[Federal Register Volume 62, Number 8 (Monday, January 13, 1997)]
[Notices]
[Pages 1788-1790]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-690]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38119; File No. SR-CHX-96-16]
Self-Regulatory Organizations; the Chicago Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to the Trading
of Nasdaq/NM Securities on the CHX
January 3, 1997.
I. Introduction
On June 14, 1996, the Chicago Stock Exchange, Inc. (``CHX'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``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 Article XX, Rule 37 and
Article XX, Rule 43 relating to the trading of Nasdaq National Market
(``Nasdaq/NM'') securities (previously known as NASDAQ/NMS securities)
on the Exchange.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ On Dec. 19, 1996, the CHX filed Amendment No. 1 to its
proposal. Letter from J. Craig Long, Attorney, Foley & Lardner, to
Howard L. Kramer, Associate Director, Division of Market Regulation,
SEC, dated Dec. 19, 1996. In Amendment No. 1, the CHX requested that
the Commission approve the proposal on a pilot basis for a one year
period.
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The proposed rule change was published for comment in the Federal
Register on July 2, 1996.\4\ No comments were received on the proposal.
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\4\ See Securities Exchange Act Release No. 37369 (June 25,
1996), 61 FR 34462 (July 2, 1996) (notice of File No. SR-CHX-96-16)
(``Notice'').
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II. Background
On May 4, 1987, the Commission approved certain Exchange rules and
procedures relating to the trading of Nasdaq/NM securities on the
Exchange.\5\ Among other things, these rules made the Exchange's BEST
Rule guarantee (Article XX, Rule 37(a)) applicable to Nasdaq/NM
securities and made Nasdaq/NM securities eligible for the automatic
execution feature of the Exchange's Midwest Automated Execution System
(``MAX system'').\6\
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\5\ Securities Exchange Act Release No. 24424 (May 4, 1987), 52
FR 17868 (May 12, 1987) (order approving File No. SR-MSE-87-2). See
Securities Exchange Act Release Nos. 28146 (June 26, 1990), 55 FR
27917 (July 6, 1990) (order expanding the number of eligible
securities to 100); 36102 (August 14, 1995), 60 FR 43626 (August 22,
1995) (order expanding the number of eligible securities to 500).
\6\ The MAX system may be used to provide an automated delivery
and execution facility for orders that are eligible for execution
under the Exchange's BEST Rule and certain other orders. See CHX,
Art. XX, Rule 37(b).
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1. BEST Rule \7\
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\7\ See CHX Manual, Art. XX, Rule 37(a).
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Currently, under the BEST Rule, Exchange specialists are required
to guarantee executions of all agency \8\ market and limit orders for
Dual Trading System issues \9\ and all agency market orders for Nasdaq/
NM securities, from 100 up to and including 2099 shares. Subject to the
requirements of the short sale rule,\10\ the specialist must fill all
agency market orders at a price equal to or greater than the national
best bid or best offer (``NBBO''). For all agency limit orders in Dual
Trading System issues, the specialist must fill the order if: (1) the
NBBO at the limit price has been exhausted in the primary market; (2)
there has been a price penetration of the limit in the primary market
(generally known as a trade-through of a CHX limit order); or (3) the
issue is trading at the limit price on the primary market unless it can
be demonstrated that the order would not have been executed if it had
been transmitted to the primary market or the broker and specialist
agree to a specific volume related to, or other criteria for, requiring
a fill.
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\8\ The term ``agency order'' means an order for the account of
a customer, but shall not include professional orders as defined in
CHX, Article XXX, Rule 2, interpretation and policy .04. The Rule
defines a ``professional order'' as any order for the account of a
broker-dealer, the account of an associated person of a broker-
dealer, or any account in which a broker-dealer or an associated
person of a broker-dealer has any direct or indirect interest. Id.
\9\ According to the Exchange, Dual Trading System Issues are
issues that are traded on the CHX, pursuant to unlisted trading
privileges, and listed on either the New York Stock Exchange or
American Stock Exchange. Telephone conversation on June 5, 1996
between David T. Rusoff, Attorney, Foley & Lardner, and George A.
Villasana, Attorney, Division of Market Regulation, SEC.
\10\ While the Commission and the NASD have rules that prohibit
short sales, under certain conditions, or securities registered on,
or admitted to unlisted trading privileges on, a national securities
exchange and short sales of securities traded on Nasdaq, there is no
rule governing short sales in Nasdaq/NM securities traded on the
CHX. See 17 CFR Sec. 240.10a-1 and NASD Rule 3350.
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2. MAX System
The Exchange's MAX system provides for the automatic execution of
orders that are eligible for execution under the Exchange's BEST Rule
(i.e., agency market orders in securities listed on the NYSE or AMEX
and Nasdaq/NM securities, as discussed above), and certain other
orders.\11\
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\11\ A MAX order that fits under the BEST parameters must be
executed pursuant to BEST Rules via the MAX system. If the order is
outside the BEST parameters, the BEST Rules do not apply, but MAX
system handling rules do apply.
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The MAX system has two size parameters which must be designated by
the specialist on a stock-by-stock basis. Currently, the specialist
must set the auto-execution threshold at 1099 shares or greater and the
auto-acceptance threshold at 2099 shares or greater. In no event may
the auto-acceptance threshold be less than the auto-execution
threshold. If the order-entry firm sends an order through the MAX
system that is greater than the specialist's auto-acceptance threshold,
a specialist may cancel the order within three minutes of it being
entered into MAX. If not canceled by the specialist, the order is
designated as an open order.\12\ If the order-entry firm sends an order
through MAX that is less than the auto-acceptance threshold but greater
than the auto-execution threshold, the order is not available for
automatic execution but is designated in the open order book. A
specialist may manually execute any portion of the order; the
difference must remain as an open order. If the order-entry firm sends
an order through MAX that is less than or equal to the auto-execution
threshold, the order is executed automatically.
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\12\ If an oversized market or limit order is received by the
specialist, he will either reject the order immediately or display
it. If the order is displayed, the specialist will check with the
order entry broker to determine the validity of the oversized order.
During the three minute period, the specialist can cancel the order
and return it to the order entry firm, but until it is cancelled the
displayed order is eligible for execution. Although these procedures
currently exist under CHX rules, the Commission has concerns as to
whether the three minute period is necessary and urges the CHX to
reduce the time period or otherwise address the necessity of the
specialists' discretion during the three minute period. Moreover,
the handling of orders by CHX specialists must still comply with the
Commission's recently adopted Order Execution Rules (Securities
Exchange Act Release No. 37619A (Sept. 6, 1996), 61 FR 48290 (Sept.
12, 1996)) and any subsequently issued interpretations of the Order
Execution Rules.
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The MAX system currently provides for a fifteen second delay
between the time an agency market order is entered into the MAX system
and the time it is automatically executed at the NBBO in
[[Page 1789]]
order to provide the specialist with an opportunity to provide price
improvement to the order. If, however, the spread between the NBBO in a
stock eligible for automatic execution in the MAX system is \1/8\ point
at the time an order is entered into the MAX system, that order is
executed immediately without the fifteen second delay. Non-marketable
agency limit orders, subject to the BEST Rule, are automatically filled
at the limit price when there is a price penetration of the limit price
in the primary market.\13\
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\13\ If, however, the difference between the trade-through price
and the last sale price is greater than \1/4\ point or 1% of the
value of the trade-through price, whichever is less, a second print
at a trade-through price, which is less than \1/4\ point or 1% away
from the previous trade-through price is necessary before that MAX
system will automatically execute the agency limit order.
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III. Description of Proposal
The Exchange proposes to end its requirement that CHX specialists
automatically execute orders in Nasdaq/NM securities when the
specialist is not quoting at the NBBO.
Under the proposed revisions to the BEST Rule, specialists must
continue to accept agency market orders or marketable limit orders, but
only for orders of 100 to 1000 shares in Nasdaq/NM securities rather
than the 2099 shares limit previously in place.\14\ Specialists must
accept all agency limit orders in Nasdaq/NM securities from 100 up to
and including 10,000 shares for placement in the limit order book. As
described below, however, specialists would be required to
automatically execute Nasdaq/NM orders only when they were quoting to
the NBBO when the order was received.
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\14\ The 100 to 2099 share auto-acceptance threshold previously
in place will only continue to apply to Dually Listed securities.
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The proposal requires the specialist to set the auto-executive
threshold at 1000 shares or greater for Nasdaq/NM securities. Orders
for a number of shares less than or equal to the auto-execution
threshold set by the specialist will be automatically executed if the
CHX specialist is quoting at the NBBO for the lesser of the size of the
order or the specialist's quote. The orders are executed automatically
after a fifteen second delay from the time the order is entered into
MAX. The size of the specialist's bid or offer will automatically be
decremented by the size of the execution. When the specialist's quote
is exhausted, the system will generate an autoquote at \1/8\ point away
from the NBBO for 1000 shares.
When the specialist is not quoting a Nasdaq/NM security at the
NBBO, it can elect, on an order-by-order basis, to manually execute
orders in that security. If the specialist does not elect manual
execution, MAX market and marketable limit orders in that security that
are of a size equal to or less than the auto-execution threshold will
automatically be executed at the NBBO after a twenty second delay.\15\
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\15\ The CHX has clarified that the twenty second delay is
designed, in part, to provide an opportunity for the order to
receive price improvement from the specialist's displayed quote. Id.
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Under the proposal, if the specialist elects manual execution, the
specialist must either manually execute the order at the NBBO or a
better price or act as agent for the order in seeking to obtain the
best available price for the order on a marketplace other than the
Exchange.\16\ If the specialist decides to act as agent for the order,
the proposed rule requires the specialist to use order-routing systems
to obtain an execution where appropriate. Market and marketable limit
orders that are for a number of shares greater than the auto-execution
threshold are not subject to these requirements, and may be canceled
within three minutes of being entered into MAX or designated as an open
order.
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\16\ Letter dated Aug. 1, 1996 from David Rusoff, Attorney,
Foley & Lardner, to George A. Villasana, Attorney, Securities &
Exchange Commission.
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IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, with the requirements of Section 6(b).\17\ In particular,
the Commission believes the proposal is consistent with the
requirements of Section 6(b)(5) that the rules of an exchange be
designed to promote just and equitable principles of trade, to prevent
fraudulent and manipulative acts, and, in general, to protect investors
and the public interest. The Commission also believes that the proposal
is consistent with Sections 11A(1)(D) and 11A(1)(C) of the Act.
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\17\ 15 U.S.C. 78f(b).
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The CHX's proposal to not require automatic execution for Nasdaq/NM
securities when the specialist is not quoting at the NBBO, and to allow
the specialist to execute the order as agent, is intended to conform
CHX specialist obligations to those applicable to OTC market makers in
Nasdaq/NM securities, while recognizing that the CHX provides a
separate, competitive market for Nasdaq/NM securities. The rules
establish execution procedures and guarantees that attempt to provide
an execution reflective of the best quotes among OTC market makers and
specialists in Nasdaq/NM securities without subjecting CHX specialists
to execution guarantees that are substantially greater than those
imposed on their competitors.
The Commission does not believe that the Act necessarily requires
the CHX to provide automatic execution of orders. Nonetheless, if the
CHX chooses to make available an order-routing system to its members,
to be consistent with the Act, this system must not be designed in a
manner that will result in customer orders receiving executions at
prices worse than those reasonably available in the market, which
generally would be the NBBO. Otherwise, members could violate their
best execution duty to their customers if they used the system. The
CHX's proposed modification of its MAX system seeks to ensure that
customer orders receive the best prices by requiring specialists, if
they do not execute orders automatically at the NBBO or better, at a
minimum to represent the orders as agent off the Exchange.
Under these circumstances, CHX Rule 43 requires a specialist to use
order-routing systems where appropriate. At present, however, CHX
specialists have available only limited order-routing systems. A CHX
specialist currently can route orders to Nasdaq market makers only via
the telephone or, if the CHX specialist is an NASD member, through
Selectnet and SOES.\18\ Clearly, a more efficient linkage between the
CHX and Nasdaq would better enable CHX specialists to access OTC market
makers quickly on a consistent basis.
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\18\ The CHX has represented that a CHX specialist in Nasdaq/NM
securities, if not an NASD member, currently may use a CHX member
that is also an NASD member to route orders via SelectNet and SOES
to Nasdaq/NM market makers. The CHX has explained further that this
access currently is provided by the NASD member to an existing CHX
specialist in Nasdaq/NM securities, but the arrangement may not
necessarily apply to any future CHX specialists in Nasdaq/NM
securities. Thus, the CHX has indicated that it will not allocate
any Nasdaq/NM securities to any additional CHX specialists until an
order-routing linkage is completed between the CHX and the Nasdaq.
Telephone conversation on October 29, 1996 between Craig Long, Esq.,
Foley & Lardner, and Betsy Prout Lefler, Esq., Division of Market
Regulation, SEC.
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While operation of the proposed system is not necessarily
inconsistent with the duty of CHX specialists to provide best execution
of customer orders, the Commission believes that the arrangement in
place for specialists to access OTC market makers is not an ideal
linkage between two markets on a permanent basis. Consequently, the CHX
has represented that it intends to
[[Page 1790]]
work towards quickly establishing a linkage between the CHX systems and
Nasdaq systems in order to permit market makers in each market to route
orders to the other market center.\19\ Consequently, the Commission is
approving the CHX proposal for only one year, during which time the
Commission expects the CHX and Nasdaq to effectuate a linkage. The
Commission also expects the CHX to monitor closely the executions
provided to CHX market and marketable limit orders for Nasdaq/NM
securities that are not automatically executed at the NBBO (or better)
at the time the order is received. The Commission further requests that
the Exchange submit to the Commission a report, based on six months of
trading data, on or before 240 days following the issuance of this
order, that describes the executions provided these orders.
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\19\ See Amendment No. 1, supra note 3.
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The Commission is approving the CHX proposal on a pilot basis for a
one-year period beginning in January 1997 and extending through
December 1997. The Commission's approval is based, in part, on CHX's
expressed commitment to work in good faith with the Nasdaq, during the
one-year pilot period, to set up an order routing system between the
Nasdaq and the CHX.\20\
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\20\ Id.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\21\ that the proposed rule change (SR-CHX-96-16) is approved.
\21\ 15 U.S.C. 78s(b)(2)
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
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\22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-690 Filed 1-10-97; 8:45 am]
BILLING CODE 8010-01-M
