[Federal Register Volume 69, Number 245 (Wednesday, December 22, 2004)]
[Notices]
[Pages 76804-76806]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-27943]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50865; File No. SR-CHX-2004-03]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated Relating to Manual 
Execution of Orders and Amendment No. 1 Thereto

December 16, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice hereby is 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 
self-

[[Page 76805]]

regulatory organization. On December 14, 2004, the Exchange filed 
Amendment No. 1 to its original submission. 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, manual execution of market 
and marketable limit orders, to eliminate a specific requirement that a 
specialist execute eligible orders at the price and size associated 
with the national best bid or offer. The text of the proposed rule 
change appears below. Additions are italicized; deletions are in 
brackets.
* * * * *
RULE 37(a). Guaranteed Executions.
    1. Eligible Orders. Specialists must accept and guarantee execution 
of all agency market and marketable limit orders from 100 through 5099 
shares in accordance with this rule.
    2. Market and Marketable Limit Orders. With respect to any market 
or marketable limit order not executed automatically, a specialist 
shall use reasonable diligence to ascertain the best available price 
for the subject security so that the resultant execution price is as 
favorable to the order sender as possible under prevailing market 
conditions. Among the factors that will be considered in determining 
whether a specialist has used ``reasonable diligence'' are:
    (a) the character of the market for the security, e.g., price, 
volatility, relative liquidity, and pressure on available 
communications; and
    (b) the size and type of transaction.
[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. The specialist's obligation shall always be subject to the 
requirements of the short sale rule. For purposes of this rule, 
``NBBO'' shall mean, for Dual Trading System issues, the size and price 
associated with the best bid among the American, Boston, Cincinnati, 
Chicago, New York, Pacific, Philadelphia or the Intermarket Trading 
System/Computer Assisted Execution System (``ITS/CAES'') quote (``ITS 
Best Bid'') on a sell order or the price and size associated with the 
best offer among the American, Boston, Cincinnati, Chicago, New York 
Pacific, Philadelphia or the ITS/CAES quote (``ITS Best Offer'') on a 
buy order (the ``ITS Best Bid'' and ``ITS Best Offer'' are collectively 
referred to as the ``ITS BBO''). For NASDAQ/NM Securities, ``NBBO'' 
shall mean the price and size associated with the best bid disseminated 
pursuant to SEC Rule 11Ac1-1 on a sell order or price and size 
associated with the best offer disseminated pursuant to SEC Rule 11Ac1-
1 on a buy order (collectively, the ``NBBO''); or, if the specialist is 
quoting at the NBBO, the size associated with the specialist's bid or 
offer and the auto-execution threshold designated by the specialist.]
* * * * *

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(a) of the CHX 
Rules, which governs, among other things, manual execution of market 
and marketable limit orders, to eliminate a specific requirement that a 
specialist execute order at the price and size associated with the 
national best bid or offer.
    Background. The CHX currently has a rule, referred to as the ``BEST 
Rule,'' which sets out specific execution guarantees for eligible 
orders. The BEST Rule provides that, when executing orders manually, as 
principal, the specialist generally must execute the order at the then-
prevailing BBO price up to the BBO displayed quantity, i.e., the best 
price and liquidity available in the national market system.\3\ 
Alternatively, the specialist may elect to act as agent for the order, 
in which case the specialist must obtain the best available price for 
the order, using order-routing systems where appropriate.\4\
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    \3\ For Nasdaq/NM securities, the NBBO is defined as the best 
bid or offer disseminated pursuant to SEC Rule 11Ac1-1. For listed 
securities, the BBO is defined as the best bid or offer disseminated 
by the participants in the Intermarket Trading System Plan. See CHX 
Article XX, Rule 37(a)(2).
    \4\ Under the CHX's rules, orders that are executed using the 
CHX's automatic execution systems are executed at the BBO. See CHX 
Article XX, Rule 37(b).
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    Since the securities industry conversion to decimal trading, the 
CHX asserts that the availability of liquidity at a BBO price point has 
declined, in many cases significantly. The Exchange represents that a 
specialist, if he chooses to offset his positions in another market, 
often encounters great difficulty in accessing liquidity at the BBO 
price that he is obligated to provide. The Exchange asserts that this 
is particularly true in the case of manually-executed orders, given the 
associated time latency and the frequency with which quotes in other 
markets are changing.
    According to the Exchange, many CHX specialists thus believe that 
it is no longer appropriate to guarantee manual principal executions at 
the BBO price. Indeed, they believe that in today's trading 
environment, the BEST Rule exposes them to unwarranted liability, which 
they often have no ability to mitigate.\5\ Moreover, they note, CHX 
order-sending firms now have access to comprehensive order execution 
quality statistics, rending a ``front-end'' execution price guarantee 
unnecessary as a means of attracting order flow. Many CHX specialists, 
the Exchange

[[Page 76806]]

contends, therefore will continue to execute orders at the BBO price 
voluntarily, as a means of maintaining superior execution quality 
statistics.
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    \5\ The CHX believes that it is important to note that under the 
current version of the BEST Rule, a CHX specialist acting in his 
principal capacity is required to execute an unlimited number of 
orders at the then-prevailing BBO price, up to the BBO displayed 
size, until the consolidated quotation stream reflects a change in 
the BBO price or size. 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 BBO price, despite the 
fact that the aggregate number of shares vastly exceeded the BBO 
size. The CHX asserts that this virtually unlimited liability is an 
unintended, and unwarranted, consequence of execution guarantees 
such as the BEST 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 BEST Rule was enacted, occur often.
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    Under the proposed revision of Article XX, Rule 37(a), the specific 
provisions of the BEST Rule would be deleted. Instead, the specialist's 
execution obligation would be described in more general terms. Under 
the proposed new standard, a CHX specialist would, in executing an 
order manually, be obligated to ``* * * use reasonable diligence to 
ascertain the best available price for the subject security so that the 
resultant execution price is as favorable to the order sender as 
possible under prevailing market conditions.'' Among the factors that 
will be considered by the Exchange's Department of Market Regulation in 
determining whether a specialist has used ``reasonable diligence'' are: 
(a) The character of the market for the security, e.g., price, 
volatility, relative liquidity, and pressure on available 
communications; and (b) the size and type of transaction.\6\
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    \6\ The proposed new standard is substantially similar to Rule 
2320 (``Best Execution'') of the National Association of Securities 
Dealers (``NASD''). However, the NASD has filed a proposed rule 
change to amend Rule 2320. See File No. SR-NASD-2004-26.
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    Significantly, although this standard may appear more general in 
its terms, it does not remove a CHX specialist's obligation to provide 
a timely best execution for each order, nor does it modify any other 
specialist obligations set forth in Article XXX of the CHX Rules. The 
CHX Department of Market Regulation has indicated that it will continue 
its surveillance of order executions to ensure that CHX specialists 
meet all of their obligations to each order.
    It is also important to note that the CHX rules (specifically, CHX 
Article XX, Rule 37(b)) would continue to require execution of the BBO 
price for orders that are automatically executed within the Exchange's 
MAX[supreg] system. The Exchange represents that there is no proposal 
forthcoming to modify automatic execution price guarantees.
2. Statutory Basis
    The Exchange believes that the proposed rule change 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).\7\ 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 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.\8\
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    \7\ 15 U.S.C. 78f(b).
    \8\ 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 Regarding 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 other 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, as amended 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-2004-03 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-2004-03. 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 
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-
2004-03 and should be submitted on or before January 12, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30\3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-27943 Filed 12-21-04; 8:45 am]
BILLING CODE 8010-01-M