[Federal Register Volume 71, Number 167 (Tuesday, August 29, 2006)]
[Notices]
[Pages 51240-51242]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-14273]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54340; File No. SR-ISE-2006-40]


Self-Regulatory Organizations; International Securities Exchange, 
Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 
Thereto Relating to the Establishment of the Second Market

August 21, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on July 5, 2006, the International Securities Exchange, Inc. 
(``ISE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the ISE. 
On August 16, 2006, ISE filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaces and supersedes the original filing 
in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The ISE is proposing to adopt Second Market rules for the listing 
and trading of low-volume options classes. The text of the proposed 
rule change, as amended, is available on the ISE's Web site (http://www.iseoptions.com), at the principal office of the ISE, and at the 
Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the ISE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The ISE has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The ISE currently trades options on approximately 900 equity 
securities that qualify for options trading pursuant to the listing 
standards contained in ISE Rule 502. The listing standards for 
underlying securities are uniform across all of the options exchanges, 
and there are many additional underlying equity securities that qualify 
for options trading under these standards which the ISE does not 
currently list for trading, but are traded on one or more of the other 
options exchanges. In general, the Exchange has chosen not to list and 
trade these options classes based on the low average daily trading 
volume (``ADV'') they have on the other options exchanges. The purpose 
of this proposal is to adopt rules for the listing and trading of these 
low-volume options classes that qualify for listing under ISE Rule 502 
in a ``Second Market.'' Establishing the Second Market would allow the 
Exchange to provide an opportunity for additional members to provide 
liquidity as market makers, and to apply a modified fee structure to 
this segment of the options market.
    Under the proposal, the Exchange would initially list eligible 
equity options classes (excluding options on exchange traded funds) 
that trade on another options exchange and that have an ADV below 500 
contracts over a six-month period in the Second Market and those with 
an ADV of over 1500 contracts in the existing market (the ``First 
Market''). The proposed rules allow the Exchange to list such options 
classes with an ADV between 500 and 1500 contracts initially in either 
market, which is necessary to take into account other factors to ensure 
that options classes are placed in the appropriate market (e.g., 
whether the volume trend over the six-month period is up or down, or 
whether the underlying security is going to be or has been part of a 
corporate action). Starting one year after the Second Market initiates 
trading,\4\ the Exchange would review the market in which options 
classes are listed every three months, and options classes would be 
moved from the First to the Second Market when their ADV in the prior 
six-month period falls below 300 contracts,\5\ and moved from the 
Second to the First Market when their ADV in the prior six-month period 
exceeds 750 contracts.
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    \4\ Initially, the Exchange intends to add options classes to 
the Second Market over several months. The Exchange believes it is 
important to provide participants in the Second Market a period of 
continuity in Second Market products before moving options between 
the First Market and Second Market. Therefore, if for example, the 
Exchange were to initiate trading in September 2006, it would not 
conduct the first review to move options classes from the First 
Market to the Second Market, and vise versa, until September 2007. 
The first review would look at the industry ADV of each options 
class over the previous 6 months. Three months later, the Exchange 
would again review the industry ADV of each options class over the 
previous 6 months, and repeat this same review every three months 
thereafter.
    \5\ Such options classes would remain in the Second Market for 
at least twelve (12) months before being returned to the First 
Market.
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    Under the proposal, all members approved to operate ISE market 
maker memberships would be eligible to be Competitive Market Makers in 
the Second Market. In addition, members that are only approved as 
Electronic Access Members may also register as Competitive Market 
Makers in the Second Market,\6\ but would pay a $0.10 transaction 
surcharge over those market makers that own or lease ISE market maker 
memberships. The Exchange believes that providing greater access to

[[Page 51241]]

make markets in the Second Market would help it attract additional 
liquidity for these low-volume options classes from firms that do not 
currently participate on the ISE as market makers, while assuring that 
such market makers do not have an inappropriate cost advantage over 
market makers that have purchased or leased ISE market maker 
memberships. Only Primary Market Makers in the First Market may be 
Primary Market Makers in the Second Market. All market makers would pay 
the same $2,000 monthly access fee for the right to quote in the Second 
Market.
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    \6\ Under proposed ISE Rule 902, members that are only 
Electronic Access Members that want to become Competitive Market 
Makers in the Second Market would be required to complete the same 
market maker application and meet the same standards that are 
applied to Competitive Market Makers under the Exchange's existing 
rules. Members that are only Electronic Access Members are not 
eligible to be Primary Market Makers in the Second Market.
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    Market making requirements in the Second Market would be mostly the 
same as those currently applied in the First Market. As in the First 
Market, a Primary Market Maker would be appointed for each class traded 
in the Second Market (``SMPMMs''). SMPMMs would have all of the same 
obligations in their appointed options as Primary Market Makers in the 
First Market, including, among other things, entering continuous 
quotations in all of the series of all of the options classes to which 
they are appointed and satisfying requirements related to the Plan for 
Creating and Operating an Intermarket Option Linkage. Competitive 
Market Makers in the Second Market (``SMCMMs'') would be considered 
``appointed'' to all of the options classes listed in the Second Market 
and, among other things, must continuously quote all of the series of 
any options class in which they choose to make markets.\7\ An SMCMM 
would be able to choose whether to make markets in one or more Second 
Market options classes on a daily basis. SMCMMs would be permitted to 
quote in all of the options classes listed in the Second Market, but 
would not be required to quote a minimum number of Second Market 
options. Accordingly, SMCMMs would be able to choose to make markets in 
as many or as few options classes as they wish. Finally, SMPMMs and 
SMCMMs would be permitted to execute a limited percentage of their 
volume in Second Market options in which they are not currently making 
markets.\8\
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    \7\ In the First Market, Competitive Market Makers are appointed 
to a group of options, but are only required to enter continuous 
quotes in a minimum number of those appointed options pursuant to 
ISE Rule 804(e)(2). Similarly in the Second Market, SMCMMs would be 
considered appointed to all of the Second Market options, but would 
not be required to enter continuous quotations in a minimum number 
of Second Market options classes. Therefore, in both the First and 
the Second Markets, there may be options classes to which a 
Competitive Market Maker is appointed for which it is not making 
markets. Other ISE rules regarding obligations and requirements 
related to market maker quotations in appointed options, such as ISE 
Rule 803(b), currently are (and would be) applicable only when a 
Competitive Market Maker is quoting in an appointed option and do 
not create an obligation for Competitive Market Makers to 
continuously quote all appointed options classes. Other than the 
minimum quotation requirement for Competitive Market Makers in the 
First Market, the rules applicable to Competitive Market Makers in 
the First Market and the Second Market for options classes in which 
they are appointed would be the same. Because SMCMMs would be 
appointed to all options classes in the Second Market, the rules 
applicable to Competitive Market Makers in the First Market in 
options classes to which they are not appointed would not apply to 
SMCMMs (i.e., ISE Rule 805(b)).
    \8\ As explained in note 7 above, ISE Rule 805(b) regarding 
options classes in which a Competitive Market Maker in the First 
Market is not appointed would not apply to SMCMMs. The Rule permits 
such Competitive Market Makers to enter orders in options classes to 
which they are not appointed, limited to 25% of their total volume. 
Since SMCMMs would be considered appointed to all of the options 
classes in the Second Market, the Exchange proposes to adopt a 
parallel rule to ISE Rule 805(b) for SMCMMs that allows them to 
enter orders in options classes in which they are not currently 
making markets (as opposed to in which they are not appointed), 
limited to 25% of their total volume. The proposed rule specifies 
that SMCMMs may only enter orders in options classes that they are 
not quoting when the SMCMMs are making markets in at least one 
options class. If a SMCMM chooses not to make markets in any Second 
Market options classes on a particular day, it would not be 
permitted to enter any orders in Second Market options.
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    The Exchange proposes several changes to its fee schedule for the 
Second Market as follows: (1) Members would be charged an execution fee 
of $.05 per contract for public customer orders; (2) a $.10 per 
contract surcharge would be applied to transactions executed by market 
makers that do not own or lease an ISE market maker membership (i.e., 
Electronic Access Members that make markets in the Second Market); (3) 
Second Market options would be excluded from the payment for order flow 
fee; (4) market makers would be charged a $2,000 per month access fee 
(there would be no additional access fee for Electronic Access Members 
to send orders to the Second Market); and (5) firms that are only 
market makers in the Second Market (i.e., Electronic Access Members 
that make markets in the Second Market) would be charged the same 
$5,000 annual regulatory fee paid by Competitive Market Makers in the 
First Market.
2. Statutory Basis
    The Exchange believes that the basis under the Act for this 
proposed rule change is the requirement under Section 6(b)(4) \9\ that 
an exchange have an equitable allocation of reasonable dues, fees and 
other charges among its members and other persons using its facilities, 
and the requirement under Section 6(b)(5) \10\ that an exchange have 
rules that are designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism for a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest. In particular, the proposal is designed to attract 
liquidity in low-volume options classes by providing for open access to 
market makers.
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    \9\ 15 U.S.C. 78f(b)(4).
    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

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

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    (a) by order approve such proposed rule change, as amended, or
    (b) institute proceedings to determine whether the proposed rule 
change, as amended, should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the amended 
proposed rule change 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 No. SR-ISE-2006-40 on the subject line.

[[Page 51242]]

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-ISE-2006-40. 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 Room. 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 
File Number SR-ISE-2006-40 and should be submitted on or before 
September 19, 2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-14273 Filed 8-28-06; 8:45 am]
BILLING CODE 8010-01-P