[Federal Register Volume 69, Number 248 (Tuesday, December 28, 2004)]
[Notices]
[Pages 77796-77802]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-28275]



[[Page 77796]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50892; File No. SR-CHX-2004-26]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 by the Chicago Stock Exchange, Inc. Relating 
to the Demutualization of the Chicago Stock Exchange, Inc.

December 20, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 24, 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 CHX. On December 
15, 2004, the CHX filed Amendment No. 1 to the proposal.\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\ In Amendment No. 1, the CHX revised several references in 
the proposal to reflect its members' November 2004 vote to approve 
the proposed demutualization.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CHX proposes a series of changes to the CHX's corporate 
structure to allow for the demutualization of the CHX. To effect the 
demutualization, the CHX proposes to create a new Delaware for-profit 
stock holding company, CHX Holdings, Inc. (``CHX Holdings'') that will 
become the parent company and sole shareholder of the CHX. The CHX will 
become a Delaware for-profit stock corporation that will continue to 
engage in the business of operating a national securities exchange 
registered under Section 6 of the Act.\4\
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    \4\ 15 U.S.C. 78f.
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    The proposed rule change for implementing the demutualization, 
including: (1) The CHX's revised rules; (2) the CHX's revised 
Certificate of Incorporation; (3) the CHX's revised Bylaws; (4) the 
Certificate of Incorporation for CHX Holdings; and (5) the Bylaws of 
CHX Holdings, are collectively referred to herein as the ``proposed 
rule change'' and are available for viewing on the Commission's Web 
site, http://www.sec.gov, and at the CHX and 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 CHX included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received regarding the proposal. The text of 
these statements may be examined at the places specified in Item IV 
below. The CHX 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
    Through this submission, the Exchange proposes a series of changes 
to the Exchange's corporate structure that will allow for the 
demutualization of the Exchange.
a. Description of the Demutualization Transaction
    The CHX proposes to demutualize by creating a new Delaware for-
profit stock holding company, CHX Holdings, which will become the 
parent company of the CHX.\5\ The CHX itself will become a Delaware 
for-profit stock corporation and will continue to engage in the 
business of operating a national securities exchange registered under 
Section 6 of the Act.\6\
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    \5\ In order to accomplish the demutualization, the CHX, which 
currently is a Delaware non-stock corporation, will establish two 
new Delaware stock for-profit corporations: CHX Holdings, a direct 
and wholly-owned subsidiary of the CHX; and CHX Merger Sub, Inc. 
(``CHX Merger Sub''), a direct and wholly-owned subsidiary of CHX 
Holdings. Pursuant to an agreement and plan of merger, CHX Merger 
Sub will merge with and into the CHX, with the CHX surviving the 
merger as a Delaware for-profit stock corporation that is a direct 
and wholly-owned subsidiary of CHX Holdings.
    \6\ 15 U.S.C. 78f. Following the demutualization, earnings of 
the CHX not retained in its business will be distributed to its 
parent, CHX Holdings, and CHX Holdings will be authorized to pay 
dividends to the stockholders of CHX Holdings as and when they are 
declared by the Board of Directors of CHX Holdings.
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    On the effective date of the demutualization (``Effective Date''), 
each person or entity that owns a membership in the CHX will receive 
1,000 shares of common stock of CHX Holdings for each membership that 
the person or entity owns, representing all of the issued and 
outstanding shares of CHX Holdings. Following the demutualization, 
persons and firms who have been qualified for membership under Articles 
1, 2, or 3 of the Exchange's current rules and, as a result, have 
access to the Exchange's trading floor and other facilities 
(``qualified trading members'') will separately receive CHX trading 
permits entitling them to maintain the same trading access to the CHX 
that they currently enjoy.
    Shares of CHX Holdings common stock and CHX trading permits will 
not be tied together. As a result, following the demutualization, 
former CHX members will be able to sell the shares of CHX Holdings 
common stock they receive in the demutualization, subject to the 
applicable restrictions described below, while still retaining any CHX 
trading permits that they were issued. Other persons who satisfy 
regulatory requirements will also be able to obtain CHX trading permits 
without regard to whether they are stockholders of CHX Holdings. 
Persons who hold CHX trading permits in the demutualized Exchange will 
be called ``participants'' or ``participant firms.''
b. Reasons for the Proposed Demutualization
    There are several benefits that the Exchange believes may result 
from the demutualization of the Exchange. Perhaps the most important of 
these benefits is that the creation of CHX Holdings as a for-profit 
stock corporation may present opportunities to enter into strategic 
alliances involving the issuance of stock to its partners in such 
transactions. The Exchange believes that demutualization may increase 
the likelihood that these kinds of opportunities may be presented to 
the CHX, which could be beneficial to the stockholders of CHX Holdings.
    The Exchange believes that another potential benefit to 
demutualizing is that converting the CHX from a not-for-profit 
corporation to a for-profit subsidiary of a for-profit holding company 
is likely to focus the business of the CHX more sharply on its 
profitability, which in turn should enhance the value of the Exchange 
to its owners. Additionally, by reorganizing the CHX into a holding 
company structure, there should be greater flexibility for the new 
holding company to acquire or expand into other businesses, as well as 
to dispose of certain business units if that should appear to be in the 
best interest of the enterprise and the stockholders of CHX Holdings.
    The Exchange remains committed to its role as a national securities 
exchange and does not believe that a change to a for-profit institution 
will undermine its responsibilities for regulating its marketplace. 
Indeed, as further described below, the Exchange has

[[Page 77797]]

proposed specific provisions in the Bylaws of both CHX Holdings and the 
CHX that reinforce the ability of the Exchange to perform its self-
regulatory functions.
c. Summary of Proposed Rule Change
    The proposed rule change is outlined below.\7\ In general, the 
proposed rule change consists of: organizational changes to the CHX 
Certificate of Incorporation and Bylaws, reflecting the change in 
corporate form; governance changes that will reduce the size of the CHX 
Board and modify certain provisions governing CHX committees; and 
membership rule changes that are necessary to implement the new CHX 
trading permit structure, which will replace the existing structure of 
owning and leasing Exchange memberships as a basis for trading rights. 
The proposed rule change also includes the CHX Holdings Certificate of 
Incorporation and Bylaws. CHX Holdings will, on the Effective Date of 
the demutualization transaction, become the Exchange's parent company. 
The Exchange is not proposing any significant change to its existing 
operational and trading structure in connection with the 
demutualization.\8\
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    \7\ Also outlined below are those provisions of the proposed CHX 
Holdings Certificate of Incorporation and Bylaws that are directly 
related to the Exchange's self-regulatory function.
    \8\ The Exchange, however, is proposing certain revisions to the 
CHX rules which will delete obsolete rule provisions. These changes 
are summarized below under ``Summary of Rule Change Not Related to 
Demutualization.''
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    (1) Governance Structure of the Demutualized CHX.
    (a) CHX Holdings. As noted above, following the demutualization, 
CHX Holdings will be a for-profit stock corporation. All of the issued 
and outstanding stock of CHX Holdings (450,000 shares of common stock) 
initially will be owned by the persons or entities that owned 
memberships in the Exchange.\9\
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    \9\ See proposed Article Fourth of the CHX Holdings Certificate 
of Incorporation. CHX Holdings will have an additional 300,000 
shares of authorized, but not issued, common stock and 25,000 shares 
of authorized, but not issued, preferred stock.
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    (i) Board of Directors. The Board of Directors of CHX Holdings 
(``CHX Holdings Board'') will consist of between 10 and 16 persons, as 
determined by the CHX Holdings Board from time to time.\10\ Initially, 
the CHX Holdings Board will have 14 directors, who will be selected by 
the Chairman, Vice Chairman, and Chief Executive Officer of the CHX 
from among the persons currently serving on the Exchange's Board of 
Governors.\11\ The directors of CHX Holdings will be divided into three 
classes, which will be as nearly equal in number as the total number of 
directors then constituting the entire CHX Holdings Board. The 
directors of CHX Holdings will serve staggered three-year terms, with 
the term of office of one class expiring each year.\12\
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    \10\ See proposed Article Sixth, Section (b) of the CHX Holdings 
Certificate of Incorporation and proposed Article II, Section 2 of 
the CHX Holdings Bylaws.
    \11\ See proposed Article Sixth, Section (g) of the CHX Holdings 
Certificate of Incorporation.
    \12\ A CHX Holdings director may serve for any number of terms, 
consecutive or otherwise, but no person will be eligible for 
election or re-election as a director if such person has reached the 
age of 71.
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    The Chairman of the CHX Holdings Board will be elected by the CHX 
Holdings Board from among the directors on the CHX Holdings Board.\13\ 
He may serve as the Chief Executive Officer of CHX Holdings but may 
have no other office in CHX Holdings. The Vice Chairman of the CHX 
Holdings Board will be nominated by the Chairman of the CHX Holdings 
Board and elected by the CHX Holdings Board.\14\ He may hold no other 
office with CHX Holdings. Neither the Chairman nor the Vice Chairman of 
CHX Holdings will be subject to any limit on the number of terms that 
he may serve. Each year, the Nominating and Governance Committee of CHX 
Holdings will nominate directors for the class of directors standing 
for election at the CHX Holdings annual meeting of stockholders that 
year.\15\ Each CHX Holdings stockholder will be entitled to one vote 
for each share of stock owned by that stockholder.\16\ At each annual 
meeting of the stockholders of CHX Holdings at which a quorum is 
present, the individuals receiving a plurality of the votes cast will 
be elected directors of CHX Holdings.
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    \13\ See proposed Article II, Section 4 of the CHX Holdings 
Bylaws.
    \14\ See proposed Article II, Section 5 of the CHX Holdings 
Bylaws.
    \15\ See proposed Article II, Section 3 of the CHX Holdings 
Bylaws.
    \16\ See proposed Article IV, Section 11 of the CHX Holdings 
Bylaws.
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    In most cases, vacancies on the CHX Holdings Board will be filled 
by persons nominated by the Chairman and Vice Chairman of CHX Holdings 
and elected by the CHX Holdings Board.\17\ If the vacancy has resulted 
from removal from office for cause pursuant to stockholder vote, 
however, that vacancy may be filled by a vote of the stockholders of 
CHX Holdings at the same meeting at which that director is removed. Any 
director chosen to fill a vacancy or newly-created seat may serve only 
until the next annual meeting of CHX Holdings stockholders, at which 
time a director will be elected by the stockholders to serve out the 
remaining portion of the term of the class to which the director 
belongs.
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    \17\ See proposed Article Sixth, Section (h) of the CHX Holdings 
Certificate of Incorporation and proposed Article II, Section 6 of 
the CHX Holdings Bylaws. The Chairman and Vice Chairman of CHX 
Holdings will be required to provide the names of nominees to fill 
vacancies to the CHX Holdings Board, in writing, no later than five 
business days before the date on which the CHX Holdings Board will 
be asked to vote to fill the vacancies.
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    (ii) Officers of CHX Holdings. The day-to-day business affairs of 
CHX Holdings will be managed by the Chief Executive Officer of CHX 
Holdings, who will be appointed by the CHX Holdings Board.\18\ The 
Chief Executive Officer of CHX Holdings may appoint such other officers 
as he believes are necessary. These officers will have the 
responsibilities and authority set out in the CHX Holdings Bylaws or 
given to them by the Chief Executive Officer of CHX Holdings. As an 
initial matter, the Chief Executive Officer of the CHX will act as the 
Chief Executive Officer of CHX Holdings and will appoint, as officers 
of CHX Holdings, such officers of the CHX as he believes are necessary 
to carry out the business of CHX Holdings.
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    \18\ See proposed Article VI, Section 4 of the CHX Holdings 
Bylaws.
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    (iii) CHX Holdings Committees. The CHX Holdings Board will have 
several standing committees.\19\ The CHX Holdings Nominating and 
Governance Committee, which will consist of six directors, will be 
appointed by the CHX Holdings Board.\20\ The Executive, Audit, and 
Compensation Committees of CHX Holdings will be appointed by the 
Chairman and Vice Chairman of the CHX Holdings Board, subject to the 
approval of the CHX Holdings Board.\21\ Other committees will be 
appointed by the Vice Chairman of CHX Holdings, subject to the CHX 
Holdings Board's approval. Each committee will have the authority and 
responsibilities as may be determined, from time to time, by the CHX 
Holdings Board.
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    \19\ See proposed Article V, Section 1 of the CHX Holdings 
Bylaws.
    \20\ See proposed Article II, Section 3 of the CHX Holdings 
Bylaws.
    \21\ See proposed Article V of the CHX Holdings Bylaws.
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    (b) The CHX. As noted above, following demutualization, the CHX 
will be a for-profit stock corporation. All of its stock will be held 
by CHX Holdings.\22\
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    \22\ See proposed Article Fourth of the CHX Certificate of 
Incorporation.
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    (i) Board of Directors. The CHX Board of Directors (``CHX Board'') 
will consist of between 10 and 16 persons, as

[[Page 77798]]

determined by the CHX Board from time to time.\23\ Initially, the CHX 
Board will have 14 directors, who will be selected by the Chairman, 
Vice Chairman, and Chief Executive Officer of the CHX from among the 
persons currently serving on the Exchange's Board of Governors. The 
directors will be divided into three classes, which will be as nearly 
equal in number as the total number of directors then constituting the 
entire CHX Board permits. The CHX's directors will serve staggered 
three-year terms, with the term of office of one class expiring each 
year.\24\
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    \23\ See proposed Article Fifth of the CHX Certificate of 
Incorporation and proposed Article II, Section 2 of the CHX Bylaws. 
The CHX's current Board of Governors consists of 24 governors.
    \24\ Under the proposed CHX Bylaws, a CHX director may serve for 
any number of terms, consecutive or otherwise, but no person will be 
eligible for election or re-election as a director if such person 
has reached the age of 71. These provisions are somewhat different 
from the Exchange's current Bylaws, which contain restrictions on 
the number of terms that CHX governors may serve and do not place 
any age restriction on member governors. The Exchange believes that 
it is appropriate to remove term restrictions to ensure that persons 
who would be interested in serving on the CHX Board are not required 
to leave at the end of a particular number of years, particularly as 
the number of member firms on the Exchange (and the number of 
persons who would be eligible to serve on the CHX Board) have 
decreased over the past several years.
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    The CHX Board will be composed of the Exchange's Chief Executive 
Officer, persons who qualify as ``participant directors'' and persons 
who qualify as ``public directors.''\25\ One-half of the members of the 
CHX Board must be public directors. The remaining directors (other than 
the Chief Executive Officer) must be participant directors.\26\ The CHX 
Board's initial directors will include the Chief Executive Officer, 
seven public directors and six participant directors of the CHX.
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    \25\ See proposed Article Fifth, Section (c) of the CHX 
Certificate of Incorporation and proposed Article II, Section 2(b) 
of the CHX Bylaws. A ``public director'' is a director who (i) is 
not a participant or an officer, managing member, partner or 
employee of an entity that is a participant, (ii) is not an employee 
of the CHX, CHX Holdings or any of their affiliates, (iii) is not a 
broker or dealer or an officer or employee of a broker or dealer, or 
(iv) does not have any other material business relationship with the 
CHX, CHX Holdings, or any of their affiliates or any broker or 
dealer. A ``participant director'' is a director who is a CHX 
participant or an officer, managing member or partner of an entity 
that is a CHX participant. The proposed definition of public 
director will replace the somewhat confusing definitions of non-
industry governor and public governor that are set out in the 
Exchange's current governing documents.
    \26\ This composition is consistent with the composition of the 
Exchange's current Board of Governors, which consists of 12 non-
industry governors (all of whom currently qualify as public 
governors), ten member governors (of which four must be on-floor 
governors and four must be off-floor governors) the Vice Chairman 
(an on-floor member firm representative) and the Chief Executive 
Officer.
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    The Chairman of the CHX Board will be elected by the CHX Board and 
will be either the Chief Executive Officer of the CHX or one of the 
public directors on the CHX Board.\27\ The Vice Chairman of the CHX 
Board will be elected by the participant directors from among the 
participant directors on the CHX Board.\28\ Neither the Chairman nor 
the Vice Chairman of the CHX may hold another office in the Exchange, 
nor will he be subject to any limit on the number of terms that he may 
serve.
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    \27\ See proposed Article II, Section 4 of the CHX Bylaws. Under 
the Exchange's current Bylaws, the CHX Chairman could also be an 
off-floor member governor. The Exchange believes that it is 
consistent with principles of good governance to ensure that the 
Chairman of the Exchange is not one of the members regulated by the 
Exchange.
    \28\ See proposed Article II, Section 5 of the CHX Bylaws. 
Currently, the Exchange's Vice Chairman is directly elected by the 
Exchange's members.
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    Each year, the Nominating and Governance Committee of the CHX will 
nominate directors for the class of directors standing for election at 
the annual meeting of the CHX stockholders that year.\29\ CHX Holdings, 
as sole stockholder of the CHX, will have the sole right and the 
obligation to vote for the directors of the CHX nominated by the CHX 
Nominating and Governance Committee.\30\
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    \29\ See proposed Article II, Section 3 of the CHX Bylaws.
    \30\ CHX Holdings will sign an agreement with the CHX confirming 
its obligation to vote for the candidates nominated through the 
process set out in the proposed CHX Bylaws.
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    Because, in the demutualized CHX, the Exchange's participants are 
not stockholders of the CHX, they cannot directly elect members of the 
CHX Board. As described below, the Exchange has set up a procedure that 
allows participants to be involved in the selection of candidates to 
fill participant director slots on the CHX Board. This procedure is 
designed to resemble the process currently used to nominate persons to 
the CHX's Board of Governors.\31\ Under the new procedures, the CHX 
Nominating and Governance Committee will hold two open meetings with 
CHX participants for the purpose of receiving recommendations of 
candidates for election to the positions of participant directors. The 
CHX Nominating and Governance Committee's initial candidates for 
nomination will be announced to CHX participants, who will then have 
the opportunity to identify additional candidates for nomination to 
those positions by submitting a petition signed by at least ten 
participants.\32\ If no petitions are submitted within the time frame 
prescribed by the CHX Bylaws, the CHX Nominating and Governance 
Committee will nominate the candidates it initially identified. If one 
or more valid petitions are submitted, the participants will be allowed 
to vote on the entire group of potential candidates. Each participant 
will have one vote, per trading permit, with respect to each 
participant director position that is to be filled, and the persons 
with the highest number of votes will be nominated by the CHX 
Nominating and Governance Committee.\33\ As noted above, CHX Holdings, 
as sole stockholder of the CHX, will have the sole right and the 
obligation to vote for the directors nominated by the CHX Nominating 
and Governance Committee. The Exchange believes that this process 
provides a fair opportunity for the participants in the Exchange--its 
``members'' under the Act --to participate in the selection of the 
Exchange's directors.
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    \31\ See proposed Article II, Section 3 of the CHX Bylaws.
    \32\ Under the Exchange's current Bylaws, its members have a 
similar ability to add candidates to a ballot through the submission 
of petitions signed by ten CHX members.
    \33\ As noted below, no participant or participant firm is 
allowed to hold more trading permits than are necessary to the 
conduct of business on the Exchange. All trading permits must be 
held by an active participant or must be held by an active 
participant firm, where the participant firm has assigned an active 
participant as its nominee. See proposed CHX Rules, Article II, Rule 
2(e).
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    In most cases, vacancies on the CHX Board will be filled by persons 
nominated by the Chairman and Vice Chairman of the CHX and elected by 
the CHX Board.\34\ As with CHX Holdings, if the vacancy has resulted 
from removal from office for cause pursuant to stockholder vote, 
however, that vacancy may be filled by a vote of the CHX stockholders 
at the same meeting at which that director is removed. Any director 
chosen to fill a vacancy or newly-created seat may serve only until the 
next annual meeting of the CHX stockholders, at which time a director 
identified by the CHX Nominating and Governance Committee will be 
elected by the CHX stockholders to serve out

[[Page 77799]]

the remaining portion of the term of the class to which the director 
belongs.
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    \34\ See proposed Article Fifth, Section (g) of the CHX 
Certificate of Incorporation and proposed Article II, Section 6 of 
the CHX Bylaws. The Chairman and Vice Chairman of the CHX will be 
required to provide the names of nominees to fill vacancies to the 
CHX Board, in writing, no later than five business days before the 
date on which the CHX Board will be asked to vote to fill the 
vacancies. The Exchange believes that having both its Chairman (a 
public director or the Chief Executive Officer) and its Vice 
Chairman (a participant director) nominate persons to fill vacancies 
on the CHX Board provides a well-balanced approach to this important 
responsibility.
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    (ii) Officers of the CHX. The day-to-day business affairs of the 
CHX will continue to be managed by its Chief Executive Officer, who is 
appointed by the CHX Board.\35\ The Chief Executive Officer of the CHX 
will continue to have the authority to appoint such other officers as 
he believes are necessary. These officers will have the 
responsibilities and authority set out in the CHX Bylaws or given to 
them by the Chief Executive Officer of the CHX.\36\
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    \35\ See proposed Article V of the CHX Bylaws.
    \36\ Although these provisions are not measurably different from 
the Exchange's current Bylaws, the proposed changes to Article V of 
the CHX Bylaws do contain two new provisions relating to officer 
compensation and term of office. Consistent with the existing CHX 
Rules, proposed Article V, Section 2 of the CHX Bylaws confirms that 
the CHX Chief Executive Officer's compensation is determined by the 
CHX Compensation Committee and that salaries of other officers are 
fixed by the Chief Executive Officer of the CHX, in consultation 
with the Compensation Committee of the CHX. Proposed Article V, 
Section 3 of the CHX Bylaws confirms that officers hold office until 
a successor is appointed or until the officer's death, resignation, 
or removal. Other changes in proposed Article V of the CHX Bylaws 
move references to the Exchange's Chairman and Vice Chairman to 
proposed Article II (Directors) to confirm that these persons are 
not officers of the Exchange and set out the general authority of 
Exchange officers.
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    (iii) CHX Committees. The CHX Board will have several standing 
committees, which are, for the most part, the same as the committees 
currently in place for the CHX.\37\
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    \37\ Information about the composition and responsibilities of 
the Exchange's committees is contained in proposed Article IV of the 
Exchange's rules.
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    (A) The CHX Nominating and Governance Committee, which will consist 
of three participant directors and three public directors, will be 
appointed by the CHX Board.\38\ This committee will be responsible for 
nominating candidates for the position of director and periodically 
reviewing the organization and governance structure of the 
Exchange.\39\
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    \38\ Under the Exchange's current rules, the Exchange's 
Nominating Committee consists of three member representatives 
(including one on-floor representative and one off-floor 
representative) and three non-industry persons. The member 
representatives currently are elected by the Exchange's members; the 
non-industry representatives are appointed by the Exchange's Board 
of Governors. The Exchange believes that it is appropriate to adopt 
a more streamlined approach to the selection of its Nominating and 
Governance Committee when it demutualizes and thus has chosen the 
process set out in the amended CHX Bylaws.
    \39\ In making this proposal, the Exchange seeks to combine the 
work of its current Nominating Committee with the work performed by 
its current (and separate) Organization and Governance Committee. 
The Exchange believes that it will be more efficient to have a 
single committee address these issues.
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    (B) The CHX's Executive, Audit, Finance, and Compensation 
Committees will be appointed by the Chairman and Vice Chairman of the 
CHX Board, subject to the approval of the CHX Board.\40\
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    \40\ The role and composition of these committees are similar, 
but not identical, to the structure under the current CHX rules. For 
example, under the revised CHX rules, a majority (not just 50%) of 
the members of the CHX's Audit and Compensation Committees would be 
public directors. In addition, the description of the CHX Audit 
Committee's role would be updated to confirm that the committee (not 
the CHX Board) has the direct responsibility to retain and oversee 
the work of the independent public accountant that audits the 
Exchange's financial statements. Other changes include a decision to 
streamline the requirements for CHX Executive Committee members by 
removing the requirement in the Exchange's current Bylaws that 
committee members be chosen (a) with a view to providing 
representation to the various geographical areas in which there are 
member organizations that support the Exchange; and (b) with a view 
to having persons on the committee who are interested in and 
knowledgeable about the Exchange's business operations and the 
securities industry as a whole. These requirements appear to have 
been included in the Exchange's Bylaws at a time when securities 
industry participants had businesses that were more local in scope 
and when persons might not have had a particular interest in serving 
as public directors on the CHX's Board of Governors. Today, the 
businesses of many of the Exchange's members are national in scope 
and the Exchange anticipates that all of its public directors will 
be interested in learning more about the Exchange's operations and 
the workings of the securities industry as a whole.
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    (C) The CHX's Regulatory Oversight Committee will be appointed by 
the Vice Chairman of the CHX Board, subject to the approval of the 
public directors on the CHX Board.\41\
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    \41\ The CHX represents that the composition, responsibilities, 
and appointment mechanism associated with this committee are 
consistent with the requirements relating to this committee that are 
set out in the CHX's September 30, 2003, settlement order with the 
Commission. See In the Matter of the Chicago Stock Exchange, 
Securities Exchange Act Release No. 48566 (September 30, 2003) 
(Admin. Proc. File No. 3-11282) (Order Instituting Public 
Administrative Proceedings Pursuant to Sections 19(h) and 21C of the 
Securities Exchange Act of 1934, Making Findings, and Imposing a 
Censure, a Cease-and-Desist Order and Other Relief) (``CHX 
Settlement Order'').
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    (D) The CHX's Judiciary Committee will continue to be appointed by 
the Chief Executive Officer of the CHX; and
    (E) Other committees, including the newly-formed Participant 
Advisory Committee of the CHX, will be appointed by the Vice Chairman 
of the CHX, subject to the CHX Board's approval.\42\ Each committee 
will have the authority and responsibilities as may be determined, from 
time to time, by the CHX Board.
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    \42\ The CHX Participant Advisory Committee will be composed 
entirely of participants of the Exchange. It will, among other 
things, recommend rules for adoption by the CHX Board and advise the 
CHX management regarding enhancements to the Exchange's trading 
facilities and other matters that affect participants. This 
committee is designed to provide participants with a formal 
opportunity to share their concerns and ideas with the CHX 
management.
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    (2) Provisions Relating to, or Arising from, the Self-Regulatory 
Functions of the CHX. The proposed Bylaws of both CHX Holdings and the 
CHX contain specific provisions relating to the self-regulatory 
function of the CHX.
    (a) CHX. For the CHX, these provisions address the following 
issues:
    (i) Management of the CHX. The CHX Board must consider applicable 
requirements under Section 6(b) of the Act \43\ in connection with the 
management of the Exchange.\44\
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    \43\ 15 U.S.C. 78f(b). Section 6(b) of the Act requires, among 
other things, that the Exchange's rules must be designed to protect 
investors and the public interest. It also requires that the 
Exchange be organized so that it can carry out the purposes of the 
Act and to enforce compliance by its participants with the Act, the 
rules and regulations under that Act, and the rules of the Exchange.
    \44\ See proposed Article X, Section 1 of the CHX Bylaws.
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    (ii) Confidentiality. Meetings of the CHX Board and of its 
committees that pertain to the self-regulatory function of the Exchange 
or to the structure of the market which the Exchange regulates must be 
closed to persons who are not members of the CHX Board or CHX officers, 
staff, counsel, or other specifically identified persons.\45\ The CHX 
books and records that relate to the Exchange's self-regulatory 
function must be kept confidential and must not be used for non-
regulatory purposes.\46\
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    \45\ See proposed Article X, Section 2 of the CHX Bylaws. These 
requirements are designed to ensure that representatives of CHX 
Holdings or of other corporations affiliated with the Exchange do 
not improperly involve themselves in specific disciplinary or other 
regulatory matters being handled by the Exchange. These requirements 
and the requirements relating to the confidentiality of records are 
not, however, designed to prevent the Exchange from sharing with CHX 
Holdings the type of information about the Exchange's business that 
would ordinarily be shared with a parent corporation, including 
information relating to the Exchange's compliance with the CHX 
Settlement Order and all applicable laws; any reports from the 
Commission or from others evaluating the Exchange's self-regulatory 
programs; and information about the trading activities and business 
strategies of the Exchange's participants.
    \46\ See proposed Article X, Section 3 of the CHX Bylaws.
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    (iii) Maintenance of books and records. All of the books and 
records of the CHX must be maintained at a location within the United 
States.\47\
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    \47\ See proposed Article X, Section 4 of the CHX Bylaws.
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    (iv) Regulatory fees and penalties. Any revenues received by the 
CHX from regulatory fees or penalties must be applied to fund the legal 
and regulatory operations of the Exchange and must not be used to pay 
dividends.\48\
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    \48\ See proposed Article X, Section 5 of the CHX Bylaws. 
Regulatory penalties that are intended to benefit customers, by, for 
example, providing restitution, must be provided to those customers 
and will not be used by the Exchange for any purpose.

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[[Page 77800]]

    (v) Restrictions on ownership. Although there are no percentage-
based restrictions on the ownership of the CHX, the proposed CHX 
Certificate of Incorporation confirms that CHX Holdings is the sole 
stockholder of the CHX.\49\ Changes to the CHX Certificate of 
Incorporation cannot take effect until they are approved by the 
Commission.
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    \49\ See proposed Article Fourth of the CHX Certificate of 
Incorporation.
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    (b) CHX Holdings. Provisions in the CHX Holdings Certificate of 
Incorporation and Bylaws address similar, but slightly different, 
issues and contain specific limitations on shareholder voting and 
ownership rights, including:
    (i) Restrictions on voting rights. As described in proposed Article 
Fifth of the CHX Holdings Certificate of Incorporation, holders of the 
common stock or preferred stock of CHX Holdings, either alone or 
together with any of their affiliates or associates or any other 
person, directly or indirectly, may not (a) vote or give a proxy or 
consent with respect to shares representing more than 20% of the voting 
power of the then-issued and outstanding capital stock of CHX Holdings 
or (b) enter into any agreement, plan, or arrangement that would result 
in the shares of capital stock of CHX Holdings, subject to that 
agreement, plan, or arrangement, not being voted on a matter or any 
proxy being withheld, where the effect of that agreement, plan, or 
arrangement would be to enable any person or group to obtain more than 
20% of the outstanding voting power.
    (ii) Restrictions on ownership rights. In addition to the 
restrictions on voting discussed above, shares of common stock of CHX 
Holdings will be subject to the following restrictions: (a) no person, 
alone or together with its affiliates and associates or any person(s) 
acting in concert with it, may own of record or beneficially, directly 
or indirectly, more than 40% of the outstanding shares of any class of 
capital stock of CHX Holdings; and (b) no person, alone or together 
with its affiliates and associates or any person(s) acting in concert 
with it, who holds a trading permit of the CHX, may own of record or 
beneficially, directly or indirectly, more than 20% of any class of 
capital stock of CHX Holdings. These restrictions may be waived by the 
CHX Holdings Board in accordance with the terms of the Certificate of 
Incorporation of CHX Holdings and an appropriate amendment to the 
Bylaws of CHX Holdings, which must be approved by the Commission.\50\
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    \50\ CHX Holdings stockholders also are prohibited from selling, 
transferring, or otherwise disposing of their shares except in 1000-
share increments, and no stockholder will be permitted to transfer 
shares in CHX Holdings until all amounts due and owing from that 
stockholder to the CHX have been paid. See proposed Article IX, 
Sections 2 and 3(b) of the CHX Holdings Bylaws.
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    (iii) Management of CHX Holdings. So long as CHX Holdings controls 
the Exchange, the CHX Holdings Board and its officers, employees and 
agents must give due regard to the preservation of the independence of 
the Exchange's self-regulatory function and to its obligations to 
investors and the public interest and must not take actions that would 
interfere with the self-regulatory activities of the Exchange.\51\
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    \51\ See proposed Article III, Section 1 of the CHX Holdings 
Bylaws.
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    (iv) Confidentiality. The CHX Holdings books and records that 
relate to the Exchange's self-regulatory function must be kept 
confidential and must not be used for non-regulatory purposes.\52\
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    \52\ See proposed Article III, Section 2 of the CHX Holdings 
Bylaws.
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    (v) Cooperation with the Commission/consent to jurisdiction. To the 
extent that they are related to the activities of the CHX, the books, 
records, officers, directors, and employees of CHX Holdings will be 
deemed to be the books, records, officers, directors, and employees of 
the Exchange for purposes of the Commission oversight.\53\ 
Additionally, CHX Holdings officers, directors, employees, and agents 
are deemed to agree to cooperate with the Commission in its oversight 
activities relating to the Exchange and are deemed to submit to the 
jurisdiction of the Commission with respect to proceedings that might 
arise out of, or relate to, the activities of the Exchange.\54\
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    \53\ See proposed Article III, Section 3 of the CHX Holdings 
Bylaws.
    \54\ See proposed Article III, Sections 4 and 5 of the CHX 
Holdings Bylaws.
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    (3) Trading Permits.
    Following the Exchange's demutualization, persons and firms who 
have been qualified for membership under Articles 1, 2, or 3 of the 
Exchange's current rules and, as a result, have access to the 
Exchange's trading floor and other facilities will separately receive 
trading permits entitling them to maintain the same trading access to 
the CHX that they currently enjoy. These persons will separately and 
automatically be issued one or more trading permits, unless they 
affirmatively ``opt out'' of the opportunity to obtain a trading 
permit.\55\
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    \55\ The Exchange will circulate written materials to all 
qualified trading members, in advance of the Effective Date, 
notifying these persons that they can decide not to receive a 
trading permit and setting out the procedures by which that opt-out 
decision can be made. See Amendment No. 1, supra note 3.
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    Each trading permit will constitute a revocable license that will 
allow the holder of the permit to access the CHX trading facilities in 
the same manner as previously authorized for the CHX's qualified 
trading members.\56\ As summarized below, and with the exceptions noted 
below, although there will be some changes in terminology and certain 
administrative procedures following demutualization, the right of a 
qualified trading member to access the CHX, and execute transactions 
through the CHX, will not be substantially changed as a result of the 
demutualization transaction. Persons holding trading permits of the CHX 
will be ``members'' of the CHX for purposes of the Act and will be 
characterized as ``participants'' in the CHX subject to the CHX's 
regulatory jurisdiction, but they will not have any ownership interest 
in the Exchange or in CHX Holdings by virtue of their trading 
permits.\57\
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    \56\ See proposed CHX Rules, Article II, Rule 2, ``Rights and 
Privileges of Participants.''
    \57\ See proposed CHX Rules, Article I, Rule 1(l) (definition of 
``participant'').
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    Following demutualization, persons other than qualified trading 
members who seek issuance of a trading permit will be required to 
complete appropriate application materials and registration forms, 
satisfy regulatory requirements and pay processing charges and 
application fees. This process will be substantially similar to the 
current membership application process.\58\ An individual participant 
may obtain only one trading permit. A participant that is not an 
individual (i.e., a participant firm) may obtain multiple trading 
permits and may assign a nominee to each trading permit. A trading 
permit will be required for each person transacting business. As an 
example, a CHX specialist firm with 50 co-specialists will be required 
to obtain 50 trading permits and to register each co-specialist as a 
nominee. Importantly, however, no participant or participant firm will 
be allowed to hold more

[[Page 77801]]

trading permits than are necessary to the conduct of business on the 
Exchange. All trading permits must be held by an active participant or 
must be held by an active participant firm, where the participant firm 
has assigned an active participant as its nominee.\59\
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    \58\ See proposed CHX Rules, Articles II and III. Other than the 
new rules relating to trading permits, the changes to the rules in 
these articles replace references to a ``member,'' ``member 
organization'' and ``member firm'' with the words ``participant'' 
and ``participant firm,'' delete references to sales of memberships, 
and consolidate the current separate articles that relate to member 
firms and member corporations into a single article regarding 
participant firms. These changes are not designed to alter the 
substantive rights and obligations of the CHX members.
    \59\ See proposed CHX Rules, Article II, Rule 2(e).
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    Once issued, a trading permit of the CHX will be effective for one 
year following its issuance date and will automatically renew for an 
additional one-year term on each anniversary of the issuance date, 
unless the holder notifies the Exchange (by giving not less than 60 
days' notice) that the holder wishes to waive its right to this 
automatic renewal. If the participant waives the right to renew the 
permit, it will expire at the end of the then-current term.\60\ A 
trading permit may not be sold, leased or otherwise transferred.\61\ As 
an exception to the non-transferability of trading permits, a trading 
permit may be transferred to the name of a nominee within the same 
participant firm with the approval of the CHX. In addition to the 
holder's right to relinquish a trading permit, the CHX may suspend or 
revoke a trading permit for the same reasons that currently entitle the 
CHX to suspend or revoke a membership and/or sell a seat.\62\
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    \60\ See proposed CHX Rules, Article II, Rules 3(d), ``Term of 
Trading Permit,'' and 7, ``Termination of Trading Permit by 
Participant.''
    \61\ See proposed CHX Rules, Article II, Rule 6, ``Transfers of 
Trading Permits.''
    \62\ See generally, CHX Rules, Articles VII, ``Suspension--
Reinstatement,'' and XII, ``Discipline and Trial Proceedings.''
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    Currently, the Exchange's rules permit a person (referred to as an 
``approved lessor'') to purchase a membership solely for the purpose of 
providing a financing mechanism for another person that seeks access to 
the Exchange.\63\ Following demutualization, the Exchange's rules will 
be amended to delete Article IA of the CHX rules. Accordingly, 
following demutualization, no person may operate as an approved lessor 
or otherwise lease trading access to the Exchange.
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    \63\ See CHX Rules, Article IA.
---------------------------------------------------------------------------

    There will be nominal processing charges and application fees 
relating to the issuance of trading permits. In addition, all 
participants and participant firms will be subject to an initial annual 
trading permit fee of $6,000 per year, payable monthly, for each 
trading permit.\64\ These new fees are set out in the proposed 
amendments to the Schedule of Member Dues and Fees.\65\
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    \64\ This fee is identical to the fee currently charged by the 
Exchange for membership dues.
    \65\ See proposed Schedule of Membership Dues and Fees.
---------------------------------------------------------------------------

    (4) Other Provisions in the Certificate of Incorporation and Bylaws
    (a) Stockholder Ownership. The proposed Bylaws for CHX Holdings and 
the CHX contain a variety of provisions relating to issues associated 
with stockholder ownership, including provisions relating to the timing 
and conduct of meetings, record dates, quorum requirements, proxies, 
and other matters.\66\ These provisions are designed to reflect current 
corporate practices and are identical for CHX Holdings and the CHX.
---------------------------------------------------------------------------

    \66\ See proposed Article IV of the CHX Holdings Bylaws and 
proposed Article III of the CHX Bylaws.
---------------------------------------------------------------------------

    (b) Updated provisions of the CHX Charter and Bylaws. The Exchange 
is proposing a few changes to its Bylaws and Certificate of 
Incorporation to modernize the Exchange's governing documents. Among 
other things, the Exchange is proposing: to include a streamlined 
description of its corporate purpose; to confirm that the CHX Board has 
the authority to set the CHX Board's compensation; to set out specific 
provisions relating to the authority of Exchange officers to enter into 
contracts, sign checks, and handle the funds of the Exchange; and to 
specifically provide that the Exchange will advance expenses, in 
appropriate circumstances, to directors, officers, and committee 
members of the CHX who are named as defendants in certain actions 
relating to Exchange business.\67\ Identical provisions are proposed 
for the Certificate of Incorporation and Bylaws of CHX Holdings. The 
Exchange believes that these provisions are consistent with current 
corporate practices relating to these issues.
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    \67\ See proposed CHX Certificate of Incorporation, Article 
Third (corporate purpose) and proposed CHX Bylaws Article II, 
Section 15 (board compensation), Article IX (contracts, loans, 
checks and deposits), and Article VI (indemnification and advancing 
of expenses).
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    (5) Summary of Rule Change Not Related to Demutualization. In 
connection with its comprehensive review of its rules as part of this 
demutualization, the Exchange is proposing to delete the following rule 
provisions that relate to events that have already occurred or to 
programs that the Exchange no longer offers: Article IB, ``E-Session 
Trading Privileges''; Article XI, Rules 11, ``Mandatory Year 2000 
Testing,'' and 12, ``Mandatory Decimal Pricing Testing;'' and Article 
XIII, Rule 4, ``Advertisements, Market Sales Literature Relating to 
Options and Communications to Customers.''
    (6) Administrative Issues
    (a) Membership market. CHX members will be able to buy and sell CHX 
memberships until the close of the seat market on the 11th business day 
prior to the expected Effective Date of the demutualization 
transaction.\68\ All existing bids and offers in the seat market will 
be immediately cancelled at the close of the seat market on that day 
because the required posting procedures associated with any 
transactions consummated after that date could not be completed before 
the Effective Date of the transaction. This hiatus in the membership 
market will permit the Exchange to identify with certainty the persons 
and firms who hold membership interests and are entitled to receive 
shares on the Effective Date of the transaction.
---------------------------------------------------------------------------

    \68\ See Amendment No. 1, supra note 3.
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    (b) Approval of demutualization transaction. Under the Exchange's 
rules, an approved lessor who is not a qualified trading member of the 
Exchange is not entitled to vote his membership interest. If such a 
membership interest is leased to an Exchange member, the lessee may 
vote the membership interest, but, if the membership interest has not 
been leased, there is no vote associated with that membership interest.
    The CHX's Board of Governors determined that it is appropriate to 
provide these approved lessors holding unleased membership interests 
with an opportunity to vote on the demutualization transaction. As a 
result, the CHX's Board of Governors conditioned the demutualization 
transaction on approval by the affirmative vote of both (1) a majority 
of the membership interests entitled to vote on the election of 
governors of the Exchange, and (2) a majority of all of the outstanding 
memberships of the Exchange. The first vote count was conducted in a 
manner consistent with prior votes of Exchange members and included 
votes cast with respect to memberships owned by (a) qualified trading 
members of the Exchange (whether or not those memberships are leased to 
other CHX members) and (b) approved lessors who were not qualified 
trading members of the Exchange where the memberships are leased to CHX 
members. The second vote count included all of the votes cast in the 
first count, as well as votes cast by approved lessors who were not 
qualified trading members of the Exchange where the memberships were 
not leased to CHX members. On November 11, 2004, the persons voting in 
these two vote counts approved the proposal to demutualize the CHX.\69\
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    \69\ See Amendment No. 1, supra note 3.

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[[Page 77802]]

2. Statutory Basis
    The CHX believes the proposal 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.\70\ The CHX believes the 
proposal is consistent with Section 6(b)(5) of the Act \71\ in that it 
would create a governance and regulatory structure of the Exchange that 
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. The Exchange represents that it 
remains committed to its role as a national securities exchange and 
does not believe that the proposed change to a for-profit institution 
will undermine its responsibilities for regulating its marketplace. 
Indeed, as described above, the Exchange believes that it has proposed 
specific provisions in the Bylaws of both CHX Holdings and the 
demutualized CHX that reinforce the ability of the Exchange to perform 
its self-regulatory functions.
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    \70\ 15 U.S.C. 78f(b).
    \71\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Moreover, according to the CHX, the Exchange is not proposing any 
significant changes to its existing operational and trading structure 
in connection with the demutualization. Instead, the CHX represents 
that the proposed rule change primarily consists of: organizational 
changes to the CHX Certificate of Incorporation and Bylaws reflecting 
the change in corporate form; governance changes that will reduce the 
size of the CHX Board and modify certain provisions governing the CHX 
committees; and membership rule changes that are necessary to implement 
the new CHX trading permit structure, which will replace the existing 
structure of owning and leasing Exchange memberships as a basis for 
trading rights. The proposed rule change also includes the CHX Holdings 
Certificate of Incorporation and Bylaws. Although the proposed 
governance structure does not reflect all of the proposals put forward 
by the Commission in its latest release on self-regulatory 
governance,\72\ the Exchange believes that it is consistent with 
governance changes approved by the Commission for other demutualized 
exchanges and does not serve to erode the principles articulated in the 
Commission's recent governance release.
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    \72\ See Securities Exchange Act Release No. 50699 (November 18, 
2004), 69 FR 71126 (December 8, 2004) (File No. S7-39-04).
---------------------------------------------------------------------------

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 proposal 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 2004-26 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 No. SR-CHX-2004-26. 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 changes 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 Room, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing will also 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 No. SR-CHX-2004-26 and should be 
submitted on or before January 18, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\73\
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    \73\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-28275 Filed 12-27-04; 8:45 am]
BILLING CODE 8010-01-P