[Federal Register Volume 73, Number 196 (Wednesday, October 8, 2008)]
[Notices]
[Pages 59002-59006]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-23758]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-58665; File No. SR-ISE-2008-21]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of Amendment No. 1 and Order Granting Accelerated
Approval of Proposed Rule Change as Modified by Amendment No. 1
Relating to an Exchange Member's Conduct of Doing Business With the
Public
September 26, 2008.
I. Introduction
On March 27, 2008, the International Securities Exchange, LLC
(``ISE'' or the ``Exchange''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the ``Act''),\1\ and Rule 19b-4
thereunder,\2\ filed with the Securities and Exchange Commission (the
``Commission'') the proposed rule change relating to the Exchange's
rules governing doing business with the public. On July 9, 2008, the
Commission issued a release noticing the proposed
[[Page 59003]]
rule change, which was published for comment in the Federal Register on
July 16, 2008.\3\ The comment period expired on August 6, 2008. The
Commission did not receive any comment letters in response to the
proposed rule change. On May 13, 2008, the Exchange filed Amendment No.
1 to the proposed rule change.\4\ This order provides notice of the
proposed rule change, as modified by Amendment No. 1, and approves the
proposed rule change as amended on an accelerated basis.
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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. 58129 (July 9,
2008), 73 FR 40895 (July 16, 2008) (``Initial Notice'').
\4\ The Initial Notice did not provide notice of Amendment No.
1. Amendment No. 1 made minor changes to the initial filing
consisting of adding clarifying text and fixing typographical and
similar errors.
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II. Description
The Exchange proposes 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.
A. Integration of Options Supervision
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.
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'').\5\ Instead, the rule requires members to integrate the SROP
and CROP functions into their overall supervisory and compliance
programs.
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\5\ 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.\6\ 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.\7\ The CROP could be the same person
designated as a SROP.
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\6\ Securities and Exchange Commission, 96th Cong., 1st Sess.,
Report of the Special Study of the Options Markets (Comm. Print
1978) 316 fn. 11.
\7\ 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 member firm to
designate certain ROPs to be responsible for a variety of supervisory
compliance functions such as approving acceptance of discretionary
accounts,\8\ approval of communications to customers,\9\ and exceptions
to a member firm's suitability standards for trading uncovered short
options.\10\ 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.\11\ Rule 602 would be
amended to specify the registration requirements of individuals who
accept orders from non-broker-dealer customers.\12\
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\8\ See Proposed Rule 611.
\9\ See Proposed Rule 601(e).
\10\ See Proposed Rule 608(f)(3).
\11\ See Proposed Rules 601(d) and 601(e).
\12\ 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.\13\ 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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\13\ 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
[[Page 59004]]
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.\14\
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\14\ 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.\15\ 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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\15\ 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.\16\ 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.\17\
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\16\ See Proposed Rule 609(a).
\17\ 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.\18\ 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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\18\ 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.\19\ 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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\19\ 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 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.\20\
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\20\ 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.\21\
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\21\ 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.\22\ 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
[[Page 59005]]
financial interest in the success of a branch office should lead to
more objective and vigorous inspections.
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\22\ 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.\23\
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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\23\ 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).\24\
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\24\ 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.\25\
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\25\ 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.\26\
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\26\ 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 effected 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 protection by clarifying the time such
discretionary orders remain pending.\27\
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\27\ 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.
III. Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder.\28\ In particular, the Commission finds the
proposal to be consistent with the objectives of Section 6(b)(5) of the
Act,\29\ in that it is designed to promote just and equitable
principles of trade, to prevent fraudulent and manipulative acts and
practices, and in general, to protect investors and the public
interest. The Commission believes the proposed rule change would
integrate the supervision and compliance functions relating to member
organizations' public customer options activities into the overall
supervisory structure of a member organization, thereby eliminating any
uncertainty over where supervisory responsibility lies. In addition,
the proposed rule change would foster the strengthening of members' and
member organizations' internal controls and supervisory systems.
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\28\ In approving this rule change, as amended, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
\29\ 15 U.S.C. 78f(b)(5).
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The Commission also finds good cause for approving the proposed
rule change, as modified by Amendment No.1, prior to the thirtieth day
after the date of publication of notice of filing of the amendment in
the Federal Register.\30\ The Commission believes that Amendment No. 1
should reduce ambiguity by providing clarifying changes and fixing
typographical and similar errors. Amendment No. 1 does
[[Page 59006]]
not contain any major modifications that would alter the scope of the
proposed rule change as published in the Federal Register. The
Commission believes that approving the proposed rule change, as
modified by Amendment No. 1, will simplify compliance, and is
consistent with the public interest and the investor protection goals
of the Act. Finally, the Commission finds that it is in the public
interest to approve the proposed rule change as modified as soon as
possible to expedite its implementation. Accordingly, the Commission
believes good cause exists, consistent with Section 19(b)(2) of the Act
\31\ to approve the proposed rule, as modified by Amendment No. 1 on an
accelerated basis.
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\30\ See supra footnotes 3 and 4.
\31\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1, including whether Amendment No. 1
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 Commissions 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 October 29, 2008.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\32\ that the proposed rule change (SR-ISE-2008-21), as amended by
Amendment No. 1, be, and hereby is, approved on an accelerated basis.
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\32\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\33\
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\33\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-23758 Filed 10-7-08; 8:45 am]
BILLING CODE 8011-01-P