[Federal Register Volume 69, Number 130 (Thursday, July 8, 2004)]
[Notices]
[Pages 41317-41318]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-15455]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49943; File No. SR-ISE-2001-22]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the International Securities Exchange, Inc., To Establish a 
Solicited Order Mechanism

June 30, 2004.

I. Introduction

    On July 26, 2001, the International Securities Exchange, Inc. 
(``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 to establish a mechanism for 
matching a member's unsolicited agency orders with orders the member 
solicits from other broker-dealers. On January 4, 2002, June 26, 2002, 
and January 6, 2004, ISE filed Amendment Nos. 1, 2, and 3 to the 
proposed rule change, respectively.\3\ Notice of the proposed rule 
change, as amended, was published for comment in the Federal Register 
on February 5, 2004.\4\ The Commission received no comments on the 
proposal. This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letters from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated January 3, 
2002, June 25, 2002, and January 5, 2004.
    \4\ See Securities Exchange Act Release No. 49141 (January 28, 
2004), 69 FR 5625.
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II. Description of the Proposal

    Under ISE Rule 717(e), an Electronic Access Member (``EAM'') is 
required to expose an unsolicited agency order (the ``Agency Order'') 
for at least 30 seconds before crossing it against an order that it has 
solicited from other broker-dealers. Currently, an EAM can comply with 
this requirement only by entering the Agency Order on the Exchange, 
waiting 30 seconds, and then entering the solicited order.
    The proposed rule change would provide an alternative, enabling 
EAMs to pair solicited orders against Agency Orders for execution 
through a Solicited Order Mechanism (``Mechanism'') designed for this 
purpose.\5\ Such trades would be required to be for at least 500 
contracts and would be executed only if the price is at or between the 
ISE best bid or offer (``BBO''). Both orders entered into the Mechanism 
would be required to be all-or-none limit orders.\6\
    When a proposed solicited cross is entered into the Mechanism, the 
Exchange would send a message to Crowd Participants,\7\ giving them ten 
seconds to enter responses with the prices and sizes at which they 
would be willing to participate in the execution of the Agency Order. 
If at the end of the ten seconds there is sufficient size to execute 
the entire Agency Order at an improved price (or prices), the Agency 
Order would be executed at that price (or prices), \8\ and the 
solicited order would be canceled.
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    \5\ The rules relating to the Mechanism would be set forth in 
new paragraph (e) of ISE Rule 716.
    \6\ Although orders solicited from public customers are not 
subject to the exposure requirement of Rule 717(e), they would be 
permitted to be entered into the Mechanism should Exchange members 
choose this alternative.
    \7\ The term ``Crowd Participants'' is defined for purposes of 
ISE Rule 716 as the market makers appointed to an option options 
class under ISE Rule 803, as well as other members with proprietary 
orders at the inside bid or offer for a particular series.
    \8\ Such execution would be subject to the condition that the 
price is equal to or better than the ISE BBO.
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    The aggregate of all orders, quotes, and responses at each price 
would be used to determine whether the entire Agency Order could be 
executed in this manner. Public customer orders would be given priority 
in the execution, and then all other non-customer interest at the same 
price would participate pro-rata based on size.
    If at the end of the ten seconds there is not sufficient size to 
execute the entire Agency Order at an improved price (or prices), the 
Agency Order would be executed against the solicited order at the 
proposed price, provided that such price is equal to or better than the 
BBO on the Exchange,\9\ and there are no public customer orders on the 
Exchange that are at the proposed price.
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    \9\ If an execution would take place at a price that is inferior 
to the BBO on the Exchange, both the solicited order and the Agency 
Order would be canceled.
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    If there are one or more public customer orders on the book at the 
proposed execution price and there is sufficient size to execute the 
entire Agency Order, the Agency Order would be executed against that 
size and the solicited order would be canceled.\10\ If there are one or 
more public customer orders on the book at the proposed execution price 
but there is not sufficient size to execute the entire Agency Order, 
both the Agency Order and the solicited order would be canceled.
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    \10\ The aggregate size of all orders, quotes, and responses 
would be used to determine whether the Agency Order could be 
executed. Public customer orders would be given priority in the 
execution, and then all other non-customer interest at the same 
price would participate pro-rata based on size.
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    The proposed rule also would stipulate that, prior to entering an 
Agency Order into the Mechanism, an EAM must deliver to the customer a 
written notification informing the customer that its order may be 
executed using the Mechanism. The document would be required to 
disclose the terms and conditions of the Mechanism in a form approved 
by the Exchange.
    The proposed rule change would include Supplementary Material 
stating that the Mechanism provides a facility for members that locate 
liquidity for their customer orders, and that members may not use the 
Mechanism to circumvent Exchange rules limiting principal 
transactions.\11\ This would include a member entering contra orders 
that are solicited from affiliated broker-dealers or broker-dealers 
with which the member has an arrangement that allows the member to 
realize similar economic benefits from the solicited transaction as it 
would achieve by executing the order in whole or in part as principal.
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    \11\ See ISE Rule 717(d).
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    The proposed rule change also adds a reference to the Mechanism in 
its rules that prohibit anticipatory hedging activities prior to the 
entry of an order on the Exchange.\12\
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    \12\ See Supplementary Material to ISE Rule 400 (Just and 
Equitable Principles of Trade).
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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,\13\ and in particular with the requirements of section 
6(b)(5) of the Act.\14\ The Commission believes that the proposal, 
which would create a mechanism to execute large-size customer orders 
against orders solicited from broker-dealers, includes appropriate 
terms and conditions to assure that the customer orders are first 
exposed to the ISE crowd participants for the possibility of price 
improvement and that public customer orders on the Exchange are 
protected.
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    \13\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation.
    \14\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the 
rules of a national securities exchange be designed to, among other 
things, promote just and equitable principles of trade, remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. It 
also requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
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    The proposal would provide a mechanism for an EAM to trade an

[[Page 41318]]

Agency Order of 500 contracts or more against a contra side order of 
the same size it has solicited from a broker-dealer,\15\ but only when 
a better price for the full size of the Agency Order is not available 
in the aggregate of all quotes, orders, and responses from Crowd 
Participants. The Mechanism would require the Agency Order to be 
exposed to Crowd Participants for 10 seconds before the solicited order 
could trade against it. In no case would the customer receive a price 
inferior to the Exchange's BBO.
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    \15\ The Commission notes that, under ISE Rule 717(g), an EAM 
generally is not permitted to represent an order for the account of 
an ISE market maker. Thus, an EAM would not be permitted to use the 
Mechanism to execute an Agency Order against an order solicited from 
an ISE market maker. Telephone conversation between Michael Simon, 
Senior Vice President and General Counsel, ISE, and Ira Brandriss, 
Assistant Director, Division, Commission, on June 29, 2004. The 
Commission notes that the ISE has filed another proposed rule change 
to amend Rule 717(g) to permit an EAM to enter an order on behalf of 
an ISE market maker under specified conditions. See File No. SR-ISE-
2004-17. This Order, however, approves the proposed rule change only 
to the extent that the restriction of current ISE Rule 717(g) 
applies.
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    Under the proposal, if the execution price is not improved for the 
full size of the customer's order (i.e., the Agency Order), the Agency 
Order would be executed in full against the solicited order at the 
originally proposed price (unless there are public customer orders on 
the book at that price or the Exchange BBO has improved over that 
price). The Commission believes that customers seeking to transact 
orders of the size eligible for entry into the Mechanism `` 500 
contracts or more `` can assess the implications of the Mechanism's 
terms of use. The Commission notes, moreover, that the proposed rule 
change would require EAMs to provide customers with the terms and 
conditions of the Mechanism in writing before entering orders into it 
on their behalf.
    In addition, the Commission notes that the proposed rule change 
would not permit solicited orders to trade when there is a public 
customer order on the book at the proposed execution price. In such 
circumstances, if there is sufficient size in the aggregate to fill the 
Agency Order, first the public customer order, and then any other 
quotes, orders, and responses, are executed against the Agency Order, 
and the solicited order is canceled. If there is insufficient size, 
both the Agency Order and solicited order are canceled.
    The Commission further notes that ISE has included a provision 
stating that an EAM may not use the Mechanism to circumvent the 
Exchange rules limiting principal transactions. For example, this 
provision would prohibit an EAM from entering contra side orders 
solicited from broker-dealers with which the EAM is affiliated or from 
broker-dealers with which the EAM has an arrangement that would allow 
it to realize economic benefits similar to internalization.
    Finally, the Commission notes that ISE's rules prohibit 
anticipatory hedging based on knowledge of an imminent transaction 
before the terms and conditions of the transaction are disclosed to the 
trading crowd. These rules already apply to solicited order 
transactions. ISE proposes to amend those rules to establish that entry 
of the terms and conditions of a solicited order transaction are deemed 
``disclosed'' when they are entered into the Mechanism. The Commission 
believes this proposed amendment is reasonable and conforms to a 
similar provision regarding transactions entered into the Exchange's 
Facilitation Mechanism.

IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-ISE-2001-22), as amended, be and 
hereby is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-15455 Filed 7-7-04; 8:45 am]
BILLING CODE 8010-01-P