[Federal Register Volume 73, Number 26 (Thursday, February 7, 2008)]
[Notices]
[Pages 7345-7348]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-2206]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57254; File No. SR-ISE-2006-26]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Notice of Filing of Proposed Rule Change, as Modified by Amendment 
No. 1, Relating to Professional Account Holders

February 1, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on May 5, 2006, the International Securities Exchange, LLC (``ISE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change as described in

[[Page 7346]]

Items I, II, and III below, which Items have been prepared 
substantially by the ISE. On January 25, 2008, the Exchange filed 
Amendment No. 1 to the proposal.\3\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as modified by 
Amendment No. 1, from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced the previously filed proposed rule 
change in its entirety.
---------------------------------------------------------------------------

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

    The ISE is proposing to amend ISE Rules 713 (Priority of Quotes and 
Orders), 716 (Block Trades) and 723 (Price Improvement Mechanism for 
Crossing Transactions) to give certain non-broker-dealer orders the 
same priority as broker-dealer orders and market maker quotes. The ISE 
also proposes to charge the same fee for the execution of certain non-
broker-dealer orders as is applicable to the execution of broker-dealer 
orders on the Exchange. The text of the proposed rule change is 
available on the Exchange's Web site (http://www.iseoptions.com), at 
the principal office of the Exchange, 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
    Under ISE rules, a ``Public Customer'' is any person or entity that 
is not a broker or dealer in securities, and a ``Public Customer 
Order'' is an order for the account of a Public Customer.\4\ A ``Non-
Customer'' is any person or entity that is a broker or dealer in 
securities, and a ``Non-Customer Order'' is an order for the account of 
a broker or dealer.\5\ These terms are used in ISE specific rules that 
provide certain marketplace advantages to Public Customer Orders over 
Non-Customer Orders. In particular, under ISE rules (i) Public Customer 
Orders are given priority over Non-Customer Orders and market maker 
quotes at the same price,\6\ and (ii) subject to certain exceptions, 
members are not charged a transaction fee for the execution of Public 
Customer Orders. The purpose of providing these marketplace advantages 
to Public Customer Orders is to attract retail investor order flow to 
the Exchange by leveling the playing field for retail investors over 
market professionals \7\ and providing competitive pricing.
---------------------------------------------------------------------------

    \4\ ISE Rule 100(a)(32) and (33).
    \5\ ISE Rule 100(a)(22) and (23).
    \6\ ISE Rules 713 (Priority of Quotes and Orders), 716 (Block 
Trades) and 723 (Price Improvement Mechanism for Crossing 
Transactions).
    \7\ Market professionals have access to sophisticated trading 
systems that contain functionality not available to a retail 
customer, including things such as continuously updated pricing 
models based upon real-time streaming data, access to multiple 
markets simultaneously, and order and risk management tools.
---------------------------------------------------------------------------

    With respect to these ISE marketplace advantages, the Exchange does 
not believe the definitions of Public Customer and Non-Customer 
properly distinguish between non-professional retail investors and 
certain professionals. According to the Exchange, providing marketplace 
advantages based upon whether the order is for the account of a 
participant that is a registered broker-dealer is no longer appropriate 
in today's marketplace because some non-broker-dealer individuals and 
entities have access to information and technology that enables them to 
professionally trade listed options in the same manner as a broker or 
dealer in securities.\8\ These individual traders and entities 
(collectively, ``professional account holders'') have the same 
technological and informational advantages over retail investors as 
broker-dealers trading for their own account, which enables them to 
compete effectively with broker-dealer orders and market maker quotes 
for execution opportunities in the ISE marketplace.\9\
---------------------------------------------------------------------------

    \8\ Exchange staff visited a broker-dealer that provided their 
professional customers with multi-screened trading stations equipped 
with trading technology that allowed the trader to monitor and place 
orders on all six options exchanges simultaneously. These trading 
stations also provided compliance filters, order management tools, 
the ability to place orders in the underlying securities, and market 
data feeds.
    \9\ Market makers enter quotes based upon the theoretical value 
of the option, which moves with various factors in their pricing 
models, such as the value of the underlying security. Professional 
customers place and cancel orders in relation to an options 
theoretical value in much the same manner as a market maker. This is 
evidenced by the entry of limit orders that join the best bid or 
offer and by a very high rate of orders that are canceled. In 
contrast, retail customers who enter orders as part of an investment 
strategy (such as a covered right or a directional trade) most 
frequently enter marketable orders or limit orders that they do not 
cancel and replace. A study of 10 retail-oriented broker-dealer 
members over a six-month period indicated that typically only around 
20% of their executed customer volume resulted from orders that 
joined the ISE best bid or offer upon entry. In contrast, over the 
same period, around 45% of the volume executed by a broker-dealer 
with a professional trader client base resulted from orders that 
joined the ISE best bid and offer upon entry. Additionally, retail-
oriented broker-dealer members generally have a cancel to trade 
ratio that is less than 1 (i.e., more of their orders are executed 
than canceled), whereas members with a professional trader client 
base generally have cancel to trade ratios that exceed 5 (i.e., for 
every order that is executed, 5 are canceled).
---------------------------------------------------------------------------

    The Exchange therefore does not believe that it is consistent with 
fair competition for these professional account holders to continue to 
receive the same marketplace advantages as retail investors over 
broker-dealers trading on the ISE. Moreover, because Public Customer 
Orders at the same price are executed in time priority, retail 
investors are prevented from fully benefiting from the priority 
advantage when professional account holders are afforded Public 
Customer Order priority.
    Accordingly, the Exchange is seeking to adopt two new terms that 
will be used to more appropriately provide ISE marketplace advantages 
to retail investors on the ISE. Under the proposal, execution priority 
under ISE Rules 713 (Priority of Quotes and Orders), 716 (Block Trades) 
and 723 (Price Improvement Mechanism for Crossing Transactions) will be 
given to ``Priority Customer Orders'' over ``Professional Orders'' and 
market maker quotes. Transaction fees will also be charged using these 
definitions. Specifically, the ISE will charge standard transaction 
fees currently applicable to broker-dealer orders for Professional 
Orders, and fee waivers currently available to Public Customer Orders 
will be limited to Priority Customer Orders. A Priority Customer Order 
will be defined as a person or entity that (i) is not a broker or 
dealer in securities, and (ii) does not place more than 390 orders in 
listed options per day on average during a calendar month for its own 
beneficial account(s). A ``Professional Order'' will be defined as an 
order that is for the account of a person or entity that is not a 
Priority Customer.
    The use of these new terms in the execution rules and fee schedule 
will result in professional account holders participating in the ISE's 
allocation process on equal terms with broker-dealer orders and market 
maker quotes. It will also result in members paying the

[[Page 7347]]

same transaction fees for the execution of orders for a professional 
account as they do for broker-dealer orders. The proposal will not 
otherwise affect non-broker-dealer individuals or entities under the 
ISE rules, and in particular, all Public Customer Orders will continue 
to be treated equally for purposes of the linkage-related rules. For 
example, the ISE will provide the same away-market protection for all 
Public Customer Orders, including non-broker-dealer orders that are 
included in the definition of ``Professional Orders.''\10\
---------------------------------------------------------------------------

    \10\ Orders for any customer that had an average of more than 
390 orders per day during any month of a calendar quarter must be 
represented as Professional Orders for the next calendar quarter. 
Members will be required to conduct a quarterly review and make any 
appropriate changes to the way in which they are representing orders 
within five days after the end of each calendar quarter. While 
Members only will be required to review their accounts on a 
quarterly basis, if during a quarter the Exchange identifies a 
customer for which orders are being represented as Priority Customer 
Orders but that has averaged more than 390 orders per day during a 
month, the Exchange will notify the Member and the Member will be 
required to change the manner in which it is representing the 
customer's orders within five days.
---------------------------------------------------------------------------

    In order to properly represent orders entered on the Exchange 
according to the new definitions, Electronic Access Members will be 
required to indicate whether Public Customer Orders are ``Priority 
Customer Orders'' or ``Professional Orders.'' To comply with this 
requirement, Electronic Access Members will be required to review their 
customers' activity on at least a quarterly basis to determine whether 
orders that are not for the account of a broker or dealer should be 
represented as Priority Customer Orders or Professional Orders.
    The Exchange believes that identifying professional account holders 
based upon the average number of orders entered for a beneficial 
account is an appropriately objective approach that will reasonably 
distinguish such persons and entities from retail investors. The 
Exchange proposes the threshold of 390 orders per day on average over a 
calendar month because it believes it far exceeds the number of orders 
that are entered by retail investors in a single day,\11\ while being a 
sufficiently low number of orders to cover the professional account 
holders that are competing with broker-dealers in the ISE marketplace. 
In addition, basing the standard on the number of orders that are 
entered in listed options for a beneficial account(s) assures that 
professional account holders cannot inappropriately avoid the purpose 
of the rule by spreading their trading activity over multiple 
exchanges, and using an average number over a calendar month will 
prevent gaming of the 390 order threshold.
---------------------------------------------------------------------------

    \11\ Three hundred and ninety orders is equal to the total 
number of orders that a person would place in a day if that person 
entered one order every minute from market open to market close. A 
study of one of the largest retail-oriented options brokerage firms 
indicated that on a typical trading day, options orders were entered 
with respect to 5922 different customer accounts. There was only one 
order entered with respect to 3765 of the 5922 different customer 
accounts on this day, and there were only 17 customer accounts with 
respect to which more than 10 orders were entered. The highest 
number of orders entered with respect to any one account over the 
course of an entire week was 27. Additionally, many of the largest 
retail-oriented electronic brokers offer lower commission rates to 
customers they define as ``active traders.'' The Exchange reviewed 
the publicly available information from the Web sites for Charles 
Schwab, Fidelity, TD Ameritrade and optionsXpress, all of which 
define an ``active trader'' as someone who executes only a few 
options trades per month. The highest required trading activity to 
qualify as an active trader among these four firms was 35 trades per 
quarter.
---------------------------------------------------------------------------

2. Statutory Basis
    The basis under the Act for this proposed rule change is the 
requirement under Section 6(b)(5) \12\ 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 will assure that retail 
investors continue to receive the appropriate marketplace and cost 
advantages in the ISE marketplace, while furthering fair competition 
among marketplace professionals by treating them equally within the ISE 
marketplace.
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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-2006-26 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-ISE-2006-26. 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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m.

[[Page 7348]]

Copies of the 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-2006-26 and should be submitted on 
or before February 28, 2008.
---------------------------------------------------------------------------

    \13\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-2206 Filed 2-6-08; 8:45 am]
BILLING CODE 8011-01-P