

[Federal Register: May 12, 2006 (Volume 71, Number 92)]
[Notices]               
[Page 27758-27762]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12my06-113]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53772; File No. SR-CHX-2004-38]

 
Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Order Granting Approval To Proposed Rule Change and Amendment Nos. 1 
and 2 Thereto and Notice of Filing and Order Granting Accelerated 
Approval to Amendment Nos. 3 and 4 Thereto Relating to Records of 
Orders and Executions

May 8, 2006.

I. Introduction

    On November 3, 2004, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend CHX Article XX, Rule 24 to require on-
floor participants to electronically record specific details about 
orders originating on or off the floor of the Exchange for execution on 
the Exchange, as well as orders issued from the floor of the Exchange 
to any other market or trading venue. On July 3, 2005 and September 8, 
2005, the

[[Page 27759]]

Exchange filed Amendment Nos. 1 \3\ and 2 \4\ to the proposed rule 
change, respectively. The proposed rule change, as amended by Amendment 
Nos. 1 and 2, was published for comment in the Federal Register on 
November 18, 2005.\5\ The Commission received no comments on the 
proposal, as amended by Amendment Nos. 1 and 2. On December 13, 2005, 
the CHX filed Amendment No. 3 to the proposed rule change.\6\ On May 3, 
2006, the CHX filed Amendment No. 4 to the proposed rule change.\7\ 
This order approves the proposed rule change, as amended by Amendment 
Nos. 1 and 2; grants accelerated approval to Amendment Nos. 3 and 4 to 
the proposed rule change; and solicits comments from interested persons 
on Amendment Nos. 3 and 4.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Amendment No. 1 dated July 3, 2005.
    \4\ See Amendment No. 2 dated September 8, 2005.
    \5\ See Securities Exchange Act Release No. 52766 (November 10, 
2005), 70 FR 70002 (``Notice'').
    \6\ See Amendment No. 3 dated December 12, 2005. Amendment No. 3 
clarified that while the Exchange's systems are the only systems 
currently recognized by the Exchange for the collection and 
recording of the required information, Exchange participants 
ultimately could develop their own systems for collecting and 
recording that information so long as the systems provide the data 
in a format acceptable to the Exchange; the Brokerplex[supreg] 
system is available to all floor participants who request the system 
and pay any applicable fees; and the Exchange is making changes to 
its existing Brokerplex[supreg] system to permit this proposal to be 
implemented. Brokerplex[supreg] is the Exchange's floor broker order 
management system that can be used by CHX floor brokers to manage 
their orders, route orders to the Exchange's co-specialists for 
execution, and report executed trades. It is not an order execution 
system, although it can send orders to the CHX's MAX[supreg] system. 
See infra note 15 (describing the MAX[supreg] system). The 
Commission notes that the Exchange does not currently impose a 
separate fee for use of the Brokerplex[supreg] system, and to the 
extent that the Exchange ever contemplates imposing such a fee it 
would need to file a rule change with the Commission under Section 
19(b) of the Act and Rule 19(b)(4) thereunder.
    \7\ See Amendment No. 4 dated May 3, 2006. In addition to 
clarifying changes to the rule text, Amendment No. 4 adds 
Interpretation and Policy .10 to the proposed rule to specify a 
compliance date of May 8, 2006 by which the Exchange's on-floor 
participants must comply with the rule. In addition, Amendment No. 4 
confirms that the Exchange's systems will permit a floor broker, 
when identifying the side of the market on which an order is 
received, to attach a special designation to a cross order (which 
will be attached to the side of the market designation in field 
(b)(6)) when, on account of the customer's instructions and to the 
extent permitted by the Exchange's rules, that order cannot be 
immediately executed. Amendment No. 4 also clarifies Interpretation 
and Policy .02 to specify that records must be kept pursuant to the 
proposed rule change for orders delivered orally or telephonically 
to a specialist at the post. Finally, in Amendment No. 4, the 
Exchange represented that (1) it will notify its participants that 
they should notify the Exchange if they believe that an Exchange 
system does not permit them to enter all of the information required 
by the proposed rule, as permitted by Interpretation and Policy .05; 
(2) it will consider further changes to CHX Rule 24 in response to 
changes to Commission or Exchange rules; and (3) it believes that 
with respect to immediately executed orders, it receives all of the 
information necessary to conduct surveillance through the 
information required under Interpretation and Policy .07 and other 
Exchange systems.
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II. Description of the Proposal

    Under the proposed rule change, the Exchange proposes to require 
its floor participants to provide particular data about all orders 
originating on or off the floor of the Exchange for execution on the 
Exchange, as well as all orders issued from the floor of the Exchange 
to any other market or trading venue.\8\ Specifically, the Exchange 
proposes to require floor participants to record, in electronic systems 
designated by the Exchange, the following details about each covered 
order: (1) The symbol of the security; (2) the clearing participant; 
(3) an order identifier that uniquely identifies the order; \9\ (4) the 
identity of the participant recording the order details; (5) the number 
of shares or quantity of the security; (6) the side of the market; (7) 
a designation of the order type (e.g., market, limit, stop, stop 
limit); (8) whether the order is agency or professional; \10\ (9) 
whether the order is being handled pursuant to Section 11(a)(1)(G) of 
the Act and any applicable rules thereunder; (10) whether the order is 
short or short exempt; (11) whether the order is a bona fide arbitrage 
order; (12) any limit price and/or stop price; (13) the date and time 
of order receipt or transmission (as applicable); (14) the market, off-
floor firm, or on-floor participant to which the order was transmitted 
or from which the order was received (if applicable); (15) the order's 
time in force; (16) designation as held or not held; (17) any special 
conditions or instructions (e.g., any customer display or do-not-
display instructions or any all-or-none conditions); (18) any 
modifications that are made to the details set out in (1) through (17) 
above or (20) below, for all or part of the order, or any cancellation 
of all or part of the order; (19) the date and time of receipt or 
transmission of any modifications to, or cancellation of, the order; 
(20) the date and time of any order expiration; (21) the identity of 
the party cancelling or modifying the order; (22) the transaction 
price, if applicable; (23) the number of shares executed, if 
applicable; (24) the date and time of execution, if applicable; (25) 
the contra party to the execution (if applicable); (26) the settlement 
instructions associated with the order, if applicable; (27) system-
generated time(s) of recording required information; and (28) any other 
information that may be required by the Exchange from time to time.\11\ 
Floor participants would be required to record this information 
immediately after that information is received or becomes 
available.\12\
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    \8\ The Exchange represents that this proposal is consistent 
with recommendations made by the independent consultant retained by 
the Exchange under its recent settlement agreement with the 
Commission. See Securities Exchange Act Release No. 48566 (September 
30, 2003), Administrative Proceeding File No. 3-11282. See also 
Notice, supra note 5, at note 13.
    The Commission notes that the Exchange recently amended CHX 
Article V, Rule 4 to prohibit Exchange participants from using any 
communications means to send orders to another market for execution 
(``layoff service''), unless that layoff service has established a 
process for providing the Exchange with specific information about 
the orders and the executions that participants receive. See 
Securities Exchange Act Release No. 52534 (September 29, 2005), 70 
FR 58500 (October 6, 2005) (SR-CHX-2004-25). In addition, the 
Exchange has represented that the Exchange's staff will present to 
the Exchange's Board of Directors a separate rule that confirms the 
record-keeping obligations of its off-floor participants. See 
Notice, supra note 5, at note 16.
    \9\ This order identifier does not change when modifications are 
made to the order, or when it is cancelled, allowing any changes to 
be tracked back to the original order.
    \10\ The Exchange's rules define a ``professional'' order as one 
that is for the account of a broker-dealer, the account of an 
associated person of a broker-dealer, or any account in which a 
broker-dealer or an associated person of a broker-dealer has any 
direct or indirect interest. See CHX Article XXX, Rule 2, 
Interpretation and Policy .04.
    \11\ See CHX Article XX, Proposed Rule 24(b).
    \12\ See CHX Article XX, Proposed Rule 24(c).
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    In addition, proposed new Interpretations and Policies .01 to .09 
to CHX Article XX, Rule 24 contain additional guidance on the 
information that participants would be required to record and preserve. 
Among other things, the interpretations establish the scope of the 
proposed rule and specify the exclusion from the proposed rule for 
principal trading by a co-specialist, market maker, or floor 
broker.\13\ In addition, the interpretations note that participants 
will not be required to record information with respect to orders sent 
or received through the Exchange's MAX[supreg] system \14\ or through 
any other electronic systems that the Exchange recognizes as providing 
the required information in an acceptable format, and further sets out 
limited

[[Page 27760]]

exceptions to the data-recording requirements.\15\
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    \13\ See CHX Article XX, Proposed Rule 24, Interpretation and 
Policy .02; and Amendment No. 4, supra note 7 (Interpretation and 
Policy .02 states that ``Except for orders delivered orally or 
telephonically to a specialist at the post, a decision by a co-
specialist, market maker or floor broker to buy or sell securities 
for his or her own account on the Floor of the Exchange shall not 
constitute an order for which a record much be made under this 
Rule.''). The Exchange has represented that this exception is 
designed to recognize that all necessary information about a floor 
participant's own trading is already captured by the Exchange's 
reporting systems. See Notice, supra note 5, at note 11.
    \14\ MAX[supreg] is the Exchange's electronic execution system.
    \15\ See Proposed Interpretations and Policies .04 (regarding 
orders sent and received through certain systems), .05 (regarding 
orders that the Exchange expressly recognizes as incompatible for 
entry into an Exchange system), .06 (regarding bona fide arbitrage 
orders and orders to offset a transaction made in error); and .07 
(regarding cross orders that are immediately executed). Proposed 
Interpretation and Policy .09, however, reminds participants that 
the provisions of proposed CHX Rule 24 do not replace any record 
retention obligations to which a participant may be subject under 
the Act.
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III. Discussion and Commission Findings

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\16\ In particular, the Commission believes that the proposal 
is consistent with section 6(b)(5) of the Act,\17\ which requires that 
the rules of an exchange be designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest.
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    \16\ In approving this proposed rule change, as amended, the 
Commission notes that it has considered the proposed rule's impact 
on efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
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    The purpose of the Exchange's proposed rule change is to require 
the Exchange's floor participants to enter order-related information 
into an electronic data capture system to facilitate automated 
surveillance of market activity by the Exchange.\18\ For example, CHX 
floor brokers have traditionally accepted orders from a variety of 
sources, some of which may not involve the creation of an electronic 
audit trail (e.g., orders taken over the telephone). In these cases, 
only the execution information would be captured electronically, and 
thus be able to be searched in an electronic form by the Exchange's 
market regulation personnel. Non-execution information relating to the 
original order (e.g., time of order receipt) is available currently 
only from the paper order ticket. By requiring the electronic capture 
of this information, the Exchange would be able to use the data 
obtained from the proposed rule change in surveillance reports relating 
to, for example, best execution, front-running surveillance, order 
execution priority, manipulative activity, and trade reporting.
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    \18\ See Letter from David C. Whitcomb, Jr., Senior Vice 
President and Chief Regulatory Officer, CHX, to Sharon Lawson, 
Senior Special Counsel, Division of Market Regulation, Commission, 
dated June 27, 2005.
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    Further, the Exchange's proposed rule change is intended to address 
recommendations made in the Exchange's 2003 settlement agreement with 
the Commission.\19\ In the settlement agreement, the Commission cited 
the Exchange's failure, with respect to its specialist firms, ``to 
detect and prevent a large number of trading rule violations, in part, 
because [the Exchange] did not have adequate surveillance systems to 
detect possible violations.'' \20\ In addition, the Commission found 
that the CHX had ``relied on ineffective and often flawed manual 
processes to detect violations * * *'' \21\ Pursuant to the settlement 
agreement, the Exchange undertook to engage a consultant to conduct a 
comprehensive review of, among other things, its trading floor 
surveillance to ascertain whether its trading floor surveillance is 
appropriately designed and implemented to promote and enforce 
compliance with the federal securities laws and CHX and Commission 
rules.
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    \19\ See Securities Exchange Act Release No. 48566 (September 
30, 2003) (Administrative Proceeding File No. 3-11282), available 
at: http://www.sec.gov/litigation/admin/34-48566.htm.

    \20\ Id.
    \21\ Id.
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    The Commission believes that the Exchange's proposed rule change, 
as amended, to require Exchange participants to enter order-related 
information into an electronic data capture system is consistent with 
the Exchange's settlement agreement with the Commission. Specifically, 
the Commission believes that the proposed rule change, as amended, 
should allow the Exchange to maintain a more automated process for 
receiving a comprehensive set of audit trail data on its floor 
participants' trading activity and thereby allow the Exchange to 
integrate more audit trail data into its surveillance systems. 
Increased automation with respect to the receipt of order details 
should, in turn, allow the Exchange to perform more automated 
surveillance and generate better surveillance reports. In addition, the 
Commission believes that the proposal will improve the Exchange's 
ability to review its participants' order-handling activities and to 
determine their compliance with applicable trading rules, including, 
for example, short sale position marking and tick test 
requirements,\22\ best execution,\23\ and trading ahead 
prohibitions.\24\
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    \22\ See 17 CFR 240.10a-1.
    \23\ See, e.g., CHX Article XX, Rule 10.
    \24\ See CHX Article XXX, Rules 2 and 3.
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    Further, the Commission notes that proposed Interpretation and 
Policy .05, which would allow the Exchange to identify specific types 
of orders that might be exempt from the data-recording requirements 
when they are incompatible for entry into Exchange systems, is designed 
to cover only those rare situations where, due to unexpected 
consequences of unrelated systems changes or a software failure, CHX 
participants cannot enter data about a particular type of order into 
the Exchange's systems for a limited period of time. The Commission 
notes that this exception is not intended to allow participants to 
avoid the recording requirements of the rule, and does not relieve a 
participant from its recordkeeping obligations under the Exchange's 
rules and applicable federal securities laws. The Commission notes that 
the Exchange has represented that it would work with participants to 
correct quickly any software or systems problems that precipitated the 
system incompatibility.\25\ Furthermore, the Exchange will notify its 
participants that the participants should notify Exchange personnel 
when a system incompatibility arises that is covered by proposed 
Interpretation and Policy .05.\26\
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    \25\ See Notice, supra note 5, at note 14.
    \26\ See Amendment No. 4, supra note 7.
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    With respect to proposed Interpretation and Policy .04, which 
recognizes that participants are not required to record information 
that is already captured by the Exchange's systems or by other systems 
that the Exchange expressly recognizes as providing the required data 
in an acceptable format, the Commission notes that the Exchange has 
represented that its MAX[supreg] system already captures all of the 
information required by the proposed rule change.\27\ The Commission 
also notes that the Exchange has represented that it retains records 
associated with its MAX[supreg] system for the applicable record 
retention period.
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    \27\ See Notice, supra note 5, at note 14.
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    With respect to proposed Interpretation and Policy .07, which 
permits a participant to record only certain information for orders to 
buy and sell the same security that are executed in full immediately 
upon receipt, the Commission notes that the Exchange has represented 
that Interpretation and Policy .07 to the proposed rule change reflects 
the Exchange's belief that it will receive all of the information 
necessary to conduct surveillance with respect to orders to buy and 
sell the same security that are

[[Page 27761]]

executed in full immediately upon receipt through a combination of 
Interpretation and Policy .07 and other information captured within the 
Exchange's system.\28\ In particular, the Commission notes that the 
Exchange's order management systems utilize an account-based approach 
in which principal transactions are entered through a principal trading 
account that is separate from the broker's agency account, and that the 
Exchange's surveillance reports are able to distinguish between a 
broker's principal and agency trades.\29\ Further, the Exchange has the 
ability to request information from its clearing participants in the 
event that the Exchange requires information about the customers 
involved in a certain transaction where a customer did not serve as the 
clearing participant to its own order.\30\
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    \28\ See Amendment No. 4, supra note 7.
    \29\ See Letter from David C. Whitcomb, Jr., Senior Vice 
President and Chief Regulatory Officer, CHX, to Sharon Lawson, 
Senior Special Counsel, Division of Market Regulation, Commission, 
dated April 26, 2006.
    \30\ Telephone conversation between Ellen J. Neely, President 
and General Counsel, CHX, and Richard Holley III, Special Counsel, 
Division of Market Regulation, Commission, on May 3, 2006.
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    Based on the above, the Commission finds that the Exchange's 
proposed rule change is consistent with the Exchange's settlement 
agreement with the Commission.\31\ Further, the Commission finds that 
the Exchange's proposal to require the electronic capture of audit 
trail data in order to enhance surveillance for compliance with CHX's 
rules, the Act, and the rules thereunder is consistent with the 
requirements of Section 6(b)(5) of the Act,\32\ which requires that the 
rules of an exchange be designed to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. The Commission believes that approving the proposal 
will help to enhance and strengthen the Exchange's surveillance program 
by providing the Exchange with the data necessary to conduct more 
thorough and efficient surveillance of its participants' trading 
activities, and should thereby promote just and equitable principles of 
trade and further the protection of investors and the public interest. 
The Commission notes that the detailed information required to be 
obtained will not replace any record retention obligations already 
required of CHX participants under the Act and the rules thereunder.
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    \31\ See supra note 19.
    \32\ 15 U.S.C. 78f(b)(5).
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Accelerated Approval of Amendment Nos. 3 and 4

    The Commission finds good cause for approving Amendment Nos. 3 and 
4 to the proposed rule change prior to the thirtieth day after the 
amendment is published for comment in the Federal Register pursuant to 
Section 19(b)(2) of the Act.\33\ In Amendment No. 3, the Exchange 
merely clarified that (1) participants could develop their own systems 
for collecting and recording required data in a format acceptable to 
the Exchange; (2) Brokerplex[supreg] is available to any participant; 
and (3) the Exchange is implementing changes to the Brokerplex[supreg] 
system to incorporate the requirements of this proposed rule change. In 
Amendment No. 4, the Exchange merely modified its proposed rule change 
to accommodate an order designation currently used by its floor brokers 
that permits a floor broker to attach a special designation to a cross 
order when, on account of the customer's instructions and to the extent 
permitted by the Exchange's rules, the cross order cannot be 
immediately executed, as well as set May 8, 2006 as the compliance 
date.\34\ In addition, the Exchange made, in part, certain 
clarifications and representations regarding the operation and 
implementation of the proposed rule, and the ability of the Exchange to 
gather sufficient surveillance information.
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    \33\ 15 U.S.C. 78s(b)(2).
    \34\ The special designation would be attached to the side of 
the market identifier. See proposed CHX Article XX, Rule 24(b)(6). 
The floor broker would be required to complete all other fields 
required by proposed CHX Article XX, Rule 24. In addition, this 
special designation does not alter a participant's obligations with 
respect to the execution of orders; if a cross transaction can be 
immediately executed in accordance with a customer's instructions 
and applicable rules, it should be immediately executed. See 
Amendment No. 4, supra note 7.
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    The Commission believes that Amendment No. 3 appropriately reflects 
that changes to the Brokerplex[supreg] system are being implemented in 
connection with the proposed rule change. In addition, the Commission 
believes that Amendment No. 4 implements a reasonable compliance date 
for the proposed rule change, as amended, since the Exchange has been 
holding biweekly meetings with its participants to educate them about 
the requirements of the proposed rule change. Furthermore, the 
Commission believes that the other changes made to the proposed rule 
change in Amendment No. 4, as described above, merely accommodate the 
functionality currently employed by floor brokers, acknowledge the 
ability of the Exchange to obtain surveillance information, clarify 
that records must be kept pursuant to the proposed rule for orders 
delivered orally or telephonically to a specialist at the post, and 
describe other responsibilities of the Exchange under the proposed rule 
change, as amended. Accordingly, the Commission believes that good 
cause exists, consistent with Section 19(b) and Section 6(b)(5) of the 
Act, to accelerate approval of Amendment Nos. 3 and 4 in order to allow 
the Exchange to implement the proposal immediately.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment Nos. 3 
and 4 to the proposed rule change is consistent with the Act. Comments 
may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-CHX-2004-38 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-CHX-2004-38. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, all 

written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying

[[Page 27762]]

information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CHX-2004-38 and should be submitted on or before June 2, 
2006.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities exchange.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\35\ that the proposed rule change (SR-CHX-2004-38) and Amendment 
Nos. 1 and 2 thereto are approved, and that Amendment Nos. 3 and 4 
thereto are approved on an accelerated basis.
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    \35\ 15 U.S.C. 78s(b)(2).
    \36\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\36\
Nancy M. Morris,
Secretary.
[FR Doc. E6-7257 Filed 5-11-06; 8:45 am]

BILLING CODE 8010-01-P
