[Federal Register Volume 67, Number 51 (Friday, March 15, 2002)]
[Notices]
[Pages 11732-11735]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-6260]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45529; File No. SR-ISE-2002-01]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the International Securities 
Exchange LLC Proposal to Restructure From a Limited Liability Company 
to a Corporation

March 8, 2002.
    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 January 11, 2002, the International Securities Exchange LLC (``ISE'' 
or ``Exchange'') 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 Exchange. 
Amendment No. 1 was filed on March 5, 2002.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated March 4, 2002 
(``Amendment No. 1''). In Amendment No. 1, the Exchange expanded the 
concentration limits regarding ownership of the Class A Common Stock 
of its proposed corporation, International Securities Exchange, Inc. 
(``New ISE''). Specifically, the Exchange amended the proposed rule 
change to include a general prohibition on the voting rights with 
respect to stock that a person owns above a 20 percent ceiling. 
However, the Exchange states that its Board of Directors (``Board'') 
would be able to exempt a person from the voting limit if such an 
exemption generally would be consistent with the Exchange's self-
regulatory responsibilities. The Board would not be able to grant an 
exemption to: members; their affiliates; or persons subject to a 
statutory disqualification. In addition, Amendment No. 1 specifies 
that any ``poison pill'' New ISE adopts will be subject to prior 
Commission approval.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The International Securities Exchange LLC (``Old ISE'') proposes to 
restructure from a limited liability company to a corporation, New ISE, 
(with the on-going business of both Old ISE and New ISE referred to 
collectively as ``ISE'' or the ``Exchange'') and to ``demutualize'' by 
separating the equity interest in the Exchange from members' trading 
rights. The text of the proposed rule change consists of: (1) A new 
Certificate of Incorporation; (2) a new Constitution; and (3) 
amendments to the Exchange's Rules. In addition, the Exchange has 
adopted the following interpretation of its Rules:

    Upon reorganization, the Exchange would be a Delaware 
corporation. Pursuant to Paragraph (a)(ii) of section II of the 
Exchange's Certificate of Incorporation, the holders of the 
Exchange's Class A Common Stock ``would be entitled to receive, when 
and if declared by the Board of Directors, out of the assets of [New 
ISE] which are by law available therefor, dividends payable either 
in cash, in stock or otherwise.'' The Exchange states its policy is 
that any revenues it receives from regulatory fees or regulatory 
penalties: would be segregated; would be applied to fund the legal, 
regulatory and surveillance operations of the Exchange; and would 
not be used to pay dividends to the holders of the Class A Common 
Stock.

    The text of the proposed rule change is available for inspection at 
the Office of the Secretary, the ISE, the Commission's Public Reference 
Room, and on the Commission's Internet Web site (http://www.sec.gov).

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 Exchange 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 Exchange 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

(1) Purpose
    The ISE is currently structured as a limited liability company 
(``LLC''), in which memberships encompass both trading rights and 
equity ownership. The Exchange states that the purpose of this proposed 
rule change is to restructure the company into a corporation, in which 
trading rights are separated from equity ownership. Except as specified 
below, the Exchange represents that these changes do not

[[Page 11733]]

affect the manner of the Exchange's operations or governance structure. 
The three documents that would accomplish the restructuring and 
demutualization of the Exchange, and that encompass this rule change, 
are as follows:
     Certificate of Incorporation: This is the basic corporate 
document and replaces Old ISE's current LLC Operating Agreement.
     Constitution and By-Laws: This document replaces Old ISE's 
Constitution.
     Amended rules: These proposed rule changes reflect the 
changes to the Certificate and Constitution. Most changes are non-
substantive and reflect changes to ``membership'' terminology required 
by the demutualization. In particular, the applicability of various 
rules to ``owners'' of shares and to ``Members'' of the Exchange, which 
are broker-dealers that have been approved to exercise trading 
privileges on the Exchange, has been clarified.

Overview of the Restructuring and Demutualization

    The Exchange would convert into a Delaware stockholder corporation 
through a merger of Old ISE with New ISE, its newly-formed subsidiary; 
the members of Old ISE would become stockholders of New ISE. 
Memberships in Old ISE would convert into shares of New ISE Class A 
Common Stock, par value $.01 per share (the ``Class A Common Stock''), 
and shares of New ISE Class B Common Stock, par value $.01 per share 
(the ``Class B Common Stock''). Other than the nominal par value of the 
Class B Common Stock, the Class A Common Stock would constitute all of 
the equity in New ISE. New ISE may issue classes of preferred stock in 
the future, the terms of which would be defined by the Board and filed 
with the Commission for approval.
    The Class B Common Stock would confer upon holders trading 
privileges and specified voting rights associated with the memberships 
in Old ISE. The Class B shares would be issued in three series 
corresponding with the existing membership types. Each series of Class 
B Common Stock would confer the same trading privileges associated with 
the membership interest that is converted into such series, and would 
be distributed as follows:
     Each Class A Membership Interest (Primary Market Maker 
(``PMM'') Members) would receive one share of Class B Common Stock, 
Series B-1 (the ``Series B-1 Stock'');
     Each Class B Membership Interest (Competitive Market Maker 
(``CMM'') Members) would receive one share of Class B Common Stock, 
Series B-2 (the ``Series B-2 Stock''); and
     Each Class C Membership Interest (Electronic Access 
Members (``EAM'')) would receive one share of Class B Common Stock, 
Series B-3 (the ``Series B-3 Stock'').

Description of New ISE Stock

Class B Common Stock

    As discussed below, the holders of the Class B Common Stock would 
have the right to elect six members of New ISE's Board of Directors. In 
addition, Series B-1 Stock holders and Series B-2 Stock holders would 
have voting rights with respect to actions affecting the number of 
issued shares of Series B-1 Stock and Series B-2 Stock (the ``Core 
Rights''). A vote with respect to a Core Right would require the 
majority approval of the Series B-1 holders, voting as a separate 
class, and the Series B-2 holders, voting as a separate class. This 
replicates the voting provisions of Old ISE.
    A holder of Class B Common Stock, together with any affiliate, may 
not own more than 20% of Series B-1 Stock or Series B-2 Stock. ISE 
Founders \4\ would have a temporary exemption, not to extend past May 
26, 2010, from the ownership concentration limits. Founders, however, 
would have no voting rights, other than a vote related to Core Rights, 
for any shares in excess of 20% of the Series B-1 Stock or 20% of the 
Series B-2 Stock.
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    \4\ As defined in the New ISE Constitution, the term ``Founder'' 
means a person or entity that purchased the former Class A or Class 
B Memberships directly from the Exchange on or prior to August 1, 
1998, but only with respect to his or its ownership of such 
memberships.
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    The holders of Class B Common Stock would not have the right to 
receive any dividends. Upon liquidation of New ISE, holders of each 
series of Class B Common Stock would be entitled to receive a 
liquidation amount equal to the par value of the shares of Class B 
Common Stock ($0.01 per share). The shares of Series B-1 and B-2 Common 
Stock may be transferred only with approval of the Exchange, as is 
currently required with respect to PMM and CMM memberships. As with 
current EAM memberships, the shares of Series B-3 Stock would be non-
transferable. In the event an EAM withdraws from trading, New ISE would 
buy back its share of B-3 Stock at par value.

Class A Common Stock

    As discussed below, the holders of shares of Class A Common Stock 
would have the right to elect nine members of the Board of Directors of 
New ISE. The holders of the Class A Common Stock also would have the 
right to vote on any matter that requires a vote of the stockholders of 
New ISE, other than votes with respect to the Core Rights. Upon 
liquidation of New ISE, the holders of Class B Common Stock receive the 
par value of their stock and the holders of Class A Common Stock 
receive all residual amounts, subject to the rights of any classes of 
preferred shares.
    If a holder of Class A Common Stock, together with any affiliate, 
owns more than 20% of the Class A Common Stock, the holder would have 
no voting rights for shares owned in excess of the 20% concentration 
limit. The New ISE Board, however, may approve an exemption to this 
prohibition for any person other than a New ISE member, an affiliate of 
a New ISE member, or a person subject to a statutory disqualification 
under section 3(a)(3) of the Act,\5\ if the Board determines that such 
an exemption generally would be consistent with the New ISE's self-
regulatory responsibilities. ISE Founders would have a temporary 
exemption, not to extend past May 26, 2010, from the voting limitation 
on Class A Common Stock shares owned in excess of 20%, but only with 
respect to any vote regarding any merger, consolidation, or dissolution 
of the New ISE or any sale of all or substantially all of the assets of 
the New ISE.
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    \5\ 15 U.S.C. 78c(a)(3).
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    The holders of shares of Class A Common Stock would be entitled to 
receive dividends, when and if declared by the Board of Directors. 
Prior to its registration as a national securities exchange, the ISE 
adopted an interpretation restricting the ISE from paying dividends out 
of revenues received from regulatory fees or regulatory penalties.\6\ 
The ISE proposes a similar interpretation to apply the same 
restrictions to New ISE.
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    \6\ File No. 10-127, Amendment No. 2 (Letter from David Krell, 
President and Chief Executive Officer, ISE, to Jonathan G. Katz, 
Secretary, Commission, dated February 17, 2000).
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Election of Board of Directors

    The size and composition of the Board of Directors of New ISE would 
remain the same following the demutualization. The Board would be 
comprised of 15 directors, and initially would consist of the current 
Board of Old ISE. In future elections, the holders of the Class B 
Common Stock would elect six directors: Two directors elected by the 
holders of Series B-1 Stock; two directors elected by the holders of 
Series B-2 Stock; and two directors elected by the holders of Series B-
3 Stock.

[[Page 11734]]

    The holders of the Class A Common Stock would elect nine directors: 
Eight non-industry directors (including at least two who would be 
public representatives) and the Chief Executive Officer. As opposed to 
the current structure, PMMs, CMMs, and EAMs would have the right to 
vote for the non-industry directors only to the extent they own Class A 
Common Stock. The Exchange believes that retaining members' rights to 
elect six directors fully complies with the statutory requirement that 
the ISE ``assure a fair representation of its members in the selection 
of its directors. * * *.''\7\
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    \7\ Section 6(b)(3) of the Act. 15 U.S.C. 78f(b)(3).
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    Currently, the Exchange has a single nominating committee, 
consisting of both industry and non-industry members, that nominates 
all candidates for election to the Board. Consistent with the new 
election structure, a nominating committee consisting of 
representatives of holders of the Series B Common Stock would select 
the nominees for Series B directors, and the non-industry directors on 
the Board would select the nominees for non-industry directors. Holders 
of the appropriate classes of common stock also would be able to 
nominate rival candidates for the Board.

Trading Privileges on the Exchange

    The holders of each series of Class B Common Stock would have the 
same trading privileges they currently hold as PMMs, CMMs, and EAMs. 
The proposed rules of New ISE do not change any trading privileges. 
According to the Exchange, virtually all of the proposed changes are 
intended simply to conform the rules to the new Certificate of 
Incorporation and Constitution.

Transfer of Memberships

    In filing number SR-ISE-2001-24, the Exchange proposed changes to 
the process by which members could transfer memberships. Concurrently 
with submitting the current filing, the ISE is withdrawing SR-ISE-2001-
24 and including the substantive provisions of that filing in the Rules 
of New ISE. These changes update the Exchange's rules relating to the 
sale, transfer, and lease of market maker memberships. In particular, 
these changes eliminate the bid/offer system of selling these 
memberships and eliminate the claims process and deposit requirements 
for sales, transfer, and leases.\8\
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    \8\ The Exchange also proposes to change the terminology used in 
these Rules to reflect the fact that the sale or transfer of market 
maker trading rights will be accomplished by the sale or transfer of 
the appropriate share of Series B-1 or Series B-2 Class B Common 
Stock.
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    Current ISE Rules provide that market maker memberships generally 
must be sold through a bid and offer system. Given its experience to 
date, the Exchange believes that the bid/offer system is not compatible 
with the unique structure of its market maker memberships. The PMM and 
CMM memberships are assigned to particular bins. In contrast to 
memberships on other exchanges, these memberships are not fungible with 
memberships outside those bins. In addition, there are relatively few 
memberships within each bin (1 PMM and 10 CMMs), rendering a bid/offer 
system limited to bin and class impractical. The Exchange proposes 
instead to allow members to negotiate their own purchases and sales, 
subject to the purchase or transfer agreement being filed with, and 
approved by, the Exchange. As a convenience, the Exchange would 
maintain a ``bulletin board'' for members to list memberships for sale, 
but use of that facility would be voluntary.
    Currently, the Rules require the Exchange to hold proceeds from 
sales made pursuant to the bid/offer system for 20 days, during which 
time claims against the proceeds may be made. Similarly, under the 
lease provisions contained in the Exchange's current rules, a deposit 
is required prior to the lease becoming effective, to be applied at the 
beginning and the end of the lease term to satisfy the claims process. 
The Exchange proposes to remove the claims process and deposit 
requirements. These modifications would eliminate a significant 
administrative burden on the Exchange, Clearing Members, and other 
members that is a byproduct of the current membership claims process. 
As exists currently, Members can still pursue claims against other 
Members through the arbitration process.
(2) Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with the requirements under section 6(b)(5) of the Act \9\ 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 foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transaction in 
securities, 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.
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    \9\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others

    The Exchange did not solicit or receive written comments on the 
proposed rule change.

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 Exchange 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, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filings will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-ISE-2002-01 and should be submitted by April 5, 2002.



[[Page 11735]]


    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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-6260 Filed 3-14-02; 8:45 am]
BILLING CODE 8010-10-P