[Federal Register Volume 75, Number 141 (Friday, July 23, 2010)]
[Notices]
[Pages 43211-43214]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-18069]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62523; File No. SR-ISE-2010-73]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of Proposed Rule Change Relating to Modified
Rules for Qualified Contingent Cross Orders
July 16, 2010.
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 July 14, 2010, the International Securities Exchange, LLC
(``Exchange'' or ``ISE'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II, and III below, which items have been prepared by the self-
regulatory organization. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange is proposing modified Qualified Contingent Cross
Orders.\3\ The text of the proposed rule change is as follows, with
deletions in [brackets] and additions in italics:
---------------------------------------------------------------------------
\3\ The Exchange first proposed to adopt Qualified Contingent
Cross Orders in SR-ISE-2009-35. Infra note 6. This proposal was
approved by the Division of Trading and Markets (``Division'')
pursuant to delegated authority, infra note 7, but this approval was
stayed by a petition seeking fully Commission review. Infra note 8.
The Exchange is now submitting this new proposed rule change that
modifies the initial proposal, along with a letter requesting that
the Commission vacate the Division's approval of SR-ISE-2009-35
simultaneously with approval of this modified proposal. Letter from
Michael J. Simon, Secretary and General Counsel, ISE, dated July 14,
2010. The rule text presented in this proposed rule change shows
proposed changes to ISE's rules as if the Commission vacated the
Division's approval of SR-ISE-2009-35.
---------------------------------------------------------------------------
Rule 715. Types of Orders
(a) through (i) no change.
(j) Qualified Contingent Cross Order. A Qualified Contingent Cross
Order is comprised of an order to buy or sell at least 1000 contracts
that is identified as being part of a qualified contingent trade, as
that term is defined in Supplementary Material .01 below, coupled with
a contra-side order to buy or sell an equal number of contracts.
(k) through (l) no change.
Supplementary Material to Rule 715
.01 A ``qualified continent trade'' is a transaction consisting of
two or more component orders, executed as agent or principal, where:
(a) At least one component is an NMS Stock, as defined in Rule 600
of Regulation NMS under the Exchange Act;
(b) all components are effected with a product or price contingency
that either has been agreed to by all the respective counterparties or
arranged for by a broker-dealer as principal or agent;
(c) the execution of one component is contingent upon the execution
of all other components at or near the same time;
(d) the specific relationship between the component orders (e.g.,
the spread between the prices of the component orders) is determined by
the time the contingent order is placed;
(e) the component orders bear a derivative relationship to one
another, represent different classes of shares of the same issuer, or
involve the securities of participants in mergers or with
[[Page 43212]]
intentions to merge that have been announced or cancelled; and
(f) the transaction is fully hedged (without regard to any prior
existing position) as a result of other components of the contingent
trade.
* * * * *
Rule 721. [Customer Cross] Crossing Orders
(a) Customer Cross Orders are automatically executed upon entry
provided that the execution is at or between the best bid and offer on
the Exchange and (i) is not at the same price as a Public Customer
Order on the Exchange's limit order book and (ii) will not trade
through the NBBO.
[(a)] (1) Customer Cross Orders will be automatically canceled if
they cannot be executed.
[(b)] (2) Customer Cross Orders may only be entered in the regular
trading increments applicable to the options class under Rule 710.
[(c)] (3) Supplemental Material .01 to Rule 717 applies to the
entry and execution of Customer Cross Orders.
(b) Qualified Contingent Cross Orders are automatically executed
upon entry provided that the execution (i) is not at the same price as
a Priority Customer Order on the Exchange's limit order book and (ii)
is at or between the NBBO.
(1) Qualified Contingent Cross Orders will be automatically
canceled if they cannot be executed.
(2) Qualified Contingent Cross Orders may only be entered in the
regular trading increments applicable to the options class under Rule
710.
* * * * *
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 self-regulatory organization
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 self-regulatory organization
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
Purpose--The Exchange proposes to adopt modified rules related to
Qualified Contingent Cross Orders (``QCC''). The Exchange first
proposed the adoption of the QCC in conjunction with the effectiveness
of the Order Protection and Locked/Crossed Market Plan (``Distributive
Linkage Plan'') \4\ and the Exchange's rules to implement the
distributive linkage (``Distributive Linkage Rules'').\5\ After a full
notice and comment period,\6\ the Commission's Division of Trading and
Markets (``Division'') approved the proposal on behalf of the
Commission by delegated authority.\7\ However, this approval was
automatically stayed by a petition submitted by the Chicago Board
Options Exchange, Incorporated (``CBOE'') requesting review of the
filing by the full Commission.\8\
---------------------------------------------------------------------------
\4\ Securities Exchange Act Release No. 60405 (July 30, 2009),
74 FR 39362 (August 6, 2009).
\5\ Securities Exchange Act Release No. 60559 (August 21, 2009),
74 FR 44425 (August 28, 2009) (Approval Order for SR-ISE-2009-27).
See email from Michael Simon, Secretary and General Counsel, ISE,
dated July 15, 2010, to Jennifer Colihan, Special Counsel, and Arisa
Tinaves, Special Counsel, Division of Trading and Markets,
Commission.
\6\ Securities Exchange Act Release No. 60147 (June 19, 2009),
74 FR 30651 (June 26, 2009) (Notice for ISE-2009-35).
\7\ Securities Exchange Act Release No. 60584 (August 28, 2009),
74 FR 45663 (September 3, 2009) (Approval Order for ISE-2009-35).
\8\ Letter from Joanne Moffic-Silver, General Counsel and
Corporate Secretary, CBOE, dated September 14, 2009.
---------------------------------------------------------------------------
The Exchange has submitted extensive support for the approval of
the QCC by the Division and the Commission,\9\ and believes that it has
fully addressed all of the issues raised by the commenters and provided
the basis needed for the Commission to affirm the Division's approval
of QCC. Nevertheless, the Commission has not taken action on the
petition, and as a result of the stay, the Exchange has been at an
extreme competitive disadvantage since the adoption of the Distributive
Linkage Rules nearly one year ago. While the Exchange continues to
believe QCC as originally approved by the Division is consistent with
the Exchange Act, the Exchange believes this modified proposal
addresses the two primary concerns raised by commenters. Specifically,
this modified QCC proposal does not permit a QCC to be executed at the
same price as a priority customer order on the Exchange and increases
the required minimum size from 500 to 1000 contracts.\10\
---------------------------------------------------------------------------
\9\ The ISE submitted a letter that addressed comments received
by the Commission prior to the approval of the proposal. Letter from
Michael J. Simon, Secretary and General Counsel, ISE, dated August
20, 2009. The ISE also submitted two briefs in support of a motion
to lift the automatic stay that was imposed by the petition for
review. Brief in Support of International Securities Exchange, LLC's
Motion to Lift the Commission Rule 431(e) Automatic Stay of
Delegated Action Triggered by Chicago Board Options Exchange,
Incorporated's Notice of Intention to petition for Review, September
11, 2009; and Reply Brief in Support of International Securities
Exchange, LLC's Motion to Lift the Commission Rule 431(e) Automatic
Stay of Delegated Action Triggered by Chicago Board Options
Exchange, Incorporated's Notice of Intention to petition for Review,
September 22, 2009. Since denial of the Exchange's motion to lift
the automatic stay, the Exchange has submitted additional support
for QCC. Letters from Michael J. Simon, Secretary and General
Counsel, ISE, dated December 3, 2009, December 16, 2009, March 1,
2010 and April 7, 2010. We incorporate by reference these
submissions into this file number SR-ISE-2010-73.
\10\ Under ISE Rule 100(37A), a priority customer is 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).
Pursuant to ISE Rule 713, priority customer orders are executed
before other trading interest at the same price. See email from
Michael Simon, Secretary and General Counsel, ISE, dated July 15,
2010, to Jennifer Colihan, Special Counsel, and Arisa Tinaves,
Special Counsel, Division of Trading and Markets, Commission.
---------------------------------------------------------------------------
Background
The Distributive Linkage Plan replaced the Plan for the Purpose of
Creating and Operating an Intermarket Option Linkage (``Old Linkage
Plan''), and the Exchange's Linkage Rules replaced the existing ISE
rules implementing the Old Plan (the ``Old Linkage Rules''). The Old
Linkage Plan and the Old Linkage Rules provided a limited Trade-Through
exemption for ``Block Trades,'' defined to be trades of 500 or more
contracts with a premium value of at least $150,000.\11\ However, as
with Regulation NMS, the Distributive Linkage Plan did not provide a
Block Trade exemption. At the time that it adopted the Distributive
Linkage Rules, the Exchange recognized that the loss of the Block Trade
exemption would adversely affect the ability of ISE members to effect
large trades that are tied to stock.\12\ Thus, the Exchange proposed
the QCC as a limited substitute for the Block Trade exemption, to be
implemented contemporaneously with the Linkage Rules.\13\
---------------------------------------------------------------------------
\11\ Old Plan Sections 2(3) and 8(c)(i)(C); Old ISE Rule
1902(d)(2). See email from Michael Simon, Secretary and General
Counsel, ISE, dated July 15, 2010, to Jennifer Colihan, Special
Counsel, and Arisa Tinaves, Special Counsel, Division of Trading and
Markets, Commission.
\12\ Both the Old Plan and the Distributive Linkage Plan have a
Trade-Through exemption for ``Complex Trades,'' including options
trades tied to stock. See Old Plan section 7(c)(iii)(G),and Plan
section 5(b)(viii). However, and while not free from doubt, the
common application of that exemption has been to apply it only to
trades announced to exchange members as a single trade at a net
price. As so interpreted, that exemption would cover only trades
executed in the ISE's ``Complex Order Mechanism.'' See ISE Rule 722.
\13\ The Exchange asserted that the Qualified Contingent Cross
Order was necessary to facilitate the execution of large stock/
options combination orders. While broker-dealers could execute these
orders in various ways, such as on the ISE's complex order book,
they often seek the flexibility to execute the various legs of such
orders in different markets, and may seek to execute the options leg
alone on the ISE. Under the Distributive Linkage Plan, and without a
Block Trade exemption, the Exchange knew it would be extremely
difficult for ISE members to effect the execution of the options leg
on the ISE. This has proved to be true since the implementation of
Distributive Linkage.
---------------------------------------------------------------------------
[[Page 43213]]
Discussion
While Regulation NMS does not provide a Block Trade exemption from
Trade-Through liability, the Commission, by order, has provided Trade-
Through relief for ``Qualified Contingent Trades'' (``QCTs'').\14\ The
QCT Release provides an exemption from Trade-Through liability in the
equity market for multi-component, fully-hedged trades where one order
is contingent on the execution of one or more additional orders.
Building on this concept, we propose that when an ISE member effects a
QCT trade in a Regulation NMS Stock that the member be permitted to
cross the options leg of the trade on the ISE immediately upon entry if
the order is for at least 1000 contracts, is part of a QCT,\15\is
executed at a price at least equal to the national best bid or offer
(``NBBO''), and there are no priority customer orders on the Exchange's
book at the same price.
---------------------------------------------------------------------------
\14\ Securities Exchange Act Release No. 57620 (April 4, 2008)
(the ``QCT Release''). That release superseded a release initially
granting the Qualified Contingent Trade exemption. Securities
Exchange Act Release No. 54389 (August 31, 2006).
\15\ We propose to define a QCC trade substantively identical to
the Commission's definition in the QCT release. A QCC trade must
meet the following conditions: (i) At least one component must be an
NMS Stock; (ii) all the components must be effected with a product
price contingency that either has been agreed to by all the
respective counterparties or arranged for by a broker-dealer as
principal or agent; (iii) the execution of one component must be
contingent upon the execution of all other components at or near the
same time; (iv) the specific relationship between the component
orders (e.g., the spread between the prices of the component orders)
must be determined by the time the contingent order is placed; (v)
the component orders must bear a derivative relationship to one
another, represent different classes of shares of the same issuer,
or involve the securities of participants in mergers or with
intentions to merge that have been announced or cancelled; and (iv)
the transaction must be fully hedged (without regard to any prior
existing position) as a result of other components of the contingent
trade. Consistent with the QCT Release members must demonstrate that
the transaction is fully hedged using reasonable risk-valuation
methodologies. See QCT Release, supra note 14, at footnote 9.
---------------------------------------------------------------------------
The QCC addresses the dislocation resulting from elimination of the
Block Trade exemption by permitting members to provide their customers
a net price for the entire trade, and then allowing the members to
execute the options leg of the trade on the ISE at a price at least
equal to the NBBO while using the QCT exemption to effect the trade in
the equities leg at a price necessary to achieve the net price. Under
the proposal, ISE will not permit the options component of a stock-
option order to trade through the national best bid and offer
(``NBBO'').\16\ Because the equity component of a stock-option order
can be executed at any price under the QCT exemption from Regulation
NMS, the pricing of the options component can be flexible. Indeed,
whether the options component is executed at or between the ISE BBO is
not material because, in most cases, the stock trade can be executed at
a price that achieves the desired net price.\17\ However, there are
times when the quotation spread for the option on the ISE would not
permit an execution of the options component between the ISE BBO,
particularly in options that trade in increments greater than $0.01. In
those cases, ISE proposes to permit an execution of the options
component at a price that matches the ISE BBO.\18\ Moreover, under the
modified proposal, ISE will not permit the execution of a QCC at the
same price as a priority customer order. In such a case, the QCC will
be rejected.\19\
---------------------------------------------------------------------------
\16\ While the QCC does not provide exposure for price
improvement for the options leg of a stock-option order, the options
leg must be executed at the NBBO or better. The Commission has
previously approved crossing transactions with no opportunity for
price improvement. See, e.g., ISE Rule 721(a); and CBOE Rule 6.74A,
Interpretations and Policies .08.
\17\ For example, assume two parties negotiate a stock-option
order to buy 100,000 shares and sell 1,000 calls with a net price of
24.38. Further assume that the NBBO for the option is $0.82 by
$0.86, and that the NBBO for the stock is $25.20 by $25.21. The
broker sends an order to the ISE to execute the options component at
$0.85 and sends the equity component to an equities marketplace at
$25.33. Note that in this example there is a range of prices at
which the price of the components could be executed between the NBBO
for the option, e.g., the options component could be executed at
$0.83, $0.84 or $0.85, and the equity component could be executed
respectively at $25.31, $25.32, or $25.33.
\18\ Continuing with the example from note 17 above, assume that
the NBBO and ISE BBO for the option is $0.85 by $0.86. According to
the CBOE's letter, the contingent trade should not be permitted
because the spread in the option is at a minimum increment.
\19\ The Commission has previously approved the rejection of
crossing transactions when there is a priority customer order on the
book at the same price. See, e.g., ISE Rule 721(a); and CBOE Rule
6.74A, Interpretations and Policies .08.
---------------------------------------------------------------------------
The ISE's proposal addresses the mechanics of executing the stock
and options components of a net-price transaction in disparate markets
with different execution rules, different trading increments and
different intermarket trade-through provisions. On balance, we believe
that providing members with the certainty that they could execute the
options legs of the large complex orders for their customers, coupled
with the flexibility members would have with respect to the price at
which the equity legs are executed, would provide customers with the
flexibility needed to achieve their investment objectives. Moreover,
the modifications to the proposal to prevent the execution of a QCC if
there is a priority customer on the book and to increase the minimum
size of a QCC remove the appearance that such orders are trading-ahead
of priority customer orders or that the QCC could be used to
disadvantage retail customers, the two most significant issues raised
by commenters on the initial proposal.\20\
---------------------------------------------------------------------------
\20\ See infra note 22.
---------------------------------------------------------------------------
Basis--The basis under the Act for this proposed rule change is the
requirement under Section 6(b)(5) 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 proposed changes to QCC will prevent
executions from occurring when there is a priority customer order on
the book at the same price and will assure that only large-size orders
(i.e., of at least 1000 contracts) are eligible. The modified rules
will facilitate the ability of ISE members to execute large options
orders that are tied to stock in an efficient manner, while also
protecting the national market system against trade-throughs.
B. Self-Regulatory Organization's Statement on Burden on Competition
This proposed rule change does not impose any burden on
competition. Rather, approval of QCC as modified by the proposed rule
change, will address a significant existing burden on competition. In
particular, it will permit fair competition between floor-based and
electronic options exchanges for large-size stock-option orders.\21\
---------------------------------------------------------------------------
\21\ ISE has submitted numerous letters detailing how the loss
of the Block Exemption without the alternative QCC has made it
virtually impossible for our all-electronic exchange to compete with
the floor-based trading models for these large-size stock-option
orders. Supra note 9.
---------------------------------------------------------------------------
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
[[Page 43214]]
unsolicited written comments from members or other interested
parties.\22\
---------------------------------------------------------------------------
\22\ The Commission received a number of comments with respect
to SR-ISE-2009-35, supra note 6, which can be found at http://www.sec.gov/comments/sr-ise-2009-35/ise200935.shtml#order. The
Commission also received comments with respect to the petition for
full Commission review of SR-ISE-2009-35, supra note 6, which can be
found at http://www.sec.gov/rules/other/2009/sr-ise-2009-35/ise200935_statements.shtml. ISE's responses to these comments,
supra note 7, are included at these locations.
---------------------------------------------------------------------------
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 self-regulatory organization 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-2010-73 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-ISE-2010-73. 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 website viewing and
printing in the Commission's Public Reference Room on official business
days between the hours of 10 a.m. and 3 p.m. 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-
2010-73 and should be submitted by August 9, 2010.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\23\
Florence E. Harmon,
Deputy Secretary.
---------------------------------------------------------------------------
\23\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
[FR Doc. 2010-18069 Filed 7-22-10; 8:45 am]
BILLING CODE 8010-01-P