[Federal Register Volume 67, Number 248 (Thursday, December 26, 2002)]
[Notices]
[Pages 78834-78840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32471]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47029; File No. SR-ISE-2002-19]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by International Securities Exchange, Inc., Relating to Rules 
Governing the Intermarket Linkage

December 18, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on

[[Page 78835]]

September 24, 2002, the International Securities Exchange, Inc. 
(``ISE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which items have been prepared 
by the self-regulatory organization.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The ISE is proposing to adopt new Chapter 19 of its rules, 
governing the operation of the intermarket linkage (the ``Linkage''). 
The Linkage Rules will become effective once the Commission approves 
this filing and as the Exchange implements the operation of the 
applicable provisions of the Linkage. For example, the provisions of 
Chapter 19 regarding order protection will not become effective until 
the Exchange implements the Linkage operations governing Satisfaction 
Orders (as defined in Chapter 19 of the Rules) and trade-through 
processing. Below is the text of the proposed rule change; proposed new 
text is italicized.
* * * * *

Chapter 19

Intermarket Linkage

Rule 1900. Definitions
    The following terms shall have the meaning specified in this Rule 
solely for the purpose of this Chapter 19:
    (1) ``Aggrieved Party'' means a member of a Participant Exchange 
whose bid or offer was traded-through.
    (2) ``Block Trade'' means a trade on a Participant Exchange that:
    (i) involves 500 or more contracts and has a premium value of at 
least $150,000;
    (ii) is effected at a price outside of the NBBO; and
    (iii) involves either:
    (A) a cross (where a member of the Participant Exchange represents 
all or a portion of both sides of the trade), or
    (B) any other transaction i.e., in which such member represents an 
order of block size on one side of the transaction only) that is not 
the result of an execution at the current bid or offer on the 
Participant Exchange.
    Contemporaneous transactions at the same price on a Participant 
Exchange shall be considered a single transaction for the purpose of 
this definition.
    (3) ``Complex Trade'' means the execution of an order in an option 
series in conjunction with the execution of one or more related 
orders(s) in different options series in the same underlying security 
occurring at or near the same time for the equivalent number of 
contracts and for the purpose of executing a particular investment 
strategy. 
    (4) ``Crossed Market'' means a quotation in which the Exchange 
disseminates a bid (offer) in a series of an Eligible Option Class at a 
price that is greater than (is less than) the price of the offer (bid) 
for the series then being displayed from another Participant Exchange. 
    (5) ``Eligible Market Maker,'' with respect to an Eligible Option 
Class, means a market maker that: 
    (i) is assigned to, and is providing two-sided quotations in, the 
Eligible Option Class; and 
    (ii) is in compliance with the requirements of Rule 1904. 
    (6) ``Eligible Option Class'' means all option series overlying a 
security (as that term is defined in Section 3(a)(10) of the Exchange 
Act) or group of securities, including both put options and call 
options, which class is traded on the Exchange and at least one other 
Participant Exchange. 
    (7) ``Firm Customer Quote Size'' with respect to a P/A Order means 
the lesser of: (a) the number of option contracts that the Participant 
Exchange sending a P/A Order guarantees it will automatically execute 
at its disseminated quotation in a series of an Eligible Option Class 
for Public Customer orders entered directly for execution in that 
market; or (b) the number of option contracts that the Participant 
Exchange receiving a P/A Order guarantees it will automatically execute 
at its disseminated quotation in a series of an Eligible Option Class 
for Public Customer orders entered directly for execution in that 
market. This number shall be at least 10. 
    (8) ``Firm Principal Quote Size'' means the number of options 
contracts that a Participant Exchange guarantees it will execute at its 
disseminated quotation for incoming Principal Orders in an Eligible 
Option Class. This number shall be 10. 
    (9) ``Linkage'' means the systems and data communications network 
that link electronically the Participant Exchanges for the purposes 
specified in the Plan. 
    (10) ``Linkage Order'' means an order routed through the Linkage as 
permitted under the Plan. There are three types of Linkage Orders: 
    (i) ``Principal Acting as Agent (``P/A'') Order,'' which is an 
order for the principal account of a Primary Market Maker (or 
equivalent entity on another Participant Exchange that is authorized to 
represent Public Customer orders), reflecting the terms of a related 
unexecuted Public Customer order for which the Primary Market Maker is 
acting as agent; 
    (ii) ``Principal Order,'' which is an order for the principal 
account of a market maker (or equivalent entity on another Participant 
Exchange) and is not a P/A Order; and 
    (iii) ``Satisfaction Order,'' which is an order sent through the 
Linkage to notify a Participant Exchange of a Trade-Through and to seek 
satisfaction of the liability arising from that Trade-Through. 
    (11) ``Locked Market'' means a quotation in which the Exchange 
disseminates a bid (offer) in a series of an Eligible Option Class at a 
price that equals the price of the offer (bid) for the series then 
being displayed from another Participant Exchange.
    (12) ``NBBO'' means the national best bid and offer in an options 
series as calculated by a Participant Exchange.
    (13) ``Non-Firm'' means, with respect to quotations, that members 
of a Participant Exchange are relieved of their obligation to be firm 
for their quotations pursuant to Rule 11Ac1-1 under the Exchange Act.
    (14) ``Participant Exchange'' means a registered national 
securities exchange that is a party to the Plan.
    (15) ``Plan'' means the Plan for the Purpose of Creating and 
Operating an Intermarket Option Linkage, as such plan may be amended 
from time to time.
    (16) ``Reference Price'' means the limit price attached to a 
Linkage Order by the sending Participant Exchange. Except with respect 
to a Satisfaction Order, the Reference Price is equal to the bid 
disseminated by the receiving Participant Exchange at the time that the 
Linkage Order is transmitted in the case of a Linkage Order to sell and 
the offer disseminated by the receiving Participant Exchange at the 
time that the Linkage Order is transmitted in the case of a Linkage 
Order to buy. With respect to a Satisfaction Order, the Reference Price 
is the bid or offer price reflecting order(s) of Public Customers 
disseminated by the sending Participant Exchange that was traded 
through, except in the case of a Trade-Through that is a Block Trade, 
in which case the Reference Price shall be the price of the Block Trade 
that caused the Trade-Through.
    (17) ``Trade-Through'' means a transaction in an option series at a 
price that is inferior to the NBBO.
    (18) ``Third Participating Market Center Trade-Through'' means a 
Trade-

[[Page 78836]]

Through in a series of an Eligible Option Class that is effected by 
executing a Linkage Order, and such execution results in a sale 
(purchase) at a price that is inferior to the best bid (offer) being 
disseminated by another Participant Exchange.
    (19) ``Verifiable Number of Customer Contracts'' means the number 
of Public Customer contracts in the book of a Participant Exchange.
Rule 1901. Operation of the Linkage
    By subscribing to the Plan, the Exchange has agreed to comply with, 
and enforce compliance by its Members with, the Plan. In this regard, 
the following shall apply:
    (a) Pricing. Members may send P/A Orders and Principal Orders 
through the Linkage only if such orders are priced at the NBBO.
    (b) P/A Orders.
    (1) Sending of P/A Orders for Sizes No Larger than the Firm 
Customer Quote Size. A Primary Market Maker may send through the 
Linkage a P/A Order for execution in the automatic execution system of 
a Participant Exchange if the size of such P/A Order is no larger than 
the Firm Customer Quote Size. Except as provided in subparagraph 
(b)(2)(ii) below, a Primary Market Maker may not break up an order of a 
Public Customer that is larger than the Firm Customer Quote Size into 
multiple P/A Orders, one or more of which is equal to or smaller than 
the Firm Customer Quote Size, so that such orders could be represented 
as multiple P/A Orders through the Linkage.
    (2) Sending of P/A Orders for Sizes Larger than the Firm Customer 
Quote Size. If the size of a P/A Order is larger than the Firm Customer 
Quote Size, a Primary Market Maker may send through the Linkage such P/
A Order in one of two ways:
    (i) The Primary Market Maker may send a P/A Order representing the 
entire Public Customer order. If the receiving Participant Exchange's 
disseminated quotation is equal to or better than the Reference Price 
when the P/A Order arrives at that market, that exchange will execute 
the P/A Order at its disseminated quotation for at least the Firm 
Customer Quote Size. Within 15 seconds of receipt of such order, the 
receiving Participant Exchange will inform the Primary Market Maker of 
the amount of the order executed and the amount, if any, that was 
canceled.
    (ii) Alternatively, the Primary Market Maker may send an initial P/
A Order for the Firm Customer Quote Size pursuant to subparagraph 
(b)(1) above. If the Participant Exchange executes the P/A Order and 
continues to disseminate the same quotation at the NBBO 15 seconds 
after reporting the execution of the initial P/A Order, the Primary 
Market Maker may send an additional P/A Order to the same Participant 
Exchange. If sent, such additional P/A Order must be for at least the 
lesser of 100 contracts or the entire remainder of the Public Customer 
order.
    In any situation where a receiving Participant Exchange does not 
execute a P/A Order in full, such exchange is required to move its 
quotation to a price inferior to the Reference Price of the P/A Order.
    (c) Principal Orders.
    (1) Sending of an Initial Principal Order. An Eligible Market Maker 
may send a Principal Order through the Linkage at a price equal to the 
NBBO. Subject to the next paragraph, if the Principal Order is not 
larger than the Firm Principal Quote Size, the receiving Participant 
Exchange will execute the order in its automatic execution system, if 
available, if its disseminated quotation is equal to or better than the 
price specified in the Principal Order when that order arrives at the 
receiving Participant Exchange. If the Principal Order is larger than 
the Firm Principal Quote Size, the receiving Participant Exchange will 
(a) execute the Principal Order at its disseminated quotation for at 
least the Firm Principal Quote Size and (b) within 15 seconds of 
receipt of such order, reply to the sending Participant Exchange, 
informing such Participant Exchange of the amount of the order that was 
executed and the amount, if any, canceled. If the receiving Participant 
Exchange does not execute the Principal Order in full, it will move its 
quote to a price inferior to the Reference Price of the Principal 
Order.
    (2) Receipt of Multiple Principal Orders. Once the Exchange 
provides an automatic execution of a Principal Order in a series of an 
Eligible Option Class (the ``initial execution''), the Exchange may 
reject any Principal Order(s) in the same Eligible Option Class sent by 
the same Participant Exchange for 15 seconds after the initial 
execution unless: (a) There is a change of price in the Exchange's 
disseminated offer (bid) in the series of the Eligible Option Class in 
which there was the initial execution; and (b) such price continues to 
be the NBBO. After this 15 second period, and until the sooner of (y) 
one minute after the initial execution or (z) a change in the 
Exchange's disseminated bid (offer), the Exchange is not obligated to 
provide an automatic execution for any Principal Orders in the same 
Eligible Option Class received from the Participant Exchange that sent 
the order resulting in the initial execution, and thus may treat any 
such Principal Orders as being greater than the Firm Principal Quote 
Size.
    (d) Responses to Linkage Orders.
    (1) Failure to Receive a Timely Response. A Member who does not 
receive a response to a P Order or a P/A Order within 20 seconds of 
sending the order may reject any response received thereafter 
purporting to report an execution of all or part of that order. The 
Member so rejecting the response shall inform the Exchange Participant 
sending that response of the rejection within 15 seconds of receipt of 
the response.
    (2) Failure to Send a Timely Response. If a Member responds to a P 
Order or P/A Order more than 20 seconds after receipt of that order, 
and the Participant Exchange to whom the Member responded cancels such 
response, the Member shall cancel any trade resulting from such order 
and shall report the cancellation to OPRA.
    (e) Receipt of Linkage Orders. The Exchange will provide for the 
execution of P/A Orders and Principal Orders if its disseminated 
quotation is (i) equal to or better than the Reference Price, and (ii) 
equal to the then-current NBBO. Subject to paragraph (c) above, if the 
size of a P/A Order or Principal Order is not larger than the Firm 
Customer Quote Size or Firm Principal Quote Size, respectively, the 
Exchange will provide for the execution of the entire order, and shall 
execute such order in its automatic execution system if that system is 
available. If the size of a P/A Order or Principal Order is larger than 
the Firm Customer Quote Size or Firm Principal Quote Size, 
respectively, the Primary Market Maker must address the order within 15 
seconds to provide an execution for at least the Firm Customer Quote 
Size or Firm Principal Quote Size, respectively. If the order is not 
executed in full, the Exchange will move its disseminated quotation to 
a price inferior to the Reference Price.
Rule 1902. Order Protection
    (a) Avoidance and Satisfaction of Trade-Throughs.
    (1) General Provisions. Absent reasonable justification and during 
normal market conditions, Members should not effect Trade-Throughs. 
Except as provided in paragraph (b) below, if a Member effects a Trade-
Through with respect to the bid or offer of a Participant Exchange in 
an Eligible Option Class and the Exchange receives a Satisfaction Order 
from an Aggrieved Party, either:
    (i) the Member who initiated the Trade-Through shall satisfy, or 
cause to

[[Page 78837]]

be satisfied, the Aggrieved Party by filling the Satisfaction Order in 
accordance with subparagraph (a)(2) below; or
    (ii) if the Member elects not to do so (and, in the case of Third 
Participating Market Center Trade-Through, the Member obtains the 
agreement of the contra party that received the Linkage Order that 
caused the Trade-Through), then the price of the transaction that 
constituted the Trade-Through shall be corrected to a price at which a 
Trade-Through would not have occurred. If the price of the transaction 
is corrected, the Member correcting the price shall report the 
corrected price to OPRA, notify the Aggrieved Party of the correction 
and cancel the Satisfaction Order.
    (2) Price and Size. The price and size at which a Satisfaction 
Order shall be filled is as follows:
    (i) Price. A Satisfaction Order shall be filled at the Reference 
Price. However, if the Reference Price is the price of an apparent 
Block Trade that caused the Trade-Through, and such trade was not, in 
fact, a Block Trade, then the Member may cancel the Satisfaction Order. 
In that case, the Member shall inform the Aggrieved Party within three 
minutes of receipt of the Satisfaction Order of the reason for the 
cancellation. Within three minutes of receipt of such cancellation, the 
Aggrieved Party may resend the Satisfaction Order with a Reference 
Price of the bid or offer that was traded through. 
    (ii) Size. An Aggrieved Party may send a Satisfaction Order up to 
the size of the Verifiable Number of Customer Contracts that were 
included in the disseminated bid or offer that was traded through. 
Subject to subparagraph (2)(i) above and paragraph (b) below, a Member 
shall fill in full all Satisfaction Orders it receives following a 
Trade-Through, subject to the following limitations:
    (A) If the number of contracts to be satisfied exceeds the size of 
the transaction that caused the Trade-Through, the size of the 
Satisfaction Order(s) that must be filled with respect to each 
Participant Exchange(s) shall be limited to the size of the transaction 
that caused the Trade-Through, and the remainder of any Satisfaction 
Order(s) shall be canceled;
    (B) If the transaction that caused the Trade-Through was for a size 
larger than the Firm Customer Quote Size with respect to any of the 
Participant Exchange(s) traded through, the total number of contracts 
to be filled, with respect to all Satisfaction Orders received, shall 
not exceed the size of the transaction that caused the Trade-Through. 
In that case, the Member shall fill the Satisfaction Orders pro rata 
based on the Verifiable Number of Customer Contracts traded through on 
each Participant Exchange, and shall cancel the remainder of such 
Satisfaction Order(s); and
    (C) Notwithstanding paragraphs (A) and (B) above, if the 
transaction that caused the Trade-Through occurred during the five 
minutes prior to the regularly-scheduled close of trading in the 
principal market in which the underlying security is traded, the 
maximum number of contracts to be satisfied with respect to any one 
Participant Exchange is 10 contracts.
    (3) Rejection of Fills of Satisfaction Orders. Within 30 seconds of 
receipt of notification that another Participant Exchange has filled a 
Member's Satisfaction Order, the Member that sent the Satisfaction 
Order may reject such fill, but only to the extent that either: (i) the 
order(s) for the customer contracts underlying the Satisfaction Order 
already have been filled; or (2) the customer order(s) to buy (sell) 
the contracts underlying the Satisfaction Order were canceled.
    (4) Protection of Customers. Whenever subparagraph (a)(1) applies, 
if Public Customer orders (or P/A Orders representing Public Customer 
orders) constituted either or both sides of the transaction involved in 
the Trade-Through, each such Public Customer order (or P/A Order) shall 
receive:
    (i) the price that caused the Trade-Through; or
    (ii) the price at which the bid or offer traded through was 
satisfied, if it was satisfied pursuant to subparagraph (a)(1)(i), or 
the adjusted price, if there was an adjustment, pursuant to 
subparagraph (a)(1)(ii),

whichever price is most beneficial to the Public Customer order. 
Resulting differences in prices shall be the responsibility of the 
Member who initiated the Trade-Through.
    (b) Exceptions to Trade-Through Liability. The provisions of 
paragraph (a) pertaining to the satisfaction of Trade-Throughs shall 
not apply under the following circumstances:
    (1) the Member who initiated the Trade-Through made every 
reasonable effort to avoid the Trade-Through, but was unable to do so 
because of a systems/equipment failure or malfunction;
    (2) the Member trades through the market of a Participant Exchange 
to which such Member had sent a P/A Order or Principal Order, and 
within 20 seconds of sending such order the receiving Participant 
Exchange had neither executed the order in full nor adjusted the 
quotation traded through to a price inferior to the Reference Price of 
the P/A Order or Principal Order;
    (3) the bid or offer traded through was being disseminated from a 
Participant Exchange whose quotes were Non-Firm with respect to such 
Eligible Option Class;
    (4) the Trade-Through was other than a Third Participating Market 
Center Trade-Through and occurred during a period when, with respect to 
the Eligible Option Class, the Exchange's quotes were Non-Firm; 
provided, however, that, unless one of the other conditions of this 
paragraph (b) applies, during any such period: (i) Members shall make 
every reasonable effort to avoid trading through the firm quotes of 
another Participant Exchange; and (ii) it shall not be considered an 
exception to paragraph (a) if a Member regularly trades through the 
firm quotes of another Participant Exchange during such period;
    (5) the bid or offer traded through was being disseminated by a 
Participant Exchange during a trading rotation in the Eligible Option 
Class;
    (6) the transaction that caused the Trade-Through occurred during a 
trading rotation;
    (7) the transaction that caused the Trade-Through was the execution 
of a Complex Trade;
    (8) in the case of a Trade-Through other than a Third Participating 
Market Center Trade-Through, a Satisfaction Order with respect to the 
Trade-Through was not received by the Exchange from the Aggrieved Party 
promptly following the Trade-Through and, in any event, (i) except in 
the final five minutes of trading, within three minutes from the time 
the report of the transaction(s) that constituted the Trade-Through was 
disseminated over OPRA, and (ii) in the final five minutes of trading, 
within one minute from the time the report of the transaction(s) that 
constituted the Trade-Through was disseminated over OPRA; or
    (9) in the case of a Third Participating Market Center Trade-
Through, a Satisfaction Order with respect to the Trade-Through was not 
received by the Exchange promptly following the Trade-Through. In 
applying this provision, the Aggrieved Party must send the Exchange a 
Satisfaction Order within three minutes from the time the report of the 
transaction that constituted the Trade-Through was disseminated over 
OPRA. To avoid liability for the Trade-Through, the Member receiving 
such Satisfaction Order must cancel the Satisfaction Order and inform 
the Aggrieved Party of the identity of the Participant Exchange that 
initiated the

[[Page 78838]]

Trade-Through within three minutes of the receipt of such Satisfaction 
Order (within one minute in the final five minutes of trading). The 
Aggrieved Party then must send the Participant Exchange that initiated 
the Trade-Through a Satisfaction Order within three minutes of receipt 
of the cancellation of the initial Satisfaction Order (within one 
minute in the final five minutes of trading).
    (c) Responsibilities and Rights Following Receipt of Satisfaction 
Orders.
    (1) When a Member receives a Satisfaction Order, that Member shall 
respond as promptly as practicable pursuant to Exchange procedures by 
either:
    (i) specifying that one of the exceptions to Trade-Through 
liability specified in paragraph (b) above is applicable and 
identifying that particular exception; or
    (ii) taking the appropriate corrective action pursuant to paragraph 
(a) above.
    (2) If the Member who initiated the Trade-Through fails to respond 
to a Satisfaction Order or otherwise fails to take the corrective 
action required under paragraph (a) within three minutes of receiving 
notice of a Satisfaction Order, and the Exchange determines that:
    (i) there was a Trade-Through; and
    (ii) none of the exceptions to Trade-Through liability specified in 
paragraph (b) above were applicable;

then, subject to the next paragraph, the Member who initiated the 
Trade-Through shall be liable to the Aggrieved Party for the amount of 
the actual loss resulting from non-compliance with paragraph (a) and 
caused by the Trade-Through.
    If either (a) the Aggrieved Party does not establish the actual 
loss within 30 seconds from the time the Aggrieved Party received the 
response to its Satisfaction Order (or, in the event that it did not 
receive a response, within four minutes from the time the Aggrieved 
Party sent the Satisfaction Order) or (b) the Aggrieved Party does not 
notify the Exchange Participant that initiated the Trade-Through of the 
amount of such loss within one minute of establishing the loss, then 
the liability shall be the lesser of the actual loss or the loss caused 
by the Trade-Through that the Aggrieved Party would have suffered had 
that party purchased or sold the option series subject to the Trade-
Through at the ``mitigation price.''
    The ``mitigation price'' is the highest reported bid (in the case 
where an offer was traded through) or the lowest reported offer (in the 
case where a bid was traded through), in the series in question 30 
seconds from the time the Aggrieved Party received the response to its 
Satisfaction Order (or, in the event that it did not receive a 
response, four minutes from the time the Aggrieved Party sent the 
Satisfaction Order). If the Participant Exchange receives a 
Satisfaction Order within the final four minutes of trading (on any day 
except the last day of trading prior to the expiration of the series 
which is the subject of the Trade-Through), then the mitigation price 
shall be the price established at the opening of trading in that series 
on the Aggrieved Party's Participant Exchange on the next trading day. 
However, if the price of the opening transaction is below the opening 
bid or above the opening offer as established during the opening 
rotation, then the mitigation price shall be the opening bid (in the 
case where an offer was traded through) or opening offer (in the case 
where a bid was traded through). If the Trade-Through involves a series 
that expires on the day following the day of the Trade-Through and the 
Satisfaction Order is received within the four minutes of trading, the 
``mitigation price'' shall be the final bid (in the case where an offer 
was traded through) or offer (in the case where a bid was traded 
through) on the day of the trade that resulted in the Trade-Through.
    (3) A Member that is an Aggrieved Party under the rules of another 
Participant Exchange governing Trade-Through liability must take steps 
to establish and mitigate any loss such Member might incur as a result 
of the Trade-Through of the Member's bid or offer. In addition, the 
Member shall give prompt notice to the other Participant Exchange of 
any such action in accordance with subparagraph (c)(2) above.
    (d) Limitations on Trade-Throughs. Members may not repeatedly trade 
through better prices available on other exchanges, whether or not the 
exchange or exchanges whose quotations are traded through are 
Participant Exchanges, unless one or more of the provisions of 
paragraph (b) above are applicable. In applying this provision:
    (1) The Exchange will consider there to have been a Trade-Through 
if a Member executes a trade at a price inferior to the NBBO even if 
the Exchange does not receive a Satisfaction Order from an Aggrieved 
Party pursuant to subparagraph (a)(1);
    (2) The Exchange will not consider there to have been a Trade-
Through if a Member executes a Block Trade at a price inferior to the 
NBBO if such Member satisfied all Aggrieved Parties pursuant to 
subparagraph (a)(2) following the execution of the Block Trade; and
    (3) The Exchange will not consider there to have been a Trade-
Through if a Member executes a trade a price inferior to the quotation 
being disseminated by an exchange that is not a Participant Exchange if 
the Member made a good faith effort to trade against the superior 
quotation of the non-Participant Exchange prior to trading through that 
quotation. A ``good faith effort'' to reach a non-Participant 
Exchange's quotation requires that a Member at least had sent an order 
that day to the non-Participant Exchange in the class of options in 
which there is a Trade-Through, at a time at which such non-Participant 
Exchange was not relieved of its obligation to be firm for its 
quotations pursuant to Rule 11Ac1-1 under the Exchange Act, and such 
non-Participant Exchange neither executed that order nor moved its 
quotation to a price inferior to the price of the Member's order within 
20 seconds of receipt of that order.
Rule 1903. Locked and Crossed Markets
    (a) Eligible Market Maker Locking or Crossing a Market. An Eligible 
Market Maker that creates a Locked Market or a Crossed Market shall 
unlock (uncross) that market or shall direct a Principal Order through 
the Linkage to trade against the bid or offer that the Eligible Market 
Maker locked (crossed).
    (b) Members Other than an Eligible Market Maker Locking or Crossing 
a Market. A Member other than an Eligible Market Maker that creates a 
Locked Market or a Crossed Market shall unlock (uncross) the market.
Rule 1904. Limitation on Principal Order Access
    A Market Maker shall not be permitted to send Principal Orders in 
an Eligible Option Class through the Linkage for a given calendar 
quarter if the market maker effected less than 80 percent of its volume 
in that Eligible Option Class on the Exchange in the previous calendar 
quarter (that is, the market maker effected 20 percent or more of its 
volume by sending Principal Orders through the Linkage). This ``80/20'' 
is represented as follows:
[GRAPHIC] [TIFF OMITTED] TN26DE02.020

    ``X'' equals the total contract volume the market maker effects in 
an Eligible Option Class against orders of Public Customers on the 
Exchange during a calendar quarter (a) including contract volume 
effected by executing P/A

[[Page 78839]]

Orders sent to the Exchange through the linkage, but (b) excluding 
contract volume effected by sending P/A Orders through the Linkage for 
execution on another Participant Exchange. ``Y'' equals the total 
contract volume the market maker effects in such Eligible Option Class 
by sending Principal Orders through the Linkage during that calendar 
quarter.
* * * * *

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 purpose of the proposed rule change is to adopt Chapter 19 of 
the ISE rules, governing operation of the Linkage. These rules 
implement the Plan for the Purpose of Creating and Operating an 
Intermarket Options Linkage (the ``Plan'').\3\ The Exchange is 
proposing the following five new rules:
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    \3\ Approved by the Commission in Exchange Act Release No. 43086 
(July 28, 2000), 65 FR 48023 (August 4, 2000), as subsequently 
amended. See Securities Exchange Act Release No. 44482 (June 27, 
2001), 66 FR 35470 (July 5, 2001) (``Initial Amendment Order'') and 
Securities Exchange Act Release No. 46001 (May 30, 2002), 67 FR 
38687 (June 5, 2002). In addition, this proposed rule change 
reflects additional changes to the Plan that the ISE is filing 
concurrently with this filing. Such pending changes are noted in the 
discussion of the proposals.
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    [sbull] ISE Rule 1900, Definitions: This proposed rule contains 
definitions unique to the Linkage; all other definitions in the 
Exchange's rules continue to apply to this chapter. Generally, these 
definitions would incorporate into the Exchange's rules the definitions 
contained in the Plan.
    [sbull] ISE Rule 1901, Operation of the Linkage: This rule would 
incorporate Section 7 of the Plan into the ISE's rules. It would 
establish the conditions pursuant to which market makers may enter 
Linkage orders and imposes obligations on the Exchange on how it must 
process incoming Linkage orders. Pursuant to a proposed amendment to 
the Plan being submitted concurrently with this filing, the proposed 
rule provides that a member of the ISE may reject an execution of 
certain Linkage orders received more than 20 seconds after sending the 
order. This would be a reduction from the 30 seconds currently in the 
Plan.
    [sbull] ISE Rule 1902, Order Protection: This proposed rule 
contains the trade-through provisions required under Section 8(c) of 
the Plan. First, it would establish a general standard that members 
should avoid trade-throughs (defined in ISE Rule 1900 to be a trade at 
a price inferior to the national best bid and offer). If a member does 
effect a trade-through, the member would be responsible for satisfying 
a member of another exchange pursuant to paragraphs (a)(2) and (c) of 
the rule, subject to the exceptions in paragraph (b) of the rule. Both 
the satisfaction procedures and the exceptions to the satisfaction 
requirements would incorporate the relevant provision of the Plan. 
Finally, paragraph (d) of the rule would establish potential regulatory 
liability for members who repeatedly trade through other exchanges, 
whether or not the exchanges traded through participate in the Linkage. 
This proposed rule also reflects two pending amendments to the Plan:
    As with ISE Rule 1901, this proposed rule reflects the pending 
amendment to reduce from 30 seconds to 20 seconds the time period a 
member must wait for a response to a Linkage order. If the member does 
not receive the response within 30 seconds, the member can trade 
through the non-responding exchange without liability.
    In addition, this proposed rule reflects a pending Plan amendment 
that would limit liability for trade-throughs in the last few minutes 
of a trading day to 10 contracts per exchange. The purpose of that 
amendment is to provide protection for small customer orders, but also 
to limit the potential risk to members who may not be able to hedge 
options positions they assume near the close of trading.
    [sbull] ISE Rule 1903, Locked and Crossed Markets: This proposed 
rule implements Section 7(a)(i)(C) of the Plan by indicating that 
locked and crossed markets should be avoided and providing procedures 
to unlock and uncross markets that do occur.
    [sbull] ISE Rule 1904, Limitation on Principal Order Access: This 
proposed rule codifies the ``80/20 Test'' contained in Section 
8(b)(iii) of the Plan. Specifically, a market maker on the Exchange 
would be restricted from sending principal orders (other than P/A 
orders, which reflect unexecuted customer orders) through the Linkage 
if the market maker effects less than 80 percent of specified order 
flow on the Exchange. The Exchange would apply this test on a calendar 
quarter basis.
    With respect to the proposed fee change, the Exchange is proposing 
to clarify that its existing fees will apply to Principal Orders (``P 
Orders'') and Principal Acting as Agent Orders (``P/A Orders''). Thus, 
market makers on other exchanges sending orders for their own account 
to the ISE would pay the same fees that the ISE levies generally on all 
non-customer transactions. Today, these fees are applicable to such 
market maker transactions if they send their orders to the ISE through 
existing order-routing facilities. These fees also are the same fees 
applicable to ISE market makers. The Exchange believes that it is 
appropriate to charge market makers on the other exchanges the same 
fees members pay for proprietary transactions when such market makers 
access the liquidity available on the ISE.
    This proposal also specifies that the existing ISE fees would not 
apply to Satisfaction Orders. The Plan amendments pending at the 
Commission would prohibit a Party to the Plan from charging a fee to a 
member of another exchange that is seeking to satisfy customer orders 
on its book that were traded-through.
2. Basis
    The Exchange believes that the basis under the Exchange Act for the 
Linkage rules generally is the requirement under Section 6(b)(5)\4\ 
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 transactions 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. The proposed fee change is 
based on Section 6(b)(4)\5\ that requires an exchange to have an 
equitable allocation of reasonable dues, fees and other charges among 
its members and other persons using its facilities. With respect to the 
proposed disciplinary sanctions for engaging in a pattern of trade-
throughs,

[[Page 78840]]

the proposal is based on Section 6(b)(6)\6\ that requires an exchange 
to have rules that provide for the appropriate discipline of members 
for violations of the Exchange Act, the rules and regulation 
thereunder, and the rules of the Exchange.
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    \4\ 15 U.S.C. 78f(b)(5).
    \5\ 15 U.S.C. 78f(b)(4).
    \6\ 15 U.S.C. 78f(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not 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 has not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any unsolicited written comments from members or other interested 
parties.

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 self-regulatory organization 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 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 filing will also be 
available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-ISE-2002-19 and 
should be submitted by January 16, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32471 Filed 12-24-02; 8:45 am]
BILLING CODE 8010-01-P