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###### Securities and Exchange Commission

          - [Release No. 34-43443; File No. SR-CHX-00-20] 

## I. Introduction

                    On June 9, 2000, 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 relating to the automatic execution of orders for Nasdaq/NM Securities. On August 18, 2000, the Exchange filed Amendment No. 1, to the proposed rule change.[3] 
      ( print page 63661)    
                    The proposed rule change, including Amendment No. 1, was published for comment in the                     **Federal Register**                     on August 30, 2000.[4]                                          No comments were received on the proposal. This order approves the proposal.                

## II. Description of Proposal

                    In its proposed rule change, the Exchange seeks to amend the CHX rules governing automatic execution sequences and algorithms relating to the trading of Nasdaq/NM Securities on the Exchange.[5]                                          The Exchange has represented that the proposed changes are intended to bring the CHX rules in line with the practices that currently exist in the Nasdaq market with respect to the trading of Nasdaq/NM Securities.[6] 

CHX Article XX, Rule 37, describes among other things, the circumstances under which orders must be accepted and guaranteed an execution at the national best bid or offer (the “BEST Rule”). CHX Rule 37 also describes a specialist's ability to set a parameter (the auto-execution threshold) that identifies (by size) which orders guaranteed a fill under the BEST Rule will be automatically executed.

                    The proposed rule change would allow specialists to reduce the minimum auto-execution threshold from 1,000 shares to 300 shares for each security in which the specialist makes a market. It would not change specialists' obligations under the BEST Rule.[7]                                          In other words, specialists could choose to obligate themselves to                     *automatically*                     execute only those orders for 300 shares or less. Under these circumstances, specialists would still be required, however, to guarantee execution at the national best bid or offer (“NBBO”) for orders up to the size associated with the NBBO.                

Further, under the proposed rule, if a specialist at the NBBO chooses to set the auto-execution threshold at 300 shares, and an order for 1,000 shares is entered, the specialist must automatically execute 300 shares (the size of his bid or offer). The portion of the order that exceeds 300 shares (in this example, 700 shares) shall be treated as an open order, and must be manually executed at the NBBO.

                    The proposed rule also would permit specialists to choose to provide an enhanced execution guarantee for orders by setting a new parameter called an “enhanced liquidity quantity.” The enhanced liquidity quantity, as the name implies, would permit a specialist to raise its automatic execution threshold to a size greater than 300 shares. If a specialist chooses to utilize this parameter, orders would be automatically executed up to the enhanced liquidity quantity designated by the specialist.[8]                                          The specialist can designate an enhanced liquidity quantity on a stock by stock basis.                

                    Lastly, the proposed rule provides new guidelines for Nasdaq/NM specialists that want to switch from automatic execution mode to a manual execution mode when unusual trading conditions exist. The proposed rule would define the term “unusual trading conditions” to include the existence of large order imbalances and/or significant price volatility. the rule would require that upon switching to manual execution mode based on the existence of unusual trading conditions, a specialist must: (1) Document the basis for election of manual execution mode; (2) disclose to its customers the differences in procedures from normal market conditions and the circumstances under which the specialist generally may activate manual execution mode; and (3) seek permission to switch to manual execution mode for two floor officials.[9] 

## III. Discussion

                    After careful review, the Commission finds that the proposed rule is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.[10]                                          In particular, the Commission believes that the proposed rule change is consistent with the requirements of Section 6(b)(5) of the Act [11]                                          in that it is designed to promote just an equitable principles of trade, to facilitate transactions in securities, 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.                

The Commission believes that it is appropriate for the Exchange to allow specialist flexibility in determining the size of orders that they will guarantee receive automatic executions. Automatic execution systems help specialists meet the demands of high trade volume in the Nasdaq market, and competitive pressures to provide fast, efficient executions. The Commission recognizes that there are conditions under which specialists are not willing to provide automatic executions. During extreme market conditions, where there are large order imbalances or significant private volatility, guarantees of automatic executions for large orders subject specialists to a high degree of risk. The proposed rule change offered by the CHX is designed to mitigate that risk. 

By giving specialists the option of lowering the size of orders that they must guarantee an automatic execution from 1,000 shares to 300 shares, the Commission believes the Exchange is providing specialists with an acceptable way to limit their exposure. The CHX has represented that reduction of the minimum auto-execution threshold is intended to limit the exposure of Nasdaq/NM specialists in the case of highly-volatile Nasdaq/NM Securities. The Exchange has stated that it anticipates that for the majority of  Nasdaq/NM Securities, specialists will voluntarily remain at the 1,000-share auto-execution threshold. 

                    In reviewing this proposal, the Commission considered it important that while a specialist may lower the size of orders that are guaranteed                     *automatic*                     execution to 300 shares, under the proposed rule change a specialist must still provide an execution at the NBBO for all orders of 1,000 shares or less pursuant to the Exchange's Best Rule. Further, the proposed rule provides that in the case of orders larger than a specialist's automatic execution threshold, the specialist must provide an automatic execution up to the specialist's threshold, with the remainder of the order sent for manual execution. In this way, the Exchange is providing investors with some opportunity for a guaranteed automatic execution, while at the same time, protecting the specialist from unreasonable risk.                 

                    The Commission also finds that the Exchange's proposal to allow specialists to designate an “enhanced liquidity quantity” will give specialists an appropriate level of flexibility in determining what size orders they want to guarantee automatic executions. If a specialist chooses to offer automatic executions to orders greater than his or                           ( print page 63662)                        her automatic execution threshold, he or she may do so using this function.                 

                    Next, the Commission believes that the Exchange's proposal to allow  Nasdaq/NM specialists to switch from automatic execution mode to a manual execution mode in the event of unusual trading situations if they comply with certain requirements will also provide specialists with adequate protection in the event of large order imbalances and/or significant price volatility, or other unusual trading situations.[12]                                          The proposed rule requires that upon switching to manual execution mode based on the existence of unusual trading conditions, a specialist must: (1) document the basis for election of manual execution mode; (2) disclose to its customers the differences in procedures from normal market conditions and the circumstances under which the specialist generally may activate manual execution mode; and (3) seek permission to switch to manual execution mode from two floor officials. The Commission believes the proposed rule adequately balances the concern that specialists not be required to offer automatic executions under truly unusual circumstances with the concern that investors who reasonably except to receive an automatic execution pursuant to Exchange rules and policies actually receive an automatic execution. The Commission believes that with the aforementioned requirements prior to switching from automatic to manual executions, both specialists and investors will be protected in the event of unusual market conditions.                 

## IV. Conclusion 

*It Is Therefore Ordered*                    , pursuant to Section 19(b)(2) of the Act,[13]                                          that the proposed rule change (SR-CHX-00-20) is approved.                 

                        For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[14] 

Margaret H. McFarland, 

Deputy Secretary. 

# Footnotes

1.                             15 U.S.C. 78s(b)(1).                    
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2.                             17 CFR 240.19b-4.                    
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3.                                                     *See*                         Letter from Paul O'Kelly, Executive Vice President, CHX, to Katherine England, Assistant Director, Division of Market Regulation, Commission, dated August 15, 2000. (“Amendment No. 1”). In Amendment No. 1, the Exchange clarified how specialists would utilize the proposed enhanced liquidity function, and deleted a portion of the proposed rule text that would have permitted a specialist to switch to manual execution mode in unusual trading situations after, among other things, seeking relief from a member of the                                                 Exchange. Under the amended version of the rule, a specialist must seek relief from two floor officials.                    
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4.                             Securities Exchange Release No. 43199 August 23, 2000), 65 FR 52802.                    
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5.                                                     *See*                         CHX Article XX, rules 37 and 43.                    
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6.                                                     *See*                         NASD Notices to Members 99-11 and 99-12 (February, 1999)(discussing NASD member firm order execution practices, particularly during periods of significant market volatility).                    
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7.                             The CHX has represented that reduction of the minimum auto-execution threshold is intended to limit the exposure of Nasdaq/NM specialists in the case of highly-volatile Nasdaq/NM Securities. The Exchange anticipates, however, that for the majority of Nasdaq/NM Securities, specialists will voluntarily remain at the 1000-share auto-execution threshold.                    
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8.                                                     *See*                         Amendment No. 1,                         *supra*                         note 3.                    
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9.                                                     *See*                         Amendment No. 1,                         *supra*                         note 3.                    
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10.                             In approving this rule proposal, the Commission notes that it has also considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).                    
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11.                             15 U.S.C. 78s(b)(5).                    
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12.                             The Commission expects the Exchange to keep records of instances when specialists are permitted to switch to a manual execution mode so that the Exchange and the Commission can monitor the use of this option.                    
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13.                             15 U.S.C. 78f(b)(2).                    
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14.                                 17 CFR 200.30-3(a)(12).                        
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[FR Doc. 00-27240  Filed 10-23-00; 8:45 am]

BILLING CODE 8010-01-M