[Federal Register Volume 59, Number 163 (Wednesday, August 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20719]
[[Page Unknown]]
[Federal Register: August 24, 1994]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34538; File No. SR-CHX-94-07]
August 17, 1994.
Self-Regulatory Organizations; Chicago Stock Exchange, Inc.;
Order Approving Proposed Rule Change Relating to Utilization of Exempt
Credit by Market Makers.
On March 15, 1994, 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 Interpretation and
Policy .01 to Article XXXIV, Rule 17, which governs utilization of
exempt credit\3\ by market makers.
---------------------------------------------------------------------------
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1991).
\3\As used herein, exempt credit means good faith margin, as
defined under Regulation T of the Board of Governors of the Federal
Reserve System. See infra, note 5.
---------------------------------------------------------------------------
The proposed rule change was published for comment in Securities
Exchange Act Release No. 34256 (June 24, 1994), 59 FR 33805 (June 30,
1994). No comments were received on the proposal. This order approves
the proposed rule change.
Under Article XXXIV, Rule 17, Exchange members registered as equity
market makers\4\ are deemed to be specialists for purposes of the Act
and thus may obtain exempt credit to finance their market maker
transactions.\6\ To qualify for exempt credit financing, Interpretation
and Policy .01 to Rule 17 imposes a minimum participation requirement.
Specifically, 50% of the quarterly share volume which creates or
increases a position in a market maker account must result from
transactions consummated on the Exchange (``50% volume test''). Market
makers who satisfy the 50% volume test are entitled to good faith
margin only for transactions initiated on the floor\7\ where the
position was established as the direct result of bona fide equity
market maker activity.\8\
---------------------------------------------------------------------------
\4\Registered market makers must engage in a course of dealings
reasonably calculated to contribute to the maintenance of fair and
orderly market, and shall not enter into transactions or make bids
or offers inconsistent with such a course of dealings. See Article
XXXIV, Rule 1. After approval of their registration, market makers
are assigned particular securities; 50% of their quarterly share
volume must be in issues to which they are assigned. See
Interpretation and Policy .01 to Article XXXIV, Rule 3. At the
request of a floor broker, a registered market maker must make a bid
or offer in an assigned security or must accept and guarantee
execution of an agency order for 100 shares. See Article XXXIV, Rule
2 and Interpretation and Policy .02 to Rule 17.
\5\Under Regulation T, a creditor may extend good faith margin
for any long or short position in a security in which a specialist
makes a market. See 12 CFR 220.12(b)(3). Regulation T defines ``good
faith margin'' as the amount of margin which a creditor, exercising
sound credit judgment, would customarily require for a specified
security position and which is established without regard to the
customer's other assets or securities positions held in connection
with unrelated transactions. See 12 CFR 220.2(k). See also Article
X, Rule 3(c)(6)(A) of the CHX Rules. Good faith margin does not
mean, however, that no margin deposit is required. See, e.g., letter
from Michael A. Macchiaroli, Assistant Director, Division of Market
Regulation, SEC, to Mary L. Bender, First Vice President, Division
of Regulatory Services, Chicago Board Options Exchange, dated June
2, 1992.
\6\For further discussion of restrictions on market maker
transactions, see infra notes 7-8 and accompanying text. Market
makers receive ``customer'' margin treatment for all other
transactions. See Article X, Rule 3 of the CHX Rules.
\7\Interpretation and Policy .01 prohibits the use of exempt
credit where market maker orders are routed to the floor from
locations off the floor.
\8\Pursuant to the CHX rules, positions resulting from options
exercises and assignments do not qualify for exempt credit
treatment.
---------------------------------------------------------------------------
The Exchange proposes to amend this interpretation to revise the
means by which market makers can satisfy their minimum participation
requirement. under the proposed rule change, orders that are initiated
on the Exchange floor but are sent to another market for execution
through the Intermarket Trading System (``ITS'')\9\ will count, along
with transactions consummated on the CHX, towards the 50% volume test.
As under current rules, a market maker must ``clear the post''\10\
before routing an ITS commitment to another market. The CHX proposal
will not affect the existing restrictions on those transactions by a
market maker which may qualify for exempt credit treatment.\11\
---------------------------------------------------------------------------
\9\The CHX has clarified that orders initiated on the Exchange
floor that are sent to another market for execution through any
means other than ITS (e.g., through terminals with direct access to
such other market's systems) will not count toward the 50% volume
test. Telephone conversation between David T. Rusoff, Attorney,
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on August 2, 1994.
\10\Specifically, before sending an order initiated on the
Exchange floor to another market, the market maker must (1) request
the specialist's quote and (2) make a bid or offer at the post for
the price and size of his or her intended interest. Failure to clear
the post properly may result in violation of just and equitable
principles of trade and in subsequent disciplinary action. See
Securities Exchange Act Release No. 28638 (November 21, 1990), 55 FR
4973 (November 30, 1990) (File No. SR-MSE-90-07).
\11\See supra, notes 7-8 and accompanying text.
---------------------------------------------------------------------------
The CHX 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 perfect the
mechanism of a free and open market and a national market system and,
in general, to protect investors and the public interest.
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 11(b).\12\ In
particular, 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 interest. The Commission also believes that the proposed
rule change is consistent with the requirement of Section 11(b) and
Rule 11b-1 thereunder\13\ that specialist (i.e., market maker)
transactions must contribute to the maintenance of fair and orderly
markets.
---------------------------------------------------------------------------
\12\15 U.S.C. 78f(b) and 78k(b) (1988).
\13\17 CFR 240.11b-1 (1991).
---------------------------------------------------------------------------
The Commission believes that registered market makers on the
Exchange can serve an important function to the extent that they add
supplemental depth and liquidity to the equity market. Under the CHX
rules, market makers are subject to both affirmative and negative
obligations\14\ and, in return, are accorded certain privileges,
including exempt credit financing. For that reason, it is critical that
only those members who are engaged in bona fide equity market maker
activity qualify for favorable margin treatment under the Act. The
Exchange's 50% volume test represents an adequate means to ensure that
the margin rules are not circumvented and that CHX market maker
activity is consistent with the maintenance of fair and orderly
markets.
---------------------------------------------------------------------------
\14\See supra, note 4.
---------------------------------------------------------------------------
After careful review, the Commission has concluded that the
proposed rule change, if appropriately utilized,\15\ should continue to
ensure that the purposes behind the Exchange's minimum participation
requirement are met while, at the same time, potentially improving the
quality of the CHX's markets. The Commission agrees with the Exchange
that a market maker who initiates an order on the floor and clears the
post\16\ should not be penalized if there is no interest in the crowd
or on the limit order book against which the market maker's order can
be executed and if the specialist does not accept that order for
placement in the book.\17\ The Commission finds that it is reasonable
for the CHX to assume that a member who makes a good faith effort to
participate as dealer on the Exchange floor, as described above, is
engaged in bona fide equity market maker activity, although the
transaction ultimately can be consummated only by exposing the member's
order to all interest in the national market system.
---------------------------------------------------------------------------
\15\See infra, note 19 and accompanying text.
\16\See supra, note 10 and accompanying text.
\17\The CHX rules require the specialist to accept and guarantee
execution of agency orders for up to 2,099 shares. See Article XX,
Rule 37. According to the Exchange, however, specialists are not
required to accept a professional order that does not better their
market. Telephone conversation between David T. Rusoff, Attorney,
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulation, SEC, on August 2, 1994. See also Article XXX, Rule 2
(defining the term ``professional order'').
---------------------------------------------------------------------------
Moreover, to the extent that the Exchange's current interpretation
of its 50% volume test may represent a disincentive for members to
register as market makers, particularly in less liquid issues, the
proposed rule change should encourage more dealer participation. This,
in turn, could add depth and liquidity to the market for CHX traded
securities.
For the above reasons, the Commission believes that the proposed
rule change will help to ensure that market maker transactions continue
to contribute to the maintenance of fair and orderly markets while, at
the same time, facilitating dealer participation. In reaching that
conclusion, the Commission has relied on the Exchange's representation
that it has the capability to determine whether market makers clear the
post before routing an order to another market, and to distinguish ITS
orders from other orders initiated on the floor.\18\ The Commission
requests that the Exchange monitor how market makers satisfy their
minimum participation requirement and, in particular, what percentage
of the relevant transactions are consummated on the CHX. If the
Exchange finds that ITS orders constitute a substantial portion of the
orders counted towards satisfying the 50% volume test, the Commission
would question whether those members actually are engaged in bona fide
equity market maker activity entitled to exempt credit and would expect
the Exchange to take appropriate action to respond to the Commission's
concerns.\19\
---------------------------------------------------------------------------
\18\Telephone conversation between David T. Rusoff, Attorney,
Foley & Lardner, and Beth A. Stekler, Attorney, Division of Market
Regulations, SEC, on August 2, 1994.
\19\The CHX plans to issue a notice to its membership describing
the rule change, including the Commission's concerns about the
appropriate use of ITS orders to satisfy the 50% volume test for the
extension of exempt credit. Telephone conversation between David T.
Rusoff, Attorney, Foley & Lardner, and Beth A. Stekler, Attorney,
Division of Market Regulation, SEC, on August 16, 1994.
---------------------------------------------------------------------------
Finally, the Commission notes that the staff of the Board of
Governors of the Federal Reserve System (``Federal Reserve Board'') has
raised no objection to the Commission's approval of the proposal based
on the Commission's belief that, pursuant to the 50% volume test, as
amended, CHX market maker transactions will continue to contribute to
the maintenance of a fair and orderly market and are consistent with
the obligations of a specialist under Section 11 of the Act.\20\
---------------------------------------------------------------------------
\20\Telephone conversation between Scott Holz, Senior Attorney,
Division of Banking Supervision and Regulation, Federal Reserve
Board, and Beth A. Stekler, Attorney, Division of Market Regulation,
SEC, on June 23, 1994.
---------------------------------------------------------------------------
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\21\ that the proposed rule change (SR-CHX-94-07) is approved.
---------------------------------------------------------------------------
\21\15 U.S.C. Sec. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
---------------------------------------------------------------------------
\22\17 CFR 200.30-3(a)(12) (1991).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20719 Filed 8-23-94; 8:45 am]
BILLING CODE 8010-01-M
