Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Order Granting Approval to Proposed Rule Change Relating to Crossing Orders of 25,000 Shares or More

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40998; File No. SR-CHX-98-27]

Self-Regulatory Organizations; Chicago Stock Exchange, Inc.;

Order Granting Approval to Proposed Rule Change Relating to Crossing

Orders of 25,000 Shares or More

January 29, 1999.

I. Introduction

On November 5, 1998, the Chicago Stock Exchange, Inc. (``CHX'' or

``Exchange'') filed with the Securities and Exchange Commission

(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and

Rule 19b-4 thereunder,\2\ a proposed rule change relating to crossing

orders of 25,000 shares or more.

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\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

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The proposed rule change was published for comment in the Federal

Register on December 15, 1998.\3\ No comments were received on the

proposal. This order approves the proposal.

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\3\ See Exchange Act Release No. 40758 (December 8, 1998), 63 FR

69125

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II. Description of the Proposal

The Exchange's general auction market procedures are codified in

CHX Article XX, Rule 16, which provides for the manner in which bids

and offers at the same price will be sequenced for execution. A member

who makes the first bid or offer at a particular price has ``priority''

at that price, which means that the member is the first one in the

market to be entitled to receive an execution at that price. If no

member can claim priority, all members who are bidding or offering at a

particular price are deemed to be on ``parity'' with each other, or

equivalent in status.\4\ Unlike the rules of certain other

exchanges,\5\ however, the CHX does not currently permit bids and

offers that have parity to obtain precedence based on size (a so-called

``size-out'' rule).\6\ In addition, unlike some other exchanges,\7\ the

CHX does not currently have a ``clean cross'' rule (as an exception to

the normal priority rules) that would permit a member to cross a large

block of stock, without the cross being broken up, by permitting the

cross to obtain priority over all other existing bids and offers at the

same price, regardless of the size of such bids or offers.\8\

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\4\ Members are on parity with each other when two or more bids

or offers are announced simultaneously, or after a trade takes place

leaving several bids or offers unfilled at the same price as the

executed trade. See CHX Art. XX, Rule 16 (b) and (c).

\5\ See New York Stock Exchange (``NYSE'') Rule 72 and similar

Philadelphia Stock Exchange and Boston Stock Exchange rules. The

American Stock Exchange (``Amex'') has a modified version of a

``size out'' rule for crosses of 25,000 shares or more. See Amex

Rule 126(g), commentary .01 and .02.

\6\ Under a typical size-out rule, the priority of existing bids

and offers are first removed by means of a sale so that all bids and

offers are on parity. Then, a person desiring to execute a cross can

usually do so by claiming precedence based on size, so long as the

size of the cross is greater than any other single bid or offer at

that price.

\7\ See, e.g., NYSE Rule 72(g) which gives priority to an agency

cross transaction of 25,000 shares or more that is executed at or

within the prevailing quotation, without regard to the size or price

of existing bids or offers on the floor. Other members can typically

interact with the cross only by bettering one side of the cross, and

even then, can only do so after satisfying all other existing bids

or offers at that price. The Pacific Exchange, Inc. (``PCX'') and

Amex have similar crossing rules.

\8\ While the CHX does have a crossing rule, Article XX, Rule

23, this rule only permits crosses between (and not at) the CHX

disseminated market. Thus, under current rules, assuming a

specialist has properly reflected all limit orders from his book in

his quote, the crossing rule does not have any effect on the

Exchange's general priority, parity and precedence rules because all

crosses must be at a better price than the disseminated market.

Therefore, they are entitled to priority because of price (and not

because of a special priority rule giving certain crosses priority

over other bids and offers).

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The purpose of the proposed rule filing is to add new

interpretation and policy .02 to Article XX, Rule 23, to allow a member

or member organization that has an order to buy and an order to sell

25,000 shares or more of the same security to cross those orders at a

price that is at or within the prevailing quotation, without the

transaction being broken up at the cross price so long as (i) the size

of the proposed cross transaction is of a size that is greater than the

aggregate size of all interest communicated on the Exchange floor at

that price at the time of the proposed cross, and (ii) neither side of

the cross is for the account of the executing member or member

organization.

As is the case for cross transactions that are permitted under

existing CHX rules, prior to effecting the cross under the new

proposal, the member will be required to make a public bid and offer on

behalf of both sides of the cross.\9\ The offer must be made at a price

which is higher than the bid by the minimum trading variation permitted

for the security. Under the Proposal, another member may trade with

either the bid or offer side of the cross transaction only to provide a

price which is better than the cross price as to all or part of the bid

or offer. A member who is providing a better price to one side of the

cross transaction must trade with all other market interest having

priority at that price before trading with any part of the cross

transaction.

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\9\ See CHX Art. XX, Rule 23.

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Because the proposal provides that the bid or offer of the member

desiring to execute the cross would be entitled to priority at such

price (over pre-existing bids and offers at that price) only if the

size of the cross is greater than the aggregate size of all interest

communicated on the Exchange floor (which includes the specialist's bid

or offer--including any limit order reflected in such quote--and any

communicated interest of floor brokers or market makers standing in the

crowd), the proposed rule is more akin to a size-out rule than a

special priority rule.

The difference between the CHX proposal and the size-out rules

contained on other exchanges is that the priority of earlier bids and

offers will not have to be removed, by means of a sale, before

effecting the cross. In addition, a cross transaction effected in

accord with the CHX proposal does not affect the priority of existing

orders in a specialist's book, and once the cross is executed, the

priority (based on time rather than size) shall remain as it was before

the execution of the cross transaction. In this sense, the proposal

does have some attributes of a special priority rule. However, unlike

the special priority afforded certain crosses on other exchanges, which

are reported to the tape as ``stopped stock,'' cross transactions

effected under the proposed rule will be reported to the tape without a

``tape designator.''

The CHX proposal limits the types of orders eligible to be crossed.

Specifically, as stated above, no part of the cross can include an

order for the account of the executing member or member organization.

Under the proposal, only customer orders of a floor broker (i.e.,

orders in which the floor broker acts as agent) can be included in the

cross. For purposes of this proposal, the term customer order includes

professional orders not for the account of the executing member (i.e.,

orders for the accounts of broker-dealers and other members or member

organizations communicated from off the floor).

The proposal is intended to facilitate the execution of certain

cross

[[Page 5845]]

transactions on the CHX. The Exchange asserts that confining the

proposed size threshold to block size orders of 25,000 shares or more

will limit the effects of the rule primarily to actively traded, liquid

securities.

The CHX further believes that the proposal, as drafted, furthers

the important auction market principle of price improvement by allowing

another member, under certain conditions, to trade with either the bid

or offer side of the cross transaction to provide a price that is

better than the proposed cross price.

Finally, the Exchange believes that limiting the proposal to

crosses not involving principal transactions of the executing broker

(i.e., limiting the proposal to orders in which the floor broker is

acting as agent), is consistent with Section 11(a)(1)(G) of the Act

\10\ as well as portions of other crossing rules at other exchanges.

For example, in approving a crossing rule for the PCX, the Commission

stated that it ``believes that the [PCX] proposal would not grant

priority, parity or precedence to the order of a member in a manner

inconsistent with Section 11(a)(1)(G) of the Act or Rule 11a1-

1(T)(a)(3) thereunder.'' \11\ The PCX proposal defined customer to

include any order that the broker represents in an agency capacity,

including a professional order that is not for an account associated

with the executing broker. The Commission concluded that because ``this

definition of customer order excludes, and thus does not grant priority

to, an order for an account over which the broker or an associated

person of the broker exercises investment discretion, the Commission is

satisfied that the proposed rule change complies with Section 11(a).''

\12\

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\10\ 15 U.S.C. 78k(a)(1)(G).

\11\ See Exchange Act Release No. 33391 (December 28, 1993), 59

FR 336 (January 4, 1994) (order approving SR-PSE-91-11). The PCX

changed its name in 1997 from Pacific Stock Exchange to Pacific

Exchange.

\12\ Id.

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III. Discussion

The Commission finds that the proposed rule change is consistent

with the requirements of the Act \13\ and the rules and regulations

thereunder applicable to a national securities exchange, and, in

particular, with the requirements of Sections 6(b) and 11A of the

Act.\14\ Specifically, the Commission believes that the proposed rule

change does not impose any burden on competition not necessary or

appropriate in furtherance of the Act and is designed to promote just

and equitable principles of trade, to prevent fraudulent and

manipulative acts, and, in general, to protect investors and the public

interest.\15\ The Commission also believes that the proposed rule

change is consistent with Section 11A of the Act,\16\ in that it will

enable the CHX to better compete with the other exchanges markets.

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\13\ In reviewing this proposal, the Commission has considered

the proposal's impact on efficiency, competition, and capital

formation. 15 U.S.C. 78c(f).

\14\ 15 U.S.C. 78f(b) and 78k-1.

\15\ 15 U.S.C. 78f(b)(5).

\16\ 15 U.S.C. 78k-1(a)(1)(C)(ii).

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The Commission believes that the proposed rule change should

enhance CHX's ability to compete for block business and could enhance

the depth and liquidity of CHX's market. That said, the Commission also

believes that limiting the proposed size threshold to block-size orders

of 25,000 shares or more should limit the effects of the rule primarily

to actively traded, liquid securities.

The Commission believes that the proposed rule change should

increase the opportunities for the efficient execution of block-sized

agency cross transactions. Specifically, the proposed rule change

should facilitate the ability of CHX members to execute block agency

transactions on the CHX by giving such orders priority over orders at

or within the prevailing quotation.

The Commission notes that the proposed rule change also preserves

the auction market principle of price improvement by prohibiting the

cross transaction from being broken up unless a member is willing to

provide price improvement to the cross price (either all or part of

such bid or offer). The proposal also preserves the principle of

priority by requiring that a member who breaks up a cross by providing

a better price must first satisfy all existing market interest having

priority at that better price before trading with any part of the

cross.

The Commission recognizes that approval of the clean cross proposal

could disadvantage smaller orders with time priority which are on the

book, or in the trading crowd, as the same price as the cross

transaction. The Commission, however, believes that the proposal

restricts sufficiently the circumstances in which members may execute

clean cross transactions on the Exchange. In particular, the Commission

believes that the share size threshold of 25,000 shares or more should

help ensure that the clean cross proposal will apply primarily to large

block-sized orders where the depth of the prevailing bid or offer may

be less likely to satisfy either side of the clean cross. In addition,

the proposal is limited to agency orders only and, therefore, it should

not give any special advantage to members, member organizations, and

non-member broker-dealers in their proprietary trading.

The Commission notes that similar rules are in place at the Amex,

NYSE, and PCX.\17\ The rules of the Amex, NYSE, and PCX, like the CHX

proposal, give priority to agency cross transactions of 25,000 shares

or more and permit such crosses to be broken up only if price

improvement will result therefrom. The Commission notes, however, that

the CHX's proposed rule is more restrictive than the rules of the Amex,

NYSE, or PCX in that it allows for an agency block-sized cross

transaction to occur without being broken up at the cross price as long

as the size of the proposed cross transaction is of a size greater than

the aggregate size of all interest communicated on the Exchange Floor

at that price at the time of the cross.

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\17\ See Amex Rule 126(g), Commentary .02; NYSE Rule

72(b)(Priority of Agency Cross Transactions); PCX Rule 5.14(b),

Commentary .05.

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Finally, the Commission believes that because the CHX proposal is

limited to crosses not involving principal transactions of the

executing broker (i.e., limited to orders in which the floor broker

acts as agent) it would not grant priority, parity or precedence to the

order of a member inconsistent with Section 11(a)(1)(G) of the Act \18\

or Exchange Act Rule 11a1-1(T)(a)(3) thereunder.\19\ For purposes of

the proposed rule change, the CHX has defined the term ``customer

order'' as an order that a broker represents in an agency capacity,

including a professional order that is not for an account associated

with the executing broker. Because the definition of ``customer order''

excludes (and, thus does not grant priority to) an order for an account

over which the broker or an associated person of the broker exercises

investment discretion, the Commission is satisfied that the proposed

rule change complies with Section 11(a) of the Act.

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\18\ 15 U.S.C. 78k(a)(1)(G).

\19\ 17 C.F.R. 240.11a1-1(T)(a)(3).

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IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\20\ that the proposed rule change (SR-CHX-98-27) is approved.

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\20\ 15 U.S.C. 78s(b)(2).

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[[Page 5846]]

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\21\

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\21\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-2736 Filed 2-4-99; 8:45 am]

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