Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Order Approving a Proposed Rule Change and Amendment No. 1 Thereto and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 Thereto to Implement a New Trading Model, 59563-59573 [E6-16626]

Download as PDF Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices jlentini on PROD1PC65 with NOTICES • Change references to the ‘‘Chief Regulatory Officer’’ in the AWC to the ‘‘General Counsel or his/her delegatee’’; • Add a provision in BSE Rule Chapter XXX imposing a late charge when a member fails to pay a fine on a timely basis; • Add violations of the Exchange’s rules governing the Intermarket Trading System to BSE Rule Chapter XXXIV; • Restructure the fine levels of violations in BSE Rule Chapter XXXIV pertaining to Failure to Display Limit Orders, Floor Order Facilitation, Failure to Designate an Order (PPS), and Dealings Outside of Exchange Operating Hours; and • Adjust the fine levels for short sale violations in BSE Rule Chapter XXXIV. 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.4 In particular, the Commission believes that the proposal is consistent with Section 6(b)(5) of the Act,5 because delineating factors to be considered in determining sanctions should promote transparency of the Exchange’s disciplinary process and the ability to impose a late charge for the failure to pay fines should help the Exchange carry out its supervisory responsibilities. The Commission further believes that the proposal is consistent with Sections 6(b)(1) and 6(b)(6) of the Act,6 which require that the rules of an exchange enforce compliance with, and provide appropriate discipline for, violations of Commission and Exchange rules. In addition, because BSE Rule Chapter XVIII provides procedural rights to contest the fine for any violation of an Exchange rule and permits disciplinary proceedings on the matter, the Commission believes BSE Rule Chapter XXXIV, as amended by this proposal, provides a fair procedure for the disciplining of members and persons associated with members, consistent with Sections 6(b)(7) and 6(d)(1) of the Act.7 Finally, the Commission finds that the proposal is consistent with the public interest, the protection of investors, or otherwise in furtherance of the purposes of the Act, as required by Rule 19d– 1(c)(2) under the Act 8 which governs minor rule violation plans. The 4 In approviing this proposed rule change, the Commission notes that it has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 5 15 U.S.C. 78f(b)(5). 6 15 U.S.C. 78f(b)(1) and 78f(b)(6). 7 15 U.S.c. 78f(b)(7) and 78f(d)(1). 8 17 CFR 240.19d–1(c)(2). VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 Commission believes that the proposed change to BSE Rule Chapter XXXIV will strengthen the Exchange’s ability to carry out its oversight and enforcement responsibilities as a self-regulatory organization in cases where full disciplinary proceedings are unsuitable in view of the minor nature of the particular violation. In approving this proposed rule change, as amended, the Commission in no way minimizes the importance of compliance with BSE rules and all other rules subject to the imposition of fines under the minor rule violation plan of the Exchange. The Commission believes that the violation of any self-regulatory organization’s rules, as well as Commission rules, is a serious matter. However, the Exchange’s minor rule violation plan under BSE Rule Chapter XXXIV provides a reasonable means of addressing rule violations that do not rise to the level of requiring formal disciplinary proceedings, while providing greater flexibility in handling certain violations. The Commission expects that BSE will continue to conduct surveillance with due diligence and make a determination based on its findings, on a case-by-case basis, whether a fine of more or less than the recommended amount is appropriate for a violation under the minor rule violation plan or whether a violation requires formal disciplinary action under BSE Rule Chapter XXX. It is therefore ordered, pursuant to Section 19(b)(2) of the Act 9 and Rule 19d–1(c)(2) under the Act,10 that the proposed rule change (SR–BSE–2005– 09), as amended, be, and hereby is, approved and declared effective. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.11 Nancy M. Morris, Secretary. [FR Doc. E6–16645 Filed 10–6–06; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54550; File No. SR–CHX– 2006–05] Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Order Approving a Proposed Rule Change and Amendment No. 1 Thereto and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 Thereto to Implement a New Trading Model September 29, 2006. I. Introduction On February 2, 2006, 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 amend its rules to implement a new trading model that provides the opportunity for fully automated executions to occur within a central matching system (the ‘‘Matching System’’). On August 10, 2006, the Exchange filed Amendment No. 1 to the proposed rule change. The proposed rule change, as amended by Amendment No. 1, was published for comment in the Federal Register on August 18, 2006.3 The Commission received one comment letter on the proposal.4 On September 29, 2006, the Exchange filed Amendment No. 2 to the proposed rule change.5 This order approves the proposed rule change, as amended by Amendment No. 1. Simultaneously, the Commission is providing notice of filing of, and granting accelerated approval to, Amendment No. 2 to the proposed rule change. II. Description The Exchange proposes to amend its rules in order to implement a new trading model that would allow Exchange participants to interact in a 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 54301 (August 10, 2006), 71 FR 47836 (‘‘Trading Rules Notice’’). 4 See Letter from Michael A. Barth, Senior Vice President, Exchanges and Market Centers, Order Execution Services Holdings, Inc. (‘‘OES’’), to Nancy M. Morris, Secretary, Commission, dated August 25, 2006 (‘‘OES Letter’’). 5 See Form 19b–4 dated September 29, 2006 (‘‘Amendment No. 2’’). The text of Amendment No. 2 is available on CHX’s Web site (https:// www.chx.com), at the principal office of CHX, and at the Commission’s Public Reference Room. See infra Section II.E for a discussion of Amendment No. 2. 2 17 9 15 U.S.C. 78s(b)(2). CFR 240.19d–1(c)(2). 11 17 CFR 200.30–3(a)(12); 17 CFR 200.30– 3(a)(44). 10 17 PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 59563 E:\FR\FM\10OCN1.SGM 10OCN1 59564 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices fully-automated Matching System. In addition, the proposed rules would enable qualifying participant firms to register as ‘‘institutional brokers,’’ that, among other things, would be permitted to execute transactions outside of the Matching System under specified conditions.6 Many of the features of the new trading model are designed to comply with Regulation NMS 7 as of the ‘‘Trading Phase Date’’ for the implementation of that regulation— February 5, 2007.8 The Exchange is also proposing a number of other changes to its rules in an effort to update them generally, as well as to reflect the elimination of the trading floor and the new automated trading system that will be central to the Exchange’s new trading model. A. The Matching System The Matching System would be the core facility of the Exchange’s new trading model. The Exchange would no longer operate a physical trading floor, but rather would operate an automated Matching System where Exchange participants could submit orders from any location for possible immediate execution. 1. Eligible Orders and Order Types jlentini on PROD1PC65 with NOTICES The Matching System generally would accept orders that are day orders, limit orders, and orders for regular way settlement.9 Orders could be submitted as round lots, odd lots, or mixed lots, except that orders in securities that only trade in specific share size increments would be required to be submitted only in those share sizes.10 The Exchange believes that its quotations would qualify as ‘‘automated quotations’’ under Rule 600(b)(3) of Regulation NMS.11 Some of the order types accepted by the Matching System that the Exchange describes as more routine would include immediate or cancel (‘‘IOC’’) 6 See infra Section II.C. for a more detailed discussion. 7 17 CFR 242.600 et seq. 8 See infra note 27. 9 See proposed CHX Article 20, Rule 4(a)(1)–(3). The proposed rules provide for certain exceptions to these basic order eligibility requirements. For example, the Matching System would also accept immediate-or-cancel (‘‘IOC’’) market orders, and would permit a ‘‘non-regular way cross order’’ to be submitted for execution and non-regular way settlement. See proposed CHX Article 20, Rules 4(a)(7) and 4(b)(13) and (16). 10 See proposed CHX Article 20, Rule 4(a)(4). 11 See 17 CFR 242.600(b)(3). The Exchange’s proposed rules provide that each order submitted to the Matching System must be a firm order and cannot be identified as a ‘‘manual’’ quotation. See proposed CHX Article 20, Rule 3(a). See also infra note 54 and accompanying text. VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 limit and market orders,12 fill or kill (‘‘FOK’’) orders,13 sell short and short exempt orders,14 reserve size orders,15 time in force orders 16 and cancel on halt orders.17 The Matching System also would accept several different types of cross transactions, including a cross,18 a cross with size,19 a cross with satisfy,20 12 IOC orders would be executed against any orders at or better than the Exchange’s Best Bid or Offer (‘‘BBO’’), including any reserve size or other undisplayed orders at or better than that price. See proposed CHX Article 20, Rules 4(b)(12) (IOC orders) and 4(b)(13) (IOC market orders). 13 See proposed CHX Article 20, Rule 4(b)(11). 14 See proposed CHX Article 20, Rule 4(b)(21) (sell short orders) and Rule 4(b)(22) (short exempt orders). 15 See proposed CHX Article 20, Rule 4(b)(20). 16 See proposed CHX Article 20, Rule 4(b)(23). 17 See proposed CHX Article 20, Rule 4(b)(3). 18 See proposed CHX Article 20, Rule 4(b)(4). A cross transaction would be an order to buy and sell the same security at a specific price that is better than the Exchange’s displayed BBO and, for securities listed on any exchange other than Nasdaq (and for Nasdaq-listed securities, when Regulation NMS is implemented in those issues), equal to or better than the National Best Bid and Offer (‘‘NBBO’’). A cross may represent interest of one or more Exchange participants, trading for a proprietary account. See infra note 43 for a description of cross order executions. 19 See proposed CHX Article 20, Rule 4(b)(6). A cross with size would be required to be for at least 5,000 shares and for a value of $100,000 that is at a price equal to or better than the Exchange’s displayed BBO and, for securities listed on the New York Stock Exchange (‘‘NYSE’’), the American Stock Exchange (‘‘Amex’’), or any other exchange except the NASDAQ Stock Market (‘‘Nasdaq’’) (and for Nasdaq-listed securities, when Regulation NMS is implemented in those issues), equal or better to the NBBO, where the size of the cross transaction is one round lot larger than the aggregate size of all interest displayed on the Exchange at that price. At such time as the Exchange disseminates a feed of all displayable orders in the Matching System, however, a cross with size order would be required to be larger only than the largest order in the Matching System at the relevant price. See Amendment No. 2. A cross with size transaction may represent interest of one or more participants of the Exchange. See also infra note 43. 20 See proposed CHX Article 20, Rule 4(b)(5). A cross with satisfy is designed to provide a participant with a mechanism for clearing out displayed orders in the Matching System that would otherwise have time priority (or displayed bids or offers in other market centers that would otherwise have price priority) and then effecting a cross transaction at that price. A cross with satisfy could represent interest of one or more participants of the Exchange but, to the extent that it represents interest of the participant sending the order to the Matching System, the participant (i) would not be eligible to satisfy existing bids or offers in the Matching System at a price that is better than the cross price (when the participant’s customer is on the same side of the order as the participant), and (ii) could only satisfy bids or offers in other markets at a price that is better than the cross price if the cross is for at least 10,000 shares or has a value of at least $200,000 (a ‘‘block size order’’) or is for the account of an institutional customer (defined elsewhere in the proposed rules) and the participant’s customer has specifically agreed to that outcome. See also infra note 44. PO 00000 Frm 00139 Fmt 4703 Sfmt 4703 a cross with yield,21 a midpoint cross,22 an ISO cross,23 an opening cross,24 and a non-regular way cross.25 The Matching System also would accept several order types that are related to Regulation NMS,26 and that would become effective on the Trading Phase Date of Regulation NMS.27 For example, the Matching System would accept benchmark orders that meet the requirements of Rule 611(b)(7) of Regulation NMS.28 The Matching System would also accept different types of intermarket sweep orders 21 See proposed CHX Article 20, Rule 4(b)(7). A cross with yield would automatically yield interest on the buy, sell, or either side of the order to any order already displayed in the Matching System at the same or better price. See also infra note 45. 22 See proposed CHX Article 20, Rule 4(b)(15). A midpoint cross would execute at the midpoint between the NBBO. However, if the NBBO is locked at the time a midpoint cross is received, the midpoint cross would execute at the locked NBBO. If the NBBO is crossed at the time a midpoint cross is received, the midpoint cross would be automatically cancelled. 23 See proposed CHX Article 20, Rule 4(b)(14), added by Amendment No. 2. An ISO cross would be defined as any type of cross order marked as required by Regulation NMS to be executed without taking any of the actions required by the Exchange’s relevant rules to prevent a trade-through. 24 See proposed CHX Article 20, Rule 4(b)(17). Opening cross orders would execute immediately after the primary market opens in a security, at the opening price. For securities listed on NYSE, Amex and any exchange other than Nasdaq, the opening price would be the primary market opening price. For Nasdaq-listed securities (except in the case of an initial IPO), the opening price would be the midpoint of the first unlocked, uncrossed market that occurs on or after 8:30 a.m. For Nasdaq-listed securities on the date of an IPO, the opening price would be the Nasdaq opening price. See also proposed CHX Article 20, Rule 8(c)(2). 25 See proposed CHX Article 20, Rule 4(b)(16). A non-regular way cross would be designated for nonregular way settlement. These orders would be automatically executed without regard to either the NBBO or any orders for regular way settlement that might be in the Matching System. 26 17 CFR 242.600 et seq. 27 See Securities Exchange Act Release No. 53829 (May 18, 2006), 71 FR 30038 (May 24, 2006) (setting new compliance dates for Rules 610 and 611 of Regulation NMS). 28 See 17 CFR 242.611(b)(7); see also CHX proposed Article 20, Rule 4(b)(2). A benchmark order, as defined in the proposed rules, would be an order submitted by an institutional broker, and could be executed at any price, without regard to the protected NBBO. A benchmark order could represent interest of one or more Exchange participants. E:\FR\FM\10OCN1.SGM 10OCN1 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices jlentini on PROD1PC65 with NOTICES (‘‘ISOs’’), such as BBO ISOs,29 outbound ISOs 30 and price-penetrating ISOs.31 In general, the Matching System would accept only orders that comply with the sub-penny restrictions set forth in Rule 612 of Regulation NMS.32 However, contingent upon the Commission granting the necessary exemptive relief from Rule 612, the proposed rules would permit any type of cross order to be submitted to the Matching System in a sub-penny increment as small as $0.000001, provided that no type of cross, except midpoint crosses, non-regular-way crosses and cross with size orders, would be permitted to execute at a price less than $.01 better than any currently displayed same-sided interest available on the Matching System (or $.0001 better when the order is priced under $1.00).33 Finally, the Matching System would accept ‘‘do-not-display’’ and ‘‘do-notroute orders.’’ A do-not-display order would be an order, for at least 1,000 shares when entered, that would not be displayed in whole or in part, but that would remain eligible for execution within the Matching System.34 A donot-route order would be executed or displayed within the Matching System and could not be routed to another market center.35 29 See proposed CHX Article 20, Rule 4(b)(1). BBO ISOs would execute against orders at the Exchange’s BBO, without regard to whether the execution would trade through another market’s protected quotation. If a BBO ISO is marked as ‘‘immediate or cancel,’’ any remaining balance in the order would be automatically cancelled. If a BBO ISO is not marked as ‘‘immediate or cancel,’’ any remaining balance in the order would be displayed in the Matching System, without regard to whether that display would lock or cross another market center. See proposed CHX Article 20, Rule 6(c)(3). 30 An outbound ISO would allow an Exchange participant to ask the Exchange to execute an order on the Exchange while simultaneously routing ISOs to those other markets to execute against their protected quotations. Outbound ISOs would be executed against any eligible orders in the Matching System (including any reserve size or other undisplayed orders). Other than the routing of ISOs to other market centers, no action would be taken to prevent an improper trade-through. See proposed CHX Article 20, Rule 4(b)(18). 31 See proposed CHX Article 20, Rule 4(b)(19). A price-penetrating ISO would operate much like a basic ISO, except that it would allow a participant to execute through displayed and undisplayed interest, at multiple price points, on the Exchange. 32 17 CFR 242.612. 33 See proposed CHX Article 20, Rule 4(a)(7)(b). See also Amendment No. 2. 34 See proposed CHX Article 20, Rule 4(b)(9). 35 See proposed CHX Article 20, Rule 4(b)(10). A do-not-route order would be immediately cancelled if its execution would improperly trade through the ITS BBO or another market’s protected quotations. Any types of cross, IOC, or FOK orders would be deemed to have been received with a ‘‘do not route’’ condition because these orders either are immediately executed in the Matching System or cancelled. VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 2. Ranking and Display of Orders All orders received by the Matching System would be ranked by price, time of receipt, and, for round-lot orders, any display instructions received with the order.36 Specifically, orders received by the Matching System would be ranked as follows: (i) Limit orders that are eligible to be displayed, including the displayed portion of reserve size orders, and all odd-lot and mixed-lot orders would be ranked together, at each price point, in time priority; (ii) at each price point, the undisplayed portions of reserve size orders would be ranked together in time priority and would be ranked after any displayed orders (and any odd-lot and mixed-lot orders) at that price; and (iii) orders that are received with a do-not-display instruction would be ranked together, at each price point, in time priority and would be ranked after any other orders at that price.37 All orders that are eligible for display would be immediately and publicly displayed through the processes set out in the appropriate transaction reporting plan for each security when they constitute the best round-lot bid or offer in the Matching System for that security. For display purposes, the Matching System would aggregate all shares, including odd-lot orders and the odd-lot portions of mixed-lot orders, at a single price point, and then round that total share amount down to the nearest round-lot amount.38 3. Automatic Execution Incoming orders generally would be matched against orders in the Matching System, in the order of their ranking, at the price of each resting order, for the full amount of shares available at that price or for the size of the incoming order, if smaller.39 If an order could not 36 See proposed CHX Article 20, Rule 8(b). Orders sent to an institutional broker for handling would not have any priority within the Matching System unless and until they are received by the Matching System. Id. 37 Id., proposed Rule 8(b)(1)–(3). The refreshed displayed portion of a reserve-size order would receive a new ranking based on the time it was refreshed, with any remaining undisplayed portion retaining the ranking at which it was originally received. Id., proposed Rule 8(b)(4). A change to an order’s size or price, or its displayed portion, could impact its ranking within the Matching System. A change to the display instructions associated with an order would need to be submitted as a new order and would be ranked based on the time the new order was received. Id., proposed Rule 8(b)(5). See also Amendment No. 2. 38 Id., proposed Rule 8(b)(6). For execution purposes, however, all orders would retain their rankings as described above. 39 See proposed CHX Article 20, Rule 8(d)(1). This general rule would be subject to certain exceptions specifically set forth in proposed CHX Article 20, Rule 8(e), and subject to the provisions relating to the prevention of trade-throughs in proposed CHX Article 20, Rule 5. PO 00000 Frm 00140 Fmt 4703 Sfmt 4703 59565 be immediately matched or matched in full when received, and it is not designated as an order type that should be immediately cancelled,40 it or its residual portion would be placed in the Matching System and ranked.41 The proposed rules describe certain order types that would be subject to specific executions within the Matching System.42 Such order types include cross and cross with size orders,43 cross with satisfy orders,44 cross with yield orders,45 sell short orders,46 do-not40 See proposed CHX Article 20, Rules 4(b)(11) through (13). Orders that would be immediately cancelled, if not executed, include FOK orders and IOC limit and market orders. 41 See proposed CHX Article 20, Rule 8(d)(2); see also supra note 37 and accompanying text. 42 See proposed CHX Article 20, Rule 8(e). 43 See proposed CHX Article 20, Rule 8(e)(1). Cross and cross with size orders would be automatically executed if they meet the requirements for such order types, and would be immediately and automatically cancelled if they do not meet these requirements. 44 See proposed CHX Article 20, Rule 8(e)(4). In executing cross with satisfy orders, the Matching System first would determine whether the order contains a share size that is sufficient to satisfy orders in the Matching System or bids or offers in other markets, as applicable. If this requirement is not met, the cross with satisfy would be automatically cancelled. If the order meets this requirement, the Matching System then would satisfy existing orders in the Matching System or send orders or commitments to other market centers to satisfy bids or offers, as necessary to prevent a trade-through and, before updating the Exchange’s quotes, would execute the cross at a price that is better than the best bid or offer to be displayed in the Matching System and, for securities listed on NYSE, Amex or any other exchange other than Nasdaq (and for Nasdaq-listed securities, when Regulation NMS is implemented in those issues), equal to or better than the NBBO. In doing so, the Matching System would determine whether the participant that sent the order to the Matching System is attempting to satisfy bids or offers in the Matching System at a price that is better than the cross price and, if so, would not allow those executions to occur, but would instead allocate the better prices to the customer, not to the participant sending the order to the Matching System. See also supra note 20. 45 See proposed CHX Article 20, Rule 8(e)(2). A cross with yield order would be automatically executed by matching the participant as principal against the customer order if the customer order that is part of a cross with yield order is at a price better than the currently displayed best bid or offer in the Matching System; provided, however, that if there is any order already displayed in the Matching System at the same price as (or better than) the participant’s interest, that order or those orders would be matched against the customer order in place of the participant’s interest as necessary to exhaust the customer order interest. If the customer order that is part of a cross with yield order is not eligible for an immediate execution because it is not priced better than the currently displayed bid or offer in the Matching System, the cross with yield order would be immediately and automatically cancelled. See also supra note 21. 46 See proposed CHX Article 20, Rule 8(e)(5). Sell short orders (including odd lot orders) would be displayed and executed only when permissible under the provisions of Rule 10a–1 (‘‘Short Sale Rule’’) under the Act and Regulation SHO. When E:\FR\FM\10OCN1.SGM Continued 10OCN1 59566 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices display orders,47 and inbound ITS commitment or linkage plan orders.48 The proposed rules also describe the handling of orders in locked and crossed markets.49 jlentini on PROD1PC65 with NOTICES 4. Preventing Trade-Throughs An inbound order for at least one round lot would not be eligible for execution on the Exchange if its execution would cause an improper trade-through, both prior to and following the Trading Phase Date of Rule 611 of Regulation NMS.50 The proposed rules provide that the Exchange will follow a series of tradethrough policies and procedures in determining whether a trade on the Exchange would create an improper trade-through.51 These procedures include clock synchronization practices, as well as plans for applying the exceptions to Rule 611 of Regulation NMS. For example, the Exchange’s rules contemplate using the self-help exception in Rule 611(b)(1) of Regulation NMS.52 Further, the Exchange would automatically place an appropriate modifier on trades executed pursuant to an exemption from, or exception to, Rule 611 of Regulation NMS in accordance with specifications approved by the operating committee of the relevant national market system plan for an NMS stock. If a trade is executed pursuant to both the intermarket sweep order exception of Rule 611(b)(5) or (6) of Regulation NMS and the self-help exception of Rule a sell short order cannot be executed or displayed at its limit price under the provisions of the Short Sale Rule and Regulation SHO, the order would be automatically re-priced (without violating its limit price) to the next available price at which it can be executed or displayed. If the Matching System cannot determine an appropriate price at which to execute or display the order, the order would be automatically cancelled. See Amendment No. 2. 47 See proposed CHX Article 20, Rule 8(e)(6). A do-not-display order would be immediately and automatically cancelled if, at any point, the order would prevent the execution of an inbound order because the do-not-display order has crossed the NBBO. 48 See proposed CHX Article 20, Rule 8(e)(7). 49 See proposed CHX Article 20, Rule 6 and proposed CHX Article 20, Rule 5, Interpretation and Policy .01(e). 50 See proposed CHX Article 20, Rule 5. An inbound order for at least one round lot would not be eligible for execution on the Exchange if its execution would cause an improper trade-through of another ITS market or if, when Regulation NMS is implemented for a security, the execution of all or a part of the order would be improper under Rule 611 of Regulation NMS. Inbound odd lot orders and odd lot crosses would be eligible for execution on the Exchange, even if they would trade through other markets’ bids and offers. 51 See proposed CHX Article 20, Rule 5, Interpretation and Policy .01. 52 See 17 CFR 242.611(b)(1); see also proposed CHX Article 20, Rule 5, Interpretation and Policy .01(d). VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 611(b)(1) of Regulation NMS, the trade would be identified as executed pursuant to the intermarket sweep order exception.53 The proposed rules also set forth the procedures that the Exchange would use to confirm that its own bids and offers qualify as automated quotations and, if they do not qualify as automated quotations, how the Exchange will identify such quotations as manual.54 5. Order Routing The proposed rules also contain provisions governing the routing of orders to other markets when execution in the Matching System would cause an improper trade-through.55 If a participant has submitted a cross with satisfy or an outbound ISO order and its execution would cause an improper trade-through, the Matching System would execute the order and simultaneously route orders or commitments necessary to satisfy the bids or offers of other markets (‘‘routing services’’). Otherwise, any inbound order for at least a round lot is not eligible for execution on the Exchange if its execution would cause an improper trade-through.56 The Exchange proposes to provide these routing services pursuant to the terms of three separate agreements, to the extent that they are applicable to a specific routing decision: (i) An agreement between the Exchange and each participant on whose behalf orders will be routed; (ii) an agreement between each participant and a specified third-party broker-dealer that will use its routing connectivity to other markets and serve as a ‘‘give-up’’ in those markets; and (iii) an agreement between the Exchange and the specified third-party broker-dealer pursuant to which the third-party broker-dealer would agree to provide routing connectivity to other markets and serve as a ‘‘give-up’’ for the Exchange’s participants in other markets. In providing the routing services, the Exchange would use its own systems to determine when, how, and where orders (or commitments) are routed away to other markets.57 In addition, the Exchange will establish and maintain procedures and internal controls 53 See proposed CHX Article 20, Rule 5, Interpretation and Policy .01(h). See also Amendment No. 2. 54 See proposed CHX Article 20, Rule 5, Interpretation and Policy .02. Specifically, the Exchange would send test IOC orders to the Matching System to make this determination. See also supra, note 11 and accompanying text. 55 See proposed CHX Article 20, Rule 5, Interpretation and Policy .03. 56 See proposed CHX Article 20, Rule 5(a). 57 Id. PO 00000 Frm 00141 Fmt 4703 Sfmt 4703 reasonably designed to adequately restrict the flow of confidential and proprietary information between the Exchange (including its facilities) and the third-party broker-dealer, and, to the extent the third-party broker-dealer reasonably receives confidential and proprietary information, that adequately restrict the use of such information by the third party broker-dealer to legitimate business purposes necessary to provide routing connectivity and to serve as a ‘‘give-up.’’ 58 6. Locking and Crossing Quotations With certain exceptions, Exchange participants would be required to reasonably avoid displaying, and refrain from engaging in a pattern or practice of displaying, any quotations that lock or cross a protected quotation.59 An order would not be eligible for display on the Exchange if its display would improperly lock or cross the ITS best bid or offer or, as of the Trading Phase Date of Regulation NMS for a security, if its display would constitute a locking or crossing quotation.60 These otherwise locking or crossing orders would either be automatically routed to another appropriate market or, if designated as ‘‘do not route,’’ automatically cancelled. B. Market Makers The proposed rules in Article 16 set forth the responsibilities of a participant that registers as a market maker on the Exchange.61 In particular, a market maker would be required to engage in a course of dealings for its own account to assist in the maintenance, to the extent reasonably practicable, of fair and 58 See Amendment No. 2, supra note 5. proposed CHX Article 20, Rule 6. The exceptions are provided when: (i) The locking or crossing quotation was displayed at a time when the other trading center was experiencing a failure, material delay, or malfunction of its systems or equipment; (ii) the locking or crossing quotation was displayed at a time when a protected bid was higher than a protected offer in the NMS stock; or (iii) the Exchange participant displaying the locking or crossing quotation simultaneously routed an intermarket sweep order to execute against the full displayed size of any locked or crossed protected quotation. 60 See proposed CHX Article 20, Rule 6. 61 An Exchange-registered market maker would be permitted to trade only on a proprietary basis and would not be permitted to handle any agency orders on the Exchange. To the extent that a participant firm wants to act as an Exchangeregistered market maker and also handle orders from customers outside the facilities of the Exchange, it would be required to create and strictly enforce information barrier procedures as described infra at note 64 and accompanying text. Since Exchange-registered market makers are not permitted to handle agency orders, the Matching Engine will reject any cross order instructions entered by a market maker in its market maker trading account. See proposed CHX Article 16, Rule 1, Interpretation and Policy .02. See also Amendment No. 2. 59 See E:\FR\FM\10OCN1.SGM 10OCN1 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices orderly markets on the Exchange. A market maker’s responsibilities would specifically include: (1) Using automated systems to maintain a continuous two-sided quote, for at least a round-lot, in each of the securities in which it is registered; 62 (2) maintaining adequate minimum capital; and (3) meeting specific quotation or trade requirements, with respect to its dealings on the Exchange, over the course of each calendar month.63 In addition, a market maker that is registered as a market maker solely on the Exchange and engages in other business activities (or that is affiliated with a broker or dealer that engages in other business activities) would be required to establish information barriers that prevent the market maker from using material, non-public information or information about customer order flow handled by the firm in its trading activities.64 C. Institutional Brokers jlentini on PROD1PC65 with NOTICES Participant firms for which the Exchange is the designated examining authority could register with the Exchange as institutional brokers.65 Institutional brokers would be deemed to be participants operating on the Exchange, although they would not effect transactions from a physical trading floor (since the Exchange will no longer have a physical trading floor) and could trade from any location. A customer order would be deemed to be on the Exchange when received by an institutional broker, but would not have priority in the Matching System until it is entered into the system. Institutional brokers would be required to: (1) Enter all orders received for execution on the Exchange into an automated system to provide an electronic record of their order handling practices; (2) handle orders with an electronic system acceptable to the Exchange that integrates their onexchange activities with the Matching System and their trading activities in other market centers; and (3) maintain separate accounts for handling agency transactions, principal transactions, and 62 A market maker’s continuous two-sided quotes would be required to be at prices which are reasonably related to the prevailing market price of the security. See CHX Article 16, Rule 8, Interpretation and Policy .01. 63 See proposed CHX Article 16, Rule 8(a)–(c). 64 See proposed CHX Article 16, Rule 9. 65 See proposed CHX Article 17, Rule 1. Each individual that would be authorized to effect trades on behalf of the firm would be required to separately register as an institutional broker representative. See proposed CHX Article 17, Rule 1, Interpretation and Policy .02. VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 transactions involving errors.66 Institutional brokers would also be required to maintain required records of their trading activities.67 An institutional broker would be required to use due diligence to execute a market order at the best price available; to use due diligence to execute a limit order at or better than the limit price, if available; and to use brokerage judgment in the execution of a not held order.68 Institutional brokers would be required to use reasonable efforts to report all transactions that are not effected through the Exchange’s Matching System to the Exchange within 10 seconds of the trade.69 If an institutional broker executes an order outside of the Matching System, it would be required to use the Exchange’s Brokerplex system to determine whether a trade would constitute a trade-through and create an electronic record that such validation had taken place.70 In general terms, the Brokerplex system would allow an institutional broker to input the symbol for a security and pull up a window that includes a snapshot of the Matching System BBO and the NBBO. The institutional broker then could report a trade that is consistent with the orders in the Matching System and the NBBO. An institutional broker that initiates the use of this functionality to report a proprietary trade against a customer order would be required to complete the transaction report (without cancelling out of the functionality), unless the institutional broker had mistakenly input the symbol for the wrong security. The transaction also could be cancelled pursuant to CHX rules relating to cancellations of transactions, clearly erroneous transactions and systems disruptions and malfunctions.71 Unless a customer specifically requests otherwise, an institutional broker would be required to clear the Matching System before sending an order to another market for execution.72 66 See proposed CHX Article 17, Rule 3(a) through Rule 3(c). The Commission recently approved, and the Exchange has implemented, a proposed rule change regarding requirements for entering orders into an electronic system to permit the Exchange to more readily surveil broker order handling activities. See CHX Article 11, Rule 3; Securities Exchange Act Release No. 53772 (May 8, 2006), 71 FR 27758 (May 12, 2006). 67 See proposed CHX Article 17, Rule 3(f). 68 See proposed CHX Article 17, Rule 3(d). 69 See proposed CHX Article 17, Rule 3(e). 70 See CHX Article 17, Rule 3, Interpretation and Policy .03. 71 See id. 72 See proposed CHX Article 20, Rule 7. Any customer directives for special handling of orders would have to be documented and reported to the Exchange. PO 00000 Frm 00142 Fmt 4703 Sfmt 4703 59567 The proposed rules provide exceptions to this requirement for: (1) Outbound ITS commitments or ISOs that are being sent to another market to satisfy its displayed bid or offer;73 and (2) customer orders that are being sent to another market that could not be executed in the Matching System.74 D. Other Rule Changes Proposed Article 9, Rule 17, based on an existing Exchange rule prohibiting participants from trading ahead of customer orders, would include a provision confirming that a participant would be deemed to be holding an unexecuted customer order when that order has been sent to the Matching System, but remains unexecuted.75 The Exchange proposes to adopt a sponsored access rule, which would allow Exchange participants to provide non-participant broker-dealers with access to the Exchange.76 Under the proposed rule, this type of sponsored access could be provided so long as the participant sponsoring access, the nonparticipant broker-dealer, and the Exchange entered into appropriate agreements confirming basic information about the parties’ roles and responsibilities.77 In addition to the changes described above, the Exchange has also proposed revisions to virtually every other chapter of its rules. These changes are generally designed to remove references to the physical trading floor, delete obsolete provisions and account for the new automated trading model, as well as to better streamline and organize the rules. For example, the CHX proposes to delete rules relating to specialists and access to the trading floor and adopt rules that contemplate remote access to the Exchange’s automated trading systems. In addition, changes are being proposed to rules relating to: hours of trading, trading halts, cancelling transactions, business conduct, disciplinary matters and trial proceedings, arbitration, Exchange emergency suspension authority; committees; trading permits; limitation of liability; voting designees; registration; fingerprinting; reporting transactions; riskless principal 73 See proposed CHX Article 20, Rule 7(c). proposed CHX Article 20, Rule 7(d). 75 See proposed CHX Article 9, Rule 17, Interpretation and Policy .05. The proposed rule would also confirm that a participant would not be in violation of the ‘‘trading ahead’’ rule if it satisfied bids and offers in other markets in accordance with the requirements for a ‘‘cross with satisfy order.’’ See proposed CHX Article 9, Rule 17, Interpretation and Policy .06; see also supra note 20 (discussing cross with satisfy orders). 76 See proposed CHX Article 5, Rule 3. 77 See id. 74 See E:\FR\FM\10OCN1.SGM 10OCN1 59568 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices transactions; use of a customer’s giveup; books and records; firm supervision; ITS; clearance and settlement; and listing on the Exchange. E. Amendment No. 2 jlentini on PROD1PC65 with NOTICES On September 29, 2006, the Exchange filed Amendment No. 2 to the proposed rule change, which made certain revisions to the original proposal, as amended by Amendment No. 1. In Amendment No. 2, the Exchange described its proposed phase-in plan for the new trading model.78 In Amendment No. 2, the Exchange also provided additional discussion and clarification on certain aspects of the proposal. The Exchange also added a discussion of how the Exchange believes that the rules of the proposed new trading model will be consistent with Section 11(a) of the Act.79 The Exchange stated that it believes that the proposed Matching System meets the requirements of Rule 11a2–2(T) under the Act,80 known as the ‘‘effect versus execute’’ rule, which provides an exemption from the prohibition of Section 11(a). Further, the Exchange stated that it believes that the proposal does not raise any of the policy concerns that Congress sought to address in Section 11(a) of the Act including, specifically, the time and place advantages that members on exchange floors might have over nonmembers off the floor and the general public. In Amendment No. 2, the Exchange also made certain changes to the rule text reflecting modifications in how the Matching System will operate. Specifically, the Exchange modified the proposed rules to: (1) Amend the definition of a ‘‘cross with size’’ order; 81 (2) confirm that the Matching System will evaluate most cross orders to see if they meet the ‘‘cross with size’’ definition and, if so, will execute them 78 The Exchange stated that it plans to phase in the new trading model as follows: (i) Beginning the week of October 2, 2006, the Exchange will begin to transition Nasdaq-listed securities to the Matching System; (ii) during the week of October 16, 2006, the Exchange will begin to transition all other securities that are not currently traded by specialists to the Matching System; and (iii) by early November 2006, the Exchange will begin to transition securities currently traded by the Exchange’s specialists to the Matching System. The Exchange stated that, in the near future, it will provide notice to participants of the exact dates for transition of specific securities. 79 15 U.S.C. 78k(a). 80 17 CFR 240.11a2–2(T). 81 See proposed CHX Article 20, Rule 4(b)(6) (requiring a cross with size to size out all of the displayed interest at a price, but providing that, once the CHX is disseminating a book feed, a cross with size would only be required to size out the largest displayed order). VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 as crosses with size; 82 (3) provide that, when the Matching System lacks sufficient information to determine the appropriate price at which a sell short order could be displayed or executed, the Matching System will automatically cancel the order; 83 (4) confirm that cross orders can be submitted as ISOs; 84 (5) remove references to functionality that is not being built; 85 and (6) confirm that a participant cannot change a ‘‘display’’ instruction for an order, but must submit a new order with a new display instruction.86 In addition, the Exchange revised the proposed rules to confirm the circumstances when the Matching System would display quotes that would lock or cross the protected quotes of other markets 87 and to clarify that the Matching System will trade in increments supported by the ITS or Regulation NMS linkage plan.88 The Exchange also clarified how a trade should be identified when it is executed pursuant to both the intermarket sweep order exception of Rule 611(b)(5) or (6) of Regulation NMS and the self-help exception of Rule 611(b)(1) of Regulation NMS.89 In Amendment No. 2, the Exchange also made certain changes intended to clarify the meaning of the proposed rules. These changes include a change in the definition of NBBO to confirm that, as of the Trading Phase Date of Regulation NMS, this term relates only to protected bids and offers; 90 the addition of language that confirms that non-regular way crosses can execute within a penny of other orders in the Matching System; 91 and a change that notes that, in the last ‘‘refresh’’ of a reserve size order, the number of shares may be less than the original number of displayed shares because that is all that is left.92 Other similar changes clarify the execution of benchmark orders; 93 82 See proposed CHX Article 20, Rule 4(b)(6). proposed CHX Article 20, Rule 8(e)(5). 84 See proposed CHX Article 20, Rule 4(b)(14). 85 See proposed CHX Article 20, Rule 4(a)(7)(b) (removing a reference to an order that executes at the midpoint of the NBBO, because this functionality is not being built at this time). 86 See proposed CHX Article 20, Rule 8(b)(5). 87 See proposed CHX Article 20, Rule 6(d). 88 See proposed CHX Article 20, Rule 4(a)(7)(d); see also proposed CHX Article 20, Rule 4(a)(7)(e). 89 See proposed CHX Article 20, Rule 5, Interpretation and Policy .01(h). 90 See proposed CHX Article 1, Rule 1(o). 91 See proposed CHX Article 20, Rule 4(a)(7)(b) (recognizing, as already expressed in the definition of this type of order, that non-regular way cross orders execute without regard to orders in the Matching System, because all orders in the Matching System are for regular-way settlement). 92 See proposed CHX Article 20, Rule 4(b)(20). 93 See proposed CHX Article 20, Rule 4(b)(2) (confirming that benchmark orders must be executed in increments permitted by Article 20, 83 See PO 00000 Frm 00143 Fmt 4703 Sfmt 4703 confirm the handling of BBO ISO orders; 94 and state, with regard to relevant provisions, that they take effect on the Trading Phase Date of Rule 611 of Regulation NMS.95 In Amendment No. 2, the Exchange also made changes to Article 16 governing market makers. The Exchange revised the rules to prohibit an individual from registering both as a market maker trader and an institutional broker representative.96 The Exchange also modified the rules to provide that market makers may only trade on a proprietary basis on the Exchange, and if a market maker handles agency orders off of the Exchange, it must create and enforce information barrier procedures pursuant to CHX Article 16, Rule 9.97 Pursuant to an exemption recently issued by the Commission,98 the Exchange proposed further provisions in Amendment No. 2 to permit ‘‘qualified contingent trades’’ to be executed on the Exchange.99 The Exchange asserts that these trades would meet the requirements of the Commission’s order exempting from Rule 611(a) any trade-throughs caused by the execution of an order involving one or more NMS stocks that are components of a ‘‘qualified contingent trade,’’ as defined in the Commission’s exemptive order.100 The Exchange also added provisions requiring it to establish and maintain information barriers to restrict the flow of information between the Exchange (including its facilities) and the thirdparty broker-dealer providing connectivity to other trading centers, and, to the extent such third-party broker-dealer receives such information, that adequately restrict the use of such Rule 4(a)(7)(b)). The Exchange also elaborated on its reasoning in proposing that benchmark orders only be permitted to be submitted to the Matching System by institutional brokers, and noted that other participants seeking to execute benchmark orders on the Exchange could do so through an institutional broker. 94 See proposed CHX Article 20, Rule 4(b)(1) (confirming that BBO ISO orders will be displayed in the circumstances set out in the rule because the participant routing the order to the Matching System has already satisfied the quotations of other markets as required by Article 20, Rule 6(c)(3)). 95 See, e.g., proposed CHX Article 20, Rules 4(b)(1), (2), (14), (18) and (19); see also proposed CHX Article 1, Rule 1(y) (defining the ‘‘Trading Phase Date’’ as February 5, 2007). 96 See proposed CHX Article 16, Rule 1, Interpretation and Policy .01. 97 See proposed CHX Article 16, Rule 1, Interpretation and Policy .02. 98 See Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR 52829 (September 7, 2006) (‘‘Qualified Contingent Trade Exemptive Order’’). 99 See proposed CHX Article 1, Rule 2(bb) and proposed CHX Article 20, Rule 5, Interpretation and Policy .01(i). 100 See Qualified Contingent Trade Exemptive Order, supra note 98. E:\FR\FM\10OCN1.SGM 10OCN1 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices information by the third party brokerdealer to legitimate business purposes necessary to provide routing connectivity and to serve as a ‘‘give-up.’’ Further, in Amendment No. 2, the Exchange revised its rule text to reflect recent changes made to Exchange rules by other proposed rule changes that have been recently approved by the Commission.101 III. Discussion and Commission Findings 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 102 and, in particular, the requirements of Section 6 of the Act 103 and the rules and regulations thereunder. The Commission finds that the proposed rule change, as amended, is consistent with Section 6(b)(5) of the Act,104 which requires that the rules of an exchange be designed, among other things, to prevent fraudulent and manipulative acts and practices, 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. jlentini on PROD1PC65 with NOTICES A. The Matching System The Matching System would allow participants to route orders to it from any location for possible immediate execution through any communications line approved by the Exchange.105 The adoption of the Exchange’s proposed rules, which feature the Matching System as the core facility of the Exchange, will fundamentally change the Exchange’s current market structure from a substantially floor-based auction market to an all-electronic one. The Commission believes that by allowing electronic access to Exchange liquidity, the proposed new model should help perfect the mechanism of a free and open market by providing investors 101 In particular, the Exchange revised the proposed rule text to reflect changes to the Exchange’s disciplinary rules made in SR–CHX– 2005–06, see Securities Exchange Act Release No. 54437 (September 13, 2006), 71 FR 55037 (September 20, 2006); and to reflect changes to the Exchange’s rules made in SR–CHX–2006–23, confirming that each participant firm only needs one trading permit to conduct business on the Exchange, see Securities Exchange Act Release No. 54494 (September 25, 2006). 102 The Commission has considered the proposed rule’s impact on efficiency, competition and capital formation. 15 U.S.C. 78c(f). 103 15 U.S.C. 78f. 104 15 U.S.C. 78f(b)(5). 105 See proposed CHX Article 20, Rule 8(a)(1). VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 with a more efficient mechanism to have their orders executed on the Exchange. The Commission also believes that the Exchange’s new trading model should facilitate securities transactions by providing investors with faster and more efficient access to the trading interest reflected in the Exchange’s published quotation, as well as interest away from the Exchange BBO. Finally, the Commission believes that the Exchange’s proposal should enhance the opportunity for a customer’s order to be executed without dealer participation, consistent with the goals of Section 11A of the Act.106 1. Eligible Orders and Order Types Under the proposed rule change, participants would be permitted to submit orders to the Matching System that are day orders, limit orders, and orders for regular way settlement (as well as certain other excepted types of orders such as IOC market orders and non-regular way crosses) and generally would be permitted to submit orders as round lots, odd lots, or mixed lots.107 The proposed rules require that orders submitted to the Matching System must meet the requirements of Rule 612 of Regulation NMS, unless an exemption therefrom applies.108 As such, except for cross orders under certain circumstances as discussed below,109 orders priced at or above $1.00 could not be submitted to the Matching System in increments less than $0.01, and orders priced less than $1.00 could not be submitted to the Matching System in increments less than $.0001.110 The Commission believes that these order eligibility requirements are consistent with the Act. The Exchange proposes to permit the Matching System to accept a wide variety of order types. These order types include: immediate or cancel limit and market orders, fill or kill orders, sell short and short exempt orders, reserve size orders, time in force orders, cancel on halt orders, do-not-display orders, do-not-route orders, various types of cross orders, and various types of ISOs.111 Many of these order types exist in the Exchange’s current rules set, while others have been proposed exclusively for use in the new trading model or for use as of the Trading Phase Date of Regulation NMS. The Commission believes that these order types should provide Exchange participants greater flexibility in reaching their trading and investment objectives. The Commission notes that a number of the proposed order types will have different definitions prior to and following the Trading Phase Date of Regulation NMS, which should enable users to make use of the trading strategies of such order types immediately, as well as after the Trading Phase Date. As noted, the Exchange has proposed a number of cross order types for use in the Matching System. The Commission notes that the cross order is already permitted in the Exchange’s electronic book.112 A cross order would be immediately executed in the Matching System if it is priced better than the Matching System’s displayed BBO and, for securities listed on any exchange other than Nasdaq (and for Nasdaqlisted securities, as of the Trading Phase Date of Regulation NMS), equal to or better than the NBBO.113 Similarly, a form of the cross with size order is already permitted in the Exchange’s electronic book.114 Under the proposed rules, a cross with size will be required to be larger than the aggregate size of all displayable orders displayed on the Matching System at the cross price, consist of at least 5,000 shares, and have a value of $100,000. The Commission notes that it has previously approved a similar rule at another exchange.115 The Exchange is also proposing several completely new cross order types that would be accepted by the Matching System, such as cross with satisfy 116 and cross with yield orders.117 The Commission believes that these cross orders may provide an efficient means to allow participants to effect cross transactions in the Matching System, consistent with the Exchange’s other priority and trade-through rules, in circumstances where a cross order would otherwise be unable to be executed and would be cancelled. A cross with satisfy order would contain an instruction to execute orders already displayed in the Matching System at their limit prices (up to a specified number of shares) to the extent necessary to allow the cross transaction to occur or to route outbound orders or commitments to other market centers to the extent necessary to prevent an 112 See 106 See Section 11A(a)(1)(C) of the Act, 15 U.S.C. 78k–1(a)(1)(C). 107 See supra notes 9–10 and accompanying text. 108 17 CFR 242.612. 109 See infra note 124 and accompanying text. 110 See proposed CHX Article 20, Rule 4(a)(5). 111 See supra Section II.A.1. PO 00000 Frm 00144 Fmt 4703 Sfmt 4703 59569 current CHX Article XXA, Rule 2. proposed CHX Article 20, Rule 4(b)(4) and supra note 18. 114 See current CHX Article XXA, Rule 2. 115 See Rules of the National Stock Exchange, Inc., Rule 11.12. 116 See supra note 20. 117 See supra note 21. 113 See E:\FR\FM\10OCN1.SGM 10OCN1 59570 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices improper trade-through.118 Once the satisfying execution has occurred, the cross order would be executed at a price that is better than the Matching System’s displayed BBO and, for securities listed on any exchange other than Nasdaq (and for Nasdaq-listed securities, as of the Trading Phase Date of Regulation NMS), equal to or better than the NBBO. The cross with yield order is similar to the cross with satisfy, and would contain an instruction to yield interest on the buy, sell, or either side of the order (as specified in the order) to any order already displayed in the Matching System at the same or better price, to the extent necessary to allow the cross transaction to occur.119 The cross order would then be executed at a price that is better than the best bid or offer to be displayed in the Matching System, and, for securities listed on any exchange other than Nasdaq (and for Nasdaqlisted securities, as of the Trading Phase Date of Regulation NMS), equal to or better than the NBBO. The Matching System would also accept mid-point cross orders, which would be executed at the midpoint of the NBBO.120 The Commission notes that this order type has been previously approved for other exchanges.121 The Exchange also proposes to permit a nonregular way cross order, which would be for non-regular way settlement and would execute without regard to the NBBO or any other orders in the Matching System.122 The Commission notes that the Exchange has represented that participants can currently execute orders for non-regular way settlement in the Exchange’s electronic book and on the floor of the Exchange,123 but this cross order type would be the only means to effectuate this type of transaction within the Matching System. Contingent upon the Exchange receiving exemptive relief from the Commission, the Exchange proposes to allow all cross orders to be submitted to the Matching System in sub-penny increments as small as $.000001, regardless of their price.124 Although participants would be permitted to submit crosses in sub-penny increments, the Exchange proposes that cross orders (except for a midpoint 118 See proposed CHX Article 20, Rule 4(b)(5). proposed CHX Article 20, Rule 4(b)(7). 120 See supra note 22. 121 See, e.g., NYSE Arca Equities Rule 7.31(y). 122 See supra note 25. 123 See current CHX Article XX, Rule 9; CHX Article XXA, Rule 2(c)(5). 124 See proposed CHX Article 20, Rule 4(a)(7)(b) (stating that the provision ‘‘shall take effect upon the granting of exemptive relief by the Commission’’). jlentini on PROD1PC65 with NOTICES 119 See VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 cross, non-regular-way cross or cross with size) would be required to be priced at least $.01 better than any order on the same side of the Matching System (or, for orders priced less than $1.00, at least $.0001 better than any order on the same side of the Matching System). The Commission believes that the proposed rules relating to cross transactions are consistent with the Act and offer participants flexibility in executions which meet the specified requirements of each type of cross. In addition, the Commission notes that proposed CHX Article 9, Rule 17, which restricts trading ahead of customer orders, would apply to the cross order types, except as noted in Interpretation and Policy .06 of that rule with respect to cross with satisfy orders.125 The Exchange also proposes to permit the Matching System to accept several order types modeled on the exceptions in Rule 611(b) of Regulation NMS. The Matching System would accept various ISOs, which would allow the Exchange to immediately execute such orders without regard to other markets’ protected quotations, as contemplated by Regulation NMS.126 The Commission believes that these proposed order types are consistent with the Act, and notes that these provisions will not become effective until the Trading Phase Date of Regulation NMS. The Matching System would also accept do-not-display 127 and do-notroute orders.128 The do-not-display order could be partially or wholly undisplayed. Such an order would remain eligible for execution in the Matching System, but would be ranked behind displayed orders and behind the undisplayed portions of reserve size orders. This order type gives a participant the ability to keep trading interest unseen, but at the same time allows the order to remain eligible for execution while being ranked behind any displayed interest in the Matching System. As its name implies, a do-notroute order is an order that could not be routed to another market. A do-notroute order would be immediately cancelled if its execution would improperly trade through the ITS BBO or another market’s protected quotations.129 The Commission believes that these proposed order types may offer participants greater flexibility in 125 See proposed CHX Article 9, Rule 17. supra notes 29–31. 127 See supra note 34 and accompanying text. 128 See supra note 35 and accompanying text. 129 See proposed CHX Article 20, Rule 5(a). 126 See PO 00000 Frm 00145 Fmt 4703 Sfmt 4703 the handling of their orders and are consistent with the Act. 2. Ranking and Display of Orders Under the proposed rule change, all orders received by the Matching System would be ranked by price, time of receipt, and any display instructions.130 No distinction would be made with regard to agency orders and professional or proprietary orders for priority purposes.131 Orders would be displayed to the public when they constitute the best round-lot bid or offer in the Matching System for a security. Generally, incoming orders would be matched against orders in the Matching System, in the order of their ranking, at the price of each resting order, for the full amount of shares available at that price or for the size of the incoming order, if smaller.132 However, orders would be subject to the proposed provisions prohibiting improper tradethroughs,133 and certain order types would be subject to specific executions within the Matching System.134 Unless the terms of the order direct otherwise, any order that could not be immediately executed or executed in full would be ranked in the Matching System in accordance with the Exchange’s order priority rules.135 In addition, the proposed rules provide that, unless a customer specifically requests otherwise, institutional brokers would be required to clear the Matching System before routing an order to another market, subject to certain exceptions.136 The Commission believes that the proposed rules relating to ranking, display and execution of orders are consistent with the Act.137 In particular, the Commission believes that the priority rules and automatic execution functionality should result in a more efficient market and promote competition in the national market system. Further, the Commission believes that requiring institutional brokers to clear the Matching System 130 See supra notes 36–37 and accompanying text. Commission has approved similar priority rules for the CHX’s electronic book. See Securities Exchange Act Release No. 52094 (July 21, 2005), 70 FR 43913 (July 29, 2005). 132 See proposed CHX Article 20, Rule 8(d)(1). 133 See proposed CHX Article 20, Rule 5; see also supra notes 50–54 and accompanying text. 134 See supra notes 43–49. 135 See supra notes 40–41 and accompanying text. 136 See supra notes 72–74 and accompanying text. 137 The Exchange has represented that the Matching System meets the requirements set forth in Rule 11a2–2(T) and therefore complies with Section 11(a) of the Act. See text accompanying notes 79–80. The Commission notes that the Exchange has the obligation to enforce the provisions of the Act, including Section 11(a) thereunder. 131 The E:\FR\FM\10OCN1.SGM 10OCN1 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices jlentini on PROD1PC65 with NOTICES before routing an order to another market is consistent with previous Exchange rules requiring members to ‘‘clear the post’’ prior to routing orders to other markets, which also were intended to promote interaction of orders on the Exchange. B. Routing The Exchange proposes to provide outbound routing services to participants for orders submitted to the Exchange that cannot be executed in whole or in part on the Exchange because of the trade-through provisions of Regulation NMS. The Exchange will use its own systems to determine when, how and where orders are routed away to other markets. To provide the necessary connectivity to transmit such orders to, and obtain executions on, other markets, the Exchange proposes to use the services of a third-party brokerdealer. The services would be provided pursuant to three separate agreements among the Exchange, the participant on whose behalf orders would be routed, and the third-party broker-dealer. The Exchange has represented that its routing services would be provided in accordance with its rules, the Act, and the rules thereunder. In particular, the Exchange routing arrangements would: (1) Provide for the equitable allocation of reasonable, dues, fees, and other charges among its participants and other persons using its facilities relating to the routing services; and (2) prohibit unfair discrimination among customers, issuers, brokers or dealers in connection with the routing services. The Commission received one comment letter regarding the proposed rule change relating to routing services.138 In its comment letter, OES asserted that the third-party brokerdealer described above would operate as a system of communication of the Exchange and therefore should be deemed a facility of the Exchange under Section 3(a)(2) of the Act. In Amendment No. 2, CHX responded to the OES Letter and stated its view that the third-party broker-dealer would not be a facility of the Exchange. The Commission does not believe that the third-party broker-dealer providing connectivity to other markets as described above should necessarily be deemed to be a facility of the Exchange. Unlike the broker-dealer addressed in the Commission’s Order approving the Pacific Exchange’s rules establishing the Archipelago Exchange,139 the third- party broker-dealer will not be owned by CHX or an affiliate of CHX. In this case, CHX will use its own systems to determine when, how, and where orders are routed away to other markets. Moreover, all of the terms and conditions for CHX members to obtain outbound routing services will be subject to CHX rules, which must be filed for approval with the Commission. The CHX rules must, among other things, provide for the equitable allocation of reasonable fees or other charges for outbound routing services and must not permit unfair discrimination among CHX members for access to the outbound routing services. CHX is contracting with an unaffiliated third-party broker-dealer solely to provide the necessary connectivity to obtain the execution of outbound orders on other markets. Given this limited role, the third-party broker-dealer should not be deemed a facility of CHX under Section 3(a)(2) of the Act. Accordingly, the Commission finds that CHX’s proposed routing arrangements are consistent with the Act. C. Market Makers Exchange market makers would be required to engage in a course of dealings to assist in the maintenance, to the extent reasonably practicable, of fair and orderly markets.140 Specifically, market makers would have an obligation to maintain continuous two-sided quotes for the securities in which it is registered, at prices reasonably related to the prevailing market; to maintain adequate capital; and to meet certain monthly quotation requirements.141 The proposed rules also impose other obligations on market makers, including a requirement to establish information barriers when engaging in other business activities.142 These rules governing CHX market makers are similar to other exchanges’ rules previously approved by the Commission.143 Accordingly, the Commission believes that the proposed rules are consistent with the Act. D. Institutional Brokers Under the Exchange’s proposed rules, institutional brokers would be considered to be ‘‘on the Exchange,’’ and as such, customer orders received by an institutional broker would be deemed to be on the Exchange and immediately subject to the Exchange’s rules.144 For example, the proposed 140 See proposed CHX Article 16, Rule 8. id. 142 See supra note 64 and accompanying text. 143 See, e.g., Nasdaq Rule 4613 and NYSE Arca Equities Rules 7.23–7.26. 144 See supra note 137. 141 See 138 OES Letter, supra note 4. Securities Exchange Act Release No. 44983 (October 25, 2001) 66 FR 55225 (November 1, 2001). 139 See VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 PO 00000 Frm 00146 Fmt 4703 Sfmt 4703 59571 rules require that institutional brokers use an electronic system, acceptable to the Exchange, integrating an institutional broker’s trading activities in the Matching System, outside of the Matching System, and in other market centers.145 Additionally, because institutional brokers could execute orders outside of the Matching System but still on the Exchange, the Exchange has proposed rules to govern this activity.146 First, such transactions would be required be reported to the Exchange within 10 seconds after the trade occurs. Further, the Exchange represents that it has built a functionality to allow an institutional broker to pull up a ‘‘validation window’’ to ensure that a trade being done outside of the Matching System does not violate trade-through provisions. In addition, to help ensure that trades outside of the Matching System are not inconsistent with an institutional broker’s fiduciary duties, once an institutional broker pulls up a validation screen, it would be required to complete the transaction and could not cancel out of the functionality, subject to certain limited exceptions.147 The Commission believes that the proposed rules governing institutional brokers should allow the Exchange to monitor appropriately the activities of institutional brokers and to help ensure that they are complying both with the rules of the Exchange and their fiduciary duties. The Commission also believes that the proposed rules will require the Exchange to carefully oversee the activities of institutional brokers, and to detect any potential abuses. Accordingly, the Commission believes that the proposed rules governing institutional brokers are consistent with the Act. E. Regulation NMS The Commission believes that the proposed rule change is consistent with the requirements of Regulation NMS.148 In proposed Article 20, Rule 6, CHX proposes to adopt a rule with regard to locked and crossed markets, as required by Rule 610(d) of Regulation NMS.149 The Exchange’s proposed rules include marking certain orders meeting the requirements of Rule 600(b)(30) of 145 See proposed CHX Article 17, Rule 3(b). supra notes 68–71 and accompanying text. 147 See proposed CHX Article 17, Rule 3, Interpretation and Policy .03. The institutional broker would only be permitted to cancel out of the functionality if the broker mistakenly input the wrong symbol for the security, or the transaction may be cancelled pursuant to CHX Article 20, Rules 9, 10, or 11. 148 See 17 CFR 242.600 et seq. 149 17 CFR 242.610(d). 146 See E:\FR\FM\10OCN1.SGM 10OCN1 59572 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices Regulation NMS 150 as intermarket sweep orders and accepting orders marked as intermarket sweep orders, which would allow orders so designated to be automatically matched and executed without reference to protected quotations at other trading centers. The Commission also believes that CHX’s proposed immediate-or-cancel functionality 151 is consistent with Rule 600(b)(3) of Regulation NMS. The Exchange has designed its proposed rules relating to orders types and eligibility 152 and order execution 153 to comply with the requirements of Regulation NMS. As noted above, these proposed rules provide that the Matching System will accept only orders (except for cross orders, as discussed above) that meet the increment requirements of Rule 612 of Regulation NMS (unless and to the extent exempted from Rule 612 by Commission order).154 In addition, as mentioned above in Section II.A, the Matching System is designed to qualify as an automated trading center under Rule 600(b)(3) of Regulation NMS.155 To ensure that its systems immediately and automatically process orders, the Exchange has included in its rules a requirement that it use automated systems to send test IOC orders to the Matching System to determine whether it accepts the order automatically.156 Similarly, the Exchange will also use automated monitoring systems to review, in real time, the Matching System’s handling of test IOC orders to determine whether, and within what time frame: (1) IOC orders are executed against the displayed quote, up to its full size; (2) any unexecuted portion of the IOC order is cancelled; (3) a confirmation of the action taken is generated and transmitted from the Matching System to the monitoring system (to serve as a proxy for a transmission to the ordersending firm); and (4) the Matching System transmits a new bid or offer (as appropriate) to the monitoring system (to serve as a proxy for a transmission to the appropriate securities information processor).157 The Exchange’s rules provide that it would automatically and immediately append a ‘‘manual’’ identifier to the bids and offers it makes publicly available when it has reason to 150 17 CFR 242.600(b)(30). proposed CHX Article 1, Rule 2(m). 152 See discussion supra Section II.A.1. 153 See discussion supra Section II.A.3. 154 17 CFR 242.612. 155 17 CFR 242.600(b)(3). 156 See proposed CHX Article 20, Rule 5, Interpretation and Policy .02. 157 See proposed Article 20, Rule 5, Interpretation and Policy .02. jlentini on PROD1PC65 with NOTICES 151 See VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 believe that it is not capable of displaying automated quotations. The Exchange has proposed a rule that renders an inbound round-lot order ineligible for execution on the Exchange if such order would cause an improper trade-through under Rule 611 of Regulation NMS.158 The Commission also notes that the proposed rules provide procedures that the Exchange will follow to determine whether a trade would create an improper trade-through and how the Exchange will apply various exceptions to Rule 611 of Regulation NMS, including the self-help exception.159 a participant would not be in violation of CHX Article 9, Rule 17 if it satisfied bids and offers in other markets in accordance with the requirements for a ‘‘cross with satisfy order’’ is consistent with the Act.162 The Commission notes that the conditions of the cross with size order provide that a participant could only satisfy bids or offers in other markets at a price that is better than the cross price if the cross is for at least 10,000 shares or has a value of at least $200,000 (a ‘‘block size order’’) or is for the account of an institutional customer and the participant’s customer has specifically agreed to that outcome.163 F. Other Rule Changes In addition to the rules described in detail above, the proposed rule change would adopt or amend a number of other Exchange rules that address, among other things, hours of trading, trading halts, cancelling transactions, trading permits, sponsored access, limitations of liability, trade execution, Exchange registration, business conduct, fingerprinting, reporting transactions, riskless principal transactions, disciplinary matters and trial proceedings, arbitration, books and records, clearance and settlement, and listing on the exchange. The Commission believes that these rules are appropriate and consistent with the Act, and many are similar to rules previously approved by the Commission at other exchanges.160 The Commission believes that the Exchange’s proposed interpretation to its trading ahead rule in CHX Article 9, Rule 17, confirming that a participant would be deemed to be holding an unexecuted customer order when that order has been sent to the Matching System but remains unexecuted,161 is consistent with the Act. The Commission believes that this rule appropriately confirms that a participant will remain the agent for any customer orders that it submits to the Matching System, and as such, will owe fiduciary duties to such customer orders until they are executed. The Commission also believes that the proposed interpretation confirming that IV. Accelerated Approval of Amendment No. 2 158 See proposed Article 20, Rule 5(a). supra notes 51–53 and accompanying text. 160 In particular, the Commission believes that the proposed changes to the firm’s supervision rules are appropriate and consistent with the Act. See proposed CHX Article 6, Rule 5. The Commission believes that these rules should help to ensure that participant firms are adequately supervising their registered and associated persons. The Commission also notes that these obligations are similar to those required by other SROs. See, e.g., NASD Rule 3010 and Philadelphia Stock Exchange Rule 748. 161 See proposed CHX Article 9, Rule 17, Interpretation and Policy .05. 159 See PO 00000 Frm 00147 Fmt 4703 Sfmt 4703 Under Section 19(b)(2) of the Act,164 the Commission may not approve any proposed rule change prior to the thirtieth day after the date of publication of notice thereof, unless the Commission finds good cause for so doing. As set forth below, the Commission finds good cause to approve Amendment No. 2 to the proposed rule change prior to the thirtieth day after Amendment No. 2 is published for comment in the Federal Register pursuant to Section 19(b)(2) of the Act.165 The modification made by Amendment No. 2 to require a cross with size to be larger than the aggregate size of all orders in the Matching System at the same price, rather than larger only than the largest individual order,166 merely retains—for the time being—a condition for cross with size orders that exists in the Exchange’s current rules.167 The new provision to execute various types of cross orders as crosses with size if they qualify as such168 simply builds in a directive into cross orders generally that enables them to receive a better execution if they meet the relevant requirements. The revision made by Amendment No. 2 regarding cancellation of certain sell short orders improves the proposal by accounting for situations in which an appropriate price cannot be determined for an order of this type.169 The addition of the ‘‘ISO Cross’’ order type makes explicit that a cross order, like other orders, may be appended with ISO 162 See proposed CHX Article 9, Rule 17, Interpretation and Policy .06. 163 See supra note 20 (discussing cross with satisfy orders). 164 15 U.S.C. 78s(b)(2). 165 Id. 166 See supra note 81. 167 See current CHX Article XXA, Rule 2(c)(4). 168 See supra note 82. 169 See supra note 83. E:\FR\FM\10OCN1.SGM 10OCN1 Federal Register / Vol. 71, No. 195 / Tuesday, October 10, 2006 / Notices instructions.170 The revision regarding new display instructions 171 changes only the method by which such an instruction would need to be submitted, but alters no principle of priority included in the original proposal. Amendment No. 2 also improves the proposal by confirming the circumstances in which the Matching System would display quotes that would lock or cross the protected quotes of other markets,172 and appropriately spells out that the Matching System will trade in increments supported by the ITS or Regulation NMS linkage plan, as may be applicable.173 Another provision adds clarity to how orders should be identified, according to the proposed rules, when a trade is executed pursuant to both the intermarket sweep order exception of Rule 611(b)(5) or (6) of Regulation NMS and the self-help exception of Rule 611(b)(1) of Regulation NMS.174 Other clarifying changes similarly enhance the proposal.175 Amendment No. 2 also incorporates a number of added restrictions and requirements for market makers that set forth in more detail the parameters by which market making may take place on the Exchange and should aid in the prevention of abuses.176 In addition, Amendment No. 2 sets forth provisions requiring the Exchange to maintain internal controls designed to restrict the flow of confidential and proprietary information between the Exchange and the third-party broker-dealer providing connectivity to other markets. The provision added by Amendment No. 2 to permit ‘‘qualified contingent trades’’ to be executed on the Exchange 177 merely assures that market participants would be able to benefit from the Commission’s order exempting from Rule 611(a) any trade-throughs caused by such trades. The revisions to the text to reflect and conform to recent changes made as the result of other, recently approved CHX proposals,178 as well as the technical changes and corrections included in Amendment No. 2, raise no substantive issues. Finally, a number of the changes mirror rules that already have been approved for other exchanges. For the above reasons, the Commission believes that the revisions to the proposed rule change made by 170 See supra note 84. supra note 86. 172 See supra note 87. 173 See supra, note 88. 174 See supra note 89. 175 See supra notes 90–95 and accompanying text. 176 See supra notes 96–97 and accompanying text. 177 See supra notes 97–99 and accompanying text. 178 See supra note 101. jlentini on PROD1PC65 with NOTICES 171 See VerDate Aug<31>2005 16:42 Oct 06, 2006 Jkt 211001 Amendment No. 2 pose no significant regulatory concerns, and should not delay implementation of the proposal. The Commission also believes that accelerated approval is reasonable because it should help to ensure that the appropriate rules are in place at the Exchange at the time that the CHX’s final technical specifications with respect to Regulation NMS must be published. V. 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 rulecomments@sec.gov. Please include File Number SR–CHX–2006–05 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–CHX–2006–05. 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 Room. Copies of the filing also will be available for inspection and copying at the principal office of 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 PO 00000 Frm 00148 Fmt 4703 Sfmt 4703 59573 Number SR–CHX–2006–05 and should be submitted on or before October 31, 2006. VI. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,179 that the proposed rule change (File No. SR– CHX–2006–05), as amended by Amendment No. 1, be, and hereby is, approved, and that Amendment No. 2 to the proposed rule change be, and hereby is, approved on an accelerated basis. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.180 Nancy M. Morris, Secretary. [FR Doc. E6–16626 Filed 10–6–06; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54558; File No. SR–NASD– 2006–076] Self-Regulatory Organizations: National Association of Securities Dealers, Inc.; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change To Exempt All Securities Included in the Nasdaq100 Index From the Price Test Set Forth in NASD Rule 5100 October 2, 2006. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on June 15, 2006, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by NASD. On August 18, 2006, NASD filed Amendment No. 1 to the proposed rule change.3 On September 20, 2006, NASD filed Amendment No. 2 to the proposed rule change, as amended.4 The Commission is publishing this notice to solicit comments on the proposed rule 179 15 U.S.C. 78s(b)(2). CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 In Amendment No. 1, which supplemented the original filing, NASD modified the scope of the proposed rule change and made certain technical and clarifying changes following discussions with Commission staff. 4 After discussions with Commission staff, NASD filed Amendment No. 2 to modify its discussion of the purpose of the proposed rule filing and to make other technical and clarifying rule changes. Amendment No. 2 replaced and superseded the original filing in its entirety. 180 17 E:\FR\FM\10OCN1.SGM 10OCN1

Agencies

[Federal Register Volume 71, Number 195 (Tuesday, October 10, 2006)]
[Notices]
[Pages 59563-59573]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-16626]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54550; File No. SR-CHX-2006-05]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Approving a Proposed Rule Change and Amendment No. 1 Thereto and 
Notice of Filing and Order Granting Accelerated Approval to Amendment 
No. 2 Thereto to Implement a New Trading Model

 September 29, 2006.

I. Introduction

    On February 2, 2006, 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 amend its rules to implement a new trading 
model that provides the opportunity for fully automated executions to 
occur within a central matching system (the ``Matching System''). On 
August 10, 2006, the Exchange filed Amendment No. 1 to the proposed 
rule change. The proposed rule change, as amended by Amendment No. 1, 
was published for comment in the Federal Register on August 18, 
2006.\3\ The Commission received one comment letter on the proposal.\4\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 54301 (August 10, 
2006), 71 FR 47836 (``Trading Rules Notice'').
    \4\ See Letter from Michael A. Barth, Senior Vice President, 
Exchanges and Market Centers, Order Execution Services Holdings, 
Inc. (``OES''), to Nancy M. Morris, Secretary, Commission, dated 
August 25, 2006 (``OES Letter'').
---------------------------------------------------------------------------

    On September 29, 2006, the Exchange filed Amendment No. 2 to the 
proposed rule change.\5\ This order approves the proposed rule change, 
as amended by Amendment No. 1. Simultaneously, the Commission is 
providing notice of filing of, and granting accelerated approval to, 
Amendment No. 2 to the proposed rule change.
---------------------------------------------------------------------------

    \5\ See Form 19b-4 dated September 29, 2006 (``Amendment No. 
2''). The text of Amendment No. 2 is available on CHX's Web site 
(https://www.chx.com), at the principal office of CHX, and at the 
Commission's Public Reference Room. See infra Section II.E for a 
discussion of Amendment No. 2.
---------------------------------------------------------------------------

II. Description

    The Exchange proposes to amend its rules in order to implement a 
new trading model that would allow Exchange participants to interact in 
a

[[Page 59564]]

fully-automated Matching System. In addition, the proposed rules would 
enable qualifying participant firms to register as ``institutional 
brokers,'' that, among other things, would be permitted to execute 
transactions outside of the Matching System under specified 
conditions.\6\ Many of the features of the new trading model are 
designed to comply with Regulation NMS \7\ as of the ``Trading Phase 
Date'' for the implementation of that regulation--February 5, 2007.\8\ 
The Exchange is also proposing a number of other changes to its rules 
in an effort to update them generally, as well as to reflect the 
elimination of the trading floor and the new automated trading system 
that will be central to the Exchange's new trading model.
---------------------------------------------------------------------------

    \6\ See infra Section II.C. for a more detailed discussion.
    \7\ 17 CFR 242.600 et seq.
    \8\ See infra note 27.
---------------------------------------------------------------------------

A. The Matching System

    The Matching System would be the core facility of the Exchange's 
new trading model. The Exchange would no longer operate a physical 
trading floor, but rather would operate an automated Matching System 
where Exchange participants could submit orders from any location for 
possible immediate execution.
1. Eligible Orders and Order Types
    The Matching System generally would accept orders that are day 
orders, limit orders, and orders for regular way settlement.\9\ Orders 
could be submitted as round lots, odd lots, or mixed lots, except that 
orders in securities that only trade in specific share size increments 
would be required to be submitted only in those share sizes.\10\ The 
Exchange believes that its quotations would qualify as ``automated 
quotations'' under Rule 600(b)(3) of Regulation NMS.\11\
---------------------------------------------------------------------------

    \9\ See proposed CHX Article 20, Rule 4(a)(1)-(3). The proposed 
rules provide for certain exceptions to these basic order 
eligibility requirements. For example, the Matching System would 
also accept immediate-or-cancel (``IOC'') market orders, and would 
permit a ``non-regular way cross order'' to be submitted for 
execution and non-regular way settlement. See proposed CHX Article 
20, Rules 4(a)(7) and 4(b)(13) and (16).
    \10\ See proposed CHX Article 20, Rule 4(a)(4).
    \11\ See 17 CFR 242.600(b)(3). The Exchange's proposed rules 
provide that each order submitted to the Matching System must be a 
firm order and cannot be identified as a ``manual'' quotation. See 
proposed CHX Article 20, Rule 3(a). See also infra note 54 and 
accompanying text.
---------------------------------------------------------------------------

    Some of the order types accepted by the Matching System that the 
Exchange describes as more routine would include immediate or cancel 
(``IOC'') limit and market orders,\12\ fill or kill (``FOK'') 
orders,\13\ sell short and short exempt orders,\14\ reserve size 
orders,\15\ time in force orders \16\ and cancel on halt orders.\17\ 
The Matching System also would accept several different types of cross 
transactions, including a cross,\18\ a cross with size,\19\ a cross 
with satisfy,\20\ a cross with yield,\21\ a midpoint cross,\22\ an ISO 
cross,\23\ an opening cross,\24\ and a non-regular way cross.\25\
---------------------------------------------------------------------------

    \12\ IOC orders would be executed against any orders at or 
better than the Exchange's Best Bid or Offer (``BBO''), including 
any reserve size or other undisplayed orders at or better than that 
price. See proposed CHX Article 20, Rules 4(b)(12) (IOC orders) and 
4(b)(13) (IOC market orders).
    \13\ See proposed CHX Article 20, Rule 4(b)(11).
    \14\ See proposed CHX Article 20, Rule 4(b)(21) (sell short 
orders) and Rule 4(b)(22) (short exempt orders).
    \15\ See proposed CHX Article 20, Rule 4(b)(20).
    \16\ See proposed CHX Article 20, Rule 4(b)(23).
    \17\ See proposed CHX Article 20, Rule 4(b)(3).
    \18\ See proposed CHX Article 20, Rule 4(b)(4). A cross 
transaction would be an order to buy and sell the same security at a 
specific price that is better than the Exchange's displayed BBO and, 
for securities listed on any exchange other than Nasdaq (and for 
Nasdaq-listed securities, when Regulation NMS is implemented in 
those issues), equal to or better than the National Best Bid and 
Offer (``NBBO''). A cross may represent interest of one or more 
Exchange participants, trading for a proprietary account. See infra 
note 43 for a description of cross order executions.
    \19\ See proposed CHX Article 20, Rule 4(b)(6). A cross with 
size would be required to be for at least 5,000 shares and for a 
value of $100,000 that is at a price equal to or better than the 
Exchange's displayed BBO and, for securities listed on the New York 
Stock Exchange (``NYSE''), the American Stock Exchange (``Amex''), 
or any other exchange except the NASDAQ Stock Market (``Nasdaq'') 
(and for Nasdaq-listed securities, when Regulation NMS is 
implemented in those issues), equal or better to the NBBO, where the 
size of the cross transaction is one round lot larger than the 
aggregate size of all interest displayed on the Exchange at that 
price. At such time as the Exchange disseminates a feed of all 
displayable orders in the Matching System, however, a cross with 
size order would be required to be larger only than the largest 
order in the Matching System at the relevant price. See Amendment 
No. 2. A cross with size transaction may represent interest of one 
or more participants of the Exchange. See also infra note 43.
    \20\ See proposed CHX Article 20, Rule 4(b)(5). A cross with 
satisfy is designed to provide a participant with a mechanism for 
clearing out displayed orders in the Matching System that would 
otherwise have time priority (or displayed bids or offers in other 
market centers that would otherwise have price priority) and then 
effecting a cross transaction at that price. A cross with satisfy 
could represent interest of one or more participants of the Exchange 
but, to the extent that it represents interest of the participant 
sending the order to the Matching System, the participant (i) would 
not be eligible to satisfy existing bids or offers in the Matching 
System at a price that is better than the cross price (when the 
participant's customer is on the same side of the order as the 
participant), and (ii) could only satisfy bids or offers in other 
markets at a price that is better than the cross price if the cross 
is for at least 10,000 shares or has a value of at least $200,000 (a 
``block size order'') or is for the account of an institutional 
customer (defined elsewhere in the proposed rules) and the 
participant's customer has specifically agreed to that outcome. See 
also infra note 44.
    \21\ See proposed CHX Article 20, Rule 4(b)(7). A cross with 
yield would automatically yield interest on the buy, sell, or either 
side of the order to any order already displayed in the Matching 
System at the same or better price. See also infra note 45.
    \22\ See proposed CHX Article 20, Rule 4(b)(15). A midpoint 
cross would execute at the midpoint between the NBBO. However, if 
the NBBO is locked at the time a midpoint cross is received, the 
midpoint cross would execute at the locked NBBO. If the NBBO is 
crossed at the time a midpoint cross is received, the midpoint cross 
would be automatically cancelled.
    \23\ See proposed CHX Article 20, Rule 4(b)(14), added by 
Amendment No. 2. An ISO cross would be defined as any type of cross 
order marked as required by Regulation NMS to be executed without 
taking any of the actions required by the Exchange's relevant rules 
to prevent a trade-through.
    \24\ See proposed CHX Article 20, Rule 4(b)(17). Opening cross 
orders would execute immediately after the primary market opens in a 
security, at the opening price. For securities listed on NYSE, Amex 
and any exchange other than Nasdaq, the opening price would be the 
primary market opening price. For Nasdaq-listed securities (except 
in the case of an initial IPO), the opening price would be the 
midpoint of the first unlocked, uncrossed market that occurs on or 
after 8:30 a.m. For Nasdaq-listed securities on the date of an IPO, 
the opening price would be the Nasdaq opening price. See also 
proposed CHX Article 20, Rule 8(c)(2).
    \25\ See proposed CHX Article 20, Rule 4(b)(16). A non-regular 
way cross would be designated for non-regular way settlement. These 
orders would be automatically executed without regard to either the 
NBBO or any orders for regular way settlement that might be in the 
Matching System.
---------------------------------------------------------------------------

    The Matching System also would accept several order types that are 
related to Regulation NMS,\26\ and that would become effective on the 
Trading Phase Date of Regulation NMS.\27\ For example, the Matching 
System would accept benchmark orders that meet the requirements of Rule 
611(b)(7) of Regulation NMS.\28\ The Matching System would also accept 
different types of intermarket sweep orders

[[Page 59565]]

(``ISOs''), such as BBO ISOs,\29\ outbound ISOs \30\ and price-
penetrating ISOs.\31\
---------------------------------------------------------------------------

    \26\ 17 CFR 242.600 et seq.
    \27\ See Securities Exchange Act Release No. 53829 (May 18, 
2006), 71 FR 30038 (May 24, 2006) (setting new compliance dates for 
Rules 610 and 611 of Regulation NMS).
    \28\ See 17 CFR 242.611(b)(7); see also CHX proposed Article 20, 
Rule 4(b)(2). A benchmark order, as defined in the proposed rules, 
would be an order submitted by an institutional broker, and could be 
executed at any price, without regard to the protected NBBO. A 
benchmark order could represent interest of one or more Exchange 
participants.
    \29\ See proposed CHX Article 20, Rule 4(b)(1). BBO ISOs would 
execute against orders at the Exchange's BBO, without regard to 
whether the execution would trade through another market's protected 
quotation. If a BBO ISO is marked as ``immediate or cancel,'' any 
remaining balance in the order would be automatically cancelled. If 
a BBO ISO is not marked as ``immediate or cancel,'' any remaining 
balance in the order would be displayed in the Matching System, 
without regard to whether that display would lock or cross another 
market center. See proposed CHX Article 20, Rule 6(c)(3).
    \30\ An outbound ISO would allow an Exchange participant to ask 
the Exchange to execute an order on the Exchange while 
simultaneously routing ISOs to those other markets to execute 
against their protected quotations. Outbound ISOs would be executed 
against any eligible orders in the Matching System (including any 
reserve size or other undisplayed orders). Other than the routing of 
ISOs to other market centers, no action would be taken to prevent an 
improper trade-through. See proposed CHX Article 20, Rule 4(b)(18).
    \31\ See proposed CHX Article 20, Rule 4(b)(19). A price-
penetrating ISO would operate much like a basic ISO, except that it 
would allow a participant to execute through displayed and 
undisplayed interest, at multiple price points, on the Exchange.
---------------------------------------------------------------------------

    In general, the Matching System would accept only orders that 
comply with the sub-penny restrictions set forth in Rule 612 of 
Regulation NMS.\32\ However, contingent upon the Commission granting 
the necessary exemptive relief from Rule 612, the proposed rules would 
permit any type of cross order to be submitted to the Matching System 
in a sub-penny increment as small as $0.000001, provided that no type 
of cross, except midpoint crosses, non-regular-way crosses and cross 
with size orders, would be permitted to execute at a price less than 
$.01 better than any currently displayed same-sided interest available 
on the Matching System (or $.0001 better when the order is priced under 
$1.00).\33\
---------------------------------------------------------------------------

    \32\ 17 CFR 242.612.
    \33\ See proposed CHX Article 20, Rule 4(a)(7)(b). See also 
Amendment No. 2.
---------------------------------------------------------------------------

    Finally, the Matching System would accept ``do-not-display'' and 
``do-not-route orders.'' A do-not-display order would be an order, for 
at least 1,000 shares when entered, that would not be displayed in 
whole or in part, but that would remain eligible for execution within 
the Matching System.\34\ A do-not-route order would be executed or 
displayed within the Matching System and could not be routed to another 
market center.\35\
---------------------------------------------------------------------------

    \34\ See proposed CHX Article 20, Rule 4(b)(9).
    \35\ See proposed CHX Article 20, Rule 4(b)(10). A do-not-route 
order would be immediately cancelled if its execution would 
improperly trade through the ITS BBO or another market's protected 
quotations. Any types of cross, IOC, or FOK orders would be deemed 
to have been received with a ``do not route'' condition because 
these orders either are immediately executed in the Matching System 
or cancelled.
---------------------------------------------------------------------------

2. Ranking and Display of Orders
    All orders received by the Matching System would be ranked by 
price, time of receipt, and, for round-lot orders, any display 
instructions received with the order.\36\ Specifically, orders received 
by the Matching System would be ranked as follows: (i) Limit orders 
that are eligible to be displayed, including the displayed portion of 
reserve size orders, and all odd-lot and mixed-lot orders would be 
ranked together, at each price point, in time priority; (ii) at each 
price point, the undisplayed portions of reserve size orders would be 
ranked together in time priority and would be ranked after any 
displayed orders (and any odd-lot and mixed-lot orders) at that price; 
and (iii) orders that are received with a do-not-display instruction 
would be ranked together, at each price point, in time priority and 
would be ranked after any other orders at that price.\37\
---------------------------------------------------------------------------

    \36\ See proposed CHX Article 20, Rule 8(b). Orders sent to an 
institutional broker for handling would not have any priority within 
the Matching System unless and until they are received by the 
Matching System. Id.
    \37\ Id., proposed Rule 8(b)(1)-(3). The refreshed displayed 
portion of a reserve-size order would receive a new ranking based on 
the time it was refreshed, with any remaining undisplayed portion 
retaining the ranking at which it was originally received. Id., 
proposed Rule 8(b)(4). A change to an order's size or price, or its 
displayed portion, could impact its ranking within the Matching 
System. A change to the display instructions associated with an 
order would need to be submitted as a new order and would be ranked 
based on the time the new order was received. Id., proposed Rule 
8(b)(5). See also Amendment No. 2.
---------------------------------------------------------------------------

    All orders that are eligible for display would be immediately and 
publicly displayed through the processes set out in the appropriate 
transaction reporting plan for each security when they constitute the 
best round-lot bid or offer in the Matching System for that security. 
For display purposes, the Matching System would aggregate all shares, 
including odd-lot orders and the odd-lot portions of mixed-lot orders, 
at a single price point, and then round that total share amount down to 
the nearest round-lot amount.\38\
---------------------------------------------------------------------------

    \38\ Id., proposed Rule 8(b)(6). For execution purposes, 
however, all orders would retain their rankings as described above.
---------------------------------------------------------------------------

3. Automatic Execution
    Incoming orders generally would be matched against orders in the 
Matching System, in the order of their ranking, at the price of each 
resting order, for the full amount of shares available at that price or 
for the size of the incoming order, if smaller.\39\ If an order could 
not be immediately matched or matched in full when received, and it is 
not designated as an order type that should be immediately 
cancelled,\40\ it or its residual portion would be placed in the 
Matching System and ranked.\41\
---------------------------------------------------------------------------

    \39\ See proposed CHX Article 20, Rule 8(d)(1). This general 
rule would be subject to certain exceptions specifically set forth 
in proposed CHX Article 20, Rule 8(e), and subject to the provisions 
relating to the prevention of trade-throughs in proposed CHX Article 
20, Rule 5.
    \40\ See proposed CHX Article 20, Rules 4(b)(11) through (13). 
Orders that would be immediately cancelled, if not executed, include 
FOK orders and IOC limit and market orders.
    \41\ See proposed CHX Article 20, Rule 8(d)(2); see also supra 
note 37 and accompanying text.
---------------------------------------------------------------------------

    The proposed rules describe certain order types that would be 
subject to specific executions within the Matching System.\42\ Such 
order types include cross and cross with size orders,\43\ cross with 
satisfy orders,\44\ cross with yield orders,\45\ sell short orders,\46\ 
do-not-

[[Page 59566]]

display orders,\47\ and inbound ITS commitment or linkage plan 
orders.\48\ The proposed rules also describe the handling of orders in 
locked and crossed markets.\49\
---------------------------------------------------------------------------

    \42\ See proposed CHX Article 20, Rule 8(e).
    \43\ See proposed CHX Article 20, Rule 8(e)(1). Cross and cross 
with size orders would be automatically executed if they meet the 
requirements for such order types, and would be immediately and 
automatically cancelled if they do not meet these requirements.
    \44\ See proposed CHX Article 20, Rule 8(e)(4). In executing 
cross with satisfy orders, the Matching System first would determine 
whether the order contains a share size that is sufficient to 
satisfy orders in the Matching System or bids or offers in other 
markets, as applicable. If this requirement is not met, the cross 
with satisfy would be automatically cancelled. If the order meets 
this requirement, the Matching System then would satisfy existing 
orders in the Matching System or send orders or commitments to other 
market centers to satisfy bids or offers, as necessary to prevent a 
trade-through and, before updating the Exchange's quotes, would 
execute the cross at a price that is better than the best bid or 
offer to be displayed in the Matching System and, for securities 
listed on NYSE, Amex or any other exchange other than Nasdaq (and 
for Nasdaq-listed securities, when Regulation NMS is implemented in 
those issues), equal to or better than the NBBO. In doing so, the 
Matching System would determine whether the participant that sent 
the order to the Matching System is attempting to satisfy bids or 
offers in the Matching System at a price that is better than the 
cross price and, if so, would not allow those executions to occur, 
but would instead allocate the better prices to the customer, not to 
the participant sending the order to the Matching System. See also 
supra note 20.
    \45\ See proposed CHX Article 20, Rule 8(e)(2). A cross with 
yield order would be automatically executed by matching the 
participant as principal against the customer order if the customer 
order that is part of a cross with yield order is at a price better 
than the currently displayed best bid or offer in the Matching 
System; provided, however, that if there is any order already 
displayed in the Matching System at the same price as (or better 
than) the participant's interest, that order or those orders would 
be matched against the customer order in place of the participant's 
interest as necessary to exhaust the customer order interest. If the 
customer order that is part of a cross with yield order is not 
eligible for an immediate execution because it is not priced better 
than the currently displayed bid or offer in the Matching System, 
the cross with yield order would be immediately and automatically 
cancelled. See also supra note 21.
    \46\ See proposed CHX Article 20, Rule 8(e)(5). Sell short 
orders (including odd lot orders) would be displayed and executed 
only when permissible under the provisions of Rule 10a-1 (``Short 
Sale Rule'') under the Act and Regulation SHO. When a sell short 
order cannot be executed or displayed at its limit price under the 
provisions of the Short Sale Rule and Regulation SHO, the order 
would be automatically re-priced (without violating its limit price) 
to the next available price at which it can be executed or 
displayed. If the Matching System cannot determine an appropriate 
price at which to execute or display the order, the order would be 
automatically cancelled. See Amendment No. 2.
    \47\ See proposed CHX Article 20, Rule 8(e)(6). A do-not-display 
order would be immediately and automatically cancelled if, at any 
point, the order would prevent the execution of an inbound order 
because the do-not-display order has crossed the NBBO.
    \48\ See proposed CHX Article 20, Rule 8(e)(7).
    \49\ See proposed CHX Article 20, Rule 6 and proposed CHX 
Article 20, Rule 5, Interpretation and Policy .01(e).
---------------------------------------------------------------------------

4. Preventing Trade-Throughs
    An inbound order for at least one round lot would not be eligible 
for execution on the Exchange if its execution would cause an improper 
trade-through, both prior to and following the Trading Phase Date of 
Rule 611 of Regulation NMS.\50\ The proposed rules provide that the 
Exchange will follow a series of trade-through policies and procedures 
in determining whether a trade on the Exchange would create an improper 
trade-through.\51\ These procedures include clock synchronization 
practices, as well as plans for applying the exceptions to Rule 611 of 
Regulation NMS. For example, the Exchange's rules contemplate using the 
self-help exception in Rule 611(b)(1) of Regulation NMS.\52\ Further, 
the Exchange would automatically place an appropriate modifier on 
trades executed pursuant to an exemption from, or exception to, Rule 
611 of Regulation NMS in accordance with specifications approved by the 
operating committee of the relevant national market system plan for an 
NMS stock. If a trade is executed pursuant to both the intermarket 
sweep order exception of Rule 611(b)(5) or (6) of Regulation NMS and 
the self-help exception of Rule 611(b)(1) of Regulation NMS, the trade 
would be identified as executed pursuant to the intermarket sweep order 
exception.\53\ The proposed rules also set forth the procedures that 
the Exchange would use to confirm that its own bids and offers qualify 
as automated quotations and, if they do not qualify as automated 
quotations, how the Exchange will identify such quotations as 
manual.\54\
---------------------------------------------------------------------------

    \50\ See proposed CHX Article 20, Rule 5. An inbound order for 
at least one round lot would not be eligible for execution on the 
Exchange if its execution would cause an improper trade-through of 
another ITS market or if, when Regulation NMS is implemented for a 
security, the execution of all or a part of the order would be 
improper under Rule 611 of Regulation NMS. Inbound odd lot orders 
and odd lot crosses would be eligible for execution on the Exchange, 
even if they would trade through other markets' bids and offers.
    \51\ See proposed CHX Article 20, Rule 5, Interpretation and 
Policy .01.
    \52\ See 17 CFR 242.611(b)(1); see also proposed CHX Article 20, 
Rule 5, Interpretation and Policy .01(d).
    \53\ See proposed CHX Article 20, Rule 5, Interpretation and 
Policy .01(h). See also Amendment No. 2.
    \54\ See proposed CHX Article 20, Rule 5, Interpretation and 
Policy .02. Specifically, the Exchange would send test IOC orders to 
the Matching System to make this determination. See also supra, note 
11 and accompanying text.
---------------------------------------------------------------------------

5. Order Routing
    The proposed rules also contain provisions governing the routing of 
orders to other markets when execution in the Matching System would 
cause an improper trade-through.\55\ If a participant has submitted a 
cross with satisfy or an outbound ISO order and its execution would 
cause an improper trade-through, the Matching System would execute the 
order and simultaneously route orders or commitments necessary to 
satisfy the bids or offers of other markets (``routing services''). 
Otherwise, any inbound order for at least a round lot is not eligible 
for execution on the Exchange if its execution would cause an improper 
trade-through.\56\
---------------------------------------------------------------------------

    \55\ See proposed CHX Article 20, Rule 5, Interpretation and 
Policy .03.
    \56\ See proposed CHX Article 20, Rule 5(a).
---------------------------------------------------------------------------

    The Exchange proposes to provide these routing services pursuant to 
the terms of three separate agreements, to the extent that they are 
applicable to a specific routing decision: (i) An agreement between the 
Exchange and each participant on whose behalf orders will be routed; 
(ii) an agreement between each participant and a specified third-party 
broker-dealer that will use its routing connectivity to other markets 
and serve as a ``give-up'' in those markets; and (iii) an agreement 
between the Exchange and the specified third-party broker-dealer 
pursuant to which the third-party broker-dealer would agree to provide 
routing connectivity to other markets and serve as a ``give-up'' for 
the Exchange's participants in other markets. In providing the routing 
services, the Exchange would use its own systems to determine when, 
how, and where orders (or commitments) are routed away to other 
markets.\57\ In addition, the Exchange will establish and maintain 
procedures and internal controls reasonably designed to adequately 
restrict the flow of confidential and proprietary information between 
the Exchange (including its facilities) and the third-party broker-
dealer, and, to the extent the third-party broker-dealer reasonably 
receives confidential and proprietary information, that adequately 
restrict the use of such information by the third party broker-dealer 
to legitimate business purposes necessary to provide routing 
connectivity and to serve as a ``give-up.'' \58\
---------------------------------------------------------------------------

    \57\ Id.
    \58\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

6. Locking and Crossing Quotations
    With certain exceptions, Exchange participants would be required to 
reasonably avoid displaying, and refrain from engaging in a pattern or 
practice of displaying, any quotations that lock or cross a protected 
quotation.\59\ An order would not be eligible for display on the 
Exchange if its display would improperly lock or cross the ITS best bid 
or offer or, as of the Trading Phase Date of Regulation NMS for a 
security, if its display would constitute a locking or crossing 
quotation.\60\ These otherwise locking or crossing orders would either 
be automatically routed to another appropriate market or, if designated 
as ``do not route,'' automatically cancelled.
---------------------------------------------------------------------------

    \59\ See proposed CHX Article 20, Rule 6. The exceptions are 
provided when: (i) The locking or crossing quotation was displayed 
at a time when the other trading center was experiencing a failure, 
material delay, or malfunction of its systems or equipment; (ii) the 
locking or crossing quotation was displayed at a time when a 
protected bid was higher than a protected offer in the NMS stock; or 
(iii) the Exchange participant displaying the locking or crossing 
quotation simultaneously routed an intermarket sweep order to 
execute against the full displayed size of any locked or crossed 
protected quotation.
    \60\ See proposed CHX Article 20, Rule 6.
---------------------------------------------------------------------------

B. Market Makers

    The proposed rules in Article 16 set forth the responsibilities of 
a participant that registers as a market maker on the Exchange.\61\ In 
particular, a market maker would be required to engage in a course of 
dealings for its own account to assist in the maintenance, to the 
extent reasonably practicable, of fair and

[[Page 59567]]

orderly markets on the Exchange. A market maker's responsibilities 
would specifically include: (1) Using automated systems to maintain a 
continuous two-sided quote, for at least a round-lot, in each of the 
securities in which it is registered; \62\ (2) maintaining adequate 
minimum capital; and (3) meeting specific quotation or trade 
requirements, with respect to its dealings on the Exchange, over the 
course of each calendar month.\63\ In addition, a market maker that is 
registered as a market maker solely on the Exchange and engages in 
other business activities (or that is affiliated with a broker or 
dealer that engages in other business activities) would be required to 
establish information barriers that prevent the market maker from using 
material, non-public information or information about customer order 
flow handled by the firm in its trading activities.\64\
---------------------------------------------------------------------------

    \61\ An Exchange-registered market maker would be permitted to 
trade only on a proprietary basis and would not be permitted to 
handle any agency orders on the Exchange. To the extent that a 
participant firm wants to act as an Exchange-registered market maker 
and also handle orders from customers outside the facilities of the 
Exchange, it would be required to create and strictly enforce 
information barrier procedures as described infra at note 64 and 
accompanying text. Since Exchange-registered market makers are not 
permitted to handle agency orders, the Matching Engine will reject 
any cross order instructions entered by a market maker in its market 
maker trading account. See proposed CHX Article 16, Rule 1, 
Interpretation and Policy .02. See also Amendment No. 2.
    \62\ A market maker's continuous two-sided quotes would be 
required to be at prices which are reasonably related to the 
prevailing market price of the security. See CHX Article 16, Rule 8, 
Interpretation and Policy .01.
    \63\ See proposed CHX Article 16, Rule 8(a)-(c).
    \64\ See proposed CHX Article 16, Rule 9.
---------------------------------------------------------------------------

C. Institutional Brokers

    Participant firms for which the Exchange is the designated 
examining authority could register with the Exchange as institutional 
brokers.\65\ Institutional brokers would be deemed to be participants 
operating on the Exchange, although they would not effect transactions 
from a physical trading floor (since the Exchange will no longer have a 
physical trading floor) and could trade from any location. A customer 
order would be deemed to be on the Exchange when received by an 
institutional broker, but would not have priority in the Matching 
System until it is entered into the system.
---------------------------------------------------------------------------

    \65\ See proposed CHX Article 17, Rule 1. Each individual that 
would be authorized to effect trades on behalf of the firm would be 
required to separately register as an institutional broker 
representative. See proposed CHX Article 17, Rule 1, Interpretation 
and Policy .02.
---------------------------------------------------------------------------

    Institutional brokers would be required to: (1) Enter all orders 
received for execution on the Exchange into an automated system to 
provide an electronic record of their order handling practices; (2) 
handle orders with an electronic system acceptable to the Exchange that 
integrates their on-exchange activities with the Matching System and 
their trading activities in other market centers; and (3) maintain 
separate accounts for handling agency transactions, principal 
transactions, and transactions involving errors.\66\ Institutional 
brokers would also be required to maintain required records of their 
trading activities.\67\ An institutional broker would be required to 
use due diligence to execute a market order at the best price 
available; to use due diligence to execute a limit order at or better 
than the limit price, if available; and to use brokerage judgment in 
the execution of a not held order.\68\
---------------------------------------------------------------------------

    \66\ See proposed CHX Article 17, Rule 3(a) through Rule 3(c). 
The Commission recently approved, and the Exchange has implemented, 
a proposed rule change regarding requirements for entering orders 
into an electronic system to permit the Exchange to more readily 
surveil broker order handling activities. See CHX Article 11, Rule 
3; Securities Exchange Act Release No. 53772 (May 8, 2006), 71 FR 
27758 (May 12, 2006).
    \67\ See proposed CHX Article 17, Rule 3(f).
    \68\ See proposed CHX Article 17, Rule 3(d).
---------------------------------------------------------------------------

    Institutional brokers would be required to use reasonable efforts 
to report all transactions that are not effected through the Exchange's 
Matching System to the Exchange within 10 seconds of the trade.\69\ If 
an institutional broker executes an order outside of the Matching 
System, it would be required to use the Exchange's Brokerplex system to 
determine whether a trade would constitute a trade-through and create 
an electronic record that such validation had taken place.\70\ In 
general terms, the Brokerplex system would allow an institutional 
broker to input the symbol for a security and pull up a window that 
includes a snapshot of the Matching System BBO and the NBBO. The 
institutional broker then could report a trade that is consistent with 
the orders in the Matching System and the NBBO. An institutional broker 
that initiates the use of this functionality to report a proprietary 
trade against a customer order would be required to complete the 
transaction report (without cancelling out of the functionality), 
unless the institutional broker had mistakenly input the symbol for the 
wrong security. The transaction also could be cancelled pursuant to CHX 
rules relating to cancellations of transactions, clearly erroneous 
transactions and systems disruptions and malfunctions.\71\
---------------------------------------------------------------------------

    \69\ See proposed CHX Article 17, Rule 3(e).
    \70\ See CHX Article 17, Rule 3, Interpretation and Policy .03.
    \71\ See id.
---------------------------------------------------------------------------

    Unless a customer specifically requests otherwise, an institutional 
broker would be required to clear the Matching System before sending an 
order to another market for execution.\72\ The proposed rules provide 
exceptions to this requirement for: (1) Outbound ITS commitments or 
ISOs that are being sent to another market to satisfy its displayed bid 
or offer;\73\ and (2) customer orders that are being sent to another 
market that could not be executed in the Matching System.\74\
---------------------------------------------------------------------------

    \72\ See proposed CHX Article 20, Rule 7. Any customer 
directives for special handling of orders would have to be 
documented and reported to the Exchange.
    \73\ See proposed CHX Article 20, Rule 7(c).
    \74\ See proposed CHX Article 20, Rule 7(d).
---------------------------------------------------------------------------

D. Other Rule Changes

    Proposed Article 9, Rule 17, based on an existing Exchange rule 
prohibiting participants from trading ahead of customer orders, would 
include a provision confirming that a participant would be deemed to be 
holding an unexecuted customer order when that order has been sent to 
the Matching System, but remains unexecuted.\75\
---------------------------------------------------------------------------

    \75\ See proposed CHX Article 9, Rule 17, Interpretation and 
Policy .05. The proposed rule would also confirm that a participant 
would not be in violation of the ``trading ahead'' rule if it 
satisfied bids and offers in other markets in accordance with the 
requirements for a ``cross with satisfy order.'' See proposed CHX 
Article 9, Rule 17, Interpretation and Policy .06; see also supra 
note 20 (discussing cross with satisfy orders).
---------------------------------------------------------------------------

    The Exchange proposes to adopt a sponsored access rule, which would 
allow Exchange participants to provide non-participant broker-dealers 
with access to the Exchange.\76\ Under the proposed rule, this type of 
sponsored access could be provided so long as the participant 
sponsoring access, the non-participant broker-dealer, and the Exchange 
entered into appropriate agreements confirming basic information about 
the parties' roles and responsibilities.\77\
---------------------------------------------------------------------------

    \76\ See proposed CHX Article 5, Rule 3.
    \77\ See id.
---------------------------------------------------------------------------

    In addition to the changes described above, the Exchange has also 
proposed revisions to virtually every other chapter of its rules. These 
changes are generally designed to remove references to the physical 
trading floor, delete obsolete provisions and account for the new 
automated trading model, as well as to better streamline and organize 
the rules. For example, the CHX proposes to delete rules relating to 
specialists and access to the trading floor and adopt rules that 
contemplate remote access to the Exchange's automated trading systems. 
In addition, changes are being proposed to rules relating to: hours of 
trading, trading halts, cancelling transactions, business conduct, 
disciplinary matters and trial proceedings, arbitration, Exchange 
emergency suspension authority; committees; trading permits; limitation 
of liability; voting designees; registration; fingerprinting; reporting 
transactions; riskless principal

[[Page 59568]]

transactions; use of a customer's give-up; books and records; firm 
supervision; ITS; clearance and settlement; and listing on the 
Exchange.

E. Amendment No. 2

    On September 29, 2006, the Exchange filed Amendment No. 2 to the 
proposed rule change, which made certain revisions to the original 
proposal, as amended by Amendment No. 1. In Amendment No. 2, the 
Exchange described its proposed phase-in plan for the new trading 
model.\78\ In Amendment No. 2, the Exchange also provided additional 
discussion and clarification on certain aspects of the proposal.
---------------------------------------------------------------------------

    \78\ The Exchange stated that it plans to phase in the new 
trading model as follows: (i) Beginning the week of October 2, 2006, 
the Exchange will begin to transition Nasdaq-listed securities to 
the Matching System; (ii) during the week of October 16, 2006, the 
Exchange will begin to transition all other securities that are not 
currently traded by specialists to the Matching System; and (iii) by 
early November 2006, the Exchange will begin to transition 
securities currently traded by the Exchange's specialists to the 
Matching System. The Exchange stated that, in the near future, it 
will provide notice to participants of the exact dates for 
transition of specific securities.
---------------------------------------------------------------------------

    The Exchange also added a discussion of how the Exchange believes 
that the rules of the proposed new trading model will be consistent 
with Section 11(a) of the Act.\79\ The Exchange stated that it believes 
that the proposed Matching System meets the requirements of Rule 11a2-
2(T) under the Act,\80\ known as the ``effect versus execute'' rule, 
which provides an exemption from the prohibition of Section 11(a). 
Further, the Exchange stated that it believes that the proposal does 
not raise any of the policy concerns that Congress sought to address in 
Section 11(a) of the Act including, specifically, the time and place 
advantages that members on exchange floors might have over non-members 
off the floor and the general public.
---------------------------------------------------------------------------

    \79\ 15 U.S.C. 78k(a).
    \80\ 17 CFR 240.11a2-2(T).
---------------------------------------------------------------------------

    In Amendment No. 2, the Exchange also made certain changes to the 
rule text reflecting modifications in how the Matching System will 
operate. Specifically, the Exchange modified the proposed rules to: (1) 
Amend the definition of a ``cross with size'' order; \81\ (2) confirm 
that the Matching System will evaluate most cross orders to see if they 
meet the ``cross with size'' definition and, if so, will execute them 
as crosses with size; \82\ (3) provide that, when the Matching System 
lacks sufficient information to determine the appropriate price at 
which a sell short order could be displayed or executed, the Matching 
System will automatically cancel the order; \83\ (4) confirm that cross 
orders can be submitted as ISOs; \84\ (5) remove references to 
functionality that is not being built; \85\ and (6) confirm that a 
participant cannot change a ``display'' instruction for an order, but 
must submit a new order with a new display instruction.\86\ In 
addition, the Exchange revised the proposed rules to confirm the 
circumstances when the Matching System would display quotes that would 
lock or cross the protected quotes of other markets \87\ and to clarify 
that the Matching System will trade in increments supported by the ITS 
or Regulation NMS linkage plan.\88\ The Exchange also clarified how a 
trade should be identified when it is executed pursuant to both the 
intermarket sweep order exception of Rule 611(b)(5) or (6) of 
Regulation NMS and the self-help exception of Rule 611(b)(1) of 
Regulation NMS.\89\
---------------------------------------------------------------------------

    \81\ See proposed CHX Article 20, Rule 4(b)(6) (requiring a 
cross with size to size out all of the displayed interest at a 
price, but providing that, once the CHX is disseminating a book 
feed, a cross with size would only be required to size out the 
largest displayed order).
    \82\ See proposed CHX Article 20, Rule 4(b)(6).
    \83\ See proposed CHX Article 20, Rule 8(e)(5).
    \84\ See proposed CHX Article 20, Rule 4(b)(14).
    \85\ See proposed CHX Article 20, Rule 4(a)(7)(b) (removing a 
reference to an order that executes at the midpoint of the NBBO, 
because this functionality is not being built at this time).
    \86\ See proposed CHX Article 20, Rule 8(b)(5).
    \87\ See proposed CHX Article 20, Rule 6(d).
    \88\ See proposed CHX Article 20, Rule 4(a)(7)(d); see also 
proposed CHX Article 20, Rule 4(a)(7)(e).
    \89\ See proposed CHX Article 20, Rule 5, Interpretation and 
Policy .01(h).
---------------------------------------------------------------------------

    In Amendment No. 2, the Exchange also made certain changes intended 
to clarify the meaning of the proposed rules. These changes include a 
change in the definition of NBBO to confirm that, as of the Trading 
Phase Date of Regulation NMS, this term relates only to protected bids 
and offers; \90\ the addition of language that confirms that non-
regular way crosses can execute within a penny of other orders in the 
Matching System; \91\ and a change that notes that, in the last 
``refresh'' of a reserve size order, the number of shares may be less 
than the original number of displayed shares because that is all that 
is left.\92\ Other similar changes clarify the execution of benchmark 
orders; \93\ confirm the handling of BBO ISO orders; \94\ and state, 
with regard to relevant provisions, that they take effect on the 
Trading Phase Date of Rule 611 of Regulation NMS.\95\
---------------------------------------------------------------------------

    \90\ See proposed CHX Article 1, Rule 1(o).
    \91\ See proposed CHX Article 20, Rule 4(a)(7)(b) (recognizing, 
as already expressed in the definition of this type of order, that 
non-regular way cross orders execute without regard to orders in the 
Matching System, because all orders in the Matching System are for 
regular-way settlement).
    \92\ See proposed CHX Article 20, Rule 4(b)(20).
    \93\ See proposed CHX Article 20, Rule 4(b)(2) (confirming that 
benchmark orders must be executed in increments permitted by Article 
20, Rule 4(a)(7)(b)). The Exchange also elaborated on its reasoning 
in proposing that benchmark orders only be permitted to be submitted 
to the Matching System by institutional brokers, and noted that 
other participants seeking to execute benchmark orders on the 
Exchange could do so through an institutional broker.
    \94\ See proposed CHX Article 20, Rule 4(b)(1) (confirming that 
BBO ISO orders will be displayed in the circumstances set out in the 
rule because the participant routing the order to the Matching 
System has already satisfied the quotations of other markets as 
required by Article 20, Rule 6(c)(3)).
    \95\ See, e.g., proposed CHX Article 20, Rules 4(b)(1), (2), 
(14), (18) and (19); see also proposed CHX Article 1, Rule 1(y) 
(defining the ``Trading Phase Date'' as February 5, 2007).
---------------------------------------------------------------------------

    In Amendment No. 2, the Exchange also made changes to Article 16 
governing market makers. The Exchange revised the rules to prohibit an 
individual from registering both as a market maker trader and an 
institutional broker representative.\96\ The Exchange also modified the 
rules to provide that market makers may only trade on a proprietary 
basis on the Exchange, and if a market maker handles agency orders off 
of the Exchange, it must create and enforce information barrier 
procedures pursuant to CHX Article 16, Rule 9.\97\
---------------------------------------------------------------------------

    \96\ See proposed CHX Article 16, Rule 1, Interpretation and 
Policy .01.
    \97\ See proposed CHX Article 16, Rule 1, Interpretation and 
Policy .02.
---------------------------------------------------------------------------

    Pursuant to an exemption recently issued by the Commission,\98\ the 
Exchange proposed further provisions in Amendment No. 2 to permit 
``qualified contingent trades'' to be executed on the Exchange.\99\ The 
Exchange asserts that these trades would meet the requirements of the 
Commission's order exempting from Rule 611(a) any trade-throughs caused 
by the execution of an order involving one or more NMS stocks that are 
components of a ``qualified contingent trade,'' as defined in the 
Commission's exemptive order.\100\
---------------------------------------------------------------------------

    \98\ See Securities Exchange Act Release No. 54389 (August 31, 
2006), 71 FR 52829 (September 7, 2006) (``Qualified Contingent Trade 
Exemptive Order'').
    \99\ See proposed CHX Article 1, Rule 2(bb) and proposed CHX 
Article 20, Rule 5, Interpretation and Policy .01(i).
    \100\ See Qualified Contingent Trade Exemptive Order, supra note 
98.
---------------------------------------------------------------------------

    The Exchange also added provisions requiring it to establish and 
maintain information barriers to restrict the flow of information 
between the Exchange (including its facilities) and the third-party 
broker-dealer providing connectivity to other trading centers, and, to 
the extent such third-party broker-dealer receives such information, 
that adequately restrict the use of such

[[Page 59569]]

information by the third party broker-dealer to legitimate business 
purposes necessary to provide routing connectivity and to serve as a 
``give-up.'' Further, in Amendment No. 2, the Exchange revised its rule 
text to reflect recent changes made to Exchange rules by other proposed 
rule changes that have been recently approved by the Commission.\101\
---------------------------------------------------------------------------

    \101\ In particular, the Exchange revised the proposed rule text 
to reflect changes to the Exchange's disciplinary rules made in SR-
CHX-2005-06, see Securities Exchange Act Release No. 54437 
(September 13, 2006), 71 FR 55037 (September 20, 2006); and to 
reflect changes to the Exchange's rules made in SR-CHX-2006-23, 
confirming that each participant firm only needs one trading permit 
to conduct business on the Exchange, see Securities Exchange Act 
Release No. 54494 (September 25, 2006).
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    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 \102\ and, in particular, the requirements of 
Section 6 of the Act \103\ and the rules and regulations thereunder. 
The Commission finds that the proposed rule change, as amended, is 
consistent with Section 6(b)(5) of the Act,\104\ which requires that 
the rules of an exchange be designed, among other things, to prevent 
fraudulent and manipulative acts and practices, 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.
---------------------------------------------------------------------------

    \102\ The Commission has considered the proposed rule's impact 
on efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \103\ 15 U.S.C. 78f.
    \104\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

A. The Matching System

    The Matching System would allow participants to route orders to it 
from any location for possible immediate execution through any 
communications line approved by the Exchange.\105\ The adoption of the 
Exchange's proposed rules, which feature the Matching System as the 
core facility of the Exchange, will fundamentally change the Exchange's 
current market structure from a substantially floor-based auction 
market to an all-electronic one. The Commission believes that by 
allowing electronic access to Exchange liquidity, the proposed new 
model should help perfect the mechanism of a free and open market by 
providing investors with a more efficient mechanism to have their 
orders executed on the Exchange.
---------------------------------------------------------------------------

    \105\ See proposed CHX Article 20, Rule 8(a)(1).
---------------------------------------------------------------------------

    The Commission also believes that the Exchange's new trading model 
should facilitate securities transactions by providing investors with 
faster and more efficient access to the trading interest reflected in 
the Exchange's published quotation, as well as interest away from the 
Exchange BBO. Finally, the Commission believes that the Exchange's 
proposal should enhance the opportunity for a customer's order to be 
executed without dealer participation, consistent with the goals of 
Section 11A of the Act.\106\
---------------------------------------------------------------------------

    \106\ See Section 11A(a)(1)(C) of the Act, 15 U.S.C. 78k-
1(a)(1)(C).
---------------------------------------------------------------------------

1. Eligible Orders and Order Types
    Under the proposed rule change, participants would be permitted to 
submit orders to the Matching System that are day orders, limit orders, 
and orders for regular way settlement (as well as certain other 
excepted types of orders such as IOC market orders and non-regular way 
crosses) and generally would be permitted to submit orders as round 
lots, odd lots, or mixed lots.\107\ The proposed rules require that 
orders submitted to the Matching System must meet the requirements of 
Rule 612 of Regulation NMS, unless an exemption therefrom applies.\108\ 
As such, except for cross orders under certain circumstances as 
discussed below,\109\ orders priced at or above $1.00 could not be 
submitted to the Matching System in increments less than $0.01, and 
orders priced less than $1.00 could not be submitted to the Matching 
System in increments less than $.0001.\110\ The Commission believes 
that these order eligibility requirements are consistent with the Act.
---------------------------------------------------------------------------

    \107\ See supra notes 9-10 and accompanying text.
    \108\ 17 CFR 242.612.
    \109\ See infra note 124 and accompanying text.
    \110\ See proposed CHX Article 20, Rule 4(a)(5).
---------------------------------------------------------------------------

    The Exchange proposes to permit the Matching System to accept a 
wide variety of order types. These order types include: immediate or 
cancel limit and market orders, fill or kill orders, sell short and 
short exempt orders, reserve size orders, time in force orders, cancel 
on halt orders, do-not-display orders, do-not-route orders, various 
types of cross orders, and various types of ISOs.\111\ Many of these 
order types exist in the Exchange's current rules set, while others 
have been proposed exclusively for use in the new trading model or for 
use as of the Trading Phase Date of Regulation NMS. The Commission 
believes that these order types should provide Exchange participants 
greater flexibility in reaching their trading and investment 
objectives. The Commission notes that a number of the proposed order 
types will have different definitions prior to and following the 
Trading Phase Date of Regulation NMS, which should enable users to make 
use of the trading strategies of such order types immediately, as well 
as after the Trading Phase Date.
---------------------------------------------------------------------------

    \111\ See supra Section II.A.1.
---------------------------------------------------------------------------

    As noted, the Exchange has proposed a number of cross order types 
for use in the Matching System. The Commission notes that the cross 
order is already permitted in the Exchange's electronic book.\112\ A 
cross order would be immediately executed in the Matching System if it 
is priced better than the Matching System's displayed BBO and, for 
securities listed on any exchange other than Nasdaq (and for Nasdaq-
listed securities, as of the Trading Phase Date of Regulation NMS), 
equal to or better than the NBBO.\113\ Similarly, a form of the cross 
with size order is already permitted in the Exchange's electronic 
book.\114\ Under the proposed rules, a cross with size will be required 
to be larger than the aggregate size of all displayable orders 
displayed on the Matching System at the cross price, consist of at 
least 5,000 shares, and have a value of $100,000. The Commission notes 
that it has previously approved a similar rule at another 
exchange.\115\
---------------------------------------------------------------------------

    \112\ See current CHX Article XXA, Rule 2.
    \113\ See proposed CHX Article 20, Rule 4(b)(4) and supra note 
18.
    \114\ See current CHX Article XXA, Rule 2.
    \115\ See Rules of the National Stock Exchange, Inc., Rule 
11.12.
---------------------------------------------------------------------------

    The Exchange is also proposing several completely new cross order 
types that would be accepted by the Matching System, such as cross with 
satisfy \116\ and cross with yield orders.\117\ The Commission believes 
that these cross orders may provide an efficient means to allow 
participants to effect cross transactions in the Matching System, 
consistent with the Exchange's other priority and trade-through rules, 
in circumstances where a cross order would otherwise be unable to be 
executed and would be cancelled. A cross with satisfy order would 
contain an instruction to execute orders already displayed in the 
Matching System at their limit prices (up to a specified number of 
shares) to the extent necessary to allow the cross transaction to occur 
or to route outbound orders or commitments to other market centers to 
the extent necessary to prevent an

[[Page 59570]]

improper trade-through.\118\ Once the satisfying execution has 
occurred, the cross order would be executed at a price that is better 
than the Matching System's displayed BBO and, for securities listed on 
any exchange other than Nasdaq (and for Nasdaq-listed securities, as of 
the Trading Phase Date of Regulation NMS), equal to or better than the 
NBBO.
---------------------------------------------------------------------------

    \116\ See supra note 20.
    \117\ See supra note 21.
    \118\ See proposed CHX Article 20, Rule 4(b)(5).
---------------------------------------------------------------------------

    The cross with yield order is similar to the cross with satisfy, 
and would contain an instruction to yield interest on the buy, sell, or 
either side of the order (as specified in the order) to any order 
already displayed in the Matching System at the same or better price, 
to the extent necessary to allow the cross transaction to occur.\119\ 
The cross order would then be executed at a price that is better than 
the best bid or offer to be displayed in the Matching System, and, for 
securities listed on any exchange other than Nasdaq (and for Nasdaq-
listed securities, as of the Trading Phase Date of Regulation NMS), 
equal to or better than the NBBO.
---------------------------------------------------------------------------

    \119\ See proposed CHX Article 20, Rule 4(b)(7).
---------------------------------------------------------------------------

    The Matching System would also accept mid-point cross orders, which 
would be executed at the midpoint of the NBBO.\120\ The Commission 
notes that this order type has been previously approved for other 
exchanges.\121\ The Exchange also proposes to permit a non-regular way 
cross order, which would be for non-regular way settlement and would 
execute without regard to the NBBO or any other orders in the Matching 
System.\122\ The Commission notes that the Exchange has represented 
that participants can currently execute orders for non-regular way 
settlement in the Exchange's electronic book and on the floor of the 
Exchange,\123\ but this cross order type would be the only means to 
effectuate this type of transaction within the Matching System.
---------------------------------------------------------------------------

    \120\ See supra note 22.
    \121\ See, e.g., NYSE Arca Equities Rule 7.31(y).
    \122\ See supra note 25.
    \123\ See current CHX Article XX, Rule 9; CHX Article XXA, Rule 
2(c)(5).
---------------------------------------------------------------------------

    Contingent upon the Exchange receiving exemptive relief from the 
Commission, the Exchange proposes to allow all cross orders to be 
submitted to the Matching System in sub-penny increments as small as 
$.000001, regardless of their price.\124\ Although participants would 
be permitted to submit crosses in sub-penny increments, the Exchange 
proposes that cross orders (except for a midpoint cross, non-regular-
way cross or cross with size) would be required to be priced at least 
$.01 better than any order on the same side of the Matching System (or, 
for orders priced less than $1.00, at least $.0001 better than any 
order on the same side of the Matching System).
---------------------------------------------------------------------------

    \124\ See proposed CHX Article 20, Rule 4(a)(7)(b) (stating that 
the provision ``shall take effect upon the granting of exemptive 
relief by the Commission'').
---------------------------------------------------------------------------

    The Commission believes that the proposed rules relating to cross 
transactions are consistent with the Act and offer participants 
flexibility in executions which meet the specified requirements of each 
type of cross. In addition, the Commission notes that proposed CHX 
Article 9, Rule 17, which restricts trading ahead of customer orders, 
would apply to the cross order types, except as noted in Interpretation 
and Policy .06 of that rule with respect to cross with satisfy 
orders.\125\
---------------------------------------------------------------------------

    \125\ See proposed CHX Article 9, Rule 17.
---------------------------------------------------------------------------

    The Exchange also proposes to permit the Matching System to accept 
several order types modeled on the exceptions in Rule 611(b) of 
Regulation NMS. The Matching System would accept various ISOs, which 
would allow the Exchange to immediately execute such orders without 
regard to other markets' protected quotations, a