[Federal Register Volume 65, Number 248 (Tuesday, December 26, 2000)]
[Notices]
[Pages 81551-81552]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32806]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43729; File No. SR-ISE-00-09]


Self Regulatory Organizations; Order Approving Proposed Rule 
Change by the International Securities Exchange LLC Relating to Chinese 
Wall Procedures

December 15, 2000.

I. Introduction

    On September 12, 2000, the International Securities Exchange LLC 
(``ISE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend ISE Rule 810 relating to 
Chinese Wall procedures. The proposed rule change was published for 
comment in the Federal Register on November 13, 2000.\3\ The Commission 
received no comments on the proposed rule change and this order 
approves the proposal.
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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. 43508 (November 2, 
2000), 65 FR 67784 (November 13, 2000).
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I. Description of the Proposal

    ISE Rule 810 requires that ISE market makers erect a ``Chinese 
Wall'' between their market making activity and certain other business 
activities, including their trading as an Electronic Access Member 
(``EAM''). The wall is intended prevent any real-time communication 
between the various business lines. Without the wall, a trader entering 
an order as an EAM could potentially inform the person making markets 
about the pending order. The market maker could then, based on this 
knowledge, move its quotation either (i) to ``intercept'' an order 
against which the firm wants to trade, or (ii) to avoid an order 
against which it does not want to trade. The Exchange adopted ISE Rule 
810 because such behavior would be inconsistent with the agency auction 
market structure of the Exchange.
    The ISE noted, however, that the broad restrictions of ISE Rule 810 
limit the ability of certain market makers to send proprietary order 
flow to the ISE in options outside of their assigned groups of options 
(``bins'').\4\ In particular, many market makers do not have the 
facilities to establish a ``Chinese Wall,'' which requires physical 
separation of functions (generally on separate floors), between their 
proprietary traders and individuals performing ISE market making 
activities.
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    \4\ The ISE assigns market makers to bins of options. There are 
10 bins, and each bin has one Primary Market Maker (``PMM'') and up 
to 10 Competitive Market Makers (``CMM'') assigned to each.
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    The proposed rule change, therefore, will allow members to conduct 
proprietary trading in the same physical space as their market making 
activities, but only: (i) In options that are not within their market 
making assignments; or (ii) in options which, pursuant to regulatory 
requirements, the member is prohibited from making markets. This latter 
provision is intended to apply to market makers that are specialists in 
the underlying stock on the New York Stock Exchange, Inc. (``NYSE''), 
whose rules limit the options trading of specialists and affiliated 
firms to ``hedging activities,'' thus prohibiting them from making 
markets in options.\5\ In addition, the proposed rule change would 
permit only proprietary trading without the Chinese Wall and would not 
permit the market maker to enter agency orders (except with respect to 
proprietary orders for its affiliates) without complying with the full 
restrictions of ISE Rule 810.
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    \5\ See NYSE Rule 105. This applies solely to CMMs. Because CMMs 
are required to provide continuous quotes in only 60 percent of the 
options in a bin, it is possible that a CMM could be assigned a bin 
in which it is not permitted to make markets in certain options 
classes. Such a CMM simply would not quote in these ``restricted'' 
options. PMMs must provide continuous quotes in all options in a bin 
and thus were not assigned bins where these regulatory restrictions 
apply.
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III. Discussion

    The Commission has reviewed the ISE's proposed rule change and 
finds, for the reasons set forth below, that the proposal is consistent 
with the requirements of Section 6 of the Act \6\ and the rules and 
regulations thereunder applicable to a national securities exchange. 
Specifically, the Commission believes the proposal is consistent with 
Section 6(b)(5) of the Act,\7\ because it promotes just and equitable 
principles of trade, removes impediments to and perfects the mechanism 
of a free and open market and a national market system, and protects 
investors and the public interest, by maintaining an information 
barrier that respects the integrity of the ISE while still permitting 
members, under certain circumstances, to conduct proprietary trading in 
the same physical space as their market making activities.\8\
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    \6\ 15 U.S.C. 78f.
    \7\ 15 U.S.C. 78f(b)(5).
    \8\ In approving the proposal, the Commission has considered the 
rule's impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
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    The Commission notes that amending ISE Rule 810 will help attract 
proprietary order flow to the ISE. Although members will be allowed to 
conduct proprietary trading in the same physical space as their market 
making acitivites, they may do so only in options that are not within 
their market making assignments or in options which, pursuant to 
regulatory requirements, the member is prohibited from making markets. 
In addition, the proposed rule change would permit only proprietary 
trading without the Chinese Wall and would not permit the market maker 
to enter agency orders (except with respect to proprietary orders for 
its affiliates) without complying with the full restrictions of ISE 
Rule 810. Limiting such activity to these specific situations reduces 
the potential for the type of harm against which ISE Rule 810 is 
intended to protect, since the member will not be making markets in the 
stocks in which it is engaging in proprietary trading. The Commission 
emphasizes, however, that the information barrier between a market 
maker and affiliated EAM should protect against any inappropriate 
sharing of information that could result in market manipulation. The 
Commission continues to expect the ISE to be vigilant in monitoring for 
possible abuses in this context.

[[Page 81552]]

IV. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\9\ that the proposed rule change (SE-ISE-00-09) is approved.
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    \9\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Maragret H. McFarland,
Deputy Secretary.
[FR Doc. 00-32806 Filed 12-22-00; 8:45 am]
BILLING CODE 8010-01-M