[Federal Register Volume 63, Number 141 (Thursday, July 23, 1998)]
[Notices]
[Pages 39611-39613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-19566]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40215; File No. SR-CHX-96-21]
Self-Regulatory Organizations; Chicago Stock Exchange,
Incorporated; Order Granting Approval to Proposed Rule Change and
Amendment No. 1 Thereto and Notice of Filing and Order Granting
Accelerated Approval to Amendment No. 2 to the Proposed Rule Change
Relating to ``Stopped'' Orders
July 15, 1998.
I. Introduction
On July 22, 1996, the Chicago Stock Exchange, Incorporated (``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 adopt a rule relating to the
entry and execution of stop orders and to clarify its rules relating to
stopped orders. On August 27, 1996, the CHX submitted to the Commission
Amendment No. 1 to
[[Page 39612]]
the proposed rule change,\3\ on February 19, 1998, the CHX submitted to
the Commission No. 2 to the proposed rule change.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from David T. Rusoff, Attorney, Foley & Lardner,
to Jon E. Kroeper, Attorney, SEC, dated August 27, 1996 (``Amendment
No. 1'').
\4\ See Letter from David T. Rusoff, Attorney, Foley & Lardner,
to Michael Walinskas, Senior Special Counsel, SEC, dated February
18, 1998 (``Amendment No. 2''). Amendment No. 2 narrows the scope of
the proposal by withdrawing the portion of the proposal that would
have defined a ``stop'' order.
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On September 12, 1996, the proposed rule change, and Amendment No.
1 thereto, were published for comment in the Federal Register.\5\ No
comments were received on the proposal. This order approved the
proposal, as amended.
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\5\ See Securities Exchange Act Release No. 37644 (September 5,
1996), 61 FR 48184.
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II. Description of the Proposal
The practice of stopping stock refers to a guarantee by a
specialist that an order received by the specialist will be executed at
no worse a price than the price agreed upon when the order was
received, with the understanding that the order may receive a better
price.
CHX Art. XX, Rule 28 sets forth the obligations of a CHX specialist
with regard to orders that he or she has stopped. The Exchange is
proposing to amend this rule to clarify that it pertains to orders that
are stopped, not stop orders.\6\ Moreover, the Exchange is proposing to
amend CHX Art. XX, Rules 28 and 37(a)(6) to place a limitation on the
guarantee a specialist may provide to an order that is stopped.
Specifically, the proposal provides such a guarantee shall in no event
be greater than the greater of the size disseminated on either the
primary market or the Exchange at the time the order was stopped. The
Exchange maintains that this is consistent with the execution guarantee
on orders that are subject to the BEST System that are not stopped,
which are guaranteed an execution based on the lesser of the size
displayed in the primary market or 2099 shares.\7\
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\6\ A stop order is an order designated as such by the customer
that requires the specialist to buy (sell) a security once a
specified price level has been reached.
\7\ See CHX Article XX, Rule 37. The Exchange's Guaranteed
Execution System (BEST System) specifies certain conditions under
which CHX specialists are required to accept and guarantee
executions of market and limit orders from 100 up to and including
2099 shares in Dual Trading System issues. Dual Trading System
issues are securities that are assigned to CHX specialists and
listed on either the New York Stock Exchange or the American Stock
Exchange.
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III. 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).\8\ In this regard,
the Commission believes the proposal is consistent with the Section
6(b)(5) requirements 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. Moreover, the Commission believes that the proposal is
consistent with Section 11(b) of the Act \9\ in that the amendments to
the stopping stock procedures do not provide discretion to a specialist
in the handling of an order.
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\8\ 15 U.S.C. 78f(b).
\9\ 15 U.S.C. 78k(b).
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The Exchange's stopping stock procedures, located in CHX Art. XX,
Rules 28 and 37(a), are intended primarily to allow a specialist to
prevent a customer order in a Dual Trading System issue subject to the
BEST System \10\ from being executed at the current primary market bid
or offer if such an execution would be outside of the primary market
range for the day (i.e., establishing a new high or low price in the
security for the day).\11\ Under this stopping stock policy, the
specialist is required to execute stopped stock based on the next
primary market sale.\12\
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\10\ See supra note 7.
\11\ For example, assume the market in ABC stock is 20-20\1/4\;
5000 shares bid and offered and that the execution of an incoming
buy market order for 500 shares at 20\1/4\ would be higher than the
range in which the stock traded on the primary market during that
trading day. A CHX specialist would stop such at 20\1/4\ and change
his or her quote to 20\1/16\-20\1/4\ 500 bid and 5000 offered to
reflect the stopped order. If the next sale on the primary market is
for 500 shares at 20\1/8\, the Exchange's existing general policy
regarding stopping stock would require the specialist to execute the
stopped order at 20\1/8\. Alternatively, if the next primary market
sale is at 20\1/4\, the stopped order will be executed at 20\1/4\.
In minimum variation markets, the CHX rules permit a specialist to
delay execution of stopped stock in minimum variation markets until
a volume equal to the pre-existing volume ahead of the stopped order
prints in the primary market. Specifically, the specialist is
required to execute stopped orders in such markets after (1) a
transaction takes place on the primary market at the bid (offer) or
lower (higher) for a stopped sell (buy) order or (2) the displayed
CHX share volume at the offer (bid) has been exhausted. See
Interpretation and Policy .03 to CHX Rules, Art. XX, Rule 37;
Securities Exchange Act Release No. 36401 (October 20, 1995), 60 FR
54893 (October 26, 1995) (File No. SR-CHX-95-10) (order permanently
approving CHX pilot program for stopping stock in minimum variation
markets) (``Pilot Program Permanent Approval Order'').
\12\ Id.
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The Exchange has proposed to revise the text of CHX Art. XX, Rule
28 to clarify that this rule relates to stopped stock and not stop
orders. The Commission believes that such a revision is appropriate in
that it will rectify any ambiguity that currently exists with regard to
the subject matter covered by this rule.\13\
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\13\ E.g., although Art. XX, Rule 28 pertains to stopped orders,
the paragraph heading to this rule currently reads ``Liability for
`Stop' Orders.''
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More significantly, the Exchange is proposing to amend CHX Art. XX,
Rules 28 and 37(a) to limit a specialist's guarantee of an order that
is stopped at a particular price to the greater of the size displayed
in the primary market for the security or by the Exchange when the
stopped order is entered. Currently, the Exchange's rules do not impose
a size limitation on the guarantee provided by the specialist to orders
that are stopped. Therefore, a specialist must execute the full size of
a stopped order based on the next primary transaction, even if such
transaction is for a lesser number of shares than the stopped
order.\14\
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\14\ For example, assume the primary market quote in ABC stock
is the National Best Bid/Offer (``NBBO'') at 20-20\1/4\, 1000 shares
bid and offered, the CHX quote is 19\7/8\-20\1/4\, 200 shares bid
and offered, and the high sale for the day in the primary market is
20\1/8\. A CHX specialist would stop an order to buy 1500 shares at
20\1/4\ and change his or her bid to 20\1/6\ for 1500 shares to
reflect the stopped order. If the next sale on the primary market is
for 500 shares at 20\1/4\, current CHX policy would require the
specialist to execute all 1500 shares of the stopped order at 20\1/
4\.
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In contrast, the CHX's execution guarantee on an order subject to
the BEST System that is not stopped is limited to the lesser of the
size displayed in the primary market or 2099 shares. Accordingly, the
Exchange maintains that by establishing a size limitation on the
guarantee provided to a stopped order, such guarantees will be more
consistent with the execution guarantee provided to orders subject to
the BEST System that are not stopped. Under the proposal, the portion
of a stopped order that is not executed as a result of the next primary
market transaction will be executed in accordance with the prices of
subsequent transactions on the primary market.\15\
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\15\ For example, assume the primary market quote in ABC stock
is the NBBO at 20-20\1/4\, 1000 shares bid and offered, the CHX
quote is 19\7/8\-20\1/4\, 200 shares bid and offered, and the high
sale for the day in the primary market is 20\1/8\. A CHX specialist
would stop a market order to buy 1500 shares at 20\1/4\ and change
his or her bid to 20\1/16\ for 1500 shares to reflect the stopped
order. If the next sale on the primary market is for 1000 shares at
20\1/4\ (regardless of whether the specialist is the buyer), the
specialist would be obligated to execute 1000 shares of the stopped
order at 20\1/4\. If the primary market quote then changes to 20\1/
8\-20\3/8\, 1000 shares bid and offered, and a transaction occurs on
the primary market at 20\3/8\ for 500 shares, then the remaining 500
shares of the order will be executed at 20\3/8\.
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[[Page 39613]]
The Commission recognizes the unintended consequences that can
arise from the interplay between a regional exchange's price protection
rules and its procedures for stopping stock. The Commission believes
that the proposal is an acceptable means for the Exchange to accomplish
the legitimate end of treating out-of-range and in-range orders in a
more equivalent manner. The Commission also believes that the proposed
rule change is appropriate in the context of current regional exchange
market making practices. In this regard, the proposal will permit the
Exchange to continue to reduce the likelihood of an out-of-range
execution for orders entered on the CHX without obligating the
specialist to execute more shares than may be available to the
specialist on the primary market to offset its risk.\16\ Moreover, the
Commission finds it significant that under the proposal CHX specialists
will continue to offer the opportunity for price improvement to orders
that are stopped to avoid an out-of-range execution, regardless of
their size. In addition, the Commission believes that the Exchange's
proposal is appropriate in that providing generally equivalent
guarantee size limitations to stopped and non-stopped orders will allow
for a more uniform treatment of such orders by CHX specialists and
systems, thereby having the potential to facilitate the ability of CHX
specialists to carry out their market making functions.
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\16\ See supra note 15.
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Further, The Commission believes that this provision is consistent
with the prohibition in Section 11(b) of the Act \17\ against providing
discretion to a specialist in the handling of an order. Section 11(b)
was designed, in part, to address potential conflicts of interest that
may arise as a result of the specialist's dual role as agent and
principal in executing stock transactions. In particular, Congress
intended to prevent specialists from unduly influencing market trends
through their knowledge of market interest from the specialist's book
and their handling of discretionary agency orders.\18\ The Commission
has stated that, pursuant to Section 11(b), all orders other than
market or limit orders are discretionary and therefore cannot be
accepted by specialists.\19\
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\17\ 15 U.S.C. 78k(b).
\18\ See H. Rep. No. 1383, 73d Cong. 2d Sess. 22, S. Rep. 792,
73d Cong. 2d Sess. 18 (1934).
\19\ See SEC, Report of the Special Study of Securities Markets
of the Securities and Exchange Commission, H.R. Doc. No. 95, 88th
Cong., 1st Sess., Pt. 2 (1963).
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In this regard, the Commission has stated previously that it is
appropriate to treat a stopped order as equivalent to a limit
order.\20\ In reaching this conclusion, the Commission did not
expressly consider the status of a stopped order under exchange rules
that limit the guarantee of a stopped order by its size. Under such
rules, a stopped order of a size exceeding the guarantee shares
features of both a limit and market order. As with the typical stopped
order, the guaranteed portion is executable at the guaranteed price or
better, and is therefore akin to a limit order. The portion of the
order that exceeds the size guarantee is subject to execution pursuant
to the same requirements applied to market orders entered with CHX
specialists.\21\ The Commission, therefore, believes that the
requirements imposed on the specialist with regard to such orders
provide sufficiently stringent guidelines to ensure that the specialist
will implement the proposed rule change in a manner consistent with his
market making duties and Section 11(b).
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\20\ See Pilot Program Permanent Approval Order, supra note 11.
A limit order is an order to buy or sell a stated amount of a
security at a specified price, or better if obtainable.
\21\ However, if the guaranteed portion is executed at a stop
price that is the new high (low) for the day, and the primary market
quote subsequently moves to the next higher (lower) trading
increment, pursuant to CHX rules the unexpected portion will itself
be stopped at that increment. In such instances this portion would
itself appropriately be deemed equivalent to a limit order.
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In conclusion, however, the Commission notes that the Exchange's
adoption of a guarantee size limitation for stopped orders does not, in
any way, modify a CHX specialist's best execution obligation to any
stopped order that exceeds the size guarantee limitation.\22\
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\22\ Moreover, the Commission's recently-released study on
``preferencing'' on national securities exchanges stated that the
practice of stopping stock should be reconsidered in the context of
minimum variation markets. See SEC, Report on the Practice of
Preferencing Pursuant to Section 510(c) of the National Securities
Markets Improvement Act of 1996 (``Preferencing Study'') (1997). The
Commission notes that nothing in this approval order should be
interpreted as affecting the conclusions reached by the Commission
in the Preferencing Study.
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The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing of this amendment in the Federal
Register. Amendment No. 2 narrows the scope of the proposal by
withdrawing the portion of the proposal that would have defined a
``stop'' order. The Exchange represents that it is reconsidering how to
better codify the Exchange's rules relating to ``stop'' orders.\23\
Granting accelerated approval to Amendment No. 2 will allow the
Exchange to codify its procedures with respect to ``stopped'' orders
immediately. The Commission notes that the original proposal was
published for the full 21-day comment period and no comments were
received by the Commission. Accordingly, the Commission believes there
is good cause, consistent with Sections 6(b)(5) and 19(b) \24\ of the
Act, to approve Amendment No. 2 to the Exchange's proposal on an
accelerated basis.
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\23\ Telephone conversation between David T. Rusoff, Attorney,
Foley & Lardner and David Sieradzki, Attorney, Commission on July
15, 1998.
\24\ 15 U.S.C. 78f(b)(5) and 15 U.S.C. 78s(b).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 2, including whether Amendment No. 2
to the proposal 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. 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-96-21 and should be submitted by August 13, 1998.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-CHX-96-21), as amended, is
approved.
\25\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-19566 Filed 7-22-98; 8:45 am]
BILLING CODE 8010-01-M
