Self-Regulatory Organizations; Chicago Stock Exchange, Incorporated; Order Approving a Proposed Rule Change Relation to the Exchange's Decorum Rules, Short Sales and Minor Rule Violation Plan

[Federal Register Volume 64, Number 23 (Thursday, February 4, 1999)]
[Notices]
[Pages 5696-5697]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-2606]



[[Page 5696]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40990; File No. SR-CHX-98-24]


Self-Regulatory Organizations; Chicago Stock Exchange, 
Incorporated; Order Approving a Proposed Rule Change Relation to the 
Exchange's Decorum Rules, Short Sales and Minor Rule Violation Plan

January 28, 1999.
    On September 29, 1998,\1\ the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 
thereunder,\3\ a proposed rule change to amend: (1) Interpretation and 
Policy .01 of Rule 3 of Article XII relating to the Exchange's Decorum 
Rules regarding repetitive administrative/executive messages; (2) Rule 
17 of Article IX, to codify the existing requirement for members to 
comply with Rule 10a-1 under the Act (``Short Sale Rule''); and (3) 
Rule 9(h) of Article XII, to add certain rules and policies to the 
Exchange's Minor Rule Violation Plan. Notice of the proposed rule 
change appeared in the Federal Register on December 22, 1998.\4\ The 
Commission received no comment letters concerning the proposed rule 
change. This order approves the proposed rule change.
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    \1\ The Exchange initially filed this proposal on September 29, 
1998. However, on December 2, 1998, the Exchange filed Amendment No. 
1 to provide an example of an ``inadvertent'' violation and to 
increase the recommended fines for short sale violations. See Letter 
from Patricia L. Levy, Senior Vice President and General Counsel, 
the Chicago Stock Exchange, Inc., to Mignon McLemore, Division of 
Market Regulation, SEC, dated December 1, 1998.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
    \4\ See Securities Exchange Act Release No. 40793 (December 15, 
1998), 63 FR 70820 (December 22, 1998).
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    First, the Exchange proposed to amend the list of Class B 
violations set forth under Rule 3, Article XII of the Exchange's 
Decorum Rules to include repetitive administrative execution messages 
sent over the Intermarket Trading System (``ITS'') or the Midwest 
Automated Execution System (``MAX'') that are inappropriate or 
unnecessary. Additionally, the Exchange proposed to include these 
violations as Class B violations for purposes of the Minor Rule 
Violation Plan and proposed to retain the existing recommended fines.
    Second, the Exchange proposed to codify the requirement for members 
to comply with the Short Sale Rule. Codifying the Short Sale Rule 
within the Exchange rules will allow the Exchange to assess fines for 
violation of this rule under its Minor Rule Violation Plan in 
appropriate circumstances. If the violation is inadvertent or isolated, 
the Exchange may assess fines pursuant to the Minor Rule Violation Plan 
and not pursuant to the Exchange's formal disciplinary procedures.
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    \5\ According to the CHX, an inadvertent violation of the Short 
Sale Rule might occur, for example, if a specialist that is long 
1,000 shares of a security sends an order to sell 1,000 shares in 
that security to the New York Stock Exchange (``NYSE'') via an NYSE 
Designated Order Turnaround (``DOT'') machine. Because a 
specialist's inventory is not automatically updated to reflect 
executions over a DOT machine (unlike executions on the CHX or via 
ITS which are automatically reflected in a specialist's inventory on 
a real-time basis), it is possible that a specialist may either 
forget about the DOT order, or may be late in manually updating his 
inventory position to reflect the sale via DOT. In either event, the 
specialist's inventory at that time would not reflect that the 
specialist is now ``flat'' rather than ``long'' the security. If the 
specialist then marks his next sale as ``long'' rather than properly 
marking the order as ``short,'' it might be because the specialist 
merely looked at his inventory position and did not take the DOT 
order into account in determining whether he was long or short. 
While this would still be a violation of the Short Sale Rule, 
depending on the totality of the facts (e.g., whether this is 
isolated or part of a larger fraud, or if other unusual 
circumstances existed, etc.) in certain circumstances, this 
violation might be considered an ``inadvertent'' violation that is 
appropriate for the minor rule violation plan. See Amendment No. 1, 
supra note 3.
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    Finally, the Exchange proposed to add certain rules and policies to 
its Minor Rule Violation Plan under Article XII, Rule 9. Specifically, 
the Exchange proposed to add violations of its rules relating to: (1) 
proprietry short sales by floor members (Article IX, Rule 17)(e.g., 
failing to properly mark a short sale a short and executing a short 
sale at an inappropriate tick); (2) the issuance of pre-opening 
responses under the ITS Rules (Article XX, Rule 39) (e.g., using DOT, 
Post Execution Reporting (``PER''), or any method other than ITS to 
send a pre-opening response); and (3) the failure of a specialist to 
adjust limit orders to the block price when MAX automatically executes 
limit orders at the limit price upon a price penetration in the primary 
market (Article XX, Rule 7.06 and related Rule 37(b)(6) of Article XX). 
The Exchange proposed that the recommended fines for the above 
violations be $100, $500 and $1,000 for the first, second, third, and 
subsequent violations, respectively, except for violations of the Short 
Sale Rule, where the recommended fines would be $500, $1,000, and 
$2,500 for the first, second, and third, and subsequent violations, 
respectively.\6\
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    \6\ The Commission staff recommended that the Exhcange's fines 
for Short Sale Rule violations be commensurate with the fine 
schedules of other exchanges. Hence, the fines for violation of this 
rule were increased. See Amendment No. 1 supra note 1.
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    The Commission believes the proposed rule change is consistent with 
the Act and the rules and regulations promulgated thereunder.\7\ 
Specifically, the Commission believes that approval of the proposed 
rule change is consistent with Sections 6(b)(6) \8\ and 6(b)(7) \9\ of 
the Act. The proposal is consistent with the requirement of Sections 
6(b)(6) and (b)(7) in that it provides fair procedures and guidelines 
that enable the Exchange to appropriately discipline its members and 
persons associated with members for violations of the rules of the 
exchange.
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    \7\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. By classifying 
certain messages as a violation of the Exchange's Decorum Rules, the 
proposal should enhance efficiency by eliminating unnecessary 
communications which could burden computer capacity. Codifying the 
Short Sale Rule in the Exchange's rules should enhance competition 
by preventing market manipulation in securities. 15 U.S.C. 78c(f).
    \8\ Section 6(b)(6) requires the Commission to determine that 
the rules of the exchange provide that its members and persons 
associated with members shall be appropriately disciplined for 
violating the federal securities laws or the rules of the exchange 
by fine or other fitting sanction. 15 U.S.C. 78f(b)(6).
    \9\ Section 6(b)(7) requires the Commission to determine that 
the rules of the exchange provide a fair procedure for disciplining 
its members and persons associated with members. 15 U.S.C. 78(b)(7).
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    The Commission believes that amending the list of Class B 
violations set forth in the Exchange's Decorum Rules to include 
inappropriate messages will provide a fair procedure whereby member 
organizations can be properly sanctioned for these violations that are 
minor in nature. Moreover, the Commission believes that including the 
Short Sale Rule within the rules of the Exchange and imposing fines for 
violations of the Short Sale Rule under its Minor Rule Violation Plan 
provide a fair procedure for the disciplining of members and persons 
associated with members, which is consistent with the Act. The 
Commission suggests that only those violations of the Short Sale Rule 
which are inadvertent or isolated be handled pursuant to the Exchange's 
Minor Rule Violation Plan. In the event that a violation occurs 
involving circumstances where more severe sanctions would be warranted, 
the Commission believes the Exhange should address them by taking a 
formal disciplinary proceeding.\10\
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    \10\ The Commission expects that the CHX would err on the side 
of caution in disposing of violations under the Minor Rule Violation 
Plan. For example, the Commission expects that the CHX would not 
issue several cautionary letters before instituting the fines under 
the Minor Rule Violation Plan or aggregate multiple violations of 
the rules before instituting abbreviated disciplinary procedures, 
or, if necessary, a formal disciplinary proceeding.

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[[Page 5697]]

    The Commission also finds that the additional rules and policies 
added to the Minor Rule Violation Plan are objective in nature and 
easily verifiable. Thus, these rules and policies qualify for the less 
labor intensive and costly disciplinary procedure. The Commission notes 
that inclusion of these additional rules and policies under the Minor 
Rule Violation Plan should make the Exchange's disciplinary system more 
efficient in prosecuting violations of these rules.
    For the above reasons, the Commission believes that the proposed 
rule change is consistent with the provisions of the Act, and in 
particular with Sections 6(b)(6) and 6(b)(7).
    It is therefore ordered, pursuant to Section 19(b)(2) \11\ of the 
Act, that the proposed rule change (SR-CHX-98-24), is hereby approved.

    \11\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-2606 Filed 2-3-99; 8:45 am]
BILLING CODE 8010-01-M