[Federal Register Volume 69, Number 112 (Thursday, June 10, 2004)]
[Notices]
[Pages 32645-32647]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13086]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49793; File No. SR-CHX-2004-02]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Relating to 
Automatic Execution of Orders

June 2, 2004.
    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 February 11, 2004, the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I, II and III below, which Items have been prepared by the 
Exchange. 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 proposes to amend Article XX, Rule 37 of the CHX 
Rules, which governs, among other things, automatic execution of market 
and marketable limit orders, to eliminate the existing 100-share 
minimum automatic execution threshold. The text of the proposed rule 
change is available from the Office of the Secretary of the CHX or at 
the Commission.

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 Exchange 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 Exchange 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 proposes to amend Article XX, Rule 37 and Rule 43 of 
the CHX Rules, which governs, among other things, automatic execution 
of market and marketable limit orders, to eliminate the existing 100-
share minimum automatic execution threshold.

Background

    The vast majority of orders received by a CHX specialist are routed 
from order-sending firms via the Exchange's MAX'' system, which 
provides for the electronic routing and automatic execution of orders. 
CHX rules require that the MAX system automatically execute orders at 
the national best bid or offer (``NBBO'') if certain conditions are 
met.\3\ In order to manage his position and prudently limit his auto-
execution exposure, each CHX specialist designates an ``auto-execution 
threshold'' for each issue.\4\ The auto-execution threshold is the 
number of shares that the specialist is willing to execute 
automatically. Under the current rule, the minimum auto-execution 
threshold is 100 shares.\5\
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    \3\ 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).
    \4\ Article XX, Rule 37(b)(1).
    \5\ The CHX believes that it is important to note that under the 
current version of the CHX rules governing automatic execution, a 
CHX specialist is required to permit MAX system execution of an 
unlimited number of orders at the then-prevailing NBBO price, until 
the consolidated quotation stream reflects a change in the NBBO 
price. As a consequence, if a large number of orders are routed to 
the CHX specialist simultaneously, before the consolidated quotation 
is updated, the CHX specialist would be obligated to fill all of the 
orders at the NBBO price, despite the fact that the aggregate number 
of shares vastly exceeded the NBBO size. The CHX represents that 
this virtually unlimited liability is an unintended, and 
unwarranted, consequence of automatic execution guarantees like the 
Exchange's current rule.
    For example, if the national best bid (``NBB'') was 50 x 1000 
shares, the CHX specialist would be obligated to execute an 
unlimited number of customer sell orders at 50, as long as each 
order was 1000 shares or less in size, until the consolidated 
quotation information indicated a change in the NBB. Continuing this 
hypothetical example, assume that 200 sell orders, each for 100 
shares, were routed to the CHX before a change in the NBB to 49 one 
second later. Notwithstanding the one-second pendency of the 50 NBB, 
the CHX specialist would be obligated to buy 20,000 shares at 50, 
when such liquidity at that price was not truly present anywhere in 
the national market system. In today's decimal environment, such 
extraordinary results, which could not have been anticipated when 
the Exchange's automatic execution provisions were enacted, occur 
often.

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[[Page 32646]]

    If an order exceeds the specialist's auto-execution threshold, the 
order is automatically directed into the specialist's book for manual 
execution.\6\ Orders that are executed manually must be executed in 
accordance with CHX Article XX, Rule 37(a), commonly referred to as the 
``BEST Rule,'' which currently requires that manually executed orders 
be executed by the CHX specialist as principal at the NBBO or, if the 
CHX specialist elects to act as agent for the order, at the best 
available price in the marketplace.\7\
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    \6\ An exception to this general rule occurs if 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. 
See CHX Article XX, Rules 37(b)(6),(7).
    \7\ The CHX has filed a proposal to modify the BEST Rule's 
requirement that specialists, when acting as principal, manually-
execute orders at the NBBO. See SR-CHX-2004-03.
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    A number of the Exchange's specialist firms have developed and are 
implementing a remote pricing functionality (``RFP'') that permits 
their specialists to better respond to orders that are dropped for 
manual handling. This RFP functionality provides the MAX system with 
automated execution instructions for orders that otherwise would 
require the manual intervention of a CHX specialist.\8\ Of course, a 
specialist firm may also continue to act as agent for an order or 
manually execute orders using more manual processes.
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    \8\ The REP systems are proprietary to the specialist firms and 
are not facilities of the Exchange.
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Proposal

    The Exchange's current rule requires a minimum auto-execution 
threshold of 100 shares, thus ensuring that all 100-share orders are 
executed automatically by the MAX system. The CHX believes, however, 
that in many cases a CHX specialist might prefer to act as agent for 
the order or manually execute the order, rather than having the order 
(or a large number of 100-share orders) executed against him 
automatically at the NBBO. Accordingly, the Exchange proposes to 
eliminate the requirement of a 100-share minimum auto-execution 
threshold, so that a CHX specialist may use his or her discretion in 
determining how best to handle these 100-share orders.
    This change is principally intended to permit CHX specialists to 
utilize their RFP functionalities to price 100-share orders.\9\ 
Although the elimination of the 100-share minimum automatic execution 
threshold would also permit specialists to switch to manual execution 
mode on the CHX floor without using an RFP functionality, the Exchange 
does not anticipate that this would occur very often, if at all; in 
today's fast-paced trading environment, a specialist would not be able 
to manually manage his order flow for any sustained period of time.
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    \9\ CHX specialists believe that use of their RFP technology for 
100-share orders will, among other things, better enable them to 
address situations in which a co-specialist simultaneously receives 
a large number of 100-share orders.
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    Significantly, the Exchange represents that orders will continue to 
be subject to surveillance by the CHX Department of Market Regulation 
and members will remain subject to CHX rules relating to order 
execution requirements.
    The CHX would further note that in today's market environment, 
where specialists are required to make public their quality-of-
execution statistics and broker-dealers are bound as fiduciaries to 
make order-routing decisions in accordance with best execution 
practices, there exist sufficient market-based incentives for 
specialists to continue to provide execution prices and liquidity akin 
to the best available in the national market.\10\ The CHX believes that 
these incentives render a rule-based requirement largely obsolete, and 
amply support the rule change that the Exchange now proposes.
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    \10\ Specialists would of course remain free to increase their 
auto execution thresholds to larger sizes if they believe that 
business/marketing considerations so demand; in fact, a number of 
specialists have indicated that they would reduce their auto 
execution threshold below 100 shares only in very limited instances, 
or for the sole purpose of routing 100-share orders to their RFP 
functionalities.
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    The Exchange also is seeking to delete CHX Article XX, Rule 37, 
Interpretation and Policy .04, which currently governs the procedures 
by which specialists are to obtain permission to switch from automatic 
execution mode to manual execution mode. Because deletion of the 100-
share minimum automatic execution threshold would effectively permit 
CHX specialists to switch to manual execution mode, it is no longer 
necessary to include procedures for seeking floor official approval.
2. Statutory Basis
    The proposed rule 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) of the Act.\11\ In particular, the proposed rule is 
consistent with Section 6(b)(5) of the Act 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.\12\
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement of Burden on Competition

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

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 self-regulatory organization 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 proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-CHX-2004-02 on the subject line.

[[Page 32647]]

Paper Comments
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-CHX-2004-02. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal offices of the 
Amex. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-CHX-
2004-02 and should be submitted on or before July 1, 2004.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13086 Filed 6-9-04; 8:45 am]
BILLING CODE 8010-01-U