Document ID: SEC-2010-1115-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: International Securities Exchange, LLC
Posted Date: 2010-07-23T04:00Z

[Federal Register Volume 75, Number 141 (Friday, July 23, 2010)]
[Notices]
[Pages 43211-43214]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-18069]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-62523; File No. SR-ISE-2010-73]

Self-Regulatory Organizations; International Securities Exchange, 
LLC; Notice of Filing of Proposed Rule Change Relating to Modified 
Rules for Qualified Contingent Cross Orders

July 16, 2010.
    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 July 14, 2010, the International Securities Exchange, LLC 
(``Exchange'' or ``ISE'') 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 self-
regulatory organization. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing modified Qualified Contingent Cross 
Orders.\3\ The text of the proposed rule change is as follows, with 
deletions in [brackets] and additions in italics:
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    \3\ The Exchange first proposed to adopt Qualified Contingent 
Cross Orders in SR-ISE-2009-35. Infra note 6. This proposal was 
approved by the Division of Trading and Markets (``Division'') 
pursuant to delegated authority, infra note 7, but this approval was 
stayed by a petition seeking fully Commission review. Infra note 8. 
The Exchange is now submitting this new proposed rule change that 
modifies the initial proposal, along with a letter requesting that 
the Commission vacate the Division's approval of SR-ISE-2009-35 
simultaneously with approval of this modified proposal. Letter from 
Michael J. Simon, Secretary and General Counsel, ISE, dated July 14, 
2010. The rule text presented in this proposed rule change shows 
proposed changes to ISE's rules as if the Commission vacated the 
Division's approval of SR-ISE-2009-35.
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Rule 715. Types of Orders

    (a) through (i) no change.
    (j) Qualified Contingent Cross Order. A Qualified Contingent Cross 
Order is comprised of an order to buy or sell at least 1000 contracts 
that is identified as being part of a qualified contingent trade, as 
that term is defined in Supplementary Material .01 below, coupled with 
a contra-side order to buy or sell an equal number of contracts.
    (k) through (l) no change.

Supplementary Material to Rule 715

    .01 A ``qualified continent trade'' is a transaction consisting of 
two or more component orders, executed as agent or principal, where:
    (a) At least one component is an NMS Stock, as defined in Rule 600 
of Regulation NMS under the Exchange Act;
    (b) all components are effected with a product or price contingency 
that either has been agreed to by all the respective counterparties or 
arranged for by a broker-dealer as principal or agent;
    (c) the execution of one component is contingent upon the execution 
of all other components at or near the same time;
    (d) the specific relationship between the component orders (e.g., 
the spread between the prices of the component orders) is determined by 
the time the contingent order is placed;
    (e) the component orders bear a derivative relationship to one 
another, represent different classes of shares of the same issuer, or 
involve the securities of participants in mergers or with

[[Page 43212]]

intentions to merge that have been announced or cancelled; and
    (f) the transaction is fully hedged (without regard to any prior 
existing position) as a result of other components of the contingent 
trade.
* * * * *

Rule 721. [Customer Cross] Crossing Orders

    (a) Customer Cross Orders are automatically executed upon entry 
provided that the execution is at or between the best bid and offer on 
the Exchange and (i) is not at the same price as a Public Customer 
Order on the Exchange's limit order book and (ii) will not trade 
through the NBBO.
    [(a)] (1) Customer Cross Orders will be automatically canceled if 
they cannot be executed.
    [(b)] (2) Customer Cross Orders may only be entered in the regular 
trading increments applicable to the options class under Rule 710.
    [(c)] (3) Supplemental Material .01 to Rule 717 applies to the 
entry and execution of Customer Cross Orders.
    (b) Qualified Contingent Cross Orders are automatically executed 
upon entry provided that the execution (i) is not at the same price as 
a Priority Customer Order on the Exchange's limit order book and (ii) 
is at or between the NBBO.
    (1) Qualified Contingent Cross Orders will be automatically 
canceled if they cannot be executed.
    (2) Qualified Contingent Cross Orders may only be entered in the 
regular trading increments applicable to the options class under Rule 
710.
* * * * *

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 self-regulatory organization 
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 self-regulatory organization 
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

    Purpose--The Exchange proposes to adopt modified rules related to 
Qualified Contingent Cross Orders (``QCC''). The Exchange first 
proposed the adoption of the QCC in conjunction with the effectiveness 
of the Order Protection and Locked/Crossed Market Plan (``Distributive 
Linkage Plan'') \4\ and the Exchange's rules to implement the 
distributive linkage (``Distributive Linkage Rules'').\5\ After a full 
notice and comment period,\6\ the Commission's Division of Trading and 
Markets (``Division'') approved the proposal on behalf of the 
Commission by delegated authority.\7\ However, this approval was 
automatically stayed by a petition submitted by the Chicago Board 
Options Exchange, Incorporated (``CBOE'') requesting review of the 
filing by the full Commission.\8\
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    \4\ Securities Exchange Act Release No. 60405 (July 30, 2009), 
74 FR 39362 (August 6, 2009).
    \5\ Securities Exchange Act Release No. 60559 (August 21, 2009), 
74 FR 44425 (August 28, 2009) (Approval Order for SR-ISE-2009-27). 
See email from Michael Simon, Secretary and General Counsel, ISE, 
dated July 15, 2010, to Jennifer Colihan, Special Counsel, and Arisa 
Tinaves, Special Counsel, Division of Trading and Markets, 
Commission.
    \6\ Securities Exchange Act Release No. 60147 (June 19, 2009), 
74 FR 30651 (June 26, 2009) (Notice for ISE-2009-35).
    \7\ Securities Exchange Act Release No. 60584 (August 28, 2009), 
74 FR 45663 (September 3, 2009) (Approval Order for ISE-2009-35).
    \8\ Letter from Joanne Moffic-Silver, General Counsel and 
Corporate Secretary, CBOE, dated September 14, 2009.
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    The Exchange has submitted extensive support for the approval of 
the QCC by the Division and the Commission,\9\ and believes that it has 
fully addressed all of the issues raised by the commenters and provided 
the basis needed for the Commission to affirm the Division's approval 
of QCC. Nevertheless, the Commission has not taken action on the 
petition, and as a result of the stay, the Exchange has been at an 
extreme competitive disadvantage since the adoption of the Distributive 
Linkage Rules nearly one year ago. While the Exchange continues to 
believe QCC as originally approved by the Division is consistent with 
the Exchange Act, the Exchange believes this modified proposal 
addresses the two primary concerns raised by commenters. Specifically, 
this modified QCC proposal does not permit a QCC to be executed at the 
same price as a priority customer order on the Exchange and increases 
the required minimum size from 500 to 1000 contracts.\10\
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    \9\ The ISE submitted a letter that addressed comments received 
by the Commission prior to the approval of the proposal. Letter from 
Michael J. Simon, Secretary and General Counsel, ISE, dated August 
20, 2009. The ISE also submitted two briefs in support of a motion 
to lift the automatic stay that was imposed by the petition for 
review. Brief in Support of International Securities Exchange, LLC's 
Motion to Lift the Commission Rule 431(e) Automatic Stay of 
Delegated Action Triggered by Chicago Board Options Exchange, 
Incorporated's Notice of Intention to petition for Review, September 
11, 2009; and Reply Brief in Support of International Securities 
Exchange, LLC's Motion to Lift the Commission Rule 431(e) Automatic 
Stay of Delegated Action Triggered by Chicago Board Options 
Exchange, Incorporated's Notice of Intention to petition for Review, 
September 22, 2009. Since denial of the Exchange's motion to lift 
the automatic stay, the Exchange has submitted additional support 
for QCC. Letters from Michael J. Simon, Secretary and General 
Counsel, ISE, dated December 3, 2009, December 16, 2009, March 1, 
2010 and April 7, 2010. We incorporate by reference these 
submissions into this file number SR-ISE-2010-73.
    \10\ Under ISE Rule 100(37A), a priority customer is a person or 
entity that (i) is not a broker or dealer in securities, and (ii) 
does not place more than 390 orders in listed options per day on 
average during a calendar month for its own beneficial account(s). 
Pursuant to ISE Rule 713, priority customer orders are executed 
before other trading interest at the same price. See email from 
Michael Simon, Secretary and General Counsel, ISE, dated July 15, 
2010, to Jennifer Colihan, Special Counsel, and Arisa Tinaves, 
Special Counsel, Division of Trading and Markets, Commission.
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Background
    The Distributive Linkage Plan replaced the Plan for the Purpose of 
Creating and Operating an Intermarket Option Linkage (``Old Linkage 
Plan''), and the Exchange's Linkage Rules replaced the existing ISE 
rules implementing the Old Plan (the ``Old Linkage Rules''). The Old 
Linkage Plan and the Old Linkage Rules provided a limited Trade-Through 
exemption for ``Block Trades,'' defined to be trades of 500 or more 
contracts with a premium value of at least $150,000.\11\ However, as 
with Regulation NMS, the Distributive Linkage Plan did not provide a 
Block Trade exemption. At the time that it adopted the Distributive 
Linkage Rules, the Exchange recognized that the loss of the Block Trade 
exemption would adversely affect the ability of ISE members to effect 
large trades that are tied to stock.\12\ Thus, the Exchange proposed 
the QCC as a limited substitute for the Block Trade exemption, to be 
implemented contemporaneously with the Linkage Rules.\13\
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    \11\ Old Plan Sections 2(3) and 8(c)(i)(C); Old ISE Rule 
1902(d)(2). See email from Michael Simon, Secretary and General 
Counsel, ISE, dated July 15, 2010, to Jennifer Colihan, Special 
Counsel, and Arisa Tinaves, Special Counsel, Division of Trading and 
Markets, Commission.
    \12\ Both the Old Plan and the Distributive Linkage Plan have a 
Trade-Through exemption for ``Complex Trades,'' including options 
trades tied to stock. See Old Plan section 7(c)(iii)(G),and Plan 
section 5(b)(viii). However, and while not free from doubt, the 
common application of that exemption has been to apply it only to 
trades announced to exchange members as a single trade at a net 
price. As so interpreted, that exemption would cover only trades 
executed in the ISE's ``Complex Order Mechanism.'' See ISE Rule 722.
    \13\ The Exchange asserted that the Qualified Contingent Cross 
Order was necessary to facilitate the execution of large stock/
options combination orders. While broker-dealers could execute these 
orders in various ways, such as on the ISE's complex order book, 
they often seek the flexibility to execute the various legs of such 
orders in different markets, and may seek to execute the options leg 
alone on the ISE. Under the Distributive Linkage Plan, and without a 
Block Trade exemption, the Exchange knew it would be extremely 
difficult for ISE members to effect the execution of the options leg 
on the ISE. This has proved to be true since the implementation of 
Distributive Linkage.

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[[Page 43213]]

Discussion
    While Regulation NMS does not provide a Block Trade exemption from 
Trade-Through liability, the Commission, by order, has provided Trade-
Through relief for ``Qualified Contingent Trades'' (``QCTs'').\14\ The 
QCT Release provides an exemption from Trade-Through liability in the 
equity market for multi-component, fully-hedged trades where one order 
is contingent on the execution of one or more additional orders. 
Building on this concept, we propose that when an ISE member effects a 
QCT trade in a Regulation NMS Stock that the member be permitted to 
cross the options leg of the trade on the ISE immediately upon entry if 
the order is for at least 1000 contracts, is part of a QCT,\15\is 
executed at a price at least equal to the national best bid or offer 
(``NBBO''), and there are no priority customer orders on the Exchange's 
book at the same price.
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    \14\ Securities Exchange Act Release No. 57620 (April 4, 2008) 
(the ``QCT Release''). That release superseded a release initially 
granting the Qualified Contingent Trade exemption. Securities 
Exchange Act Release No. 54389 (August 31, 2006).
    \15\ We propose to define a QCC trade substantively identical to 
the Commission's definition in the QCT release. A QCC trade must 
meet the following conditions: (i) At least one component must be an 
NMS Stock; (ii) all the components must be effected with a product 
price contingency that either has been agreed to by all the 
respective counterparties or arranged for by a broker-dealer as 
principal or agent; (iii) the execution of one component must be 
contingent upon the execution of all other components at or near the 
same time; (iv) the specific relationship between the component 
orders (e.g., the spread between the prices of the component orders) 
must be determined by the time the contingent order is placed; (v) 
the component orders must bear a derivative relationship to one 
another, represent different classes of shares of the same issuer, 
or involve the securities of participants in mergers or with 
intentions to merge that have been announced or cancelled; and (iv) 
the transaction must be fully hedged (without regard to any prior 
existing position) as a result of other components of the contingent 
trade. Consistent with the QCT Release members must demonstrate that 
the transaction is fully hedged using reasonable risk-valuation 
methodologies. See QCT Release, supra note 14, at footnote 9.
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    The QCC addresses the dislocation resulting from elimination of the 
Block Trade exemption by permitting members to provide their customers 
a net price for the entire trade, and then allowing the members to 
execute the options leg of the trade on the ISE at a price at least 
equal to the NBBO while using the QCT exemption to effect the trade in 
the equities leg at a price necessary to achieve the net price. Under 
the proposal, ISE will not permit the options component of a stock-
option order to trade through the national best bid and offer 
(``NBBO'').\16\ Because the equity component of a stock-option order 
can be executed at any price under the QCT exemption from Regulation 
NMS, the pricing of the options component can be flexible. Indeed, 
whether the options component is executed at or between the ISE BBO is 
not material because, in most cases, the stock trade can be executed at 
a price that achieves the desired net price.\17\ However, there are 
times when the quotation spread for the option on the ISE would not 
permit an execution of the options component between the ISE BBO, 
particularly in options that trade in increments greater than $0.01. In 
those cases, ISE proposes to permit an execution of the options 
component at a price that matches the ISE BBO.\18\ Moreover, under the 
modified proposal, ISE will not permit the execution of a QCC at the 
same price as a priority customer order. In such a case, the QCC will 
be rejected.\19\
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    \16\ While the QCC does not provide exposure for price 
improvement for the options leg of a stock-option order, the options 
leg must be executed at the NBBO or better. The Commission has 
previously approved crossing transactions with no opportunity for 
price improvement. See, e.g., ISE Rule 721(a); and CBOE Rule 6.74A, 
Interpretations and Policies .08.
    \17\ For example, assume two parties negotiate a stock-option 
order to buy 100,000 shares and sell 1,000 calls with a net price of 
24.38. Further assume that the NBBO for the option is $0.82 by 
$0.86, and that the NBBO for the stock is $25.20 by $25.21. The 
broker sends an order to the ISE to execute the options component at 
$0.85 and sends the equity component to an equities marketplace at 
$25.33. Note that in this example there is a range of prices at 
which the price of the components could be executed between the NBBO 
for the option, e.g., the options component could be executed at 
$0.83, $0.84 or $0.85, and the equity component could be executed 
respectively at $25.31, $25.32, or $25.33.
    \18\ Continuing with the example from note 17 above, assume that 
the NBBO and ISE BBO for the option is $0.85 by $0.86. According to 
the CBOE's letter, the contingent trade should not be permitted 
because the spread in the option is at a minimum increment.
    \19\ The Commission has previously approved the rejection of 
crossing transactions when there is a priority customer order on the 
book at the same price. See, e.g., ISE Rule 721(a); and CBOE Rule 
6.74A, Interpretations and Policies .08.
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    The ISE's proposal addresses the mechanics of executing the stock 
and options components of a net-price transaction in disparate markets 
with different execution rules, different trading increments and 
different intermarket trade-through provisions. On balance, we believe 
that providing members with the certainty that they could execute the 
options legs of the large complex orders for their customers, coupled 
with the flexibility members would have with respect to the price at 
which the equity legs are executed, would provide customers with the 
flexibility needed to achieve their investment objectives. Moreover, 
the modifications to the proposal to prevent the execution of a QCC if 
there is a priority customer on the book and to increase the minimum 
size of a QCC remove the appearance that such orders are trading-ahead 
of priority customer orders or that the QCC could be used to 
disadvantage retail customers, the two most significant issues raised 
by commenters on the initial proposal.\20\
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    \20\ See infra note 22.
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    Basis--The basis under the Act for this proposed rule change is the 
requirement under Section 6(b)(5) that an exchange have rules that are 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism for a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest. In particular, the proposed changes to QCC will prevent 
executions from occurring when there is a priority customer order on 
the book at the same price and will assure that only large-size orders 
(i.e., of at least 1000 contracts) are eligible. The modified rules 
will facilitate the ability of ISE members to execute large options 
orders that are tied to stock in an efficient manner, while also 
protecting the national market system against trade-throughs.

B. Self-Regulatory Organization's Statement on Burden on Competition

    This proposed rule change does not impose any burden on 
competition. Rather, approval of QCC as modified by the proposed rule 
change, will address a significant existing burden on competition. In 
particular, it will permit fair competition between floor-based and 
electronic options exchanges for large-size stock-option orders.\21\
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    \21\ ISE has submitted numerous letters detailing how the loss 
of the Block Exemption without the alternative QCC has made it 
virtually impossible for our all-electronic exchange to compete with 
the floor-based trading models for these large-size stock-option 
orders. Supra note 9.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any

[[Page 43214]]

unsolicited written comments from members or other interested 
parties.\22\
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    \22\ The Commission received a number of comments with respect 
to SR-ISE-2009-35, supra note 6, which can be found at http://www.sec.gov/comments/sr-ise-2009-35/ise200935.shtml#order. The 
Commission also received comments with respect to the petition for 
full Commission review of SR-ISE-2009-35, supra note 6, which can be 
found at http://www.sec.gov/rules/other/2009/sr-ise-2009-35/ise200935_statements.shtml. ISE's responses to these comments, 
supra note 7, are included at these locations.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) By order approve such proposed rule change; or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether 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 No. SR-ISE-2010-73 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-ISE-2010-73. 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 website viewing and 
printing in the Commission's Public Reference Room on official business 
days between the hours of 10 a.m. and 3 p.m. Copies of such filing also 
will be available for inspection and copying at the principal office of 
the ISE. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-ISE-
2010-73 and should be submitted by August 9, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
Florence E. Harmon,
Deputy Secretary.
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    \23\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2010-18069 Filed 7-22-10; 8:45 am]
BILLING CODE 8010-01-P