[Federal Register: December 3, 2002 (Volume 67, Number 232)]
[Notices]
[Page 72007-72008]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr03de02-130]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46872; File No. SR-CSE-2002-04]
Self-Regulatory Organizations; Cincinnati Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change and Amendment Nos. 1
and 2 Thereto Relating to the Introduction of Order Delivery and
Automated Response
November 21, 2002.
I. Introduction
On April 22, 2002, the Cincinnati Stock Exchange, Inc. (``CSE'' 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 related to the introduction of order delivery and
automated response. The proposed rule change was published for comment
in the Federal Register on May 10, 2002.\3\ On September 13, 2002, the
CSE filed Amendment No. 1 to the proposed rule change \4\ and on
September 17, 2002, filed Amendment No. 2 to the proposed rule
change.\5\ The proposed rule change, as amended by Amendment Nos. 1 and
2, was republished in its entirety for comment in the Federal Register
on October 11, 2002.\6\ No comments were received on the proposal. This
order approves the proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 45873 (May 3, 2002),
67 FR 31856.
\4\ See letter from Jennifer M. Lamie, CSE, to Katherine
England, Assistant Director, Division of Market Regulation
(``Division''), Commission (September 12, 2002). In Amendment No. 1,
the CSE deleted proposed rule language in Paragraph 11.9(i)(2)(a)
regarding price/time and agency/principal priorities, which was
inadvertently included in the original proposal.
\5\ See letter from Jennifer M. Lamie, CSE, to Katherine
England, Assistant Director, Division, Commission (September 16,
2002). In Amendment No. 2, the CSE expanded the proposed order
delivery and automated response alternative to all securities traded
through the Exchange's National Securities Trading System (``NSTS''
or ``System''), rather than simply Nasdaq National Market
Securities. In addition, Amendment No. 2 made certain non-
substantive grammatical changes.
\6\ See Securities Exchange Act Release No. 46599 (October 4,
2002), 67 FR 63484.
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II. Description of the Proposal
The Exchange proposes to amend its rules to increase the
flexibility of CSE execution systems to accommodate member needs.
Specifically, CSE proposes to modify CSE's execution functionality
within the CSE System from a process of automatically matching and
executing like-priced displayed orders and quotes to an optional
process of delivering orders to quoting CSE members and requiring
automated responses from such members back to the CSE System. CSE is
proposing this modification to facilitate a diverse membership base
while promoting a fair and orderly market. CSE members that operate as
electronic communications networks (``ECNs'')\7\ or alternative trading
systems (``ATSs'') subject to SEC Regulation ATS,\8\ as well as members
that act as Designated Dealers or specialists on CSE will have the
option of selecting the type of centralized execution system that best
fits their business model.
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\7\ ECNs are defined in SEC Rule 11Ac1-1(a)(8), 17 CFR
240.11Ac1-1(a)(8), as any electronic system that widely disseminates
to third parties orders entered therein by an exchange market maker
or OTC market maker, and permits such orders to be executed against
in whole or in part.
\8\ 17 CFR 242.300-303.
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Currently, CSE's NSTS functions solely in an automatic execution
mode. In an automatic execution system like NSTS, a Designated Dealer's
quotation is held in NSTS, and NSTS executes any like-priced contra-
side order against the dealer's quotation. NSTS then informs the
Designated Dealer and the contra-side CSE member that the quotation and
the order have been executed by delivering execution messages to both
parties.
With the advent of ECN/ATS trading on CSE, members have expressed
concern that CSE's automatic execution system exposes them to
significant multiple execution liability. Given the speed with which
ECN/ATSs operate, it is likely that displayed quotations will be
subject to internal matches at the same time as another CSE member
attempts to execute against the same displayed quotations. When faced
with a similar dilemma, the Nasdaq Stock
[[Page 72008]]
Market, Inc. permitted ECN/ATSs to remain on SelectNet (an order
delivery system) for inbound executions against the ECN/ATSs' displayed
quotations rather than requiring them to migrate to the automatic
execution methodology of the Nasdaq National Market Execution System
(``NNMS'').\9\ Nasdaq even amended its Intermarket Trading System
(``ITS'') / Computer Assisted Execution System (``CAES'') (together,
``ITS/CAES'') definitions and functionality to permit ECN/ATSs to
operate in an order delivery format when interacting with inbound
commitments from ITS. Similarly, CSE now proposes to permit members to
select order delivery and automated response for order interaction with
displayed quotations within the CSE System or to continue interacting
through CSE's automatic execution facility.
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\9\ See Securities Exchange Act Release No. 42344 (January 14,
2000), 65 FR 3987 (January 25, 2000) in which Nasdaq designated
SelectNet as the link to ECNs pursuant to the SEC's Order Handling
Rules. See Securities Exchange Act Release No. 38156 (January 10,
1997), 62 FR 2415 (January 16, 1997).
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In an order delivery and automated response system, a member's
quotation or displayed order will be held in the CSE System, and when a
contra-side order is received in the CSE System, CSE will immediately
forward the order message to the quoting member, who will be obligated
by rule to respond instantaneously to the order message. Moreover, the
quoting member must have a demonstrated capability to respond
instantaneously to the order message. On receipt of the order message
delivered by CSE, the quoting member will automatically determine
whether its quote is still active. If so, the member will automatically
deliver to the CSE System matched orders representing its quote and the
contra-side for execution. If the member's quote is in the process of
changing due to a prior internal match at the displayed price,
consistent with the Firm Quote Rule,\10\ the member will reject the
inbound order and send it back to the CSE System. The CSE System will
then automatically send a cancellation message to the member submitting
the order. The entire duration of the order delivery and automated
response process likely will be less than one second.
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\10\ 17 CFR 240.11Ac1-1.
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CSE will require that members demonstrate the capacity to accept
inbound orders and to automatically respond to the CSE System before
they will be permitted use of this functionality. Moreover, CSE Rule
11.9(i)(2) provides that the CSE System will offer order delivery and
automated response subject to the requirement that members demonstrate
the capability to respond in an automated manner. Therefore, by rule
and through demonstrated capacity verified by CSE examiners before
operation, the CSE will reduce the risk of multiple execution
liability, while ensuring that members comply with their obligations
under the Firm Quote Rule.
III. Discussion
The Commission finds that the proposed rule change, as amended, is
consistent with the provisions of section 6(b) of the Act,\11\ in
general, and section 6(b)(5) of the Act,\12\ in particular, which
requires, among other things, that the rules of an exchange be designed
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.
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\11\ 15 U.S.C. 78f(b). In approving this proposal, the
Commission has considered the proposed rule change's impact on
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
\12\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the proposal furthers the purpose of
this section by reducing the risk of dual liability to CSE members. By
reducing the risk of dual liability, the proposal may encourage CSE
members, such as ECNs, to display larger sized quotations thereby
adding liquidity and transparency to the market. Moreover, the
Commission approved a similar approach to reducing the risk of dual
liability in the Nasdaq market and believes that CSE's proposal should
similarly benefit all market participants in the Nasdaq and listed
markets. The Commission believes that the proposal's requirement that
CSE members demonstrate the ability to process inbound orders and
respond appropriately within one second should facilitate the efficient
functioning of the order delivery and automated response execution
option. The Commission believes that encouraging greater participation
in the national market system by market participants, including ECNs,
furthers the Congressional goal of developing a comprehensive national
market system.
It is important to note that, upon approval of the instant
proposal, a CSE member (or other market participant routing an order to
the CSE via ITS) may attempt to execute a trade at a price quoted on
the CSE by an ECN. In such a case, a CSE member (or ITS user)
submitting an order to the CSE's NSTS may not receive an execution at
the price originally quoted by the ECN on the CSE, because the ECN may
have adjusted its quoted price while the order was in transit from the
CSE to the ECN. CSE represents that this transit time is less than one
second, and, for firm quote rule \13\ compliance purposes, the
Commission believes this time to be de minimis. Moreover, the
Commission believes it is significant that this one-second transit time
is generally less than the internal transmission time of order routing
systems in place in other markets.
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\13\ SEC Rule 11Ac1-1, 17 CFR 240.11Ac1-1 (``Firm Quote Rule'').
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CSE has committed to examine regularly for patterns of adjustments
in ECNs' quoted prices that lead to the rejection of orders.
Specifically, the CSE will analyze those rejections that occur after an
order arrives at the CSE and before the order arrives at the ECN.
Should any such patterns be detected, CSE will scrutinize them for
violations of the Firm Quote Rule and take appropriate action. The CSE
has also committed to reporting the results of its examination of ECN
order rejection patterns to the Commission.
IV. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-CSE-2002-04), as amended, is
hereby approved.
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\14\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
Margaret H. McFarland,
Deputy Secretary.
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\15\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 02-30537 Filed 12-2-02; 8:45 am]
BILLING CODE 8010-01-P