[Federal Register Volume 67, Number 149 (Friday, August 2, 2002)]
[Notices]
[Pages 50497-50499]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-19535]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46272; File No. SR-ISE-2002-11]


Self-Regulatory Organizations; International Securities Exchange, 
Inc.; Order Approving Proposed Rule Change, and Notice of Filing and 
Order Granting Accelerated Approval to Amendment Nos. 1 and 2 Relating 
to a Market Maker Inactivity Fee

July 26, 2002.

I. Introduction

    On April 16, 2002, the International Securities Exchange LLC 
(``ISE'') 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 impose a Competitive Market Maker (``CMM'') 
inactivity fee. On May 6, 2002, the Exchange's rule proposal was 
published for comment in the Federal Register.\3\ The Commission 
received two comment letters on the proposal.\4\ On April 30, 2002 and 
June 19, 2002, ISE submitted Amendment Nos. 1 and 2 to the proposal, 
respectively. \5\ On June 19, 2002, the ISE submitted a response to 
comments.\6\ This order approves the proposed rule change, publishes 
notice of Amendment Nos. 1 and 2 to the proposed rule change, and 
grants accelerated approval of Amendment Nos. 1 and 2.
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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. 45816 (April 24, 
2002), 67 FR 30406.
    \4\ See letters to Jonathan G. Katz, Secretary, Commission, from 
Henry Swartz, Principal, Equity Financial Products, Banc of America 
Securities, LLC, (``Banc of America'') dated May 23, 2002 (``Banc of 
America Letter''), and Matthew D. Wayne, Chief Legal Officer, Knight 
Financial Products LLC, (``Knight'') dated April 30, 2002 (``Knight 
Letter'').
    \5\ See letters from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division 
of Market Regulation, Commission, dated April 29, 2002 (``Amendment 
No. 1'') and June 18, 2002 (``Amendment No. 2''). In Amendment No. 
1, the ISE made a technical change to the rule text. In Amendment 
No. 2, the ISE clarified the application of the fee between lessors 
and lessees, changed terminology to reflect the fact that the ISE 
has ``demutualized'' and that trading rights are now reflected in 
shares of Class B Common Stock, removed obsolete language from the 
Primary Market Maker (``PMM'') inactivity fee regarding the 
effective date of that fee, and extended the proposed effective date 
from July 1, 2002 to August 1, 2002.
    \6\ See letter from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Jonathan G. Katz, Secretary, Commission, 
dated June 18, 2002 (``ISE Response'').
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II. Description of the Proposed Rule Change

    The Exchange proposes to adopt a fee that would allow it to charge 
$25,000 per month to inactive CMM memberships, effective August 1, 
2002.\7\ The fee would apply to the owner of an inactive CMM membership 
except with regard to an owner that entered into a lease prior to 
August 1, 2002. In that case, the fee would apply to the lessee, if the 
lessee has been approved to operate the membership.
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    \7\ See Amendment No. 2, supra note.
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    The fee would not apply to a member that holds an inactive CMM 
membership in a group of securities in which it also is operating the 
PMM membership pursuant to a lease. In that case, the member cannot 
operate both the PMM and CMM membership, and the member reasonably may 
want to retain control of the CMM membership so that it can operate the 
membership when its PMM lease expires. The proposal also would 
authorize the Exchange staff to grant exemptions if a member holds 
multiple inactive CMM memberships. In that situation, the Exchange 
could grant exemptions for all but one such membership as long as the 
member presents a business plan establishing that trading will begin in 
the inactive memberships over a reasonable time period.
    The Exchange represents that it based the amount of the fee on 
conservative estimates of the revenues lost due to an inactive CMM 
membership. In addition, the Exchange represents that it would 
periodically reevaluate this fee to maintain the relationship between 
the amount of the fee and the lost revenue being recouped.

III. Comments Received

    The Commission received comments on the proposal from Banc of 
America and Knight.\8\ Banc of America objected to the proposal for 
several reasons. In particular, Banc of America argued that no 
precedent supports the proposed fee; the proposal improperly targets 
owners that do not operate their memberships, and that owners could not 
always rely on leasing to avoid the fee because seats would unlikely be 
leased continually and the proposed effective date would not provide 
enough time for owners to lease their seats; the fee would add to the 
start-up costs for market makers which may result in a barrier to entry 
to the exchange; and to require

[[Page 50498]]

additional members to trade could reduce liquidity on the exchange.\9\
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    \8\ See Banc of America Letter and Knight Letter, supra note.
    \9\ See Banc of America Letter, supra note.
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    ISE responded to Banc of America's comment regarding precedent for 
the fee by arguing that its PMM inactivity fee and the Philadelphia 
Stock Exchange, Inc.'s shortfall fee, which imposes a fee on 
specialists who do not meet certain volume thresholds, set precedent 
for the CMM inactivity fee.\10\ In response to Banc of America's 
argument that the proposal targets owners, ISE believes that the 
purpose of an exchange is to provide a market place on which members 
can trade, and that it is reasonable for an exchange to take action 
that encourages the active use of its trading rights and that imposes 
fees for revenues that are foregone when those rights are not used.\11\ 
ISE believes that this is particularly true due to its recent 
demutualization. ISE notes that the proposed fee applies only to those 
persons with trading rights associated with its Series B-2 Common 
Stock, the CMM interests. In addition, ISE notes that Banc of America 
is free to hold its Class A Common Stock (the ISE Class A Stock 
representing virtually all the equity in the ISE) for investment 
purposes without being subject to an inactivity fee. Further, ISE 
believes that leasing is a viable alternative for an owner of a CMM 
membership to avoid the fee.\12\ ISE notes that it provided all ISE 
members with notice of this proposed fee on April 18, 2002, and amended 
the proposal to delay the effective date by one month. In addition, ISE 
represents that some current ISE members that already have trading 
operations on the ISE and could promptly begin trading in such 
memberships once entering into a lease, are seeking to lease or buy 
additional memberships.
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    \10\ See ISE Response, supra note 6. See also Exchange Act 
Release No. 45442 (February 13, 2002), 67 FR 8330 (February 22, 
2002) (File No. SR-Phlx-2001-115).
    \11\ See ISE Response, supra note 6. See also ISE Rule 300(b), 
which requires non-member owners of market maker shares to lease the 
trading rights to approved members.
    \12\ See ISE Response, supra note 6.
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    With regard to Banc of America's claim that the fee could be a 
barrier to entry, ISE notes that a potential lessee can control the 
time it enters into a lease and is approved for membership so that it 
can start trading immediately.\13\ In addition, if a member leases 
multiple CMM memberships, the proposal permits the ISE to grant a 
lessee an exemption from the fee if the lessee is operating one 
membership and presents a reasonable plan for opening trading in all 
additional memberships. Thus, ISE believes that the proposed inactivity 
fee would not create a barrier to entry to the ISE market because the 
fee could be avoided. Finally, Banc of America suggested that the 
proposed fee could reduce liquidity on ISE.\14\ In contrast, ISE 
believes that the fee would likely enhance liquidity on the 
Exchange.\15\
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    \13\ See ISE Response, supra note 6.
    \14\ See Banc of America Letter, supra note 4.
    \15\ See ISE Response, supra note 6.
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    Knight supported a monthly fee applicable to inactive CMM 
memberships but argued that the amount of the fee should be no more 
than $10,000 per month, one-tenth the amount charged to inactive PMM 
memberships.\16\ ISE responded to Knight's concern by noting that 
although there is a ten-to-one ratio between PMMs and CMMs on the ISE, 
both the PMM and CMM inactivity fees are based on the approximate 
revenue the ISE foregoes when a membership is not trading. ISE 
represents that PMMs do not, on average generate ten times the fees 
that a CMM generates. ISE believes that both the $100,000 PMM 
inactivity fee and the $25,000 CMM inactivity fee fairly represent the 
lost revenue for each category of membership and thus each fee is 
proper.\17\
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    \16\ See Knight Letter, supra note 4.
    \17\ See ISE Response, supra note 6.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 2, including whether 
Amendments No. 1 and 2 are 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 
filing also will be available for inspection and copying at the 
principal office of the ISE. All submissions should refer to File No. 
SR-ISE-2002-11 and should be submitted by August 23, 2002.

V. 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 
\18\ and, in particular, the requirements of section 6 of the Act.\19\ 
Among other provisions, section 6(b)(4) of the Act \20\ requires that 
the rules of the Exchange provide for the equitable allocation of 
reasonable dues, fees, and other charges among its members and issuers 
and other persons using its facilities.
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    \18\ The Commission has considered the proposed rules' impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \19\ 15 U.S.C. 78f.
    \20\ 15 U.S.C. 78f(b)(4).
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    The Commission notes that the Exchange currently imposes an 
inactivity fee on PMM memberships and that the Phlx also imposes a 
similar fee on its specialists.\21\ In addition, the Commission 
believes that under ISE's unique market structure the proposal should 
provide an appropriate incentive for entities that control ISE trading 
rights to encourage participation on the Exchange. In this regard, the 
Commission notes that shares of ISE common stock, exclusive of trading 
rights, may be held for investment purposes without being subject to 
the proposed fee.\22\ Finally, the Commission believes that the 
criteria used by the Exchange to calculate the amount of the fee is 
consistent with its obligation to equitably allocate reasonable fees 
and charges among its members.
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    \21\ See supra note 10.
    \22\ See ISE Response, supra note 6.
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VI. Conclusion

    The original rule proposal was noticed for public comment in April 
2002. Amendment No. 1 makes a technical correction to the rule text. 
Amendment No. 2 makes, technical changes, clarifies the proposal, and 
extends the effective date in response to comments. The Commission 
believes that it has received and fully considered substantial, 
meaningful comments with respect to the ISE's proposal, and that 
Amendment Nos. 1 and 2 do not raise issues that warrant delay. In 
addition, the Commission notes that ISE proposes August 1, 2002, as the 
effective date for this proposal. Accordingly, pursuant to section 
19(b)(2) of the Act,\23\ the Commission finds good cause to approve 
Amendment Nos. 1 and 2 prior to the thirtieth day after notice of the

[[Page 50499]]

Amendments is published in the Federal Register.
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    \23\ 15 U.S.C. 78s(b)(2).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\24\ that Amendment Nos. 1 and 2 to the ISE's proposed rule change 
are hereby granted accelerated approval; and
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    \24\ Id.
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    It is also ordered, pursuant to section 19(b)(2) of the Act,\25\ 
that the proposed rule change (File No. SR-ISE-2002-11), as amended, is 
hereby approved.
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    \25\ Id.
    \26\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-19535 Filed 8-1-02; 8:45 am]
BILLING CODE 8010-01-P