

[Federal Register: October 4, 2006 (Volume 71, Number 192)]
[Notices]               
[Page 58650-58656]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04oc06-102]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54528; File No. SR-ISE-2006-48]

 
Self-Regulatory Organizations; International Securities Exchange, 
Inc. (n/k/a International Securities Exchange, LLC); Order Approving 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 1 Thereto Relating to the 
Adoption of Rules To Govern Its Electronic Trading System for Equities

 September 28, 2006.

I. Introduction

    On August 4, 2006, the International Securities Exchange, Inc. (n/
k/a International Securities Exchange, LLC) (``ISE'' or ``Exchange'') 
\1\ filed with the

[[Page 58651]]

Securities and Exchange Commission (``Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'') \2\ and Rule 19b-4 thereunder,\3\ to adopt rules to 
govern its electronic trading system for equity securities. The 
proposed rule change was published for comment in the Federal Register 
on August 15, 2006.\4\ The Commission received no comments on the 
proposal. On September 27, 2006, the Exchange filed Amendment No. 1 to 
the proposal.\5\ This order approves the proposed rule change, grants 
accelerated approval to Amendment No. 1, and solicits comments from 
interested persons on Amendment No. 1.
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    \1\ On September 1, 2006, the Exchange adopted a holding company 
structure by forming a new parent company, International Securities 
Exchange Holdings, Inc. (``Holdings''). As part of the 
restructuring, International Securities Exchange, Inc. (``ISE 
Inc.''), the registered national securities exchange, merged into a 
newly formed entity, International Securities Exchange, LLC (``ISE 
LLC''), a wholly-owned subsidiary of Holdings. ISE LLC continues to 
conduct the business operations of the exchange and is the successor 
to the registration of ISE Inc. as a national securities exchange. 
See Securities Exchange Act Release No. 53705 (April 21, 2006), 71 
FR 25260 (April 28, 2006) (File No. SR-ISE-2006-04). Holdings is 
also the parent company of ISE Stock Exchange, LLC, the facility to 
which the proposed rule change relates. All references herein to 
``ISE'' or the ``Exchange'' refer to ISE Inc. or ISE LLC, as 
appropriate.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
    \4\ See Securities Exchange Act Release No. 54287 (August 8, 
2006), 71 FR 46947.
    \5\ In Amendment No. 1, the Exchange: (i) Amended proposed ISE 
Rule 2110 (Minimum Price Variation) to conform with the language of 
Rule 612 of Regulation NMS; (ii) amended proposed ISE Rule 2106 
(Opening Process) to reflect all order types that cannot participate 
in the opening process and to add a provision addressing closing 
procedures; (iii) changed the term ``partial round lot'' to ``mixed 
lots'' to correspond to the current industry term and clarified 
corresponding proposed ISE Rule 2105 (Order Entry); (iv) amended 
proposed ISE Rule 2107 (Priority and Execution of Orders) to address 
how orders entered into the ISE Stock Exchange will interact with 
MidPoint Match orders; (v) amended proposed ISE Rule 2118 (Trade 
Modifiers) to incorporate applicable requirements of Rule 611 of 
Regulation NMS; (vi) made clarifying changes to the clearing 
requirements; (vii) made conforming changes to the proposed rules to 
match, where applicable, the rules filed under the Form PILOT 
relating to MidPoint Match; (viii) added proposed ISE Rule 2120 
(Taking or Supplying Securities); (ix) clarified routing procedures 
before and after February 5, 2007, the Regulation NMS ``Trading 
Phase Date''; and (x) made other minor clarifying changes to various 
proposed rules. The complete text of Amendment No. 1 is available on 
the Commission's Web site (http://www.sec.gov/rules/sro.shtml), at 

the Commission's Public Reference Room, and at the Exchange.
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II. Summary Description of the Proposal

    The Exchange proposes to adopt new rules and amend existing ISE 
rules to govern the operation of the ISE Stock Exchange, LLC (``ISE 
Stock Exchange''), a new electronic trading system for equity 
securities (``System'').\6\ In addition, the Exchange proposes to apply 
certain of its options rules to the trading of equity securities on the 
ISE Stock Exchange. The ISE Stock Exchange will trade equity securities 
only pursuant to unlisted trading privileges (``UTP'').\7\
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    \6\ On September 1, 2006, the Commission approved a proposed 
rule change establishing the ISE Stock Exchange as a ``facility,'' 
as defined in Section 3(a)(2) of the Act, of the Exchange. See 
Securities Exchange Act Release No. 54399, 71 FR 53728 (September 
12, 2006) (SR-ISE-2006-45).
    \7\ While the proposed rules would allow the ISE Stock Exchange 
to trade common stock, Commodity-Based Trust Shares, Currency Trust 
Shares, Partnership Units, Trust Issued Receipts including those 
based on Investment Shares, and Investment Company Units by either 
listing and/or trading pursuant to UTP, the Commission notes that, 
to list equity securities, the Exchange would need to amend its 
rules to comply with Rule 10A-3 under the Act, 17 CFR 240.10A-3, and 
to incorporate qualitative listing criteria by filing a proposed 
rule change under Section 19(b)(1) of the Act.
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    The System will provide for the electronic execution and display of 
orders, as well as a midpoint matching feature (``MidPoint Match''). 
The class of members who will be eligible to trade on the ISE Stock 
Exchange are electronic access members (``EAMs'') of the Exchange whom 
ISE specifically authorizes to trade on the ISE Stock Exchange 
(``Equity EAMs''). Orders will be ranked in the System based on price-
time priority, regardless of the identity of the entering Equity EAM. 
Executions will take place automatically and immediately upon order 
entry if trading interest is available. The System will provide a 
routing service for orders when trading interest is not present on the 
ISE Stock Exchange. The ISE Stock Exchange will not have any market 
makers, only Equity EAMs who will provide liquidity to the ISE Stock 
Exchange. The ISE Stock Exchange will be an order-driven marketplace.
    The proposed rules incorporate the ISE Stock Exchange's compliance 
with Rule 611 of Regulation NMS \8\ by requiring that, for any 
execution to occur on the ISE Stock Exchange during regular trading 
hours, the price must be equal to, or better than, any ``protected 
quotation'' within the meaning of Regulation NMS (``Protected 
Quotation''),\9\ unless an exception to Rule 611 of Regulation NMS is 
available.\10\ The Exchange proposes to direct to away markets for 
execution all or a portion of the orders that cannot be executed at the 
Protected Quotation on the ISE Stock Exchange, and are not 
cancelled.\11\ The proposed rules also incorporate the prohibition in 
Regulation NMS on locking or crossing Protected Quotations,\12\ except 
in certain circumstances.\13\
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    \8\ 17 CFR 242.611.
    \9\ See proposed ISE Rule 2100(c)(16).
    \10\ See proposed ISE Rule 2107(c).
    \11\ See proposed ISE Rule 2107(d).
    \12\ 17 CFR 242.610(d).
    \13\ See proposed ISE Rule 2112.
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    The MidPoint Match feature of the System will be a mechanism for 
trading equity securities in a continuous matching system.\14\ Users 
will enter unpriced orders into MidPoint Match, and MidPoint Match will 
continuously monitor buy and sell orders in MidPoint Match and, subject 
to certain limitations discussed more fully below, will execute orders 
at the midpoint of the NBBO when interest is resident in MidPoint Match 
on both sides of the market.\15\
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    \14\ See proposed ISE Rule 2129.
    \15\ The Exchange previously filed with the Commission pursuant 
to Rule 19b-5 under the Act, 17 CFR 240.19b-5, a Form PILOT setting 
forth rules governing MidPoint Match. See PILOT-ISE-2006-01 (July 
28, 2006). ISE commenced operation of MidPoint Match on September 8, 
2006. The rules filed under the Form PILOT, with minor 
modifications, were incorporated into the Exchange's proposed rule 
change, as amended. Upon the Commission's approval of the proposed 
rule change, the rules relating to the fully displayed market will 
be effective, but will not be operative until ISE launches its fully 
displayed market, and the rules pertaining to MidPoint Match that 
are incorporated into the proposed rule change will be operative 
immediately. Prior to launch of the fully displayed market, the 
Exchange intends to file a proposed rule change with the Commission 
to indicate that the rules relating to the fully displayed market 
have become operative. The Exchange represents that it intends to 
commence trading in the displayed market prior to February 5, 2007, 
the Regulation NMS ``Trading Phase Date.''
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    A more complete discussion of the features of the ISE Stock 
Exchange is contained below.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the Act and the rules and 
regulations promulgated thereunder applicable to a national securities 
exchange \16\ and, in particular, with the requirements of Section 6(b) 
of the Act.\17\ Specifically, the Commission finds that approval of the 
proposed rule change is consistent with Section 6(b)(5) of the Act \18\ 
in that it is designed to facilitate transactions in securities; 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

[[Page 58652]]

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.
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    \16\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b).
    \18\ 15 U.S.C. 78f(b)(5).
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A. Access to ISE Stock Exchange

    The class of members who will be eligible to trade on the ISE Stock 
Exchange are Equity EAMs. All current EAMs of the Exchange are eligible 
to become Equity EAMs. Any broker-dealer that is not currently an EAM 
can become an Equity EAM first by applying for EAM status through the 
existing membership process and then by connecting to the ISE Stock 
Exchange through the FIX or CMS protocols and paying any applicable 
fees. Such fees will be the same for current and new EAMs seeking to 
become Equity EAMs. The Commission believes that the proposed 
definition of, and the procedures relating to authorization of an EAM 
to act as, an Equity EAM are consistent with the Act.

B. Order Types

    The following order types will be eligible for execution on the ISE 
Stock Exchange, including MidPoint Match orders, which are described 
below.
    Market Orders: A Market Order is an order to buy or sell a stated 
amount of a security that is to be executed immediately and 
automatically at the best available price(s) \19\ when the order 
reaches the ISE Stock Exchange, to the greatest extent possible without 
causing an execution during regular trading hours at a price that is 
inferior to a Protected Quotation (``Trade-Through''). Any unexecuted 
shares of a Market Order may be routed in whole or in part to other 
Trading Centers \20\ with Protected Quotations.
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    \19\ The ``best available price'' means the highest bid price 
and the lowest offer price, including orders with executable 
undisplayed interest to buy or sell and interest to buy or sell that 
may exist in MidPoint Match. See proposed ISE Rule 2100(c)(3).
    \20\ A ``Trading Center'' is a national securities exchange or 
national securities association that operates an SRO trading 
facility, an alternative trading system, an exchange market maker, 
an OTC market maker, or any other broker or dealer that executes 
orders internally by trading as principal or crossing orders as 
agent. See proposed ISE Rule 2100(c)(20).
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    Limit Orders: A Limit Order is a one-sided order to buy or sell a 
stated quantity of a security at a specified price or better. The types 
of Limit Orders that the ISE Stock Exchange will accept include Reserve 
Orders, Immediate-or-Cancel (``IOC'') Orders, Intermarket Sweep Orders 
(``ISOs''), Fill-or-Kill (``FOK'') Orders, Not Routable Orders, and 
Post Only Orders.
    Reserve Orders will have a portion of their size displayed, while a 
reserve portion of their size at the same price will not be displayed. 
The reserve size will be used to refresh the displayed size when the 
displayed size is executed in full. When the displayed size of a 
Reserve Order is replenished from the reserve size, the displayed order 
is considered newly entered for purposes of time priority.
    IOC Orders will be executed immediately and automatically against 
existing orders on the System at the best available price(s) to the 
greatest extent possible without causing a Trade-Through, and any 
unexecuted balance will be cancelled. Any Equity EAM may use an IOC 
Order to immediately and automatically execute against the full size of 
the displayed quotation on the System (including any undisplayed or 
reserve size available at the price of the displayed quotation).
    With respect to orders received by the ISE Stock Exchange, ISOs are 
orders to be executed in whole or in part upon receipt against existing 
orders on the System at their executable price, in order of their 
ranking and without regard to better-priced quotations displayed at 
other Trading Centers, and if not so executed are to be cancelled. With 
respect to orders sent by the ISE Stock Exchange to other Trading 
Centers, ISOs are orders to be executed in whole or in part at such 
Trading Centers without regard to better-priced quotations displayed at 
other Trading Centers, and if not so executed are to be cancelled.\21\
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    \21\ The Exchange intends the ISO order type to be equivalent to 
the ``intermarket sweep order'' defined in Rule 600(b)(30) of 
Regulation NMS under the Act, 17 CFR 242.600(b)(30).
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    FOK Orders are to be executed in their entirety or cancelled upon 
receipt. Not Routable Orders are to be executed in whole or in part 
upon receipt, and if not fully executed, displayed on the ISE Stock 
Exchange, as long as the order would not be executable against a 
Protected Quotation. Post Only Orders are to be displayed on the ISE 
Stock Exchange upon receipt or cancelled if they are executable upon 
entry, either on the ISE Stock Exchange or at another Trading Center.
    Pegged Orders: Pegged Orders are Limit Orders to buy or sell a 
stated amount of a security at a displayed price set to track the 
current NBBO. The tracking of the relevant NBBO for Pegged Orders will 
occur on a real-time basis. If the calculated price for the Pegged 
Order would exceed its limit price, it will no longer track the NBBO 
and will remain displayed at its limit price.
    The Commission believes that these order types are appropriate in 
the context of the trading services proposed to be offered by the ISE 
Stock Exchange. In addition, these order types should help provide 
market participants with flexibility in executing transactions that 
meet the specific requirements of the order type.

C. Operating Hours and Opening Process

    The ISE Stock Exchange will operate during regular trading 
hours.\22\ The System will accept orders each day prior to the 
opening.\23\ The ISE Stock Exchange will open based upon the opening of 
the primary market for a security.\24\ When the primary market is 
either the NYSE or the Amex, the opening trade will be executed at the 
midpoint of the first reported NBBO subsequent to a reported trade on 
the primary market. When the primary market is Nasdaq, the opening 
trade will be executed at the midpoint of the first reported NBBO. All 
orders eligible to trade at the midpoint will be processed in time 
sequence, beginning with the oldest order. Matches will occur until 
there is no remaining volume or there is an imbalance of orders. 
Following the opening execution process in an individual security, all 
orders remaining will be executed in accordance with the proposed ISE 
rules, as more fully discussed in the following section. All unexecuted 
orders will be displayed on the order book, cancelled, or routed to 
other Trading Centers in accordance with the proposed rules.
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    \22\ For common stock, the hours of business for the ISE Stock 
Exchange will be 9:30 a.m. until 4 p.m. (ET). For securities other 
than common stock, the hours of business are set forth in proposed 
ISE Rules 2123 through 2127. See proposed ISE Rule 2102.
    \23\ All order types other than Stop, Stop Limit, No MPM, Post 
Only, FOK, and IOC may participate in the opening transaction.
    \24\ Proposed ISE Rule 2106(c) defines the primary market as the 
listing market for a security. If a security is traded on both the 
NYSE and the Amex, the primary market would be considered the NYSE. 
If a security is listed on both the NYSE and Nasdaq, the NYSE would 
be considered the primary market.
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    The Commission believes that the proposed rules relating to the 
System's operating hours and opening procedures are consistent with the 
Act.

D. Order Execution and Priority

    Once the opening occurs for individual securities, the ISE Stock 
Exchange will operate during regular trading hours. All orders will be 
ranked automatically by the ISE Stock Exchange following price-time 
priority as soon they are entered in the order book. Orders are ranked 
beginning with the highest priced orders to buy and the lowest priced 
orders to sell.\25\ For the

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purposes of ranking, the System will use the price at which the order 
is displayed. Within each price, orders will be ranked in time priority 
based on the time that an order is displayed or ``updated'' at that 
price, except that the undisplayed portions of Reserve Orders will be 
ranked after all other orders and displayed portions of Reserve Orders 
at the same price. When the displayed size of a Reserve Order is 
replenished from the reserve size, the displayed order is considered 
newly entered for the purposes of time priority.
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    \25\ See proposed ISE Rule 2107.
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    In addition, all orders will be available for price improvement at 
the midpoint of the NBBO if contra-side interest exists in MidPoint 
Match, unless the order is marked ``No MPM.'' \26\ Except as indicated 
below, incoming orders will be executed at or within the NBBO. The 
Commission believes that the proposed rules relating to order priority 
and order execution are consistent with the Act.\27\
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    \26\ Equity EAMs can choose to place orders into MidPoint Match 
or into the displayed market. Orders placed into the displayed 
market will be eligible, by default, to interact with MidPoint Match 
orders for purposes of gaining price improvement. Optionally, orders 
in the displayed market can bypass MidPoint Match by being marked as 
No MPM.
    \27\ Section 11(a) of the Act, 15 U.S.C. 78k(a)(1), prohibits a 
member of a national securities exchange from effecting transactions 
on that exchange for its own account, the account of an associated 
person, or an account over which it or an associated person 
exercises discretion, unless an exception applies. Rule 11a2-2(T) 
under the Act, 17 CFR 240.11a2-2(T), commonly known as the ``effect 
versus execute'' rule, provides exchange members with an exemption 
from this prohibition. The Exchange represents that, consistent with 
this rule, the System's time-priority execution parameters will 
place all participants on the ``same footing,'' and no participant 
will enjoy any special control over the timing of execution or any 
special order handling advantages. According to the Exchange, all 
orders will be transmitted directly to the System by electronic 
means, and, once submitted, all orders will be executed, displayed, 
cancelled, or routed automatically by the System, based on 
established trading rules. The Commission notes that the Exchange 
would enforce this requirement pursuant to its obligation under 
Section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1), to enforce 
compliance by its members and persons associated with its members 
with the Federal securities laws and rules thereunder.
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E. Compliance With Regulation NMS Under the Act

    The System is designed to automatically prevent Trade-Throughs of 
Protected Quotations. The System will accomplish this in two principal 
ways: (i) By providing outbound routing for those orders that will be 
available to route; and (ii) by displaying orders at prices that would 
not cause a Trade-Through when executed. Additionally, the System will 
take advantage of various exceptions to Rule 611 of Regulation NMS 
under the Act.\28\ The Exchange has proposed to adopt an exception 
(``self-help'') to allow for the System to Trade-Through a Protected 
Quotation displayed by a Trading Center that is experiencing a failure, 
material delay, or malfunction of its systems or equipment. If another 
Trading Center repeatedly fails to respond within one second to 
incoming orders attempting to access its Protected Quotations, the 
System may bypass those Protected Quotations by: (i) Notifying the non-
responding Trading Center immediately after (or at the same time as) 
electing self-help; and (ii) assessing whether the cause of the problem 
lies with its own systems and, if so, taking immediate steps to resolve 
the problem. ISOs may, by definition, trade at a price inferior to a 
Protected Quotation. In addition, transactions may be executed at a 
time when the Protected Quotations are crossed.
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    \28\ See proposed ISE Rule 2107(c).
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    The ISE Stock Exchange will not intentionally lock or cross any 
Protected Quotations on another Trading Center,\29\ except in certain 
circumstances. For instance, the System may lock or cross a Protected 
Quotation: (i) When a Protected Bid is higher than a Protected 
Offer;\30\ or (ii) if the locking or crossing quotation is an automated 
quotation and an ISO has simultaneously been routed to execute against 
the full displayed size of the locked or crossed Protected Quotation.
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    \29\ See proposed ISE Rule 2112.
    \30\ See proposed ISE Rule 2100(c)(15).
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    The Commission believes that the proposed rule change is consistent 
with the requirements of Rule 610(d) and Rule 611 of Regulation NMS.

F. Order Routing

    The ISE Stock Exchange will offer a routing service for Equity 
EAMs, when it does not have interest equal to or better than the 
Protected Bid or Protected Offer.\31\ Certain order types, including 
Market Orders and Limit Orders, are eligible to be routed.\32\ To be 
eligible to enter routable orders into the ISE Stock Exchange, Equity 
EAMs must, among other things, enter into a Routing Agreement with the 
outbound routing facility of the Exchange.\33\
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    \31\ Prior to February 5, 2007, the Regulation NMS ``Trading 
Phase Date,'' the ISE Stock Exchange will not execute orders at a 
price that is inferior to the best bid or offer of other Trading 
Centers.
    \32\ See proposed ISE Rule 2107(d).
    \33\ See proposed ISE Rule 2105(d). A ``Routing Agreement'' is 
an agreement between an Equity EAM and the outbound routing facility 
of the ISE Stock Exchange, under which the outbound routing facility 
agrees to act as agent for routing orders of the Equity EAM entered 
into the ISE Stock Exchange to other market centers or broker-
dealers for execution, other than orders excluded by the terms of 
the Routing Agreement, whenever such routing is required. See 
proposed ISE Rule 2100(c)(18).
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    The System will accept the following orders to be handled on the 
ISE Stock Exchange, without routing to another Trading Center: IOC 
Orders, FOK Orders, Not Routable Orders, and Post Only Orders.\34\ No 
Equity EAM may enter any other type of order unless it has entered into 
a Routing Agreement with the outbound routing facility of the 
Exchange.\35\
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    \34\ See proposed ISE Rules 2107(b)(2)(i), (ii), (iii), and 
(iv), respectively. In addition, MidPoint Match orders would not be 
routed, because MidPoint Match will execute all trades at the 
midpoint of the NBBO.
    \35\ See proposed ISE Rule 2105(d).
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    Market Orders and Routable Limit Orders Executable on the ISE Stock 
Exchange. For orders that are routable, an IOC or ISO will 
automatically be sent to one or more Trading Centers with a Protected 
Quotation that is better than the ISE Stock Exchange quote for the 
lesser of the full displayed size of the Protected Quotation or the 
balance of the order. Any additional balance of the order will be 
executed on the ISE Stock Exchange simultaneously. If the market is 
crossed, the order will be handled as described below.
    Routable Limit Orders Unexecutable on the ISE Stock Exchange. If 
display of a Limit Order (or any balance thereof) on the ISE Stock 
Exchange would lock or cross a Protected Quotation, an ISO will 
automatically be sent to one or more Trading Centers with a Protected 
Quotation that would be locked or crossed by the display of the order 
for up to the full displayed size of the Protected Quotation. Any 
additional balance of the order will be displayed on the ISE Stock 
Exchange immediately.
    Market Orders Unexecutable on the ISE Stock Exchange. An IOC will 
automatically be sent to one or more Trading Centers with a Protected 
Quotation for the full size of the Market Order that is not executable 
on the ISE Stock Exchange.
    The Commission finds that the proposed rules governing the routing 
of orders to other Trading Centers are consistent with the Act.

G. Outbound Routing Facility

    In connection with the proposed trading rules described above, the 
Exchange intends to enter into a contractual relationship with a 
broker-dealer that will function solely as the outbound routing 
facility (``ORF'') of the Exchange. The ORF will be a member of both 
the National Association of Securities Dealers, Inc. (``NASD'') and

[[Page 58654]]

ISE. The ORF will provide an optional routing service for the Exchange, 
in which the ORF will route orders from the ISE Stock Exchange to 
Trading Centers with Protected Quotations through other brokers 
(``Access Brokers'') that are members or participants of those Trading 
Centers. As an outbound router, the ORF will receive routing 
instructions from the System, route orders to another Trading Center 
through an Access Broker, and be responsible for reporting resulting 
executions back to the System, which in turn will report resulting 
executions back to the Equity EAM. All orders routed through the ORF 
will be subject to the Exchange's rules. The ORF would not be able to 
change the terms of an order or the routing instructions, nor would it 
have any discretion about where to route an order. The ORF includes the 
clearing functions that the ORF may perform for trades with respect to 
orders routed to other Trading Centers. Use of the ORF is optional for 
Equity EAMs.
    The outbound router function of the ORF will operate as a facility 
(as defined in Section 3(a)(2) of the Act) of the Exchange.\36\ As 
such, the outbound router function of the ORF is subject to the 
Commission's continuing oversight. In particular, and without 
limitation, under the Act, the Exchange is responsible for filing with 
the Commission proposed rule changes and fees relating to the ORF 
outbound router function, and the ORF is subject to exchange non-
discrimination requirements.\37\
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    \36\ 15 U.S.C. 78c(a)(2).
    \37\ 15 U.S.C. 78f(b)(5).
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    Pursuant to Rule 17d-1 under the Act,\38\ where a member of the 
Securities Investor Protection Corporation is a member of more than one 
self-regulatory organization (``SRO''), the Commission will designate 
to one of such organizations the responsibility for examining such 
member for compliance with the applicable financial responsibility 
rules.\39\ The SRO designation by the Commission is referred to as a 
``Designated Examining Authority'' (``DEA''). As noted above, the ORF 
will apply to become a member organization of the Exchange and a member 
of the NASD. The NASD is an SRO not affiliated with the Exchange or its 
affiliates and is a DEA pursuant to Rule 17d-1 under the Act.\40\ 
Furthermore, the Exchange represents that it will enter into a 17d-2 
Agreement with the NASD to delegate to the NASD all regulatory 
oversight and enforcement responsibilities with respect to the ORF 
pursuant to applicable laws. The Exchange represents that it will 
submit the 17d-2 Agreement to the Commission under Rule 17d-2 within 90 
days of the date of this order.
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    \38\ 17 CFR 240.17d-1.
    \39\ Pursuant to Rule 17d-1 under the Act, in making such 
designation the Commission will take into consideration the 
regulatory capabilities and procedures of the SROs, availability of 
staff, convenience of location, unnecessary regulatory duplication, 
and such other factors as the Commission may consider germane to the 
protection of investors, the cooperation and coordination among 
SROs, and the development of a national market system for the 
clearance and settlement of securities transactions.
    \40\ 17 CFR 240.17d-1.
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    The Exchange will establish and maintain procedures and internal 
controls to restrict the flow of confidential and proprietary 
information between the Exchange and the ORF and any other entity or 
affiliate of the ORF.\41\ The books, records, premises, officers, 
directors, agents, and employees of the ORF, as a facility of the 
Exchange, shall be deemed to be the books, records, premises, officers, 
directors, agents, and employees of the Exchange for purposes of and 
subject to oversight pursuant to the Act. The books and records of the 
ORF, as a facility of the Exchange, shall be subject at all times to 
inspection and copying by the Exchange and the Commission.
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    \41\ See proposed ISE Rule 2108.
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    The Commission agrees with the Exchange that the ORF's services 
would qualify it as a ``facility'' of the Exchange, and, consequently, 
the operation of the ORF will be subject to Exchange oversight, as well 
as Commission oversight. The Commission notes that the outbound routing 
functionality is not the exclusive means for accessing better-priced 
orders in other market centers should an order not be executable on the 
ISE Stock Exchange. Accordingly, the ORF's routing services are 
optional, and an Equity EAM is free to route its orders to other market 
centers through alternative means. In light of the protections afforded 
by the conditions discussed above, the Commission believes that the 
Exchange's outbound routing function, and the rules and procedures 
governing the ORF, are appropriate and consistent with the Act.

H. MidPoint Match

    MidPoint Match is a mechanism of the ISE Stock Exchange for trading 
common stocks and similar securities in a continuous midpoint matching 
system.\42\ Equity EAMs will be able to enter MidPoint Match orders to 
buy or sell at the midpoint of the NBBO. Although orders in MidPoint 
Match will be unpriced, members may specify a boundary price above 
which they will not buy (or below which they will not sell). The System 
will continuously monitor buy and sell orders in MidPoint Match and 
will execute orders at the midpoint of the NBBO as long as the 
execution does not violate the boundary price on an order.
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    \42\ See proposed ISE Rule 2129.
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    When entering an order, a member can specify what, if any, 
information the System should disseminate:
    (i) The member can specify that the System not disseminate any 
information regarding the order (``Standard Order''); or
    (ii) The member can specify that the System disseminate that there 
is a pending order in a particular security, but not identify the side 
or the size of the order (``Solicitation of Interest'' or ``SOI'').\43\
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    \43\ However, an SOI must be for a minimum of 2000 shares, so 
users would be aware that the SOI represented interest of at least 
that size.
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    MidPoint Match will reject an SOI (but not a Standard Order) with a 
boundary price that is not then currently executable. Upon arrival of 
an SOI, MidPoint Match will immediately generate a single broadcast 
internally to all Equity EAMs that have programmed their systems to 
accept this message announcing the arrival of the order. An Equity EAM 
entering an SOI may not cancel that SOI for five seconds. In addition, 
if an SOI is not executed within ten seconds, the SOI will convert into 
a Standard Order.
    Because MidPoint Match will execute all trades at the midpoint of 
the NBBO, MidPoint Match will never execute a trade outside of the 
NBBO. In addition, MidPoint Match will not execute a trade if the 
quotation for a security is ``crossed,'' with the national best bid 
being greater than the national best offer. In that situation, MidPoint 
Match will suspend executions, since both buyers and sellers may be 
able to receive executions in other markets at prices better than the 
NBBO midpoint. If the quotation is ``locked,'' with the national best 
bid equaling the national best offer, MidPoint Match will execute all 
trades at the locked price.
    Unless marked otherwise, all incoming orders to the ISE Stock 
Exchange will be eligible for price improvement at the midpoint of the 
NBBO if contra-side interest exists in MidPoint Match. As set forth in 
the proposed rules, incoming orders will be executed at the best 
available price on the ISE Stock Exchange, which means the highest bid 
price and the lowest offer price, including undisplayed

[[Page 58655]]

orders to buy or sell that may exist in MidPoint Match. Orders marked 
``No MPM'' will not be executed against orders residing in MidPoint 
Match.
    The Commission believes that the order types and execution 
parameters established in MidPoint Match are consistent with the Act.

I. Anonymity

    Except as described below, transactions executed on the ISE Stock 
Exchange will be processed anonymously.\44\ This means that the ISE 
Stock Exchange transaction reports will indicate the details of the 
transaction but will not reveal contra-party identities.\45\ The 
Commission notes that post-trade anonymity should not compromise an 
Equity EAM's ability to settle an erroneous trade, because under 
proposed ISE Rule 2128, the clearly erroneous execution resolution 
process is coordinated by the Exchange, without the need for contra 
parties to know each other's identities.
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    \44\ See proposed ISE Rule 2117.
    \45\ ISE intends to submit a request for a limited exemption 
from paragraph (a)(2)(i)(A) of Rule 10b-10 under the Act, 17 CFR 
240.10b-10, on behalf of Equity EAMs that execute trades on the ISE 
Stock Exchange for their customers and a request for no-action 
relief with respect to the corresponding books and records 
requirements of Rules 17a-3 and 17a-4 under the Act, 17 CFR 240.17a-
3 and 17a-4, respectively. Rule 10b-10, among other things, requires 
a broker-dealer to disclose to its customers the identity of the 
party the broker-dealer sold to, or bought from, to fill the 
customer's order. The ISE Stock Exchange will not routinely reveal 
the identity of the actual contra-party when the order is executed 
against another Equity EAM. Therefore, the Equity EAMs will not be 
able to comply with the contra-party identification requirement of 
Rule 10b-10. To permit Equity EAMs to utilize the ISE Stock Exchange 
without violating Rule 10b-10, the Exchange is seeking an exemption, 
on behalf of such Equity EAMs, from the contra-party identification 
requirement. Additionally, the Exchange has asked the Commission not 
to recommend enforcement action for violations of the corresponding 
books and records requirements of Rules 17a-3 and 17a-4 if, in lieu 
of making and preserving a separate record, a broker-dealer relies 
on the Exchange's retention of the identities of Equity EAMs that 
execute anonymous trades on the ISE Stock Exchange. The Exchange 
represents that it will not commence operation of the displayed 
market unless the Exchange receives an exemption from Rule 10b-10 
with respect to that market.
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    The Exchange will only reveal the identity of the Equity EAM or the 
Equity EAM's clearing firm in the following circumstances: (i) For 
regulatory purposes or to comply with an order of a court or 
arbitrator; (ii) when the National Securities Clearing Corporation 
(``NSCC'') ceases to act for the Equity EAM or the Equity EAM's 
clearing firm, and NSCC determines not to guarantee the settlement of 
the Equity EAM's trades; or (iii) on risk management reports provided 
to the contra-party of the Equity EAM or Equity EAM's clearing firm 
each day after 4:00 p.m. that discloses trading activity on an 
aggregate dollar value basis. Also, the Exchange will reveal to an 
Equity EAM, no later than the end of the day on the date an anonymous 
trade was executed, when that Equity EAM submits an order that has 
executed against an order submitted by that same Equity EAM.
    The Commission finds that the Exchange's proposed anonymity 
provisions are appropriate and consistent with the Act.

J. Clearly Erroneous Executions

    Pursuant to proposed ISE Rule 2128, an Equity EAM that receives an 
execution on an order that was submitted erroneously to the ISE Stock 
Exchange for its own or a customer account may request that Market 
Control, along with a member of the regulatory staff, review the 
transaction under proposed ISE Rule 2128(b) within the time limits 
described therein. Market Control will review the transaction with a 
view toward maintaining a fair and orderly market and the protection of 
investors and the public interest. A member of the regulatory staff 
will advise and participate in all steps of Market Control's review of 
the transaction. Based upon this review, Market Control will decline to 
``break'' a disputed transaction if Market Control believes that the 
transaction under dispute is not clearly erroneous. However, if Market 
Control determines that the transaction in dispute is clearly 
erroneous, Market Control will declare that the transaction is null and 
void or modify one or more terms of the transaction. When adjusting the 
terms of a transaction, Market Control will seek to adjust the price 
and/or size of the transaction to achieve an equitable rectification of 
the error that would place the parties to a transaction in the same 
position, or as close as possible to the same position, as they would 
have been in had the error not occurred. For purposes of the clearly 
erroneous rule, the terms of a transaction are ``clearly erroneous'' 
when there is an obvious error in any term, such as price, number of 
shares or other unit of trading, or identification of the security.
    Market Control may, on its own motion, review transactions on the 
ISE Stock Exchange that arose during any disruption or malfunction in 
the use or operation of any electronic communications or trading 
facilities of the ISE Stock Exchange, or extraordinary market 
conditions or other circumstances in which the nullification or 
modification of transactions may be necessary for the maintenance of a 
fair and orderly market or the protection of investors and the public 
interest. Each affected Equity EAM will be notified as soon as 
practicable, and the Equity EAM aggrieved by the action may appeal such 
action to the Trade Panel.
    The Commission believes that proposed ISE Rule 2128 is consistent 
with the Act because it is reasonably designed to promote fair and 
orderly markets by setting forth procedures for reviewing and, if 
necessary, nullifying or adjusting a clearly erroneous trade. The 
Commission previously has determined that it is consistent with the Act 
for an exchange to be able to nullify or adjust trades that are clearly 
erroneous.\46\
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    \46\ See, e.g., NYSE Arca Equities Rule 7.10 (Clearly Erroneous 
Executions) and Nasdaq Rule 11890 (Clearly Erroneous Transactions).
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K. Miscellaneous Rules

    Proposed ISE Rules 2123 (Investment Company Unit), 2124 (Trust 
Issued Receipts), 2125 (Commodity-Based Trust Shares), 2126 (Currency 
Trust Shares), and 2127 (Partnership Units) would permit the trading of 
derivative products on the ISE Stock Exchange. While these proposed ISE 
rules would allow the ISE Stock Exchange to trade such products by 
either listing and/or trading pursuant to UTP, the ISE Stock Exchange 
will only trade these products pursuant to UTP. In order to list such 
products, the Exchange would first need to seek Commission approval and 
amend its applicable rules.
    Proposed ISE Rule 2117 (Settlement Through Clearing Corporations) 
adds provisions governing the settlement and clearing of equity 
securities.
    Proposed ISE Rule 2101 (Equity Securities Traded) provides that, if 
the Exchange trades its own securities, or the securities of an 
affiliate or any entity that operates and/or owns a trading system or 
facility of the Exchange, on the ISE Stock Exchange, the Exchange will 
file a report each quarter with the SEC describing: (i) The Exchange's 
monitoring of the issuer's compliance with the Exchange's listing 
standards (in the event the Exchange adopts such listing standards); 
and (ii) the Exchange's monitoring of the trading of the security. If 
the Exchange adopts listing standards, an independent accounting firm 
must annually review the listing standards for the subject security to 
ensure that the issuer is in compliance with the applicable listing 
requirements. If the Exchange determines that the subject issuer is 
non-compliant with any listing standard, the Exchange must file a

[[Page 58656]]

report with the Commission at the same time that the Exchange notifies 
the issuer of its non-compliance.
    The following Rules have been incorporated from the Exchange's 
options rules: ISE Rule 100 (Definitions) is being expanded to include 
equities in the following definitions: Bid, clearing corporation, offer 
and order; ISE Rule 500 (Designation of Securities) is being amended to 
accommodate for the newly adopted rules in Chapter 21; and ISE Rules 
702 and 703 (Trading Halts and Trading Halts Due to Extraordinary 
Market Volatility, respectively) are being amended to account for 
halting trading in equity securities.\47\
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    \47\ In addition, the Exchange proposes to apply certain of its 
options rules to the trading of equity securities on the ISE Stock 
Exchange, as set forth in Appendix A to proposed Chapter 21 of the 
ISE rules.
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    The Commission finds that these various proposed ISE rules are 
consistent with the Act.

L. Accelerated Approval of Amendment No. 1

    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after publishing 
notice of Amendment No. 1 in the Federal Register pursuant to Section 
19(b)(2) of the Act.\48 \
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    \48\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    In Amendment No. 1, the Exchange amended proposed ISE Rule 2110 
(Minimum Price Variation) to conform with the language of Rule 612 of 
Regulation NMS and amended proposed ISE Rule 2118 (Trade Modifiers) to 
incorporate applicable requirements of Rule 611 of Regulation NMS. The 
Exchange also amended proposed Rule 2106 (Opening Process) to reflect 
that Stop Orders, Stop Limit Orders, No MPM Orders, Post Only Orders, 
FOK Orders and IOC Orders cannot participate in the opening process and 
to add a provision that the System would cease matching orders in a 
security upon the close of the primary market for that security. In 
addition, the Exchange changed the term ``partial round lot'' to 
``mixed lots'' to correspond to the current industry term and clarified 
corresponding proposed ISE Rule 2105 (Order Entry). The Exchange also 
added proposed ISE Rule 2120 (Taking or Supplying Securities), which 
governs situations in which an Equity EAM can, upon receipt of a 
customer order, take or supply securities named in the order on behalf 
of itself or related parties.
    In Amendment No. 1, the Exchange made certain revisions to the 
proposed rules to provide for the interaction of MidPoint Match orders 
with other orders entered into the ISE Stock Exchange, as described 
more fully above. The Exchange also revised the text of proposed ISE 
Rule 2107(d) to clarify that, prior to February 5, 2007, the ISE Stock 
Exchange will not trade through the best bid or offer of other Trading 
Centers, while on and after February 5, 2007, the ISE Stock Exchange 
will not trade through a Protected Quotation. Finally, the Exchange 
made clarifying changes to the clearing requirements and other proposed 
rules and made changes to the proposed rules to conform them to the 
rules filed with the Commission on the Form PILOT relating to MidPoint 
Match.\49\
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    \49\ See supra note 15.
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    The Commission notes that Amendment No. 1 is intended to clarify 
various provisions of the Exchange's proposed rules. The Commission 
believes that Amendment No. 1 proposes revisions that are non-
substantive in nature and do not raise novel issues, and that Amendment 
No. 1 is consistent with the Act. Therefore, the Commission finds good 
cause to accelerate approval of Amendment No. 1, pursuant to Section 
19(b)(2) of the Act.\50\
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    \50\ 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 rule-comments@sec.gov. Please include 

File No. SR-ISE-2006-48 on the subject line.

Paper Comments

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

All submissions should refer to Amendment No. 1 to File No. SR-ISE-
2006-48. 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. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. 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 
Amendment No. 1 to File No. SR-SE-2006-48 and should be submitted on or 
before October 25, 2006.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\51\ that the proposed rule change (SR-ISE-2006-48) be, and it 
hereby is, approved, and Amendment No. 1 is approved on an accelerated 
basis.
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    \51\ 15 U.S.C. 78s(b)(2).
    \52\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\52\
Nancy M. Morris,
Secretary.
 [FR Doc. E6-16366 Filed 10-3-06; 8:45 am]

BILLING CODE 8010-01-P
