[Federal Register Volume 59, Number 157 (Tuesday, August 16, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-19961]
[[Page Unknown]]
[Federal Register: August 16, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34505; File No. SR-CHX-93-31]
August 9, 1994.
Self-Regulatory Organizations; Chicago Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change and Notice of and Order
Granting Accelerated Approval to Amendments 3, 4, 5, and 6 to Proposed
Rule Change to Define Members' Rights and Obligations More Precisely
I. Introduction
On November 19, 1993, as subsequently amended on December 29,
1993,\1\ May 5, 1994,\2\ July 5, 1994,\3\ July 26, 1994,\4\ July 29,
1994,\5\ and August 9, 1994,\6\ 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'')\7\ and Rule 19b-4
thereunder,\8\ a proposed rule change to adopt a short sale rule, amend
its summary suspension rule and adopt procedures for the review of
summary suspensions, adopt provisions relating to suits against the
Exchange and its employees, and adopt a provision to make conduct
inconsistent with the maintenance of fair and orderly markets or the
protection of investors a violation of Exchange Rules.
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\1\See Amendment No. 1 to SR-CHX-93-31. Amendment No. 1 added a
subsection (c) to proposed Rule 18 of Article I of the Exchange's
Rules relating to suits against the Exchange.
\2\See Letter Amendment No. 2 from George T. Simon, Foley &
Lardner, to Sharon Lawson, Assistant Director, Division, dated April
27, 1994. Amendment No. 2 made several substantive changes to the
proposed rule change and added a proposed rule change to Article
VIII, Rule 12 to make conduct inconsistent with the maintenance of
fair and orderly markets or the protection of investors a violation
of Exchange Rules.
\3\See Letter Amendment No. 3 from David T. Rusoff, Foley &
Lardner, to Sharon Lawson, Assistant Director, Division, dated July
5, 1994. Amendment No. 3 raised the amount of legal expenses which
must be incurred by the Exchange before a member who fails in a law
suit against the Exchange is obligated to pay such expenses from
$20,000 to $50,000.
\4\See Letter Amendment No. 4 from George T. Simon, Foley &
Lardner, to Sharon Lawson, Assistant Director, Division, dated July
26, 1994. Amendment No. 4 made several changes to the proposed rule
change to Article VII, Rule 2 of the Exchange's Rules and a
technical change to proposed Rule 18(c) of Article I of the
Exchange's Rules.
\5\See Letter Amendment No. 5 from David T. Rusoff, Foley &
Lardner, to Sharon Lawson, Assistant Director, Division, dated July
27, 1994. Amendment No. 5 made some technical changes, but had no
substantive effect on the rule proposal.
\6\See Letter Amendment No. 6 from David T. Rusoff, Foley &
Lardner, to Sharon Lawson, Assistant Director, Division, dated July
9, 1994. Amendment No. 6 excluded from proposed Rule 18 of Article I
of the CHX's Rules (Limitation of Liability) violations of the
federal securities laws.
\7\15 U.S.C. 78s(b)(1) (1988).
\8\17 CFR 240.19b-4 (1993).
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The proposed rule change and amendment nos. 1 and 2 were published
for comment in Securities Exchange Act Release No. 34142 (June 1,
1994), 59 FR 29451 (June 6, 1994). No comments were received on the
proposal.\9\
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\9\The CHX did submit a letter in support of certain provisions
of their rule filing. See letter from George Simon, Foley & Lardner,
to Sharon Lawson, Assistant Director, Division, dated June 24, 1994.
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II. Description of the Proposal
Short Sale Rule
Currently, as a matter of just and equitable principles of trade,
members must believe at the time they enter into a contract to sell
stock that they will be able to perform the contract. The Exchange is
adopting Rule 17 under Article IX of the Exchange's Rules to require
that prior to effecting a short sale, members make arrangements to
borrow the security or obtain other assurances that delivery can be
made on settlement.\10\ The new rule provides an exception for bona
fide market making activities. To use the exception, specialists,
market makers, and odd-lot dealers must show that the sale was part of
their bona fide market making activities. The rule also requires
specialists, market makers, and odd-lot dealers to notify the Exchange
whenever they accumulate a position in a security that is greater than
or equal to 5% of the outstanding public float of the security.
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\10\This rule is similar to New York Stock Exchange Rule
440C.10, interpretation 01 (Short Sales).
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Summary Suspension
The Exchange is modifying Article VII of its Rules concerning
summary suspension and reinstatement of members and member
organizations (collectively ``members'').\11\ Currently, Rule 2 of
Article VII permits the emergency suspension of a member if it has
failed to perform its contracts or is insolvent or is in such financial
or operational condition or otherwise conducting its business in such a
manner that it cannot be permitted to continue in business with safety
to its customers, creditors, or the Exchange. The rule change codifies
in Rule 2 the language of Section 6(d)(3) of the Act which allows
national securities exchanges to summarily suspend members, or limit
members' or non-members' access to exchange services. Specifically, the
Exchange is adding to Rule 2 of Article VII that the president may
suspend a member if the member has been and is expelled or suspended
from any self-regulatory organization, or barred or suspended from
being associated with a member of any self-regulatory organization.\12\
In addition, the rule change adds to Rule 2 that the President may
limit or prohibit access to services offered by the Exchange whenever
it appears that persons who are not members fail to meet the
qualification requirements or other prerequisites for access to such
services and cannot be permitted to continue to have access with safety
to creditors, investors, members or the Exchange.\13\ The rule change
also clarifies that the CHX may find that the member cannot continue to
do business as a member with safety to investors, creditors, other
members, or the Exchange if there is a reasonable belief that a member
is violating and will continue to violate any material provision of the
Rules of the Exchange or the federal securities laws.\14\
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\11\The rule change does not affect Article VII, Rule 1 of the
Exchange's Rules regarding the automatic suspension of a member who
fails to perform its contracts or is insolvent.
\12\See Section 6(d)(3)(A) of the Act, 15 U.S.C. 8f(d)(3)(A)
(1988).
\13\See Section 6(d)(3)(C) of the Act, 15 U.S.C. 8f(d)(3)(C)
(1988).
\14\See Section 6(d)(3)(C) of the Act, 15 U.S.C. 8f(d)(3)(B)
(1988).
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The Exchange also is adopting procedures for review of the
President's summary action when taken according to the new
provisions.\15\ Any person affected by the President's summary action
will have the right to appeal the President's decision to a panel
composed of three members of the Board.\16\ All appeals will be
expedited to the maximum extent possible and, in any event, will be
heard within ten days. After consideration of the appeal, the panel
will affirm, reverse, or modify the President's action. The decision of
the panel is final.
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\15\The new provision does not change the procedures for the
review of automatic suspensions under Article VII, Rule 1 of the
Exchange's Rules. See supra note 11.
\16\The members of the review panel will be appointed by the
Board. No member of the panel may have any direct or indirect
interest in the matter presented which might preclude the member
from rendering an objective and impartial determination.
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Standard of Review
Currently, the Exchange's Rules do not contain a formal standard of
review for the hearing of appeals. The Exchange is adopting a formal
standard of review that prohibits an appeal panel from overturning the
facts finder's decision if the factual conclusions are supported by
substantial evidence and if the decision itself is not arbitrary,
capricious, or an abuse of discretion.
Liability Provisions
The Exchange also is adopting several new provisions related to the
liability of the Exchange and its officers, directors, or employees.
First, new Rule 17 under Article I of the Exchange's Rules prohibits
members from instituting a lawsuit or any other type of legal
proceeding against any officer, director, employee or agent of the
Exchange if that person was acting on Exchange business. The provision
does not prohibit members from suing the Exchange itself, nor does it
apply where there has been a violation of the federal securities laws.
Second, the Exchange is adopting a new rule that limits the
liability of the Exchange to members for non-performance or
misperformance of its duties and responsibilities, except where damages
are suffered as a result of the willful misconduct, gross negligence,
bad faith, or fraudulent or criminal acts of the Exchange or its
officers, employees or agents, and except where there has been a
violation of the federal securities laws. The Rule is in addition to
the limitation of Exchange liability as a result of a member's use or
enjoyment of Exchange facilities currently contained in the Exchange's
Constitution.\17\
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\17\See Article X, Section 5 of the CHX's Constitution.
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Finally, the Exchange is adopting a Rule that requires members who
fail to prevail in a lawsuit or administrative adjudicative proceeding
they institute against the Exchange or its officers, directors, and
employees, to pay all of the Exchange's reasonable expenses, including
attorneys' fees, incurred by the Exchange in the defense of such
proceeding. This provision is applied only in the event that the
Exchange's expenses exceed $50,000. In addition, the new Rule does not
apply to internal disciplinary actions by the Exchange or
administrative appeals.
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) of the Act.\18\
Specifically, the Commission believes that, in general, the proposal is
consistent with Section 6(b)(5) of the Act\19\ which requires 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.
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\18\15 U.S.C. 78f(b) (1988).
\19\15 U.S.C. 78f(b)(5) (1988).
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The Commission believes that the proposed rule change to adopt a
short sale rule is consistent with Section 6(b)(5) of the Act because
it will help to ensure that members effecting short sales are in a
position to complete the transaction. In addition, the Commission
believes that the rule change will help facilitate the settlement of
transactions by promoting the timely delivery of securities that are
sold short.\20\ The requirement that specialists, market makers and
off-lot dealers report to the Exchange short and long positions in
excess of 5% of the outstanding float will aid the exchange in
monitoring compliance with its rule.
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\20\See, e.g., New York Stock Exchange Rule 440C.10,
Interpretation .01.
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The Commission believes that the proposed rule change to the
Exchange's summarily suspension provisions is consistent with Section
6(d)(3) of the Act.\21\ Section 6(d)(3) permits a national securities
exchange to summarily suspend members and non-members under certain
circumstances. Specifically, an exchange may summarily suspend members
from the exchange or limit or prohibit members with respect to access
to services offered by the exchange if they (1) have been and are
expelled or suspended from any self-regulatory organization or barred
or suspended from being associated with a member of any self-regulatory
organization, or (2) are in such financial or operating difficulty that
the exchange determines that the member cannot be permitted to continue
to do business as a member with safety to investors, creditors, other
members, or the exchange. An exchange may limit or prohibit persons who
are not members from access to exchange services if the exchange
determines that such person does not meet the qualification
requirements or other prerequisites for such access and that the person
cannot be permitted to continue to have access with safety to
investors, creditors, members, or the exchange. The rule change to the
CHX's summary suspension provision incorporates the language of Section
6(d)(3) described above.
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\21\15 U.S.C. 78f(d)(3) (1988).
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In addition, the rule change clarifies that a member may be
summarily suspended or denied access to Exchange services if there is a
reasonable belief that the member is violating and will continue to
violate any material provision of the Rules of the Exchange or the
federal securities laws or the rules promulgated thereunder, and if
such violations indicate that the member cannot be permitted to
continue to do business with safety to investors, creditors, other
members, or the exchange. This provision is consistent with the summary
suspension provisions of Section 6(d)(3) of the Act and merely codifies
that material violations of Exchange rules and the Act can result in a
finding that the member cannot be permitted to continue business with
safety to customers, creditors or the Exchange. The Commission notes
that in determining that a material violation of Exchange rules or the
Act and rules thereunder warrant an emergency or summary suspension
under Rule 2, the CHX must take into consideration the egregious nature
of the conduct and the likelihood of continuing violations.
Proposed Rule 2 also sets forth new due process procedures for
review of a summary suspension action by the CHX president under the
rule. Those provisions ensure that a person aggrieved by a summary
suspension will have a right to an expeditious review of the matter,
including the final decision by the hearing panel. Under the new
provisions, any person suspended under Rule 2 must be furnished with
the reasons for the action within two business days of the suspension.
In addition any appeal will be heard within 10 days. The Commission
believes these provisions ensure adequate due process and that a
suspension under these new provisions will be handled and treated in a
timely manner, consistent with the requirements of Section 6(b)(7) of
the Act.
The Commission also believes that the proposed rule change to adopt
a formal standard of review that prohibits an appeal panel from
overturning the fact finder's decision if the factual conclusions are
supported by substantial evidence and if the decision itself is not
arbitrary, capricious, or an abuse of discretion, is consistent with
Section 6(b)(7) of the Act.\22\ Section 6(b)(7) requires that the rules
of the exchange provide fair procedures for disciplining members and
denying access to services offered by an exchange. The Commission
believes that adopting a formal standard for review will add certainty
and consistency to the Exchange's appellate process.
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\22\15 U.S.C. 78f(b)(7) (1988).
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The Commission further believes the liability provisions described
above should be approved. Specifically, the rule change prohibiting
members from suing Exchange officers, directors, employees, or agents
of the Exchange will prevent those parties from having liability to
members when acting on official Exchange business, while maintaining
members' ability to pursue actions against the Exchange itself, as well
as the ability to sue those persons and the Exchange for violations of
the federal securities laws. Moreover, under the provisions, actions
against Board members for breach of fiduciary duty consistent with
Delaware law could still be pursued.\23\ The Commission believes this
provision is consistent with the Act because it will help to ensure
that such persons will be able to carry out their duties under the Act
and enforce compliance with the Act, the rules thereunder and Exchange
rules without the threat of personal liability from a lawsuit.
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\23\The new rule does not conflict with the limitation of Board
of Governor's monetary damages for breach of fiduciary duty approved
by the Commission in Securities Exchange Act Release No. 33901
(April 12, 1994), 59 FR 18586 (April 19, 1994). That provision
limits a governor's monetary liability for a breach of their
fiduciary duty as a director to the full extent of Delaware state
law. That rule, as well as the new provision being approved herein,
will not prevent the imposition of other legal remedies for breach
of fiduciary duty, such as rescission and injunction.
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In addition, limiting the liability of the Exchange to its members
to willful misconduct, gross negligence, bad faith, or fraudulent or
criminal acts of the Exchange or its officers, employees or agents,
will preserve members' right to pursue actions against the Exchange in
certain circumstances where the Exchange should be held accountable, or
where there has been a violation of the federal securities laws. We
find this provision consistent with the Act for the same reasons set
forth in our order approving a limitation on Board of Governor
liability for monetary damages for breach of fiduciary duty.\24\
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\24\See Securities Exchange Act Release No. 33901, note 23
supra. See also Securities Exchange Act Release No. 30346 (February
6, 1992), 57 FR 5195 (February 12, 1992).
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Finally, the Commission believes that the rule change requiring
that members who are unsuccessful in a suit against the Exchange to pay
the Exchange's legal expenses if they exceed $50,000 is consistent with
Section 6(b)(4) of the Act,\25\ which requires that the rules of the
exchange provide for the equitable allocation of reasonable dues, fees
and other charges among its members. Because the funds to pay the legal
expenses incurred by the Exchange in defending legal suits are
generated, in part, by membership fees, the Commission believes the
rule change reflects a reasonable business decision by the membership
to shift the financial burden of litigation to the responsible member
under certain circumstances. Because the Exchange's legal expenses must
be reasonable and must accrue to at least $50,000 before a member would
be obligated to compensate the Exchange, the Commission believes the
rule change should not provide an undue disincentive to litigation, in
so far as it will permit the discovery needed to assess the merits of
the members' cases. The Commission also notes that the provision
specifically excludes internal disciplinary actions by the Exchange and
administrative appeals. This will ensure that members will be able to
freely pursue their right to appeal any disciplinary action brought by
the Exchange for violations of its rules. The Commission also notes
that if the minimum amount in the fee provision were substantially
lower it might have a more difficult time concluding that the provision
was consistent with Section 6(b)(4) because such a lower threshold
amount could be found to represent an inequitable allocation of fees to
the disadvantage of certain members.
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\25\15 U.S.C. 78f(b)(4) (1988).
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The rule change and amendments nos. 1 and 2 were published in the
Federal Register for the full statutory period and no comments were
received.\26\ Amendment nos. 3, 4, 5, and 6 generally narrowed the
scope of the proposal as published in the Federal Register and made
clarifying and technical changes. The Commission therefore finds good
cause for approving amendment nos. 3, 4, 5, and 6 to the rule change
prior to the thirtieth day after publication of notice of filing
thereof.
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\26\See Securities Exchange Act Release No. 34142 (June 1,
1994), 59 FR 29451 (June 6, 1994).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning amendment nos. 3, 4, 5, and 6. 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 Section, 450 Fifth Street
NW., Washington, DC 20549. Copies of such filing will also be available
for inspection and copying at the principal office of the CHX. All
submissions should refer to File No. SR-CHX-93-31 and should be
submitted by September 6, 1994.
V. Conclusion
Based on the above the Commission finds that the proposed rule
change is consistent with the Act.
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\27\ that the proposed rule change (SR-CHX-93-31) as amended,
including amendments nos. 3, 4, 5, and 6 on an accelerated basis, are
approved.
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\27\15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\28\
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\28\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-19961 Filed 8-15-94; 8:45 am]
BILLING CODE 8010-01-M
