[Federal Register Volume 67, Number 83 (Tuesday, April 30, 2002)]
[Notices]
[Pages 21306-21308]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-10580]



[[Page 21306]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45803; File No. SR-ISE-2002-01]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1 thereto by the International Securities 
Exchange LLC To Restructure From a Limited Liability Company to a 
Corporation

April 23, 2002.

I. Introduction

    On January 11, 2002, 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 \3\ to restructure from a limited 
liability company to a corporation and to ``demutualize'' by separating 
the equity interest in the Exchange from members' trading rights. On 
March 5, 2002, the Exchange filed Amendment No. 1 to the proposed rule 
change.\4\ The proposed rule change, as amended, was published for 
comment in the Federal Register on March 15, 2002.\5\ The Commission 
received no comments on the proposed rule change. This order approves 
the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 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.
    \4\ 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. 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'' the new corporation adopts will 
be subject to prior Commission approval.
    \5\ See Securities Exchange Act Release No. 45529 (March 8, 
2002), 67 FR 11732.
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II. Description of the Proposal

    The ISE is currently structured as a limited liability company 
(``LLC''), in which memberships encompass both trading rights and 
equity ownership. The Exchange plans to restructure from a limited 
liability company (``Old ISE'') to a Delaware stockholder corporation 
(``New ISE'') and to demutualize by separating the equity interest in 
the Exchange from members' trading rights. Newly issued Class A Common 
Stock would represent the equity ownership in ISE and newly issued 
Class B Common Stock would represent the trading rights on ISE. The 
members of Old ISE would become stockholders of 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.
    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.

A. Class B Common Stock

    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. Accordingly, 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'').
    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''). 
The holders of each series of Class B Common Stock would have the same 
trading privileges they currently hold as PMMs, CMMs, and EAMs.
    A holder of Class B Common Stock, together with any affiliate, 
would not be permitted to own more than 20% of Series B-1 Stock or 
Series B-2 Stock. ISE Founders \6\ would have a temporary exemption, 
not to extend past May 26, 2010, from these 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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    \6\ 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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B. Class A Common Stock

    In addition to receiving a share of Series B-1 common stock, each 
PMM will also receive several shares of Class A Common Stock. The 
holders of Class A Common Stock 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 Core Rights. 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,\7\ 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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    \7\ 15 U.S.C. 78c(a)(3).
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C. Transfer of Memberships

    In addition, the Exchange proposes to eliminate the bid/offer 
system of selling memberships and to eliminate the claims process and 
deposit requirements for sales, transfer, and leases. The Exchange 
proposes 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.

D. Election of the Board of Directors

    The size and composition of the Board of Directors of New ISE would

[[Page 21307]]

remain the same following the demutualization. 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. 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. 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.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange.\8\ 
In particular, the Commission believes that the proposed rule change is 
consistent with section 6(b) of the Act,\9\ in that that it is designed 
to (1) assure fair representation of its members in the selection of an 
exchange's directors and administration of its affairs and provide 
that, among other things, one or more directors shall be representative 
of investors and not be associated with the exchange, or with a broker 
or dealer; (2) 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 (3) protect investors and the public interest.
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    \8\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78f(b).
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A. Fair Representation of Members

    Section 6(b)(3) of the Act requires that the rules of an exchange 
assure fair representation of its members in the selection of its 
directors and administration of its affairs and provide that one or 
more directors be representative of issuers and investors and not be 
associated with a member of the exchange, or with a broker or 
dealer.\10\
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    \10\ 15 U.S.C. 78f(b)(3).
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    The size and composition of the Board of Directors of New ISE would 
remain the same following the demutualization; the Board would continue 
to consist of 15 directors and initially will consist of the current 
Board of Old ISE. In future elections, the holders of the Class B 
Common Stock will 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. The nominations of these six directors would be made by the 
New ISE nominating committee, which would be comprised of one Series B-
1 Common Stock representative, one Series B-2 Common Stock 
representative, and one Series B-3 Common Stock representative. Persons 
may also be nominated to be Series B Directors by a petition signed by 
5% or more of the holders of the Series of Class entitled to elect such 
persons.
    The holders of the Class A Common Stock will elect nine directors: 
Eight non-industry directors (including at least two who would be 
public representatives) and the Chief Executive Officer. Nominees for 
election of the Non-Industry Board Directors, including Public 
Directors, would be selected by the Non-Industry Directors currently on 
the Board. Persons may also be nominated to be Non-Industry Directors 
by petition signed by 20% or more of the holders of Class A Common 
Stock. Thus, the Board would include six directors nominated and 
elected by members. In addition, the proposed New ISE Constitution 
provides that the number of non-industry members on the executive and 
audit committees equals or exceeds the number of industry members. The 
New ISE executive committee will consist of six directors, at least 
three of which will be non-industry directors and at least one of whom 
will be a public director.\11\ In addition, the New ISE audit committee 
will consist of three to five directors, each of which will be a non-
industry director, and at least one of the non-industry directors will 
be a public director.\12\
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    \11\ New ISE Constitution, Article V, Section 5.2.
    \12\ New ISE Constitution, Article V, Section 5.4.
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    The Commission finds that the selection of 6 of the 15 directors on 
the New ISE's Board and the manner in which such directors will be 
nominated and elected satisfies the fair representation requirement in 
Section 6(b)(3) of the Act.\13\ Moreover, the Commission finds that the 
majority non-industry composition of the Board of the New ISE, together 
with the compostional balance on the committees, is sufficient to help 
assure that the Exchange actively works to protect the public's 
interest in the fairness of the securities markets and is consistent 
with Section 6(b)(3) of the Act.\14\
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    \13\ 15 U.S.C. 78f(b)(3).
    \14\ 15 U.S.C. 78f(b)(3).
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B. Concentration Limits

    The ISE has also proposed concentration limits to restrict the 
number of shares that a stockholder, together with any affiliate, may 
own or vote. A holder of Class B Common Stock, together with any 
affiliate, would not be permitted to own more than 20% of Series B-1 
Stock or Series B-2 Stock. ISE Founders 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.
    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, would be permitted to 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,\15\ if the 
Board determines that such an exemption generally would be consistent 
with 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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    \15\ 15 U.S.C. 78c(a)(3).
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    The Commission finds that the proposed restrictions on the 
ownership and voting on members, who are also subject to regulation by 
the Exchange, is consistent with the requirements of Section 6(b) of 
the Act.\16\ Moreover, the Commission believes that the proposed

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ownership and voting concentration limits on other shareholders will 
minimize the potential that the control of the Exchange by one or a few 
shareholders would impair the Exchange's ability to carry out its self-
regulatory obligations.
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    \16\ 15 U.S.C. 78f(b)(1).
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    Finally, the Commission notes that New ISE, like Old ISE, will not 
be structured to provide its shareholders a profit from revenue 
generated by the Exchange as a result of regulatory fees or penalties 
imposed on Exchange members. The New ISE's policy is that any revenues 
it receives from regulatory fees or regulatory penalties: (1) Would be 
segregated; (2) would be applied to fund the legal, regulatory, and 
surveillance operations of the Exchange; and (3) would not be used to 
pay dividends to the holders of Class A Common Stock. In addition, the 
proposed rules of New ISE do not change any trading privileges of its 
members. The Commission finds that the allocation and use of regulatory 
fees or regulatory penalties is consistent with Section 6(b)(3) of the 
Act \17\ because it will ensure that the regulatory authority of the 
Exchange is not used improperly to benefit the shareholders.
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    \17\ 15 U.S.C. 78f(b)(3).
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-ISE-2002-01), as amended, is 
approved.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-10580 Filed 4-29-02; 8:45 am]
BILLING CODE 8010-01-P