[Federal Register: August 18, 2006 (Volume 71, Number 160)]
[Notices]
[Page 47836-47850]
[DOCID:fr18au06-134]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54301; File No. SR-CHX-2006-05]

Self-Regulatory Organizations; Chicago Stock Exchange, Inc,;
Notice of Filing of a Proposed Rule Change and Amendment No. 1 Thereto
to Implement a New Trading Model

August 10, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on February 2, 2006, 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 CHX. On August 10,
2006, the Exchange filed Amendment No. 1 to the proposed rule
change.\3\ The Commission is publishing this notice to solicit comments
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaces and supersedes the original filing
in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The CHX proposes to amend its rules to implement a new trading
model that provides the opportunity for entirely automated executions
to occur within a central matching system accessible by all Exchange
participants. The new model also would end the Exchange's operation of
a physical trading floor and is intended to comply with the
requirements of Regulation NMS (``Reg. NMS'').\4\ The text of this
proposed rule change is available on the Exchange's Web site at http://www.chx.com/rules/proposed_rules.htm
, in the Commission's Public

Reference Room, and on the Commission's Web site at http://www.sec.gov.

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    \4\ 17 CFR 242.600, et seq.
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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 CHX 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 CHX has prepared summaries, set forth in Sections 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
    Through this proposed rule change, the Exchange seeks to implement
a new trading model that allows its participants to interact in a
fully-automated matching system. In this model, the Exchange would no
longer operate a physical trading floor where on-floor specialists,
brokers and market makers seek execution of their orders. Instead, the
Exchange would operate an automated system where its participants--from
any location--could submit orders for immediate execution. The Exchange
believes that this new model provides an opportunity for its
participants and their customers to receive efficient, low-cost
executions, while giving the Exchange enhanced capabilities for
surveilling its participants' trading activities.
    In this new model, the Exchange anticipates that most of its
participants would continue to be ``off-Exchange'' order-sending firms
that would simply send orders to the Matching System for execution.
These firms would not be required to register with the Exchange to act
in any specific capacity other than as trading participants.\5\ The
Exchange would, however, allow participant firms to register in two
special categories--to operate as proprietary market makers on the
Exchange or to act as institutional brokers. Market makers could choose
to post two-sided quotations and trade for their proprietary accounts.
Any customer order would be accepted off the Exchange and a market
maker could then choose whether or not to enter the order in the
Exchange's Matching System or submit the order to a different venue. In
contrast, any customer orders accepted by institutional brokers would
be deemed to be on the Exchange when accepted. These market makers and
institutional brokers would operate on the Exchange, even if they are
not physically located on a single trading floor.
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    \5\ Since its demutualization in February 2005, the Exchange has
not had ``members.'' Instead, a broker-dealer that seeks to effect
transactions directly on the Exchange must become an Exchange
``participant.''
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    Because the Exchange is taking this opportunity to modernize many
of its long-standing procedures and rules, the implementation of the
new trading model will result in changes to virtually

every section of the Exchange's rule book. The most significant changes
can be found in new CHX Article 20 of the Exchange's rules, which
describes the operation of the Exchange's central matching system. CHX
Article 16 details the new role of market makers on the Exchange, and
CHX Article 17 describes the role and responsibilities of the
Exchange's institutional brokers. Changes to other sections of the
rules are designed to eliminate obsolete provisions--including those
that relate to the operation of a physical trading floor--and to update
other responsibilities to reflect the more automated trading that is
the hallmark of the Exchange's new model. The Exchange has also made an
effort to better organize the rules. After describing the provisions of
new CHX Articles 20, 16 and 17, this submission will review each of the
other sets of proposed rule changes beginning with CHX Article 1.\6\
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    \6\ Throughout its rule book, the Exchange is replacing the
Roman numerals currently used to identify each of its articles with
an easier-to-understand Arabic number.
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a. The Matching System

    The Exchange's Matching System would be the core facility of the
Exchange. It would provide the only means for the display of orders and
a central point for the execution of orders. On one hand, the Matching
System is simply an extension of the operation of the Exchange's
electronic book to all securities traded on the Exchange.\7\ On the
other hand, this Matching System would provide a much more robust
platform for the interaction of orders than is possible on the Exchange
today.
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    \7\ See Securities Exchange Act Release No. 52094 (July 21,
2005), 70 FR 43913 (July 29, 2005) (approving the electronic book
for the trading of securities not assigned to a specialist firm).
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    1. Trading hours. The Matching System would operate a regular
trading session and a late trading session each day.\8\ The regular
trading session ordinarily would begin immediately after the primary
market for a security opens its market and would end at 3 p.m. each day
for all securities except specified exchange-traded funds, which would
trade until 3:15 p.m.\9\ The second trading session--the late trading
session--would begin immediately after the close of the first session
and would end at 3:30 p.m.\10\ Two senior officers of the Exchange
could decide to open the Exchange for trading if the primary market
announces that it will not open or will open later than usual, or if
the primary market has not opened within 15 minutes after its normal
operating time.\11\ Special rules apply to the trading hours for
securities listed exclusively on the Exchange.\12\
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    \8\ See CHX Article 20, Rule 1(b).
    \9\ All times referenced in this filing are expressed in Central
Time.
    \10\ These sessions are similar to the trading sessions that
occur on the Exchange today, except that the late trading session in
the new model (unlike the extended session under the current rules,
in which the MAX system is not operational) would be a fully
automated trading session. See CHX Article IX, Rule 10(b).
    \11\ See CHX Article 20, Rule 1, Interpretation and Policy .03.
If these officers decide to open one or more NYSE-listed, Amex-
listed or other listed securities (other than Nasdaq-listed
securities) when the primary market for these securities is not
trading, the Matching System will cancel all pending opening cross
orders in affected securities and, at the opening time selected by
these officers, will then accept all other orders and match them as
provided by the Matching System rules. If these officers decide to
open one or more Nasdaq-listed securities when the primary market
for these securities is not trading, the Matching System will: (a)
If the decision is made before 8:30 a.m., execute all opening cross
orders in affected securities as if the primary market had opened
and then accept all other orders and match them as provided by the
Matching System rules; or (b) if the decision is made on or after
8:30 a.m., cancel all pending opening cross orders in affected
securities and, at the opening time selected by the Exchange
officers, then accept all other orders and match them as provided by
the Matching System rules.
    \12\ See CHX Article 20, Rule 1, Interpretation and Policy .04
(confirming that the regular trading session for these securities
would begin at 8:30 a.m. and end at 3:00 p.m.).
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    2. Access to the Matching System. Exchange participants could route
orders to the Matching System through any communications line approved
by the Exchange.\13\ To the extent that the Exchange participates in
the Intermarket Trading System (``ITS'') Plan or any other linkage
plan, ITS commitments and other intermarket orders could be sent to the
Matching System through those linkages.\14\
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    \13\ See CHX Article 20, Rule 8(a)(1).
    \14\ See CHX Article 20, Rule 8(a)(2). So long as it is required
by the OTC/UTP Plan, the Exchange would also provide telephonic
access to NASD market makers. See CHX Article 20, Rule 8(a)(3).
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    3. Eligible orders--basic requirements. The Exchange's Matching
System would only accept day orders; orders designated good-till-
canceled would not be accepted.\15\ Similarly, except for immediate-or-
cancel market orders or specially-designated cross orders, the Matching
System would only accept limit orders and orders for regular-way
settlement.\16\ Orders could be submitted as round lots, odd lots or
mixed lots, except that orders in securities that only trade in
specific share size increments must be submitted only in those share
sizes.\17\
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    \15\ See CHX Article 20, Rule 4(a)(2).
    \16\ See CHX Article 20, Rules 4(a)(1), 4(a)(3) and 4(a)(7). A
special type of order--a non-regular way cross order--could be
submitted for execution and non-regular way settlement. See CHX
Article 20, Rule 4(b)(15).
    \17\ See CHX Article 20, Rule 4(a)(4).
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    Except for any types of cross and cross with size orders (described
later in this filing), the Matching System would only accept orders
that comply with the sub-penny requirements of Reg. NMS set out in Rule
612 \18\ and that do not exceed any size and/or price limitations
imposed by the Exchange to help eliminate erroneous transactions or
orders and transactions that cannot be processed by the Exchange's
systems.\19\ Because cross and cross with size orders essentially are
sub-penny executions (rather than orders), these transactions could be
submitted to the Matching System in sub-penny increments down to
$0.000001.\20\ Importantly, however, the Matching System would not
allow any type of cross or cross with size order (except a midpoint
cross, a cross that executes at the midpoint of the NBBO or a cross
with size) (i) Priced at or above $1.00, to execute at a price less
than $.01 better than any order on the same side of the Matching
System, or (ii) priced under $1.00, to execute at a price less than
$.0001 better than any order on the same side of the Matching
System.\21\
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    \18\ 17 CFR 242.612.
    \19\ See CHX Article 20, Rule 4(a)(6). The Exchange intends to
develop a set of parameters that would be used to identify orders
that either appear to be erroneous (based on their relationship to
current market conditions) or that exceed the Exchange's systems
capabilities (such as orders priced higher than a very high dollar
level or those for a very large number of shares). These orders
would be rejected to permit the continued effective operation of the
Matching System.
    \20\ See CHX Article 20, Rule 4(a)(7)(b), confirming that cross
and cross with size orders can be submitted in sub-penny increments,
whether the orders are priced less than or at or above $1.00. The
Exchange represents that it understands that it will need to obtain
exemptive relief from the requirements of Reg. NMS to permit these
executions to occur and will work with Commission staff to obtain
that relief.
    \21\ See CHX Article 20, Rule 4(a)(7)(b). The Exchange
represents that it has imposed this requirement based on input from
Commission staff that it is required for any market operated by a
national securities exchange.
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    4. Order types and conditions. The Matching System would accept a
wide variety of order types and conditions, which are set out in CHX
Article 20, Rule 4(b). Some of the more routine order types would
include immediate or cancel (``IOC'') limit and market orders, fill or
kill (``FOK'') orders, sell short and short exempt orders, reserve size
orders, time in force orders and cancel on halt orders.\22\ As required
by Reg. NMS, IOC

orders would be executed against any orders at or better than the
Exchange's best bid or offer (``BBO''), including any reserve size or
other undisplayed orders at or better than that price.\23\ Reserve size
orders would permit a participant to identify a portion of an order to
be displayed and a portion that should remain undisplayed, and to
provide an instruction that the displayed portion should be refreshed
to the original display quantity whenever the displayed share size
falls below a specific threshold.\24\ Time in force orders would be
eligible for execution within a specified time period, with any
unexecuted balance to be immediately cancelled when this period
expires.\25\ Cancel on halt orders would be automatically cancelled by
the Matching System if a trading halt or suspension is declared on the
Exchange in that security.\26\
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    \22\ See CHX Article 20, Rule 4(b)(12) (IOC orders); Rule
4(b)(13) (IOC market orders); Rule 4(b)(11) (FOK orders); Rule
4(b)(20) (sell short orders); Rule 4(b)(21) (short exempt orders);
Rule 4(b)(19) (reserve size orders); Rule 4(b)(22) (time in force
orders); and Rule 4(b)(3) (cancel on halt orders).
    \23\ See CHX Article 20, Rules 4(b)(12) (IOC orders) and
4(b)(13) (IOC market orders).
    \24\ See CHX Article 20, Rule 4(b)(19).
    \25\ See CHX Article 20, Rule 4(b)(22). The Matching System
initially would permit participants to identify any time period of a
minute or a multiple of a minute as the ``time in force'' for a
particular order. In later upgrades to the Matching System,
participants would be allowed to identify an order's ``time in
force'' in seconds.
    \26\ See CHX Article 20, Rule 4(b)(3).
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    The Matching System also would accept several different types of
cross transactions, including a basic cross, a cross with size, a cross
with satisfy, a cross with yield, a midpoint cross, an opening cross
and a non-regular way cross. A basic cross transaction would be an
order to buy and sell the same security at a specific price that is
better than the Exchange's displayed BBO and, where required by the ITS
Plan, another linkage plan or Reg. NMS, equal to or better than the
NBBO.\27\ A cross with size would be a cross for at least 5,000 shares
and for a value of $100,000 that is at a price equal to or better than
the Exchange's displayed BBO (and, where required by the ITS Plan,
another linkage plan, or Reg. NMS, equal to or better than the NBBO),
where the size of the cross transaction is larger than the largest
order displayed on the Exchange at that price.\28\ A cross with satisfy
is designed to provide a participant with an efficient mechanism for
clearing out displayed orders in the Matching System that would
otherwise have time priority (or displayed bids or offers in other
market centers that would otherwise have price priority) and then
effecting a cross transaction at that price.\29\ A cross with yield is
a similar order type, which would automatically yield interest on the
buy, sell or either side of the order to any order already displayed in
the Matching System at the same or better price.\30\ And, finally, as
their names suggest, an opening cross is a cross transaction that would
be specifically designated to be executed at the opening price; a non-
regular way cross would be designated for non-regular way settlement;
and a midpoint cross would execute at the midpoint between the
NBBO.\31\
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    \27\ See CHX Article 20, Rule 4(b)(4). A cross may represent
interest of one or more Exchange participants, trading for a
proprietary account. This order or transaction type is already
permitted in the Exchange's electronic book. See CHX Article XXA,
Rule 2.
    \28\ See CHX Article 20, Rule 4(b)(6). A cross with size is
already permitted in the Exchange's electronic book and is similar
to the type of transaction that can take place on the Exchange's
trading floor. See CHX Article XXA, Rule 2; CHX Article XX, Rule 23.
The proposed definition of a cross with size transaction would
reduce the required number of shares in the order to 5,000 shares
from 25,000 shares, mirroring similar requirements in the floor
trading rules of other markets. See Boston Stock Exchange Rules,
Chapter II, Section 18; Philadelphia Stock Exchange Rule 126(h). At
the same time, the definition would be changed to also require that
a cross must have a value of $100,000. The Exchange represents that
it has imposed this requirement based on input from Commission staff
that it is required for any market operated by a national securities
exchange and based on an assurance from Commission staff that all
national securities exchanges would be required to impose a similar
requirement. The proposed definition of a cross with size
transaction also would confirm that this order could represent
interest of one or more participants of the Exchange.
    \29\ See CHX Article 20, Rule 4(b)(5). With this order type, a
participant would send: (A) An instruction to execute a cross
transaction at a specific price; and (B) an instruction (i) To
execute orders already displayed in the Matching System at their
limit prices (up to a specified number of shares) against a
specified party to the extent necessary to allow the cross
transaction to occur and/or (ii) to route outbound orders or
commitments to other market centers to the extent necessary to
prevent an improper trade-through. If a cross with satisfy is sent
with a share size that is too small to satisfy orders in the
Matching System or bids or offers in other markets, as applicable,
the order would be automatically cancelled. Once the satisfying
execution has occurred (or, for orders or commitments sent to other
market centers, those orders or commitments have been sent), the
cross would be executed at a price that is better than the best bid
or offer to be displayed in the Matching System and, for securities
listed on NYSE, Amex and any exchange other than Nasdaq (and for
Nasdaq-listed securities, when Reg. NMS is implemented in those
issues), equal to or better than the NBBO.
    A cross with satisfy may represent interest of one or more
participants of the Exchange but, to the extent that it represents
interest of the participant sending the order to the Matching
System, the participant would not be eligible to satisfy existing
bids or offers in the Matching System at a price that is better than
the cross price and could only satisfy bids or offers in other
markets at a price that is better than the cross price if the cross
is for at least 10,000 shares or has a value of at least $200,000 (a
``block size order'') or is for the account of an institutional
customer (as that term is defined in CHX Article 8, Rule 11,
Interpretation and Policy .03) and the participant's customer has
specifically agreed to that outcome.
    \30\ See CHX Article 20, Rule 4(b)(7). This order would have:
(A) An instruction to execute a cross transaction at a specific
price; and (B) an instruction to yield interest on the buy, sell or
either side of the order (as specified in the order) to any order
already displayed in the Matching System at the same or better
price, to the extent necessary to allow the cross transaction to
occur. The cross would be executed at a price that is better than
the best bid or offer to be displayed in the Matching System and,
for securities listed on NYSE, Amex and any exchange other than
Nasdaq (and for Nasdaq-listed securities, when Reg. NMS is
implemented in those issues), equal to or better than the NBBO.
    \31\ See CHX Article 20, Rule 4(b)(16) (opening cross); Rule
4(b)(15) (non-regular way cross); and Rule 4(b)(14) (midpoint
cross). As described later in this submission, opening cross orders
would execute immediately after the primary market opens in a
security, at the opening price. For securities listed on NYSE, Amex
and any exchange other than Nasdaq, the opening price would be the
primary market opening price. For Nasdaq-listed securities (except
in the case of an initial IPO), the opening price would be the
midpoint of the first unlocked, uncrossed market that occurs on or
after 8:30 a.m. For Nasdaq-listed securities on the date of an IPO,
the opening price would be the Nasdaq opening price. Opening cross
orders would not be accepted in securities exclusively listed on the
Exchange and would not be accepted if any part of the sell side of
the order is marked as a sell short order. A midpoint cross would be
executed at the midpoint of the NBBO, but if the NBBO is locked at
the time a midpoint cross is received, the midpoint cross would
execute at the locked NBBO. If the NBBO is crossed at the time a
midpoint cross is received, the midpoint cross would be
automatically cancelled.
    A non-regular way settlement cross would execute without regard
to the NBBO or any other orders the Matching System and could
represent the interest of one or more participants in the Exchange.
Any non-regular way cross that is for cash settlement must be
received by the Matching System by 2 p.m. or such other time that
may be established by the Exchange and communicated to participants
from time to time. The Matching System would not accept one-sided
orders for non-regular way settlement. The only way to effect a non-
regular way transaction within the Matching System would be through
a non-regular way cross. Exchange participants currently may execute
orders for non-regular way settlement, both on the floor of the
Exchange and in the Exchange's electronic book. See CHX Article XX,
Rule 9; CHX Article XXA, Rule 2(c)(5).
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    The Matching System also would accept several order types that are
specifically contemplated by Reg. NMS.\32\ For example, the Matching
System would accept benchmark orders which meet the requirements of
Rule 611(b)(7) of Reg. NMS. Initially, the Exchange would limit
submission of benchmark orders to the Exchange's institutional
brokers.\33\ The Matching

System would also accept BBO intermarket sweep orders (``BBO ISOs''),
which would execute against orders at the Exchange's BBO, without
regard to whether the execution would trade through another market's
protected quotation.\34\ If a BBO ISO is marked as ``immediate or
cancel,'' any remaining balance in the order would be automatically
cancelled. If a BBO ISO is not marked as ``immediate or cancel,'' any
remaining balance in the order would be placed in the Matching System
and displayed, without regard to whether that display would lock or
cross another market center.\35\ Two other Reg. NMS-related orders--an
outbound ISO and a price-penetrating ISO--would also be accepted by the
Exchange's Matching System.\36\
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    \32\ These order types--and other expressly-identified
provisions--take effect with the implementation of Rule 611 of Reg.
NMS. 17 CFR 242.611. The Exchange will use February 5, 2007 (the
``Trading Phase Date'') as the effective date for these provisions.
See Securities Exchange Act Release No. 53829 (May 18, 2006), 71 FR
30038 (May 24, 2006) (setting new compliance dates for Rules 610 and
611).
    \33\ The Exchange initially has limited the use of this order
type to its institutional brokers to ensure that the Exchange can
determine whether or not the requirements of Rule 611(b)(7) Reg. NMS
have been met. See CHX Article 20, Rule 4(b)(2). A benchmark order
may execute at any price, without regard to the protected NBBO and
may represent interest of one or more Exchange participants.
    \34\ See CHX Article 20, Rule 4(b)(1). These orders are executed
based on the premise that the participant routing the order to the
Matching System has already satisfied the protected quotations of
other market centers. See CHX Article 20, Rule 6(c)(3).
    \35\ These orders are displayed based on the premise that the
participant routing the order to the Matching System has already
satisfied the quotations of other markets so that the display of the
order would not lock or cross those markets.
    \36\ An outbound ISO would allow an Exchange participant to ask
the Exchange to execute an order on the Exchange without regard to
the protected quotations at other markets while simultaneously
routing ISOs to those other markets to execute against their
protected quotations. See CHX Article 20, Rule 4(b)(17). A price-
penetrating ISO would operate much like a basic ISO, except that it
would allow a participant to execute through displayed and
undisplayed interest, at multiple price points, on the Exchange. See
CHX Article 20, Rule 4(b)(18).
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    Finally, the Matching System would accept do-not-display and do not
route orders. A do not route order, as its name implies, would be
executed or displayed within the Matching System and could not be
routed to another market center.\37\ A do-not-display order would be an
order, for at least 1,000 shares when entered, that should not be
displayed in whole or in part, but that would remain eligible for
execution within the Matching System.\38\
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    \37\ As further described in the section relating to the
prevention of trade-throughs, a do not route order would be
immediately cancelled if its execution would improperly trade
through the ITS BBO or another market's protected quotations. Any
types of cross, IOC or FOK orders would deemed to have been received
with a ``do not route'' condition because these orders either are
immediately executed in the Matching System or cancelled. See CHX
Article 20, Rule 4(b)(10).
    \38\ See CHX Article 20, Rule 4(b)(9). A do-not-display order
could receive that designation because a customer specifically
instructed a participant not to display the order or because a
participant decided that its own order should not be displayed. As
described later in this submission, a do-not-display order would be
ranked, at any given price point, behind displayed orders (and any
odd-lot and mixed-lot orders at the price) and behind the
undisplayed portions of any reserve size orders. These completely
undisplayed orders would both allow a participant to fulfill a
customer's instructions and to otherwise keep trading interest
hidden, but to remain within the Matching System where the orders
could be executed against inbound orders seeking liquidity.
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    5. Ranking of orders in the Matching System. As described in CHX
Article 20, Rule 8, all orders received by the Matching System would be
ranked by price, time of receipt and, for round-lot orders, any display
instructions received with the orders. Specifically, orders received by
the Matching System would be ranked as follows:
    a. Orders that are eligible for display, as well as mixed-lot and
odd lot orders. Limit orders that are eligible to be displayed,
including the displayed portion of reserve size orders, and all odd-lot
and mixed-lot orders would be ranked together, at each price point, in
time priority.\39\
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    \39\ For the most part, executions in the Matching System would
occur on a ``share-for-share'' basis, regardless of whether the
incoming or resting orders were round-lot, mixed-lot or odd-lot
orders. The one exception to this share-for-share matching is in the
handling of ITS commitments or linkage plan orders, which would only
be matched in round-lot increments, for the full amount of round-lot
shares available at the price reflected in the NBBO. See CHX Article
20, Rule 8(e)(9). Any remaining portion of the ITS commitment or
linkage plan order would then be automatically cancelled.
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    b. Orders that are displayed in part, where a portion is not
displayed. At each price point, the undisplayed portions of reserve
size orders would be ranked together in time priority and would be
ranked after any displayed orders (and any odd-lot and mixed-lot
orders) at that price.
    c. Completely undisplayed orders. Orders that are received with a
do-not-display instruction would be ranked together, at each price
point, in time priority and would be ranked after any other orders at
that price.
    Changes to an order's size or price, or its displayed portion,
could impact its ranking within the Matching System. For example, when
the displayed portion of a reserve size order is refreshed with new
volume, the displayed portion of the order would receive a new ranking
based on the time at which it was refreshed.\40\ Similarly, if a
participant increases the number of shares in a fully-displayed order,
that order would receive a new ranking based on the time at which these
shares were added to the order.\41\ Any change in the price of an order
would result in a new price and time ranking for the order, based on
the time of the price change.\42\ Finally, any change to the display
instruction associated with an order would result in a new ranking for
the order based on the time that the new instruction was received.\43\
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    \40\ See CHX Article 20, Rule 8(b)(4). Any remaining undisplayed
portion of the order would continue to be ranked at the price and
time at which it was originally received.
    \41\ See CHX Article 20, Rule 8(b)(5). Any reduction in the
number of shares in an order, however, would not change its ranking
within the Matching System.
    \42\ Id.
    \43\ Id.
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    6. Display of orders within the Matching System. All orders that
are eligible for display would be immediately and publicly displayed
through the processes set out in the appropriate transaction reporting
plan for each security when they constitute the best round-lot bid or
offer in the Matching System for that security. In addition, the
Matching System would aggregate all shares, including odd-lot orders
and the odd-lot portions of mixed-lot orders, at a single price point,
and then round that total share amount down to the nearest round-lot
amount for display purposes.\44\ The undisplayed portion of a reserve
size order and any other orders received with a do-not-display
instruction would not be eligible for display.
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    \44\ This aggregation and rounding process would apply for
display purposes only; all orders would retain their rankings for
execution purposes as described in CHX Article 20, Rule 8(b)(1)
through (5). However, as noted in CHX Article 20, Rule 8(g), the
Matching System would report each round-lot transaction that occurs
within the Matching System, including executions of resting odd-lot
orders that have been aggregated into one or more round-lots for
display purposes, to the appropriate consolidated reporting system.
---------------------------------------------------------------------------

    The Exchange believes that its disseminated quotations would
constitute automated quotations under the definition set out in Rule
600(b)(3) of Reg. NMS.\45\ The Exchange's proposed rules confirm that
each order submitted to the Matching System must be a firm order and
cannot be identified as a ``manual'' quotation.\46\
---------------------------------------------------------------------------

    \45\ As required by Rule 600(b)(3) of Reg. NMS in its definition
of ``automated quotations,'' the Exchange's Matching System is
designed to accept IOC orders; to immediately and automatically
execute an IOC order against the displayed BBO, up to its full size;
to immediately and automatically cancel any unexecuted portion of
the IOC order without routing the order elsewhere; to immediately
and automatically transmit a response to the order-sending
participant indicating the action taken on the order; and to
immediately and automatically update the BBO to reflect any change
that occurred as a result of the execution.
    \46\ See CHX Article 20, Rule 3(a).
---------------------------------------------------------------------------

    7. Opening of the regular trading session. Immediately after the
primary market opens, the Matching System would execute all opening
cross orders, then start accepting and matching orders as provided in
CHX Article 20, Rule 8(d).\47\ If the primary market in a

security other than a Nasdaq-listed security opens with a quote, but
has not reported a trade for 30 seconds following the dissemination of
the initial quote, the Matching System would cancel all opening cross
orders, and then start accepting and matching all other orders.\48\
---------------------------------------------------------------------------

    \47\ See CHX Article 20, Rule 8(d).
    \48\ Id. This provision would apply only to securities other
than Nasdaq-listed securities. As noted above, Nasdaq-listed
securities would open based on the first unlocked, uncrossed market
that occurs on or after 8:30 a.m.
---------------------------------------------------------------------------

    8. Automated matching of orders. With certain exceptions
specifically set out in CHX Article 20, Rule 8(e), and subject to the
provisions relating to the prevention of trade throughs that are set
out in CHX Article 20, Rule 5, incoming orders would be matched against
one or more orders in the Matching System, in the order of their
ranking, at the price of each resting order, for the full amount of
shares available at that price or for the size of the incoming order,
if smaller.\49\ If an order could not be immediately matched or matched
in full when received (and it is not designated as an order type that
should be immediately cancelled), it or its residual portion would be
placed in the Matching System and ranked as described above.\50\
---------------------------------------------------------------------------

    \49\ See CHX Article 20, Rule 8(d)(1).
    \50\ See CHX Article 20, Rule 8(d)(2). Orders that would be
immediately cancelled, if not executed, include FOK orders and IOC
limit and market orders. See CHX Article 20, Rules 4(b)(11) through
(13).
---------------------------------------------------------------------------

    The following order types would be subject to specific executions
within the Matching System:
    a. Benchmark orders. Benchmark orders, which are cross transactions
submitted by institutional brokers that meet the requirements of Rule
611(b)(7) of Reg. NMS, would execute at any price, without regard to
the NBBO and may represent the interest of one or more participants of
the Exchange.\51\
---------------------------------------------------------------------------

    \51\ See CHX Article 20, Rule 8(e)(1) and Rule 4(b)(2). A
benchmark order is defined in Rule 611(b)(7) of Reg. NMS as an order
that is executed at a price that was not based, directly or
indirectly, on the quoted price of the security at the time of
execution and for which the material terms were not reasonably
determinable at the time the commitment to execute the order was
made.
---------------------------------------------------------------------------

    b. Cross and cross with size orders. Cross and cross with size
orders would be automatically executed if they meet the requirements
set out in Rule 4(b)(4) and (6) respectively, but would be immediately
and automatically cancelled if they do not meet these requirements.\52\
---------------------------------------------------------------------------

    \52\ See CHX Article 20, Rule 8(e)(1).
---------------------------------------------------------------------------

    c. Cross with satisfy orders. In executing this order type, the
Matching System first would determine whether the order contains a
share size that is sufficient to satisfy orders in the Matching System
or bids or offers in other markets, as applicable. If this requirement
is not met, the cross with satisfy would be automatically
cancelled.\53\
---------------------------------------------------------------------------

    \53\ See CHX Article 20, Rule 8(e)(4).
---------------------------------------------------------------------------

    If the order meets this requirement, the Matching System then would
satisfy existing orders in the Matching System or send orders or
commitments to other market centers to satisfy bids or offers, as
necessary to prevent a trade-through and, before updating the
Exchange's quotes, would execute the cross at a price that is better
than the best bid or offer to be displayed in the Matching System and,
for securities listed on NYSE, Amex or any other exchange other than
Nasdaq (and for Nasdaq-listed securities, when Reg. NMS is implemented
in those issues), equal to or better than the NBBO. In doing so, the
Matching System would determine whether the Participant that sent the
order to the Matching System is attempting to satisfy bids or offers in
the Matching System at a price that is better than the cross price and,
if so, would not allow those executions to occur, but would instead
allocate the better prices to the customer, not to the Participant
sending the order to the Matching System.
    d. Cross with yield orders. When the customer order that is part of
a cross with yield order is eligible for an immediate execution because
it is at a price better than the currently displayed best bid or offer
in the Matching System, the cross with yield order would be
automatically executed by matching the participant as principal against
the customer order; provided, however, that if there is any order
already displayed in the Matching System at the same price as (or
better than) the participant's interest, that order or those orders
would be matched against the customer order in place of the
participant's interest as necessary to exhaust the customer order
interest.\54\ If the customer order that is part of a cross with yield
order is not eligible for an immediate execution because it is not
better than the currently displayed bid or offer in the Matching
System, the cross with yield order would be immediately and
automatically cancelled.
---------------------------------------------------------------------------

    \54\ See CHX Article 20, Rule 8(e)(2).
---------------------------------------------------------------------------

    e. Midpoint cross. A midpoint cross order would be immediately
executed at the midpoint between the NBBO. If the NBBO is locked at the
time the order is received, the midpoint cross would be executed at the
locked market price, unless the order could be executed in subpenny
increments. If the NBBO is crossed at the time the order is received,
the midpoint cross would be immediately and automatically
cancelled.\55\
---------------------------------------------------------------------------

    \55\ See CHX Article 20, Rule 4(b)(14).
---------------------------------------------------------------------------

    f. Non-regular way cross orders. These orders would be
automatically executed without regard to either the NBBO or any orders
for regular way settlement that might be in the Matching System.\56\
---------------------------------------------------------------------------

    \56\ See CHX Article 20, Rule 4(b)(15).
---------------------------------------------------------------------------

    g. Sell short orders. Sell short orders (including odd lot orders)
would be displayed and executed only when permissible under the
provisions of Rule 10a-1 (``Short Sale Rule'') and Regulation SHO.\57\
When a sell short order cannot be executed or displayed at its limit
price under the provisions of the Short Sale Rule and Regulation SHO,
the order would be automatically repriced (without violating its limit
price) to the next available price at which it can be executed or
displayed.\58\
---------------------------------------------------------------------------

    \57\ Because there is no exemption from the requirements of the
Short Sale Rule or Reg. SHO for odd lots executed within a system
such as the Matching System, odd lot orders would be treated as all
other orders in determining whether they could be executed under the
Short Sale Rule and Reg. SHO.
    \58\ See CHX Article 20, Rule 8(e)(5).
---------------------------------------------------------------------------

    h. Do not display orders. A do-not-display order would be executed
as provided in CHX Rule 8(d), but would be immediately and
automatically cancelled if, at any point, the order would prevent the
execution of an inbound order because the do-not-display order has
crossed the NBBO.\59\
---------------------------------------------------------------------------

    \59\ See CHX Article 20, Rule 8(e)(6).
---------------------------------------------------------------------------

    i. Inbound ITS commitment or linkage plan order. An inbound ITS
commitment or linkage plan order, if it is priced at or better than the
current Exchange-displayed BBO (or if it is marked ``market''), would
be automatically matched, in round-lot increments, against the order(s)
at the price reflected in the BBO (or at a better undisplayed price),
for the full amount of round-lot shares available at that price, and
any remaining portion of the ITS commitment or linkage plan order would
be automatically cancelled.\60\ An inbound ITS commitment marked as a
``block'' trade would be automatically matched, in round-lot
increments, at the price reflected in the ITS commitment, against the
order(s) in the Matching System, in regular price-time priority.
---------------------------------------------------------------------------

    \60\ See CHX Article 20, Rule 8(e)(7). The Exchange believes
that this handling of ITS commitments and linkage plan orders is
consistent with the ITS Plan and the current draft of the linkage
plan that might replace the ITS Plan.
---------------------------------------------------------------------------

    j. Trades in locked markets. Trades would continue to be executed
in the Matching System when the NBBO is

crossed; provided however, that (i) If the ITS Plan requires that the
Matching System route the inbound order to another market for
execution, the Matching System would do so or, if the order is marked
``do not route,'' the Matching System would automatically cancel the
order; and (ii) once Reg. NMS is implemented in a security, the
Matching System would only execute orders in that security up to (but
not beyond) the first uncrossed NBBO.\61\
---------------------------------------------------------------------------

    \61\ See CHX Article 20, Rule 5, Interpretation and Policy
.01(e).
---------------------------------------------------------------------------

    9. Prevention of trade-throughs and other order routing. The
Exchange's Matching System would prevent the execution of all or a part
of an inbound order for at least a round lot if the execution would
cause an improper trade-through of another ITS market or if, when Reg.
NMS is implemented for a security, the execution of all or a part of
the order would be improper under Reg. NMS Rule 611.\62\ Inbound odd
lot orders and odd lot crosses would be eligible for execution on the
Exchange, even if they would trade through other markets' bids and
offers.
---------------------------------------------------------------------------

    \62\ See CHX Article 20, Rule 5. At least initially, however,
the Exchange would not apply the ``flickering quote'' exception to
Rule 611 of Reg. NMS (Reg. NMS Rule 611(b)(8)) when determining
whether or not the execution of the order would create an improper
trade-through.
---------------------------------------------------------------------------

    If a participant has submitted a cross with satisfy or an outbound
ISO order and its execution would cause an improper trade through, the
Matching System would execute the order and simultaneously route
commitments or orders to other markets to satisfy their protected
quotes. In these situations, the Exchange's systems would determine
when, how and where these orders (or commitments) should be routed to
satisfy protected quotes. The Exchange would route these orders (or
commitments), at the participant's election, either through the
Intermarket Trading System (or any later linkage that supersedes ITS)
or through the connectivity provided by a routing services provider
with whom the Exchange has negotiated an agreement.
    The Exchange will provide these routing services pursuant to the
terms of three separate agreements, to the extent that they are
applicable to a specific routing decision: (1) An agreement between the
Exchange and each Participant on whose behalf orders will be routed
(``Participant-Exchange Agreement''); (2) an agreement between each
Participant and a specified third-party broker-dealer that will use its
routing connectivity to other markets and serve as a ``give-up'' in
those markets (``Give-Up Agreement''); and (3) an agreement between the
Exchange and the specified third-party broker-dealer (``Routing
Connectivity Agreement'') pursuant to which the third-party broker-
dealer agrees to provide routing connectivity to other markets and
serve as a ``give-up'' for the Exchange's Participants in other
markets. The Exchange will provide these routing services in compliance
with its rules and with the provisions of the Act and the rules
thereunder, including, but not limited to, the requirements of Sections
6(b)(4) and (5) of the Act that the rules of a national securities
exchange provide for the equitable allocation of reasonable dues, fees
and other charges among its members and issuers and other persons using
its facilities, and not be designed to permit unfair discrimination
between customers, issuers, brokers or dealers. The Routing
Connectivity Agreement will include terms and conditions that enable
the Exchange to comply with these obligations.
    In addition to these routing services, the Exchange is developing a
functionality that would, in all other situations where the execution
of an inbound round lot order, in whole or in part, would cause a
trade-through, (a) Route the order to another venue, according to each
participant's instructions, or (b) if the order is marked ``do not
route,'' automatically cancel the order.\63\ The Exchange plans to
supplement this filing, or file a new rule submission, with respect to
this functionality, as soon as possible.
---------------------------------------------------------------------------

    \63\ There would be one exception to the general rule that an
inbound ``do not route'' order would be cancelled if its execution
would constitute an improper trade-through. If an undisplayed order
is resting in the Matching System and the execution of an inbound
order (that is not an IOC or FOK order) against the undisplayed
resting order would cause an improper trade-through, the resting
order would be cancelled to the extent necessary to allow the
inbound order to be executed or quoted.
---------------------------------------------------------------------------

    The Exchange has developed an initial series of trade-through
policies and procedures that describe how the Exchange will implement
the provisions of Rule 611 of Reg. NMS.\64\ These procedures describe
the Exchange's clock synchronization practices, as well as its plans
for applying the exceptions to Rule 611 of Reg. NMS.\65\ Among other
things, these procedures confirm that the Exchange would apply the
self-help exception (and disregard another market's quotations for
trade-through purposes) when that market has publicly announced that it
is not disseminating automated quotations (but has not identified those
quotes as manual); or when the Exchange has a reasonable basis for
believing that the other market is experiencing systems problems and
that market (a) Has not responded, within 30 seconds, to an Exchange
inquiry seeking information about possible systems problems, or (b) has
not confirmed, within two minutes after an Exchange inquiry, that it is
not having systems problems.\66\ These procedures also confirm that the
Exchange automatically would place an appropriate modifier on trades
executed pursuant to an exemption from, or exception to, Rule 611 of
Reg. NMS in accordance with specifications approved by the operating
committee of the relevant national market system plan for an NMS
stock.\67\
---------------------------------------------------------------------------

    \64\ See CHX Article 20, Rule 5, Interpretation and Policy .01.
The Exchange will further define its policies in more detail over
the next month or so.
    \65\ The Exchange's systems will routinely, throughout the
trading day, use processes that capture the time reflected on the
atomic clock operated by the National Institute of Standards and
Technology and will automatically make adjustments to the time
recorded in the Exchange's Matching System to ensure that the period
between the two times does not exceed 500 milliseconds.
    \66\ See CHX Article 20, Rule 5, Interpretation and Policy
.01(d). The Exchange would notify the other market of its use of the
self-help exception by using appropriate technology made available
for intermarket communications from time to time. The Exchange then
would continue to apply this self-help exception until the other
market has provided reasonable assurance to the Exchange (or to the
public) that the problems have been corrected.
    \67\ See CHX Article 20, Rule 5, Interpretation and Policy
.01(h). In addition, if an on-Exchange participant submits an
outbound ISO order (consisting of an order to execute on the
Exchange, coupled with outbound ISOs to execute against protected
quotations of other markets), the Matching System will not execute
the order on the Exchange until it either simultaneously routes ISOs
to other markets or confirms that the participant submitting the
order has simultaneously routed ISOs designed to execute against the
full size of any other market's protected bid or offer, as required
by Rule 600(b)(30) and Rule 611(b)(6) of Reg. NMS.
---------------------------------------------------------------------------

    The Exchange's initial trade-through policies also describe its
plans for confirming that its own bids and offers qualify as automated
quotations. Specifically, the Exchange would periodically (no less
often than once every five seconds and no more often than once every
second) send a test IOC order to the Matching System to determine
whether the Exchange's Matching System accepts the order and would use
automated monitoring systems to further measure the Matching System's
handling of test IOC orders within the Matching System.\68\ These

monitoring systems would provide immediate reports to other Exchange
systems for further handling. If these systems receive a report that
gives the Exchange reason to believe that it is not capable of
displaying automated quotations, the Exchange would automatically and
immediately append a ``manual'' identifier to the bids and offers it
makes publicly available.\69\ The Exchange would not remove this
``manual'' identifier until it has determined that its quotations
qualify as automated quotations. It would then notify other markets
that its quotations are automated to ensure that all markets recognize
the Exchange's bids and offers as automated quotations.
---------------------------------------------------------------------------

    \68\ These systems would review, in real time, the Matching
System's handling of test IOC orders to determine whether, and
within what time frame, (i) IOC orders are executed against the
displayed quote, up to its full size; (ii) any unexecuted portion of
the IOC order is cancelled; (iii) a confirmation of the action taken
is generated and transmitted from the Matching System to the
monitoring system (to serve as a proxy for a transmission to the
order-sending firm); and (iv) the Matching System transmits a new
bid or offer (as appropriate) to the monitoring system (to serve as
a proxy for a transmission to the appropriate securities information
processor).  See CHX Article 20, Rule 5, Interpretation and Policy
.02(a).
    \69\ In the event that the Exchange's systems do not permit the
Exchange to disseminate a ``manual'' identifier, the Exchange would
announce that its quotes are manual over an appropriate
functionality available for communications with other market
centers. See CHX Article 20, Rule 5, Interpretation and Policy
.02(b).
---------------------------------------------------------------------------

    10. Locking and crossing quotations. An order would not be
displayed on the Exchange if its display would improperly lock or cross
the ITS best bid or offer or, when Reg. NMS is implemented for a
security, if its display would constitute a locking or crossing
quotation.\70\ These otherwise locking or crossing orders would either
be routed to another appropriate market or, if designated as ``do not
route,'' would be automatically cancelled.
---------------------------------------------------------------------------

    \70\ See CHX Article 20, Rule 6(d).
---------------------------------------------------------------------------

    11. Clearing the matching system. To ensure that orders on the
Exchange have an appropriate opportunity to interact with each other,
institutional brokers ordinarily would be required to clear the
Matching System before sending an order to another market for
execution.\71\ Any outbound ITS commitments that are seeking liquidity
in another market--whether they represent agency or proprietary
interest--would be required to first clear the displayed and
undisplayed orders in the Exchange's Matching System before being sent
through the ITS System. Outbound ITS commitments (or ISOs) that are
being sent to another market to satisfy its displayed bid or offer,
however, would not be required to clear the Exchange's Matching System
before being sent to the other market.\72\ Additionally, an
institutional broker would not be required to clear the Matching System
if the customer order that is being sent to another market could not be
executed in the Matching System (e.g., the order is a stop or stop
limit order which has not yet been elected).\73\
---------------------------------------------------------------------------

    \71\ If a customer specifically requests otherwise, an
institutional broker is not required to clear the Matching System.
See CHX Article 20, Rule 7(a). Institutional brokers would be
required to document any directives for special handling of orders
under this rule. See CHX Article 20, Rule 7(b).
    \72\ See CHX Article 20, Rule 7(c).
    \73\  See CHX Article 20, Rule 7(d).
---------------------------------------------------------------------------

    12. Trading halts. Under the proposed rules, two senior officers of
the Exchange would be authorized to suspend and restart trading within
a trading session or to halt trading for the remainder of a trading
session, in one or more securities, when the officials believe it is in
the public interest.\74\ If trading in one or more issues is suspended
or halted, the Matching System would not accept any additional orders
and would resume quoting and matching orders only after the end of the
trading halt.\75\ Because the Matching System would not be locked or
crossed when trading is halted, and because it would not accept orders
during the halt, the Matching System would be able to emerge from the
halt without any special reopening process, by simply displaying its
BBO and then accepting and matching orders as provided by the Matching
System rules described above.
---------------------------------------------------------------------------

    \74\ See CHX Article 20, Rule 1(d). Under the Exchange's current
rules, a trading halt could be declared by the chairman or vice
chairman of the Exchange's Board of Directors, or by its president,
with the prior approval of a director from a participant firm and a
director from the trading floor. The Exchange believes that it no
longer is appropriate or effective to require its directors to
participate in the decisions to suspend or halt trading,
particularly with the automated environment proposed by the new
trading model and the fact that the Exchange will no longer be
operating a trading floor.
    \75\ See CHX Article 20, Rule 1, Interpretation and Policy .02.
Participants could cancel orders during the halt.
---------------------------------------------------------------------------

    13. Cancelling transactions/handling clearly erroneous
transactions. Under the proposed rules, participants that make a
transaction in demonstrable error could agree to cancel and unwind the
transaction, subject to the approval of the Exchange.\76\ The Exchange
also proposes to extend its current electronic book rule for the
handling of clearly erroneous transactions, with a few minor changes,
to the operation of the Matching System.\77\ This rule would allow the
Exchange to review, and potentially modify or cancel, executions where
one party believes that the terms of the transaction were clearly
erroneous when submitted. A related rule relating to systems
disruptions and malfunctions would allow the Exchange to modify or
cancel executions that result from a disruption or malfunction in the
use or operation of the Matching System, or any communications system
associated with the Matching System or when extraordinary market
conditions or other circumstances exist in which the nullification or
modification of transactions may be necessary for the maintenance of a
fair and orderly market or the protection of investors and the public
interest. The proposed rules set out procedures for each of these
reviews, including specific means for participants to appeal the
Exchange's decisions.\78\
---------------------------------------------------------------------------

    \76\ See CHX Article 20, Rule 9.
    \77\ See CHX Article 20, Rule 10; see also CHX Article XXA, Rule
7 (the policy approved for use within the electronic book).
    \78\ For example, a participant seeking review of a ``clearly
erroneous'' transaction would be required to notify the Exchange of
the request immediately after the execution by telephone, and within
15 minutes after the execution in writing. The Exchange would
promptly notify the other party to the transaction. Both parties
then would be required to submit information relating to the
disputed transaction, within specified time frames. After reviewing
the transaction, an Exchange official would notify both parties of
his or her decision, in writing; either party could appeal the
decision to a subcommittee of the Exchange's Committee on Exchange
Procedure and, if not satisfied, to the full Committee on Exchange
Procedure. In making his or her decision, the Exchange official
would consider the goals of maintaining a fair and orderly market
and protecting investors and the public interest; if an Exchange
official determines that a transaction was clearly erroneous, he or
she would try to return the parties to the positions that they would
have been in (or positions reasonably similar to those positions) if
the error had not occurred. Similarly, in the event of a disruption
or malfunction that impacts the operation or use of the Matching
System (or in the event of extraordinary market conditions or other
circumstances), an Exchange official could declare transactions void
or modify transactions. Absent extraordinary circumstances, any
Exchange action to void or modify transactions in this manner must
be taken within 30 minutes of detection of the erroneous
transaction, but in no event later than 2 p.m. on the trading day
following the date of the trade at issue. The official would be
required to notify each member involved in the transaction as soon
as practicable after making any decision; decisions could be
appealed using the procedure set out for the review of decisions
addressing clearly erroneous transactions.
---------------------------------------------------------------------------

    14. The late trading session. The Exchange's Matching System would
begin accepting orders for the late trading session immediately after
the closing of the regular trading session.\79\ Orders for the late
trading session would be matched according to the same process used
during the regular trading session. As noted above, the late trading
session would end at 3:30 p.m.
---------------------------------------------------------------------------

    \79\  See CHX Article 20, Rule 8(c)(2). Orders for the late
trading session would not be allowed queue before the close of the
regular trading session; they would only be accepted by the Exchange
after the close of the regular trading session.
---------------------------------------------------------------------------

b. Market Makers

    The Exchange's proposed new trading model would allow participants
to register to act as proprietary market makers on the Exchange. The
provisions that would govern the activities of these

market makers are set out in the proposed rules in CHX Article 16.
These proposed rules replace the current market maker rules contained
in CHX Article XXXIV.
    Under the proposed rules, a participant firm seeking to act as a
market maker would be required to register with the Exchange.\80\
Participant firms would be required to register as market makers;
individual traders within those firms would be required to separately
register as market maker traders.\81\ The proposed rules specifically
provide that a market maker that is a participant in the Exchange, but
is not a member of another self-regulatory organization, would be
permitted to trade only on a proprietary basis and would not be
permitted to handle any agency orders on the Exchange.\82\ More than
one market maker could register in each security.\83\
---------------------------------------------------------------------------

    \80\ See CHX Article 16, Rule 1(a). A participant would be not
be considered to be acting as a market maker unless it was
registered in that capacity and was in good standing.
    \81\ See CHX Article 16, Rule 1, Interpretation and Policy .01.
    \82\ See CHX Article 16, Rule 1, Interpretation and Policy .02.
    \83\ See CHX Article 16, Rule 3, Interpretation and Policy .03.
---------------------------------------------------------------------------

    A participant would register as a market maker by submitting an
application to the Exchange, confirming its ability to comply with
applicable rules and identifying the number of securities in which it
seeks to make markets.\84\ The Exchange would review each application
and, using specific criteria, would determine whether or not the
participant should be registered in that capacity.\85\ The Exchange
would notify each participant of the action taken with respect to its
application and, if it denies a participant's registration request,
would describe the reasons for that denial.\86\ An unsuccessful
applicant would be permitted to seek a review from that decision
pursuant to the provisions of CHX Article 15.\87\
---------------------------------------------------------------------------

    \84\ See CHX Article 16, Rule 2(b).
    \85\ See CHX Article 16, Rule 3. In considering a participant's
request for registration as a market maker, the Exchange would
consider: (a) The participant's financial resources; (b) the
participant's experience and demonstrated ability in making markets,
including the depth and quality of the market quoted by the
participant in other securities; (c) the participant's demonstrated
ability to make markets in such a manner as to increase the order
flow to the Exchange and, as a result, the competitiveness of its
market with markets elsewhere; (d) the participant's disciplinary
record, including its violations of Exchange rules, the rules of
other SROs and Federal securities laws; (e) the participant's
operational capability, including its ability to comply with the
responsibilities set out in CHX Article 16, Rule 8; and (f) the
overall best interests of the Exchange.
    \86\ See CHX Article 16, Rule 2(d).
    \87\ See CHX Article 16, Rule 2(d).
---------------------------------------------------------------------------

    Under the proposed rules, once a firm's market maker registration
is approved, the firm could select the securities in which it would act
as market maker by notifying the Exchange.\88\ The Exchange would
require a firm to seek prior approval before acting as market maker in
more than 500 securities and with respect to each increment of an
additional 100 securities after that threshold is reached.\89\ If a
market maker drops a security from its selected list, that participant
would not be allowed to trade that security again as market maker for
20 calendar days.\90\
---------------------------------------------------------------------------

    \88\ See CHX Article 16, Rule 5. A market maker would be
required to notify the Exchange of a decision to add or drop
securities by 9 a.m. on the trading day preceding the date on which
the change would take effect, unless the Exchange is able to
accommodate a notification closer to the effective date. Id.
    \89\ See CHX Article 16, Rule 5, Interpretation and Policy .01.
This process would allow the Exchange to evaluate a market maker's
request, using the criteria in CHX Rule 3, to determine whether the
firm appears capable of handling its market maker responsibilities
in these additional issues.
    \90\ See CHX Article 16, Rule 5, Interpretation and Policy .02.
This prohibition would not apply where a market maker has received
approval to voluntarily deregister as a market maker under the
provisions of CHX Article 16, Rule 6.
---------------------------------------------------------------------------

    A firm's registration as a market maker could be terminated
voluntarily, by the market maker itself, or involuntarily, by the
Exchange.\91\ The proposed rules would allow market makers to
voluntarily deregister by filing the appropriate form with the
Exchange. As part of that process, a firm would be permitted to request
temporary or partial deregistration as a market maker--and thus avoid
the need to complete the registration process again--in specific
circumstances that temporarily prevent a market maker from acting in
that role.\92\ Under the proposed rules, the Exchange could grant a
request for temporary or partial deregistration for up to 60 days and
could extend that period in its discretion. The proposed rules would
allow the Exchange to suspend, terminate or limit a market maker's
registration upon a determination of any substantial or continued
failure by the participant to engage in dealings as required by CHX
Article 16, Rule 8 or as set out in CHX Article 13.\93\
---------------------------------------------------------------------------

    \91\  See CHX Article 16, Rules 6 (voluntary deregistration) and
7 (involuntary deregistration). In addition, the Exchange would
consider a firm to have deregistered if it is not trading any
securities as a market maker (i.e., it is not submitting bids or
offers in the securities it has selected). See CHX Article 16, Rule
6. If a firm is deemed to have deregistered, it would be required to
complete the registration process again before acting as a market
maker on the Exchange.
    \92\ These reasons include software, hardware, connectivity or
other problems that interfere with the market maker's ability to
appropriately send bids or offers to the Exchange or otherwise act
as market maker; legal or regulatory considerations that temporarily
prevent the participant from acting as market maker; or other
circumstances, including, but not limited to, those that are beyond
a market maker's control, that interfere with the participant's
ability to act as market maker. See CHX Article 16, Rule 6,
Interpretation and Policy .01.
    \93\ CHX Article 13 contains the Exchange's rules and procedures
relating to the suspension and reinstatement of a participant's
ability to act as a participant and to retain its registration in a
special capacity (such as a market maker).
---------------------------------------------------------------------------

    During the Exchange's regular trading session, a market maker would
be required to engage in a course of dealings for its own account to
assist in the maintenance, to the extent reasonably practicable, of
fair and orderly markets on the Exchange. A market maker's
responsibilities would specifically include: (1) Using automated
systems to maintain a continuous two-sided quote, for at least a round-
lot, in each of the securities in which it is registered; (2)
maintaining adequate minimum capital; and (3) meeting specific
quotation or trade requirements, with respect to its dealings on the
Exchange, over the course of each calendar month.\94\ A market maker's
continuous two-sided quotes must be at prices which are reasonably
related to the prevailing market price of the security.\95\
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    \94\ See CHX Article 16, Rule 8(a) through (c). Over the course
of each calendar month, a market maker would be required to meet
either of these requirements: (1) At least 5% of the total number of
a market maker's principal bids or offers on the Exchange, in each
quarter, for each of its assigned securities, must, when entered on
the Exchange, be at the NBBO or improve the NBBO in a manner that
attributes market data revenue to the Exchange under the terms of
applicable national market system reporting plans; or (2) the shares
traded by a market maker for its own account, for each of its
assigned issues, must equal or exceed 1% of the total number of
shares executed on the Exchange in that issue.
    \95\ See CHX Article 16, Rule 8, Interpretation and Policy .01.
The proposed rules provide that, in most circumstances, a market
maker's quotations should be priced no more than 10% away from the
prevailing NBBO (as applicable) for securities priced under $1.00,
5% for securities priced between $1.00 and $50.00 and 3% for
securities priced above $50.00. This quoting guidance is
substantially similar to that currently provided by the Exchange's
Market Regulation Department to participants (such as specialists
and market makers) that have a quoting obligation on the Exchange.
---------------------------------------------------------------------------

    Market makers would have two other specific obligations. First, a
market maker that is registered as a market maker solely on the
Exchange and engages in other business activities (or that is
affiliated with a broker or dealer that engages in other business
activities) would be required to establish, and describe to the
Exchange, information barriers that prevent the market maker

from using material, non-public information or information about
customer order flow in its trading activities.\96\ And, second, a
market maker would be required to record and, provide upon request, to
the Exchange in an approved electronic format, its long or short
position in a security as of the time that it initiates an order in
that security on the Exchange.\97\
---------------------------------------------------------------------------

    \96\ See CHX Article 16, Rule 9. At the time a participant
becomes a market maker, the participant would be required to submit
a written statement describing its plans for establishing and
maintaining the required information barriers, including the
internal controls that will be put in place to monitor the barriers'
effectiveness. A market maker engaging in these other business
activities would not be allowed to act as a market maker on the
Exchange until the Exchange had approved the information barrier
procedures.
    \97\ See CHX Article 16, Rule 10. The requirement to report
information to the Exchange would apply only to market makers that
are not NASD members. NASD members would provide this information
directly to the NASD and would be subject to the NASD's oversight
with respect to their trading activity.
---------------------------------------------------------------------------

c. Institutional Brokers

    Under the Exchange's proposed new trading model, any participant
firm that acts as a broker in effecting transactions on the Exchange
and for which the Exchange is the designated examining authority would
be permitted to register with the Exchange as an institutional broker
and to use Exchange systems for handling orders and reporting
transactions.\98\ Each individual that would be authorized to effect
trades on behalf of the firm would be required to separately register
as an institutional broker representative.\99\ The Exchange anticipates
that its existing floor brokers would register as institutional brokers
in the new model. Importantly, although institutional brokers would
operate as participants on the Exchange, they could trade from any
location and would not effect transactions from a physical trading
floor.\100\
---------------------------------------------------------------------------

    \98\ See CHX Article 17, Rule 1.
    \99\ See CHX Article 17, Rule 1, Interpretation and Policy .02.
This requirement essentially tracks the current requirement that
individual floor brokers separately register with the Exchange and
take required examinations. See CHX Article VI, Rules 2 and 3.
    \100\ As noted above, the Exchange would not operate a physical
trading floor in the new trading model. The Exchange anticipates
that it would continue to allow participants to remain in their
current locations within the trading floor space, paying current
rent, through the end of the year, at which time the trading floor
space would be more formally subleased to interested parties
(including participants) for use as office or trading space. The
Exchange believes that it would be appropriate to allow participants
to remain in their current locations on the floor (and to pay the
current rent for that space) during, and for a short time after, the
transition to the new trading model so that firms that choose to
relocate are not unnecessarily required to disrupt their operations
by both a transition to a new trading model and a physical
relocation.
---------------------------------------------------------------------------

    Under the proposed rules, institutional brokers would be required
to adhere to trading and business conduct rules that apply to
participant firms generally and would be subject to specific
obligations set out in CHX Article 17. Among other things,
institutional brokers would be required to enter all orders received
for execution on the Exchange into an automated system to provide an
electronic record of their order handling practices; would be required
to maintain separate accounts for handling agency transactions,
principal transactions and transactions involving errors; and would be
required to enter transactions into the appropriate accounts.\101\
Institutional brokers would also be required to maintain required
records of their trading activities, including records of their
relationships with their customers.\102\ Finally, institutional brokers
would be required to use an electronic system, acceptable to the
Exchange, for the handling of orders that integrates the institutional
broker's on-Exchange trading activities with the Matching System and
with its trading activities in other market centers.\103\
---------------------------------------------------------------------------

    \101\ See CHX Article 17, Rule 3(a) and Rule 3(c). The
requirement for entering orders into an electronic system to permit
the Exchange to more readily surveil broker order handling
activities has been approved and implemented. See CHX Article 11,
Rule 3; Securities Exchange Act Release No. 53772 (May 8, 2006), 71
FR 27758 (May 12, 2006). In addition, although the Exchange's
current rules do not specifically require brokers to maintain
specific principal, agency and error accounts, the Exchange's Market
Regulation Department has encouraged them to do so as a way to
evidence their compliance with general order handling obligations.
    \102\ See CHX Article 17, Rule 3(f).
    \103\ See CHX Article 17, Rule 3(b).
---------------------------------------------------------------------------

    A customer order would be deemed to be on the Exchange when
received by an institutional broker, but would not have priority in the
Matching System until it is entered into that system. The proposed
rules would also set out specific order handling obligations for
institutional brokers.\104\ Specifically, an institutional broker
handling a market order would be required to use due diligence to
execute the order at the best price or prices available.\105\
Similarly, an institutional broker handling a limit order would be
required to use due diligence to execute the order at or better than
the limit price, if available. And, an institutional broker who has
been given a not held order would be required to use brokerage judgment
in the execution of the order, and if he exercises such judgment, would
be relieved of all responsibility with respect to the time of the
order's execution and the execution price or prices given to the
order.\106\ These proposed rules are similar to rules that relate to
broker trading activities on at least one other market and are designed
to establish a specific standard by which institutional broker order
handling activities could be measured.\107\
---------------------------------------------------------------------------

    \104\ See CHX Article 17, Rule 3(d). An institutional broker
generally would execute its customers' orders on an agency basis.
If, however, an institutional broker believes it is in the best
interests of its customer to execute an order on a principal basis,
it must comply with the requirements of CHX Article 9, Rule 18. See
CHX Article 17, Rule 3(d)(4).
    \105\ In handling a market order, an institutional broker could
assign an appropriate limit price to the order and send it to the
Matching System, could enter an IOC market order into the Matching
System or could route the order to another market center after
clearing the Exchange's Matching System.
    \106\ See CHX Article 17, Rule 3(d)(3).
    \107\ See NYSE Rule 123A.41-.44. The Exchange's Rules do not
currently contain any specific order execution standards that apply
to its brokers.
---------------------------------------------------------------------------

    The final new requirement under the proposed rules would require
that brokers use reasonable efforts to report all transactions that are
not effected through the Exchange's Matching System to the Exchange
within 10 seconds after the trade occurs.\108\ Although the Exchange
anticipates that most executions by its institutional brokers would
occur within the Matching System, the Exchange recognizes that its
institutional brokers could, from time to time, execute orders outside
of that system. To ensure that the Exchange and its institutional
brokers can establish compliance with the trade-through provisions of
the ITS Plan and Rule 610 of Reg. NMS, the Exchange is developing
functionality in its Brokerplex system that would allow an
institutional broker to electronically validate whether a trade would
constitute a trade-through before the trade occurs and that would
create an electronic record that that validation had taken place.\109\
Because of the possibility that a broker trading on a proprietary basis
against a customer order could use this functionality in a manner
inconsistent with the broker's fiduciary obligations to the customer
order, the proposed rules would require

a broker that pulls up the validation window to complete the required
information and report the transaction (without cancelling out of the
functionality) unless the broker mistakenly input the symbol for the
wrong security or the transaction may be cancelled pursuant to the
provisions set out in CHX Article 20, Rules 9, 10 and 11 (relating to
cancellations of transactions, clearly erroneous transactions and
systems disruptions and malfunctions).\110\
---------------------------------------------------------------------------

    \108\ See CHX Article 17, Rule 3(e). This provision would also
require that an institutional broker mark as ``SOLD'' any trades
reported after this time.
    \109\ See CHX Article 17, Rule 3, Interpretation and Policy .03.
Other possible functionality might allow a broker to enter the
details of a proposed cross transaction (such as its price, the
number of shares and whether the sell side of the order is
``short'') into the Brokerplex system, which would send the cross to
the Matching System for execution when it could be executed. The
first type of functionality--to allow a broker to report a trade
outside of the Matching System in a manner that is consistent with
the NBBO and orders in the Matching System--is slated for roll-out
to brokers in (or before) early October 2006.
    \110\ See CHX Article 17, Rule 3, Interpretation and Policy .03.
---------------------------------------------------------------------------

d. Other Rule Changes

    1. CHX Article 1. (Definitions and General Information). Within
this Article of the rules, the Exchange proposes to add new definitions
for terms that are used elsewhere in the rules.\111\ The Exchange also
seeks to add two new sections--one new rule that lists and defines
types of orders and conditions and one new rule that confirms that all
times identified in the rules are Central Time unless otherwise
indicated.\112 \
---------------------------------------------------------------------------

    \111\ These newly-defined terms include ``Act'' and ``Exchange
Act,'' ``Amex,'' ``BBO,'' ``CHX,'' ``CHX Holdings,'' ``institutional
broker,'' ``NBBO,'' ``Nasdaq,'' ``NYSE,'' ``primary market,'' ``Rule
10a-1 and Regulation SHO,'' ``rules,'' and ``Securities Act.'' The
Exchange's BBO would be the best bid or offer displayed in the
Exchange's Matching System. The NBBO would be described in reference
to the definition used in Rule 600(b)(42) of Reg. NMS. The ``primary
market''--a term used largely to determine the execution price of
opening cross orders--would mean, unless otherwise designated by the
Exchange, the initial listing market for a security. References to
the Exchange's Rules would include the rules of the Exchange that
have been adopted by the Exchange's Board of Directors and that have
either been approved by the Commission or become effective pursuant
to Section 19(b)(3) of the Act. The Exchange proposes to delete the
definitions of ``floor'' and to delete references to the trading
floor from the ``trading facilities'' definition to reflect the fact
that the Exchange will not be operating a physical trading floor in
the new model.
    \112\ See CHX Article 1, Rules 2 and 3. The order types and
conditions set out in Rule 2 primarily are those that are accepted
by the Exchange's Matching System and described in CHX Article 20,
Rule 4. A few new definitions were added to clarify basic
information such as the definition of ``odd lot,'' ``round lot'' and
``mixed lot.'' See CHX Article 1, Rules 2(w) (odd lot), 2(cc) (round
lot) and 2(r) (mixed lot).
---------------------------------------------------------------------------

    2. CHX Article 2. (Committees). The proposed changes to this
Article eliminate references to the Exchange's trading floor and to the
Exchange's current Committee on Specialist Assignment and
Evaluation.\113\ Under the proposed new model, the Exchange would no
longer have specialists who are responsible for handling orders in each
issue and thus there is not a need to have a committee to assign
securities and evaluate specialist performance. The proposed changes
also would confirm that the Committee on Exchange Procedure would
consist of not less than seven participants, without specifying the
specialized roles in which those persons must serve.\114\
---------------------------------------------------------------------------

    \113\ See CHX Article 2, Rule 5 (removing references to the
trading floor and to the Committee on Specialist Assignment and
Evaluation); Rule 6 (deleting the description of the role of the
Committee on Specialist Assignment and Evaluation); and Rule 10
(deleting references to the Exchange's trading floor).
    \114\ See CHX Article 2, Rule 5 (removing a requirement that
three of the Committee members be active on the Exchange's Floor as
specialists, odd-lot dealers or floor brokers). The Exchange
believes that, with its move the new trading model, it is no longer
appropriate to mandate that Committee members trade in certain
capacities and not others.
---------------------------------------------------------------------------

    3. CHX Article 3. (Participants). The primary substantive changes
in this Article are designed to streamline the process of obtaining a
trading permit on the Exchange. Under the Exchange's current rules, the
Exchange's staff makes a preliminary determination about an applicant's
qualifications and then posts the applicant's name to permit other
participants to submit any objections to that applicant's desire to
trade on the Exchange. The Exchange believes that this posting process
is not a necessary component of the application process--indeed, it
appears to relate back to a time when information about a firm's prior
business dealings might best be learned by talking with others in the
business community. The electronic databases of information that are
available today eliminate the need for this sort of process.\115\
---------------------------------------------------------------------------

    \115\ See CHX Article 3, Rules 3 and 4. Other changes to the
application process would confirm that, with the posting process
eliminated, Exchange staff would make the initial determination on
each application for a trading permit. These changes also would
refer applicants to a new CHX Article, CHX Article 15, for a single
set of procedures for seeking review of Exchange decisions, such as
the denial of a trading permit.
---------------------------------------------------------------------------

    There are three other groups of proposed changes within CHX Article
3. In CHX Rule 1, the Exchange seeks to eliminate the definitions that
identify when a participant is engaging in a public securities
business--these definitions do not relate to any particular requirement
applicable to Exchange participants under the current rules. And, in
CHX Rule 2, the Exchange proposes to replace references to ``co-
specialists,'' ``floor brokers'' and ``registered market makers'' with
references to ``institutional broker representatives'' and ``market
maker traders,'' the terms used in CHX Articles 16 and 17 to refer to
the individuals who would have special registration on the Exchange in
the new model.
    One final change to CHX Article 3 would create a more detailed
limitation of liability provision that tracks similar provisions on
other markets.\116\ This provision would confirm that neither the
Exchange, nor its affiliates, nor any of the directors, officers,
committee members, officials, employees, contractors or agents of the
Exchange or its affiliates would be liable to participants or persons
associated with participants for any loss arising out of the use of the
facilities, systems, services or equipment provided by the Exchange or
for any loss associated with an interruption in, or in a failure or
unavailability of, of any such facilities, systems, services or
equipment, whether or not the loss resulted from negligence or other
unintentional errors omissions or from any other cause within or
without the Exchange's control.\117\ The provision would also confirm
that the Exchange makes no warranty as to results that might be
obtained by persons using the Exchange's facilities or services or any
data transmitted by or on behalf of the Exchange.\118\ Other changes to
this provision would bar a participant from instituting a legal
proceeding against the Exchange, its affiliates or their directors,
officer, committee members, officials, employees, contractors or agents
for actions taken or omitted in connection with the official business
of the Exchange, except to the extent that such actions or omissions
constitute violations of the Federal securities laws for which a
private right of action exists.\119\
---------------------------------------------------------------------------

    \116\ See ISE Rule 705(a) and CBOE Rule 6.7A.
    \117\ See the full text of this provision at CHX Article 3, Rule
8(a).
    \118\ See the full text of this provision at CHX Article 3, Rule
8(b).
    \119\ See CHX Article 3, Rule 8(c) for the complete text of this
provision. Importantly, this last provision would not apply to
appeals of disciplinary actions or other actions by the Exchange for
which an appellate right is provided by the rules.
---------------------------------------------------------------------------

    4. CHX Article 4. (Participant Firms). In this Article, the
Exchange seeks to eliminate references to its trading floor and to
floor brokers.\120\ It also proposes to change existing requirements
relating to the nominees and voting designees named on trading permits
to confirm that any person affiliated with a participant firm, not just
a general partner of the firm, who is acting as an institutional broker
representative or a market maker trader can be named as a nominee on a
trading permit.\121\ Similarly, the Exchange proposes to confirm that
any officer of a participant firm can be named as voting designee, not
just the firm's president or one of its

vice presidents.\122\ These changes are designed to reflect the fact
that participant firms are structured in various ways--some are
partnerships and others are not--and that the Exchange is concerned
with an individual's authority to act on behalf of the firm, not
whether he or she fits into a narrowly selected job title or role.\123\
---------------------------------------------------------------------------

    \120\ See CHX Article 4, Rules 4 and 15.
    \121\ See CHX Article 4, Rule 13(b).
    \122\ See CHX Article 4, Rule 13(c).
    \123\ Other proposed changes in this Article correct a
misspelling (CHX Rule 4) and clarify that participants do not
``own'' trading permits, they ``hold'' them. (CHX Rule 13(a)).
---------------------------------------------------------------------------

    5. CHX Article 5. (Access to the Exchange). Under the Exchange's
current rules, this Article (entitled ``Admission to Floor--
Communications'') contains rules describing visitor and employee access
to the trading floor, the making of announcements on the floor and the
connections that can be made to and from the Exchange's trading
floor.\124\ Because the Exchange would not operate a physical trading
floor in its new model, the Exchange proposes to delete these rules and
to replace them with rules that contemplate remote access to the
Exchange's automated trading systems. These proposed new rules would
begin by requiring that participants have reasonable procedures to
maintain the physical security of the equipment and systems used to
access the Exchange and to maintain an updated list of the persons who
can obtain access to the Exchange on the Participant's behalf.\125\
Another rule would confirm that, as a condition of obtaining access to
the Exchange, each participant agrees to pay Exchange fees, including
fees associated with the routing of orders to other markets.\126\
---------------------------------------------------------------------------

    \124\ One of these provisions, CHX Rule 4, contains a new
interpretation and policy that requires participants to provide
specific information to the Exchange about connections to, and
orders handled through, layoff vendors. The Exchange proposes to
move this provision to CHX Article 11, its new Books and Records
rule.
    \125\ See CHX Article 5, Rule 1.
    \126\ See CHX Article 5, Rule 2.
---------------------------------------------------------------------------

    One of the last proposed new rules in this Article would set out a
structure through which Exchange participants could provide non-
participant broker-dealers with access to the Exchange, through
clearing arrangements or otherwise.\127\ Under this proposed rule, this
type of sponsored access could be provided so long as the participant
sponsoring access (the ``sponsoring participant''), the non-participant
broker-dealer and the Exchange entered into appropriate agreements
confirming basic information about the roles and responsibilities of
the various parties. These agreements would confirm that: (1) All
orders submitted by the non-participant broker-dealer, and any
executions resulting from those orders, are binding in all respects on
the sponsoring participant; (2) the sponsoring participant is
responsible for all actions taken and fees incurred in connection with
any order submitted or transaction executed by the non-participant
broker-dealer; (3) in all matters relating to the non-participant's
access to the Exchange and its use of Exchange facilities, the Exchange
would communicate with the sponsoring participant and would not be
required to communicate with the non-participant at any time; (4) the
non-participant broker-dealer would have reasonable procedures to
maintain the physical security of the equipment used to access the
Exchange to prevent improper use of, or access to, the Exchange; and
(5) the sponsoring participant would indemnify and hold the Exchange
harmless from any liability, loss, claim or expense which the Exchange
may incur in connection with the agreement. The Exchange believes that
these provisions provide sufficient assurances to the Exchange, to
other participants using the Exchange's facilities and to the non-
participants themselves that non-participant broker-dealer access to
the Exchange's facilities would be subject to the same standards and
obligations that apply to participant access.\128\
---------------------------------------------------------------------------

    \127\ See CHX Article 5, Rule 3.
    \128\ For example, because the sponsoring participant confirms
that it is responsible for the non-participant's actions, the
Exchange can enforce compliance with its rules through actions taken
against the sponsoring participant. In addition, the non-participant
(like a participant) would be required to use reasonable procedures
to maintain the physical security of the equipment used to access
the Exchange and the Exchange would communicate with the participant
on all issues relating to the use of the Exchange's facilities.
---------------------------------------------------------------------------

    The final proposed rule in this Article would permit an appeal from
a Market Regulation Department decision to deny access to a participant
(or a non-participant broker-dealer) under any of the rules in the
Article. Any appeal from such a decision would be made pursuant to the
procedures set out in CHX Article 15.\129\
---------------------------------------------------------------------------

    \129\ See CHX Article 5, Rule 4.
---------------------------------------------------------------------------

    6. CHX Article 6. (Registration). In this Article, the proposed
rule changes would begin by confirming that individuals acting as
institutional broker representatives and market maker traders would be
required to register with the Exchange and successfully complete
certain written examinations.\130\ Other proposed changes would set out
more specific obligations relating to notifications that would need to
be made to the Exchange when a registered or associated person is
terminated and would require participant firms to notify the Exchange
of any firm-related event constituting a statutory
disqualification.\131\ Additional changes would update the firm
supervision rules to require participants to identify the person(s)
responsible for acting as supervisors; to recognize that supervisory
authority could be delegated and to establish the mechanism for doing
so; to provide that, in the absence of a specific designation, the
firm's general partner(s), president, chief executive officer or other
principal executive officer would be deemed to have supervisory
responsibility; to require firms to meet, at least annually, with staff
about compliance matters; and to require firms to establish internal
controls to assure that appropriate supervision is being
exercised.\132\ Other changes would require that a participant opening
a branch office file a Form BR with the Exchange (instead of Schedule E
to Form BD) and confirm that a participant must retain records that
identify the names of all persons who are designated as supervisory
personnel (and the dates for which those designations are effective)
for six years (the first two years in an easily accessible place).
Finally, the changes in this Article would add a new rule relating to
fingerprinting of Exchange staff and contractors and would incorporate
two rules that currently occur elsewhere in the Exchange's rules.\133\
---------------------------------------------------------------------------

    \130\ See CHX Article 6, Rules 2(b)(7) and 3.
    \131\ See CHX Article 6, Rule 2(e)-(f) and Interpretations and
Policies .03 and .04.
    \132\ See CHX Article 6, Rule 5(a) (various provisions relating
to the designation of persons with supervisory authority) and 5(c)
(internal controls and training). These obligations are similar to
those required by other SROs and would ensure that the Exchange's
participant firms are strengthening the work that they do to
supervise their registered and associated persons.
    \133\ See CHX Article 6, Rule 10 (fingerprinting) and Rules 8
and 9 (formerly, CHX Article VIII, Rule 16 and CHX Article VIII,
Rule 11). Under the proposed fingerprinting rule, the Exchange would
conduct fingerprint-based criminal records checks of all prospective
employees, as well as of independent contractors and temporary
employees who are expected to have access to Exchange facilities for
more than 10 days. The Exchange would similarly conduct checks of
persons who would have access to premises controlled by CHX
Holdings, when those premises are in the same building as Exchange
facilities. This proposed rule would codify the Exchange's current
practice of conducting these checks for prospective Exchange
employees and would extend that practice to independent contractors
and temporary workers who have more than fleeting access to Exchange
facilities, as well as to other persons who have access to certain
CHX Holdings premises.
---------------------------------------------------------------------------

    7. CHX Article 7. (Financial Responsibility and Reporting).\134\ In
this

Article, the proposed rule changes would delete references to
requirements that current apply to specialist firms and incorporate
three fee-related provisions that currently appear in other
Articles.\135\
---------------------------------------------------------------------------

    \134\ This Article previously was numbered CHX Article XI of the
Exchange's Rules. The marked version of the rules in this submission
compares the current CHX Article XI to the changes that would be
made as part of the Exchange's new trading model, including the
change in numbering. The provisions in current CHX Article VII have
been moved to new CHX Article 13, as described below.
    \135\ The specialist-related provisions that would be deleted
are shown in CHX Article 7, Rule 3. The three fee-related rules that
would be added to this section--so that all fee-related provisions
could be gathered as much as possible in one place--formerly were
CHX Article XIV, Rules 1 (fixing and paying fees); 10 (failure to
pay debts); and 11 (fees for participants in military service).
---------------------------------------------------------------------------

    8. CHX Article 8. (Business Conduct). As noted above, as part of
its new model filing, the Exchange has sought to better organize its
rules. Although there were some minor organizational changes in earlier
Articles, the proposed changes in CHX Article 8 are somewhat more
extensive.\136\ Importantly, though, CHX Article 8 does not contain any
completely new rule provisions; indeed, eleven of the sixteen proposed
rules in this CHX Article have not been changed at all.\137\ Instead,
the rules in this section were gathered from throughout the Exchange's
rulebook and, with three exceptions discussed below, are not
substantially modified.\138\
---------------------------------------------------------------------------

    \136\ To try to enhance a reader's ability to understand which
rules the Exchange proposes to keep in force, the Exchange shows the
reorganized rules as new text in the first section of Exhibit 5 and
the existing rule text as deleted text in the second section of
Exhibit 5. Some of these apparently deleted rules have not been
completely removed; instead, they have been moved to other CHX
Articles in the rulebook. See CHX Article VIII, Deleted Rules 3, 7,
9 and 17 (moved to CHX Article 9); Rules 8, 11 and 16 (moved to CHX
Article 12); and Rule 23 and 24 (moved to new CHX Article 14).
    \137\ See CHX Article 8, Rules 2 (formerly Rule 12); 3 (formerly
Rule 1); 4 (formerly Rule 5); 5 (formerly Rule 2); 8 (formerly Rule
18); 9 (formerly Rule 19); 11 (formerly Rule 25); 12 (formerly CHX
Article XV, Rule 3); 13 (formerly CHX Article XIII); 14 (formerly
CHX Article XXXIII) and 15 (formerly CHX Article XV, Rule 1).
    \138\ Small modifications include changes that would delete
references to the trading floor, eliminate obsolete provisions or
clarify wording. See CHX Article 8, Rule 1 (replacing the reference
to ``constitution'' with a reference to the Exchange's ``bylaws''
and deleting the unnecessary word ``Firm'' in the first few words of
the text); Rule 7 (eliminating references to non-participants on the
trading floor and to employees of banks, insurance companies and
other corporations); and Rule 8 (eliminating references to floor
employees).
---------------------------------------------------------------------------

    The existing version of CHX Article VIII, Rule 21 extensively
details how one participant firm must coordinate with another
participant in the transfer of customer accounts. Because the Exchange
is not the designated examining authority for any firm that carries
participant accounts, the Exchange believes that this detailed
recitation of account transfer procedures is not a necessary component
of its rules. Instead, the Exchange proposes to adopt, in CHX Article
8, Rule 10, rule language similar to that used by other markets that
have similarly constrained examining responsibilities.\139\ Also, the
Exchange has proposed revisions to CHX Rule 16 that would make the text
relating to its policy against harassment and other conduct rules
applicable, once the Exchange no longer operates a trading floor, to
conduct that occurs on Exchange premises, while conducting business on
the Exchange or when interacting with Exchange staff who are conducting
Exchange business.
---------------------------------------------------------------------------

    \139\ See PCXE Rule 9.19.
---------------------------------------------------------------------------

    The Exchange has proposed the deletion of several rules in the
existing CHX Article VIII. As an initial matter, the Exchange seeks to
delete CHX Article VIII, Rule 22 (Responsibility for Acts of Others),
which identifies supervisory obligations that are much like those being
added to CHX Article 6, Rule 5, as described above. Other provisions
that would be deleted appear to be unnecessarily duplicative of
existing Exchange authority or of provisions that are being retained or
seem otherwise unnecessary for the regulation of the automated market
which the Exchange will operate.\140\
---------------------------------------------------------------------------

    \140\ See e.g., CHX Article VIII, Rule 4 (Upsetting Market
Equilibrium) and Rule 10 (Dealings on Market Price Fluctuations),
which address issues similar to those set out in other Exchange
rules, including CHX Article 9, Rule 11 (Price Manipulation). See
also CHX Article VIII, Rule 8 (unnecessarily confirming that a
participant, or a partner, officer, director or registered employee
of a participant firm that is found guilty of conduct inconsistent
with just and equitable principles of trade shall be expelled,
suspended or disciplined).
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    9. CHX Article 9. (General Trading Rules). The Exchange proposes to
reorganize CHX Article 9 in much the same manner as CHX Article 8.\141\
The proposed changes to CHX Article 9 include only three new rules--
relating to the reporting of transactions (including riskless principal
transactions) and to the use of a customer's give-up.\142\ Other
provisions have been gathered from the text of the existing CHX Article
IX and from other sections of the current rulebook and have been
modified primarily to remove references to the Exchange's trading floor
or to make other clarifications to the text.\143\
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    \141\ As above, the Exchange shows the reorganized rules as new
text in the first section of Exhibit 5 and the existing rule text as
deleted text in the second section of Exhibit 5.
    \142\ See CHX Article 9, Rules 13, 14 and 25. Proposed Rule 13
contains provisions that confirm that transactions on the Exchange
may occur only in the Matching System or through an institutional
broker and require institutional brokers to report all executions
that occur on the Exchange (except for transactions that occur
within the Matching System, because the Exchange has already stored
information about those transactions). Proposed CHX Rule 14 sets out
riskless principal trade reporting rules that are similar to those
put in place by other markets and could be used by institutional
brokers in their handling of customer orders. Most frequently,
however, the Exchange anticipates that its institutional brokers
would continue their current practice of acting on an agency, not
riskless principal, basis when representing orders in other markets.
Rule 14 confirms that the second, riskless principal leg of the
riskless principal transaction is not required to clear the Matching
System pursuant to CHX Article 20, Rule 7 and is not required to
yield to orders otherwise resident on the Exchange.
    \143\ See CHX Article 9, Rules 1 (moved from CHX Article XX,
Rule 1 and modified to state simply that the trading rules apply to
trading on the Exchange); 2 (moved from CHX Article VIII, Rule 7 and
modified to confirm that, even if not willful, a pattern or practice
of rule violations may be considered conduct inconsistent with just
and equitable principles of trade); 3 (moved from CHX Article XX,
Rule 4 and modified to eliminate obsolete references to Exchange
employees who are authorized to close contracts under the rule); 4
(moved from CHX Article IX, Rule 8); 5 (moved from CHX Article XX,
Rule 6); 6 (moved from CHX Article XX, Rule 8 and modified to
replace references to ``bids and offers'' with references to
``orders''); 7 (moved from CHX Article XXVII, Rules 1 and 2); 8
(moved from CHX Article XX, Rule 3); 9 (moved from CHX Article VIII,
Rule 3); 10 (moved from CHX Article XX, Rule 29); 11 (moved from CHX
Article IX, Rule 6 and modified to confirm that the rule applies to
both purchases and sales); 12 (moved from CHX Article IX, Rule 11);
16 (moved from CHX Article VIII, Rule 17); 17 (moved from CHX
Article IX, Rule 5 and modified (i) To confirm that a participant
may not execute an incoming order for its own account at a price
less than a penny better than an unexecuted customer limit order
that it is aware of or holding; (ii) to confirm that a participant
will be deemed to be holding or aware of an unexecuted customer
order when the order remains unexecuted in the Matching System; and
(iii) to clarify that a participant will not violate this provision
if it satisfies bids and offers in other markets at a price that is
better than the cross price of a customer order, in accordance with
the requirements for a ``cross with satisfy'' order); 18 (moved from
CHX Article XX, Rule 31 and modified to remove references to public
bidding and offering, as on the floor of the Exchange); 19 (moved
from CHX Article IX, Rule 1); 20 (combined from CHX Article IX,
Rules 2 and 9; CHX Article XX, Rule 32); 21 (moved from CHX Article
IX, Rule 4); 22 (combined from CHX Article IX, Rule 15 and CHX
Article XX, Rule 33; modified to eliminate references to the trading
floor); 23 (moved from CHX Article IX, Rule 17); and 24 (moved from
CHX Article VIII, Rule 9 and modified to eliminate the definition of
``Act'' because that definition is already contained in CHX Article
1 of the rules).
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    As in CHX Article VIII, the Exchange has proposed the deletion of
rules that are obsolete; that appear to be unnecessarily duplicative of
existing Exchange authority or of provisions that are being retained;
or that seem otherwise unnecessary for the regulation of the automated
market which the Exchange will operate. For example, the Exchange
proposes to delete its existing general books and records rule (CHX
Article IX, Rule 7) because it has been replaced by much more detailed
provisions in CHX Article 11. Similarly, the existing rule relating to
the business

days and hours of the Exchange (CHX Article IX, Rule 10) would be
replaced by the provisions of CHX Article 20, Rule 1, which contains
information (including the operating hours) associated with the
Matching System's trading sessions.\144\
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    \144\ Other rules that would be deleted include CHX Article IX,
Rule 10B (containing an obsolete rule relating to a stop order ban
based on a no-longer-existing NYSE rule on the same topic); Rule 12
(containing a broad prohibition on the circulation of rumors that
seems to be focused on a floor-based trading environment) and Rule
16 (relating to floor trading).
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    10. CHX Article 10. (Margins). The Exchange proposes to delete,
from this section of its rules, the provisions relating to any margin
requirements for specialists.\145\
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    \145\ See CHX Article 10, Rule 3(c)(6).
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    11. CHX Article 11. (Books and Records). This Article is an
entirely new Article that would include the four primary books and
records rule that apply to Exchange participants.\146\ Two of these
proposed rules contain provisions that already appear elsewhere in the
Exchange's current rules.\147\ One new rule--CHX Rule 2--would confirm
that Exchange participants must make and preserve all books, accounts,
records, memoranda and correspondence as required by applicable law,
including Commission rules and Exchange rules. Another new rule--CHX
Rule 1--would require that participants provide the Exchange with
access to books and records and must furnish requested financial and
transaction-related records to the Exchange upon request. The Exchange
believes that these new rules bolster the Exchange's ability to perform
its regulatory responsibilities.
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    \146\ The provisions in current CHX Article XI have been moved
to CHX Article 7 of the proposed set of rules.
    \147\ See Proposed CHX Rule 3 (incorporating text from CHX
Article XX, Rule 24) and Proposed CHX Rule 4 (moved from CHX Article
V, Rule 4).
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    12. CHX Article 12. (Disciplinary Matters and Trial Proceedings).
The Exchange's proposal would make two primary changes to this CHX
Article.\148\ First, because the Exchange would not operate a trading
floor in the new trading model, the proposal would eliminate the
Exchange Procedure Committee's ability to take action against
participants with respect to trading floor and other on-site decorum
violations.\149\ The proposal also would eliminate, from the Minor Rule
Violation Plan, any rules that would otherwise be deleted by this
proposal.\150\
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    \148\ The Exchange has sought other changes to CHX Article 12,
and to other Exchange rules, as part of a pending rule filing, SR-
CHX-2005-06. When that proposal is approved, the Exchange will amend
this submission, if necessary, to incorporate any changes arising
from the other proposal.
    \149\ See CHX Article 12, deleted Rule 3.
    \150\ See e.g., CHX Article 12, Rule 8(h) (proposed deletion of
rules relating to the submission of the co-specialist survey, as
well as failure to comply with decorum and open outcry
requirements).
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    13. CHX Article 13. (Suspensions and Reinstatements). In this
Article, which previously was numbered CHX Article VII, the Exchange
proposes one substantive change.\151\ As an initial matter, the
Exchange seeks to add new text that would allow the Exchange to use its
emergency suspension authority whenever a participant firm that is
registered as an institutional broker or market maker has failed to
perform, or is failing to perform, any material responsibility imposed
on the participant because of that role and, as a result, cannot be
permitted to continue in business with safety to its customers or
creditors or to the Exchange.\152\ The Exchange believes that it is
important to extend its suspension authority in this manner to allow
the Exchange to address egregious circumstances that might arise
because of an institutional broker's or market maker's failure to meet
the obligations that arise because of its specialized role in the
market.
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    \151\ The advertising requirements of CHX Article XIII have been
moved to CHX Article 8, Rule 14.
    \152\ See CHX Article 13, Rule 2.
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    14. CHX Article 14. (Arbitration). Under the Exchange's proposal,
this Article would consist of Rules 23 and 24 from former CHX Article
VIII. The Exchange does not propose any substantive changes to these
provisions, although it has re-numbered provisions to make them
somewhat more consistent with the other sets of rules.\153\ Also, in
Section 31 of Proposed CHX Rule 2, the Exchange has replaced a
reference to an effective date that was ``after 120 days have elapsed
from the date of Commission approval of this Rule'' with a reference to
the appropriate specific date, January 5, 1990.
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    \153\ The current provisions of CHX Article XIV (``Fiscal
Policies'') were either transferred to CHX Article 7 (``Financial
Responsibility and Reporting'') or would be deleted as no longer
necessary in the new trading model.
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    15. CHX Article 15. (Hearings and Reviews).\154\ The Exchange
currently has several disparate provisions that permit participants to
seek review of an Exchange decision. These provisions often do not
define the specifics associated with any hearing or review; they
sometimes (but not always) permit further review by the Board. This new
Article is designed to consolidate many of these provisions into one
section that can be uniformly applied to Exchange decisions that do not
involve disciplinary matters or appeals from arbitration
decisions.\155\
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    \154\ The current text of CHX Article XV (``Commissions'') has
either been moved to other CHX Articles (e.g., CHX Article XV, Rule
5 has been moved to CHX Article 22) or it has been deleted.
    \155\ See CHX Article 15, Rule 1.
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    Among other things, this new Article would provide details about
requesting a hearing (which must be done within 30 days of the initial
decision at issue, unless an extension of time is granted); the
appointment of the hearing panel (which would be the entire Executive
Committee, unless the Committee chooses to appoint a panel of five of
its members to hear a matter); requesting extensions of time;
submitting documents and witness lists (which ordinarily must be done
at least 72 hours before the start of the hearing); the notice of
hearing; the conduct of the hearing (during which all parties may be
represented by counsel and the formal rules of evidence would not
apply); the parameters of the decision that would be reached (for
example, the decision would be in writing and ordinarily distributed
within 90 days after the end of the hearing or the submission of post-
hearing briefs, whichever is later); and seeking further review of the
decision (which can be done by either party, within 30 days, or by the
Board on its own motion).\156\ Throughout these proposed rules, the
Exchange has sought to provide a central set of rules for these
hearings which is similar to, but more expansive than, the various
provisions scattered throughout the existing rulebook.
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    \156\ See CHX Article 15, Rule 2 (submission of requests for
hearing); Rule 3 (requests for hearings on emergency actions); Rule
4 (hearing panel); Rule 5 (extensions of time); Rule 6 (submissions
of supporting materials); Rule 7 (notice of hearing); Rule 8
(conduct of hearing); Rule 9 (decision); and Rule 10 (seeking review
of that decision).
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    16. CHX Article 19. (ITS). This Article contains the ITS-related
rules applicable to the Exchange's participants. The Exchange has
proposed only a few changes to these rules. The most substantive change
to this section of the rulebook confirms that the Exchange's Matching
System will accept and execute inbound ITS commitments on behalf of its
participants.\157\ This change recognizes the much more automated
nature of the trading that will occur on the Exchange in the new
trading model. Other proposed changes to the rules highlight the
sections that will be deleted on the effective date of the NMS Linkage
Plan among various exchanges--these sections include the

provisions relating to the Preopening Application, the Locked Markets
requirements and the Block Trade Policy.\158\ Other changes to the ITS
rules eliminate references to the Exchange's trading floor and to rules
that are being deleted as part of the implementation of the new trading
model.
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    \157\ See CHX Article 19, Rule 1(b)(4). The proposed changes
confirm that the Matching System will execute ITS commitments as set
out in CHX Article 20 of the Exchange's rules.
    \158\ The Exchange will file a proposal, nearer the effective
date of the NMS Linkage Plan, to formally propose the deletion of
these sections.
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    17. CHX Article 21. (Clearance and Settlement). In this new
Article, the Exchange seeks to incorporate all of the rules that it
believes would be necessary in connection with the clearance and
settlement of transactions in the new trading model. These rules have
been gathered from various existing CHX Articles; the section does not
include any entirely new rules, although a few rules have been modified
to eliminate references to the trading floor.\159\ Among other things,
this proposed new Article would require participants to maintain
accounts with a qualified clearing agency, or with another participant
that has such an account, for the recording of transactions on the
Exchange.\160\ The proposed Article would also confirm that the
Exchange may extend or postpone the time for performance of contracts
when required by just and equitable principles of trade or to meet
unusual conditions.\161\
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    \159\ The Exchange has updated the definition of ``registered
clearing agency'' to confirm that it means a clearing agency which
is registered with the Commission pursuant to the provisions of
Section 17(A)(b)(2) of the Act or has obtained from the Commission
an exemption from registration granted specifically to allow the
clearing agency to provide confirmation and affirmation services.
See CHX Article 21, Rule 1, Interpretation and Policy .01.
    \160\ This rule--and a related rule relating to book-entry
settlement--currently are found in CHX Article XXII, Rule 3 and CHX
Article XXI, Rule 4 of the Exchange's rules.
    \161\ See CHX Article 21, Rule 3 (formerly, CHX Article XXII,
Rule 1). As a final matter, this provision would allow the Exchange
to continue to provide services, including back-office clearing
work, for participants. See CHX Article 21, Rule 4 (formerly, CHX
Article XXI, Rule 13).
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    18. CHX Article 22. (Listing). This Article is numbered CHX Article
XXVIII in the Exchange's current rules.\162\ The proposed changes in
this section would delete references to the Exchange's specialist
firms; correct a telephone number and a typographical error; eliminate
references to the Exchange's trading floor; and more accurately
describe the work done by Exchange staff in connection with its
surveillance of trading in exclusively listed securities.\163\ No other
changes to the Exchange's listing rules are contemplated in connection
with the proposed new trading model.
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