[Federal Register Volume 59, Number 47 (Thursday, March 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5476]
[[Page Unknown]]
[Federal Register: March 10, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33708; File No. SR-MSE-93-05]
Self-Regulatory Organizations; Midwest Stock Exchange, Inc.;
Order Approving Proposed Rule Change and Amendment No. 1 to Proposed
Rule Change and Notice of Filing and Order Granting Accelerated
Approval to Amendment No. 2 to Proposed Rule Change Relating to Agency
Crosses Between the Disseminated Exchange Market
March 3, 1994.
I. Introduction
On March 2, 1993, the Midwest Stock Exchange, Inc. (``MSE,''
``Exchange'' or ``Chicago Stock Exchange'')\1\ submitted to the
Securities and Exchange Commission (``SEC'' or ``Commission''),
pursuant to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\2\ and rule 19b-4 thereunder,\3\ a proposed rule change
relating to the execution of agency cross transactions at a price
between the disseminated Exchange market. On December 10, 1993, the MSE
submitted to the Commission Amendment No. 1 to the proposed rule change
in order to summarize and respond to a comment letter it received in
opposition to this proposal.\4\ On February 16, 1994, the MSE submitted
Amendment No. 2 to the proposed rule change to specify that the
proposal only applies to block trades and to clarify the Exchange's
position regarding specialist participation in cross transactions.\5\
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\1\As of July 8, 1993, the MSE changed its name to the Chicago
Stock Exchange, Inc. (``CHX''). See Securities Exchange Act Release
Nos. 32488 (June 18, 1993), 58 FR 34284 (June 24, 1993) (File No.
SR-MSE-93-13) (immediate effectiveness of proposed rule change to
amend the MSE's Certificate of Incorporation and Constitution to
effect a name change); and 32489 (June 18, 1993), 58 FR 34285 (June
24, 1993) (File No. SR-MSE-93-16) (immediate effectiveness of
proposed rule change to make conforming changes to the MSE Rules.)
\2\15 U.S.C. 78s(b)(1) (1988).
\3\17 CFR 240.19b-4 (1991).
\4\See letter from David T. Rusoff, Foley & Lardner, to Beth A.
Stekler, Attorney, Division of Market Regulation, SEC, dated
December 9, 1993 (``Amendment No. 1'').
\5\See letter from David T. Rusoff, Foley & Lardner, to Sharon
Lawson, Assistant Director, Division of Market Regulation, SEC,
dated February 15, 1994 (``Amendment No. 2'').
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 33500 (January 21, 1994), 59 FR 4128 (January
28, 1994). One comment letter was received on the proposal.\6\ This
order approves the proposed rule change, including both amendments.
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\6\See letter from Robert Hill, Vice President, The Chicago
Corporation, to the Executive Committee, MSE, dated October 20, 1992
(``Hill comment letter''). The Hill comment letter was forwarded to
the Commission as part of Amendment No. 1, supra, note 4.
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II. Description of the Proposal
Article XX, Rule 23 of the Exchange's rules outlines the current
method for the execution of cross transactions on the MSE.\7\ Under
that rule (in conjunction with the MSE's priority rule), a member or
member organization effecting a cross transaction first must assure
that all existing bids or offers, at or better than the cross price,
are filled at their limits.\8\ Thereafter, the member or member
organization must publicly announce both sides of the cross; the
member's offer must be higher than its bid by at least the minimum
variation permitted for that security.\9\ Rule 23 then allows the
member or member organization to execute the cross transaction at its
bid or offer. Under this method, however, another member can ``break
up'' the cross, by trading with either the bid or offer side of the
transaction when it is presented to the crowd. According to the
Exchange, the ability of the specialist, in particular, to participate
in a cross transaction decreases the likelihood of the order sending
firm receiving an immediate execution.
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\7\In a cross transaction, a member or member organization that
holds an order to buy and an order to sell an equivalent amount of
the same security wishes to execute the orders against each other.
Because it already holds both sides of the trade, the member does
not want the orders to interact with other market interest.
\8\As a general matter, the bid/offer entered at the best price
(i.e., the highest bid or the lowest offer) is entitled to priority
over bids/offers at inferior prices; similarly, the first bid/offer
clearly established at a given price is entitled to priority over
other bids/offers at the same price. See Article XX, rules 15-18 of
the MSE Rules.
\9\Article XX, Rule 22 of the MSE Rules sets forth the minimum
variation permitted for securities traded on the Exchange.
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The Exchange proposes to add a new Interpretation and Policy .01 to
Rule 23. Specifically, the proposed interpretation will require that
the MSE specialist refrain from interfering with a floor-brokered
agency cross,\10\ of 10,000 shares or more,\11\ at a cross price
between the disseminated Exchange market.\12\ Even if the above
requirement precludes specialist participation, once a cross is
executed, the specialist nevertheless will be obligated, as under
current rules, to satisfy all book orders with priority at the cross
price. In contrast, the MSE proposal will allow the specialist to
participate in a block agency cross if he or she has a disseminated bid
or offer at the cross price, regardless of the size thereof.\13\
Finally, the MSE has clarified that a specialist who is willing to
provide one side of the cross with a better price will have the
opportunity to do so.\14\
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\10\For purposes of this proposal, the Exchange has defined the
term ``agency cross'' as a cross where neither the order to buy nor
the order to sell is for the account of any member or member
organization (i.e., including, but not limited to, the member or
member organization executing the cross). Telephone conversation
between David T. Rusoff, Foley & Lardner, and Beth A. Stekler,
Attorney, Division of Market Regulation, SEC, on January 5, 1994.
\11\The proposed interpretation will not apply to crosses of
less than 10,000 shares. According to the Exchange, the current
rules, see supra notes 7-9 and accompanying text, will continue to
govern the execution of, and specialist participation in, crosses
that fall below the MSE's 10,000 share size threshold for block
trades. Telephone conversation between David T. Rusoff, Foley &
Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on February 18, 1994.
\12\However, the specialist will be allowed to participate if
the member presenting the cross previously solicited his or her
assistance in consummating any part of the transaction.
\13\In particular, the Exchange has indicated that a specialist
who is displaying a bid or offer at the cross price will be allowed
to participate at that price, even in a size greater than his or her
quotation. Telephone conversation between David T. Rusoff, Foley &
Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on December 20, 1993.
\14\See Amendment No. 2, supra, note 5.
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The MSE states that the purpose of the proposed rule change is to
increase the possibility of immediate execution of agency crosses on
the Exchange when the cross price is between the disseminated MSE
market. The Exchange believes that the proposed rule change is
consistent with section 6(b)(5) of the Act, in that it is designed to
promote just and equitable principles of trade, to remove impediments
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.
III. Comments Received and MSE Response
One comment letter on the proposed rule change, from a MSE
specialist, was received by the Exchange and forwarded to the
Commission.\15\ In his letter, the commentator recommends that the MSE
proposal be disapproved and raises several arguments, as discussed
below, in support of his position.
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\15\See Hill comment letter, supra, note 6.
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First, the commentator states that the MSE's rules have always
provided for the protection of customer orders, no matter how small,
and claims that this proposal represents a significant philosophical
change from that stance. The commentator fears that this will undermine
the Exchange's leverage in arguing for increased protection and
participation of public orders.
The letter also suggests that a new policy is not necessary at this
time. In the commentator's opinion, most instances where crosses are
broken up occur for legitimate reasons, and, while there may be
problems with certain specialists, overall brokers believe that the
current rules are adequate. Moreover, the commentator contends that the
Exchange does not have much to gain, except for ``window dressing
trades,'' from the proposed rule change. To this end, the commentator
states that the Exchange will receive little in the way of additional
transaction fees or CTA revenue.
In addition, the commentator argues that the proposed
interpretation makes no allowance for human slowness and asks what will
happen in busy markets. The commentator notes that a public order which
has come in to the MSE specialist, but has not yet been reflected in
his or her quote, cannot participate in a cross; the letter implies
that this result is contrary to the type of business an exchange (as
opposed to a crossing network) wants to encourage. In addition, the
commentator suggests that the new policy will be susceptible to abuse
because the MSE cannot determine, on an immediate basis, whether a
particular transaction is really an agency cross. His letter predicts
that monitoring ``after the fact'' will have a negative impact on the
Exchange's ability to attract business.
Finally, the commentator expresses concern that this proposal will
reduce the natural tension between specialist and broker that allows
for efficiency in the marketplace. The commentator argues that the
Exchange should be encouraging more orders and less crosses. From his
perspective, liquidity is based on the flow of orders into the price
discovery network, and, accordingly, it is not in the Exchange's
interest to facilitate what he describes as passively priced orders
that trade without interaction.
The MSE responded to the issues raised by the specialist's comment
letter.\16\ In its response, the MSE asserts that the proposed rule
change will not interfere with the execution of public orders on the
specialist's book. According to the Exchange, customer orders will
continue to be protected under its proposal, because the specialist
will be required to fill limit orders at the cross price, even if they
are not displayed due to the specialist's oversight. In the Exchange's
view, this requirement also should encourage specialists to be more
efficient in representing customer orders and to quote their true
market.
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\16\See Amendment No. 1, supra, note 4.
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Second, the MSE disputes the commentator's assessment of the costs
and benefits of the proposed rule change. The MSE believes that its new
policy will encourage more institutional trades to be routed to the
Exchange floor; whether this will result in more revenue is described
as a ``secondary consideration.'' In conclusion, the MSE states that
its proposal will create a more attractive marketplace for
institutional orders, without sacrificing traditional agency auction
market principles.
In addition, the MSE does not agree with the commentator that the
potential for abuse (i.e., by not having an agency order on both sides
of the trade) is a valid argument against adopting the proposed
interpretation in the first place. The Exchange states that many of its
present rules cannot be monitored for compliance on an immediate basis,
and pledges to take appropriate action if it finds that members are
abusing this rule.
Finally, according to the MSE, the proposed rule change will not
reduce the possibility of order interaction on the floor. The Exchange
notes that a specialist who is not displaying his or her market at the
cross price (and who has not previously been solicited for help) will
be the only one who cannot participate in a cross transaction. This
proposal will not affect the requirement that both sides of the cross
be announced publicly and/or the ability of other interest in the crowd
to participate. In fact, the MSE contends that, as a result of this
policy, more orders could be routed to the Exchange floor and could
take part in the auction process.
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 sections 6(b) and P11(a).\17\ In
particular, the Commission believes that the proposed rule change is
consistent with the section 6(b)(5) requirement 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; and with the section 6(b)(8)
requirement that the rules of an exchange not impose any unnecessary
burden on competition. The Commission also believes that the proposed
rule change does not operate in a manner inconsistent with the
traditional auction market principle of customer priority, as embodied
in section 11(a) of the Act.
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\17\15 U.S.C. 78f(b) (1988).
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After careful review of the comments received as well as the
applicable statutory provisions, the Commission has concluded that the
proposed rule change should further competition among the exchanges, as
well as between exchanges and other markets, and should increase the
opportunities for the efficient execution of cross transactions. In the
past, the Commission has recognized the competition that exists between
the various markets for order flow, and especially for block business.
Several exchanges recently have received Commission approval to amend
their rules, on the grounds that exchange rules may hinder members'
ability to execute a cross transaction without interference and thus
may place an exchange at a competitive disadvantage.\18\
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\18\See, e.g., Securities Exchange Act Release Nos. 27205
(August 31, 1989), 54 FR 37180 (September 7, 1989) (File No. SR-
Phlx-89-17) (approving Philadelphia Stock Exchange (``Phlx'')
proposal to prohibit members from interfering, with either side of
an agency cross or the customer side of a facilitation cross, by
buying or selling for their own account at the cross price; except
that a specialist can participate to the extent of a publicly
disseminated bid or offer at that price, or to better the price);
31343 (October 21, 1992), 57 FR 48645 (October 27, 1992) (File No.
SR-NYSE-90-39) (approving New York Stock Exchange (``NYSE'') ``clean
cross'' proposal to allow members to execute agency crosses of
25,000 shares or more, at a price at or within the prevailing
quotation, without interference, irrespective of any pre-existing
bids or offers at the cross price; however, the cross can be broken
up at a better price); and 33391 (December 28, 1993, 59 FR 336
(January 4, 1994) (File No. SR-PSE-91-11) (approving Pacific Stock
Exchange (``PSE'') proposal to prohibit specialists from
participating for their own account on either side of an agency
cross, or the customer side of a facilitation cross, at a price
within the disseminated PSE market; except that a specialist can
participate to better the price).
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In response to today's competitive market environment, the MSE has
proposed to add a new requirement that a specialist's proprietary bid
or offer must yield to a block agency cross at a cross price between
the prevailing Exchange quotation. The MSE's new policy, however, will
allow a specialist who has a disseminated bid or offer at the cross
price to participate at that price. On balance, the Commission believes
that the proposal will clarify the roles of various market participants
and assure that, under routine circumstances, crosses are executed in a
fair and orderly manner, without disadvantaging public customer orders.
For instance, the Commission has determined that, for a regional
exchange like the MSE, a size threshold of 10,000 shares is not
unreasonable. Similarly, specialists will be protected from yielding
priority if they have exposed themselves to market risk at the cross
price. Accordingly, the Commission finds that the proposed rule change
should improve the MSE's ability to compete for block business and
potentially could enhance the depth and liquidity of the Exchange
market.\19\
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\19\The Commission appreciates all the exchanges' competitive
concerns with respect to the facilitation of cross transactions and,
at the same time, continues to emphasize the importance of adherence
with traditional auction market principles.
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In terms of auction market principles, the Commission believes that
the proposed rule change strikes an appropriate balance between the
competing needs of various customer orders represented for execution on
the MSE and the proprietary trading operations of Exchange members and
member organizations, including specialists. The Commission notes that
the MSE's new policy only applies to crosses between the disseminated
Exchange market. Accordingly, a member effecting a cross transaction at
the prevailing bid or offer will, consistent with current rules, be
required to obtain priority over all existing limit orders at that
price.\20\ In the event that an order on the specialist's book has not
been displayed in the quote but has time priority, the MSE proposal
guarantees that, after an order is effected at its price (pursuant to
rule 23 or otherwise), that limit order will be filled, even if the
specialist is precluded from interfering with the cross on its behalf.
Thus the Commission has concluded that the MSE proposal adheres to the
auction market principles of time and price priority and that this
method for the execution of crosses (and, in particular, the priority
granted to block agency crosses) will not disadvantage existing
orders.\21\ In fact, limit orders on the MSE which coincide with the
cross price could benefit from being assured of receiving an execution
at that price.
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\20\See supra, note 8.
\21\In this regard, the MSE proposal contrasts favorably with
other rule changes approved by the Commission, such as the NYSE's
clean cross proposal, see supra note 18.
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Furthermore, the Commission finds that the MSE proposal does not
restrict the opportunity for customer orders to receive price
improvement. To this end, rule 23 will allow the specialist to
participate in a cross transaction to provide one side with a better
price, notwithstanding any other provisions of this rule.\22\ In
addition, under the proposed rule change, it is still possible for
interest in the trading crowd, including an order for the principal
account of a member, to break up the cross and improve the price.
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\22\See Amendment No. 2, supra, note 5.
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The Commission also believes that the MSE proposal would not grant
priority, parity or precedence to the order of a member in a manner
inconsistent with section 11(a)(1)(G) of the Act or SEC rule 11a1-
1(T)(a)(3) thereunder.\23\ For purposes of this proposed rule change,
the MSE has defined the term ``agency cross'' as a cross where neither
the order to buy nor the order to sell is for the account of a member
or member organization. Because the definition of ``agency cross''
excludes (and, thus, does not grant priority to) an order for the
account of the broker effecting the cross transaction or an associated
person thereof,\24\ the Commission is satisfied that the proposed rule
change complies with section 11(a).
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\23\17 CFR 240.11a1-1(T)(a)(3).
\24\Telephone conversation between David T. Rusoff, Foley &
Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on March 3, 1994.
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The Commission does not agree with the commentator that this
proposed rule change represents a significant philosophical change from
the MSE's traditional stance of customer protection. As discussed
above, the Exchange will continue to afford time and price protection
to orders on the specialist's book.\25\ In the Commission's opinion,
this proposal contains adequate safeguards to ensure that public
customers are not disadvantaged.
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\25\See supra, notes 20-21 and accompanying text.
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In addition, the Commission finds that the Exchange has advanced a
satisfactory rationale for its new policy. The MSE believes that the
specialist's ability to participate in a cross transaction decreases
the likelihood of the order sending firm receiving an immediate
execution. Conversely, the MSE argues that minimizing such interference
will make the Exchange a more attractive marketplace for institutional
orders (regardless of the effect on Exchange revenues). In the absence
of a finding that this proposal is inconsistent with the Act, which the
Commission cannot make at this time, the Commission is willing, in
these circumstances, to defer to the MSE's judgment about the need for
and the potential gains from the proposed rule change.
The Commission also believes that the means the exchange has chosen
to accomplish its goals are not unreasonable, despite the potential for
abuse identified by the commentator. In reaching that conclusion, the
Commission placed great weight on the MSE's assurances that its current
surveillance methods (especially, the existence of an audit trail) are
capable of determining, in a relatively prompt fashion, whether a
particular transaction was really an agency cross.\26\ The Exchange,
moreover, has pledged to take appropriate action to remedy any
instances of noncompliance. Based on the above, the Commission is
satisfied that existing surveillance procedures will detect, as well as
deter, abuse of the rule. Where appropriate, the Commission expects the
Exchange to take prompt action to discipline members that fail to
comply with the agency cross requirement.
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\26\Telephone conversation between David T. Rusoff, Foley &
Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on February 24, 1994.
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Finally, the Commission does not believe that the MSE proposal will
significantly reduce order interaction on the floor of the Exchange. As
discussed above, only a MSE specialist who does not have a displayed
bid or offer at the cross price must refrain from participating in a
cross transaction at that price.
The specialist, however, will be allowed to participate at a better
price; and other interest in the trading crowd will not be subject to a
comparable yielding requirement.\27\ In the context of other rule
changes that have been approved by the Commission,\28\ the limited
scope of the yielding requirement and the protection afforded book
orders at the cross price, the Commission does not expect that the MSE
proposal will substantially impair the price discovery network and/or
market liquidity.
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\27\See supra, note 22 and accompanying text.
\28\See supra, note 18.
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The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice of filing
thereof. Amendment No. 2 merely delineates the scope of the original
filing and clarifies the intent of certain language used therein.
Finally, the interpretation the MSE proposes to adopt is substantially
similar to the rules of several other exchanges that were published in
the Federal Register for the full comment period and were approved by
the Commission.\29\
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\29\No comments were received in connection with the rule
changes submitted by the Phlx and PSE, which, as discussed above,
see supra note 18, are substantially similar to the interpretation
proposed herein.
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Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street
NW., Washington, DC 20549. 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 Amendment No. 2 between the Commission and
any persons, other than those that may be withheld from the public in
accordance with the provisions of 5 U.S.C. 552, will be available for
inspection and copying in the Commission's Public Reference Section,
450 Fifth Street NW., Washington, DC 20549. Copies of such filing will
also be available at the principal office of the Chicago Stock
Exchange, All submissions should refer to File No. SR-MSE-93-05 and
should be submitted by March 30, 1994.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\30\ that the proposed rule change (SR-MSE-93-05), including
Amendments No. 1 and No. 2, is approved.
\30\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\31\
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\31\17 CFR 200.30-3(a) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5476 Filed 3-9-94; 8:45 am]
BILLING CODE 8010-01-M
