01-30140. Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by The Chicago Stock Exchange, Incorporated, Relating to Eligibility of Limit Orders for Trade Through Protection

November 28, 2001.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“the Act”),^[1] and Rule 19b-4 thereunder,^[2] notice is hereby is given that on August 6, 2001, the Chicago Stock Exchange, Incorporated (“CHX” or “Exchange”) filed with the Securities and Exchange Commission (“Commission” or “SEC”) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the self-regulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

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(b)(6), which governs execution of limit orders in the specialist's book in the event of a trade through in the primary market. The proposed rule change would require that a limit order be resident in the specialist's book for a time period of 0-15 seconds (as designated by the specialist) before it would be eligible for limit order protection. The text of the proposed rule change is available from the Office of the Secretary, 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 Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received regarding the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

1. Purpose

The Exchange proposes to amend Article XX, Rule 37(b)(6) of its rules, which governs execution of limit orders in the specialist's book in the event of a trade through in the primary market. The proposed rule change would require that a limit order be resident in the specialist's book for a time period of 0-15 seconds (as designated by the specialist) before it would be eligible for limit order protection.

Under current CHX rules, limit orders resting in a specialists's book are afforded trade through protection, which requires execution of the limit orders in the event of a price penetration in the primary market. The limit orders are entitled to price protection in their entirety regardless of their size. The Exchange represents that, at present, an order sender is able to take advantage of the time latency between a primary market execution and the reporting of the execution to the tape to gain these liquidity guarantees. The Exchange believes that an order sender will do so by placing a large limit order in a CHX specialist's book between the time of the primary market execution and the tape print. The limit order will typically be priced at a penny or two superior to the primary market trade price. According to the Exchange, the print of the inferior priced primary market trade will cause an automatic execution of the limit order in its entirety on the CHX at the limit price, thus giving the order sender inexpensive access to large amounts of liquidity.

In the example above, the Exchange explains that the limit order would not be due an execution because it was not “resting” on the specialist's book at the time the trade through occurred in the primary market. Rather, it was resting at the time the trade through execution was reported to the tape. The Exchange believes that this practice exploits a limitation in the trade reporting system that equates “trade time” with “report time.” The Exchange believes that this practice has grown more prevalent with the transition to a decimal pricing environment because the premium needed to secure the increased liquidity (the minimum price variation) has been reduced to a penny.

The proposed rule change would provide that before a limit order in the specialist's book is automatically executed following a price penetration in the primary market, the limit order must have resided in the specialist's book for a time period of 0-15 seconds (as designed by the specialist).^[3] This requirement is intended to preclude order-senders from taking advantage of the time latency between a primary market execution and the reporting of the execution to the tape.

2. Statutory Basis

The Exchange believes that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder that are applicable to a national securities exchange, and, in particular, with the requirements of section 6(b).^[4] In particular, the proposed rule is consistent with section 6(b)(5) of the Act ^[5] in that it is designed to promote just and equitable principles of trade, to remove impediments to 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.

B. Self-Regulatory Organization's Statement on Burden on Competition

The Exchange does not believe that the proposed rule change will impose my inappropriate burden on competition.

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

Written comments were neither solicited nor 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 longer 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 is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington DC 20549-0609. 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 at the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the Exchange. All submissions should refer to File No. SR-CHX-2001-17 and should be submitted by December 26, 2001.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[6]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  A specialist might chose a lesser time as a competitive inducement to attract order flow.

4.  15 U.S.C. 78f(b).

5.  15 U.S.C. 78f(b)(5).

6.  17 CFR 200.30-3(a)(12).