[Federal Register: May 12, 2006 (Volume 71, Number 92)]
[Notices]
[Page 27758-27762]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12my06-113]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-53772; File No. SR-CHX-2004-38]
Self-Regulatory Organizations; Chicago Stock Exchange, Inc.;
Order Granting Approval To Proposed Rule Change and Amendment Nos. 1
and 2 Thereto and Notice of Filing and Order Granting Accelerated
Approval to Amendment Nos. 3 and 4 Thereto Relating to Records of
Orders and Executions
May 8, 2006.
I. Introduction
On November 3, 2004, the Chicago Stock Exchange, Inc. (``CHX'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to amend CHX Article XX, Rule 24 to require on-
floor participants to electronically record specific details about
orders originating on or off the floor of the Exchange for execution on
the Exchange, as well as orders issued from the floor of the Exchange
to any other market or trading venue. On July 3, 2005 and September 8,
2005, the
[[Page 27759]]
Exchange filed Amendment Nos. 1 \3\ and 2 \4\ to the proposed rule
change, respectively. The proposed rule change, as amended by Amendment
Nos. 1 and 2, was published for comment in the Federal Register on
November 18, 2005.\5\ The Commission received no comments on the
proposal, as amended by Amendment Nos. 1 and 2. On December 13, 2005,
the CHX filed Amendment No. 3 to the proposed rule change.\6\ On May 3,
2006, the CHX filed Amendment No. 4 to the proposed rule change.\7\
This order approves the proposed rule change, as amended by Amendment
Nos. 1 and 2; grants accelerated approval to Amendment Nos. 3 and 4 to
the proposed rule change; and solicits comments from interested persons
on Amendment Nos. 3 and 4.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Amendment No. 1 dated July 3, 2005.
\4\ See Amendment No. 2 dated September 8, 2005.
\5\ See Securities Exchange Act Release No. 52766 (November 10,
2005), 70 FR 70002 (``Notice'').
\6\ See Amendment No. 3 dated December 12, 2005. Amendment No. 3
clarified that while the Exchange's systems are the only systems
currently recognized by the Exchange for the collection and
recording of the required information, Exchange participants
ultimately could develop their own systems for collecting and
recording that information so long as the systems provide the data
in a format acceptable to the Exchange; the Brokerplex[supreg]
system is available to all floor participants who request the system
and pay any applicable fees; and the Exchange is making changes to
its existing Brokerplex[supreg] system to permit this proposal to be
implemented. Brokerplex[supreg] is the Exchange's floor broker order
management system that can be used by CHX floor brokers to manage
their orders, route orders to the Exchange's co-specialists for
execution, and report executed trades. It is not an order execution
system, although it can send orders to the CHX's MAX[supreg] system.
See infra note 15 (describing the MAX[supreg] system). The
Commission notes that the Exchange does not currently impose a
separate fee for use of the Brokerplex[supreg] system, and to the
extent that the Exchange ever contemplates imposing such a fee it
would need to file a rule change with the Commission under Section
19(b) of the Act and Rule 19(b)(4) thereunder.
\7\ See Amendment No. 4 dated May 3, 2006. In addition to
clarifying changes to the rule text, Amendment No. 4 adds
Interpretation and Policy .10 to the proposed rule to specify a
compliance date of May 8, 2006 by which the Exchange's on-floor
participants must comply with the rule. In addition, Amendment No. 4
confirms that the Exchange's systems will permit a floor broker,
when identifying the side of the market on which an order is
received, to attach a special designation to a cross order (which
will be attached to the side of the market designation in field
(b)(6)) when, on account of the customer's instructions and to the
extent permitted by the Exchange's rules, that order cannot be
immediately executed. Amendment No. 4 also clarifies Interpretation
and Policy .02 to specify that records must be kept pursuant to the
proposed rule change for orders delivered orally or telephonically
to a specialist at the post. Finally, in Amendment No. 4, the
Exchange represented that (1) it will notify its participants that
they should notify the Exchange if they believe that an Exchange
system does not permit them to enter all of the information required
by the proposed rule, as permitted by Interpretation and Policy .05;
(2) it will consider further changes to CHX Rule 24 in response to
changes to Commission or Exchange rules; and (3) it believes that
with respect to immediately executed orders, it receives all of the
information necessary to conduct surveillance through the
information required under Interpretation and Policy .07 and other
Exchange systems.
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II. Description of the Proposal
Under the proposed rule change, the Exchange proposes to require
its floor participants to provide particular data about all orders
originating on or off the floor of the Exchange for execution on the
Exchange, as well as all orders issued from the floor of the Exchange
to any other market or trading venue.\8\ Specifically, the Exchange
proposes to require floor participants to record, in electronic systems
designated by the Exchange, the following details about each covered
order: (1) The symbol of the security; (2) the clearing participant;
(3) an order identifier that uniquely identifies the order; \9\ (4) the
identity of the participant recording the order details; (5) the number
of shares or quantity of the security; (6) the side of the market; (7)
a designation of the order type (e.g., market, limit, stop, stop
limit); (8) whether the order is agency or professional; \10\ (9)
whether the order is being handled pursuant to Section 11(a)(1)(G) of
the Act and any applicable rules thereunder; (10) whether the order is
short or short exempt; (11) whether the order is a bona fide arbitrage
order; (12) any limit price and/or stop price; (13) the date and time
of order receipt or transmission (as applicable); (14) the market, off-
floor firm, or on-floor participant to which the order was transmitted
or from which the order was received (if applicable); (15) the order's
time in force; (16) designation as held or not held; (17) any special
conditions or instructions (e.g., any customer display or do-not-
display instructions or any all-or-none conditions); (18) any
modifications that are made to the details set out in (1) through (17)
above or (20) below, for all or part of the order, or any cancellation
of all or part of the order; (19) the date and time of receipt or
transmission of any modifications to, or cancellation of, the order;
(20) the date and time of any order expiration; (21) the identity of
the party cancelling or modifying the order; (22) the transaction
price, if applicable; (23) the number of shares executed, if
applicable; (24) the date and time of execution, if applicable; (25)
the contra party to the execution (if applicable); (26) the settlement
instructions associated with the order, if applicable; (27) system-
generated time(s) of recording required information; and (28) any other
information that may be required by the Exchange from time to time.\11\
Floor participants would be required to record this information
immediately after that information is received or becomes
available.\12\
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\8\ The Exchange represents that this proposal is consistent
with recommendations made by the independent consultant retained by
the Exchange under its recent settlement agreement with the
Commission. See Securities Exchange Act Release No. 48566 (September
30, 2003), Administrative Proceeding File No. 3-11282. See also
Notice, supra note 5, at note 13.
The Commission notes that the Exchange recently amended CHX
Article V, Rule 4 to prohibit Exchange participants from using any
communications means to send orders to another market for execution
(``layoff service''), unless that layoff service has established a
process for providing the Exchange with specific information about
the orders and the executions that participants receive. See
Securities Exchange Act Release No. 52534 (September 29, 2005), 70
FR 58500 (October 6, 2005) (SR-CHX-2004-25). In addition, the
Exchange has represented that the Exchange's staff will present to
the Exchange's Board of Directors a separate rule that confirms the
record-keeping obligations of its off-floor participants. See
Notice, supra note 5, at note 16.
\9\ This order identifier does not change when modifications are
made to the order, or when it is cancelled, allowing any changes to
be tracked back to the original order.
\10\ The Exchange's rules define a ``professional'' order as one
that is for the account of a broker-dealer, the account of an
associated person of a broker-dealer, or any account in which a
broker-dealer or an associated person of a broker-dealer has any
direct or indirect interest. See CHX Article XXX, Rule 2,
Interpretation and Policy .04.
\11\ See CHX Article XX, Proposed Rule 24(b).
\12\ See CHX Article XX, Proposed Rule 24(c).
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In addition, proposed new Interpretations and Policies .01 to .09
to CHX Article XX, Rule 24 contain additional guidance on the
information that participants would be required to record and preserve.
Among other things, the interpretations establish the scope of the
proposed rule and specify the exclusion from the proposed rule for
principal trading by a co-specialist, market maker, or floor
broker.\13\ In addition, the interpretations note that participants
will not be required to record information with respect to orders sent
or received through the Exchange's MAX[supreg] system \14\ or through
any other electronic systems that the Exchange recognizes as providing
the required information in an acceptable format, and further sets out
limited
[[Page 27760]]
exceptions to the data-recording requirements.\15\
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\13\ See CHX Article XX, Proposed Rule 24, Interpretation and
Policy .02; and Amendment No. 4, supra note 7 (Interpretation and
Policy .02 states that ``Except for orders delivered orally or
telephonically to a specialist at the post, a decision by a co-
specialist, market maker or floor broker to buy or sell securities
for his or her own account on the Floor of the Exchange shall not
constitute an order for which a record much be made under this
Rule.''). The Exchange has represented that this exception is
designed to recognize that all necessary information about a floor
participant's own trading is already captured by the Exchange's
reporting systems. See Notice, supra note 5, at note 11.
\14\ MAX[supreg] is the Exchange's electronic execution system.
\15\ See Proposed Interpretations and Policies .04 (regarding
orders sent and received through certain systems), .05 (regarding
orders that the Exchange expressly recognizes as incompatible for
entry into an Exchange system), .06 (regarding bona fide arbitrage
orders and orders to offset a transaction made in error); and .07
(regarding cross orders that are immediately executed). Proposed
Interpretation and Policy .09, however, reminds participants that
the provisions of proposed CHX Rule 24 do not replace any record
retention obligations to which a participant may be subject under
the Act.
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III. Discussion and Commission Findings
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.\16\ In particular, the Commission believes that the proposal
is consistent with section 6(b)(5) of the Act,\17\ which requires that
the rules of an exchange be designed to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system, and, in
general, to protect investors and the public interest.
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\16\ In approving this proposed rule change, as amended, 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).
\17\ 15 U.S.C. 78f(b)(5).
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The purpose of the Exchange's proposed rule change is to require
the Exchange's floor participants to enter order-related information
into an electronic data capture system to facilitate automated
surveillance of market activity by the Exchange.\18\ For example, CHX
floor brokers have traditionally accepted orders from a variety of
sources, some of which may not involve the creation of an electronic
audit trail (e.g., orders taken over the telephone). In these cases,
only the execution information would be captured electronically, and
thus be able to be searched in an electronic form by the Exchange's
market regulation personnel. Non-execution information relating to the
original order (e.g., time of order receipt) is available currently
only from the paper order ticket. By requiring the electronic capture
of this information, the Exchange would be able to use the data
obtained from the proposed rule change in surveillance reports relating
to, for example, best execution, front-running surveillance, order
execution priority, manipulative activity, and trade reporting.
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\18\ See Letter from David C. Whitcomb, Jr., Senior Vice
President and Chief Regulatory Officer, CHX, to Sharon Lawson,
Senior Special Counsel, Division of Market Regulation, Commission,
dated June 27, 2005.
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Further, the Exchange's proposed rule change is intended to address
recommendations made in the Exchange's 2003 settlement agreement with
the Commission.\19\ In the settlement agreement, the Commission cited
the Exchange's failure, with respect to its specialist firms, ``to
detect and prevent a large number of trading rule violations, in part,
because [the Exchange] did not have adequate surveillance systems to
detect possible violations.'' \20\ In addition, the Commission found
that the CHX had ``relied on ineffective and often flawed manual
processes to detect violations * * *'' \21\ Pursuant to the settlement
agreement, the Exchange undertook to engage a consultant to conduct a
comprehensive review of, among other things, its trading floor
surveillance to ascertain whether its trading floor surveillance is
appropriately designed and implemented to promote and enforce
compliance with the federal securities laws and CHX and Commission
rules.
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\19\ See Securities Exchange Act Release No. 48566 (September
30, 2003) (Administrative Proceeding File No. 3-11282), available
at: http://www.sec.gov/litigation/admin/34-48566.htm.
\20\ Id.
\21\ Id.
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The Commission believes that the Exchange's proposed rule change,
as amended, to require Exchange participants to enter order-related
information into an electronic data capture system is consistent with
the Exchange's settlement agreement with the Commission. Specifically,
the Commission believes that the proposed rule change, as amended,
should allow the Exchange to maintain a more automated process for
receiving a comprehensive set of audit trail data on its floor
participants' trading activity and thereby allow the Exchange to
integrate more audit trail data into its surveillance systems.
Increased automation with respect to the receipt of order details
should, in turn, allow the Exchange to perform more automated
surveillance and generate better surveillance reports. In addition, the
Commission believes that the proposal will improve the Exchange's
ability to review its participants' order-handling activities and to
determine their compliance with applicable trading rules, including,
for example, short sale position marking and tick test
requirements,\22\ best execution,\23\ and trading ahead
prohibitions.\24\
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\22\ See 17 CFR 240.10a-1.
\23\ See, e.g., CHX Article XX, Rule 10.
\24\ See CHX Article XXX, Rules 2 and 3.
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Further, the Commission notes that proposed Interpretation and
Policy .05, which would allow the Exchange to identify specific types
of orders that might be exempt from the data-recording requirements
when they are incompatible for entry into Exchange systems, is designed
to cover only those rare situations where, due to unexpected
consequences of unrelated systems changes or a software failure, CHX
participants cannot enter data about a particular type of order into
the Exchange's systems for a limited period of time. The Commission
notes that this exception is not intended to allow participants to
avoid the recording requirements of the rule, and does not relieve a
participant from its recordkeeping obligations under the Exchange's
rules and applicable federal securities laws. The Commission notes that
the Exchange has represented that it would work with participants to
correct quickly any software or systems problems that precipitated the
system incompatibility.\25\ Furthermore, the Exchange will notify its
participants that the participants should notify Exchange personnel
when a system incompatibility arises that is covered by proposed
Interpretation and Policy .05.\26\
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\25\ See Notice, supra note 5, at note 14.
\26\ See Amendment No. 4, supra note 7.
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With respect to proposed Interpretation and Policy .04, which
recognizes that participants are not required to record information
that is already captured by the Exchange's systems or by other systems
that the Exchange expressly recognizes as providing the required data
in an acceptable format, the Commission notes that the Exchange has
represented that its MAX[supreg] system already captures all of the
information required by the proposed rule change.\27\ The Commission
also notes that the Exchange has represented that it retains records
associated with its MAX[supreg] system for the applicable record
retention period.
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\27\ See Notice, supra note 5, at note 14.
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With respect to proposed Interpretation and Policy .07, which
permits a participant to record only certain information for orders to
buy and sell the same security that are executed in full immediately
upon receipt, the Commission notes that the Exchange has represented
that Interpretation and Policy .07 to the proposed rule change reflects
the Exchange's belief that it will receive all of the information
necessary to conduct surveillance with respect to orders to buy and
sell the same security that are
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executed in full immediately upon receipt through a combination of
Interpretation and Policy .07 and other information captured within the
Exchange's system.\28\ In particular, the Commission notes that the
Exchange's order management systems utilize an account-based approach
in which principal transactions are entered through a principal trading
account that is separate from the broker's agency account, and that the
Exchange's surveillance reports are able to distinguish between a
broker's principal and agency trades.\29\ Further, the Exchange has the
ability to request information from its clearing participants in the
event that the Exchange requires information about the customers
involved in a certain transaction where a customer did not serve as the
clearing participant to its own order.\30\
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\28\ See Amendment No. 4, supra note 7.
\29\ See Letter from David C. Whitcomb, Jr., Senior Vice
President and Chief Regulatory Officer, CHX, to Sharon Lawson,
Senior Special Counsel, Division of Market Regulation, Commission,
dated April 26, 2006.
\30\ Telephone conversation between Ellen J. Neely, President
and General Counsel, CHX, and Richard Holley III, Special Counsel,
Division of Market Regulation, Commission, on May 3, 2006.
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Based on the above, the Commission finds that the Exchange's
proposed rule change is consistent with the Exchange's settlement
agreement with the Commission.\31\ Further, the Commission finds that
the Exchange's proposal to require the electronic capture of audit
trail data in order to enhance surveillance for compliance with CHX's
rules, the Act, and the rules thereunder is consistent with the
requirements of Section 6(b)(5) of the Act,\32\ which requires that the
rules of an exchange be designed to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. The Commission believes that approving the proposal
will help to enhance and strengthen the Exchange's surveillance program
by providing the Exchange with the data necessary to conduct more
thorough and efficient surveillance of its participants' trading
activities, and should thereby promote just and equitable principles of
trade and further the protection of investors and the public interest.
The Commission notes that the detailed information required to be
obtained will not replace any record retention obligations already
required of CHX participants under the Act and the rules thereunder.
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\31\ See supra note 19.
\32\ 15 U.S.C. 78f(b)(5).
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Accelerated Approval of Amendment Nos. 3 and 4
The Commission finds good cause for approving Amendment Nos. 3 and
4 to the proposed rule change prior to the thirtieth day after the
amendment is published for comment in the Federal Register pursuant to
Section 19(b)(2) of the Act.\33\ In Amendment No. 3, the Exchange
merely clarified that (1) participants could develop their own systems
for collecting and recording required data in a format acceptable to
the Exchange; (2) Brokerplex[supreg] is available to any participant;
and (3) the Exchange is implementing changes to the Brokerplex[supreg]
system to incorporate the requirements of this proposed rule change. In
Amendment No. 4, the Exchange merely modified its proposed rule change
to accommodate an order designation currently used by its floor brokers
that permits a floor broker to attach a special designation to a cross
order when, on account of the customer's instructions and to the extent
permitted by the Exchange's rules, the cross order cannot be
immediately executed, as well as set May 8, 2006 as the compliance
date.\34\ In addition, the Exchange made, in part, certain
clarifications and representations regarding the operation and
implementation of the proposed rule, and the ability of the Exchange to
gather sufficient surveillance information.
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\33\ 15 U.S.C. 78s(b)(2).
\34\ The special designation would be attached to the side of
the market identifier. See proposed CHX Article XX, Rule 24(b)(6).
The floor broker would be required to complete all other fields
required by proposed CHX Article XX, Rule 24. In addition, this
special designation does not alter a participant's obligations with
respect to the execution of orders; if a cross transaction can be
immediately executed in accordance with a customer's instructions
and applicable rules, it should be immediately executed. See
Amendment No. 4, supra note 7.
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The Commission believes that Amendment No. 3 appropriately reflects
that changes to the Brokerplex[supreg] system are being implemented in
connection with the proposed rule change. In addition, the Commission
believes that Amendment No. 4 implements a reasonable compliance date
for the proposed rule change, as amended, since the Exchange has been
holding biweekly meetings with its participants to educate them about
the requirements of the proposed rule change. Furthermore, the
Commission believes that the other changes made to the proposed rule
change in Amendment No. 4, as described above, merely accommodate the
functionality currently employed by floor brokers, acknowledge the
ability of the Exchange to obtain surveillance information, clarify
that records must be kept pursuant to the proposed rule for orders
delivered orally or telephonically to a specialist at the post, and
describe other responsibilities of the Exchange under the proposed rule
change, as amended. Accordingly, the Commission believes that good
cause exists, consistent with Section 19(b) and Section 6(b)(5) of the
Act, to accelerate approval of Amendment Nos. 3 and 4 in order to allow
the Exchange to implement the proposal immediately.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether Amendment Nos. 3
and 4 to 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 (http://www.sec.gov/rules/sro.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-CHX-2004-38 on the subject line.
Paper Comments
Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, Station Place, 100 F
Street, NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-CHX-2004-38. 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 (http://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 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
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information from submissions. You should submit only information that
you wish to make available publicly. All submissions should refer to
File Number SR-CHX-2004-38 and should be submitted on or before June 2,
2006.
V. Conclusion
For the foregoing reasons, 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.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\35\ that the proposed rule change (SR-CHX-2004-38) and Amendment
Nos. 1 and 2 thereto are approved, and that Amendment Nos. 3 and 4
thereto are approved on an accelerated basis.
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\35\ 15 U.S.C. 78s(b)(2).
\36\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\36\
Nancy M. Morris,
Secretary.
[FR Doc. E6-7257 Filed 5-11-06; 8:45 am]
BILLING CODE 8010-01-P