[Federal Register Volume 78, Number 79 (Wednesday, April 24, 2013)]
[Notices]
[Pages 24273-24276]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-09625]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69396; File No. SR-ISE-2013-18]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Granting Approval of Proposed Rule Change To Address Order 
Handling Under the Options Order Protection and Locked/Crossed Market 
Plan, the Authority of the Exchange To Cancel Orders When a Technical 
or Systems Issue Occurs, and To Describe the Operation of Linkage 
Handler Error Accounts

April 18, 2013.

I. Introduction

    On March 7, 2013, the International Securities Exchange, LLC 
(``Exchange'' or ``ISE'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to address: (i) Order handling 
under the Options Order Protection and Locked/Crossed Market Plan; (ii) 
the authority of the Exchange to cancel orders (or release routing-
related orders) when a technical or systems issue occurs; and (iii) 
describe the operation of Linkage Handler (defined below) error 
account(s), which may be used to liquidate unmatched executions that 
may occur in the provision of the Exchange's routing service. The 
proposed rule change was published for comment in the Federal Register 
on March 18, 2013.\3\ The Commission received no comment letters 
regarding the proposed rule change. This order approves the proposed 
rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 69114 (March 12, 2013), 
78 FR 16733 (March 18, 2013) (SR-ISE-2013-18) (``Notice'').
---------------------------------------------------------------------------

II. Description of the Proposal

New Supplementary Material .02 to ISE Rule 1901 (Order Protection) and 
New ISE Rule 1903 (Order Routing to Other Exchanges)

    In its proposal, the Exchange states that, under the Options Order 
Protection and Locked/Crossed Market Plan (``Plan''),\4\ it cannot 
execute orders at a price that is inferior to the national best bid or 
offer (``NBBO''), nor can ISE place an order on its book that would 
cause the Exchange best bid or offer to lock or cross another 
exchange's quote.\5\ The Exchange states that, in compliance with this 
requirement, incoming orders are not automatically executed at a price 
inferior to another exchange's protected bid or protected offer, nor 
placed on the limit order book if they would lock or cross an away 
market. ``Non-Customer Orders'' (orders for the account of a broker or 
dealer) \6\ are rejected in these

[[Page 24274]]

circumstances, while ``Public Customer Orders'' (orders for the account 
of a person that is not a broker-dealer) \7\ are handled by the Primary 
Market Maker.\8\ Currently, Primary Market Makers \9\ have the 
responsibility of either executing the Public Customer Order at a price 
that at least matches the NBBO or obtaining better prices from the away 
market(s) by sending one or more intermarket sweep orders (``ISOs'') on 
the Public Customer's behalf.\10\ The Exchange proposes to amend its 
rules to remove the requirement that Primary Market Makers handle 
Public Customer Orders in the circumstances described above,\11\ and to 
instead provide a centralized process for sending ISOs to other 
exchanges on behalf of Public Customer Orders. The Exchange proposes 
that it will contract with one or more unaffiliated brokers to route 
orders to other exchanges when necessary to comply with the linkage 
rules (``Linkage Handlers''). Specifically, in circumstances where 
marketable Public Customer Orders are received when the ISE is not at 
the NBBO or orders are received that would lock or cross another 
market, they will be exposed to ISE members for up to one second.\12\ 
Under the proposed rules if, after a Public Customer Order is exposed, 
such order cannot be executed in full on the Exchange at the then-
current NBBO or better and is marketable, the lesser of the full 
displayed size of the Protected Bid(s) or Protected Offer(s) that are 
priced better than the ISE's quote or the balance of the order will be 
sent to the Linkage Handler, and any additional balance of the order 
that is not marketable against the then-current NBBO will be placed on 
the ISE book.\13\
---------------------------------------------------------------------------

    \4\ The Commission notes that the Plan is a national market 
system plan proposed by the options exchanges and approved by the 
Commission. See Securities Exchange Act Release No. 60405 (July 30, 
2009), 74 FR 39362 (August 6, 2009) (File No. 4-546). ISE is a 
participant in the Plan. Among other things, the Plan requires each 
participant in the Plan to adopt rules that are reasonably designed 
to prevent trade-throughs and establish, maintain and enforce 
written rules that require its members to reasonably avoid 
displaying locked and crossed markets. See Sections 5 and 6 of the 
Plan.
    \5\ See Notice, 78 FR at 16733; see also, ISE Rules 1901 and 
1902. The Commission notes that ISE Rules 1901 and 1902 were 
designed to implement certain of the Plan's requirements with 
respect to trade-throughs and locked and crossed markets. See 
Securities Exchange Act Release No. 60559 (August 21, 2009), 74 FR 
44425 (August 28, 2009) (SR-ISE-2009-27).
    \6\ ISE Rule 100(a)(28).
    \7\ ISE Rule 100(a)(39).
    \8\ ISE Rule 714(a).
    \9\ In addition to the obligations for market makers generally, 
a ``Primary Market Maker'' has certain responsibilities for options 
classes to which it is appointed as a Primary Market Maker. See ISE 
Rule 803(c).
    \10\ See Notice, 78 FR at 16734; and ISE Rule 803(c)(2).
    \11\ The Exchange proposes to eliminate Rule 803(c)(1)-(3) and 
Supplementary Material .02 to Rule 803, which addresses Primary 
Market Makers' obligations in handling Public Customer Orders.
    \12\ The current process for exposure is being moved from 
Supplementary Material .02 to Rule 803 to Supplementary Material .02 
to Rule 1901.
    \13\ See Proposed Supplementary Material .02 to ISE Rule 1901. 
Any additional balance of the order will be executed on the ISE if 
it is marketable. Any additional balance of the order that is not 
marketable against the then-current NBBO will be placed on the ISE 
book.
---------------------------------------------------------------------------

    The Exchange proposes to adopt new ISE Rule 1903 (Order Routing to 
Other Exchanges), which would govern the Exchange's process for routing 
ISOs to other markets. As discussed above, the Exchange intends to 
contract with one or more Linkage Handlers that are not affiliated with 
the Exchange to route ISOs to other exchanges. The Exchange represents 
that any such contract will restrict the use of any confidential and 
proprietary information that the Linkage Handler receives to legitimate 
business purposes necessary for routing orders at the direction of the 
Exchange.\14\ Routing services would be available to ISE members only 
and are optional. Members that do not want orders routed can use the 
``Do Not Route'' designation to avoid routing.\15\ Also, ISE is not 
approved to be a designated examining authority.\16\
---------------------------------------------------------------------------

    \14\ See Notice, 78 FR at 16734.
    \15\ See id.
    \16\ See Notice, 78 FR at 16734 n.14. The Commission notes that, 
therefore, ISE is not the designated examining authority for any 
Linkage Handlers. See also, email from Laura Clare, Assistant 
General Counsel, ISE, to Theodore S. Venuti, Senior Special Counsel 
(confirming (i) that neither the Exchange nor any of its affiliates 
is approved to be a designated examining authority and therefore, 
neither the Exchange nor any of its affiliates may be a designated 
examining authority for any of the Linkage Handlers, as defined in 
.03 of the Supplementary Material to Rule 1901; and (ii) to become a 
designated examining authority, the Exchange would need Commission 
approval and would also need to amend its rules governing linkage 
handling).
---------------------------------------------------------------------------

    New ISE Rule 1903 also provides that: (1) The Exchange shall 
establish and maintain procedures and internal controls reasonably 
designed to adequately restrict the flow of confidential and 
proprietary information between the Exchange and the Linkage Handler, 
and any other entity, including any affiliate of the Linkage Handler, 
and, if the Linkage Handler or any of its affiliates engages in any 
other business activities other than providing routing services to the 
Exchange, between the segment of the Linkage Handler or affiliate that 
provides the other business activities and the segment of the Linkage 
Handler that provides the routing services; (2) the Exchange will 
provide its routing services in compliance with the provisions of the 
Act and the rules thereunder, including, but not limited to, the 
requirements in Section 6(b)(4) and (5) of the Act that the rules of a 
national securities exchange provide for the equitable allocation of 
reasonable dues, fees, and other charges among its Members and other 
persons using its facilities, and not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers; (3) the 
Exchange will determine the logic that provides when, how, and where 
orders are routed away to other exchanges; \17\ (4) the Linkage Handler 
will receive routing instructions from the Exchange, to route orders to 
other exchanges and report such executions back to the Exchange and the 
Linkage Handler cannot change the terms of an order or the routing 
instructions, nor does the Linkage Handler have any discretion about 
where to route an order; and (5) any bid or offer entered on the 
Exchange routed to another exchange via a Linkage Handler that results 
in an execution shall be binding on the Member that entered such bid/
offer.\18\
---------------------------------------------------------------------------

    \17\ The Exchange notes that this provision would not prohibit a 
Linkage Handler from complying with its obligations under Rule 15c3-
5 under the Act. See Notice, 78 FR at 16734 n.15.
    \18\ Proposed Supplementary Material .01 to Rule 1903 states 
that the rule does not prohibit a Linkage Handler from designating a 
preferred market-maker (or equivalent market participant) at the 
other exchange to which an outbound ISO is being routed. The 
Exchange states that this proposed provision has no impact on 
customer orders, and does not disadvantage customers in any way. See 
Notice, 78 FR at 16734-35. The Exchange will still be making the 
sole determination as to which exchange an order will be routed, as 
well as when and how the order will be routed. See id.
    Proposed Supplementary Material .02 to Rule 1903 is designed to 
address how the Exchange will handle orders in the event that there 
are no operable Linkage Handlers to provide routing services. In 
such circumstance, the Exchange will cancel orders that, if 
processed by the Exchange, would violate Rules 1901 (prohibition on 
trade-throughs) or 1902 (prohibition on locked and crossed markets). 
See id. at 16735.
---------------------------------------------------------------------------

New ISE Rule 1904 (Order Cancellation/Release)

    The Exchange is also proposing to adopt Rule 1904 (Order 
Cancellation/Release) which, the Exchange states, is designed to 
address the Exchange's authority to cancel orders (or release routing-
related orders) when a technical or systems issue occurs. The Exchange 
states that paragraph (a) of Proposed Rule 1904 is designed to 
authorize the Exchange to cancel orders as it deems to be necessary to 
maintain fair and orderly markets if a technical or systems issue 
occurs at the Exchange,\19\ the Linkage Handler, or another exchange to 
which an Exchange order has been routed. Paragraph (a) also provides 
that a Linkage Handler may only cancel orders being routed to another 
exchange

[[Page 24275]]

based on the Exchange's standing or specific instructions or as 
otherwise provided in the Exchange rules.\20\ In addition, paragraph 
(a) provides that the Exchange shall provide notice of the cancelation 
of the Members' original order to affected Members as soon as 
practicable.
---------------------------------------------------------------------------

    \19\ The Exchange states that the authority to cancel orders to 
maintain fair and orderly markets under proposed Rule 1904 would 
apply to any technical or systems issue at the Exchange and would 
include any orders at the Exchange (i.e., the authority to cancel 
orders would apply to any orders that are subject to the Exchange's 
routing service and any orders that are not subject to the 
Exchange's routing service). By comparison, the routing service 
error account provisions under proposed Rule 1905 (discussed below) 
would apply to original and corresponding orders that are subject to 
the Exchange routing service. See Notice, 78 FR at 16735.
    \20\ The Exchange states that, in addition to being unaffiliated 
with the Exchange, the Linkage Handlers are not facilities of the 
Exchange. For all routing services, the Exchange determines the 
logic that provides when, how and where orders are routed away to 
other exchanges. The Linkage Handler receives the routing 
instructions from the Exchange to route orders to other exchanges 
and to report executions back to the Exchange. The Linkage Handler 
cannot change the terms of an order or the routing instructions, nor 
does the Linkage Handler have any discretion about where to route an 
order. See proposed Rule 1903(c), (d) and (e). Under paragraph (a) 
to proposed Rule 1904, the decision to take action with respect to 
orders affected by a technical or systems issue shall be made by the 
Exchange. Depending on where those orders are located, a Linkage 
Handler would be permitted to initiate a cancelation of an order(s) 
pursuant to the Exchange's standing or specific instructions or as 
otherwise provided in Exchange Rules (e.g., the Exchange's standing 
instruction might provide, among other things, that the Linkage 
Handler could initiate the cancelation of orders if the Linkage 
Handler is experiencing technical or systems issues routing orders 
to an away exchange). See Notice, 78 FR at 16735 n.20.
---------------------------------------------------------------------------

    Paragraph (b) of Proposed Rule 1904 provides that the Exchange may 
also determine to release orders being held on the Exchange awaiting an 
away exchange execution as it deems to be necessary to maintain fair 
and orderly markets if a technical or systems issue occurs at the 
Exchange, a Linkage Handler, or another exchange to which an order has 
been routed.

Proposed Rule 1905 (Routing Service Error Accounts)

    New ISE Rule 1905 provides that each Linkage Handler shall 
maintain, in the name of the Linkage Handler, one or more accounts for 
the purpose of liquidating unmatched trade positions that may occur in 
connection with the routing service provided under new ISE Rule 1903 
(``error positions'').
    Paragraph (a) of the rule provides that errors to which the rule 
applies include any action or omission by the Exchange, a Linkage 
Handler, or another exchange to which an Exchange order has been 
routed, that results in an unmatched trade position due to the 
execution of an order that is subject to the away market routing 
service and for which there is no corresponding order to pair with the 
execution (each a ``routing error''); and that such routing errors 
would include, without limitation, positions resulting from 
determinations by the Exchange to cancel or release an order pursuant 
to new ISE Rule 1904.
    Paragraph (b) of the rule provides that error positions will be 
liquidated in a Linkage Handler's error account. Paragraph (c) of new 
ISE Rule 1905 requires that a Linkage Handler utilizing its error 
account to liquidate error positions shall liquidate the positions as 
soon as practicable. The Linkage Handler could determine to liquidate 
the position itself or have a third-party broker-dealer liquidate the 
position on the Linkage Handler's behalf. Paragraph (c)(i) provides 
that the routing broker shall establish and enforce policies and 
procedures reasonably designed to (1) adequately restrict the flow of 
confidential and proprietary information associated with the 
liquidation of the error position in accordance with Rule 1903 and (2) 
prevent the use of information associated with other orders subject to 
the routing services when making determinations regarding the 
liquidation of error positions. In addition, paragraph (c)(ii) provides 
that the Linkage Handler shall make and keep records associated with 
the liquidation of such error positions and shall maintain such records 
in accordance with Rule 17a-4 under the Act.\21\
---------------------------------------------------------------------------

    \21\ 17 CFR 240.17a-4. Because a Linkage Handler will be 
performing an Exchange function on a contractual basis and at the 
direction of the Exchange, the Exchange also proposes to exclude 
Linkage Handlers from the limits on compensation in ISE Rule 705(d). 
Instead, the Exchange states that such liability matters will be 
handled on a contractual basis as they are with other vendors or 
services to the Exchange. See Notice, 78 FR at 16737.
---------------------------------------------------------------------------

    Finally, paragraph (d) provides that the Exchange shall make and 
keep records to document all determinations to treat positions as error 
positions under the rule, and shall maintain such records in accordance 
with Rule 17a-1 under the Act.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

III. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of Section 6(b) of the Act 
\23\ and the rules and regulations thereunder applicable to a national 
securities exchange.\24\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\25\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest; and are not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. The Commission also believes 
the proposed rule change is consistent with Section 11A(a)(1)(C) of the 
Act \26\ in that it seeks to assure economically efficient execution of 
securities transactions.
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78f(b).
    \24\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \25\ 15 U.S.C. 78f(b)(5).
    \26\ 15 U.S.C. 78k-1(a)(1)(C).
---------------------------------------------------------------------------

    The Commission finds that ISE's proposed rules governing the 
routing of orders are consistent with the Act. As described above, the 
Exchange would contract with one or more Linkage Handlers that are not 
affiliated with the Exchange to route ISOs to other markets.\27\ 
Further, the routing of orders would be optional; \28\ and the Exchange 
would be responsible for routing decisions and would retain control of 
the routing logic.\29\ None of ISE or its affiliates is approved to be 
a designated examining authority, and therefore, neither the Exchange, 
nor any affiliate of the Exchange,\30\ may be the designated examining 
authority for a Linkage Handler absent Commission approval and 
amendment of ISE's rules governing the routing of orders by its Linkage 
Handlers.\31\ The Commission also notes that the rule contemplates 
procedures and internal controls designed to protect confidential and 
proprietary information, which should help ensure that the Linkage 
Handlers do not misuse routing information obtained from the Exchange. 
In addition, the Exchange would provide its routing services in 
compliance with the Act and the rules thereunder, including but not 
limited to, the requirements in Sections 6(b)(4) and (5) of the Act 
\32\ that the rules of a national securities exchange provide for the 
equitable allocation of reasonable dues, fees, and other charges among 
Exchange members and other persons using the Exchange's facilities, and 
not be designed to permit unfair discrimination between customers,

[[Page 24276]]

brokers, or dealers.\33\ The Commission notes that such rules governing 
the routing of orders by Linkage Handlers should help ISE comply with 
its responsibility under the Plan.\34\
---------------------------------------------------------------------------

    \27\ The Commission notes that Linkage Handlers would be 
required to comply with Rule 15c3-5 under the Act. See supra note 
17.
    \28\ Members may choose to avoid routing by using the Do Not 
Route designation. See supra note 15 and accompanying text.
    \29\ See proposed ISE Rule 1903(d) and (e).
    \30\ See supra note 16 and accompanying text.
    \31\ See id.
    \32\ 15 U.S.C. 78f(b)(4) and (5).
    \33\ See proposed ISE Rule 1903(c).
    \34\ See supra note 4.
---------------------------------------------------------------------------

    The Commission recognizes that technical or systems issues may 
occur, and believes that new ISE Rule 1904, in allowing ISE to cancel 
or release orders affected by technical or systems issues, should 
provide a reasonably efficient means for ISE to handle such orders, and 
appears reasonably designed to permit ISE to maintain fair and orderly 
markets.\35\
---------------------------------------------------------------------------

    \35\ The Commission notes that ISE states that it believes that 
allowing the Exchange to cancel or release orders under such 
circumstances would allow the Exchange to maintain fair and orderly 
markets, and that new ISE Rule 1905 is designed ensure full trade 
certainty for market participants and avoid disrupting the clearance 
and settlement process. See Notice, 78 FR at 16737. The Commission 
also notes that ISE states that a decision to cancel or release 
orders due to a technical or systems issue is not equivalent to the 
Exchange declaring self-help against another exchange pursuant to 
ISE Rule 1905. See 17 CFR 242.611(b). See also Notice, 78 FR at 
16735 n.21.
---------------------------------------------------------------------------

    The Commission also believes that allowing the Exchange to resolve 
error positions through the use of error accounts maintained by each 
Linkage Handler pursuant to the procedures set forth in the rule, and 
as described above, is consistent with the Act.\36\ The Commission 
notes that the rule establishes criteria for determining which 
positions are error positions to which the rule applies, and the 
procedures for the handling of such positions. In particular, the 
Commission notes that Proposed ISE Rule 1905 only applies to error 
positions that result from the Linkage Handler's routing service, and 
that such positions shall be liquidated by the Linkage Handler, as 
applicable, as soon as practicable.\37\ In this regard, the Commission 
believes that the new rule appears reasonably designed to further just 
and equitable principles of trade and the protection of investors and 
the public interest, and to help prevent unfair discrimination, in that 
it should help assure the handling of error positions will be based on 
clear and objective criteria, and that the resolution of those 
positions will occur promptly through a transparent process.
---------------------------------------------------------------------------

    \36\ The Commission notes that ISE states that it believes that 
it is reasonable and appropriate to address routing errors through 
the error account of a Linkage Handler in the manner proposed 
because, among other reasons, the Linkage Handler is the executing 
broker associated with such transactions. See Notice, 78 FR at 
16736.
    \37\ See ISE Rule 1905(c).
---------------------------------------------------------------------------

    The Commission is also concerned about the potential for misuse of 
confidential and proprietary information. The Commission notes that 
Linkage Handlers will be required to establish and enforce policies and 
procedures reasonably designed to (1) adequately restrict the flow of 
confidential and proprietary information associated with the 
liquidation of the error positions, and (2) prevent the use of 
information associated with other orders subject to the routing 
services when making determinations regarding the liquidation of error 
positions.\38\ The Commission believes that these requirements should 
help mitigate the Commission's concerns. In particular, the Commission 
believes that these requirements should help assure that none of ISE, 
its Linkage Handlers, or any third-party broker-dealer is able to 
misuse confidential or proprietary information obtained in connection 
with the liquidation of error positions for its own benefit. The 
Commission also notes that each Linkage Handler would be required to 
make and keep records associated with the liquidation of error 
positions \39\ and ISE would be required to make and keep records to 
document all determinations to treat positions as error positions under 
this Rule.\40\
---------------------------------------------------------------------------

    \38\ See ISE Rule 1905(c)(i).
    \39\ See ISE Rule 1905(c)(ii).
    \40\ See ISE Rule 1905(d). The Commission notes that the 
Exchange will transition options classes from the current process to 
the new proposed process using Linkage Handlers over a period of 
time and will notify its members via information circular as 
products are transitioned.
---------------------------------------------------------------------------

    Finally, the Commission notes that the proposed procedures for 
routing orders, canceling orders and the handling of error positions 
are similar to procedures the Commission has approved for other 
exchanges.\41\
---------------------------------------------------------------------------

    \41\ See, e.g., Securities Exchange Act Release Nos. 68583 
(January 4, 2013), 78 FR 2302 (January 10, 2013) (SR-C2-2012-038); 
68584 (January 4, 2013), 78 FR 2304 (January 10, 2013) (SR-CBOE-
2012-109); 68585 (January 4, 2013), 78 FR 2308 (January 10, 2013) 
(SR-CBOE-2012-108); and 60551 (August 20, 2009), 74 FR 43196 (August 
26, 2009) (SR-CBOE-2009-040).
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\42\ that the proposed rule change (SR-ISE-2013-18) be, and it 
hereby is, approved.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
---------------------------------------------------------------------------

    \43\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-09625 Filed 4-23-13; 8:45 am]
BILLING CODE 8011-01-P