Self-Regulatory Organizations; Chicago Stock Exchange, Incorporated; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Related to the Treatment of Customer Orders and the Prohibition Against Trading Ahead of Customer Orders, 27735-27737 [2011-11585]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 76, Number 92 (Thursday, May 12, 2011)]
[Notices]
[Pages 27735-27737]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-11585]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64418; File No. SR-CHX-2011-08]


Self-Regulatory Organizations; Chicago Stock Exchange, 
Incorporated; Notice of Filing and Immediate Effectiveness of Proposed 
Rule Change Related to the Treatment of Customer Orders and the 
Prohibition Against Trading Ahead of Customer Orders

May 6, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on April 26, 2011, the Chicago Stock Exchange, Incorporated 
(``Exchange'' or ``CHX'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I and II below, which Items have been prepared by the 
Exchange. The Exchange filed the proposal as a ``non-controversial'' 
proposed rule change pursuant to Section 19(b)(3)(A)(iii) of the Act 
\3\ and Rule 19b-4(f)(6) thereunder.\4\ The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend CHX Article 9, Rule 17 which rule 
governs the treatment of customer orders and the prohibition against 
trading ahead of customer orders. The text of this proposed rule change 
is available on the Exchange's Web site at (https://www.chx.com), at the 
Exchange's Office of the Secretary, on the Commission's Web site at 
https://www.sec.gov, and in the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the CHX included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received regarding the proposal. The text of 
these statements may be examined at the places specified in Item IV 
below. The CHX has prepared summaries, set forth in sections A, B and C 
below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange is proposing to amend Article 9, Rule 17 of its rules 
which governs the treatment of customer orders and prohibits a CHX 
Participant \5\ from proprietarily trading ahead of a customer order. 
Specifically, this proposal includes redrafting of the customer order 
protection rule language and adds a number of exceptions to the rule in 
order to make the rule more consistent with the Financial Industry 
Regulatory Authority's (``FINRA'') Rule 5320.
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    \5\ Pursuant to CHX Article 1, Rule 1(s), a ``Participant'' 
means any Participant Firm that holds a valid Trading Permit and any 
person associated with a Participant Firm who is registered with the 
Exchange under CHX Articles 16 and 17 as a Market Maker Trader or 
Institutional Broker Representative, respectively. A Participant 
shall be considered a ``member'' of the Exchange for purposes of the 
Exchange Act. If a Participant is not a natural person, the 
Participant may also be referred to as a ``Participant Firm,'' but 
unless the context requires otherwise, the term Participant shall 
refer to an individual Participant and/or a Participant Firm.
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Customer Order Protection
    Currently, CHX Article 9, Rule 17 states, in part, that a 
Participant is prohibited from trading proprietarily while the 
Participant personally holds or has knowledge that the Participant (or 
any partner, officer or director thereof) holds an unexecuted market or 
limit order to buy (sell) such security in the unit of trading for a 
customer. The proposed rule change still includes customer order 
protection language as it applies to unexecuted market and limit orders 
with the clarification of allowing a Participant, who has traded 
proprietarily ahead of a customer order, to immediately thereafter 
execute the customer order up to the size and at the same or better 
price at which it traded for its own account. In other words, in the 
event that a Participant trades ahead of an unexecuted customer order 
at a price that is equal to or better than the unexecuted customer 
order, such Participant is required to execute the customer order at 
the price received by the Participant or better; otherwise the 
Participant shall be in violation of improperly trading ahead of such 
customer order. The proposal also prescribes the minimum ``level'' of 
price improvement necessary for a Participant to execute an order on a 
proprietary basis when holding an unexecuted customer limit order. For 
example, for customer limit orders priced greater than or equal to 
$1.00, the minimum amount of price improvement required is $0.01.
    The Exchange also proposes to establish that a Participant must 
have written procedures in place governing the execution and priority 
of all pending orders that is consistent with the best execution 
requirements of CHX Article 17, Rule 3(d) and ensure that these 
procedures are consistently applied.
    In furtherance of ensuring customer order protection, the proposed 
rule change clarifies Participant obligations in handling marketable 
customer orders. In meeting these obligations, a Participant must make 
every effort to execute a marketable customer order that it receives 
fully and promptly. A Participant that is holding a customer order that 
is marketable and has not been immediately executed must make every 
effort to cross such order with any other order received by the 
Participant on the other side of the market up to the size of such 
order at a price that is no less than the best bid and no greater than 
the best offer at the time that the subsequent order is received by the 
Participant and that is consistent with the terms of the orders. In the 
event that a Participant is holding multiple orders on both sides of 
the market that have not been executed, the Participant must make every 
effort to cross or otherwise execute such orders in a manner that is 
reasonable and consistent with the objectives of the proposed rule and 
with the terms of the orders.
Large Orders and Institutional Accounts
    In addition, the Exchange is proposing to add several exceptions to 
the customer order protection rule. The most notable exception is to 
allow Participants to negotiate terms and conditions on the acceptance 
of certain large-sized orders (orders of 10,000 shares or more and 
greater than $100,000 in value) or orders from institutional accounts 
as defined in this proposal as Interpretation and Policy .09 of CHX 
Article 9, Rule 17 (collectively referred to as ``Institutional/Large-
Sized Orders''). Such terms and conditions would permit the Participant 
to continue to trade along side or ahead of such customer orders if the 
customer agrees.
    Specifically, under the proposed rule, a Participant would be 
permitted to trade a security on the same side of the market for its 
own account at a price that would satisfy a customer order provided 
that the Participant provides clear and comprehensive written 
disclosure to each customer at account

[[Page 27736]]

opening and annually thereafter that: (a) Discloses that the 
Participant may trade proprietarily at prices that would satisfy the 
customer order, and (b) provides the customer with a meaningful 
opportunity to opt in to the CHX Article 9, Rule 17 protections with 
respect to all or any portion of its order(s).
    If a customer does not opt in to the protections with respect to 
all or any portion of its order(s), the Participant may reasonably 
conclude that such customer has consented to the Participant trading a 
security on the same side of the market for its own account at a price 
that would satisfy the customer's order.\6\
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    \6\ As is always the case, customers retain the right to 
withdraw consent at any time. Therefore, a Participant's reasonable 
conclusion that a customer has consented to the Participant trading 
along with such customer's order is subject to further instruction 
and modification from the customer.
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    In lieu of providing written disclosure to customers at account 
opening and annually thereafter, the proposed rule would permit 
Participants to provide clear and comprehensive oral disclosure to, and 
obtain consent from, a customer on an order-by-order basis, provided 
that the Participant documents who provided such consent and that such 
consent evidences the customer's understanding of the terms and 
conditions of the order. In addition, where a customer has opted in to 
the CHX Article 9, Rule 17 protections, a Participant may still obtain 
consent on an order-by-order basis to trade ahead of or along with an 
order from that customer, provided that the Participant documents who 
provided such consent and that such consent evidences the customer's 
understanding of the terms and conditions of the order.\7\
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    \7\ While a firm relying on this or any exception must be able 
to proffer evidence of its eligibility for and compliance with the 
exception, CHX believes that when obtaining consent on an order-by-
order basis, Participants must, at a minimum, document not only the 
terms and conditions of the order (e.g., the relative price and size 
of the allocated order/percentage split with the customer), but also 
the identity of the person at the customer who approved the trade-
along request. For example, the identity of the person must be noted 
in a manner that will enable subsequent contact with that person if 
a question as to the consent arises (i.e., first names only, 
initials, and nicknames will not suffice). A trade along request 
would be when a CHX Participant asks to trade for his/her 
proprietary account while simultaneously holding and working a 
customer order in that same stock.
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No-Knowledge Exception

    The Exchange is also proposing to add a ``no-knowledge'' exception 
to its customer order protection rule. The proposed exception would 
allow a proprietary trading unit of a CHX Participant firm to continue 
trading in a proprietary capacity and at prices that would satisfy 
customer orders that were being held by another, separate trading unit 
at the Participant firm. The ``no-knowledge'' exception would be 
applicable with respect to NMS stocks, as defined in Rule 600 of SEC 
Regulation NMS. In order to avail itself of the ``no-knowledge'' 
exception, a Participant firm must first implement and utilize an 
effective system of internal controls (such as appropriate information 
barriers) that operate to prevent the proprietary trading unit from 
obtaining knowledge of the customer orders that are held at a separate 
trading unit. For example, a CHX Institutional Broker \8\ that conducts 
both a proprietary and agency brokerage business and has implemented 
and utilized an effective system of internal controls, the ``walled 
off'' proprietary desk(s) of such Institutional Broker would be 
permitted to trade at prices that would satisfy the customer orders 
held by the agency brokerage desk without any requirement that such 
proprietary executions trigger an obligation to fill pending customer 
orders at the same price. The ``no-knowledge'' exception would also 
apply to a Participant firm's market-making unit.
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    \8\ Pursuant to CHX Article 1, Rule 1(n), an Institutional 
Broker means a member of the Exchange who is registered as an 
institutional broker and has satisfied all Exchange requirements to 
operate as an institutional broker on the Exchange.
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    A Participant that structures its order handling practices in NMS 
stocks to permit its proprietary and/or market-making desk to trade at 
prices that would satisfy customer orders held as [sic] a separate 
trading unit must disclose in writing to its customers, at account 
opening and annually thereafter, a description of the manner in which 
customer orders are handled by the Participant and the circumstances 
under which the Participant may trade proprietarily at its market-
making desk at prices that would satisfy the customer order.
    To the extent a Participant firm structures its order handling 
practices in NMS stocks to ``wall off'' customer order flow from its 
proprietary/market-making desks, CHX is proposing to require the firm 
to disclose that fact in writing to its customers. This disclosure 
would include a description of the manner in which customer orders are 
handled and the circumstances under which the firm may trade 
proprietarily at prices that would satisfy a customer order. The 
proposed disclosure would be required at account opening and on an 
annual basis thereafter and may be combined with the disclosure and 
negative consent statement permitted in connection with the proposed 
Institutional/Large-Sized Order exception.
Riskless Principal Exception
    The Exchange's proposal also clarifies that the obligations under 
this rule shall not apply to a Participant's proprietary trade if such 
proprietary trade is for the purposes of facilitating the execution, on 
a riskless principal basis, of another order from a customer (whether 
its own customer or the customer of another broker-dealer), provided 
that the Participant: (a) Submits a report, contemporaneously with the 
execution of the facilitated order, identifying the trade as riskless 
principal to CHX and (b) has written policies and procedures to ensure 
that riskless principal transactions relied upon for this exception 
comply with applicable CHX rules. At a minimum these policies and 
procedures must require that the customer order was received prior to 
the offsetting principal transaction, and that the offsetting principal 
transaction is at the same price as the customer order exclusive of any 
markup or markdown, commission equivalent or other fee and is allocated 
to a riskless principal or customer account in a consistent manner and 
within 60 seconds of execution.
    Participants must have supervisory systems in place that produce 
records that enable the Participant and CHX to reconstruct accurately, 
readily, and in a time-sequenced manner all orders on which a 
Participant relies in claiming this exception.
ISO Exception
    The filing also clarifies that a Participant shall be exempt from 
the obligation to execute a customer order in a manner consistent with 
the customer order protection rule with regard to trading for its own 
account that is the result of an intermarket sweep order routed in 
compliance with Rule 600(b)(30)(ii) of SEC Regulation NMS (``ISO'') 
where the customer order is received after the Participant routed the 
ISO. Where a Participant routes an ISO to facilitate a customer order 
and that customer has consented to not receiving the better prices 
obtained by the ISO, the Participant also shall be exempt with respect 
to any trading for its own account that is the result of the ISO with 
respect to the consenting customer's order.
Odd Lot and Bona Fide Error Exception
    In addition, the Exchange proposes applying an exception for a 
firm's proprietary trade that (1) Offsets a

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customer odd lot order (i.e., an order less than one round lot, which 
is typically 100 shares); or (2) corrects a bona fide error. With 
respect to bona fide errors, Participant firms would be required to 
demonstrate and document the basis upon which a transaction meets the 
bona fide error exception. For purposes of this rule, the definition of 
a ``bona fide error'' is as defined in SEC Regulation NMS's exemption 
for error correction transactions.\9\
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    \9\ Securities Exchange Act Release No. 55884 (June 8, 2007), 72 
FR 32926 (June 14, 2007) (Order Exempting Certain Error Correction 
Transactions from Rule 611 of Regulation NMS under the Securities 
Exchange Act of 1934).
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Trading Outside Normal Market Hours
    This proposal also expands the customer order protection 
requirements to apply at all times that a customer order is executable 
by the Participant, even outside the period of normal market hours. 
Thus, customers would have the benefit of the customer order protection 
rules at all times where such order is executable by the Participant 
firm, subject to any applicable exceptions. This exception shall apply 
to those Participants that accept customer orders after normal market 
hours.
2. Statutory Basis
    CHX believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act, which requires, among other 
things, that CHX rules must be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade and, in general, to protect investors and the 
public interest. CHX believes that amending its customer order 
protection rule as proposed, will bring it more in line with industry 
standards, most notably FINRA's Rule 5320, which we believe will in 
turn reduce the complexity of customer order protection for those firms 
subject to the rules of multiple trading venues. CHX also believes that 
changing its rule as proposed will maintain the necessary protection of 
customer orders without imposing any undue regulatory costs on industry 
participants.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The Exchange has filed the proposed rule change pursuant to Section 
19(b)(3)(A)(iii) of the Act \10\ and Rule 19b-4(f)(6) thereunder.\11\ 
Because the foregoing proposed rule change does not: (i) Significantly 
affect the protection of investors or the public interest; (ii) impose 
any significant burden on competition; and (iii) become operative prior 
to 30 days from the date on which it was filed, or such shorter time as 
the Commission may designate, if consistent with the protection of 
investors and the public interest, it has become effective pursuant to 
Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder.\12\
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    \10\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \11\ 17 CFR 240.19b-4(f)(6).
    \12\ In addition, Rule 19b-4(f)(6)(iii) requires the self-
regulatory organization to submit to the Commission written notice 
of its intent to file the proposed rule change, along with a brief 
description and text of the proposed rule change, at least five 
business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission. The 
Exchange has satisfied this requirement.
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    CHX will announce the implementation date of the proposed rule 
change in a Regulatory Notice to be issued no later than 90 days from 
the date of publication of notice in the Federal Register. 
Implementation of the rule will take effect no later than 90 days from 
the date when the Exchange issues the Regulatory Notice.
    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-CHX-2011-08 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-CHX-2011-08. 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 Web site viewing and 
printing in the Commission's Public Reference Room on official business 
days between the hours of 10 a.m. and 3 p.m. Copies of such filing also 
will be available for inspection and copying at the principal office of 
the Exchange. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-CHX-
2011-08 and should be submitted on or before June 2, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy.
Secretary.
[FR Doc. 2011-11585 Filed 5-11-11; 8:45 am]
BILLING CODE 8011-01-P