[Federal Register Volume 69, Number 137 (Monday, July 19, 2004)]
[Notices]
[Pages 43036-43042]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-16322]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50002; File No. SR-CHX-2004-11]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Stock Exchange, Inc. 
Relating to the Implementation of a Fully-Automated Electronic Book for 
the Display and Execution of Orders in Securities That Are Not Assigned 
to a Specialist

July 12, 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 20, 2004, the Chicago Stock Exchange, Inc. (``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 Exchange. On June 
18, 2004, the Exchange amended the proposed rule change.\3\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Ellen J. Neely, Senior Vice President and 
General Counsel, CHX, to Nancy J. Sanow, Assistant Director, 
Division of Market Regulation, Commission, dated June 17, 2004, and 
the attached Form 19b-4, which replaced the original filing in its 
entirety (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CHX proposes to implement a fully-automated electronic book for 
the display and execution of orders in securities that are not assigned 
to a specialist. Below is the text of the proposed rule change. 
Proposed new language is in italics; proposed deletions are in 
[brackets].
* * * * *

Article XXA

Operation of Electronic Book

    The electronic book is a fully-automated system operated by the 
Exchange, which allows eligible orders in eligible securities to match 
against one another.

Eligible Securities

    Rule 1. All securities eligible for trading on the Exchange that 
are not assigned to a specialist shall be eligible for trading through 
the electronic book. Any specialist request to remove a security from 
the electronic book shall be considered by the Committee on Specialist 
Assignment and Evaluation.

Eligible Orders

    Rule 2.(a) All orders sent to the electronic book must be round-lot 
limit orders, specifically designated in the manner specified by the 
Exchange to confirm that they are eligible for trading in the 
electronic book.
    (b) Eligible orders additionally may be designated as one of the 
following order types:
    (1) ``Immediate or cancel'': An order that is to be executed, 
either in whole or in part, as soon as the order is received by the 
electronic book, with any unexecuted balance of the order to be 
immediately cancelled.
    (2) ``Fill or kill'': an order that is to be executed in full as 
soon as the order is received by the electronic book, but that should 
be immediately cancelled if it is not executed.

[[Page 43037]]

    (3) ``Cross'': An order to buy and sell the same security at a 
specific price equal to or better than the NBBO and better than the 
best bid and offer displayed in the electronic book. A cross order may 
represent interest of one or more members of the Exchange.
    (4) ``Cross with size'': An order to buy and sell at least 25,000 
shares of the same security (A) at a price equal to or better than both 
the NBBO and the best bid or offer displayed in the electronic book; 
(B) where the size of the order is larger than the aggregate size of 
all interest displayed in the electronic book at that price; and (C) 
where neither side of the order is for the account of the CHX member 
sending the order to the electronic book.
    (c) Orders may be entered by a member on its own behalf (a 
proprietary or professional order) or for the account of a customer (an 
agency order). In the electronic book, however, agency orders are 
subject to the same display and execution processes as professional 
orders and agency orders do not receive any priority in order execution 
or handling.
    (d) In listed securities, an order is not eligible for execution in 
the electronic book if it crosses or locks the NBBO at the time that it 
is received, unless the order locks or crosses the BBO in the 
electronic book. An order in a listed security that locks or crosses 
the NBBO at the time it is received shall be immediately cancelled. An 
order in a listed security that locks or crosses the BBO in the 
electronic book shall be executed against orders in the electronic 
book, as set out in Rule 4(c), below; any remaining portion of the 
order shall be automatically cancelled, if it would lock or cross the 
NBBO.
    (e) All orders submitted to the electronic book are good for the 
day on which they are submitted only and shall be automatically 
cancelled at the end of each day's trading session.

Operating Hours

    Rule 3.(a) The electronic book will operate during the Exchange's 
Primary and Post-Primary Trading Sessions, as further described below.
    (b) The electronic book will accept orders each day once the 
primary market for a security opens its market on either a quote or a 
trade. For purposes of this rule, the primary market in a security is, 
unless otherwise designated by the Rules Subcommittee, the listing 
market for a security; provided, however, that if a security is traded 
by the NYSE, then the primary market for such security is the NYSE and 
if a security is traded by the Amex, then the primary market for such 
security is the Amex. If a security is traded on both the NYSE and the 
Amex, whichever of the two is the listing market is the primary market. 
If a security is listed on both the NYSE and Nasdaq, the NYSE will be 
considered the primary market.
    (c) The electronic book will close at 3:30 p.m. (Central Time).
    (d) The electronic book will not operate during regulatory halts 
called by the primary or listing market in a security, in accordance 
with rules set out in the appropriate transaction reporting plans. 
Additionally, the electronic book will halt its operation during 
periods of market volatility following the rules in Article IX, Rule 
10A.

Operation of the Electronic Book

    Rule 4. (a) Routing of orders. Orders shall be routed to the 
electronic book using one of the following methods:
    (1) Except for the orders described in paragraph (2) below, all 
orders must be sent to the electronic book through the Exchange's MAX 
system or through other communications lines approved by the Exchange 
for the delivery of orders by its members.
    (2) ITS commitments for ITS-eligible securities traded in the 
electronic book shall be sent through the ITS system. NASD market 
participants shall have direct telephonic access to the supervisory 
center for the Exchange's electronic book to enter orders in the 
electronic book, for the securities in which those participants are 
registered with NASD as market makers or as electronic communications 
networks/alternative trading systems.
    (b) Ranking and display of orders. All orders sent to the 
electronic book shall be ranked according to their price and time of 
receipt, as follows:
    (1) Limit orders shall be ranked based on their limit prices and 
times of receipt by the electronic book.
    (2) All orders shall be immediately and publicly displayed through 
the processes set out in the appropriate transaction reporting plan for 
each security when they constitute the best bid or offer in the 
electronic book for that security.
    (c) Automated matching of orders. Orders shall automatically match 
against each other, as follows:
    (1) Except for ``cross with size'' transactions, which shall be 
executed as described in Rule 2(b)(4), above, an incoming order shall 
be matched against one or more orders in the electronic book, in the 
order of their ranking, at the price of each order, for the full amount 
of shares available at that price, or for the size of the incoming 
order, if smaller.
    (2) If an incoming order cannot be matched when it is received and 
it is not designated as a type that should be immediately cancelled, 
the order shall be placed in the electronic book and ranked as 
described in Rule 4(b) above.
    (3) An inbound ITS commitment, if it is priced at the current BBO 
in the electronic book, shall be automatically matched against the 
order(s) reflected in the BBO, for the full amount of shares available 
at that price, and any remaining portion of the ITS commitment shall be 
automatically cancelled; provided, however, that the inbound ITS 
commitment shall be automatically cancelled if its execution would 
occur at a price worse than the NBBO. If an inbound ITS commitment to 
sell is priced, at the time it is received, lower than the best bid in 
the electronic book or an ITS commitment to buy is priced, at the time 
it is received, higher than the best offer in the electronic book, the 
ITS commitment shall be automatically cancelled.
    (4) In listed securities, orders shall only be matched at prices 
that are equal to, or better than, the NBBO.
    (d) Submission of cross or cross with size orders. Cross or cross 
with size orders shall be automatically executed if they meet the 
requirements set out in Rule 2(b)(3) and 2(b)(4) above. If an order 
designated as cross or cross with size does not meet the requirements 
for its designation at the time it is received by the electronic book, 
it shall be immediately cancelled.

Cancellation of Transactions

    Rule 5. A transaction made in demonstrable error and cancelled by 
both parties may be unwound, subject to the approval of the Exchange. 
Unresolved controversies relating to transactions that occur in the 
electronic book, and which are not addressed pursuant to the procedures 
in Rule 7, below, shall be subject to the arbitration rules of the 
Exchange set out in Article VIII, Rules 23 and 24.

Registration of Market Makers

    Rule 6. Upon application and approval by the Exchange, any Exchange 
floor member may register as a market maker in one or more of the 
securities traded in the electronic book. A market maker shall meet the 
following requirements and shall have the following obligations:
    (a) Registration. Applicants seeking to register as electronic book 
market makers must submit an application on the form(s) required by the 
Exchange.

[[Page 43038]]

The Committee on Floor Procedure shall consider each application, 
considering factors including, but not limited to, an applicant's 
financial and technical resources, trading experience, personnel and 
disciplinary history. The Committee shall approve or disapprove each 
application, providing written reasons for any disapproval. If an 
application is not approved, the applicant may obtain review of the 
decision by the Exchange's Executive Committee by filing a written 
request for review with the Secretary of the Exchange within five 
business days after being notified of the disapproval.
    (b) Obligations of a market maker. Each market maker must maintain 
a continuous, two-sided market in each of the securities in which he or 
she is registered.
    (c) Utilization of exempt credit. Exchange members registered as 
electronic book market makers are registered as dealers on the Exchange 
for purposes of the Securities Exchange Act of 1934 and the rules and 
regulations under that Act.
    (d) Suspension or termination of registration. The registration of 
a market maker may be suspended or terminated by the Committee on Floor 
Procedure based upon a finding that the market maker has not 
satisfactorily performed his or her responsibilities as defined in the 
federal securities laws and the rules of the Exchange. Proceedings to 
suspend or terminate the registration of a market maker shall be 
conducted in accordance with the procedures set out in Article XVII of 
the Exchange's Rules.

Handling of Clearly Erroneous Transactions

    Rule 7. The Exchange will respond to requests for review of clearly 
erroneous transactions using the following procedures:
    (a) The terms of a transaction are ``clearly erroneous'' where 
there is an obvious error in any term, such as price, number of shares 
or other unit of trading, or identification of the security.
    (b) Any member may request a review of an execution received 
through the electronic book when the member believes that the terms of 
the transaction were clearly erroneous when submitted.
    (1) The member must make a request for review by telephone 
immediately after the execution and also must provide a written 
request, by facsimile or by e-mail, within 15 minutes after the 
execution.
    (2) The Exchange shall promptly notify the other party to the 
transaction of the request for review.
    (3) The member making a request for review shall provide, within 30 
minutes after making the written request for review (or within such 
longer period of time specified by Exchange staff), written 
documentation relating to the disputed transaction that is reasonably 
necessary for use by the Exchange in resolving the matter. The other 
party to the transaction shall provide, within 30 minutes after 
receiving notice from the Exchange of the request for review (or within 
such longer period of time specified by Exchange staff), written 
documentation relating to the disputed transaction that is reasonably 
necessary for use by the Exchange in resolving the matter. Once a party 
has submitted its documentation, and the period for providing the 
documentation has ended (or, if earlier, the party has notified the 
Exchange that it has no further information), the party may not provide 
additional information unless requested to do so by Exchange staff. 
Either party to the transaction may request, and the Exchange shall 
provide, the written documentation submitted by the other party.
    (4) The Exchange, acting through one of its officers designated by 
the Chief Executive Officer, shall review the transaction and determine 
whether it is clearly erroneous. In making that determination, the 
officer shall consider the goals of maintaining a fair and orderly 
market and the protection of investors and the public interest.
    (c) If the Exchange officer determines that a transaction is not 
clearly erroneous, the officer shall notify both parties, in writing, 
that no action will be taken with respect to the completed trade. If 
the Exchange officer determines that a transaction is clearly 
erroneous, the officer shall declare the transaction null and void or 
modify one or more of the terms of the transaction with the aim of 
trying to return the parties to the positions that they would have been 
in (or to positions reasonably similar to those positions) if the error 
had not occurred. The officer shall document this decision in writing 
and provide copies of the decision to all parties.
    (d) Either party may appeal this determination to a subcommittee of 
the Exchange's Committee on Floor Procedure by submitting an appeal to 
the Exchange's Secretary, by facsimile or in writing, within 30 minutes 
after receiving the Exchange's written decision or, if the Exchange 
notifies parties of its decision after 3:00 p.m. (Central Time), by 
8:30 a.m. (Central Time), the next trading day. Once an appeal is 
received, the Exchange shall notify the counterparty to the trade and 
both parties and the Exchange itself will be permitted to submit any 
additional supporting written materials up to the time that the 
subcommittee considers the appeal. Either party to a disputed trade may 
request, and the Exchange shall provide, the written documentation 
presented to the subcommittee by the other party or by the Exchange. An 
appeal does not operate as a stay on the decision being appealed. After 
consideration of any written materials provided by the parties or by 
the Exchange, and after any hearings that the subcommittee may hold, 
the subcommittee, using the standards set out in this rule, shall 
affirm, modify or reverse the original decision. The subcommittee's 
decision on a matter may be appealed to the full Committee on Floor 
Procedure as set out in CHX Article IV, Rule 3, except that the appeal 
does not operate as a stay on the decision of the subcommittee. The 
decision of the Exchange's Committee on Floor Procedure shall be the 
final Exchange action on the matter. Any decision by an Exchange 
officer under section (c) above or by the Committee on Floor Procedure 
or any of its subcommittees under this section (d) shall be rendered 
without prejudice as to the rights of the parties to the transaction to 
submit their dispute to arbitration.
    (e) If there is any disruption or malfunction in the use or 
operation of the electronic book, or the communications systems 
associated with the electronic book, the Chief Executive Officer, or 
another officer designated by the Chief Executive Officer may declare 
any transaction arising out of the use of the electronic book during 
the period of the disruption or malfunction null and void or may modify 
the terms of these transactions. In making this decision, the Chief 
Executive Officer, or any designee, must find that the transactions 
were clearly erroneous or that the actions are necessary for the 
maintenance of a fair and orderly market or the protection of investors 
and the public interest. Absent extraordinary circumstances, any action 
by the Chief Executive Officer or other designee shall be taken within 
30 minutes of detection of the erroneous transaction, but in no event 
later than 2:00 p.m., Central Time, on the trading day following the 
date of the trade at issue. The Exchange shall notify each member 
involved in the transaction as soon as practicable following the 
decision and any party to the transaction may appeal that decision by 
following the procedures set out above in section (d) of this rule.

Application of CHX Rules

    Rule 8. The rules and procedures in this Article shall apply to 
trading conducted in the electronic book.

[[Page 43039]]

Unless otherwise defined in this Article, terms used in this Article 
shall have the same meanings given them elsewhere in the Rules. Except 
where the context requires otherwise, the provisions of the 
Constitution and all other Rules and policies of the Board of Governors 
shall continue to be applicable to trading that occurs in the 
electronic book. If any rule in this Article is inconsistent with any 
other provision of the Rules, the provisions of this Article shall 
control and shall be deemed to supplement or amend the inconsistent 
provision.
* * * * *

Article XII--Discipline and Trial Proceedings

* * * * *
Minor Rule Violations
    Rule 9.
    (a) No change to text.
    (b) No change to text.
    (c) No change to text.
    (d) No change to text.
    (e) No change to text.
    (f) No change to text.
    (g) No change to text.
    (h) Exchange Rules and Policies subject to the Minor Rule Violation 
Plan:
(i) Reporting and Record Retention Violations
* * * * *
(ii) Floor Decorum and Minor Trading Rule Violations
    (1)-(10) No change to text.
    (11) [Failure to comply with Cabinet Securities Provision (Article 
XX, Rule 11)] Reserved for future use.
* * * * *

ARTICLE XX

* * * * *
[Cabinet Securities]
    Rule 11. Reserved for future use. [Stocks having no designated 
specialist unit of trading shall be assigned for dealings by use of 
cabinets and shall be dealt in at a location designated for that 
purpose.]
    [The Exchange may also designate bonds which are to be dealt in by 
use of cabinets.]
    [Bids and offers in securities dealt in by use of cabinets shall be 
written on cards, which shall be filed in the cabinets in the following 
sequence:]
    [1. According to price; and]
    [2. According to the time received at the cabinet.]
    [Orders in such securities shall be filled according to the bids 
and offers filed in the cabinets, in the sequence indicated above, 
except that oral bids and offers in such securities may be made if not 
in conflict with bids and offers in the cabinets. Oral bids and offers 
may be made by clearing the cabinet post by phone provided that such 
bids and offers are audibly announced at the cabinet post through a 
speaker system maintained by the Exchange.]
    [Every card placed in the cabinets shall bear a definite price and 
number of shares and no mark or identification shall be placed thereon 
to indicate it is other than a limited order at the price.]
* * * * *

ARTICLE XXVIII--Listed Securities

* * * * *
[Cabinet System]
    Rule 6. Reserved for future use. [The Board of Governors may 
designate to be traded in the cabinet system those securities which in 
the judgment of the Board do not trade with sufficient frequency to 
warrant their retention in the specialist system and may place 
securities in the cabinet system on the unrestricted list. Securities 
on the unrestricted list may thereafter, until removed from the 
unrestricted list, be traded off the Floor of the Exchange without 
special permission from the Exchange.]
* * * * *

ARTICLE XXXIV--Registered Market Makers--Equity Floor

* * * * *
Assigned Securities
    Rule 3. A registered market maker shall engage to a reasonable 
degree under existing circumstances in a course of dealing in the 
securities to which he is assigned that is reasonably calculated to 
contribute to the maintenance of a fair and orderly market. The Floor 
Procedure Committee (or other committee appointed for the purpose by 
the Board) shall specify the percentage of the shares purchased and 
sold by a registered market maker that must be of securities to which 
he is assigned.
    * * * Interpretations and Policies:
    .01 No change to text.

    [.02 The Committee on Floor Procedure has approved a program which 
provides for the dissemination of continuous two-sided quotations by 
Market Makers in those issues lacking a registered specialist (Cabinet 
Issues). In discussing the implementation of the program, the Committee 
recognized that definitive procedures must be set forth in order to 
avoid any misunderstanding concerning this program and current Cabinet 
System policy. The Committee wishes to make it clear that the program 
is open to all floor members who are interested in seeing all Exchange 
issues quoted. The Committee retains the right to review the program on 
an ongoing basis.]
    [The procedures and policies relative to this program are as 
follows:]
    [1. A Market Maker who agrees to disseminate a continuous two-sided 
quotation in a Cabinet System Issues will be considered the ``Post'' in 
the issue.]
    [2. The ``Post'' classification carries with it the obligation to 
accept and reflect all orders which qualify for entry on a ``Post 
Protection'' basis.]
    [3. The subject issues are no longer classified as Cabinet System 
issues.]
    [4. All current rules and policies in effect relative to clearing 
the Post apply with equal force with respect to the subject issues.]
    [5. Limit orders will be handled under the same guidelines which 
apply to the handling of such orders by Specialists except for 
application of the Best requirement which is limited to 100 shares.]
    [6. The designation of ``Lead'' or ``Primary'' Market Maker will be 
assigned to the first Market Maker in a given Cabinet System issue who 
is willing to abide by the dictates of this program.]
    [7. The Lead or Primary Market Maker, as the repository for limit 
orders in the subject issues, will be responsible for lodging all 
applicable Trade Through complaints against other ITS Participants.]
* * * * *

Membership Dues and Fees

    A.-L. No change to text.
    M. Credits
    1. Specialist Credits--No change to text
    2. Floor Broker Credits--No change to text.
    [3. Credits for Qualified Market Makers Registered in Cabinet 
Securities]
    [Effective July 1, 2002, total monthly fees owed by a market maker 
registered in a cabinet security will be reduced (and qualified market 
makers will be paid each month for any unused credits) by a Transaction 
Credit.]
    [``Transaction Credit'' when used in connection with a credit for a 
Qualified Market Maker registered in a cabinet security means 18% of 
the monthly CHX tape revenue from the Consolidated Tape Association 
(less all direct CTA costs) generated by the security in which the 
market maker is registered. To the extent that CHX tape revenue is 
subject to a year-end

[[Page 43040]]

adjustment, market maker credits may be adjusted accordingly.]
    [``Qualified Market Maker'' means a lead market maker who is 
registered as such in 100 or more cabinet securities.]
* * * * *

Minor Rule Violation Plan Recommended Fine Schedule

(Pursuant to Article XII, Rule 9(e))
* * * * *
    [Failure to comply with Cabinet Securities
    Provision: $100.00, $500.00, $1,000.00]
* * * * *

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. 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 implement a fully-automated electronic 
book for the display and execution of orders in securities that are not 
assigned to a specialist. Under the Exchange's current rules, 
securities that are not assigned to a specialist currently are traded 
in two ways: (1) Securities can be placed in the cabinet; \4\ or (2) 
securities can be removed from the cabinet and assigned to a lead 
market maker for trading.\5\ According to the Exchange, the procedures 
associated with the trading of these products are quite manual. For 
example, the Exchange maintains a physical location, known as the 
cabinet, at which written information is manually maintained regarding 
existing bids, offers and orders for each cabinet security. These 
orders are filled manually and each transaction is recorded on a 
written trade ticket before being entered into the Exchange's systems 
for public dissemination. Securities that are assigned to lead market 
makers are subject to similar manual procedures, quite like those for 
cabinet securities, except that these orders are also entered into the 
Exchange's systems so that they can be automatically quoted.
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    \4\ See CHX Article XX, Rule 11.
    \5\ See CHX Article XXXIV, Rule 3, Interpretation and Policy 
.02. Among other things, market makers assigned to these former 
cabinet securities are required to engage, to a reasonable degree 
under existing circumstances, in a course of dealing that is 
reasonably calculated to contribute to the maintenance of a fair and 
orderly market.
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    The Exchange believes that these antiquated manual procedures are 
an extraordinarily inefficient way to trade securities that are not 
assigned to a specialist. As a result, the Exchange now proposes to 
replace these procedures with a new fully-automated electronic book 
that would display and match eligible limit orders in these securities, 
without the participation of a specialist or lead market maker. As 
described below, this new electronic book would allow the Exchange's 
members, whether or not they are on the Exchange's floor, to enter 
orders into an automated matching system operated by the Exchange for 
possible execution.
    Eligible securities and eligible orders. Under the proposed rules, 
all securities eligible for trading on the Exchange that are not 
assigned to a specialist would be traded in the electronic book. Orders 
sent to the electronic book would be required to be specifically 
designated for handling in the electronic book.\6\ The electronic book 
would accept only round-lot limit orders that are good for the day on 
which they are submitted.\7\ No odd-lot orders or good-till-cancelled 
orders would be accepted.
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    \6\ See Proposed CHX Article XXA, Rule 2 (requiring orders to be 
specifically designated, in the manner specified by the Exchange, to 
confirm that they are eligible for trading in the electronic book).
    \7\ See Proposed CHX Article XXA, Rule 2.
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    Orders could be designated as ``immediate or cancel'' or ``fill or 
kill'' orders to ensure that they are immediately filled or 
cancelled.\8\ Orders could also be designated as ``cross'' or ``cross 
with size'' to permit the handling of orders to buy and sell the same 
security.\9\ Orders could not be designated with any other conditions.
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    \8\ An immediate or cancel order would be executed, in whole or 
in part, as soon as it is received by the electronic book; if 
execution is not possible, or if only a partial execution is 
possible, any unexecuted balance of the order would be immediately 
cancelled. A fill or kill order would be executed in full as soon as 
it is received; if execution is not possible, the entire order would 
be immediately cancelled. See Proposed CHX Article XXA, Rule 2(b)(1) 
and (2).
    \9\ A ``cross'' order would be an order to buy and sell the same 
security at a specific price that is equal to or better than the 
National Best Bid or Offer (``NBBO'') and better than the best bid 
and offer displayed in the electronic book. A ``cross with size'' 
order would be an order to buy and sell at least 25,000 shares of 
the same security (a) at a price equal to or better than both the 
NBBO and the best bid or offer (``BBO'') displayed in the electronic 
book; (b) where the size of the order is larger than the aggregate 
size of all interest displayed in the electronic book at that price; 
and (c) where neither side of the order is for the account of the 
CHX member sending the order to the electronic book. These 
definitions are substantially similar to the descriptions of the 
types of cross transactions that can occur today on the Exchange's 
floor without interference from the trading crowd. See CHX Article 
XX, Rule 23. Because there would not be a trading crowd operating in 
connection with the electronic book, however, the Exchange has not 
incorporated other aspects of its existing crossing rules, such as 
the requirement for asking the crowd for a market before executing a 
crossing transaction between the quoted market. Similarly, because 
there would not be a trading crowd or specialist's post in these 
issues, the Exchange has not incorporated rules relating to 
instances where a specialist or other floor member can break up the 
crossing transaction by providing an improved price to one side of 
the proposed trade. In the electronic book, all bids and offers 
would be reflected in the book itself--there would be no on-floor 
auction market trading in these issues.
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    In addition, otherwise eligible orders would be cancelled in 
certain circumstances, to ensure compliance with applicable intermarket 
trading rules. For example, if an order in a listed security crosses or 
locks the NBBO at the time that it is received, the order would be 
immediately cancelled to ensure compliance with the Intermarket Trading 
System (``ITS'') Plan's rules relating to locked markets.\10\
    Operating hours. Under the proposed rules, the electronic book 
would operate during the Exchange's Primary Trading Session and its 
Post-Primary Trading Session.\11\ Specifically, the electronic book 
would accept orders on each day for a particular security once the 
primary market in that security opens on a quote or a trade.\12\ The 
electronic book would close at 3:30 p.m. (central

[[Page 43041]]

time), and all unexecuted orders would be automatically cancelled.
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    \10\ Similarly, if an order in a listed security locks or 
crosses the BBO in the electronic book at the time it is received, 
but not the NBBO, the order would be executed according to the 
electronic book's matching algorithm, and any remaining portion 
would be immediately cancelled, if it would lock or cross the NBBO.
    \11\ The Exchange's Primary Trading Session is open, for a 
particular security, during the same times that such security is 
traded on its primary market (e.g., 8:30 to 3 p.m. central time, for 
most securities). The Exchange's Post-Primary Trading Session 
operates until 3:30 p.m. See CHX Article IX, Rule 10(b).
    \12\ The proposed rules define the primary market as the listing 
market for a security, unless otherwise designated by the Rules 
Subcommittee; provided, however, that if a security is traded by the 
New York Stock Exchange, Inc. (``NYSE''), then the primary market 
for such security would be the NYSE and if a security is traded by 
the American Stock Exchange LLC (``Amex''), then the primary market 
for such security would be the Amex. If a security is traded on both 
the NYSE and the Amex, whichever of the two is the listing market 
would be considered the primary market. If a security is listed on 
both the NYSE and The Nasdaq Stock Market, Inc. (``Nasdaq''), the 
NYSE would be considered the primary market. See Proposed CHX 
Article XXA, Rule 3(b).
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    Routing of orders. Orders could be sent to the electronic book 
through the Exchange's MAX system or through any other communications 
lines approved by the Exchange for the delivery of orders by Exchange 
members.\13\ The Exchange anticipates that all CHX members--whether 
they are located on the Exchange's trading floor or off the floor--
would be able to receive access to the electronic book. The electronic 
book would also accept and automatically execute commitments sent by 
market centers that participate in the ITS. National Association of 
Securities Dealers, Inc. (``NASD'') market participants would have 
direct telephone access to the supervisory center for the electronic 
book to enter orders, as required by the OTC/UTP Plan.\14\
    Ranking and display of orders. All orders received by the 
electronic book would be ranked according to their price and time of 
receipt and would be displayed to the public when they constitute the 
BBO in the electronic book for a security.\15\ The Exchange initially 
plans to disseminate these best bids and offers through the systems 
used for that purpose today--through the CTA/CQ Plan for listed 
securities, and through the OTC/UTP Plan for Nasdaq/NM securities.
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    \13\ See Proposed CHX Article XXA, Rule 4(a)(1).
    \14\ See CHX Article XX, Rule 43.
    \15\ See CHX Proposed Article XXA, Rule 4(b).
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    Automated matching of orders. In the electronic book, orders would 
automatically match against each other, in price/time priority.\16\ 
Specifically, an incoming order would be matched against one or more 
orders in the electronic book, in the order of their ranking, at the 
price of each order, for the full amount of shares available at that 
price, or for the size of the incoming order, if smaller. If an 
incoming order could not be matched when it is received, and it is not 
designated as an order that should be immediately cancelled, the order 
would be placed in the electronic book. For example:
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    \16\ The only exception to this price/time priority matching 
would occur when certain ``cross with size'' orders are executed. In 
those instances, eligible ``cross with size'' transactions--where 
there is an order to buy and sell at least 25,000 shares of the same 
security (A) at a price equal to or better than both the NBBO and 
the BBO displayed in the electronic book; (B) where the size of the 
order is larger than the aggregate size of all interest displayed in 
the electronic book at that price; and (C) where neither side of the 
order is for the account of the CHX member sending the order to the 
electronic book--could execute at the price of orders in the 
electronic book, without executing those earlier-received orders. 
Because this type of crossing transaction is permitted on the floor 
of the Exchange today, the Exchange believes it is appropriate to 
include this transaction type in the fully-automated electronic 
book.
---------------------------------------------------------------------------

    Assume that the electronic book contains the following bids and 
offers in a particular security, FAA:

----------------------------------------------------------------------------------------------------------------
                               Buy                                     Price           Price           Sell
----------------------------------------------------------------------------------------------------------------
200.............................................................          $47.50          $48.20             400
1,500...........................................................           47.00           48.50             700
600.............................................................           46.75           49.00             100
-----------------------------------------------------------------
--An incoming limit order to buy 500 shares at a price of $48.00 would become the top-of-the-book best bid......
--An incoming limit order to buy 500 shares at a price of $48.20 would match for 400 shares against the top-of-
 the-book best offer at a price of $48.200, leaving 100 shares to buy at $48.20.................................
--Similarly, an incoming limit order to buy 500 shares at a price of $48.50 would match for 400 shares against
 the top-of-the-book best offer at a price of $48.20 and would match for 100 shares at a price of $48.50........
----------------------------------------------------------------------------------------------------------------

    Inbound ITS commitments would be automatically matched against the 
order(s) reflected in the electronic book's BBO for the full amount of 
shares at that price, and any remaining portion of the ITS commitment 
would be automatically cancelled. An ITS commitment, however, would be 
automatically cancelled if its execution would occur at a price worse 
than the NBBO or if it is hypermarketable at the time it is 
received.\17\ Importantly, to ensure that the electronic book does not 
trade through another market in violation of the ITS Plan's trade-
through provisions, orders in listed securities would only be matched 
at prices that are equal to, or better than, the NBBO.
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    \17\ In other words, if an inbound ITS commitment to sell is 
priced, at the time it is received, lower than the best bid in the 
electronic book, or an ITS commitment to buy is priced, at the time 
it is received, higher than the best offer in the electronic book, 
the ITS commitment would be automatically cancelled.
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    Cross or cross with size orders would be automatically executed if 
they meet the requirements for those types of orders. If they do not 
meet applicable requirements, they would be immediately cancelled.
    No distinction between agency and professional orders. Under the 
proposed rules, agency orders (entered on behalf of a customer) and 
professional or proprietary orders (entered for the account of a CHX 
member or other broker-dealer) would be handled in an identical way in 
the electronic book's matching algorithms.\18\
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    \18\ The Exchange believes that this handling is appropriate 
because the electronic book is a fully-automated functionality of 
the Exchange. Orders for the electronic book would be submitted 
directly and electronically to the Exchange. Once transmitted, an 
order could be cancelled, but a member could not influence the 
execution of that order in any way. The orders would enter a line of 
other orders to be matched against one another based on an 
established algorithm.
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    Cancellations of transactions and handling of clearly erroneous 
transactions. Under the proposed rules, members that make a transaction 
in demonstrable error could agree to cancel and unwind the transaction, 
subject to the approval of the Exchange.\19\ For purposes of the 
electronic book, the Exchange also proposes to adopt a policy for the 
handling of clearly erroneous transactions.\20\ This policy would allow 
the Exchange to (a) review, and potentially modify or cancel, 
executions where one party believes that the terms of the transaction 
were clearly erroneous when submitted; and (b) modify or cancel 
executions that result from a disruption or malfunction in the use or 
operation of the electronic book, or any communications system 
associated with the electronic book. The proposed rules set out 
procedures for each of these reviews, including specific means for 
members to appeal the Exchange's decisions.\21\
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    \19\ See Proposed CHX Article XXA, Rule 5.
    \20\ See Proposed CHX Article XXA, Rule 7.
    \21\ For example, a member seeking review of a ``clearly 
erroneous'' transaction would be required to notify the Exchange of 
the request, by telephone and in writing, promptly after the 
execution. After reviewing the transaction, an Exchange official 
would notify both parties of his or her decision, in writing; either 
party could appeal the decision to a subcommittee of the Exchange's 
Committee on Floor Procedure and, if not satisfied, to the full 
Committee on Floor Procedure. In making his or her decision, the 
Exchange official would consider the goals of maintaining a fair and 
orderly market and protecting investors and the public interest. If 
an Exchange official determines that a transaction was clearly 
erroneous, he or she would try to return the parties to the 
positions that they would have been in (or positions reasonably 
similar to those positions) if the error had not occurred. 
Similarly, in the event of disruption or malfunction that impacts 
the operation or use of the electronic book, an Exchange official 
could act promptly to declare transactions void or to modify 
transactions. The official would be required to notify each member 
involved in the transaction as soon as practicable after making any 
decision. Decisions could be appealed using the procedure set out 
for the review of decisions addressing clearly erroneous 
transactions.

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[[Page 43042]]

    Registration of market makers. Under the proposal, Exchange members 
could seek registration as market makers in one or more of the 
securities traded in the electronic book. A market maker would be 
required to maintain a continuous two-sided market in each security in 
which he or she is registered and would be entitled to utilize exempt 
credit for financing their market maker transactions. The proposed 
rules would set out a process for market makers to apply for this 
registration and for the suspension or termination of their 
registrations, where appropriate.\22\
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    \22\ See Proposed CHX Article XXA, Rules 6(a) and (d).
---------------------------------------------------------------------------

    Additional changes to rules. Because this proposal is designed to 
replace the Exchange's existing cabinet security and lead market maker 
systems, this submission also contains proposed changes to various 
rules associated with those trading systems.\23\
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    \23\ See proposed changes to CHX Article XII, Rule 9 (deleting 
the cabinet securities rule from the Minor Rule Violation Plan 
(``MRVP'')); CHX Article XX, Rule 11 (deleting the cabinet 
securities rule); CHX Article XXVIII, Rule 6 (deleting the rule 
permitting the Board of Governors to place securities in the 
cabinet); CHX Article XXXIV, Rule 3 (deleting the interpretation 
that creates the lead market maker program); and Schedule of 
Membership Dues and Fees (deleting the lead market maker credits and 
the recommended MRVP fines for violations of the cabinet system 
rule).
---------------------------------------------------------------------------

    The Exchange represents that it has designed this electronic book 
to be a fully-automated system that would permit eligible orders in 
eligible securities to match against one another, without the required 
participation of a specialist or lead market maker. The Exchange 
believes that this system functionality would provide all Exchange 
members with an efficient way to trade securities that are not assigned 
to a specialist and would protect investors and the public interest by 
automatically handling orders in a fair and reasonable manner.
2. Statutory Basis
    The Exchange believes that the proposed rule change, as amended, is 
consistent with Section 6(b) of the Act \24\ in general, and furthers 
the objectives of Section 6(b)(5) of the Act \25\ in particular, 
because it is designed to promote just and equitable principles of 
trade, to remove impediments to and 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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    \24\ 15 U.S.C. 78(f)(b).
    \25\ 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, as 
amended, will impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

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

    The Exchange has neither solicited nor received written comments on 
the proposed rule change, as amended.

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 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-2004-11 on the subject line.

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-2004-11. 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 office of the CHX. 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-2004-11 and should be 
submitted on or before August 9, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-16322 Filed 7-16-04; 8:45 am]
BILLING CODE 8010-01-P