[Federal Register Volume 69, Number 194 (Thursday, October 7, 2004)]
[Notices]
[Pages 60197-60200]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2527]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50481; File No. SR-CHX-2004-12]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1 Thereto and Notice of Filing and Order 
Granting Accelerated Approval of Amendments No. 2 and 3 to the Proposed 
Rule Change by the Chicago Stock Exchange, Inc. Relating to the 
Implementation of a Fully-Automated Functionality for the Handling of 
Particular Orders Called CHXpress

September 30, 2004.

I. Introduction

    On February 20, 2004, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``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 amend CHX Article XX, Rule 37 to implement a 
new automated functionality for handling particular orders called 
CHXpress. On April 8, 2004, the Exchange amended the proposed rule 
change.\3\ The proposed rule change, as amended by Amendment No. 1, was 
published for comment in the Federal Register on April 21, 2004.\4\ The 
Commission received no comments on the proposed rule change, as 
amended. On May 11, 2004 and August 23, 2004, the Exchange filed 
Amendments No. 2 and 3 to the proposed rule change, respectively.\5\

[[Page 60198]]

This order approves the proposed rule change, as amended, grants 
accelerated approval to Amendments No. 2 and 3, and solicits comments 
from interested persons on Amendments No. 2 and 3.
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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 (``Division''), Commission, dated 
April 7, 2004, and the attached Form 19b-4, which replaced the 
original filing in its entirety (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 49567 (April 15, 
2004), 69 FR 21591.
    \5\ See letters from Ellen J. Neely, Senior Vice President and 
General Counsel, CHX, to Nancy J. Sanow, Assistant Director, 
Division, Commission, dated May 10, 2004 (``Amendment No. 2'') and 
August 20, 2004 (``Amendment No. 3''). In Amendment No. 2, the 
Exchange made technical corrections to the text of the proposed rule 
change. In Amendment No. 3, the Exchange changed the designator that 
would identify CHXpress orders in the Exchange's MAX system from 
``E'' to ``XPR,'' provided additional detail regarding the handling 
of CHXpress orders during a trading halt, and confirmed that the 
Exchange would automatically cancel both inbound orders and orders 
already in the book, if the execution of the order would improperly 
trade through another Intermarket Trading System (``ITS'') market or 
if the display of the order would improperly lock or cross another 
ITS market.
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II. Description of the Proposed Rule Change

    The Exchange proposes to implement a new automated functionality 
built into the Exchange's MAX[supreg] system called CHXpress for 
certain orders.\6\ Under the proposal, only unconditional, round-lot 
limit orders could be designated as CHXpress orders.\7\ CHXpress orders 
could be submitted in an issue only after an order has been executed on 
the primary market in that issue and would be automatically cancelled 
at the end of each trading day, if they remain unexecuted.\8\
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    \6\ The MAX system provides automated display and execution for 
orders sent to the Exchange's specialists for execution.
    \7\ See CHX Article XX, Rule 37(b), proposed section 11(A).
    \8\ Id.
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    CHXpress orders could be routed into the MAX system by the 
Exchange's order-sending firms or by CHX floor brokers. All orders 
would be required to be specifically designated as CHXpress orders to 
ensure appropriate handling in the Exchange's automated systems.\9\ 
Under the proposal, CHXpress orders would be executed immediately and 
automatically against same or better-priced orders in the specialist's 
book, or against the specialist, unless those executions would trade 
through another ITS market or unless trading in the issue has been 
halted.\10\
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    \9\ See CHX Article XX, Rule 37(b), proposed section 11(A), and 
Amendment No. 3, supra note 5.
    \10\ If the execution of a CHXpress order would cause an 
improper trade-through of another ITS market, the CHXpress order 
would be automatically cancelled. See CHX Article XX, Rule 37(b), 
proposed section (11)(C), and Amendment No. 3, supra note 5. If 
trading in an issue has been halted, all CHXpress orders in that 
issue would be automatically cancelled. The Exchange would not 
accept any CHXpress orders in an issue during a trading halt and 
would not resume accepting such orders until an execution has 
occurred in the primary market. Id.
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    If a CHXpress order could not be immediately executed, it would be 
placed in the specialist's book for instantaneous display or later 
execution.\11\ However, CHXpress orders, like all other orders at the 
Exchange, would not be eligible for automated display if that display 
would improperly lock or cross another ITS market.\12\ In such 
instances, the CHXpress order would be automatically cancelled.
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    \11\ A CHXpress order would be instantaneously and automatically 
displayed when it constitutes the best bid or offer in the CHX book. 
See CHX Article XX, Rule 37(b), proposed section 11(D).
    \12\ The Exchange's MAX system does not permit the automatic 
display of any order greater than 100 shares where that order would 
lock or cross another ITS market.
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    Finally, under the proposed rules, CHXpress orders would be 
primarily designed to match against orders in the specialist's 
book.\13\ As a result, CHX specialists would not provide CHXpress 
orders with the execution guarantees that might otherwise be available 
to agency limit orders.\14\ Specifically, these orders would not be 
eligible for automated price improvement, or execution based on quotes 
in the national market system or prints in the primary market for a 
security.\15\ CHX specialists also would not act as agent for the 
orders in other markets. CHX specialists, however, would be required to 
integrate their handling of CHXpress orders with any executions that 
occur at the post with floor brokers or market makers.\16\
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    \13\ A specialist could participate in filling a CHXpress order, 
but could not do so if that execution would cause the specialist to 
trade ahead of any other order in the book.
    \14\ See CHX Article XX, Rule 37(b), proposed sections 11(E) and 
(F).
    \15\ Under the Exchange's existing rules, a specialist can 
engage an automated functionality in the MAX system to provide price 
improvement to eligible agency orders and can use automated 
functionalities to provide agency orders with protection against 
trades in the primary market for both listed and Nasdaq/NM 
securities. See CHX Article XX, Rule 37(d) (describing the SuperMAX 
price improvement functionality) and Rule 37(a)(3) (setting out the 
limit order protections otherwise guaranteed to limit orders, such 
as protections against primary market trades at or through a limit 
order's price).
    \16\ For example, if the specialist is in the process of 
manually executing an order on the floor at the displayed bid, and a 
CHXpress order automatically executes against that bid before the 
specialist is able to complete the transaction on the floor, the 
specialist would still be required to honor the trade on the floor 
at the displayed bid price, even if that displayed interest is no 
longer available. See CHX Article XX, Rule 37(b), proposed section 
11(G).
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\17\ In particular, the Commission finds that the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act \18\ in that 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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    \17\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \18\ 15 U.S.C. 78f(b)(5).
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    As noted by the Exchange, CHXpress orders will automatically and 
immediately execute against orders in the specialist's book or against 
the specialist unless the execution would cause a trade through of 
another ITS market or trading has been halted in the particular 
security. The Commission believes that this new automatic execution 
system should provide investors with an efficient mechanism by which to 
immediately interact with the Exchange's quote and allow investors to 
immediately access liquidity on the Exchange.
    Moreover, the Commission believes that the proposal, as amended, 
will provide investors with additional order routing capabilities that 
may enhance the execution of their orders. The proposal provides a new 
execution facility in addition to the current execution facilities on 
the CHX. Investors will be able to choose a more immediate execution 
that will not provide them with price improvement opportunities on 
CHXpress or choose to direct their order to the current CHX BEST or MAX 
system for price improvement opportunities. The Commission finds that 
allowing the automatic execution of CHXpress orders against orders in 
the specialist's book will help to perfect the mechanism of a free and 
open market by providing an execution vehicle for investors who value 
immediate and automatic access to available liquidity at the Exchange 
more than the opportunity for price improvement.\19\
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    \19\ The Commission notes, however, that while it believes that 
the proposed rule change, as amended, is consistent with the 
requirements of the Act, the Commission is not making a 
determination that the CHX's automatic execution capabilities would 
satisfy the ``automated order execution facility'' definition in 
Rule 600(b)(3) of proposed Regulation NMS. See Securities Exchange 
Act Release No. 49325 (February 26, 2004), 69 FR 11126 at 11203 
(March 9, 2004). See also Securities Exchange Act Release No. 49749 
(May 20, 2004), 69 FR 30142 (May 26, 2004).
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    Furthermore, the Commission believes that the Exchange's proposal 
to automatically cancel and not accept any CHXpress orders in an issue 
during a trading halt, and cancel both inbound

[[Page 60199]]

orders and orders already in the book if the execution of the order 
would improperly trade through another ITS market will protect 
investors and promote the fair and orderly operation of the markets. 
Specifically, the Commission believes these proposed rules will 
increase the efficiency of the Exchange's order routing and execution 
system and enable market participants to make informed order entry 
decisions based on current, disseminated information regarding the 
issue.

Application of ``Effect v. Execute'' Exemption From Section 11(a) of 
the Act

    Section 11(a) of the Act \20\ prohibits a member of a national 
securities exchange from effecting transactions on that exchange for 
its own account, the account of an associated person, or an account 
over which it or its associated person exercises discretion 
(collectively, ``covered accounts'') unless an exception applies. In 
addition to the exceptions set forth in the statute, Rule 11a2-2(T) 
\21\ provides exchange members with an exemption from this prohibition. 
Known as the ``effect versus execute'' rule, Rule 11a2-2(T) permits an 
exchange member, subject to certain conditions, to effect transactions 
for covered accounts by arranging for an unaffiliated member to execute 
the transactions on the exchange. To comply with the rule's conditions, 
a member: (i) Must transmit the order from off the exchange floor; (ii) 
may not participate in the execution of the transaction once it has 
been transmitted to the member performing the execution; \22\ (iii) may 
not be affiliated with the executing member; and (iv) with respect to 
an account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in the 
connection with effecting the transaction except as provided in the 
Rule.
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    \20\ 15 U.S.C. 78k(a).
    \21\ 17 CFR 240.11a2-2(T).
    \22\ The member, however, may participate in clearing and 
settling the transaction.
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    In a letter dated July 6, 2004,\23\ the CHX represents that 
transactions effected using the CHXpress functionality satisfy the 
conditions of Rule 11a2-2(T). Based on these representations, the 
Commission finds that the CHXpress functionality complies with the 
requirements of Section 11(a) of the Exchange Act and Rule 11a2-2(T) 
thereunder.\24\
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    \23\ See letter from Ellen J. Neely, Senior Vice President and 
General Counsel, CHX, to Katherine England, Assistant Director, 
Division, Commission, dated July 6, 2004.
    \24\ The Commission and its staff, on numerous occasions, have 
considered the application of Rule 11a2-2(T) to electronic trading 
and order routing systems. See, e.g., Securities Exchange Act 
Release Nos. 49068 (January 13, 2004) (Order approving the Boston 
Options Exchange as an options trading facility of the Boston Stock 
Exchange); 44983 (October 25, 2001) (Order approving the Archipelago 
Exchange as the equities trading facility of PCX Equities Inc.); 
29237 (May 31, 1991) (regarding NYSE's Off-Hours Trading Facility); 
15533 (January 29, 1979) (regarding the Amex Post Execution 
Reporting System, the Amex Switching System, the Intermarket Trading 
System, the Multiple Dealer Trading Facility of the Cincinnati Stock 
Exchange, the PCX's Communications and Execution System, and the 
Phlx's Automated Communications and Execution System); and 14563 
(March 14, 1978) (regarding the NYSE's Designated Order Turnaround 
System). See also letter from Larry E. Bergmann, Senior Associate 
Director, Division, Commission, to Edith Hallahan, Associate General 
Counsel, Phlx (March 24, 1999) (regarding Phlx's VWAP Trading 
System); letter from Catherine McGuire, Chief Counsel, Division, 
Commission, to David E. Rosedahl, PCX (November 30, 1998) (regarding 
Optimark); and letter from Brandon Becker, Director, Division, 
Commission, to George T. Simon, Foley & Lardner (November 30, 1994) 
(regarding Chicago Match).
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    First, according to the CHX, all CHXpress orders would be 
electronically submitted either by members from locations off the 
exchange floor or by floor brokers located on the Exchange floor for 
the accounts of off-floor members. Specifically, floor brokers may 
receive an order, by telephone, from an off-floor member not affiliated 
with the floor broker. Thereafter, the floor broker may decide that it 
would be best to execute all or a portion of the off-floor member's 
order in CHXpress. Accordingly, because the off-floor member submitted 
its order to an unaffiliated floor broker on the floor from off the 
Exchange floor, the Commission believes that it has satisfied the off-
floor transmission requirement. Second, because a member would 
relinquish control of its order after it is submitted to CHXpress and 
would not be able to influence or guide the execution of its order, the 
member would not be participating in the execution of its order. Third, 
although the rule contemplates having an order executed by an exchange 
member who is not affiliated with the member initiating the order, the 
Commission recognizes that this requirement is satisfied when automated 
exchange facilities are used.\25\ Fourth, the CHX states that members 
that rely on Rule 11a2-2(T) for a managed account transaction would be 
required to comply with the limitations on compensation set forth in 
the rule.
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    \25\ In considering the operation of automated execution systems 
operated by an exchange, the Commission noted that while there is no 
independent executing exchange member, the execution of an order is 
automatic once it has been transmitted into the systems. Because the 
design of these systems ensures that members do not possess any 
special or unique trading advantages in handling their orders after 
transmitting them to the exchange, the Commission has stated that 
executions obtained through these systems satisfy the independent 
execution requirement of Rule 11a2-2(T). See Securities Exchange Act 
Release No. 15533 (January 29, 1979).
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Accelerated Approval of Amendments No. 2 and 3

    The Commission finds good cause to approve Amendments No. 2 and 3 
to the proposed rule change prior to the thirtieth day after the 
amendments are published for comment in the Federal Register pursuant 
to Section 19(b)(2) of the Act.\26\ Amendment No. 2 made technical 
corrections to the proposed rule text. Amendment No. 3 also made 
technical corrections to the proposed rule text and addressed concerns 
raised by the Commission staff by clarifying in the proposed rule text 
how CHXpress orders would be handled during a trading halt, and 
confirming that, if an execution of a CHXpress order in the book would 
cause an improper trade-through of another ITS market or if the display 
of the order would improperly lock or cross another market, the 
Exchange would automatically cancel both inbound orders and orders 
already in the book. The Commission believes that the proposed changes 
in Amendments No. 2 and 3 provide a clearer understanding of the 
operation of the CHXpress functionality and raise no new issues of 
regulatory concern and, therefore, believes good cause exists to 
accelerate approval of Amendments No. 2 and 3.
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    \26\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendments No. 2 and 3, including whether 
Amendments No. 2 and 3 are 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-2004-12 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission,

[[Page 60200]]

450 Fifth Street, NW., Washington, DC 20549-0609.
    All submissions should refer to File Number SR-CHX-2004-12. 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-
2004-12 and should be submitted on or before October 28, 2004.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5) of the Act.\27\
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    \27\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-CHX-2004-12) and Amendment 
No. 1 thereto are approved, and that Amendments No. 2 and 3 thereto are 
approved on an accelerated basis.
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    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-2527 Filed 10-6-04; 8:45 am]
BILLING CODE 8010-01-P