Document ID: SEC-2011-0267-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: International Securities Exchange, LLC
Posted Date: 2011-03-02T05:00Z

[Federal Register Volume 76, Number 41 (Wednesday, March 2, 2011)]
[Notices]
[Pages 11533-11541]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-4574]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63955; File No. SR-ISE-2010-73]

Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Granting Approval of a Proposed Rule Change To Modify 
Qualified Contingent Cross Order Rules

February 24, 2011.

I. Introduction

    On July 14, 2010, the International Securities Exchange, LLC 
(``ISE'' 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 modify rules for Qualified 
Contingent Cross (``QCC'') Orders. The proposed rule change was 
published for comment in the Federal Register on July 23, 2010.\3\ The 
Commission received eight comment letters on the proposed rule change 
\4\ and a response letter from ISE.\5\

[[Page 11534]]

This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 62523 (July 16, 
2010), 75 FR 43211 (``Notice'').
    \4\ See Letters from Anthony J. Saliba, Chief Executive Officer, 
LiquidPoint, LLC, to Elizabeth M. Murphy, Secretary, Commission 
dated, July 30, 2010 (``LiquidPoint Letter 2''); William J. Brodsky, 
Chairman and Chief Executive Officer, Chicago Board Options 
Exchange, Incorporated (``CBOE''), to Elizabeth M. Murphy, 
Secretary, Commission, dated August 9, 2010 (``CBOE Letter 1''); Ben 
Londergan and John Gilmartin, Co-Chief Executive Officers, Group One 
Trading, LP, to Elizabeth M. Murphy, Secretary, Commission, dated 
August 9, 2010 (``Group One Letter 2''); Janet M. Kissane, Senior 
Vice President--Legal and Corporate Secretary, NYSE Euronext, to 
Elizabeth M. Murphy, Secretary, Commission, dated August 9, 2010 
(``NYSE Letter 2''); Thomas Wittman, President, NASDAQ OMX PHLX, 
Inc. (``Phlx''), to Elizabeth M. Murphy, Secretary, Commission, 
dated August 13, 2010 (``Phlx Letter 2''); J. Micah Glick, Chief 
Compliance Officer, Cutler Group LP to Elizabeth M. Murphy, 
Secretary, Commission, dated September 3, 2010 (``Cutler Letter''); 
Janet L. McGinness, Senior Vice President--Legal and Corporate 
Secretary, NYSE Euronext, to Elizabeth M. Murphy, Secretary, 
Commission, dated October 21, 2010 (``NYSE Letter 3''); and Gerald 
D. O'Connell, Chief Compliance Officer, Susquehanna International 
Group, LLP, to Elizabeth M. Murphy, Secretary, Commission, dated 
October 22, 2010 (``Susquehanna Letter 2'').
    \5\ See Letter from Michael J. Simon, Secretary and General 
Counsel, ISE, to Elizabeth M. Murphy, Secretary, Commission, dated, 
August 25, 2010 (``ISE Response'').
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II. Background

A. Regulation NMS and Qualified Contingent Trades

    The Commission adopted Regulation NMS in June 2005.\6\ Among other 
things, Regulation NMS addressed intermarket trade-throughs of 
quotations in NMS stocks.\7\ In 2006, pursuant to Rule 611(d) of 
Regulation NMS,\8\ the Commission provided an exemption \9\ for each 
NMS stock component of certain qualified contingent trades (as defined 
below) from Rule 611(a) of Regulation NMS for any trade-throughs caused 
by the execution of an order involving one or more NMS stocks (each an 
``Exempted NMS Stock Transaction'') that are components of a qualified 
contingent trade.
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    \6\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005).
    \7\ See 17 CFR 242.611. An ``NMS stock'' means any security or 
class of securities, other than an option, for which transaction 
reports are collected, processed, and made available pursuant to an 
effective transaction reporting plan. See 17 CFR 242.600(b)(46) and 
(47).
    \8\ 17 CFR 242.611(d). See also 15 U.S.C. 78mm(a)(1) (providing 
general authority for the Commission to grant exemptions from 
provisions of the Act and the rules thereunder).
    \9\ See Securities Exchange Act Release No. 54389 (August 31, 
2006), 71 FR 52829 (September 7, 2006) (``Original QCT Exemption''). 
The Securities Industry Association (``SIA,'' n/k/a Securities 
Industry and Financial Markets Association) requested the exemption. 
See Letter to Nancy M. Morris, Secretary, Commission, from Andrew 
Madoff, SIA Trading Committee, SIA, dated June 21, 2006.
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    The Original QCT Exemption defined a ``qualified contingent trade'' 
to be a transaction consisting of two or more component orders, 
executed as agent or principal, where: (1) At least one component is in 
an NMS stock; (2) all components are effected with a product or price 
contingency that either has been agreed to by the respective 
counterparties or arranged for by a broker-dealer as principal or 
agent; (3) the execution of one component is contingent upon the 
execution of all other components at or near the same time; (4) the 
specific relationship between the component orders (e.g., the spread 
between the prices of the component orders) is determined at the time 
the contingent order is placed; (5) 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 intentions to merge that have been announced or since 
cancelled; \10\ (6) the Exempted NMS Stock Transaction is fully hedged 
(without regard to any prior existing position) as a result of the 
other components of the contingent trade; \11\ and (7) the Exempted NMS 
Stock Transaction that is part of a contingent trade involves at least 
10,000 shares or has a market value of at least $200,000.\12\
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    \10\ Transactions involving securities of participants in 
mergers or with intentions to merge that have been announced would 
meet this aspect of the requested exemption. Transactions involving 
cancelled mergers, however, would constitute qualified contingent 
trades only to the extent they involve the unwinding of a pre-
existing position in the merger participants' shares. Statistical 
arbitrage transactions, absent some other derivative or merger 
arbitrage relationship between component orders, would not satisfy 
this element of the definition of a qualified contingent trade. See 
Original QCT Exemption, supra, note 9.
    \11\ A trading center may demonstrate that an Exempted NMS Stock 
Transaction is fully hedged under the circumstances based on the use 
of reasonable risk-valuation methodologies. Id.
    \12\ See 17 CFR 242.600(b)(9) (defining ``block size'' with 
respect to an order as at least 10,000 shares or $200,000 in market 
value).
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    In 2008, in response to a request from the CBOE, the Commission 
modified the Original QCT Exemption to remove the ``block size'' 
requirement of the exemption (i.e., that the Exempted NMS Stock 
Transaction be part of a contingent trade involving at least 10,000 
shares or having a market value of at least $200,000).\13\
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    \13\ See Securities Exchange Act Release No. 57620 (April 4, 
2008) 73 FR 19271 (April 9, 2008) (``CBOE QCT Exemption''). The 
current QCT Exemption (i.e., as modified by the CBOE QCT Exemption) 
is referred to herein as the ``NMS QCT Exemption.''
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B. Background of ISE's Proposal

    In August 2009, the Commission approved the Order Protection and 
Locked/Crossed Market Plan \14\ which, among other things, required the 
options exchanges to adopt written policies and procedures reasonably 
designed to prevent trade-throughs.\15\ Unlike its predecessor 
plan,\16\ the New Linkage Plan does not include a trade-through 
exemption for ``Block Trades,'' defined to be trades of 500 or more 
contracts with a premium value of at least $150,000.\17\ However, 
because the New Linkage Plan does not provide a Block Trade exemption, 
the Exchange was concerned that the loss of the Block Trade exemption 
would adversely affect the ability of its members to effect large 
trades that are tied to stock. Accordingly, the Exchange proposed the 
Original QCC Order (defined below) as a limited substitute for the 
Block Trade exemption to facilitate the execution of large stock/option 
combination orders, to be implemented contemporaneously with the New 
Linkage Rules.
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    \14\ See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) (``New Linkage 
Plan''). ISE also proposed revisions to its rules to implement the 
New Linkage Plan (``New Linkage Rules''). See Securities Exchange 
Act Release No. 60559 (August 21, 2009), 74 FR 44425 (August 28, 
2009) (SR-ISE-2009-27).
    \15\ A trade-through is a transaction in a given option series 
at a price that is inferior to the best price available in the 
market.
    \16\ The former options linkage plan, the Plan for the Purpose 
of Creating and Operating an Intermarket Option Linkage (``Former 
Linkage Plan''), was approved by the Commission in 2000 and was 
operative until August 31, 2009, when the New Linkage Plan took 
effect. See Securities Exchange Act Release No. 43086 (July 28, 
2000), 65 FR 48023 (August 4, 2000) (File No. 4-429).
    \17\ See Sections 2(3) and 8(c)(i)(C) of the Former Linkage Plan 
and old ISE Rule 1902(d)(2).
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C. SR-ISE-2009-35

1. ISE's Original Qualified Contingent Cross Order Proposal
    In SR-ISE-2009-35,\18\ ISE proposed a new order type, the QCC 
Order. The QCC Order as proposed in SR-ISE-2009-35 (``Original QCC 
Order'') permitted an ISE member to cross the options leg of a 
Qualified Contingent Trade (``QCT'') (as defined below) on ISE 
immediately upon entry, without exposure, if the order: (i) Was for at 
least 500 contracts; (ii) met the six requirements of the NMS QCT 
Exemption; and (iii) was executed at a price at or between the national 
best bid or offer (``NBBO''). Proposed Supplementary Material .01 to 
ISE Rule 715 defined a QCT as a transaction composed of two or more 
orders, executed as agent or principal, where: (i) At least one 
component is in an NMS stock; (ii) 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; (iii) the execution of one component is 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) is determined by the 
time the contingent order is placed; (v) 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 intentions to merge that have been announced or 
cancelled; and (vi) the transaction is fully hedged (without regard to 
any prior existing position) as a result of other components of the 
contingent trade.\19\
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    \18\ See Securities Exchange Act Release No. 60147 (June 19, 
2009), 74 FR 30651 (June 26, 2009) (SR-ISE-2009-35 Notice).
    \19\ The six requirements are substantively identical to the six 
elements of a QCT under the NMS QCT Exemption. See supra notes 9 and 
13.
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    On August 28, 2009, the Commission approved, by authority delegated 
to the

[[Page 11535]]

Division of Trading and Markets, ISE's Original QCC Order proposal.\20\ 
On September 4, 2009, CBOE filed with the Commission a notice of 
intention to file a petition for review of the Commission's approval by 
delegated authority \21\ and, on September 14, 2009, CBOE filed a 
petition for review, which automatically stayed the delegated approval 
of the Original QCC Order.\22\ On September 11, 2009, ISE filed a 
motion to lift the automatic stay.\23\ On September 17, 2009, CBOE 
filed a response to ISE's Motion.\24\ On September 22, 2009, ISE filed 
a reply in support of its motion to lift the automatic stay.\25\ In 
addition to the submissions from CBOE and ISE, the Commission received 
eight comment letters requesting that the Commission grant CBOE's 
Petition for Review.\26\
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    \20\ See Securities Exchange Act Release No. 60584 (August 28, 
2009), 74 FR 45663 (September 3, 2009) (``Original Approval 
Order'').
    \21\ See Letter from Paul E. Dengel, Counsel for CBOE, Schiff 
Hardin LLP, to Elizabeth M. Murphy, Secretary, Commission, dated 
September 4, 2009.
    \22\ See Letter from Joanne Moffic-Silver, General Counsel and 
Corporate Secretary, CBOE, to Elizabeth M. Murphy, Secretary, 
Commission, dated September 14, 2009 (``Petition for Review'').
    \23\ See Brief in Support of ISE's Motion to Lift the Commission 
Rule 431(e) Automatic Stay of Delegated Action Triggered by CBOE's 
Notice of Intention to Petition for Review, dated September 11, 2009 
(``ISE's Motion'').
    \24\ See Response of CBOE to Motion of ISE to Lift Automatic 
Stay, dated September 17, 2009 (``Response to Motion'').
    \25\ See Reply in Support of ISE's Motion to Lift the Commission 
Rule 431(e) Automatic Stay of Delegated Action Triggered by CBOE's 
Notice of Intention to Petition for Review, dated September 22, 2009 
(``ISE Reply'').
    \26\ See Letters from Jeffrey S. Davis, Vice President and 
Deputy General Counsel, NASDAQ OMX PHLX, Inc., to Elizabeth M. 
Murphy, Secretary, Commission, dated September 22, 2009 (``Phlx 
Letter''); Gerald D. O'Connell, Chief Compliance Officer, 
Susquehanna International Group, LLP, to Elizabeth M. Murphy, 
Secretary, Commission, dated September 30, 2009 (``Susquehanna 
Letter''); Megan A. Flaherty, Chief Legal Counsel, Wolverine 
Trading, LLC, to Elizabeth M. Murphy, Secretary, Commission, dated 
October 2, 2009 (``Wolverine Letter''); Janet M. Kissane, Senior 
Vice President--Legal and Corporate Secretary, NYSE Euronext, to 
Elizabeth M. Murphy, Secretary, Commission, dated October 5, 2009 
(``NYSE Letter''); Ben Londergan, Co-CEO, Group One Trading, L.P., 
to Elizabeth M. Murphy, Secretary, Commission, dated October 5, 2009 
(``Group One Letter''); Anthony J. Saliba, Chief Executive Officer, 
LiquidPoint, LLC, to Elizabeth M. Murphy, Secretary, Commission, 
dated October 7, 2009 (``LiquidPoint Letter''); Kimberly Unger, 
Executive Director, The Security Traders Association of New York, 
Inc., to Elizabeth M. Murphy, Secretary, Commission, dated October 
29, 2009 (``STA Letter''); and Peter Schwarz, Integral Derivatives, 
LLC, to Elizabeth M. Murphy, Secretary, Commission, dated November 
25, 2009 (``Integral Derivatives Letter''). In addition, ISE 
submitted certain market volume and share statistics. See E-mail 
from Michael J. Simon, ISE, to Elizabeth King, Associate Director, 
Division of Trading and Markets, Commission, dated September 30, 
2009.
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    On November 12, 2009, the Commission granted CBOE's Petition for 
Review and denied ISE's motion to lift the automatic stay.\27\ In 
connection with the Order Granting Petition, the Commission received 
three statements in support of the Original Approval Order (two of 
which were submitted by ISE) \28\ and five statements in opposition to 
the Original Approval Order (two of which were submitted by CBOE).\29\
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    \27\ See Commission Order Granting Petition for Review and 
Scheduling Filing of Statements, dated November 12, 2009 and 
Commission Order Denying ISE's Motion to Lift the Commission Rule 
431(e) Automatic Stay of Delegate Action Triggered by CBOE's Notice 
of Intention to Petition for Review, dated November 12, 2009 
(``Order Granting Petition'').
    \28\ See Letters from Michael J. Simon, Secretary, ISE, to 
Elizabeth M. Murphy, Secretary, Commission, dated December 3, 2009 
(``ISE Statement 1''); from Leonard Ellis, Head of Capital Markets, 
Capstone Global Markets, LLC, to Elizabeth Murphy, Secretary, 
Commission, dated December 3, 2009 (``Capstone Statement''); and 
Michael J. Simon, Secretary, ISE, to Elizabeth M. Murphy, Secretary, 
Commission, dated December 16, 2009 (``ISE Statement 2'').
    \29\ See Letters from Joanne Moffic-Silver, Executive Vice 
President, General Counsel & Corporate Secretary, CBOE, to Elizabeth 
M. Murphy, Secretary, Commission, dated December 3, 2009 (``CBOE 
Statement 1''); Michael Goodwin, Senior Managing Member, Bluefin 
Trading, LLC, to Elizabeth M. Murphy, Secretary, Commission, dated 
December 2, 2009 (``Bluefin Statement''); John C. Nagel, Managing 
Director and Deputy General Counsel, Citadel, to Elizabeth M. 
Murphy, Commission, dated December 3, 2009 (``Citadel Statement''); 
Janet M. Kissane, Senior Vice President--Legal & Corporate 
Secretary, NYSE Euronext, to Elizabeth M. Murphy, Secretary, 
Commission, dated December 3, 2009 (``NYSE Statement 1''); and 
Angelo Evangelou, Assistant General Counsel, CBOE, to Elizabeth M. 
Murphy, Secretary, Commission, dated January 20, 2010 (``CBOE 
Statement 2''). The Commission also received a statement from ISE 
responding to the CBOE Statement 2 regarding its statistical claim 
and number of trade-throughs. See Letter from Michael J. Simon, 
Secretary, ISE, to Elizabeth M. Murphy, Secretary, Commission, dated 
March 1, 2010.
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2. Commenter's to ISE's Original QCC Order Proposal
    In its Petition for Review and statements in support thereof, CBOE 
argued that ISE's Original QCC Order proposal was inconsistent with the 
Act \30\ and raised important policy concerns that the Commission 
should address, including whether crossing straight or complex option 
orders without exposure is appropriate and whether permitting a 
``clean'' cross in front of public customer orders is appropriate. CBOE 
believed that ISE's proposal was inconsistent with the Act because ``it 
effectively establishes ISE as a print facility for large options 
orders rather than an exchange where orders are able to interact in an 
auction setting.'' \31\ CBOE and certain commenters objected to the 
Original QCC Order proposal because, for crosses that satisfy the QCC's 
requirements, a member of ISE could execute a clean cross without 
exposing the cross to other ISE participants, which CBOE stated would 
represent a significant change from historical and current market 
practices in the options markets.\32\ CBOE contended that the 
Commission's policy and practice had been to limit the percentage of 
the crossing entitlement to an amount below 50% of the order being 
executed, and then only after ensuring that all crossing entitlements 
are exposed and yield to public customer orders.\33\ CBOE stated that 
the policies requiring exposure and yielding to public customer 
interest balance ``the desire to permit internalization/solicitations 
to some degree while at the same time ensuring competition and price 
discovery and, to some degree, protecting public customers (including 
retail investors).'' \34\ Without an exposure requirement, CBOE 
contended that the proposal would have a major adverse impact on 
options market structure, and result in a trading environment that is 
``sluggish, nontransparent, and noncompetitive.'' \35\
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    \30\ See e.g., Petition for Review, supra note 22, at 11. See 
also CBOE Statement 1, supra note 29, at 5-6, 15-16.
    \31\ See Petition for Review, supra note 22, at 13. See also 
Bluefin Statement, supra note 29; Citadel Statement, supra note 29, 
at 2; and LiquidPoint Letter, supra note 26, at 4. See also 
Wolverine Letter, supra note 26 and CBOE Statement 1, supra note 29, 
at 8.
    \32\ See Petition for Review, supra note 22, at 5, 9, 13-15. See 
also Bluefin Statement, supra note 29; Citadel Statement, supra note 
29, at 2; NYSE Statement 1, supra note 29, at 2; Wolverine Letter, 
supra note 26; and LiquidPoint Letter, supra note 26, at 2.
    \33\ See Petition for Review, supra note 22, at 5, 17. CBOE also 
noted ISE's investment in an entity that CBOE asserted is ``geared 
towards the non-transparent execution of block size stock-option 
transactions,'' which CBOE contended would benefit from the ISE's 
proposal. Id. at 11. See also CBOE Statement 1, supra note 29, at 
13-14.
    \34\ See Petition for Review, supra note 22, at 15.
    \35\ Id. at 10, 14. CBOE and some commenters also noted their 
belief that the lack of exposure also degrades market transparency, 
which they believe is related to the Commission's concerns relating 
to dark pools. Id. at 16. See also, e.g., NYSE Statement 1, supra 
note 29, at 1, 4.
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    CBOE and many of the commenters to the Original QCC Order proposal 
believed that the lack of any exposure requirement in ISE's Original 
QCC Order would have a detrimental effect on the options market as it 
would provide a disincentive to ISE's market makers to quote 
competitively, undercut their market making function and could result 
in market makers migrating off other exchanges that do not offer a QCC 
Order type to ISE, to take advantage of potentially wider spreads and 
where greater margins might be available with

[[Page 11536]]

less competitive quoting.\36\ One commenter stated that the Original 
QCC Order, by preventing market makers from participating in trades 
occurring at their quoted prices, would cause market makers to spread 
their quotes wider to increase their profit margins in compensation for 
the lower volume of trading in which they participate.\37\ This 
commenter further stated that, eventually, such market makers might 
very well question the wisdom of committing capital to make firm 
markets in the thousands of options series in which they have 
continuous quoting obligations.\38\ Another commenter noted that, 
ultimately, this would ``increase the costs and decrease the 
availability of proven, effective risk management through derivatives'' 
and harm options market participants, as their ability ``to execute 
their myriad strategies would disappear.'' \39\ Thus, some commenters 
believed that permitting the implementation of the QCC Order would harm 
the growth prospects of the overall options industry.\40\
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    \36\ See CBOE Statement 1, supra note 29, at 8; NYSE Statement 
1, supra note 29 at 2, 3; and LiquidPoint Letter, supra note 26, at 
3, 5. See also Petition for Review, supra note 22, at 13.
    \37\ See NYSE Statement 1, supra note 29 at 3.
    \38\ Id.
    \39\ See LiquidPoint Letter, supra note 26, at 3, 5.
    \40\ See NYSE Statement 1, supra note 29, at 2 and LiquidPoint 
Letter, supra note 26, at 3-5. See also CBOE Statement 1, supra note 
29, at 8.
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    However, ISE argued that the QCC Order type would not impact the 
options markets, and that large-size contingency orders are executed on 
floor-based exchanges in a manner very similar to the new order type 
proposed by ISE. In addition, ISE noted that there is no meaningful 
transparency on floors because there is no requirement that information 
on orders presented to the floor be announced electronically to all 
exchange members or the public.\41\ ISE also noted that some floor-
based options exchanges have eliminated the requirement that market 
makers have a physical presence on the floor, which it believes 
undermines the claim that price discovery and transparency occur on the 
trading floor.\42\ One commenter to the Original QCC Order proposal 
agreed and stated that the exposure-related concerns of other 
commenters ``do not adequately recognize the reality of how this 
business is conducted today and seem to simply endorse a manual trading 
environment that prevents competition from electronic exchanges.'' \43\
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    \41\ See ISE Statement 1, supra note 28, at 2, 6.
    \42\ Id.
    \43\ See Capstone Statement, supra note 28, at 2.
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    In addition to CBOE's opposition to the Original QCC Order because 
of its lack of an exposure requirement, CBOE also argued that public 
customers that have previously placed limit orders at the execution 
price of a QCC Order would be harmed because those customers would lose 
priority and would not receive executions of their resting orders.\44\ 
CBOE expressed concern that, because certain customer orders would not 
receive priority, the proposal would create a disincentive to placing 
limit orders.\45\ CBOE maintained that, with respect to intra-market 
priority in the exchange-listed options markets, the long-standing 
industry policy and practice has been to require public customer 
priority for simple option orders.\46\ Two commenters also expressed 
concern that the Original QCC Order would cause public customers with 
existing orders to be disadvantaged in the executions that they receive 
and would be a direct disincentive to market makers and would likely 
encourage wider quoted markets.\47\
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    \44\ See Response to Motion, supra note 24, at 4.
    \45\ See Petition for Review, supra note 22, at 13.
    \46\ Id. at 17. See also CBOE Statement 1, supra note 29, at 5, 
9.
    \47\ See Bluefin Statement, supra note 29 and NYSE Statement 1, 
supra note 29 at 2.
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    ISE disagreed with the commenters' claims that public customers 
with resting limit orders would be harmed by its QCC proposal. ISE 
stated that large-size contingency trades that would qualify as QCC 
Orders are currently almost exclusively executed on floor-based 
exchanges, thus ``the occasional customer limit order resting on ISE's 
book * * * has no opportunity to interact with [such orders].'' \48\
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    \48\ See ISE Statement 1, supra note 28, at 2, 5.
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    In addition, CBOE stated that no execution entitlements have been 
permitted thus far, unless there is first yielding to public customer 
interest.\49\ CBOE contrasted the Original QCC Order with the rules of 
all options exchanges relating to net-priced complex orders, which 
require that each options leg(s) of the complex order trade at or 
inside the NBBO and, at a minimum, price improve public customer orders 
in at least one component options leg.\50\ CBOE also noted that, in a 
stock-option order net-priced package, it has been the Commission 
policy to require that the option leg of the stock-option order either 
yield to the same priced public customer order represented in the 
individual options series or trade at a better price.\51\ CBOE argued 
that the Original QCC Order, in contrast, would be given special 
priority that goes beyond the priority afforded to packaged stock-
option orders by permitting it to be crossed without giving priority to 
public customers.\52\
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    \49\ See Petition for Review, supra note 22, at 15.
    \50\ Id. at 18.
    \51\ Id.
    \52\ Id. at 19.
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    In response, ISE noted that there are many examples of exception to 
rules to accommodate specific trading strategies.\53\ ISE further 
argued that there is no basis under the Act to prevent exchanges from 
adopting market structures and priority rules that are tailored for 
large-size contingent orders and that customer priority is not required 
in all circumstances.\54\
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    \53\ See ISE Statement 1, supra note 28, at 2, 5. For example, 
ISE pointed to the existing rules of the options exchanges that 
permit the execution of one leg of a complex trade at the same price 
as a public customer order on the limit order book if another leg of 
the order is executed at an improved price. See CBOE Rule 6.45A.
    \54\ Id.
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    Commenters to the Original QCC Order also questioned whether the 
customer involved in the QCC Order would be able to receive the best 
price for its order because, without a requirement for the order to be 
exposed, the submitting member's customer would not have the 
opportunity to receive price improvement for the options leg of the 
order.\55\ Specifically, CBOE expressed concern that, because the QCC 
Order would eliminate the requirement of market exposure, the customer 
whose order is submitted through the QCC Order mechanism might receive 
a fill at a price that is inferior to the price the customer would have 
received if the full package or even the options component had been 
represented to the market.\56\
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    \55\ See CBOE Statement 1, supra note 29, at 7-8 and Petition 
for Review, supra note 22, at 13. See also Bluefin Statement, supra 
note 29; Group One Letter, supra note 26, at 1-2; and Integral 
Derivatives Letter, supra note 26.
    \56\ See CBOE Statement 1, supra note 29, at 7.
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    ISE responded to these concerns by explaining that, when 
negotiating a stock-option order, market participants agree to a ``net 
price,'' i.e., a price that reflects the total price of both the 
options and stock legs of the transaction which are executed separately 
in the options and equity markets.\57\ Accordingly, ISE believed that, 
for such trades, the actual execution price of each component is not as 
material to the parties to the trade as is the net price of the 
transaction.\58\
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    \57\ See ISE Statement 1, supra note 28, at 2, 6.
    \58\ See id.

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[[Page 11537]]

3. RiskFin Analysis of Large-Size Contingency Orders
    In support of the Original QCC Order, ISE stated that its proposed 
QCC Order provided an all-electronic alternative to the open-outcry 
execution of large stock-option trades on floor-based exchanges. While 
both all-electronic exchanges and floor-based exchanges have rules that 
require exposure of an order before a member is permitted to trade with 
such order, ISE believes that the requirement under ISE's rules is 
significantly more onerous than the similar requirement of floor-based 
exchanges, where such exchanges are only required to expose such orders 
to their members on the floor and not electronically to all members. 
Accordingly, ISE asserted, among other things, that it needed the QCC 
Order to remain competitive with other exchanges, particularly floor-
based exchanges, because although these orders are exposed on the 
floor-based exchanges, they are rarely broken up.\59\
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    \59\ See ISE Reply, supra note 25, at 5.
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    In order to examine ISE's contention with respect to activity on 
floor-based exchanges regarding large-sized contingent trades, in 
October 2009, the Commission's Division of Risk, Strategy and Financial 
Innovation (``RiskFin'') requested Consolidated Options Audit Trail 
System (``COATS'') data from certain options exchanges for each Tuesday 
in August and September of 2009. On March 17, 2010, RiskFin placed in 
the public file a memorandum analyzing the COATS data, in which it 
presented the findings of its analysis of ISE's contention that large-
size contingency orders on floor-based exchanges were never or nearly 
never broken up.\60\ The RiskFin Analysis provided some support for 
ISE's contention that large orders are broken up less frequently on 
floor-based exchanges than on an electronic exchange, though it did not 
definitively confirm ISE's contention. Specifically, in examining the 
percentage of trades that are either fully or near-fully executed 
against a single contra-party, the RiskFin Analysis showed that, for 
trades with a size of 2,000 contracts or more, only 12% were completely 
executed with only one execution on ISE, compared to 26% and 29% of 
trades that were filled with only one execution on two floor-based 
exchanges. Similarly, the data also showed that for orders of 2,000 
contacts or more, only 16% of orders on ISE were 90% filled against a 
single contra-party, while the comparable figures for two floor-based 
exchanges were 35% and 37%.
---------------------------------------------------------------------------

    \60\ See Memorandum Regarding ISE Qualified Contingent Cross 
Proposal from Division of Risk, Strategy and Financial Innovation, 
dated March 1, 2010 (``RiskFin Analysis'') (available at http://www.sec.gov/rules/other/2010/sr-ise-2009-35/riskfinmemo030110.pdf). 
The RiskFin Analysis reviewed COATS data from ISE, CBOE and Phlx.
---------------------------------------------------------------------------

    While the RiskFin Analysis provided the percentage of orders on 
each exchange that were filled in a single execution versus multiple 
executions, the COATS data used for the analysis was not limited to 
facilitation orders.\61\ Thus, the RiskFin Analysis was not dispositive 
with respect to ISE's contention because it contained orders unrelated 
to ISE's proposed order type. Concurrently with the placement of the 
RiskFin Analysis in the public file, the Commission issued an order 
extending the time to file a statement in support of or in opposition 
to the Original Approval Order.\62\ Subsequently, the Commission 
received three statements relating to the RiskFin Analysis.\63\
---------------------------------------------------------------------------

    \61\ For example, ISE notes that the inclusion of index options 
trading in the data distorts the extent to which there is ``break-
up'' of large crosses on the floor-based exchanges and believes that 
excluding index options from the RiskFin Analysis would 
significantly increase the number of floor-based exchanges' large 
orders that were executed without break-up. See ISE Statement 3, 
infra note 63, at 2-3.
    \62\ See Commission Order Extending Time to File Statements, 
dated March 17, 2010.
    \63\ See Letters from Edward J. Joyce, President and Chief 
Operating Officer, CBOE, to Elizabeth M. Murphy, Secretary, 
Commission, dated April 7, 2010 (``CBOE Statement 3''); Pia K. 
Bennett, Associate Corporate Secretary, NYSE Euronext, to Elizabeth 
M. Murphy, Secretary, Commission, dated April 7, 2010 (``NYSE 
Statement 2''); and Michael J. Simon, Secretary, ISE, to Elizabeth 
M. Murphy, Secretary, Commission, dated April 7, 2010 (``ISE 
Statement 3'').
---------------------------------------------------------------------------

    Both CBOE and ISE focused on the RiskFin Analysis and noted that 
the ``analysis did not confirm ISE's contention that large orders are 
broken-up less frequently on floor-based exchanges, though certain data 
did provide support for ISE's position.'' Although CBOE believed that 
the conclusion was favorable to its opposing position on ISE's QCC 
Order type, it clarified that it did not believe the study was 
necessary and that the policy question of exposure and whether it would 
benefit investors or not was the critical concern.\64\
---------------------------------------------------------------------------

    \64\ See CBOE Statement 3, supra note 63, at 1 and 4.
---------------------------------------------------------------------------

    Alternatively, ISE believed that the RiskFin Analysis conclusion 
strongly supported ISE's position that the QCC Order type is an 
appropriate and necessary competitive tool for the ISE.\65\ In support 
of its belief, ISE noted that the most critical statistic in 
determining whether exchange members can affect a trade without being 
broken up is to look at how often large trades are executed in a single 
execution. ISE points to the RiskFin Analysis data that demonstrates 
that for the largest trades (2,000 or more contracts) only 12% of such 
trades were executed without a break-up on the ISE, while the 
percentages for the two floor-based exchanges were more than twice as 
high.\66\
---------------------------------------------------------------------------

    \65\ See ISE Statement 3, supra note 63, at 2.
    \66\ Id. at 2.
---------------------------------------------------------------------------

    Another commenter reiterated its concern that the proposed QCC 
Order type creates a disincentive to competitively quote by limiting 
price discovery opportunities and dampens transparency in the options 
markets.\67\ In response to the RiskFin Analysis data, the commenter 
stated that the crossing of two orders on or within the best bid or 
offer of the options markets, with no interference from other 
participants despite exposure to the market, indicated that the cross 
was fairly priced as part of the off-exchange negotiation and that 
without exposure, there is no such comfort that the best possible price 
was obtained.\68\
---------------------------------------------------------------------------

    \67\ See NYSE Statement 2, supra note 63, at 1.
    \68\ Id. at 3.
---------------------------------------------------------------------------

4. Request To Vacate SR-ISE-2009-35 Original Approval Order
    On July 14, 2010, concurrently with the filing of the current 
proposal to modify the rules for QCC Orders (i.e., SR-ISE-2010-73), the 
Commission received a letter from ISE requesting the Commission to 
vacate the Original Approval Order concurrently with an approval of SR-
ISE-2010-73.\69\ Specifically, the Vacate Letter stated that ISE 
submitted its current proposal to address the most significant issues 
that commenters raised regarding the Original QCC Order.
---------------------------------------------------------------------------

    \69\ See Letter from Michael J. Simon, Secretary, ISE, to 
Elizabeth M. Murphy, Secretary, Commission, dated July 14, 2010 
(``Vacate Letter'').
---------------------------------------------------------------------------

D. Description of Current Proposal To Modify QCC Order Rules

    As noted above, among their objections to ISE's Original QCC Order, 
CBOE and some commenters argued that public customers with limit orders 
resting on ISE's book at the execution price of a QCC Order would be 
harmed because the QCC Order would execute ahead of their resting 
orders and that, because certain customer orders would not receive 
priority, the proposal would create a disincentive to placing limit 
orders.\70\ CBOE and some commenters also questioned whether the 
customer involved in the QCC Order would be able to receive the best 
price for its

[[Page 11538]]

order because, without a requirement for the order to be exposed, the 
submitting member's customer would not have the opportunity to receive 
price improvement for the options leg of the order.\71\
---------------------------------------------------------------------------

    \70\ See, e.g., Petition for Review, supra note 22, at 13, 15, 
17. See also Bluefin Statement, supra note 29; Phlx Letter, supra 
note 26; Wolverine Letter, supra note 26; Group One Letter, supra 
note 26, at 1; and Integral Derivatives Letter, supra note 26.
    \71\ See, e.g., CBOE Statement 1, supra note 29, at 7-8 and 
Petition for Review, supra note 22, at 13. See also Bluefin 
Statement, supra note 29; Group One Letter, supra note 26, at 1-2; 
and Integral Derivatives Letter, supra note 26.
---------------------------------------------------------------------------

    Though ISE believes that there is nothing novel about granting or 
not granting customer priority, that the Commission had approved 
exchange rules that do not provide customer priority, and that there is 
no statutory requirement that customer orders receive priority,\72\ in 
SR-ISE-2010-73 the Exchange proposes to modify the Original QCC Order 
rules to require that a QCC Order be automatically cancelled if there 
are any Priority Customer \73\ orders on the Exchange's limit order 
book at the same price. This modification thus prohibits QCC Orders 
from trading ahead of Priority Customer orders. In addition, in SR-ISE-
2010-73, ISE proposes to increase the minimum size requirement for a 
QCC Order from 500 contracts to 1,000 contracts. ISE contends that such 
an increase supports the Exchange's intention to permit the crossing of 
only large-sized institutional stock-option orders.\74\
---------------------------------------------------------------------------

    \72\ See ISE Statement 1, supra note 28, at 4. See also Capstone 
Statement, supra note 28, at 2.
    \73\ 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.
    \74\ See Vacate Letter, supra note 69, at 1.
---------------------------------------------------------------------------

    Thus, as modified, an ISE member effecting a trade pursuant to the 
NMS QCT Exemption could cross the options leg of the trade on ISE as a 
QCC Order immediately upon entry, without exposure, only if there are 
no Priority Customer orders on the Exchange's limit order book at the 
same price and if the order: (i) Is for at least 1,000 contracts; (ii) 
meets the six requirements of the NMS QCT Exemption; \75\ and (iii) is 
executed at a price at or between the NBBO (``Modified QCC 
Order'').\76\ In the Notice, ISE stated that the modifications to the 
Original QCC Order (i.e., to prevent the execution of a QCC if there is 
a Priority Customer on its book and to increase the minimum size of a 
QCC Order) remove the appearance that such orders are trading ahead of 
Priority Customer orders or that the QCC Order could be used to 
disadvantage retail customers.\77\
---------------------------------------------------------------------------

    \75\ See supra notes 9 and 13 and accompanying text.
    \76\ If there are Priority Customer orders on ISE's limit order 
book at the same price, the QCC Order would be automatically 
canceled. See proposed ISE Rule 721(b)(1).
    \77\ See Notice, supra note 3.
---------------------------------------------------------------------------

E. Commenters to ISE's Modified QCC Order Proposal

    The Commission received eight comment letters opposing ISE's 
Modified QCC Order proposal and a response letter from ISE.\78\ While 
some commenters noted that ISE had addressed their prior objections 
relating to customer priority,\79\ commenters objected to ISE's 
modified proposal because it remained unchanged from the original 
proposal with respect to exposure, in that QCC Orders would still be 
crossed without exposure.\80\ Commenters noted that exposure is 
especially critical in the options market, which is quote-driven and 
relies on market makers to ensure that two-sided quotations are 
available for hundreds of thousands of different options series.\81\ 
Commenters argued that exposure, in addition to allowing for the 
possibility of price improvement, provides market makers an opportunity 
to participate in trades, which in turn provides them incentives to 
quote aggressively, thus benefiting the market as a whole.\82\
---------------------------------------------------------------------------

    \78\ See supra notes 4 and 5.
    \79\ See CBOE Letter 1, supra note 4, at 1, NYSE Letter 2, supra 
note 4, at 7, and Susquehanna Letter 2, supra note 4, at 1. See also 
supra notes 44-54 and accompanying text.
    \80\ See CBOE Letter 1, supra note 4, at 1; Phlx Letter 2, supra 
note 4, at 1; LiquidPoint Letter 2, supra note 4, at 1-2; Group One 
Letter 2, supra note 4, at 1; NYSE Letter 2, supra note 4, at 1-2, 
7-8; and Susquehanna Letter 2, supra note 4, at 1.
    \81\ See CBOE Letter 1, supra note 4, at 1-2; Phlx Letter 2, 
supra note 4, at 1; LiquidPoint Letter 2, supra note 4, at 1, 2; 
Group One Letter 2, supra note 4, at 2; NYSE Letter 2, supra note 4, 
at 3, 7-8; NYSE Letter 3, supra note 4, at 2; and Susquehanna Letter 
2, supra note 4, at 3.
    \82\ See CBOE Letter 1, supra note 4, at 2-3 and Phlx Letter 2, 
supra note 4, at 1. See also Cutler Letter, supra note 4 (stating 
that without exposure, there is no incentive for market makers to 
display liquidity, provide liquidity or offer price improvement) and 
LiquidPoint Letter 2, supra note 4, at 2 (stating that if market 
makers are not able to participate in all price discovery 
opportunities, they would be left to participate in only price 
discovery opportunities that are less-desirable and that the result 
of this negative selection would be ``increased risk, a higher 
probability of unprofitable trades and a reticence to post their 
best markets. See also Group One Letter 2, supra note 4, at 2; NYSE 
Letter 2, supra note 4, at 2, 3; and Susquehanna Letter 2, supra 
note 4, at 3.
---------------------------------------------------------------------------

    Relatedly, several commenters warned against removing incentives 
for liquidity providers in light of the market events of May 6, 
2010.\83\ One commenter noted that any tightening of market maker 
obligations could only succeed if market maker benefits were 
correspondingly aligned, and argued that ISE's proposal would withdraw 
significant options order flow and, thus, the opportunity for market 
makers to interact with that order flow via exposure.\84\
---------------------------------------------------------------------------

    \83\ See CBOE Letter 1, supra note 4, at 1, 3-4; Group One 
Letter 2, supra note 4, at 2; and NYSE Letter 2, supra note 4, at 2.
    \84\ See CBOE Letter 1, supra note 4, at 3.
---------------------------------------------------------------------------

    In addition, CBOE stated that order exposure and the opportunity 
for market participant interaction was integrally related to what 
constitutes an exchange and stressed that the Commission should not 
abandon such long-held standards to permit ``print'' mechanisms on 
options exchanges, which it believed the ISE proposal to be.\85\ CBOE 
and NYSE also noted that the Commission has generally not permitted 
100% participation guarantees, as the QCC Order would provide for.\86\
---------------------------------------------------------------------------

    \85\ See CBOE Letter 1, supra note 4, at 3, 5.
    \86\ See NYSE Letter 2, supra note 4, at 3; NYSE Letter 3, supra 
note 4, at 1-2; and CBOE Letter 1, supra note 4, at 2.
---------------------------------------------------------------------------

    CBOE also noted that the component legs of stock-option orders are 
exposed on options exchanges as a package (e.g., through complex order 
mechanisms) with all terms of the complete order being transparent to 
the marketplace.\87\ This commenter noted that such stock-option 
orders, while still requiring exposure, are granted intermarket trade-
through relief. In contrast, this commenter saw no reason why QCC 
Orders should receive any special treatment (i.e., not be required to 
be exposed) and noted that they are not represented as a package and 
thus do not provide the same transparency as stock-option orders, with 
only upstairs parties to these trades aware of the complete terms of 
the total transaction.\88\ In response, ISE reiterated its belief that 
the crossing of large-size contingency orders on a floor today is not 
transparent because ``there are very few traders (if any) on the floor 
to hear an order `announced''' and are executed with little, if any. 
interruption.\89\ ISE stated that commenters opposed to its proposal 
were arguing about the theoretical benefits of exposure and ignoring 
the realities of what is occurring in the markets.\90\ Further, ISE 
stated that, currently, members arrange large stock-option trades 
upstairs and then bring them to an exchange for execution. Floor 
exchanges, ISE argued, accommodate these trades by providing a market 
structure where there is little

[[Page 11539]]

or no chance that members will break up the pre-arranged trade.\91\ 
Another commenter believed that splitting a stock-option order into 
separate executions for the individual stock and options legs, rather 
than representing the stock-option order as a package, was generally 
not in the best interest of the customer from a best execution point of 
view.\92\
---------------------------------------------------------------------------

    \87\ See CBOE Letter 1, supra note 4, at 4-5. See also NYSE 
Letter 2, supra note 4, at 4.
    \88\ See CBOE Letter 1, supra note 4, at 4-5. See also Cutler 
Letter, supra note 4; and NYSE Letter 2, supra note 4, at 4.
    \89\ See ISE Statement 1, supra note 28, at 3.
    \90\ See ISE Response, supra note 5, at 2.
    \91\ Id.
    \92\ See Susquehanna Letter 2, supra note 4, at 4-5.
---------------------------------------------------------------------------

    Another commenter reiterated its belief that the benefits of price 
discovery and transparency afforded by exposure were especially crucial 
for broker facilitated crosses such as QCC Orders because of the 
inherent conflict of interest for such orders since a broker is 
``betting against the customer'' in such trades.\93\ Commenters also 
contended that ISE's claim that it needed the QCC Order to compete with 
trading on floor-based exchanges is erroneous and disingenuous, and 
that it ignored the broader ramification of QCC Orders that, whereas 
trading floors require exposure of orders before any executions can 
occur, the QCC Order would ensure that exposure was eliminated 
altogether.\94\
---------------------------------------------------------------------------

    \93\ See Group One Letter 2, supra note 4, at 1-2. See also 
supra note 55 and accompanying text.
    \94\ See CBOE Letter 1, supra note 4, at 4-5. See also NYSE 
Letter 2, supra note 4, at 3-4 and NYSE Letter 3, supra note 4, at 
2.
---------------------------------------------------------------------------

    With respect to the increase in contract size for QCC Orders from 
500 contracts (as originally proposed in SR-ISE-2009-35) to 1,000 
contracts, NYSE questioned whether the change was meaningful in 
limiting the scope of the proposed QCC Order type, as it believed that 
market participants could game the rule to meet this requirement,\95\ 
while another commenter believed that the 1,000 contract requirement 
was a relatively low threshold that would permit large broker-dealers 
to shut out other market participants on relatively small trades.\96\
---------------------------------------------------------------------------

    \95\ See NYSE Letter 2, supra note 4, at 5-7 and NYSE Letter 3, 
supra note 4, at 3.
    \96\ See Cutler Letter, supra note 4.
---------------------------------------------------------------------------

    In its response letter, ISE reiterated its argument that its QCC 
Order proposals were simply a way for ISE to compete against floor-
based options exchanges for the execution of large stock-option 
orders.\97\ ISE countered commenters' arguments regarding the lack of 
exposure of QCC Orders by stating that the required exposure of orders 
on floor-based exchanges was nominal and theoretical, and ignores the 
realities of what is occurring on those markets.\98\ One commenter 
agreed with ISE's assertion that floor-based options exchanges enjoy an 
unfair competitive advantage over all-electronic options exchanges for 
executing clean blocks, noting that, in its own experience, 
``institutional brokers are much more apt to use a trading floor when 
the primary intention is to execute as clean a cross as possible.'' 
\99\ ISE stated its belief that floor-based options markets accommodate 
such trades by ``providing a market structure in which there is little 
or no chance that members will break up the pre-arranged trade'' by 
structuring their markets to provide such trades with the least amount 
of ``friction.'' \100\ ISE contended that, if floor-based exchanges 
were serious about exposure, they would expose such orders to their 
entire marketplace, rather than limiting exposure to ``those few (if 
any) members physically present in the floor-based trading crowd.'' 
\101\ One commenter echoed ISE's contention and suggested that a common 
rule for all block crosses on all options exchanges should be adopted 
to require all pre-negotiated option block crosses, including floor 
crosses, to be entered into an electronic crossing mechanism. This 
commenter believed that such a requirement would ensure that market 
makers could compete for such orders and thus provide the orders a 
greater chance at price improvement, as well as act as a check to 
ensure that the brokers facilitating these orders priced them 
competitively.\102\
---------------------------------------------------------------------------

    \97\ See ISE Response, supra note 5, at 1-2.
    \98\ Id. at 2.
    \99\ See Susquehanna Letter 2, supra note 4, at 2.
    \100\ Id.
    \101\ Id.
    \102\ See Susquehanna Letter 2, supra note 4, at 2.
---------------------------------------------------------------------------

    ISE also countered commenters' arguments that the QCC Order 
proposal, because it does not provide for exposure, would not allow for 
price improvement by reiterating its prior explanation that those 
parties involved in a stock-option order negotiate such transactions on 
a ``net price'' basis, reflecting the total price of both the stock and 
options legs of the trade. Thus, ISE argued, the actual execution price 
of each individual component is not as material to the parties involved 
as is the net price of the entire transaction, which ISE believes means 
that price improvement of the individual legs of the trade is not a 
critical issue in the execution of a QCC Order.\103\
---------------------------------------------------------------------------

    \103\ See ISE Response, supra note 5, at 3-4.
---------------------------------------------------------------------------

    In addition, ISE argued that its QCC Order proposal has no 
relevance to the market events of May 6, 2010, despite commenters' 
attempts to link the two. ISE again noted that large stock-options 
trades are currently arranged upstairs and then shopped among exchanges 
to achieve a clean cross.\104\ ISE argued that, accordingly, large 
stock-option trades today ``rely on the liquidity that firms can 
provide in arranging these trades and do not now include exchange-
provided liquidity.'' \105\ ISE believed that the QCC Order type would 
simply provide a competitive electronic vehicle for such trades and 
will have no effect on available liquidity.\106\
---------------------------------------------------------------------------

    \104\ See ISE Response, supra note 5, at 4.
    \105\ Id.
    \106\ Id.
---------------------------------------------------------------------------

    In response to NYSE's contention that the QCC Order's contract size 
requirement could be gamed, ISE noted that any member creating ``fake 
customer orders'' would be misrepresenting its order in violation of 
ISE's rules and expressed confidence that its surveillance program 
would be able to catch any such attempt.\107\ In addition, ISE 
clarified the calculation of the 1,000 contract minimum size for a QCC 
Order noting that, in order to meet this requirement, an order must be 
for at least 1,000 contracts and could not be, for example, two 500 
contract orders or two 500 contract legs.\108\
---------------------------------------------------------------------------

    \107\ Id. at 5-6.
    \108\ Id. at 6.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    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 
and, in particular, with Section 6(b) of the Act.\109\ Specifically, 
the Commission finds that the proposal is consistent with Sections 
6(b)(5) \110\ and 6(b)(8),\111\ which require, among other things, that 
the rules of a national securities 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 and that 
the rules of an exchange do not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act. In 
addition, the Commission finds that the proposed rule change is 
consistent with Section 11A(a)(1)(C) of the Act,\112\ in which Congress 
found that it is in the public

[[Page 11540]]

interest and appropriate for the protection of investors and the 
maintenance of fair and orderly markets to assure, among other things, 
the economically efficient execution of securities transactions.
---------------------------------------------------------------------------

    \109\ 15 U.S.C. 78f(b). In approving this proposed rule change, 
the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \110\ 15 U.S.C. 78f(b)(5).
    \111\ 15 U.S.C. 78f(b)(8).
    \112\ 15 U.S.C. 78k-1(a)(1)(C).
---------------------------------------------------------------------------

A. Consistency With the NMS QCT Exemption

    In approving the Original QCT Exemption, the Commission recognized 
that contingent trades can be ``useful trading tools for investors and 
other market participants, particularly those who trade the securities 
of issuers involved in mergers, different classes of shares of the same 
issuer, convertible securities, and equity derivatives such as options 
[italics added].'' \113\ The Commission stated that ``[t]hose who 
engage in contingent trades can benefit the market as a whole by 
studying the relationships between the prices of such securities and 
executing contingent trades when they believe such relationships are 
out of line with what they believe to be fair value.'' \114\ As such, 
the Commission stated that transactions that meet the specified 
requirements of the NMS QCT Exemption could be of benefit to the market 
as a whole, contributing to the efficient functioning of the securities 
markets and the price discovery process.\115\
---------------------------------------------------------------------------

    \113\ See Original QCT Exemption, supra note 9, at 52830.
    \114\ Id. at 52831.
    \115\ See CBOE QCT Exemption, supra note 13.
---------------------------------------------------------------------------

    The parties to a contingent trade are focused on the spread or 
ratio between the transaction prices for each of the component 
instruments (i.e., the net price of the entire contingent trade), 
rather than on the absolute price of any single component.\116\ 
Pursuant to the requirements of the NMS QCT Exemption, the spread or 
ratio between the relevant instruments must be determined at the time 
the order is placed, and this spread or ratio stands regardless of the 
market prices of the individual orders at their time of execution. As 
the Commission noted in the Original QCT Exemption, ``the difficulty of 
maintaining a hedge, and the risk of falling out of hedge, could 
dissuade participants from engaging in contingent trades, or at least 
raise the cost of such trades.'' \117\ Thus, the Commission found that, 
if each stock leg of a qualified contingent trade were required to meet 
the trade-through provisions of Rule 611 of Regulation NMS, such trades 
could become too risky and costly to be employed successfully and noted 
that the elimination or reduction of this trading strategy potentially 
could remove liquidity from the market.\118\
---------------------------------------------------------------------------

    \116\ See Original QCT Exemption, supra note 9, at 52829 
(explaining SIA's position on the need for the Original QCT 
Exemption).
    \117\ Id. at 52831.
    \118\ Id.
---------------------------------------------------------------------------

    The Commission believes that ISE's proposal, which would permit a 
clean cross of the options leg of a subset of qualified contingent 
trades (i.e., a stock-option qualified contingent trade that meets the 
requirements of the NMS QCT Exemption), is appropriate and consistent 
with the Act in that it would facilitate the execution of qualified 
contingent trades, for which the Commission found in the Original QCT 
Exemption to be of benefit to the market as a whole, contributing to 
the efficient functioning of the securities markets and the price 
discovery process.\119\ The QCC Order would provide assurance to 
parties to stock-option qualified contingent trades that their hedge 
would be maintained by allowing the options component to be executed as 
a clean cross.
---------------------------------------------------------------------------

    \119\ Id.
---------------------------------------------------------------------------

B. Exposure and Qualified Contingent Trades

    Commenters believed that ISE's modifications to the Original QCC 
Order did not adequately address their main objection regarding the QCC 
Order, particularly in that it would continue to permit option crosses 
to occur without prior exposure to the marketplace. Commenters 
generally reiterated their prior comments that exposing options orders 
promotes price competition, increases order interaction, and leads to 
better quality executions for investors by providing opportunities for 
price improvement.\120\ These commenters continued to argue that, 
without exposure, the Modified QCC Order would cause significant harm 
to the options market because it would eliminate valuable incentive for 
dedicated liquidity provider participation.\121\
---------------------------------------------------------------------------

    \120\ See supra notes 70 and 85-94 and accompanying text.
    \121\ See supra notes 81-84 and accompanying text.
---------------------------------------------------------------------------

    In response to commenters' concerns that the Modified QCC Order 
would have a detrimental effect on the options markets because of the 
lack of any exposure requirement, ISE stated that exchange members 
arrange large stock-option trades upstairs and then bring them to an 
exchange for execution, and that exchange floors accommodate the trades 
by providing a market structure in which there is little or no chance 
that members will break up the pre-arranged trade.\122\ ISE believed 
that, rather than harming the options markets, the QCC proposal would 
permit fair competition to occur between floor-based and all-electronic 
options exchanges by providing an all-electronic execution alternative 
to floor-based executions.\123\
---------------------------------------------------------------------------

    \122\ See supra notes 97-100 and accompanying text.
    \123\ See ISE Response, supra note 5, at 3.
---------------------------------------------------------------------------

    The Commission recognizes that significant liquidity on options 
exchanges is derived from quotations submitted by members of an 
exchange that are registered as market makers.\124\ Pursuant to the 
options exchanges' rules, market makers generally are required to 
maintain continuous two-sided quotations in their registered options 
for a specified percentage of the time, or in a specified number of 
series or classes. One of the perceived benefits for market makers with 
such obligations is the opportunity to participate in transactions 
through the exposure requirement. As noted above, some commenters argue 
that the lack of exposure for QCC Orders would act as a disincentive 
for market maker participation.\125\
---------------------------------------------------------------------------

    \124\ See, e.g., Susquehanna Letter 2, supra note 4, at 3 
(noting that, in the options market, market makers provide over 90% 
of the liquidity).
    \125\ See supra notes 81-82 and accompanying text.
---------------------------------------------------------------------------

    While the Commission believes that order exposure is generally 
beneficial to options markets in that it provides an incentive to 
options market makers to provide liquidity and therefore plays an 
important role in ensuring competition and price discovery in the 
options markets, it also has recognized that contingent trades can be 
``useful trading tools for investors and other market participants, 
particularly those who trade the securities of issuers involved in 
mergers, different classes of shares of the same issuer, convertible 
securities, and equity derivatives such as options [italics 
added]''.\126\ and that ``[t]hose who engage in contingent trades can 
benefit the market as a whole by studying the relationships between the 
prices of such securities and executing contingent trades when they 
believe such relationships are out of line with what they believe to be 
fair value.'' \127\ As such, the Commission stated that transactions 
that meet the specified requirements of the NMS QCT Exemption could be 
of benefit to the market as a whole, contributing to the efficient 
functioning of the securities

[[Page 11541]]

markets and the price discovery process.\128\
---------------------------------------------------------------------------

    \126\ See Original QCT Exemption, supra note 9, at 52830-52831.
    \127\ Id.
    \128\ See CBOE QCT Exemption, supra note 13, at 19273.
---------------------------------------------------------------------------

    Thus, in light of the benefits provided by both the requirement for 
exposure as well as by qualified contingent trades such as QCC Orders, 
the Commission must weigh the relative merits of both for the options 
markets.\129\ The Commission believes that the proposal, in requiring a 
QCC Order to be: (1) Part of a qualified contingent trade under 
Regulation NMS; (2) for at least 1,000 contracts; (3) executed at a 
price at or between the national best bid or offer; and (4) cancelled 
if there is a Priority Customer Order on ISE's limit order book, 
strikes an appropriate balance for the options market in that it is 
narrowly drawn \130\ and establishes a limited exception to the general 
principle of exposure and retains the general principle of customer 
priority in the options markets. Furthermore, not only must a QCC Order 
be part of a qualified contingent trade by satisfying each of the six 
underlying requirements of the NMS QCT Exemption, the requirement that 
a QCC Order be for a minimum size of 1,000 contracts provides another 
limit to its use by ensuring only transactions of significant size may 
avail themselves of this order type.\131\
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    \129\ The Commission notes that it has previously permitted the 
crossing of two public customer orders, for which no exposure is 
required on ISE and CBOE. See CBOE Rule 6.74A.09 and ISE Rules 
715(i) and 721.
    \130\ The Commission notes that, in its request to remove the 
block-size requirement of the Original QCT Exemption, CBOE stated 
that the NMS QCT Exemption's other requirements would ensure that 
the exemption was narrowly drawn and limited to a small number of 
transactions. See Letter, dated November 28, 2007, from Edward J. 
Joyce, President and Chief Operating Officer, CBOE, to Nancy M. 
Morris, Secretary, Commission, at 1, 4.
    \131\ The Commission notes that the requirement that clean 
crosses be of a certain minimum size is not unique to the QCC Order. 
See, e.g., NSX Rule 11.12(d), which requires, among other things, 
that a Clean Cross be for at least 5,000 shares and have an 
aggregate value of at least $100,000.
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    As noted above, some commenters argue that the concerns regarding 
the impact of the QCC Order on the incentives for liquidity providers 
are heightened by the events of May 6, 2010.\132\ Specifically, 
commenters argued that in light of the events of May 6, 2010, the 
Commission should not improve measures that would create disincentives 
for market makers to provide liquidity to the markets.\133\ The 
Commission recognizes the important role liquidity providers play, 
particularly in the options markets, which tend to be more quote driven 
than the cash equities markets. In addition, the Commission is 
cognizant of the concerns raised by some commenters with regard to the 
events of May 6, 2010. However, as discussed above, the Commission has 
weighed the relative merits of the QCC Order and of the exposure of 
such orders and believes that ISE's proposal is consistent with the 
Act.
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    \132\ See supra notes 83-84 and accompanying text.
    \133\ Id.
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C. Customer Protection

    In response to concerns that the Original QCC Order did not provide 
adequate customer protection because the QCC Order would have priority 
over resting customer orders on ISE's books,\134\ ISE proposes to 
modify the QCC Order to provide for automatic cancellation of a QCC 
Order if there is a Priority Customer order on the Exchange's limit 
order book at the same price. The Commission believes that this 
modification to yield to a Priority Customer order on the book would 
ensure that QCC Orders do not trade ahead of Priority Customer orders 
at the same price, and thus should alleviate commenters' concerns 
regarding the Original QCC Order that customers would not receive 
executions of their resting orders, which could also create a 
disincentive to placing limit orders.
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    \134\ See Petition for Review, supra note 22, at 15, 17. See 
also Bluefin Statement, supra note 29; Phlx Letter, supra note 26; 
Wolverine Letter, supra note 26; Group One Letter, supra note 26, at 
1; and Integral Derivatives Letter, supra note 26.
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    Some commenters objected to the Modified QCC Order because they 
believed that a customer order submitted as a QCC Order risks receiving 
a fill at an inferior price to the price it could have received if it 
has been exposed to the market.\135\ Another commenter was concerned 
that, while the option trade would be within the NBBO, the stock trade 
may be priced outside of the market and that ``[t]he effect is a 
valuation for the stock/option package * * * unrestricted by 
competition * * * . '' \136\ In response to commenters concerns 
regarding price improvement, ISE argued that the actual execution price 
of each component is not as material to the parties as is the net price 
of the transaction and accordingly, price improvement of the individual 
legs of the trade is not a critical issue in executing the QCC 
Order.\137\
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    \135\ See Group One Letter 2, supra note 4, at 1; and CBOE 
Letter 1, supra note 4, at 2.
    \136\ See LiquidPoint Letter 2, supra note 4, at 2.
    \137\ See supra note 103 and accompanying text.
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    As discussed above, QCC Orders must be for 1,000 or more contracts, 
in addition to meeting all of the requirements of the NMS QCT 
Exemption. The Commission believes that those customers participating 
in QCC Orders will likely be sophisticated investors who should 
understand that, without a requirement of exposure for QCC Orders, 
their order would not be given an opportunity for price improvement on 
the Exchange. These customers should be able to assess whether the net 
prices they are receiving for their QCC Order are competitive, and who 
will have the ability to choose among broker-dealers if they believe 
the net price one broker-dealer provides is not competitive. Further, 
broker-dealers are subject to a duty of best execution for their 
customers' orders, and that duty does not change for QCC Orders.

IV. Conclusion

    In sum, the Commission believes that ISE's Modified QCC Order is 
consistent with the NMS QCT Exemption, which found that qualified 
contingent trades are of benefit to the market as a whole and a 
contribution to the efficient functioning of the securities markets and 
the price discovery process.\138\ In addition, the Exchange's Modified 
QCC Order is narrowly drawn to provide a limited exception to the 
general principle of exposure, and retains the general principle of 
customer priority. Accordingly, 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 and, in particular, with Section 6(b) of the Act.\139\ 
Specifically, the Commission finds that the proposal is consistent with 
Sections 6(b)(5) \140\ and 6(b)(8) of the Act.\141\ Further, the 
Commission finds that the proposed rule change is consistent with 
Section 11A(a)(1)(C) of the Act.\142\
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    \138\ See supra note 13.
    \139\ 15 U.S.C. 78f(b). In approving this proposed rule change, 
the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \140\ 15 U.S.C. 78f(b)(5).
    \141\ 15 U.S.C. 78f(b)(8).
    \142\ 15 U.S.C. 78k-1(a)(1)(C).
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    It is therefore ordered, the proposed rule change (SR-ISE-2010-73) 
is approved pursuant to Section 19(b)(2) of the Act.\143\
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    \143\ 15 U.S.C. 78s(b)(2).

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-4574 Filed 3-1-11; 8:45 am]
BILLING CODE 8011-01-P