[Federal Register Volume 70, Number 13 (Friday, January 21, 2005)]
[Notices]
[Pages 3233-3242]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-198]



[[Page 3233]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51029; File No. SR-ISE-2004-29)]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the International 
Securities Exchange, Inc., Relating to Proposed Amendments to Its 
Certificate of Incorporation and Constitution and ISE Rule 303

January 12, 2005.

I. Introduction

    On October 22, 2004, the International Securities Exchange, Inc., 
(``Exchange'' or ``ISE'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 \1\ (``Act''), and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend its Certificate of 
Incorporation (``Certificate of Incorporation'') and Constitution 
(``Constitution''). The proposed rule change was published for comment 
in the Federal Register on November 12, 2004.\3\ On December 21, 2004, 
ISE filed Amendment No. 1 to the proposal. On December 22, 2004, ISE 
withdrew Amendment No. 1 and filed Amendment No. 2 to the proposal.\4\ 
No comment letters were received on the proposed rule change. This 
order approves the proposed rule change, as amended.\5\
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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. 50641 (November 5, 
2004), 69 FR 65481.
    \4\ In Amendment No. 2, ISE made typographical corrections to 
the proposed Amended and Restated Certificate of Incorporation (the 
``Amended Certificate'') and proposed Amended and Restated 
Constitution (``Amended Constitution''), previously filed as part of 
the proposal, and revised Section 2 of its Form 19b-4 (Procedures of 
the Self-Regulatory Organization) to reflect actions by the ISE 
Board and ISE's stockholders approving the final forms of the 
Amended Certificate and Amended Constitution. In Amendment No. 2, 
ISE also proposed changes to ISE Rule 303(b) to incorporate the 20% 
limit on the number of trading rights associated with ISE's Series 
B-1 and Series B-2 Common Stock that may be exercised by a Member of 
ISE that currently is imposed by Section 14(b) of the Constitution, 
and amended related portions of its Form 19b-4. Exhibit 5 to 
Amendment No. 2, which sets forth the text of the Amended 
Certificate, the Amended Constitution and Rule 303, as proposed to 
be amended, is available on the Commission's Web site (http://www.sec.gov/rules/sro.shtml), at the Commission and at ISE. The 
complete text of Amendment No. 2 is available at the Commission and 
the ISE.
    At the request of the ISE, the Commission staff corrected the 
description of certain typographical corrections to the amended rule 
text provided in Amendment No. 2. Telephone conversation between 
Katherine Simmons, Vice President and Assistant Secretary, ISE and 
Jennifer C. Dodd, Attorney, Division of Market Regulation, 
Commission on January 4, 2005.
    \5\ The proposed rule change includes the Amended Certificate, 
Amended Constitution (also serving as the ``Exchanges Bylaws''), and 
proposed amendments to Rule 303.
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II. Description of Proposed Rule Change

    The purpose of the proposed rule change is to amend ISE's 
Certificate of Incorporation and Constitution (also serving as the 
Exchange's bylaws), as well as ISE Rule 303, in connection with ISE's 
contemplated initial public offering (``IPO'') of its Class A common 
stock, par value $.01 per share (the ``Class A Common Stock''), of the 
Exchange.\6\ The Exchange represents that the proposed rule change, if 
approved, would become effective concurrently with the IPO.\7\
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    \6\ Separately, the Exchange also is contemplating a 
reorganization into a holding company structure, the completion of 
which is contingent upon receipt of a favorable tax ruling from the 
Internal Revenue Service and Commission approval. The Exchange will 
separately file a proposed rule change seeking Commission approval 
of that reorganization. The Exchange currently anticipates that the 
reorganization will occur sometime following the IPO.
    \7\ In connection with the proposed IPO, the Exchange filed a 
registration statement on Form S-1 with the Commission on July 2, 
2004 (File No. 333-117145); as amended from time to time (the 
``Registration Statement'').
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    Following the IPO, the Exchange will continue to operate as a 
registered ``national securities exchange'' under Section 6 of the 
Act,\8\ and will maintain its current regulatory authority over its 
members. All persons using the Exchange will continue to be subject to 
the Exchange's rules. The Exchange also will continue to interpret its 
rules to require that any revenues it receives from regulatory fees or 
regulatory penalties will be segregated and applied to fund the legal, 
regulatory and surveillance operations of the Exchange and will not be 
used to pay dividends to the holders of Class A Common Stock.\9\ 
Certain of the proposed changes to the Certificate of Incorporation and 
Constitution, as well as the proposed changes to ISE Rule 303, are 
intended to ensure that the IPO of the Exchange will not unduly 
interfere with or restrict the ability of the Exchange or the 
Commission to effectively carry out their respective regulatory 
oversight responsibilities under the Act and generally to enable the 
Exchange to operate in a manner that complies with the federal 
securities laws, including furthering the objectives of Section 6(b)(5) 
of the Act.\10\ ISE also represents that some of the proposed changes 
to the Certificate of Incorporation and Constitution are intended to 
facilitate the IPO or otherwise relate to the Exchange's status as a 
public company following its IPO.
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    \8\ 15 U.S.C. 78f.
    \9\ The Exchange adopted this interpretation in connection with 
its demutualization in 2002. See Securities Exchange Act Release No. 
45803 (April 23, 2002), 67 FR 21306 (April 30, 2002).
    \10\ 15 U.S.C. 78f(b)(5).
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A. Current Capital Stock and Board Structure of ISE \11\
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    \11\ For a discussion of the Exchange's current capital board 
structure, see Securities Exchange Act Release No. 45803, supra note 
9.
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    The Exchange currently has two classes of common stock, Class A 
Common Stock and Class B common stock, par value $.01 per share 
(``Class B Common Stock'').\12\ The Class A Common Stock has the 
traditional features of common stock, including voting, dividend and 
liquidation rights.\13\ Subject to certain limitations, holders of 
Class A Common Stock are entitled to vote on all matters submitted to 
stockholders for a vote.\14\
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    \12\ The Exchange represents that some owners of shares of Class 
A Common Stock also own shares of Class B Common Stock. For a list 
of principal stockholders and their ownership of Class A and Class B 
Common Stock, see the Registration Statement, ``Principal and 
Selling Stockholders.''
    \13\ The Amended Certificate will clarify that, as is currently 
the case, holders of shares of Class A Common Stock are entitled to 
all residual interests in the event of a liquidation, winding up or 
dissolution of the Exchange after payment of or provision for the 
obligations of the Exchange, any preferential amounts payable to 
holders of shares of preferred stock and amounts payable to the 
holders of any outstanding shares of Class B Common Stock.
    \14\ For the provisions relating to the Class A Common Stock, 
see Certificate of Incorporation, Article Fourth, Subdivision II(a). 
The holders of shares of Class A Common Stock are not entitled to 
vote with respect to the Core Rights (as defined in note 19, infra), 
the definition of ``Core Rights,'' or the election of Industry 
Directors (as defined herein, see infra note 22 and accompanying 
text).
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    The Exchange has three series of Class B Common Stock, each series 
representing certain trading rights and privileges and limited voting 
rights. Ownership of the Class B Common Stock, Series B-1 (``Series B-1 
Common Stock''), is a predicate to obtaining the trading rights and 
privileges associated with a Primary Market Maker.\15\ Ownership of the 
Class B Common Stock, Series B-2 (``Series B-2 Common Stock''), is a 
predicate to obtaining the trading rights and privileges associated

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with a Competitive Market Maker.\16\ Ownership of the Class B Common 
Stock, Series B-3 (the ``Series B-3 Common Stock''), is a predicate to 
obtaining the trading rights and privileges associated with an 
Electronic Access Member.\17\
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    \15\ ``Primary Market Makers'' are market makers with 
significant responsibilities, including overseeing the opening of 
trading in their assigned options classes, providing continuous 
quotations in all of their assigned options classes, and handling 
customer orders that are not automatically executed. See Chapter 8 
of the ISE Rules and the Registration Statement, ``Business,'' for a 
discussion of the role of Primary Market Makers on the Exchange.
    \16\ ``Competitive Market Makers'' are market makers that add 
depth and liquidity to the market and are required to provide 
continuous quotations in at least 60% of the options classes in 
their assigned group. See Chapter 8 of the ISE Rules and the 
Registration Statement, ``Business,'' for a discussion of the role 
of Competitive Market Makers on the Exchange.
    \17\ ``Electronic Access Members'' are broker-dealers that 
represent agency and proprietary orders on the Exchange, and cannot 
enter quotations or otherwise engage in market making activities on 
the Exchange. See Chapter 8 of the ISE Rules and the Registration 
Statement, ``Business,'' for a discussion of the role of Electronic 
Access Members on the Exchange.
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    The holders of the Class B Common Stock are not entitled to receive 
dividends; rather, the holders of such stock are only entitled to 
receive an amount equal to the par value of each share of Class B 
Common Stock (i.e., $.01) held upon the liquidation, dissolution or 
winding up of the Exchange.\18\ Also, such holders are entitled to vote 
on the election of directors representing the applicable series of 
Class B Common Stock, with each series of Class B Common Stock being 
entitled to elect two directors to the Board of Directors of ISE (the 
``ISE Board'').
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    \18\ The Amended Certificate will clarify that, as is currently 
the case, such amount will be paid before any proceeds from the 
liquidation, dissolution or winding up of the Exchange are paid to 
the holders of Class A Common Stock.
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    The owners of Series B-1 Common Stock and Series B-2 Common Stock 
also are entitled to vote on any change in, or amendment or 
modification to, the ``Core Rights'' \19\ or the definition of Core 
Rights. In such a case, the Exchange must obtain the approval of the 
holders of a majority of both the of Series B-1 Common Stock and the 
Series B-2 Common Stock, each voting as a separate class with respect 
to such action.\20\
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    \19\ ``Core Rights'' as defined in Article Fourth, Subdivision 
II(a)(i) of the Certificate of Incorporation means any ``increase in 
the number of authorized shares of the Series B-1 Stock or the 
Series B-2 Stock.''
    \20\ For the provisions relating to the Class B Common Stock, 
see Certificate of Incorporation, Article Fourth, Subdivision II(b). 
The Amended Certificate proposes to make certain technical 
amendments to clarify that, as is currently the case, neither the 
holders of Class A Common Stock nor the holders of Series B-3 Common 
Stock are entitled to vote on the Core Rights.
    Additionally, the vote required with respect to the Core Rights 
would be increased from a majority of the votes cast by each of the 
holders of the Series B-1 Stock and Series B-2 Stock to a majority 
of the then outstanding shares of each of the Series B-1 Stock and 
Series B-2 Stock. See Amended Certificate, Article Fourth, 
Subdivision II(a) and (b). As is now the case, any increase or 
decrease in the overall number of authorized shares of Class B 
Common Stock would require approval of the holders of a majority of 
the outstanding shares of Class A Common Stock, voting as a separate 
class, and the holders of a majority of the outstanding shares of 
Series B-1 Stock and Series B-2 Stock, voting together as a separate 
class; any decrease in the number of authorized shares of Series B-1 
Stock or Series B-2 Stock would require approval of the holders of a 
majority of the outstanding shares of Class A Common Stock; and any 
increase or decrease in the number of authorized shares of Series B-
3 Stock would require approval of the holders of a majority of the 
outstanding shares of Class A Common Stock. The Exchange also may 
issue preferred stock in the future, the terms of which would be 
determined by the ISE Board, subject to Commission approval. See 
Certificate of Incorporation, Article Fourth, Subdivision I.
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    The ISE Board consists of 15 members, eight of whom are elected by 
the holders of the Class A Common stock (the ``Non-Industry 
Directors''),\21\ six of whom are elected by the holders of the Class B 
Common Stock (the ``Industry Directors'') \22\ and the Chief Executive 
Officer of the Exchange. In accordance with the current Certificate of 
Incorporation and Constitution of the Exchange, each director, other 
than the Chief Executive Officer, holds office for a term of two 
years.\23\ The Chief Executive Officer holds office for a term of one 
year, or such earlier time as such person no longer serves as Chief 
Executive Officer. The directors, other than the Chief Executive 
Officer, are divided into two classes, designated as Class I and Class 
II directors.\24\ At each annual meeting of stockholders, the 
successors of the class of directors whose term expires at that meeting 
will be elected to hold office for a term expiring at the annual 
meeting of stockholders held in the second year following the year of 
their election, and until their successors are elected and qualified. 
Directors, other than the Chief Executive Officer, may not hold office 
for more than three consecutive terms.\25\
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    \21\ Nominees for election to the ISE Board to serve as Non-
Industry Directors are currently made by the Exchange's Corporate 
Governance Committee, on which all of the Non-Industry Directors 
serve. Stockholders also may nominate Non-Industry Director 
candidates for election to the ISE Board by petition. See Section 
3.10 of the Constitution.
    \22\ Nominees for election to the ISE Board to serve as Industry 
Directors are currently made by the Exchange's Nominating Committee, 
which is not a committee of the ISE Board, and is comprised of 
representatives of the holders of each series of Class B Common 
Stock. Stockholders also may nominate Industry Director candidates 
for election to the ISE Board by petition. See Section 3.10 of the 
Constitution.
    \23\ The Amended Certificate would clarify that the ISE Board is 
authorized to fill any vacancies on the ISE Board. See Amended 
Certificate, Article Fourth, Subdivision II(a)(i) and (b)(v)(A). The 
Amended Certificate also would provide that directors may only be 
removed for cause by the stockholders to the extent permitted under 
applicable law, and not by a vote of two-thirds of the directors as 
is currently the case. See Amended Certificate, Article Fifth, 
paragraph (b).
    \24\ For a list of the Exchange's current directors and their 
respective classes, see Registration Statement, ``Management.'' As 
currently and prospectively constructed, each class will be composed 
of half of the Non-Industry Directors and half of each of the Series 
B-1, Series B-2 and Series B-3 directors.
    \25\ For the provisions relating to the ISE Board, see 
Certificate of Incorporation, Article Fifth and Constitution, 
Section 3.2.
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    In addition, the Exchange currently has an Audit Committee (which 
is proposed to be renamed as the Finance & Audit Committee), a 
Corporate Governance Committee and a Compensation Committee, all of 
which are governed by charters.\26\
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    \26\ For a discussion of these committees and their 
responsibilities, see Registration Statement, ``Management.'' The 
Exchange represents that the ISE Board designated these committees 
pursuant to its authority under Section 5.1 of the Constitution, 
though the Corporate Governance and Compensation Committees are not 
specifically designated in the current Constitution itself.
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B. Proposed Amendments to Certificate of Incorporation and Constitution

    The Exchange proposes to amend its current Certificate of 
Incorporation and Constitution to:
     Increase the number of authorized shares of Class A Common 
Stock from 5,000,000 to 150,000,000;
     Remove the term limits of the Non-Industry Directors;
     Adopt certain limitations on the ownership and voting of 
shares of Class A Common Stock and of Class B Common Stock;
     Require the Board to consider applicable requirements of 
the Act in managing the business and affairs of the Exchange;
     Clarify that the Exchange has a Corporate Governance 
Committee and Compensation Committee, and that these committees, as 
well as the Finance & Audit Committee of the Exchange, are governed by 
charters;
     Adopt certain anti-takeover provisions, including with 
respect to the nomination of Non-Industry Directors by the holders of 
Class A Common Stock; and
     Reduce the vote of the holders of Class A Common Stock 
required to amend certain provisions of the Amended Constitution from 
two-thirds of the outstanding shares of Class A Common Stock to a 
majority of such shares.\27\
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    \27\ The Exchange also would correct certain typographical and 
grammatical errors, eliminate outdated or irrelevant references and 
make certain non-material changes to the Certificate of 
Incorporation and Constitution. Such changes include, among others, 
the flexibility to provide notice of ISE Board meetings by several 
alternate means (see Section 3.6 of the Amended Constitution); the 
empowerment of the ISE Board (instead of the Chief Executive 
Officer) to appoint and remove officers (see Sections 4.2 and 4.3 of 
the Amended Constitution); the consolidation of the positions of 
Chief Executive Officer and President (see Section 4.1 of the 
Amended Constitution); and the prohibition on ownership of shares of 
Class B Common Stock by officers of the Exchange (see Section 4.5 of 
the Amended Constitution).


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The Exchange also proposes to amend ISE Rule 303 to provide for certain 
member trading concentration limits with respect to shares of Class B 
Common Stock currently provided for in the Constitution, as discussed 
below.
1. Increase in Number of Authorized Shares of Class A Common Stock of 
ISE
    The Exchange proposes to increase the number of authorized shares 
of ISE's Class A Common Stock in the Amended Certificate from 5,000,000 
to 150,000,000.\28\ The Exchange represents that this increase will 
provide the ISE Board with the flexibility to declare a stock dividend 
that, in the opinion of the underwriters of its IPO, will be sufficient 
to result in an appropriate market price per share of the Class A 
Common Stock. The Exchange also represents that the increase in the 
number of authorized shares of Class A Common Stock will provide 
shares: (1) To be offered in ISE's IPO, as well as additional shares 
that can be used by the Exchange for future acquisitions that may be 
approved by the Board (and by Class A stockholders to the extent 
required by the rules of the marketplace for the shares of Class A 
Common Stock); and (2) to be used by ISE for stock options, stock 
purchase and other equity compensation plans that are approved by the 
ISE Board (and by Class A stockholders to the extent required by the 
rules of the marketplace for the shares of Class A Common Stock).
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    \28\ See Amended Certificate, Article Fourth.
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2. Change in the Term Limits of the ISE Board
    The Exchange represents that in order to maintain continuity with 
respect to its Non-Industry Directors during the transition of the 
Exchange to a public company, the Exchange proposes that the three-term 
limit (a total of six years of service) currently in the Certificate of 
Incorporation and Constitution with respect to all directors, other 
than the Chief Executive Officer, would apply only to Industry 
Directors.\29\ The Exchange also represents that currently, all of 
ISE's Non-Industry Directors face term limits that would result in a 
total turn-over of such directors over a two-year period. The Exchange 
believes that removing term limits for Non-Industry Directors will 
allow the ISE Board to continue to function with experienced Non-
Industry Directors, thereby facilitating a smooth transition to a 
public company structure. Once it becomes a public company, the 
Exchange represents that it will address term limits for Non-Industry 
Directors through amendments to its Corporate Governance 
Principles.\30\
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    \29\ See Amended Certificate, Article Fifth, and Amended 
Constitution, Section 3.2.
    \30\ Because the ISE Board believes it is important that 
following the Exchange's IPO there be a smooth transition from the 
Non-Industry Directors serving at the time of the IPO to their 
successors, the ISE Board has adopted Corporate Governance 
Principles providing that it may be appropriate for up to four of 
the eight original Non-Industry Directors to serve one additional 
term. This would result in a transition to new Non-Industry 
Directors over a four-year period, rather than a two-year period. 
The ISE Corporate Governance Committee will determine whether, and 
how, to provide for this phased transition.
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3. Ownership and Voting Limitations With Respect to the Exchange's 
Capital Stock \31\
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    \31\ Currently, with the exception of certain exemptions for 
Founders (as defined in the Constitution), no holder of Class A 
Common Stock, together with any affiliate (as defined in the 
Constitution), shall vote or give any proxy in relation to a vote 
with respect to any shares owned in excess of 20 percent of the 
Class A Common Stock, and no holder of Class B Common Stock, 
together with any affiliate (as defined in the Constitution) may own 
more than 20 percent of Series B-1 Stock or Series B-2 Stock. In 
addition, no Member (as defined in the Constitution), together with 
any affiliate (as defined in the Constitution), may be approved to 
exercise trading rights associated with more than 20 percent of 
Series B-1 Stock or Series B-2 Stock (the ``member trading 
concentration limit''). Certificate of Incorporation, Article 
Fourth, Subdivision II(a)(iv) and Constitution, Article XIV. See 
also Securities Exchange Act Release No. 45803, supra note 9. As 
discussed herein, the Exchange proposes to amend ISE Rule 303 to 
provide for the member concentration limit that is currently 
provided for in the Constitution.
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     a. Ownership Limitations. Under the proposed Amended Certificate, 
no ``Person'' \32\ either alone or together with its ``Related 
Persons'' \33\ would be permitted to own, directly or indirectly, of 
record or beneficially,\34\ shares of capital stock (whether common or 
preferred stock) of the Exchange (1) constituting more than 40 percent 
of the then outstanding shares of any class or series of capital stock 
(the ``40 percent ownership limitation''); or (2) constituting more 
than 20 percent of the then outstanding shares of any class or series 
of capital stock if such holder also is a member of the Exchange (that 
is, a Primary Market Maker, Competitive Market Maker or Electronic 
Access Member) (the ``20 percent member ownership limitation'').\35\
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    \32\ ``Person'' as defined in Article Fourth, Subdivision III of 
the Amended Certificate means any ``individual, partnership (general 
or limited), joint stock company, corporation, limited liability 
company, trust or unincorporated organization or any governmental 
entity or agency or political subdivision thereof.''
    \33\ ``Related Person'' as defined in Article Fourth, 
Subdivision III of the Amended Certificate means ``(1) with respect 
to any Person, all `affiliates' and `associates' of such Person (as 
such terms are defined in Rule 12b-2 under the Act); (2) with 
respect to any Person constituting a Member, any broker or dealer 
with which such Member is associated; and (3) any two or more 
Persons that have any agreement, arrangement or understanding 
(whether or not in writing) to act together for the purpose of 
acquiring, voting, holding or disposing of shares of the capital 
stock of the [Exchange].''
    \34\ Beneficial ownership (and derivative or similar words) as 
defined in Article Fourth, Subdivision III of the Amended 
Certificate, would have the meaning set forth in Regulation 13D-G 
under the Act. The Exchange believes that use of this existing 
Commission definition will aid it in verifying the ownership of its 
capital stock by monitoring filings on Schedules 13D and 13G by its 
stockholders.
    \35\ See Amended Certificate, Article Fourth, Subdivisions 
III(a)(i) and (a)(ii).
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    Furthermore, pursuant to the Amended Certificate, any Person, alone 
or together with its Related Persons, who owns more than five percent 
of the then outstanding shares of any class or series of the Exchange's 
capital stock will be required to provide certain information to the 
Board and will have an ongoing obligation to update such 
information.\36\ The Exchange believes these provisions will enable it 
to obtain information necessary to determine whether there has been a 
violation of the voting or ownership limitations described herein.
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    \36\ Article Fourth, Subdivision III(a)(iii) of the Amended 
Certificate requires that any Person, either alone or together with 
its Related Persons, that at any time owns 5 percent or more of the 
then outstanding shares of any class or series of capital stock of 
ISE, that has the right by its terms to vote in the election of 
members of the ISE Board, must, immediately upon so owning 5 percent 
or more, give the ISE Board written notice of such ownership 
stating: (1) Such Person's full legal name; (2) such Person's title 
or status and the date on which such title or status was acquired; 
(3) such Person's approximate ownership interest in the Exchange; 
and (4) whether such Person has the power, directly or indirectly, 
to direct the management or policies of the Exchange, whether 
through ownership of securities, by contract or otherwise. Each such 
Person must notify the ISE Board of any changes in ownership except 
when such change is an increase or decrease of less than 1 percent 
in the ownership percentage so reported (such increase or decrease 
to be measured cumulatively from the amount shown on the last such 
report) unless any increase or decrease of less than 1 percent 
results in such Person so owning more or less than 20 percent or 
more than 40 percent of the shares of any class or series of capital 
stock then outstanding (at a time when such Person so owned less 
than such percentages), as the case may be. The Exchange represents 
that it also will consider, among other things, any filings made 
with the Commission under Section 13(d) and Section 13(g) of the Act 
by such Person and its Related Persons and will aggregate all shares 
owned or voted by such Person and its Related Persons deemed to be 
beneficially owned by them. For information on ISE's current 
principal stockholders, see also the Registration Statement, 
``Principal and Selling Stockholders.''
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    The Exchange represents that it would apply standard corrective 
procedures used by public companies with similar

[[Page 3236]]

ownership limits if any Person, alone or together with its Related 
Persons, purports to sell, transfer, assign or pledge any shares of 
capital stock in the Exchange in violation of the ownership limits. 
Specifically, pursuant to the Amended Certificate, any such sale, 
transfer, assignment or pledge would be void, and that number of shares 
in excess of the ownership limitation would be deemed to have been 
transferred to the Exchange, as special trustee of a charitable trust, 
for the exclusive benefit of a charitable beneficiary to be determined 
by the Exchange.\37\ These corrective procedures also would apply if 
there is any other event causing any holder of capital stock to exceed 
the ownership limits, such as a repurchase of shares by the 
Exchange.\38\ The automatic transfer would be deemed to be effective as 
of the close of business on the business day prior to the date of the 
violative transfer or other event.
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    \37\ See Article Fourth, Subdivision III(c) of the Amended 
Certificate. The Exchange may also determine to appoint as special 
trustee an entity unaffiliated with the Exchange and any Person or 
its Related Persons owning excess shares. See Article Fourth, 
Subdivision III(c)(ii) of the Amended Certificate.
    \38\ Any holders owning excess shares as a result of any event 
other than a sale, transfer, assignment or pledge would cease to 
have rights in such shares.
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    The special trustee of the trust would be required to sell the 
excess shares to a person whose ownership of shares is not expected to 
violate the ownership limitations, subject to the right of the Exchange 
to repurchase those shares.\39\ The net proceeds of the sale would be 
distributed first to the original prohibited transferee or holder, who 
would receive the lesser of (1) the price per share received by the 
Exchange from the transfer of the excess shares, (2) the price per 
share the prohibited transferee or holder paid for the shares in the 
violative transfer, or (3) if the prohibited transferee or holder did 
not give value for such excess shares, a price per share equal to the 
market price for the excess shares on the date of the purported 
transfer or other event that resulted in the excess shares, except that 
in the case of a prohibited holder holding excess shares solely as the 
result of an action or event by the Exchange (such as an action 
resulting in a reduction in the number of outstanding shares), such 
prohibited holder would receive the greater of (1) or (3) above for the 
excess shares. After such distribution, any proceeds in excess of the 
amount payable to the prohibited transferee or holder would be payable 
to the charitable beneficiary. Prior to the sale, the special trustee 
would be entitled to receive, in trust for the beneficiary, all 
dividends and other distributions paid by the Exchange with respect to 
the excess shares, and also would be entitled to exercise all voting 
rights with respect to the excess shares.\40\
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    \39\ See infra note 41 and accompanying text.
    \40\ Any excess shares held by the special trustee would be 
entitled to be voted by the special trustee and would be deemed 
outstanding for purposes of determining a quorum or minimum vote 
required for the transaction of any business at any stockholders' 
meeting. See Article Fourth, Subdivision III(c)(v) of the Amended 
Certificate.
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    In addition, excess shares (including any shares deemed to be 
excess shares by reason of a reduction in outstanding shares caused by 
a purchase of excess shares by the Exchange) would be deemed to have 
been offered for sale to the Exchange.\41\ The Exchange shall have the 
right to accept such offer until the special trustee has sold the 
shares held in the charitable trust.\42\ If the Exchange accepts such 
offer, it would determine the additional number of shares (if any) that 
become excess shares by reason of the reduction in outstanding shares 
caused by the Exchange's purchase of excess shares (whether any Person, 
either alone or together with its Related Persons, holds such excess 
shares in connection with a purported transfer or is deemed to hold 
such excess shares as a result of the Exchange's purchase of excess 
shares) and take all action reasonably necessary to ensure that such 
additional excess shares are added to the initial number of excess 
shares subject to the Exchange's corrective procedures.\43\
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    \41\ The excess shares would be deemed to be offered to the 
Exchange at a price per share equal to the lesser of (1) the price 
per share the purported transferee or holder paid for the shares in 
the purported transfer or other event that resulted in excess shares 
(or in the case of an event not involving any payment, the market 
price at the time of the transfer or other event) and (2) the market 
price of the shares on the date the Exchange accepts such offer. The 
Exchange may accept the offer in whole or in part.
    \42\ See Article Fourth, Subdivision III(c)(vi) of the Amended 
Certificate.
    \43\ The Exchange believes that this mechanism will prevent 
repeated violations (i.e., an endless loop) of the ownership 
provisions in connection with repurchases by the Exchange (both 
generally and with respect to excess shares). In practice, the 
Exchange represents that it would structure repurchases, if any, in 
a manner designed not to trigger any new violations of the ownership 
restrictions set forth in Article Fourth, Subdivision III, or if 
triggered, to include such new violations in its repurchase. For 
example, if there were 100 shares of Class A Common Stock 
outstanding and two members of the Exchange (Member A and Member B) 
each currently owned 20% of the outstanding shares of Class A Common 
Stock, and Member A purchased 5 shares of Class A Common Stock 
(increasing his ownership to 25%), the Exchange could either (a) 
repurchase the 5 shares from Member A and permit the special trustee 
to sell one share from Member A and one share from Member B to third 
parties or (b) repurchase 9 shares of Class A Common Stock from 
Member A and 3 shares of Class A Common Stock from Member B, all of 
which would be deemed excess shares pursuant to the mechanism 
described above.
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    As applied to the current outstanding capital stock of the 
Exchange, the 40 percent ownership limitation would apply to any holder 
of Class A Common Stock, other than an Exchange member. The 20 percent 
member ownership limitation would apply to any member, and would limit 
to that amount such holder's ownership of each of the Class A Common 
Stock and each Series of Class B Common Stock. The Exchange represents 
that currently no Person, either alone or together with its Related 
Persons, owns more than 40 percent of the outstanding shares of Class A 
Common Stock, and no member, either alone or together with its Related 
Persons, owns more than 20 percent of the outstanding shares of Class A 
Common Stock or any series of Class B Common Stock.\44\
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    \44\ See Amendment No. 2, supra note 4.
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    b. Voting Limitations. The proposed rule change would prohibit any 
Person, either alone or together with its Related Persons, from voting, 
or causing the voting of, shares of capital stock of the Exchange (or 
giving a consent or proxy with respect to shares) representing more 
than 20 percent of the voting power of any class or series of capital 
stock (the ``20 percent voting limitation'').\45\ In the event that a 
stockholder purports to vote, grant any proxy or enter into any other 
agreement for the voting of shares that would violate the 20 percent 
voting limitation, such vote, proxy or agreement would not be honored 
by the Exchange to the extent that the 20 percent voting limitation 
provision would be violated. The 20 percent voting limitation would not 
apply to any solicitation of any revocable proxy from any stockholder 
of the Exchange by the Exchange or by any

[[Page 3237]]

stockholder of the Exchange pursuant to Regulation 14A under the 
Act.\46\
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    \45\ The 20 percent voting limitation also would prohibit any 
Person, either alone or together with its Related Persons, from 
entering into any agreement, plan or other arrangement with another 
Person that would result in the shares of any class or series of 
capital stock that are subject to such agreement, plan or 
arrangement not being voted on any matter or matters where the 
effect of such agreement, plan or other arrangement would be to 
enable any Person to vote, possess the right to vote or cause the 
voting of shares of any class or series of capital stock that would, 
as a result thereof, represent more than 20 percent of any class or 
series of capital stock available to be voted.
    The Amended Certificate and the Amended Constitution clarify 
that only those shares entitled to vote would be counted for 
purposes of determining a quorum or a minimum vote required for the 
transaction of any business at any stockholders' meeting, including, 
without limitation, when specified business is to be voted on by a 
class or a series voting as a class. See Article Fourth, Subdivision 
III(b)(iii) of the Amended Certificate and Section 2.4 of the 
Amended Constitution. See also Amendment No. 2, supra note 4.
    \46\ See Amended Certificate, Article Fourth, Subdivision 
III(b).
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    c. Board Notice Regarding Certain Limitations. The proposed rule 
change would impose certain requirements on Persons to give notice of 
events regarding ownership that would exceed the proposed ownership or 
voting threshold. Specifically, any Person intending to exceed these 
ownership or voting limitations must provide the ISE Board with written 
notice of the fact at least 45 days (or such shorter period to which 
the Board expressly consents) prior to either the proposed acquisition 
of shares or the proposed exercise of voting rights, as the case may 
be.\47\
---------------------------------------------------------------------------

    \47\ See Amended Certificate, Article Fourth, Subdivisions 
III(a)(i)(E) and (b)(i).
---------------------------------------------------------------------------

    d. Board Waiver of Certain Limitations. The ISE Board may adopt a 
resolution specifying that it has determined that the 40 percent 
ownership limitation or the 20 percent voting limitation or both should 
be waived if it finds that such waiver (1) will not impair the ability 
of the Exchange to carry out its functions and responsibilities as an 
``exchange'' under the Act; (2) is otherwise in the best interests of 
the Exchange and its stockholders; (3) will not impair the ability of 
the Commission to enforce the Act; and (4) will apply to a Person and 
its Related Persons who are not subject to any applicable ``statutory 
disqualification'' (within the meaning of Section 3(a)(39) of the Act). 
In the event of such a finding, the waiver would take the form of an 
amendment to the Constitution, which would not be effective until 
approved by the Commission. The Board may not waive the 20 percent 
member ownership limitation.\48\
---------------------------------------------------------------------------

    \48\ See Amended Certificate, Article Fourth, Subdivisions 
III(a)(i)(B) and (b)(i).
---------------------------------------------------------------------------

    e. Elimination of Founders Exemption. The Amended Certificate also 
eliminates the ``founders exemption'' that permitted the original 
founders of the Exchange to own shares of Class A Common Stock and 
Class B Common Stock in excess of the stated limits for a certain 
period of time.\49\ The Exchange represents that because all of the 
founders have fallen below the ownership thresholds in place, the 
exemption is no longer necessary.
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    \49\ The founders exemption, which applied to persons or 
entities that purchased LLC memberships directly from the Exchange 
on or prior to August 1, 1998 and extended to May 26, 2010, was 
approved by the Commission in connection with the Exchange's 
demutualization in 2002. See supra note 9.
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4. Exchange Act Obligations
    The proposed rule change would provide that the ISE Board shall, in 
managing the affairs and business of the Exchange, consider 
requirements applicable to its registration and operation as a national 
securities exchange under the Act, including without limitation, the 
requirements that (a) the rules of the Exchange be designed to protect 
investors and the public interest, and (b) the Exchange be so organized 
and have the capacity to carry out the purposes of the Act and (subject 
to such exceptions as are set forth in the Act or the rules and 
regulations thereunder) to enforce compliance by its members and 
persons associated with its members with the provisions of the Act, the 
rules and regulations thereunder, and the rules of the Exchange. These 
provisions in the Amended Certificate shall not be construed to create 
the basis for any cause of action against any director, and no director 
shall be liable, by virtue of these provisions, for such director's 
consideration or failure to consider the matters referred to 
therein.\50\
---------------------------------------------------------------------------

    \50\ See Amended Certificate, Article Twelfth.
---------------------------------------------------------------------------

5. Board Committees
    The proposed rule change would include provisions relating to 
specific Board committees in connection with the contemplated listing 
of the Exchange on a national securities exchange or national 
securities association following its IPO. In particular, the Exchange 
proposes to add the Corporate Governance Committee and the Compensation 
Committee to its list of specifically designated ISE Board committees 
in the Amended Constitution, and require that each of the Finance & 
Audit, Corporate Governance and Compensation Committees be governed by 
charters.\51\
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    \51\ See Amended Constitution, Sections 5.4, 5.5 and 5.6. The 
Exchange represents that it currently has a Corporate Governance and 
Compensation Committee, designated by the ISE Board pursuant to its 
authority under Section 5.1 of the Constitution; the Amended 
Constitution will specifically provide for these committees.
---------------------------------------------------------------------------

6. Certain Anti-Takeover Provisions
    The Exchange proposes that the Amended Certificate and the Amended 
Constitution include certain anti-takeover provisions for protection 
against certain types of coercive corporate takeover practices and 
inadequate takeover bids. The proposed provisions relate to special 
meetings of stockholders and the required stockholder vote with respect 
to certain actions. In view of the limitations on ownership and voting 
described above, the provisions proposed do not include a ``poison 
pill'' arrangement. The Exchange represents that the ISE Board does, 
however, maintain the authority under its current organizational 
documents to adopt such an arrangement with Commission approval.
    a. Elimination of a Stockholder's Right to Call a Special Meeting. 
The Exchange proposes to deny the Exchange's stockholders the right to 
call a special meeting of stockholders, and provide that only the 
Chairman of the Board or a majority of the Board may call a special 
meeting of the stockholders.\52\
---------------------------------------------------------------------------

    \52\ See Amended Certificate, Article Eighth and Amended 
Constitution, Section 2.2.
---------------------------------------------------------------------------

    b. Advance Notice Requirement for Stockholder Proposals. The 
Amended Constitution establishes advance notice procedures with regard 
to stockholder proposals relating to the nomination of candidates for 
election as Non-Industry Directors or new business to be brought before 
meetings of stockholders. The Exchange's advance notice requirement 
would not apply to nominations of Industry Director nominees for 
election to the Board by the Exchange's Nominating Committee (which is 
not a committee of the Board) or stockholders pursuant to Sections 
3.10(a) and 5.3(c) of the Constitution.
    Following the IPO, pursuant to the Exchange's Corporate Governance 
Committee charter and Section 3.10(b) of the Constitution, the 
Corporate Governance Committee would nominate for election to the Board 
a slate of Non-Industry Directors pursuant to Section 2.7(a) and 
(b).\53\ These procedures also provide that notice of stockholder 
nominations for election of Non-Industry Directors and stockholder 
proposals must be given in writing to the Secretary of the Exchange 
prior to the meeting at which the action is to be taken.\54\ Generally, 
such notice would have to be received at the principal executive 
offices of the Exchange not fewer than 60 days nor more than 90 days 
prior to the meeting. Any such notice must comply with certain 
additional informational and descriptive requirements set out in the 
Amended

[[Page 3238]]

Constitution.\55\ Additionally, stockholders shall comply with all 
applicable requirements of the Act and the rules and regulations 
thereunder with respect to any proposals submitted pursuant to the 
advance notice procedures.\56\
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    \53\ Class A stockholders also would be able to nominate Non-
Industry Directors pursuant to Sections 2.7 and 3.10(b) of the 
Constitution.
    \54\ With the institution of Section 2.7 of the Amended 
Constitution, Non-Industry Director nominations by Class A 
stockholders will likely be required to be made in advance of the 
selection or announcement of a slate of Non-Industry Director 
candidates by the Corporate Governance Committee. Currently, Non-
Industry Director nominations by Class A stockholders must be made 
in advance of the stockholders' meeting, but generally after the 
Corporate Governance Committee announces its slate.
    \55\ In particular, the notice must set forth (1) as to each 
person whom the stockholder proposes to nominate for election or 
reelection as a director all information relating to such person 
that is required to be disclosed in solicitations of proxies for 
election of directors, or is otherwise required, in each case 
pursuant to Regulation 14A under the Act, including such person's 
written consent to being named in the proxy statement as a nominee 
and to serving as a director if elected and a statement that such 
nominee complies with the requirements set forth in the Amended 
Certificate; (2) as to any other business that the stockholder 
proposes to bring before the meeting, a brief description of the 
business desired to be brought before the meeting, the reasons for 
conducting such business at the meeting and any material interest in 
such business of such stockholder and the beneficial owner, if any, 
on whose behalf the proposal is made; and (3) as to the stockholder 
giving the notice and the beneficial owner, if any, on whose behalf 
the nomination or proposal is made (i) the name and address of such 
stockholder, as they appear on the Corporation's books, and of such 
beneficial owner and (ii) the class and number of shares of the 
Corporation which are owned beneficially and of record by such 
stockholder and such beneficial owner. See Amended Constitution, 
Section 2.7.
    \56\ See Amended Constitution, Section 2.7. Previously, Section 
2.7 of the Constitution addressed stockholder record dates; that 
matter will now be addressed in Section 7.4 of the Amended 
Constitution.
---------------------------------------------------------------------------

    The requirement in Section 2.7(c) of the Amended Constitution, 
which states that only persons who are nominated in accordance with the 
procedures set forth in Section 2.7 shall be eligible to serve as 
directors, will not apply to nominations of Industry Director nominees 
for election to the Board. Such Industry Directors are, instead, 
nominated by the Exchange's Nominating Committee (which is not a 
committee of the Board) or stockholders pursuant to Sections 3.10(a) 
and 5.3(c) of the Constitution.
    c. Increase in Required Vote for Certain Stockholder Actions. In 
addition to other currently required items,\57\ the Amended Certificate 
would require a two-thirds vote of stockholders to amend, repeal or 
adopt any provisions inconsistent with (1) the limitations on ownership 
and voting of capital stock contained in the Amended Certificate, as 
described above in Section II.B.3, (2) the provision in the Amended 
Certificate providing the Board with the authority to create and issue 
rights under a rights plan, and (3) the advance notice provision 
contained in the proposed Amended Constitution as described above in 
Section II.B.6.b.\58\
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    \57\ Pursuant to the Certificate of Incorporation, Article 
Seventh (b), the affirmative vote of the holders of at least two-
thirds of the voting power of the then outstanding shares of Class A 
Common Stock shall be required to amend, repeal or adopt Article 
Seventh of the Certificate of Incorporation or Sections 2.2, 2.4, 
2.5, 2.9, 3.2, 3.3, 3.5 or Article XI of the Constitution.
    \58\ See Amended Certificate, Article Seventh.
---------------------------------------------------------------------------

7. Reduction in Votes Required To Approve Amendments to the Amended 
Constitution
    The Exchange proposes that the current vote required to approve 
amendments to the Constitution be reduced from two-thirds of the voting 
power of each class of capital stock of ISE entitled to vote on such 
amendment to a majority vote of the voting power of each class or 
series of stock entitled to vote, voting together as a single class, in 
order to amend certain provisions of the Amended Constitution that are 
not subject to a required two-thirds vote under the Amended 
Certificate.\59\ Such amendments to the current Constitution may be 
accomplished by a two-thirds vote of the stockholders or by action of 
the Board. The two-thirds vote requirement for an amendment to the 
current Constitution was deemed appropriate for a private securities 
exchange owned primarily by its members, in order to assure substantial 
agreement as to changes in significant aspects of corporate governance. 
However, the Exchange believes that the continuation of such a high 
vote requirement, in the context of a publicly traded company with a 
widely diverse stockholder base and the likelihood of lower voting 
participation, makes it unduly difficult to effect any necessary 
changes by stockholder vote to these corporate governance provisions in 
the future.
---------------------------------------------------------------------------

    \59\ See Amended Certificate, Article Seventh and Amended 
Constitution, Section 11.1.
---------------------------------------------------------------------------

8. Confidential Information and Books and Records
    Pursuant to the Amended Certificate, all confidential information 
pertaining to the self-regulatory function of the Exchange (including 
but not limited to disciplinary matters, trading data, trading 
practices and audit information) contained in the books and records of 
the Exchange shall: (1) Not be made available to any Persons other than 
to those officers, directors, employees and agents of the Exchange that 
have a reasonable need to know the contents thereof and to the 
Commission; and (2) be retained in confidence by the Exchange and the 
officers, directors, employees and agents of the Exchange; and (3) not 
be used for any commercial purposes.\60\ In addition, the ISE's books 
and records shall be maintained within the United States.\61\
---------------------------------------------------------------------------

    \60\ See Amended Certificate, Article Thirteenth.
    \61\ See Amended Constitution, Section 1.3.
---------------------------------------------------------------------------

C. Amendment to ISE Rule 303

    The Exchange proposes to amend ISE Rule 303(b) to include the 
member trading concentration limit currently included in the 
Constitution. Currently, pursuant to Section 14.1(b) of the 
Constitution, no Member (as defined in the Constitution), together with 
any affiliate (as defined in the Constitution), may be approved to 
exercise trading rights associated with more than 20 percent of Series 
B-1 Stock or Series B-2 Stock (the ``member trading concentration 
limit''). Section 14.1(b) also permits the Exchange to establish 
further limitations relating to its approval of a Member's ability to 
effect transaction on or through the facilities of ISE. Article XIV of 
the Constitution, including Section 14.1(b), is being deleted from the 
Amended Constitution. Rule 303 currently provides for a stricter member 
trading concentration limit than 20% but permits the ISE Board to waive 
such member trading concentration limit for good cause shown.\62\ The 
Exchange proposes to amend Rule 303(b) to include the member trading 
concentration limit currently provided for in Section 14.1(b) and to 
state that the Board shall not waive the Exchange's member trading 
concentration limit if such a waiver would result in the applicant or 
approved Member (as defined in the Constitution) (together with any of 
its affiliates) being approved to exercise the trading privileges 
associated with more than 20% of the outstanding Primary Market Maker 
memberships (which memberships are associated with the shares of Series 
B-1 Stock as set forth in Article XIII of the Amended Certificate) or 
more than 20% of the outstanding Competitive Market Maker memberships 
(which memberships are associated with the shares of Series B-2 Stock 
as set forth in Article XIII of the Amended Constitution). Rule 303(b), 
as amended, will not permit the Exchange to establish further 
limitations, as the current Constitution does. ISE represents that the 
amendment to Rule 303(b) will enable the Exchange and the Commission to 
protect the integrity of the Exchange's and the Commission's regulatory 
oversight responsibilities in much the same way as the proposed 
ownership and voting limitations discussed above will.\63\
---------------------------------------------------------------------------

    \62\ See infra Section IV.D for further discussion of the 
current requirements of ISE Rule 303.
    \63\ See Amendment No. 2, supra note 4.

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[[Page 3239]]

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether this submission 
is consistent with the Act. Comments may be submitted by any of the 
following methods:
    Electronic Comments
     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or send an e-mail to [email protected]. Please include File Number SR-ISE-2004-29 on the 
subject line.
    Paper Comments
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-ISE-2004-29. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
ISE. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to Amendment No. 2 of 
File Number SR-ISE-2004-29 and should be submitted on or before 
February 10, 2005.

IV. Discussion

    The Commission has considered the ISE's proposed rule change, as 
amended, and finds that the proposal is consistent with the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\64\ In particular, the Commission finds that the proposal is 
consistent with Section 6(b)(1) of the Act,\65\ which requires a 
national securities exchange to be so organized and have the capacity 
to be able to carry out the purposes of the Act and to enforce 
compliance by its members and persons associated with its members with 
the provisions of the Act, the rules or regulations thereunder, and the 
rules of the Exchange. In addition, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\66\ 
which requires, among other things, that the rules of an exchange be 
designed to promote just and equitable principles of trade; to 
facilitate transactions in securities; to remove impediments to and 
perfect the mechanisms of a free and open market and a national market 
system; and, in general, to protect investors and the public interest.
---------------------------------------------------------------------------

    \64\ In approving the proposed rule change, the Commission has 
considered its impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \65\ 15 U.S.C. 78f(b)(1).
    \66\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission discusses below significant aspects of the proposed 
rule change.

A. Exchange Governance Structure

    The proposed rule change would clarify in the Amended Constitution 
that the ISE Board, in addition to an Executive Committee, has a 
Corporate Governance Committee, Finance & Audit Committee \67\ and 
Compensation Committee. The Exchange also has a Nominating Committee 
which is not a committee of the ISE Board. Pursuant to the Amended 
Constitution, each of the Finance & Audit and Compensation Committees 
will be comprised of three (3) and no more than five (5) Non-Industry 
Directors. The Corporate Governance Committee will be comprised of 
three (3) and no more than eight (8) Non-Industry Directors. The ISE 
Board will adopt a charter setting forth the responsibilities of each 
of these committees.\68\ The Commission notes that information about 
the existence of the Corporate Governance and Compensation Committee 
was previously not widely available or specified in the Constitution. 
Thus, the proposed amendments would serve to increase transparency with 
respect to these key committees and, thus, serve to improve their 
accountability to the benefit of the Exchange and the investing public. 
The Exchange also has proposed certain other changes to facilitate its 
conversion to a public company.\69\
---------------------------------------------------------------------------

    \67\ The Finance & Audit Committee is referred to as the Audit 
Committee under the current Constitution. See Section 5.4 of the 
Constitution.
    \68\ See Sections 5.4, 5.5 and 5.6 of the Amended Constitution.
    \69\ See supra Section II.B for a discussion of the other 
proposed changes.
---------------------------------------------------------------------------

    The Commission generally believes ISE's proposed changes should 
serve to strengthen and improve the Exchange's governance structure and 
are consistent with the Act. The Commission notes, however, that it is 
in the process of reviewing a range of governance issues relating to 
self-regulatory organizations (``SROs''), including possible steps to 
strengthen the framework for the governance of SROs and ways to improve 
the transparency of the governance procedures of all SROs and has 
proposed rules in furtherance of this goal.\70\ Depending upon the 
results of the proposed rules, the ISE may be required to make further 
changes to further strengthen its governance structure. The Commission 
also believes that the ISE Board should continue to monitor and 
evaluate the Exchange's governance structure and processes on an 
ongoing basis, and propose further changes as appropriate.
---------------------------------------------------------------------------

    \70\ See Securities Exchange Act Release No. 50699 (November 18, 
2004), 69 FR 71126 (December 8, 2004).
---------------------------------------------------------------------------

B. Changes in Control of the ISE

    The proposed Amended Certificate would impose limitations on direct 
and indirect changes in control of the ISE through voting and ownership 
limitations placed on ISE's capital stock (whether common stock or 
preferred stock) and allow the ISE Board to monitor potential changes 
in control through a notification requirement, once a threshold 
percentage of ownership of capital stock is reached.\71\ The Commission 
believes that the limitations on direct and indirect changes in control 
of the ISE, which are designed to prevent any shareholder (or 
shareholders acting together) from exercising undue control over the 
operation of the exchange and to help ensure that the ISE and the 
Commission are able to carry out their regulatory

[[Page 3240]]

responsibilities, are consistent with the Act.\72\
---------------------------------------------------------------------------

    \71\ The Amended Certificate requires that any Person, either 
alone or together with its Related Persons), who at any time owns 
five percent (5%) or more of the then outstanding shares of the 
capital stock and who has the right to vote in the election of the 
ISE Board of the Exchange shall, immediately upon so owning five 
percent (5%) or more of the then outstanding shares of such stock 
give the ISE Board written notice of such ownership and update the 
notice promptly after an ownership change of a specified percentage. 
See Article Fourth, Subdivision III(a)(iii)-(iv) of the Amended 
Certificate.
    \72\ The Commission notes that it is in the process of reviewing 
issues relating to new ownership structures of SROs, and has 
proposed rules relating to the ownership of SROs, including imposing 
limitations on member ownership of an SRO or facility of an SRO. See 
Securities Exchange Act Release No. 50699, supra note 70.
---------------------------------------------------------------------------

    Specifically, the proposed Amended Certificate provides that, 
unless approved by the ISE Board and effective under Section 19(b) of 
the Act,\73\ no person, either alone or together with its related 
persons, has any right to vote, or to give any consent or proxy with 
respect to, more than 20% of the then outstanding shares of any class 
or series of capital stock of ISE.\74\ Moreover, no person, either 
alone or together with its related persons, unless approved by the ISE 
Board and effective under Section 19(b) of the Act,\75\ may own, of 
record or beneficially, whether directly or indirectly, more than 40% 
of the then outstanding shares of any class or series of capital stock 
of ISE.\76\ To the extent that such person, or its related person, 
purports to acquire or own more than 40% of the then outstanding shares 
of any class or series of capital stock of ISE, the person, and its 
related persons, will not have any rights incident to ownership of 
shares in excess of the 40% limit.\77\
---------------------------------------------------------------------------

    \73\ 15 U.S.C. 78s(b).
    \74\ See Article Fourth, Subdivision III(b) of the Amended 
Certificate. The terms ``person'' and ``related persons'' are 
defined in Article Fourth, Subdivision III(a) of the Amended 
Certificate, and are described in Section II.B.3.a above.
    \75\ 15 U.S.C. 78s(b).
    \76\ See Article Fourth, Subdivision III(a) of the Amended 
Certificate.
    \77\ See Article Fourth, Subdivision III(c) of the Amended 
Certificate. See also supra Section III.B.3.a.
---------------------------------------------------------------------------

    The ISE Board will only be able to waive the 20% voting and 40% 
ownership limitations if it adopts an amendment to ISE's Constitution 
after making certain findings that doing so would not impair the 
ability of ISE and the Commission to carry out their respective 
regulatory obligations and is otherwise in the best interests of the 
Exchange. The ISE Board, however, will not be permitted to approve a 
member or person subject to a statutory disqualification to exceed the 
limits.\78\ The resolution would then be filed with the Commission as a 
proposed rule change under Rule 19b-4 of the Act,\79\ and the 
resolution would not become effective until the proposed rule change 
becomes effective thereunder.\80\ The proposed rule change would 
present the Commission with an opportunity to determine what additional 
measures, if any, might be necessary to provide sufficient regulatory 
jurisdiction over the proposed controlling persons.
---------------------------------------------------------------------------

    \78\ In making such determinations, the ISE Board may impose any 
conditions and restrictions on such person and its related persons 
owning any shares of stock of ISE entitled to vote on any matter as 
the ISE Board in its sole discretion deems necessary, appropriate or 
desirable. See Article Fourth, Subdivision III(a)(i) and (b)(i) of 
the Amended Certificate.
    \79\ 17 CFR 240.19b-4.
    \80\ See Article Fourth, Subdivision III(a)(i) and (b)(i) of the 
Amended Certificate.
---------------------------------------------------------------------------

    Furthermore, the Amended Certificate also contains provisions 
designed to provide a disincentive for persons to exceed these 
limitations without the requisite prior approval.\81\ Specifically, 
pursuant to the Amended Certificate, shares in excess of the ownership 
limitations would be deemed to have been transferred to the Exchange, 
as special trustee of a charitable trust, for the exclusive benefit of 
a charitable beneficiary to be determined by the Exchange.\82\ The 
purchaser would cease to have voting and economic rights in the excess 
shares, other than the right to receive proceeds from the sale of such 
shares by the trustee.\83\ In addition, if votes were cast in excess of 
the 20% voting limitation, ISE would be required to disregard such 
votes cast in excess of the 20% voting limitation.\84\
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    \81\ See Article Fourth, Subdivision III(c) of the Amended 
Certificate.
    \82\ See Article Fourth, Subdivision III(c) of the Amended 
Certificate. These corrective procedures also would apply if there 
is any other event causing any holder of capital stock to exceed the 
ownership limits, such as a repurchase of shares by the Exchange. 
Any holders owning excess shares as a result of any event other than 
a sale, transfer, assignment or pledge would cease to have rights in 
such shares.
    \83\ See supra Section II.B.3.a for a more detailed description 
of how this process works.
    \84\ Article Fourth, Subdivision III(b)(ii) of the Amended 
Certificate provides that the 20% voting limitation provisions would 
not apply to (1) any solicitation of any revocable proxy from any 
stockholder of ISE by the ISE or by any stockholder of the ISE that 
is conducted pursuant to, and in accordance with, Regulation 14A 
promulgated pursuant to the Act. This provision is designed to 
ensure that the voting limitations will not restrict the exercise of 
proxy rights under Regulation 14A of the Act.
    Article Fourth, Subdivision III(b)(iii) of the Amended 
Certificate provides that, to the fullest extent permitted by 
applicable law, shares of capital stock that are not entitled to be 
voted as a result of the 20% voting limitation shall not be deemed 
to be outstanding for the purposes of determining a quorum or a 
minimum vote required for the transaction of any business at any 
meeting of stockholders of ISE, including, without limitation, when 
specified business is to be voted on by a class or a series voting 
as a class.
---------------------------------------------------------------------------

    The proposed Amended Certificate also provides that no member of 
ISE, either alone or together with its related persons, will be allowed 
to own, of record or beneficially, whether directly or indirectly, more 
than 20% of the then outstanding shares of any class or series of 
capital stock of ISE.\85\ To the extent any member, or its related 
persons, purports to acquire or own more than 20% of the then 
outstanding shares of any class or series of capital stock of ISE, that 
member, and its related persons, will not have any rights incident to 
ownership of shares in excess of the 20% limit.\86\ Furthermore, the 
Amended Certificate also contains provisions designed to provide a 
disincentive for persons to exceed this limitation.\87\
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    \85\ See Article Fourth, Subdivision III(a)(ii) of the Amended 
Certificate.
    \86\ See Article Fourth, Subdivision III(c) of the Amended 
Certificate.
    \87\ See supra notes 82-83 and accompanying text.
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    The Commission believes that the 20% ownership (and thus voting) 
limitation restriction on ISE members is reasonable and consistent with 
the Act. Members who trade on an exchange or through a facility of an 
exchange have traditionally had ownership interests in such exchange or 
facility. However, a member's interest could become so large as to cast 
doubt on whether the exchange can fairly and objectively exercise its 
self-regulatory responsibilities with respect to that member. An 
exchange may hesitate to diligently monitor and surveil the trading 
conduct of a member that is a controlling shareholder of the exchange, 
or to diligently enforce its rules and the federal securities laws with 
regard to conduct by such member that violates these provisions. The 
Commission believes that the proposed limitation would help mitigate 
the conflict of interest that could occur if a member were to control a 
significant stake in the Exchange, and are necessary and appropriate to 
help ensure that the Exchange can effectively carry out its statutory 
obligations under Section 6(b) of the Act.\88\ The Commission notes 
that the Exchange represented that no member currently owns shares in 
excess of the 20% limitation.
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    \88\ 15 U.S.C. 78f(b).
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    The Amended Certificate of Incorporation also would require 
shareholders to report ownership interest of 5% or more to ISE. This 
provision would help the ISE Board more readily monitor ownership of 
its shares of stock in order to determine whether a person, either 
alone or with its related persons, would exceed these voting and 
ownership limitations.\89\ The

[[Page 3241]]

Commission believes that this approach is consistent with the Act in 
that it allows the ISE to comply with the reporting requirements of 
Form 1, the application for (and amendments to application for) 
registration as a national securities exchange. Exhibit K of Form 1 
requires any exchange that is a corporation or partnership to list any 
persons that have an ownership interest of five percent (5%) or more in 
the exchange, and Rule 6a-2(a)(2) under the Act requires an exchange to 
update its Form 1 within ten days after any action that renders 
inaccurate the information previously filed in Exhibit K.\90\
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    \89\ See supra note 71 and accompanying text. In addition, upon 
consummation of ISE's proposed IPO, the information required to be 
filed by shareholders pursuant to Regulations 13D and 13G will be 
available to ISE for purposes of determining whether any person, 
along or together with its related persons, has exceeded the voting 
and ownership limitations. The Commission also notes that, upon 
completion of its IPO, the Exchange would be required to publicly 
disclose on a quarterly basis information regarding the number of 
outstanding shares of its Common Stock, so that persons with a stake 
in the Common Stock can determine whether they are reaching, or have 
reached, any of the thresholds that restrict that person's ability 
to vote or own shares. See 17 CFR 240.13a-13.
    \90\ 17 CFR 240.6a-2(a)(2).
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C. Self-Regulatory Function of the ISE

    After its IPO, the Exchange will continue to operate as a 
registered national stock exchange under Section 6 of the Act \91\ and 
will maintain its current regulatory authority over members. All 
persons effecting transactions on or through the facilities of the 
Exchange will continue to be subject to the Exchange's rules. Certain 
provisions in the Amended Certificate and Amended Constitution are 
designed to facilitate the ability of ISE and the Commission to fulfill 
their regulatory obligations under the Act, and in particular under 
Sections 6(b) \92\ and 19(g) \93\ of the Act, with respect to the 
Exchange. Specifically, Article Twelfth of the Amended Certificate 
expressly requires the Directors, in managing the business and affairs 
of the ISE, to consider applicable requirements for registration as a 
national securities exchange under the Act, including the requirements 
that the rules of the ISE be designed to protect investors and the 
public interest and the ISE shall be so organized and have the capacity 
to carry out the purposes of the Act and (subject to exceptions set 
forth in the Act and rules and regulations thereunder) to enforce 
compliance with it members and persons associated with its members, 
with the provisions of the Act and the rules and regulations thereunder 
and with the ISE's Rules. In the Commission's view, this provision will 
serve to remind the Directors that they must consider the requirements 
of the Act when taking actions on behalf of the ISE and thus promote 
greater awareness and accountability on the part of the Directors.
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    \91\ 15 U.S.C. 78f.
    \92\ 15 U.S.C. 78f(b).
    \93\ 15 U.S.C. 78s(g).
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    Additionally, pursuant to the Amended Certificate, all confidential 
information pertaining to the self-regulatory function of the Exchange 
(including but not limited to disciplinary matters, trading data, 
trading practices and audit information) contained in the books and 
records of the Exchange shall: (1) Not be made available to any persons 
other than to those officers, directors, employees and agents of the 
Exchange that have a reasonable need to know the contents thereof; (2) 
be retained in confidence by the Exchange and the officers, directors, 
employees and agents of the Exchange; and (3) not be used for any 
commercial purposes.\94\ In addition, the ISE's books and records shall 
be maintained within the United States.\95\ The Commission believes 
that these provisions, which are designed to help maintain the 
independence and effectiveness of ISE's self-regulatory function, are 
appropriate and consistent with the Act.
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    \94\ See Amended Certificate, Article Thirteenth.
    \95\ See Amended Constitution, Section 1.3.
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    The Exchange also will continue to interpret its rules to require 
that any revenues it receives from regulatory fees or regulatory 
penalties will be segregated and applied to fund the legal, regulatory 
and surveillance operations of the Exchange and will not be used to pay 
dividends to the holders of Class A Common Stock.\96\ The Commission 
finds that the prohibition on the use of regulatory fines, fees or 
penalties to fund dividends is consistent with Section 6(b)(3) of the 
Act \97\ because it will further advance ISE's ability to effectively 
comply with its statutory requirements by helping to ensure the 
regulatory authority of the Exchange is not improperly used.
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    \96\ The Exchange adopted this interpretation in connection with 
its demutualization in 2002. See infra note 9. The Commission also 
notes that the Exchange represents that the holders of the Class B 
Common Stock are not entitled to receive dividends. See Section II.A 
of Securities Exchange Act Release No. 50641, supra note 3.
    \97\ 15 U.S.C. 78f(b)(3).
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D. Membership Trading Concentration Limits

    Currently, pursuant to ISE Rule 303, the ISE Board may not approve 
a member to operate more than one Primary Market Maker Membership or 
more than 10 Competitive Market Maker Memberships, unless the 
restriction is waived by the ISE Board for good cause. In addition, 
Section 14.1(b) of the Constitution requires that ISE may not approve 
an ISE member, together with any affiliate, to exercise the trading 
rights associated with more than twenty percent (20%) of ISE's Series 
B-1 Stock, nor more than twenty (20%) of ISE's Series B-2 Stock, and 
permits the Exchange to establish further limitations relating to the 
Exchange's approval of a member's ability to effect transactions on or 
through the facilities of the Exchange.
    Pursuant to the proposed rule change, ISE would delete the 20% 
limitation from Section 14.1(b) of the Constitution, and would move it 
to Rule 303(b). Specifically, Rule 303(b) would not permit the ISE 
Board to waive the Primary Market Maker and Competitive Market Maker 
Membership concentration limits in Rule 303(b) if such waiver would 
result in an ISE member, together with any of its affiliates, being 
approved to exercise trading privileges associated with more than 
twenty percent (20%) of ISE's outstanding Primary Market Maker 
Memberships or more than twenty (20%) of ISE's outstanding Competitive 
Market Maker Memberships. The Commission believes this limitation on 
the ability to operate more than a certain percentage of memberships 
will serve to protect the integrity of the Exchange's regulatory 
oversight responsibilities by preventing the Exchange from becoming 
overly dependent on the business generated by any one member. Without 
such a provision, the Exchange may be reluctant to surveil and enforce 
its rules against such a member.

V. Accelerated Approval of Amendment No. 2

    Pursuant to Section 19(b)(2) of the Act,\98\ the Commission may not 
approve any proposed rule change, or amendment thereto, prior to the 
thirtieth day after the date of publication of the notice of filing 
thereof, unless the Commission finds good cause for so finding. The 
Commission hereby finds good cause for approving Amendment No. 2 to the 
proposed rule change prior to the thirtieth day after publishing notice 
of the same in the Federal Register pursuant to Section 19(b)(2) of the 
Act.\99\ Specifically, Amendment No. 2 provides technical, non-
substantive amendments to correct typographical errors in the Amended 
Certificate and Amended Constitution, previously filed as part of the 
original proposed rule change,\100\ and revises Section 2 of ISE's

[[Page 3242]]

Form 19b-4 (Procedures of the Self-Regulatory Organization) to reflect 
actions by the ISE Board and ISE's stockholders approving the final 
forms of the Amended Certificate and Amended Constitution. Amendment 
No. 2 also proposes changes to ISE Rule 303(b) and amended related 
portions of its Form 19b-4. Specifically, Amendment No. 2 amends ISE 
Rule 303(b) to incorporate the 20% limit on the trading privileges 
associated with Primary Market Maker and Competitive Market Maker 
Memberships that may be exercised by a member of ISE that currently is 
imposed by ISE's Constitution.\101\ Because Amendment No. 2 moves the 
substance of an existing rule from ISE's Constitution to its Rules, the 
Commission believes that there is no new novel issue. Therefore, the 
Commission finds that good cause exists to accelerate approval of 
Amendment No. 2 to the proposed rule change, pursuant to Section 
19(b)(2) of the Act.\102\
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    \98\ 15 U.S.C. 78s(b)(2).
    \99\ Id.
    \100\ The Commission notes that the Exchange also undertakes to 
present to the ISE Board and stockholders for approval the 
correction of certain typographical errors in the Amended 
Certificate at the next meetings of the ISE Board and stockholders 
at which other amendments to the Amended Certificate are also 
proposed, and will promptly file such corrections with the 
Commission pursuant to Section 19(b) of the Exchange Act. 
Specifically, the Exchange undertakes to propose to correct: Article 
Fourth, Subdivision III(a)(i) of the Amended Certificate to add a 
comma between the words ``Person'' and ``either''; Article Fourth, 
Subdivision III(b)(i) of the Amended Certificate to delete a comma 
appearing between the words ``ability of the Corporation'' and ``to 
carry out its functions''; and Article Fourth, Subdivision 
III(a)(i)(E) of the Amended Certificate to insert the word ``would'' 
between the words ``or preferred) that'' and ``result in such.'' The 
Exchange also undertakes to present to the ISE Board for approval 
the insertion of the word ``a'' between the words ``the meeting 
until'' and ``quorum is present'' in Section 5.5(b) of the Amended 
Constitution at the next meeting of the Board at which other 
amendments to the Amended Constitution are also proposed. See 
Amendment No. 2, supra note 4.
    \101\ See Section 14.1(b) of the Constitution. Pursuant to 
Section 14.1(b), ISE may not approve a Member of ISE, together with 
any affiliate, to exercise the trading rights associated with more 
than 20% of ISE's Series B-1 Stock, nor more than 20% of ISE's 
Series B-2 Stock, and may establish further limitations relating to 
ISE's approval of an ISE Member's ability to effect transactions 
executed on or through the facilities of the Exchange. The 20% 
limitation will be moved to Rule 303(b) of ISE's rules. Rule 303(b), 
as amended, would not permit the Exchange to establish further 
limitations, as the current Constitution does. The Exchange 
represents that it does not believe it will be necessary to 
establish further limitations. The language also reflects the 
current language of Rule 303(b) in that it refers to the exercise of 
trading privileges associated with a Primary Market Maker or 
Competitive Market Maker Membership, rather than the exercise of 
trading rights associated with series B-1 or B-2 stock.
    \102\ Id.
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VI. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and rules and 
regulations thereunder applicable to a national securities exchange.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\103\ that the proposed rule change, including Amendment No. 2 
thereto (SR-ISE-2004-29) be, and hereby is, approved, and that 
Amendment No. 2 thereto is approved on an accelerated basis. The 
proposed rule change shall be effective upon the closing of ISE's IPO 
as described herein.
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    \103\ Id.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\104\
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    \104\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-198 Filed 1-19-05; 8:45 am]
BILLING CODE 8010-01-P