Self-Regulatory Organizations; Proposed Rule Change by Chicago Stock Exchange, Incorporated Proposing to Establish Rules for an Institutional Trading System, Called the Match Market Exchange Facility

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33542; File No. SR-CHX-93-19]

Self-Regulatory Organizations; Proposed Rule Change by Chicago

Stock Exchange, Incorporated Proposing to Establish Rules for an

Institutional Trading System, Called the Match Market Exchange Facility

January 28, 1994.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ notice is hereby given that on August 6, 1993, the

Chicago Stock Exchange, Inc. (``CHX'' or ``Exchange'') filed with the

Securities and Exchange Commission (``Commission'') the proposed rule

change as described in Items I, II and III below, which Items have been

prepared by the self-regulatory organization. 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) (1988).

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The CHX proposes to establish rules for an institutional trading

system, the Match Market Exchange (``MMX'') facility, that integrates

an electronic order match system with a facility for brokering trades.

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 self-regulatory organization

included statements concerning the purpose of, and basis for, the

proposed rule change and discussed any comments it received on the

proposed rule change. The text of these statements may be examined at

the places specified in Item IV below. The self-regulatory organization

has prepared summaries, set forth in section (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 purpose of the proposed rule change is to establish rules for

the MMX facility, an institutional trading system that integrates an

electronic order match system with a facility for brokering trades. The

MMX facility is designed to combine the advantages of current

institutional order systems with the advantages of exchange trading.

Although the MMX will be operated by the Exchange, it was jointly

developed by the CHX and Global Trade, Inc. Users of the MMX will

include institutional customers, specialists, MMX market makers and

brokers. These users will communicate with the MMX facility through

personal computers and modems. The MMX facility will electronically

match users' orders in an allocation procedure described more fully

below. If an electronic match occurs, the trade will be priced at the

market price at a random time within a pre-determined ten minute window

period and will be executed at that time. If a match does not occur,

users will still have the opportunity to find the other side of their

trades through participating brokers.

2. Description of How the MMX Facility Operates

The following is a brief overview of the MMX facility, followed by

a more detailed description about certain aspects of the system.

MMX will permit direct order entry by both CHX members and

customers of those members. Prior to the time a non-member user enters

orders into the system, the user will enter into an agreement with CHX

agreeing to be bound by the Exchange's rules governing MMX and will

submit the names of the Midwest Clearing Corporation members through

which the user will clear. In order for the non-member user to

designate a clearing firm, it must enter into a give-up agreement with

the clearing firm and provide a copy to the Exchange. CHX member users

will clear MMX transactions through their existing clearing

arrangements.

For each order, the user will enter the following information:

Stock ticker symbol;

The number of shares;

Capacity (buy, sell or sell short);

The limit price (optional);

Linked order conditions (optional);

Minimum trade size (optional);

Excluded category of contra parties (optional);

Names of individual excluded users (optional);

Liquidity fee or credit (optional);

Near match range and near match broker (optional);

Order visibility; and

Clearing firm.

The user will send this information via modem to the MMX during the

Pre-Cross Period. During this time users can review, edit or cancel

their orders.

In addition to orders manually entered by users, MMX will include

guarantees by MMX market makers. These market makers will be Exchange

members who register with the Exchange to be MMX market makers. As

such, they will be obligated to guarantee a maximum execution size to

all users of the system. It is currently anticipated that the maximum

size of the guarantee will be ten thousand shares per issue for a

certain class of stocks, five thousand shares per issue for another

class of stocks, and two thousand shares per issue for a third class of

stocks. MMX market maker guarantees will automatically be entered at

the beginning of the Pre-Cross Period and will include a default

liquidity fee or credit to be associated with a specific MMX guarantee.

(Liquidity fees and liquidity credits are discussed below.) MMX market

makers can improve this liquidity fee or credit and increase the size

of their guarantee during the Pre-Cross Period.

Users other than MMX market makers will have the option of having

their orders displayed to other users of MMX. If a non-market maker

user elects to have its order displayed, the order will be displayed

under certain circumstances. Users will be charged lower fees for using

the MMX Facility if they agree to have their orders displayed.

Finally, the CHX's CQS quotation will automatically be fed into the

MMX Facility on a real-time basis. When the consolidated best bid and

offer spread of an issue is 1/8, the MMX Facility will look at the CHX

quote to determine whether there are orders which would be executed if

a trade took place at the consolidated best bid or best offer (i.e., if

the CHX quote equaled the consolidated quote). If so, this bid and/or

offer will be entered as an order in MMX. If entered, these orders will

have the highest priority of execution.

All matched orders will be executed at a random time within a pre-

determined ten minute window period at the market price at such time.

The market price will be calculated based upon the spread of a

particular issue. In issues where the spread in the consolidated best

bid and offer is \1/4\ or other even fraction point spread, the cross

will be priced at the middle of the spread. In issues with a

consolidated best bid and offer spread of \3/8\ or other odd fraction

(other than \1/8\), the price will be at the \1/8\ closest to the last

sale. In issues with a consolidated best bid and offer of \1/8\, if

there are more shares offered for sale in the MMX Facility (excluding

the MMX market maker guarantee), then the \1/8\ spread issues will

cross at the bid. If, however, there are more bids than offers in the

MMX facility, then the \1/8\ spread issues will be crossed at the offer

price. In the event that there are an equal number of shares on both

sides of the CHX quotation, the cross will execute at the offer.

Executions in MMX will be limited to those equity securities that are

either listed or admitted to unlisted trading privileges (``UTP'') on

the CHX. Users may, however, enter orders for securities in which the

Exchange does not have UTP; if a match is found in these securities,

the cross will not be executed in MMX. Instead, these orders will be

delivered to a broker-dealer who is eligible to execute the cross in

the market in which it is traded.

Those orders that have been executed in the cross will be

immediately transmitted by MMX to the Exchange for recordation and

reporting to the Consolidated Tape. Trades will then be cleared by the

designated clearing firm. After receiving an execution report

(described below), institutions will then be able to reallocate trades

to different clearing brokers, if desired.

Immediately after the cross, users will be notified if their orders

have been executed. If an order was not executed, the user may receive

an administrative message (depending on the ``near match'' parameters

they have specified) asking whether the user wants a broker to call it

to negotiate a trade with another user that has entered similar ``near

match'' parameters.

3. Unique Aspects of the MMX Facility

The most fundamental feature of the MMX facility is the use of

liquidity fees and liquidity credits to determine the level of priority

for order matching. Rather than matching orders on the basis of time

priority, the MMX facility provides incentives to those users that

provide liquidity to the system. The size of the liquidity fee or

credit determines the level of priority for order matching, with those

users that are willing to pay the highest liquidity fee having the

highest execution priority (except for orders that are part of the CHX

quote) and those users desiring to be paid for providing liquidity

(i.e., orders with a liquidity credit) having the lowest execution

priority. Liquidity fees and credits will only be paid when an order

with a liquidity fee is matched with an order with a liquidity credit.

When that happens, a liquidity fee that is equal to the size of the

liquidity credit will be paid. In all other cases, no liquidity fees

will be paid.

In order to provide executions that are equitable, immediately

prior to the match, all orders for a security are first sorted into

groups and then each group is prioritized for execution. Except for

orders that are part of CHX's quote, which will be placed in one group

and will receive the highest priority for execution, a group will

consist of either all buy orders or all sell orders in a security that

have the same liquidity fee or credit. Groups will be prioritized by

liquidity fee or credit (as stated earlier).

Groups will only be matched if the liquidity credit required by

orders in one group is less than or equal to the liquidity fee offered

by orders in the other group. Groups will be matched starting with the

group of buy orders with the highest priority. This group will be

matched with the group of sell orders with the highest priority.

If the aggregate size of all orders in both groups is the same, all

orders in both groups will be matched. If the aggregate size of all

orders in both groups is not the same, orders in the group with the

smaller aggregate size will be allocated among orders in the group with

the larger size on a pro-rata basis. If this results in any order

receiving an odd lot or a mixed lot (e.g., 265 shares), the amount of

shares that order receives shall be rounded down to the nearest round

lot (e.g., 200 shares). All the odd lots for a particular Group (e.g.,

the 65 shares) shall be aggregated and then allocated to the largest

order in the Group. If, after matching orders in a buy group with

orders in a sell group, unmatched orders remain in the group of buy

orders, MMX will continue the process of matching this group with

successively lower priority groups of sell orders until all of the

orders in the group of buy orders are either matched or are unable to

be matched.

After completion of the match described above, MMX will continue

the process of matching groups and orders within those groups in

accordance with the rules described above starting with successively

lower priority buy order groups until no more matches can be made.

Once all of the matches are made, MMX will determine whether any

matched orders are conditional orders and if so, whether their

conditions are fully satisfied. In the event that certain conditions

are not fully satisfied, MMX will remove that order (and any other

orders whose conditions are not fully satisfied). MMX will then erase

the match for all orders in that security and will restart the matching

process excluding all conditional orders whose conditions were not

fully satisfied in the last matching process.

This matching process and liquidity fee/credit payment scheme

results in the liquidity fee being paid only when necessary, providing

meaningful advantages to those willing to pay.

a. Example #1:

Buy group 1: Order 1--BUY 2000 XYZ + will pay 1 cents/shr liquidity fee

Buy group 2: Order 1--BUY 2000 XYZ

Sell group 1: Order 1--SELL 2000 XYZ

Because the order in Buy group 1 is willing to pay a liquidity fee,

this order will have the highest priority and will match with the order

in Sell group 1. It will not be necessary for the order in Buy group 1

to pay a liquidity fee in this case.

b. Example #2:

Buy group 1: Order 1--BUY 2000 XYZ + will pay 1 cents/shr liquidity fee

Buy group 2: Order 1--BUY 2000 XYZ

Sell group 1: Order 1--SELL 1000 XYZ

Sell group 2: Order 1--SELL 2000 XYZ + wants a 1 cents/shr liquidity

credit

Sell group 2: Order 2--SELL 2000 XYZ + wants a 1 cents/shr liquidity

credit

Because the order in Buy group 1 is willing to pay a liquidity fee,

this order will match first with the order in Sell group 1 (1000

shares), then with the orders in Sell group 2 (each of whom will

receive 500). The order in Buy group 1 will pay no liquidity fee for

the order in Sell group 1, but will pay 1 cents/share for the orders in

Sell group 2. Thus, the user will only pay an average liquidity fee of

\1/2\ cents/share. Note: The order in Buy group 2 would not participate

in the match as the only shares remaining to be matched require that a

liquidity fee be paid.

Orders willing to pay a liquidity fee will experience higher match

rates than the other order types, with only an occasional payment of

the liquidity fee. As in the above examples, because of the higher

priority, a willingness to pay a higher liquidity fee will often result

in a lower average liquidity fee paid or even no liquidity fee paid.

Again, because of the priority rules, this system minimizes the

liquidity fee rather than maximizing the shares matched. The CHX

believes that this encourages users to enter liquidity fees and credits

without fear of being disadvantaged by the system. These liquidity

charges are exchange fees and credits and will be paid to the exchange

for disbursal to those entitled to receive them.

4. Other Issues

As discussed above, while entering stocks into his computer, a user

can include a limit price. This feature allows a user to specify a

maximum buy price or minimum sell price to protect the user against

large swings in the price of a stock that may occur between the time he

enters the trade into his computer and the cross. If a limit price is

entered, the order will not participate in the match if the stock is

above (or below) the limit price at the time of the cross, depending on

whether the order is a buy order (or sell order). Of course, if the

stock is within the limit range, the execution price will be the same

as for all other stocks in the cross.

In addition, as discussed above, users can enter linked orders.

These are orders that are combined with other orders. For example, a

user may only want to sell stock A if he can buy stock B. A user would

then link his sell order of stock A to his buy order of stock B. Then,

when the match occurs, the user's order to sell stock A will only be

executed if the user's order to buy stock B is also executed.

Otherwise, both orders will remain unmatched.

The MMX facility, by allowing linked orders and allowing orders

that specify a limit price, allows money managers greater cash

management capabilities. The CHX believes that this in turn will cause

the effective match rate of the MMX facility to be greater than other

crossing systems.

It should also be noted that a user can only prohibit a match with

another particular user because of a concern that an ERISA violation

might occur if a match took place.

5. Fees

The Exchange will only charge a fee to users of the MMX Facility if

their order is executed (or matched, in the case of securities that are

not listed on the Exchange or have UTP). The Exchange fee will be as

follows: Orders entered by MMX market makers and orders that are part

of CHX's quote will not be charged a transaction fee; users who enter

orders that the user is willing to display will be charged $.005 per

share; and all other users will pay $.02 per share. There will be no

fee to enter or cancel orders in the system. The Exchange fee does not

cover liquidity fees and credits. The MMX market makers will be paid

\1/8\th of a cent per share when they do not participate in a cross in

their issue so long as the liquidity parameter enter by the MMX market

maker is within a pre-determined range. This \1/8\ of a cent per share

fee will be paid by the Exchange out of the \1/2\ of a cent (or 2 cent)

user fee that CHX will receive from users of the MMX facility. This

will provide the MMX Market Maker with an incentive to providing a

guarantee. In the event there is more than one MMX market maker in an

issue, the \1/8\ of a cent per share fee will be paid to the MMX market

maker that enters the highest liquidity fee or lowest liquidity credit.

If more than one MMX market maker enters the same fee or credit, such

fee will be pro-rated. An additional Exchange fee will be imposed on

all users equal to the liquidity fee to be paid with respect to a

particular order, and an Exchange credit will occur that is equal to

the liquidity credit to be received. The clearing broker will collect

all fees from institutions and submit the appropriate amounts to

Midwest Clearing Corporation (``MCC''). MCC, in turn, will pay the

appropriate amounts to clearing brokers for forwarding to institutions.

6. Surveillance

To protect against any potentially manipulative activity, the

Exchange will monitor quote changes prior to the match and shortly

thereafter to identify unusual trading activity.

7. ``Near Match Orders'' and Floor Broker Participation

Because of the possibility that the match rate will be below 100%,

the MMX facility will allow users to send orders that are not crossed

in the match to a broker in the event of a ``near match.'' A near match

is the presence of a buyer and seller in the MMX facility who did not

match merely because the liquidity fees and credits that they required,

differed. For example, a seller may be willing to sell and pay a 6 cent

per share liquidity fee, but the buyer wants to be paid 7 cents per

share for providing liquidity. If a near match occurs users will get

administrative messages stating that a near match occurred. Each user

would then have the option of indicating that it would like a pre-

determined broker to call to negotiate that order. If both parties to

the near match wish to negotiate, then the broker (or brokers) will

receive a negotiate message. Because the broker or brokers do not learn

anything about the order unless both parties to the near match have

given their approval, the users of the MMX facility retain complete

control during this process.

Similar to the ``near match'' function described above, floor

brokers can enter a message that, after the match, will tell the users

entering orders in a particular stock of an indication of interest in

that stock (even when there is not an actual order). The user would

then be free to contact the floor broker to negotiate a trade. The MMX

facility will give users the ability to screen out indications if they

become dissatisfied with the quality of the information.

8. Execution Reports

Execution reports will be sent after any execution occurs. For

customers using DTC's ID system, information will be forwarded to the

clearing broker who will then submit the information to the ID system.

9. Statutory Basis

The proposed rule change is consistent with Section 6(b)(5) of the

Securities Exchange Act of 1934 in that it is designed to promote just

and equitable principles of trade and to protect investors and the

public interest, and is not designed to permit unfair discrimination

between customers, issuers, brokers or dealers.

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

The Exchange believes that no burden will be placed on competition

as a result of the proposed rule change.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received From Members, Participants or Others

No comments were received.

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

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(A) By order approve the proposed rule change, or

(B) Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

Copies of the submissions, 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 at the

principal office of the CHX. All submissions should refer to File No.

SR-CHX-93-19 and should be submitted by February 25, 1994.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority.

Jonathan G. Katz,

Secretary.

[FR Doc. 94-2579 Filed 2-3-94; 8:45 am]

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