share Threshold into 
the specialist's designated auto-execution parameters. The specialist 
can enable the Aggregate Share Threshold on an issue-by-issue basis. 
The functionality is entirely optional, however, and a specialist can 
still elect to provide additional liquidity guarantees.
    Under this voluntary system enhancement, the specialist would agree 
to provide automatic execution (at the NBBO) of an aggregate number of 
shares (the ``Aggregate Share Threshold''). Once an aggregate number of 
shares equal to the Aggregate Share Threshold was automatically 
executed, whether as a result of one order or numerous orders, 
subsequent orders would be directed into the specialist's book for 
manual execution. Under the proposed rule change, a specialist would 
then be obligated to either execute the order at a price and size equal 
to or better than the NBBO price and size at the time the order was 
received, or act as agent for the order to obtain the best available 
price on a marketplace other than the Exchange.
    The Aggregate Share Threshold would reset after a prescribed amount 
of time designated by a specialist \11\ and could never be set at a 
level less than the shares included in the specialist's own bid or 
offer.
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    \11\ A specialist choosing to enable the Aggregate Share 
Threshold functionality would be required to provide CHX staff with 
the designated time increment for each issue. The time increment 
would commence (and restart) upon any change in the NBBO.
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    The Exchange also proposes to relocate Article XX, Rule 43(d) to 
Rule 37(a), rendering the provisions of Rule 43(d) applicable to both 
over-the-counter and listed securities. This provision states that with 
respect to any market or marketable limit order not executed 
automatically, a specialist shall be obligated to either (a) manually 
execute such order at a price and size equal to or better than the NBBO 
price and size at the time the order was received; or (b) act as agent 
for such order in seeking to obtain the best available price for such 
order on a marketplace other than the Exchange, using order routing 
systems where appropriate.

III. Discussion

    After careful review, the Commission finds that the proposed 
changes to CHX Article XX, Rules 37(a)(1), 37(a)(2), 37(b)(1) and 43(d) 
described above are consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national

[[Page 25917]]

securities exchange.\12\ Specifically, the Commission finds that these 
proposed changes are consistent with the requirements of Section 
6(b)(5) of the Act \13\ because they are designed 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; and are not 
designed to permit unfair discrimination between customers, issuers, 
brokers or dealers.\14\
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    \12\ In approving this portion of the 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).
    \13\ 15 U.S.C. 78f(b)(5).
    \14\ The Commission notes that it is not approving proposed 
Interpretation .01 to CHX Rule 37, nor the corresponding 
modifications to Rule 37 that would accompany this interpretation.
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    The Commission believes that the proposed changes to CHX Article 
XX, Rule 37(a)(2) providing for an Aggregate Share Threshold achieve an 
appropriate balance between providing customers with efficient and 
prompt executions of orders and limiting the risk that specialists are 
exposed to by guaranteeing automatic executions. The Commission further 
finds that the proposed changes to CHX Article XX, Rule 37(b)(1) 
dealing with a specialist's obligations for manually handling market 
and marketable limit orders are consistent with the Act and the manner 
in which specialists currently handle orders for listed securities.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the portion of proposed rule change (SR-CHX-2002-20) 
relating to CHX Article XX, Rules 37(a)(1), 37(a)(2), 37(b)(1) and 
43(d), as discussed above, is approved.
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    \15\ 15 U.S.C. 78f(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-11992 Filed 5-13-03; 8:45 am]
BILLING CODE 8010-01-P