[Federal Register Volume 65, Number 104 (Tuesday, May 30, 2000)]
[Notices]
[Pages 34513-34515]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13413]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42807; File No. SR-ISE-00-03]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 1 by the International Securities Exchange LLC Relating 
to Block and Facilitation Trades

May 22, 2000.

I. Introduction

    On February 25, 2000, the International Securities Exchange LLC 
(``ISE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 29b-4 
thereunder,\2\ a proposed rule change relating to its proposed block 
order and facilitation mechanisms.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on March 6, 2000.\3\ The Commission received three comment 
letters regarding the proposal.\4\ On May 19, 2000, the ISE filed 
Amendment No. 1 to the proposed rule change.\5\ This order approves the 
proposed rule change. In addition, the Commission is publishing this 
notice to solicit comments on Amendment No. 1 and is simultaneously 
approving Amendment No. 1 on an accelerated basis.
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    \3\ Securities Exchange Act Release No. 42473 (February 29, 
2000), 65 FR 11818.
    \4\ See letters to Jonathan G. Katz, Secretary, SEC, from Holly 
H. Smith, Sutherland, Asbill & Brennan LLP, dated March 24, 2000 
(``SA&B Letter''); Peter J. Chepucavage, Fulbright 7 Jaworski 
L.L.P., dated March 28, 2000 (``Phlx Letter''); and Charles J. 
Henry, President and Chief Operating Officer, Chicago Board Options 
Exchange, dated March 31, 2000 ``CBOE Letter'').
    \5\ See letter from Katherine Simmons, Vice President and 
Associate General Counsel, ISE, to Deborah Flynn, Senior Special 
Counsel, Division of Market Regulation, SEC, dated May 19, 2000 
(``Amendment No. 1''). In Amendment No. 1, ISE proposes to delete a 
reference to ISE Rule 713 to eliminate a Primary Market Maker's 
participation right with respect to facilitation orders. ISE also 
proposes to clarify that members may enter indications at prices 
that improve the facilitation price if such improved price is 
inferior to the ISE best bid or offer.
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II. Description of the Proposal

    ISE Rule 716(c) establishes a ``block mechanism'' through which ISE 
members can obtain liquidity for the execution of block-size orders \6\ 
from market makers and other ISE members with orders at the ISE inside 
bid or offer (``Crowd Participants''). Similarly, ISE Rule 716(d) 
establishes a ``facilitation mechanism'' through which members can seek 
to facilitate block-size public customer orders. Upon the entry of an 
order into the block or facilitation mechanisms, a broadcast message is 
sent to the Crowd Participants.
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    \6\ For purposes of ISE rules only, block-size orders are orders 
for fifty contracts or more. See ISE Rule 716(a).
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    The proposed rule change contains several proposed revisions to 
existing ISE Rule 716. First, the ISE has proposed commentary to ISE 
Rules 716(c) and (d) with respect to the block order mechanism and the 
facilitation mechanism, specifying that participants will be given 30 
seconds to respond to a broadcast message from either the block or 
facilitation mechanism.
    Second, the ISE proposes to amend ISE Rule 716(d)(4)(i) to provide 
that only public customer bids (offers) on the Exchange at the time a 
facilitation order is executed that are priced higher (lower) than the 
facilitation price will be executed at the facilitation price, unless 
there is sufficient size to execute a facilitation order entirely at a 
better price. Higher bids and lower offers from non-customer orders and 
quotes will be executed at their stated price. The current rule 
provides non-customer orders and quotes the benefit of the facilitation 
or ``block clean-up'' price.
    Third, ISE is proposing amendments to ISE Rule 716(d)(4)(ii) \7\ to 
eliminate a Primary Market Maker's (``PMM'') participation right with 
respect to the allocation of orders entered into the facilitation 
mechanism by deleting a reference to ISE Rule 713.\8\ In other words, 
under ISE's proposed amendments to ISE Rule 716(d)(4)(ii), if a PMM is 
among the Crowd Participants with interest at the facilitation price, 
the PMM will be treated the same as all other Crowd Participants and 
not given a preferential allocation under ISE Rule 713.
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    \7\ See Amendment No. 1, supra note 5.
    \8\ ISE Rule 713 sets forth the PMM's allocation algorithm. See 
Securities Exchange Act Release No. 42808.
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    Finally, ISE is proposing to amend ISE Rule 716(d)(2) and (3) \9\ 
to clarify that a Crowd Participant may enter into the facilitation 
mechanism an indication at a better price than the facilitation price, 
but only if such better price is inferior to the ISE best bid or offer. 
If a Crowd Participant wishes to enter an indication at a price equal 
to or better than the ISE best bid or offer, the Crowd Participant may 
do so only by changing its quote or entering an order, so that

[[Page 34514]]

such interest will be disseminated to the public.
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    \9\ See Amendment No. 1, supra note 5.
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III. Summary of Comments

    The Commission received three comment letters on the proposal. \10\ 
These commenters opposed ISE's proposed rule change, as originally 
proposed.\11\ Commenters argued that the proposed 30 second response 
time would make it easier for ISE members to execute as principal their 
own customers' orders for 50 contracts or more without meaningful 
opportunity for price improvement by competitors, which they argued 
would undermine the intended purpose of having customers' orders 
reasonably exposed to other trading interest before being executed by 
the facilitating ISE member.\12\ Moreover, this proposed 30 second 
response time, commenters emphasized, is not enough time for market 
participants to have a reasonable opportunity to improve the 
facilitation price, especially because Crowd Participants who wish to 
improve the price are required by the rules to do so 10 seconds prior 
to the expiration of the 30 second time period, effectively reducing 
the response time to 20 seconds.\13\
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    \10\ See note 4, supra.
    \11\ The Commission notes that commenters expressed views on a 
number of issues related to the ISE block and facilitation 
mechanisms that were outside the scope of the current ISE proposal, 
several of which were addressed in the Commission's approval of ISE 
as a national securities exchange. See Securities Exchange Act 
Release No. 42455 (February 24, 2000, 65 FR 11388. Consequently, 
this order addresses only comments regarding those issues presented 
by the current proposal.
    \12\ See SA&B Letter; Phlx Letter; CBOE Letter.
    \13\ See SA&B Letter; Phlx Letter.
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    In response to commenters' objections to the proposed 30 second 
``exposure period,'' ISE states that 30 seconds is sufficient time for 
Crowd Participants in the ISE market to respond to an order, noting 
that the Commission has approved exposure times of as few as 15 seconds 
for certain equity exchanges.\14\ ISE notes that floor-based exchanges 
have no specific limitation on how long a proposed facilitation order 
must be exposed to the crowd before it is executed. Moreover, ISE 
states that commenters have no basis to assert that 20, 30 or 60 
seconds is the appropriate exposure time, given the lack of precedent 
for an electronic options market.\15\ ISE asserts that, based upon 
consultation with its members and using the knowledge and understanding 
of electronic trading it has developed, its proposal is reasonably 
designed to protect both customers and liquidity providers in its 
electronic marketplace and is consistent with the requirements of the 
Act.\16\
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    \14\ See letter to Jonathan G. Katz, Secretary, SEC, from 
Katherine Simmons, Vice President and Associate General Counsel, 
ISE, dated May 19, 2000 (``ISE Response Letter'').
    \15\ Id.
    \16\ Id.
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    Commenters also objected to the proposed amendment requiring non-
customer bids (offers) priced higher (lower) than the facilitation 
price to be executed at their stated price, rather than a single 
``clean-up'' price.\17\ The commenters argued that the ISE's proposal 
would act as a disincentive to ISE Competitive Market Makers (``CMMs'') 
and other Electronic Access Members (``EAMs'') to display their true 
trading interest and offer price improvement, because a CMM who wants 
to trade, but cannot facilitate the entire order at an improved price, 
will likely elect not to offer any price improvement to avoid the 
``penalizing impact'' of the rule.\18\
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    \17\ See SA&B Letter; Phlx Letter.
    \18\ Id.
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    In response, ISE argues that this proposed amendment benefits 
customers because where a non-customer (i.e., broker-dealer or market 
maker) indicates that it is willing to trade at a price that is better 
than the facilitation or ``clean-up'' price, the customer order being 
facilitated would get the benefit of the better price, even if the 
entire order cannot be executed at the better price.\19\ The ISE 
believes that the effect of the proposed change will be to increase 
opportunities for price improvement for customer orders.\20\
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    \19\ See ISE Response Letter.
    \20\ Id.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether the proposed 
amendment is consistent with the Act. Persons making written submission 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 
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 at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
ISE. All submissions should refer to File No. SR-ISE-00-03 and should 
be submitted by June 20, 2000.

V. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\21\ In particular, the Commission finds that proposal is 
consistent with Section 6(b)(5) of the Act.\22\
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    \21\ In approving this rule, the Commission has considered its 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \22\ 15 U.S.C. 78f(b)(5).
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    Under Section 6(b)(5) of the Act,\23\ a registered national 
securities exchange must have rules that are designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, 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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    \23\ Id.
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    Specifically, the Commission finds that ISE's proposed commentary 
to ISE Rule 716 establishing the ``exposure time'' for a facilitation 
order at 30 seconds is consistent with Section 6(b)(5) of the Act.\24\ 
Currently, there is no time period specified in the ISE's rules for how 
long facilitation orders must be exposed to the trading crowd. Instead, 
the amount of time to respond is set by the Exchange. The Commission 
believes that setting out in the ISE's rules the response period will 
provide certainty to the other market participants and ensure that this 
time period will not be changed without a corresponding change in the 
ISE rules. On floor-based exchanges, there are no rules that govern how 
long an order, including a proposed facilitation order, must be exposed 
to the crowd before it is executed. In addition, in the Commission's 
view, 30 seconds is a reasonable time frame for Crowd Participants in 
ISE's market to assess market conditions and their own trading interest 
and to enter a response to a facilitation order. Accordingly, the 
Commission is approving the ISE's proposed commentary to ISE Rule 716.
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    \24\ Id.

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[[Page 34515]]

    The Commission also agrees with the ISE that public customer bids 
(offers) on the Exchange at the time a facilitation order is executed 
that are priced higher (lower) than the facilitation price should be 
executed at the facilitation price. The Commission believes that this 
proposal will both protect public customer limit orders on the ISE's 
book and provide public customers with the benefit of price improvement 
through the facilitation mechanism. The Commission also believes that 
allowing the execution of higher bids and lower offers from non-
customer orders and quotes by executing them at their stated price is 
reasonable. Accordingly, the Commission finds that the proposed 
amendment to ISE Rule 716(d)(4)(i) is consistent with Section 6(b)(5) 
of the Act \25\ in that it promotes just and equitable principles of 
trade and facilitates transactions in securities by allowing the 
partial execution of a facilitation order at an improved price for the 
number of non-customer contracts available, while protecting public 
customer orders on the book by giving them the benefit of a better 
execution price.
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    \25\ Id.
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    The Commission also finds that the proposed amendments to ISE Rule 
716(d)(4)(ii) are consistent with Section 6(b)(5) of the Act.\26\ Under 
current ISE rules, a PMM is guaranteed certain participation rights in 
a facilitation order after public customer orders are executed and the 
facilitating EAM receives an allocation of 40 percent of the order. 
Amendment No. 1 eliminates the PMM's participation guarantee. Thus, any 
indication or quote by a PMM will be treated the same as other Crowd 
Participants' interest. The Commission believes that this proposed 
amendment is consistent with the public interest, and that it promotes 
just and equitable principles of trade by ensuring that market makers 
will be able to compete in a fair and equitable manner, based on the 
competitiveness of their quotes, for that portion of an order remaining 
after public customer interest and the EAM's facilitation guarantee.
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    \26\ Id.
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    The Commission finds good cause for approving this proposed 
amendment prior to the thirtieth day after date of publication of the 
notice of filing in the Federal Register. The proposed change to 
paragraph (d)(4)(ii) of ISE Rule 716 makes available to Crowd 
Participants a greater percentage of facilitation orders. \27\ 
Specifically, this change ensures that, if a PMM is among the Crowd 
Participants with interest at the facilitation price, the PMM will be 
treated equally with all other Crowd Participants, rather than being 
``guaranteed'' special participation rights. Because this amendment 
reduces the guarantees to PMMs, the Commission believes it will 
increase the opportunity for other participants in ISE to complete for 
order flow and finds that granting accelerated approval to the proposed 
amendments to ISE Rule 716(d)(4)(ii) in Amendment No. 1 consistent with 
Section 18(b)(2) Act. \28\
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    \27\ See Amendment No. 1, supra note 5.
    \28\ 15 U.S.C. 78f(b)(2).
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    Finally, the Commission believes that ISE's proposed amendment to 
ISE Rules 716(d)(2) and (3) to clarity that members may enter 
indications into the facilitation mechanism at prices that improve the 
facilitation price, if such improved price is inferior to the ISE best 
bid or offer, is consistent with the Act. ISE's rules currently state 
that indications from Crowd Participants must be priced at the price of 
the order to be facilitated and must not exceed the size of the order 
to be facilitated. To facilitate the order at a price superior to the 
facilitation price, ISE's current rules require Crowd Participants to 
enter orders change their quotes, as applicable. The proposed amendment 
allows a Crowd Participant to enter an indication to facilitate an 
order at a price better than the facilitation price, but inferior to 
the ISE best bid or offer. Without this change, it would have been 
possible for a Crowd Participant to improve the facilitation price, but 
not be at the ISE best bid or offer. In this situation, only the PMM 
\29\ would know about the improved price, creating the potential for 
PMM to benefit at the expense of the customer order being facilitated. 
For these reasons, the Commission finds that ISE's proposed amendment 
is consistent with Section 6(b)(5) of the Act \30\
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    \29\ Under ISE's rules, only the PMM has access to all orders on 
the ISE book; not just the top of the book.
    \30\ 15 U.S.C. 78f(b)(5).
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    The Commission also finds good cause for approving the proposed 
amendments of ISE Rules 716(d)(2) and (3) prior to the thirtieth day 
after the date of publication of notice of filing in the Federal 
Register. These proposed changes eliminate a potential avenue for abuse 
and ensure that a public customer order would receive the benefit of 
any price offered that is better than the facilitation price. 
Accordingly, the Commission believes that these proposed amendments do 
not significantly alter the original proposal, which was subject to a 
full notice and comment period and addresses the issued raised by 
commenters. Therefore, the Commission finds that granting accelerated 
approval to the proposed changes to ISE Rules 716(d)(2) and (3) in 
Amendment No. 1 is consistent with Section 19(a)(2) of Act. \31\
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    \31\ 15 U.S.C. 78f(b)(2).
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VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
\32\ that the proposed rule change (SR-ISE-00-03), including Amendment 
No. 1, is approved.
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    \32\ Id.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-13413 Filed 5-26-00; 8:45 am]
BILLING CODE 8010-01-M