[Federal Register Volume 70, Number 134 (Thursday, July 14, 2005)]
[Notices]
[Pages 40760-40762]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-3743]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51997; File No. SR-CHX-2004-17]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto To 
Amend Article XX, Rule 37(a)(3) of Its Rules To Eliminate Its 
Requirement That Specialists Guarantee Execution of Limit Orders When 
Certain Conditions Occur in Another Market

July 8, 2005.
    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 June 21, 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 July 5, 
2005, the Exchange filed an amendment to the proposed rule change.\3\ 
The Commission is publishing this notice to solicit

[[Page 40761]]

comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Amendment No. 1 dated July 5, 2005, replacing the 
original filing in its entirety. In Amendment No. 1, the Exchange 
modified the text of the proposed rule change and the discussion in 
response to comments by the Commission staff.
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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 CHX Article XX, Rule 37(a)(3), which 
provides for execution of resting CHX limit orders based on activity in 
other markets, to permit, but not require, CHX specialists to guarantee 
execution of such limit orders when certain conditions occur in another 
market. The text of the proposed rule change, as amended, is available 
on CHX's Web site (http://www.chx.com/marketreg/proposed rules.htm), at 
CHX's principal office, and at the Commission's Public Reference Room.

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 Changes

1. Purpose
    The Exchange proposes to amend Article XX, Rule 37(a) of the CHX 
Rules, which provides for execution of resting CHX limit orders based 
on activity in other markets. The proposed rule change would permit, 
but not require, CHX specialists to guarantee execution of such limit 
orders when certain conditions occur in another market.

Background

    CHX Article XX, Rule 37(a)(3) sets out specific execution 
guarantees for eligible limit orders. For listed issues, the rule 
generally obligates a CHX specialist to guarantee execution of limit 
orders resting in the specialist's book, when the issue is being traded 
in the primary market at a price equal to or better than the limit 
price. For NASDAQ/NM securities, the rule permits, but does not 
require, a CHX specialist to guarantee execution of limit orders 
resting in the specialist's book, when another market center's 
quotation locks or crosses the limit price.
    The guarantees set forth in CHX Article XX, Rule 37(a)(3), commonly 
referred to as ``limit order protection'' or ``primary market 
protection,'' were adopted voluntarily by the CHX over 15 years ago, as 
a means of attracting order flow. As noted by the Commission, the 
Exchange's initiatives relating to primary market protection were 
intended to ensure ``* * * fair competition among exchange markets, 
which benefits public investors.'' \4\
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    \4\ See Securities Exchange Act Release No. 32124 (April 13, 
1993), 58 FR 21325 (April 20, 1993). The Exchange believes that 
other regional exchanges have enacted similar rule-based guarantees. 
See, e.g., BSE Chapter II, Section 33, Interpretation and Policy 
.01, NSX Rule 11.9, and Phlx Rule 229. The Exchange believes that 
the rule-based guarantees were enacted on a strictly voluntary basis 
and were not required by the Act or by any requirement promulgated 
by Congress or the Commission in accordance with the Act, including 
the Order Handling Rules issued by the Commission in 1996. See 
Securities Exchange Act Release No. 37619A (September 6, 1996), 61 
FR 48290 (September 12, 1996). The standards for execution of limit 
orders set forth in the Order Handling Rules do not require that 
best execution be measured on an order-by-order basis. Rather, they 
contemplate evaluation using aggregate standards.
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Industry Changes Since Adoption of the Execution Guarantees

    As our industry has evolved, the Exchange's principal competitors 
for order flow, namely ``third market'' execution venues and 
alternative trading systems, do not provide such limit order protection 
guarantees. Accordingly, the Exchange believes that the guarantees no 
longer serve a clear competitive purpose. This is particularly the case 
in recent years, since CHX order-sending firms now have free access to 
comprehensive monthly order execution quality statistics, rendering 
``front-end'' execution guarantees unnecessary as a means of attracting 
order flow. Firms are able to closely monitor execution quality and, 
thereby, ensure that they are meeting their best execution obligations, 
without relying on rule-based guarantees.\5\
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    \5\ The Exchange notes the dramatic increase in market share 
that has been achieved by several of the Exchange's third market 
competitors as evidence that order-sending firms no longer consider 
rule-based execution guarantees essential to their order-routing 
decisions, or presumably to satisfaction of their best execution 
obligations.
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    Compounding the lack of competitive value, the guarantees currently 
subject CHX specialists to exposure that was never intended when the 
rule-based guarantees were enacted. Since the securities industry 
conversion to decimal trading, the availability of liquidity at a best 
bid or offer (``BBO'') price point has declined, in many cases 
significantly. The CHX specialist, if he chooses to offset his 
positions in another market, often encounters great difficulty in 
accessing liquidity at the price that he is obligated to provide. 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.
    Many CHX specialists, thus, believe that it is no longer 
appropriate to mandate that specialists guarantee execution of resting 
limit orders for listed issues, based on activity in other market 
centers. Indeed, they believe that in today's trading environment, the 
limit order execution guarantee exposes them to unwarranted liability, 
which they often have limited ability to mitigate.\6\
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    \6\ In fact, the exposure of a CHX specialist exceeds that of a 
specialist on the primary market, whose best execution obligation 
effectively requires only that he guarantee a limit order execution, 
if another market executes an order at a price better than the limit 
price. Under the current CHX rule, the CHX specialist is required to 
execute a limit order, if the primary market executes an order at 
the limit price.
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    In short, the CHX believes that the environment has changed 
significantly since it voluntarily enacted its rule-based execution 
guarantees, warranting the amendments proposed by the CHX. The CHX 
believes that the guarantees no longer foster significant competition 
between markets. Absent this benefit to investors, the Exchange 
believes that there is no legal basis for continuing to mandate such 
guarantees, which, as discussed above, are not required under the Act 
or other requirements promulgated by Congress or the Commission. 
Accordingly, the Exchange believes that it is appropriate to render 
such guarantees voluntary, on the terms outlined below.

Proposed Rule Change

    Under the proposed revision to CHX Article XX, Rule 37(a)(3), the 
mandate that CHX specialists guarantee execution of resting limit 
orders for listed issues, based on triggering activity in other 
markets, would be deleted. Instead, the amended rule would permit CHX 
specialists to continue to provide such guarantees solely on an issue-
by-issue basis, on non-discriminatory terms approved by the Exchange. 
The Exchange's existing functionality providing for automated execution 
of resting limit orders would remain available for CHX specialists who 
elect to continue to guarantee limit order protection.\7\
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    \7\ The Exchange anticipates that for the foreseeable future, 
CHX specialists would continue to provide limit order protection 
voluntarily, using the criteria for voluntary limit order protection 
currently set forth in CHX Article XX, Rule 37(a)(3). To the extent 
that the Exchange approved some variation in the limit order 
protection criteria, the Exchange would notify all CHX participants 
of this change.

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[[Page 40762]]

    Significantly, deletion of the rule-based mandate regarding limit 
order protection would not remove a CHX specialist's obligation to 
provide a timely best execution for each order, nor would it modify any 
other specialist obligations set forth in CHX Article XXX of the CHX 
Rules. The CHX Department of Market Regulation would continue its 
surveillance of order executions to ensure that CHX specialists meet 
all of their obligations to each order. Accordingly, many CHX 
specialists would continue to execute resting limit orders for listed 
issues voluntarily, when quotes or executions at the limit price occur 
in other markets, as a means of satisfying their best execution 
obligations and maintaining superior execution quality statistics.
2. Statutory Basis
    The Exchange believes that the proposal, as amended, 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.\8\ 
Specifically, the CHX believes that the proposal, as amended, is 
consistent with Section 6(b)(5) of the Act,\9\ 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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    \8\ 15 U.S.C. 78f(b).
    \9\ 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, as 
amended, will impose any burden on competition.

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

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Changes 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-2004-17 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File No. SR-CHX-2004-17. 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 Room. 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-2004-17 and should be submitted on or before August 4, 
2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-3743 Filed 7-13-05; 8:45 am]
BILLING CODE 8010-01-P