[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]


-----------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \5\ See Securities Exchange Act Release No. 37644 (September 5, 
1996), 61 FR 48184.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78k(b).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \13\ E.g., although Art. XX, Rule 28 pertains to stopped orders, 
the paragraph heading to this rule currently reads ``Liability for 
`Stop' Orders.''
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\.

---------------------------------------------------------------------------

[[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.
---------------------------------------------------------------------------

    \16\ See supra note 15.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
---------------------------------------------------------------------------

    \26\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 98-19566 Filed 7-22-98; 8:45 am]
BILLING CODE 8010-01-M