Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule Change to Implement a Fully-Automated Electronic Book for the Display and Execution of Orders in Securities That Are Not Assigned to a Specialist, 43913-43917 [E5-4026]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 145 (Friday, July 29, 2005)]
[Notices]
[Pages 43913-43917]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-4026]



[[Page 43913]]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52094; File No. SR-CHX-2004-11]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Amendment No. 1 Thereto and 
Notice of Filing and Order Granting Accelerated Approval of Amendment 
No. 2 to the Proposed Rule Change to Implement a Fully-Automated 
Electronic Book for the Display and Execution of Orders in Securities 
That Are Not Assigned to a Specialist

July 21, 2005.

I. Introduction

    On February 20, 2004, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``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 implement a fully-automated electronic book for 
the display and execution of orders in securities that are not assigned 
to a specialist. On June 18, 2004, the Exchange amended the proposed 
rule change.\3\ The proposed rule change, as amended by Amendment No. 
1, was published for comment in the Federal Register on July 19, 
2004.\4\ The Commission received no comments on the proposed rule 
change, as amended. On May 20, 2005, the Exchange filed Amendment No. 2 
to the proposed rule change.\5\ This order approves the proposed rule 
change, as amended and approves Amendment No. 2 on an accelerated 
basis. In addition, the Commission solicits comments from interested 
persons on Amendment No. 2.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Ellen J. Neely, Senior Vice President and 
General Counsel, CHX, to Nancy J. Sanow, Assistant Director, 
Division of Market Regulation (``Division''), Commission, dated June 
17, 2004, and the attached Form 19b-4, which replaced the original 
filing in its entirety (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 50002 (July 12, 
2004), 69 FR 43036 (``Notice'').
    \5\ See Form 19b-4 dated May 20, 2005, which replaced the 
original filing in its entirety (``Amendment No. 2''). Amendment No. 
2 clarifies the operation of the electronic book in particular 
circumstances; clarifies the obligations of a market maker in the 
electronic book; incorporates new provisions relating to orders for 
non-regular way settlement and to a floor member's responsibility to 
clear the electronic book before sending orders to other markets; 
and updates the filing to reflect the Exchange's recent 
demutualization. The amended rule text proposed in Amendment No. 2 
is available on the Exchange's Web site (https://www.chx.com), at the 
Exchange's Office of the Secretary, and at the Commission's Public 
Reference Room.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    The Exchange proposes to implement a fully-automated electronic 
book for the display and execution of orders in securities that are not 
assigned to a CHX specialist. Under the Exchange's current rules, 
securities that are not assigned to a CHX specialist are traded in two 
ways: (a) securities can be placed in the cabinet \6\ or (b) securities 
can be removed from the cabinet and assigned to a lead market maker for 
trading.\7\ According to the Exchange, the procedures associated with 
the trading of these securities are quite manual. For example, the 
Exchange maintains a physical location, known as the cabinet, at which 
written information is manually maintained regarding existing bids, 
offers, and orders for each cabinet security. Orders for these cabinet 
securities are filled manually, and each transaction is recorded on a 
written trade ticket before being entered into the Exchange's systems 
for public dissemination. Securities that are assigned to lead market 
makers also are subject to manual procedures similar to those used for 
cabinet securities, except that these orders are also entered into the 
Exchange's systems so that they can be automatically quoted.
---------------------------------------------------------------------------

    \6\ See CHX Article XX, Rule 11.
    \7\ See CHX Article XXXIV, Rule 3, Interpretation and Policy 
.02.
---------------------------------------------------------------------------

    The proposed rule change, as amended, would replace these manual 
procedures with a new fully-automated electronic book that would 
display and match eligible limit orders in these securities, without 
the participation of a specialist or lead market maker. Specifically, 
as described below, this new electronic book would allow the Exchange's 
participants, whether or not they are on the Exchange's floor, to enter 
orders into an automated matching system operated by the Exchange for 
possible execution.
    Eligible securities and eligible orders. Under the proposed rules, 
all securities eligible for trading on the Exchange that are not 
assigned to a specialist would be traded in the electronic book.
    Orders sent to the electronic book would be required to be 
specifically designated for handling in the electronic book.\8\ The 
electronic book would accept only round-lot limit orders that are good 
for the day on which they are submitted.\9\ No odd-lot orders or good-
till-cancelled orders would be accepted.
---------------------------------------------------------------------------

    \8\ See Proposed CHX Article XXA, Rule 2.
    \9\ Id.
---------------------------------------------------------------------------

    Orders could be designated as ``immediate or cancel'' or ``fill or 
kill'' orders to ensure that they are immediately filled or 
cancelled.\10\ Orders could also be designated as ``cross'' or ``cross 
with size'' to permit the handling of orders to buy and sell the same 
security.\11\ Orders could not be designated with any other conditions 
and, except for certain cross orders, would be required to be for 
regular way settlement.\12\
---------------------------------------------------------------------------

    \10\ An immediate or cancel order would be executed, in whole or 
in part, as soon as it is received by the electronic book. If 
execution is not possible, or if only a partial execution is 
possible, any unexecuted balance of the order would be immediately 
cancelled. A fill or kill order would be executed in full as soon as 
it is received. If execution is not possible, the entire order would 
be immediately cancelled. See Proposed CHX Article XXA, Rule 2(c)(1) 
and (2).
    \11\ A ``cross'' order would be an order to buy and sell the 
same security at a specific price that is better than the best bid 
and offer (``BBO'') displayed in the electronic book and, for listed 
securities, equal to or better than the National Best Bid or Offer 
(``NBBO''). A ``cross with size'' order would be an order to buy and 
sell at least 25,000 shares of the same security: (a) At a price 
equal to or better than the BBO displayed in the electronic book 
and, for listed securities, equal to or better than the NBBO; (b) 
where the size of the order is larger than the aggregate size of all 
interest displayed in the electronic book at that price; and (c) 
where neither side of the order is for the account of the CHX 
participant sending the order to the electronic book. The Exchange 
represented that these definitions are substantially similar to the 
descriptions of the types of cross transactions that can occur today 
on the Exchange's floor without interference from the trading crowd. 
See CHX Article XX, Rule 23.
    \12\ See Proposed CHX Article XXA, Rules 2(b) and 2(c)(5). Under 
the proposed rules, orders could be designated as ``non-regular way 
cross'' and ``non-regular way cross with size.'' These cross and 
cross with size orders would be for non-regular way settlement and 
would be executed without regard to either the NBBO or orders for 
regular way settlement that could be in the electronic book. The 
Exchange represented that the procedures for cross transactions with 
non-regular way settlement are the same as the Exchange's current 
procedures on the floor.
---------------------------------------------------------------------------

    In addition, otherwise eligible orders would be cancelled in 
certain circumstances, to ensure compliance with applicable intermarket 
trading rules. For example, if an order in a listed security improperly 
crosses or locks another Intermarket Trading System (``ITS'') market, 
the order would not be displayed, but would be immediately cancelled to 
ensure compliance with the ITS Plan's rules relating to locked 
markets.\13\ Similarly, inbound orders in Nasdaq/NM securities that 
lock or cross the NBBO would be automatically cancelled.\14\
---------------------------------------------------------------------------

    \13\ See Proposed CHX Article XXA, Rule 2(e).
    \14\ The Exchange represented that this handling of Nasdaq/NM 
securities is not required by any intermarket plan, but is 
consistent with the rules governing the Exchange's participation in 
The Nasdaq Stock Market, Inc.'s (``Nasdaq's'') SuperMontage system.

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

[[Page 43914]]

    Operating hours. Under the proposed rules, the electronic book 
would operate during the Exchange's Primary Trading Session and its 
Post-Primary Trading Session.\15\ Specifically, the electronic book 
would accept orders on each day for a particular security once the 
primary market in that security opens.\16\ The electronic book would 
close at 3:30 p.m. (Central Time) and all unexecuted orders would be 
automatically cancelled.
---------------------------------------------------------------------------

    \15\ The Exchange's Primary Trading Session is open, for a 
particular security, during the same times that such security is 
traded on its primary market (e.g., 8:30 to 3 p.m. Central Time, for 
most securities). The Exchange's Post-Primary Trading Session 
operates until 3:30 p.m. Central Time. See CHX Article IX, Rule 
10(b).
    \16\ The proposed rules define the primary market as the listing 
market for a security, unless otherwise designated by the Exchange's 
Committee on Exchange Procedure; provided, however, that if a 
security is traded by the New York Stock Exchange, Inc. (``NYSE''), 
then the primary market for such security would be the NYSE, and if 
a security is traded by the American Stock Exchange LLC (``Amex''), 
then the primary market for such security would be the Amex. If a 
security is traded on both the NYSE and the Amex, whichever of the 
two is the listing market would be considered the primary market. If 
a security is listed on both the NYSE and Nasdaq, the NYSE would be 
considered the primary market. See Proposed CHX Article XXA, Rule 
3(b).
---------------------------------------------------------------------------

    Routing of orders. Orders could be sent to the electronic book 
through the Exchange's MAX system or through any other communications 
lines approved by the Exchange for the delivery of orders by Exchange 
participants.\17\ The Exchange anticipates that all CHX participants--
whether they are located on the Exchange's trading floor or off the 
floor--would be able to receive access to the electronic book. The 
electronic book would also accept and automatically execute commitments 
sent by market centers that participate in the ITS. National 
Association of Securities Dealers, Inc. (``NASD'') market participants 
would have direct telephone access to the supervisory center for the 
electronic book to enter orders in the Nasdaq/NM securities in which 
they are registered, as required by the OTC/UTP Plan.\18\
---------------------------------------------------------------------------

    \17\ See Proposed Article XXA, Rule 4(a)(1).
    \18\ See CHX Article XX, Rule 43.
---------------------------------------------------------------------------

    Ranking and display of orders. Except for cross and cross-with-size 
orders, all orders received by the electronic book would be ranked 
according to their price and time of receipt and would be displayed to 
the public when they constitute the BBO in the electronic book for a 
security.\19\ In the Notice, the Exchange stated that it initially 
plans to disseminate these best bids and offers through the systems 
used for that purpose today--through the CTA/CQ Plan for listed 
securities, and through the OTC/UTP Plan for Nasdaq/NM securities.\20\
---------------------------------------------------------------------------

    \19\ See Proposed CHX Article XXA, Rule 4(b).
    \20\ See Notice, supra note 4.
---------------------------------------------------------------------------

    Automated matching of orders. In the electronic book, orders would 
automatically match against each other, in price/time priority.\21\ 
Specifically, an incoming order would be matched against one or more 
orders in the electronic book, in the order of their ranking, at the 
price of each order, for the full amount of shares available at that 
price, or for the size of the incoming order, if smaller. If an 
incoming order could not be matched when it is received and it is not 
designated as an order that should be immediately cancelled, the order 
would be placed in the electronic book.
---------------------------------------------------------------------------

    \21\ The only exceptions to this price/time priority matching 
would occur when certain ``cross'' and ``cross with size'' orders 
are executed. First, eligible ``cross with size'' transactions could 
execute at the price of orders in the electronic book, without 
executing those earlier-received orders. See Proposed CHX Article 
XXA, Rules 2(c)(4) and 4(d). Because this type of crossing 
transaction is permitted on the floor of the Exchange today, the 
Exchange believes it is appropriate to include this transaction type 
in the fully-automated electronic book. Similarly, when non-regular 
way cross and cross with size orders are placed in the electronic 
book, they would execute without regard to either the NBBO or orders 
for regular way settlement that could be in the electronic book. See 
Proposed CHX Article XXA, Rules 2(c)(5) and 4(d).
---------------------------------------------------------------------------

    Inbound ITS commitments, if priced at or better than the current 
BBO in the electronic book, would be automatically matched against the 
order(s) reflected in the electronic book's BBO, for the full amount of 
shares at that price, and any remaining portion of the ITS commitment 
would be automatically cancelled.\22\ To ensure that the electronic 
book does not trade through another market in violation of the ITS 
Plan's trade-through provisions, orders in listed securities would only 
be matched at prices that are equal to, or better than, the NBBO.\23\
---------------------------------------------------------------------------

    \22\ See Proposed CHX Article XXA, Rule 4(c)(3).
    \23\ See Proposed CHX Article XXA, Rule 4(c)(4).
---------------------------------------------------------------------------

    Cross or cross with size orders would be automatically executed if 
they meet the requirements for those types of orders. If they do not 
meet applicable requirements, they would be immediately cancelled.\24\
---------------------------------------------------------------------------

    \24\ See Proposed CHX Article XXA, Rule 4(d).
---------------------------------------------------------------------------

    Finally, unless a customer specifically requests otherwise, all 
orders in securities that are traded in the electronic book that are 
received on the floor of the Exchange would have to clear the 
electronic book before the orders could be routed to another market. 
Any customer directives for special handling of orders would have to be 
documented and reported to the Exchange.\25\
---------------------------------------------------------------------------

    \25\ See Proposed CHX Article XXA, Rule 8. The Exchange stated 
that it believes that this requirement for clearing the electronic 
book is consistent with the Exchange's current requirement that 
floor brokers or market makers clear the specialist's post in 
securities before sending orders to other markets. See CHX Article 
XX, Rule 10, Interpretation and Policy .02.
---------------------------------------------------------------------------

    No distinction between agency and professional orders. Under the 
proposed rules, agency orders (entered on behalf of a customer) and 
professional or proprietary orders (entered for the account of a CHX 
participant or other broker-dealer) would be handled in an identical 
way in the electronic book's matching algorithms.
    Cancellations of transactions and handling of clearly erroneous 
transactions. Under the proposed rules, participants that make a 
transaction in demonstrable error could agree to cancel and unwind the 
transaction, subject to the approval of the Exchange.\26\ For purposes 
of the electronic book, the Exchange also proposes to adopt a policy 
for the handling of clearly erroneous transactions.\27\ This policy 
would allow the Exchange to: (a) Review, and potentially modify or 
cancel, executions where one party believes that the terms of the 
transaction were clearly erroneous when submitted, and (b) modify or 
cancel executions that result from a disruption or malfunction in the 
use or operation of the electronic book, or any communications system 
associated with the electronic book. The proposed rules set out 
procedures for each of these reviews, including specific means for 
participants to appeal the Exchange's decisions.
---------------------------------------------------------------------------

    \26\ See Proposed CHX Article XXA, Rule 5.
    \27\ See Proposed CHX Article XXA, Rule 7.
---------------------------------------------------------------------------

    Registration of market makers. Under the proposal, Exchange 
participants could seek registration as market makers in one or more of 
the securities traded in the electronic book. A market maker would be 
required to maintain a continuous two-sided market in each security in 
which he or she is registered, and to engage, to a reasonable degree 
under existing circumstances, in a course of dealing in the securities 
in which he or she is registered that is reasonably calculated to 
contribute to the maintenance of a fair and orderly market.\28\ In 
exchange, these market makers would be entitled to utilize exempt 
credit for financing their market maker transactions. The proposed 
rules set out a process for market makers to apply for this 
registration and for the

[[Page 43915]]

suspension or termination of their registrations, where 
appropriate.\29\
---------------------------------------------------------------------------

    \28\ See Proposed CHX Article XXA, Rule 6(b).
    \29\ See Proposed CHX Article XXA, Rule 6(a) and (d).
---------------------------------------------------------------------------

    Additional changes to rules. Because this proposal is designed to 
replace the Exchange's existing cabinet security and lead market maker 
systems, the proposed rule change, as amended, also contains changes to 
various rules associated with those trading systems.\30\
---------------------------------------------------------------------------

    \30\ See proposed changes to CHX Article XII, Rule 9 (deleting 
the cabinet securities rule from the Minor Rule Violation Plan 
(``MRVP'')); CHX Article XX, Rule 11 (deleting the cabinet 
securities rule); CHX Article XXVIII, Rule 6 (deleting the rule 
permitting the Board of Governors to place securities in the 
cabinet); CHX Article XXXIV, Rule 3 (deleting the interpretation 
that creates the lead market maker program); and Participant Fees 
and Credits (deleting the lead market maker credits and the 
recommended MRVP fines for violations of the cabinet system rule).
---------------------------------------------------------------------------

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\31\ In particular, the Commission finds that the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act \32\ 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.
---------------------------------------------------------------------------

    \31\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \32\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The proposal would replace the Exchange's current manual procedures 
used to trade securities that are not assigned to a specialist with a 
fully-automated electronic book that would display and match eligible 
limit orders in these securities, without the participation of a 
specialist or lead market maker. The Commission believes that this new 
automatic execution system should provide investors with a more 
efficient mechanism by which to immediately access and trade such 
securities. Moreover, the Commission finds that the automated display 
of orders and transactions will help to perfect the mechanism of a free 
and open market by automatically handling orders in a fair and 
reasonable manner and by increasing the transparency of orders and 
transactions in these securities on the Exchange.\33\
---------------------------------------------------------------------------

    \33\ The Commission notes that, while it believes that the 
proposed rule change, as amended, is consistent with the 
requirements of the Act, the Commission is not making a 
determination that the Exchange's automatic execution capabilities 
would satisfy the ``automated trading center'' definition in Rule 
600(b)(4) of Regulation NMS. See Securities Exchange Act Release No. 
51808 (June 9, 2005), 70 FR 37496 (June 29, 2005). The Commission 
also notes that the Exchange may need to amend its trading rules 
prior to the applicable effective dates of Regulation NMS.
---------------------------------------------------------------------------

    As noted by the Exchange, all eligible orders in the electronic 
book would be round-lot limit orders, good for the day on which they 
are submitted and would be automatically cancelled at the end of each 
day's trading session. Except for certain cross orders, the Exchange 
proposes that all of the orders would be for regular way settlement and 
automatically matched against each other in price and time priority in 
the electronic book. Cross and cross with size orders for non-regular 
way settlement would also be permitted. These orders would execute 
automatically without regard to either the NBBO or orders for regular 
way settlement. The Exchange represented that this is consistent with 
how these types of crossing transactions are handled on the Exchange's 
floor today. Accordingly, the Commission believes that it is 
appropriate to include this transaction type in the electronic book as 
well.
    In addition, the proposed rule change would permit CHX participants 
to seek registration as market makers in one or more of the securities 
traded in the electronic book. Under the proposal, a market maker would 
be required to maintain a continuous two-sided market in each security 
in which he or she is registered, and to engage, to a reasonable degree 
under existing circumstances, in a course of dealing in the securities 
in which he or she is registered that is reasonably calculated to 
contribute to the maintenance of a fair and orderly market. Proposed 
CHX Article XXA, Rule 6(c) also states that market makers would be 
considered dealers on the Exchange for purposes of the Act and the 
rules and regulations thereunder. Because market makers receive certain 
benefits for carrying out their duties, the Commission believes that 
they should have an affirmative obligation to hold themselves out as 
willing to buy and sell securities for their own account on a regular 
or continuous basis to justify this favorable treatment. In this 
regard, proposed CHX Article XXA, Rule 6(b) would impose such 
affirmative obligations on market makers for securities traded in the 
electronic book.
    Furthermore, the Commission believes that the proposed rules 
provide a reasonable method by which all CHX participants could have 
access to the electronic book and route orders. Orders would be sent to 
the electronic book through the Exchange's MAX system or through any 
other communications lines approved by the Exchange for the delivery of 
orders by Exchange participants; ITS commitments would be sent to the 
electronic book through the ITS system; and NASD market participants 
would have direct telephone access to the supervisory center for the 
electronic book to enter orders in Nasdaq/NM securities. Furthermore, 
except for cross and cross-with-size orders, all orders received by the 
electronic book would be ranked according to their price and time of 
receipt, and would be displayed to the public when they constitute the 
BBO in the electronic book for a security through the CTA/CQ Plan for 
listed securities, and through the OTC/UTP Plan for Nasdaq/NM 
securities. The Commission believes that these proposed rules provide a 
reasonable process by which market participants would access and 
participate in the electronic book and will increase the efficiency of 
the Exchange's routing and display of eligible orders in the electronic 
book.
    Furthermore, the Commission believes that the Exchange's proposal 
to automatically cancel and not accept any order in listed securities 
whose execution would cause the improper trade-through of another ITS 
market or that improperly locks or crosses another ITS market, any 
inbound order in Nasdaq/NM securities that improperly locks or crosses 
the NBBO, or any orders during a trading halt of the particular 
security, will protect investors and promote the fair and orderly 
operation of the markets.
    In addition, the Commission believes it is appropriate for the 
Exchange to codify in its rules the method in which erroneous 
transactions in the electronic book could be handled. The Exchange's 
proposal would allow participants making a demonstrable error to agree 
to cancel and unwind the transaction, subject to the Exchange's 
approval. The Exchange also sets forth formal procedures in proposed 
CHX Article XXA, Rule 7 regarding the Exchange's review of clearly 
erroneous transactions, and the specific means for market participants 
to appeal decisions made by Exchange officials. The Commission believes 
that the proposed rules are consistent with the Act and provide for a 
fair, transparent, and reasonable process in which CHX participants can 
correct erroneous transactions in the electronic book.

[[Page 43916]]

Application of ``Effect v. Execute'' Exemption from Section 11(a) of 
the Act

    Section 11(a) of the Act \34\ prohibits a member \35\ of a national 
securities exchange from effecting transactions on that exchange for 
its own account, the account of an associated person, or an account 
over which it or its associated person exercises discretion 
(collectively, ``covered accounts'') unless an exception applies. In 
addition, Rule 11a2-2(T) \36\ under the Act, known as the ``effect 
versus execute'' rule, provides exchange members with an exemption from 
the Section 11(a) prohibition. Rule 11a2-2(T) permits an exchange 
member, subject to certain conditions, to effect transactions for 
covered accounts by arranging for an unaffiliated member to execute the 
transactions on the exchange. To comply with Rule 11a2-2(T)'s 
conditions, a member (a) must transmit the order from off the exchange 
floor; (b) may not participate in the execution of the transaction once 
it has been transmitted to the member performing the execution; (c) may 
not be affiliated with the executing member; and (d) with respect to an 
account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in the 
connection with effecting the transaction except as provided in the 
Rule.
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78k(a).
    \35\ In connection with the Exchange's demutualization, the 
Exchange modified its rules to call its members ``participants'' of 
the Exchange. See Securities Exchange Act Release No. 51149 
(February 8, 2005), 70 FR 7531 (February 14, 2005). The Exchange's 
participants are considered members of the Exchange for purposes of 
the Act. See CHX Article I, Rule 1(l).
    \36\ 17 CFR 240.11a2-2(T).
---------------------------------------------------------------------------

    In a letter to the Commission,\37\ the Exchange represented that 
transactions effected in the electronic book meet the requirements of 
Rule 11a2-2(T). Based on these representations, the Commission finds 
that the electronic book satisfies the four conditions of Rule 11a2-
2(T).
---------------------------------------------------------------------------

    \37\ See Letter from Ellen J. Neely, Senior Vice President and 
General Counsel, CHX, to Katherine A. England, Assistant Director, 
Division, Commission, dated May 10, 2005.
---------------------------------------------------------------------------

    Specifically, orders would be sent to the electronic book through 
the Exchange's MAX[supreg] system or through any other communications 
lines approved by the Exchange for the delivery of orders by Exchange 
members. In the context of other automated trading systems, the 
Commission has found that the off-floor transmission requirement is met 
if a covered account order is transmitted from a remote location 
directly to an exchange's floor by electronic means.\38\ The Exchange, 
however, in its letter stated that it proposes that its floor members 
be able to use automated means while on the physical floor to transmit 
orders for their own account into the electronic book. The Commission 
has stated that the off-floor transmission requirement may be met when 
an order is sent from one trading floor of an exchange to another, 
separate trading floor of the same exchange.\39\ On the basis of the 
Exchange's representations, the Commission believes that orders sent, 
by electronic means, from the Exchange's trading floor may be 
considered to be sent from ``off-floor'' for purposes of the CHX 
electronic book. Specifically, the Commission believes that because the 
securities traded on the electronic book are not traded on the CHX's 
physical floor, the electronic book is essentially a different, 
separate ``trading floor.'' The Commission notes that CHX floor members 
will not have a time/place advantage with regard to the securities 
traded in the electronic book. Specifically, orders transmitted from 
the Exchange's trading floor will not be processed any more quickly by 
the electronic book than those orders received from off the physical 
floor. In addition, floor members will see information about orders 
that are at the top of the electronic book at the same time as the 
public. Specifically, floor brokers will receive this information from 
the securities information processor that disseminates it to the 
public. Thus, based on these facts, the Commission believes the off-
floor transmission requirement is satisfied in this case.
---------------------------------------------------------------------------

    \38\ See, e.g., Securities Exchange Act Release Nos. 49066 
(January 13, 2004), 69 FR 2773 (January 20, 2004) (order approving 
the Boston Options Exchange as an options trading facility of the 
Boston Stock Exchange); 29237 (May 24, 1991), 56 FR 24853 (May 31, 
1991) (regarding New York Stock Exchange's (``NYSE'') Off-Hours 
Trading Facility); 15533 (January 29, 1979), 44 FR 6084 (January 31, 
1979) (regarding the Amex Post Execution Reporting System, the Amex 
Switching System, the Intermarket Trading System, the Multiple 
Dealer Trading Facility of the Cincinnati Stock Exchange, the 
Pacific Exchange's (``PCX'') Communications and Execution System, 
and the Philadelphia Stock Exchange's (``Phlx``) Automated 
Communications and Execution System (``1979 Release'')); and 14563 
(March 14, 1978), 43 FR 11542 (March 17, 1978) (regarding the NYSE's 
Designated Order Turnaround System). See also Letter from Paula R. 
Jenson, Deputy Chief Counsel, Division, Commission, to Angelo 
Evangelou, Senior Attorney, Chicago Board Options Exchange 
(``CBOE''), dated March 31, 2003 (regarding CBOE's CBOEdirect system 
(``CBOEdirect Letter'')); Letter from Paula R. Jenson, Deputy Chief 
Counsel, Division, Commission, to Jeffrey P. Burns, Assistant 
General Counsel, Amex, dated July 9, 2002 (regarding Amex's Auto-Ex 
system for options); Letter from Paula R. Jenson, Deputy Chief 
Counsel, Division, Commission, to Richard S. Rudolph, Counsel, Phlx, 
dated April 15, 2002 (regarding Phlx's AUTOM System and its 
automatic execution feature AUTO-X); Letter from Paula R. Jenson, 
Deputy Chief Counsel, Division, Commission, to Kathryn L. Beck, 
Senior Vice President, Special Counsel and Antitrust Compliance 
Officer, PCX, dated October 25, 2001 (regarding Archipelago Exchange 
(``ArcaEx'') (``ArcaEx Letter'')); Letter from Brandon Becker, 
Director, Division, Commission, to George T. Simon, Foley & Lardner, 
dated November 30, 1994 (regarding Chicago Match (``Chicago Match 
Letter'')).
    \39\ See Letter from Richard A. Steinwurtzel, Attorney, Office 
of Chief Counsel, Division, Commission, to Philip J. Lo Bue, Senior 
Vice President, PCX, dated December 22, 1978.
---------------------------------------------------------------------------

    Second, the rule requires that the member not participate in the 
execution of its order. Exchange represented that its members 
relinquish control of orders after they are submitted to the electronic 
book and noted that the members do not receive special or unique 
trading advantages.\40\ Third, although Rule 11a2-2(T) contemplates 
having an order executed by an exchange member who is unaffiliated with 
the member initiating the order, the Commission recognizes that the 
requirement is satisfied when automated exchange facilities are 
used.\41\ Finally, the Exchange represents that members that rely on 
Rule 11a2-2(T) for a managed account transaction must comply with the 
limitations on compensation set forth in the rule.
---------------------------------------------------------------------------

    \40\ See Securities Exchange Act Release No. 44983 (October 25, 
2001), 66 FR 55225 (November 1, 2001) (Order approving ArcaEx as the 
equities trading facility of PCX Equities Inc.); 1979 Release, supra 
note 38, at 6086 note 25. See also CBOEdirect Letter, supra note 38; 
Letter from Larry E. Bergmann, Senior Associate Director, Division, 
Commission, to Edith Hallahan, Associate General Counsel, Phlx, 
dated March 24, 1999 (regarding Phlx's VWAP Trading System); Letter 
from Catherine McGuire, Chief Counsel, Division, Commission, to 
David E. Rosedahl, PCX, dated November 30, 1998 (regarding 
Optimark); and Chicago Match Letter, supra note 38.
    \41\ In considering the operation of automated execution systems 
operated by an exchange, the Commission noted that while there is no 
independent executing exchange member, the execution of an order is 
automatic once it has been transmitted into the systems. Because the 
design of these systems ensures that members do not possess any 
special or unique trading advantages in handling their orders after 
transmitting them to the exchange, the Commission has stated that 
executions obtained through these systems satisfy the independent 
execution requirement of Rule 11a2-2(T). See 1979 Release, supra 
note 38, at 6086 note 25.
---------------------------------------------------------------------------

Accelerated Approval of Amendment No. 2

    The Commission finds good cause to approve Amendment No. 2 to the 
proposed rule change, as amended, prior to the thirtieth day after the 
amendment is published for comment in the Federal Register pursuant to 
Section 19(b)(2) of the Act.\42\ Amendment No. 2 clarifies how orders

[[Page 43917]]

in the electronic book would be handled during a trading halt, that 
orders that improperly lock or cross other markets or that would trade 
through another ITS market would be cancelled, and the obligations of a 
market maker in the electronic book.\43\ Amendment No. 2 also clarifies 
the definitions of cross and cross with size orders,\44\ incorporates 
new provisions relating to orders for non-regular way settlement and to 
a floor member's responsibility to clear the electronic book before 
sending orders to other markets,\45\ and updates the proposed rule 
change to reflect the Exchange's recent demutualization.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78s(b)(2).
    \43\ See changes to rule text proposed in CHX Article XXA, Rules 
2(e), 2(f), 3(d), 4(c)(3), and 6(b).
    \44\ See changes to rule text proposed in CHX Article XXA, Rules 
2(c)(3) and (4).
    \45\ See Proposed CHX Article XXA, Rules 2(c)(5) and 8.
---------------------------------------------------------------------------

    The Commission believes that the proposed changes in Amendment No. 
2 provide a clearer understanding of the operation of the electronic 
book and raise no new issues of regulatory concern. In addition, the 
Commission notes that the requirement for clearing the electronic book 
is consistent with the Exchange's current requirement that floor 
brokers or market makers clear the specialist's post in securities 
before sending orders to other markets.\46\ For these reasons, the 
Commission believes that good cause exists to accelerate approval of 
Amendment No. 2.
---------------------------------------------------------------------------

    \46\ See CHX Article XX, Rule 10, Interpretation and Policy .02.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-CHX-2004-11 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE, 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-CHX-2004-11. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (https://www.sec.gov/
rules/sro.shtml). 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 in the Commission's Public Reference Section, 100 F Street, 
NE, Washington, DC 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of the CHX. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-CHX-2004-11 and should be 
submitted on or before August 19, 2005.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5) of the Act.\47\
---------------------------------------------------------------------------

    \47\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\48\ that the proposed rule change (SR-CHX-2004-11) and Amendment 
No. 1 thereto are approved, and that Amendment No. 2 thereto is 
approved on an accelerated basis.
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78s(b)(2).
    \49\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\49\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-4026 Filed 7-28-05; 8:45 am]
BILLING CODE 8010-01-P