[Federal Register Volume 73, Number 137 (Wednesday, July 16, 2008)]
[Notices]
[Pages 40895-40898]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-16231]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58129; File No. SR-ISE-2008-21]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by International Securities Exchange, LLC Relating to an 
Exchange Member's Conduct of Doing Business With the Public

July 9, 2008.
    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 March 27, 2008, the International Securities Exchange, LLC (the 
``Exchange'' or the ``ISE'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I, II, and III below, which items have been substantially 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend certain Exchange rules that 
govern an Exchange member's conduct of doing business with the public. 
Specifically, the proposed rule change would require members to 
integrate the responsibility for supervision of their public customer 
options business into their overall supervisory and compliance 
programs. In addition, the proposal would require members to strengthen 
their supervisory procedures and internal controls as related to their 
public customer options business. The text of the proposed rule change 
is available at ISE's Web site at http://www.ise.com, the Office of the 
Secretary, 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 Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B and C below, of the most significant aspects of such 
statements.

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

Purpose
I. Integration of Options Supervision
    The purpose of the proposed rule change is to create a supervisory 
structure for options that is similar to that required by New York 
Stock Exchange, Inc. (``NYSE'') Rule 342 and National Association of 
Securities Dealers, Inc. (``NASD'') Rule 3010. The proposed rule change 
would also conform ISE rules to those of the Chicago Board Options 
Exchange (``CBOE'') which has recently eliminated the requirement that 
members qualified to do a public customer business in options must 
designate a single person to act as a Senior Registered Options 
Principal (``SROP'') for the member and that each such member designate 
a specific individual as a Compliance Registered Options Principal 
(``CROP'').\3\ Instead, the rule requires members to integrate the SROP 
and CROP functions into their overall supervisory and compliance 
programs.
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    \3\ See Securities and Exchange Act Release No. 56492 (September 
21, 2007), 72 FR 54952 (September 27, 2007) (SR-CBOE-2007-106).
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    The SROP concept was first introduced during the early years of 
development of the listed options market. Previously, members were 
required to designate one or more persons qualified as Registered 
Options Principals (``ROPs'') to have supervisory responsibilities with 
respect to the firms' options business. As the number of ROPs at larger 
firms began to increase, an additional requirement was imposed that 
firms designate one of their ROPs as the SROP. This was intended to 
eliminate confusion as to where the compliance and supervisory 
responsibilities lay by centralizing in a single supervisory officer 
overall responsibility for the supervision of a firm's options 
activities.\4\ Subsequently, following the recommendation of the 
Commission, the options exchanges required firms to designate a CROP to 
be responsible for each firm's overall compliance program with respect 
to its options activities.\5\ The CROP could be the same person 
designated as a SROP.
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    \4\ Securities and Exchange Commission, 96th Cong., 1st Sess., 
Report of the Special Study of the Options Markets (Comm. Print 
1978) 316 fn. 11.
    \5\ Id. at p. 335.
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    Since the SROP and CROP requirements were first imposed, the 
supervisory function with respect to options activities of most 
securities firms has been integrated into the matrix of supervisory and 
compliance functions in respect of the firms' other securities 
activities. This not only reflects the maturity of the options market, 
but also recognizes the ways in which the uses of options themselves 
have become more integrated with other securities in the implementation 
of particular strategies. By permitting supervision of a firm's options 
activities to be handled in the same manner as the supervision of its 
securities and futures activities, the proposed rule change would 
ensure that supervisory responsibility over each segment of a firm's 
business is assigned to the best qualified persons in the firm, thereby 
enhancing the overall quality of supervision and compliance.
    The proposed rule change would allow firms the flexibility to 
assign such supervisory and compliance responsibilities, which formerly 
resided with the SROP and/or CROP, to more than one individual. For 
example, the proposed rule change would permit a

[[Page 40896]]

member firm to designate certain ROPs to be responsible for a variety 
of supervisory compliance functions such as approving acceptance of 
discretionary accounts \6\ approval of communications to customers,\7\ 
and exceptions to a member firm's suitability standards for trading 
uncovered short options.\8\ A firm would be likely to do this in 
instances where the firm believes it advantageous to do so to enhance 
its supervisory or compliance structure. Typically, a firm may also 
wish to divide these functions on the basis of geographic region or 
functional considerations. Rule 601 would be amended to clarify the 
qualification requirements of individuals designated as ROPs.\9\ Rule 
602 would be amended to specify the registration requirements of 
individuals who accept orders from non-broker-dealer customers.\10\
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    \6\ See Proposed Rule 611.
    \7\ See Proposed Rule 601(e).
    \8\ See Proposed Rule 608(f)(3).
    \9\ See Proposed Rules 601(d) and 601(e).
    \10\ See Proposed Rule 602(d).
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    The proposed rule change would call for options discretionary 
accounts, the acceptance of which must be approved by a ROP qualified 
individual (other than the ROP who accepted the account), to be 
supervised in the same manner as the supervision of other securities 
accounts that are handled on a discretionary basis. The proposed rule 
change would eliminate the requirement that discretionary options 
orders be approved on the day of entry by a ROP (with one exception as 
discussed below). This requirement predates the Special Study and is 
not consistent with the use of supervisory tools in computerized format 
or exception reports generated after the close of a trading day. No 
similar requirement exists for supervision of other securities accounts 
that are handled on a discretionary basis.\11\ Discretionary orders 
would be reviewed in accordance with a firm's written supervisory 
procedures. The Exchange believes the proposed rule change would ensure 
that supervisory responsibilities are assigned to specific ROP-
qualified individuals, thereby enhancing the quality of supervision.
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    \11\ See, e.g., NYSE Rule 408.
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    Exchange Rule 611 would be revised by adding the requirement that 
any member that does not utilize computerized surveillance tools for 
the frequent and appropriate review of discretionary account activity 
must establish and implement procedures to require ROP-qualified 
individuals who have been designated to review discretionary accounts 
to approve and initial each discretionary order on the day entered. The 
Exchange believes that any firm that does not utilize computerized 
surveillance tools to monitor discretionary account activity should 
continue to be required to perform the daily manual review of 
discretionary orders.
    Under the proposed rule change, firms would continue to be required 
to designate ROP-qualified individuals to provide frequent appropriate 
supervisory review of options discretionary accounts. This review 
includes the requirement that these ROP-qualified individuals review 
the accounts in order to determine whether the ROP accepting the 
account had a reasonable basis for believing that the customer was able 
to understand and bear the risks of the proposed strategies or 
transactions. This requirement provides an additional level of 
supervisory audit over options discretionary accounts that does not 
exist for other securities discretionary accounts.
    In addition, Proposed Rule 609(g) would require that each member 
submit to the Exchange a written report by April 1 of each year that 
details the member's supervision and compliance effort, including its 
options compliance program, during the preceding year and reports on 
the adequacy of the member's ongoing compliance processes and 
procedures.\12\
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    \12\ See Proposed Rule 609(g), which is modeled after NYSE Rule 
342.20.
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    Proposed Rule 609(h) would require that each member submit, by 
April 1 of each year, a copy of the Rule 609(g) annual report to one or 
more of its control persons or, if the member has no control person, to 
the audit committee of its board of directors or its equivalent 
committee or group.\13\ Further, the proposed rule would provide that a 
member that specifically includes its options compliance program in a 
report that complies with substantially similar NYSE and NASD rules 
would be deemed to have satisfied the requirements of Rules 609(g) and 
609(h).
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    \13\ See Proposed Rule 609(h), which is modeled after NYSE Rule 
354.
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    Members would be required to designate a single general partner or 
executive officer to assume overall authority and responsibility for 
internal supervision, control of the organization and compliance with 
securities laws and regulations.\14\ Members would also be required to 
designate specific qualified individuals as having supervisory or 
compliance responsibilities over each aspect of the firm's options 
activities and to set forth the names and titles of these individuals 
in their written supervisory procedures.\15\
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    \14\ See Proposed Rule 609(a).
    \15\ See Proposed Rule 609(i).
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b. Supervisory Procedures and Internal Controls
    The Exchange is also proposing to amend certain rules to strengthen 
members' supervisory procedures and internal controls relating to a 
member's public customer options business. The proposed rule changes 
discussed below are modeled after NYSE and NASD rules approved by the 
Commission in 2004.\16\ The Exchange believes its proposal to 
strengthen member supervisory procedures and internal controls is 
appropriate and consistent with the proposal discussed above to 
integrate the responsibility for supervision of a member firm's public 
customer options business into its overall supervisory and compliance 
program.
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    \16\ See Securities Exchange Act Release Nos. 49882 (June 17, 
2004), 69 FR 35108 (June 23, 2004) (SR-NYSE-2002-36) (approval 
order), 49883 (June 17, 2004), 69 FR 35092 (June 23, 2004) (SR-NASD-
2002-162).
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    The Exchange is proposing to revise Rule 609(a) to require members 
to develop and implement written policies and procedures reasonably 
designed to supervise sales managers and other supervisory personnel 
who service customer options accounts.\17\ This requirement would apply 
to branch office managers, sales managers, regional/district sales 
managers, or any person performing a similar supervisory function. Such 
policies and procedures are expected to encompass all options sales-
related activities. Proposed Rule 609(a)(3)(i) would require that 
supervisory reviews of producing sales managers be conducted by a 
qualified ROP who is either senior to, or otherwise ``independent of,'' 
the producing manager under review. This provision is intended to 
ensure that all options sales activity of a producing manager is 
monitored for compliance with applicable regulatory requirements by 
persons who do not have a personal interest in such activity.
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    \17\ Proposed Rule 609(a) is modeled after NYSE Rule 342.19.
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    Proposed Rule 609(a)(3)(ii) would provide an exception for firms so 
limited in size and resources that there is no qualified person senior 
to, or otherwise independent of, the producing manager to conduct the 
review. In this case, the review would be conducted by a qualified ROP 
to the extent practicable. Under proposed Rule

[[Page 40897]]

609(a)(3)(iii), a member relying on the limited size and resources 
exception must document the factors used to determine that compliance 
with each of the ``senior'' or ``otherwise independent'' standards of 
proposed Rule 609(a)(3)(i) is not possible, and that the required 
supervisory systems and procedures in place with respect to any 
producing manager comply with the provisions of proposed Rule 
609(a)(3)(i) to the extent practicable.\18\
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    \18\ Proposed Rule 609(a)(3)(iv) would provide that a member 
organization that complies with the NYSE or NASD rules that are 
substantially similar to the requirements in Rules 609(a)(3)(i), 
(a)(3)(ii) and (a)(3)(iii) will be deemed to have met such 
requirements.
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    Proposed Rule 609(c)(1) would require members to develop and 
maintain adequate controls over each of their business activities. The 
proposed rule would further require that such controls include the 
establishment of procedures to independently verify and test the 
supervisory systems and procedures for those business activities. A 
member would be required to include in the annual report, prepared 
pursuant to proposed Rule 609(g), a review of the member's efforts in 
this regard, including a summary of the tests conducted and significant 
exceptions identified. The Exchange believes proposed Rule 609(c)(1) 
would enhance the overall quality of each member organization's 
supervision and compliance function.\19\
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    \19\ Proposed Rule 609(c)(i) is modeled after NYSE Rule 342.23. 
Paragraph (c)(ii) of proposed Rule 609 would provide that a member 
organization that complies with NYSE or NASD rules that are 
substantially similar to the requirements in paragraph (c)(i) of 
proposed Rule 609 will be deemed to have met such requirements.
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    Proposed Rule 609(d) would establish requirements for branch office 
inspections similar to the requirements of NYSE Rule 342.24. 
Specifically Rule 609(d) would require a member to inspect, at least 
annually, each supervisory branch office and inspect each non-
supervisory branch office at least once every three years.\20\ The 
proposed rule would further require persons who conduct a firm's annual 
branch office inspection to be independent of the direct supervision or 
control of the branch office (i.e., not the branch office manager, or 
any person who directly or indirectly reports to such manager, or any 
person to whom such manager directly reports). The Exchange believes 
that requiring branch office inspections to be conducted by someone who 
has no significant financial interest in the success of a branch office 
should lead to more objective and vigorous inspections.
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    \20\ Proposed Rules 609(d)(1)(i) and (ii) would provide members 
with two exceptions from the annual supervisory branch office 
inspection requirement.
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    Under proposed Rule 609(e), any firm seeking an exemption, pursuant 
to Rule 609(d)(1)(ii), from the annual branch office inspection 
requirement would be required to submit to the Exchange written 
policies and procedures for systematic risk-based surveillance of its 
branch offices, as defined in Rule 609(e). Proposed Rule 609(f) would 
require the annual branch office inspection programs to include, at a 
minimum, testing and verification of specified internal controls.\21\ 
Proposed Rule 609(d)(3) would provide that a member that complies with 
the requirements of NASD or the NYSE that are substantially similar to 
the requirements of Rules 609(d), (e) and (f) would be deemed to have 
met such requirements. The Exchange is also proposing to amend Rule 609 
to define ``branch office'' in a way that is substantially similar to 
the definition of branch office in NYSE Rule 342.10.
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    \21\ Proposed Rules 609(e) and (f) are modeled after NYSE Rules 
342.25 and 342.26.
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    Proposed Rule 609(g)(4) would require a firm to designate a Chief 
Compliance Officer (CCO). Proposed Rule 609(g)(5) would require each 
firm's Chief Executive Officer (CEO), or equivalent, to certify 
annually that the member organization has in place processes to: (1) 
Establish and maintain policies and procedures reasonably designed to 
achieve compliance with applicable Exchange rules and federal 
securities laws and regulations, (2) modify such policies and 
procedures as business, regulatory, and legislative changes and events 
dictate, and (3) test the effectiveness of such policies and procedures 
on a regular basis, the timing of which is reasonably designed to 
ensure continuing compliance with Exchange rules and federal securities 
laws and regulations.
    Proposed Rule 609(g)(5) would also require the CEO to attest (1) 
That the CEO has conducted one or more meetings with the CCO in the 
preceding 12 months to discuss the compliance processes in proposed 
Rule 609(g)(5)(i), (2) that the CEO has consulted with the CCO and 
other officers to the extent necessary to attest to the statements in 
the certification, and (3) that the compliance processes are evidenced 
in a report, reviewed by the CEO, CCO and such other officers as the 
member firm deems necessary to make the certification, that is provided 
to the member firm's board of directors and audit committee (if such 
committee exists).\22\
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    \22\ Proposed Rule 609(g)(5) is modeled after NASD Rule 3013 and 
NYSE Rule 342.30(e).>
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    Under proposed Rule 609(b)(2), a member, upon a customer's written 
instructions, may hold mail for a customer who will not be at his or 
her usual address for no longer than two months if the customer is on 
vacation or traveling, or three months if the customer is going abroad. 
This provision would help ensure that members that hold mail for 
customers who are away from their usual addresses do so only pursuant 
to the customer's written instructions and for a specified, relatively 
short period of time.\23\
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    \23\ Proposed Rule 609(b)(2) is modeled after NASD Rule 3110(i).
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    Proposed Rule 609(b)(3) would require that, before a customer 
options order is executed, the account name or designation must be 
placed upon the memorandum for each transaction. In addition, only a 
qualified ROP would be permitted to approve any changes in account 
names or designations. The ROP would be required to document the 
essential facts relied upon in approving the changes and maintain the 
record in an easily accessible place. A member would be required to 
preserve any documentation that provides for an account designation 
change for a period of not less than three years, with the 
documentation preserved for the first two years in an easily accessible 
place, as the term ``easily accessible place'' is used in Rule 17a-4 of 
the Act. The Exchange believes the proposed rule would help to protect 
account name and designation information from possible fraudulent 
activity.\24\
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    \24\ Proposed Rule 609(b)(3) is modeled after NASD Rule 3110(j).
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    Proposed Rule 611(d) would allow a member to exercise time and 
price discretion on orders for the purchase or sale of a definite 
number of options contracts in a specified security. The Exchange 
proposes to limit the duration of this discretionary authority to the 
day it is granted, absent written authorization to the contrary. In 
addition, the proposed rule would require any exercise of time and 
price discretion to be reflected on the customer order ticket. The 
proposed one-day limitation would not apply to time and price 
discretion exercised for orders affected with or for an institutional 
account (as defined in the Rule) pursuant to valid Good-Till-Cancelled 
instructions issued on a ``not held'' basis. The Exchange believes that 
investors would receive greater

[[Page 40898]]

protection by clarifying the time such discretionary orders remain 
pending.\25\
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    \25\ Proposed Rule 611(d) is modeled after NASD Rule 2510(d)(1).
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    The Exchange believes the proposed rule changes recognize that 
options have become more integrated with other securities in the 
implementation of particular strategies, and thus should not continue 
to be regulated as though they are a new and experimental product. The 
Exchange further asserts that the supervisory and compliance structure 
in place for non-options products at most firms is not materially 
different from the structure in place for options. The proposed rule 
change would also conform ISE rules to those of the CBOE. Accordingly, 
the Exchange submits that the proposed rule changes are appropriate and 
would not materially alter the supervisory operations of member firms.
2. Statutory Basis
    The basis for this proposed rule change is found in Section 6(b)(5) 
of the Exchange Act, in that the proposed rule change is designed to 
promote just and equitable principles of trade, 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.
    Specifically, the Exchange believes this proposed rule change would 
achieve these ends by integrating the supervision and compliance 
functions relating to member organizations' public customer options 
activities over where supervisory responsibility lies, and by fostering 
the strengthening of member organizations' internal controls and 
supervisory systems.

B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

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

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the 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 No. SR-ISE-2008-21 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-ISE-2008-21. 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. 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-2008-21 and should be 
submitted by August 6, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-16231 Filed 7-15-08; 8:45 am]
BILLING CODE 8010-01-P