
[Federal Register: August 28, 2009 (Volume 74, Number 166)]
[Notices]               
[Page 44425-44430]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28au09-96]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60559; File No. SR-ISE-2009-27]

 
Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Granting Approval of a Proposed Rule Change as Modified by 
Amendment No. 1 Thereto To Adopt Rules Implementing the Options Order 
Protection and Locked/Crossed Market Plan

I. Introduction

    On May 11, 2009, the International Securities Exchange, LLC 
(``ISE'' or ``Exchange'') 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 amend and adopt rules to 
implement the Options Order Protection and Locked/Crossed Market Plan. 
The proposed rule change was published for comment in the Federal 
Register on June 8, 2009.\3\ On June 10, 2009, the Exchange filed 
Amendment No. 1 to the proposed rule change.\4\ The Commission received 
no comments on the proposal. This order approves the proposed rule 
change, as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 60014 (June 1, 
2009), 74 FR 27224 (``Notice'').
    \4\ Amendment No. 1 clarified that this proposed rule change 
will become effective upon the Exchange's withdrawal from the Plan 
for the Purpose of Creating and Operating an Intermarket Option 
Linkage and the effectiveness of the Options Order Protection and 
Locked/Crossed Market Plan. Because the amendment only provided 
clarification and did not affect the substance of the rule filing, 
the amendment did not require notice and comment.
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II. Description of the Proposal

    The Exchange proposes to amend and adopt new ISE rules to implement 
the Options Order Protection and Locked/Crossed Market Plan 
(``Plan'').\5\ Specifically, the Exchange proposes to completely 
replace Chapter 19 of its rules with new rules implementing the Plan, 
amend other Exchange rules to reflect the Plan, and delete rules 
rendered unnecessary by the Plan.
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    \5\ The Plan is a national market system plan proposed by the 
seven existing options exchanges and approved by the Commission. See 
Securities Exchange Act Release No. 59647 (March 30, 2009), 74 FR 
15010 (April 2, 2009) (File No. 4-546) (``Plan Notice'') and 60405 
(July 30, 2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) 
(``Plan Approval''). The seven options exchanges are: Chicago Board 
Options Exchange, Incorporated (``CBOE''); The NASDAQ Stock Market 
LLC (``Nasdaq''); NASDAQ OMX BX, Inc. (``BOX''); NASDAQ OMX PHLX, 
Inc. (``Phlx''); NYSE Amex LLC (``NYSE Amex''); NYSE Arca, Inc. 
(``NYSE Arca''); and ISE (each exchange individually a 
``Participant'' and, together, the ``Participating Options 
Exchanges'').
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The Old Plan

    Each of the Participating Options Exchanges are signatories to the 
Plan for the Purpose of Creating and Operating an Intermarket Option 
Linkage (``Old Plan'').\6\ In pertinent part, the Old Plan generally 
requires its participants to avoid trading at a price inferior to the 
national best bid or offer (``trade-through''), although it provides 
for a number of exceptions to trade-through liability.\7\ The 
Participating Options Exchanges comply with this requirement of the Old 
Plan by utilizing a stand alone system (``Linkage Hub'') to send and 
receive specific order types,\8\ namely Principal Acting as Agent 
Orders (``P/A Orders''), Principal Orders, and Satisfaction Orders.\9\ 
The Old Plan also provided that dissemination of ``locked'' or 
``crossed'' markets should be avoided, and remedial actions that should 
be taken to unlock or uncross such market.\10\ Each of the 
Participating Options Exchanges, including the Exchange, has submitted 
an amendment to the Old Plan to withdraw from such Plan.\11\ The 
withdrawals will be effective upon approval by the Commission of such 
amendments pursuant to Rule 608 of Regulation NMS under the Act 
(``Regulation NMS'').\12\
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    \6\ On July 28, 2000, the Commission approved the Old Plan as a 
national market system plan for the purpose of creating and 
operating an intermarket options market linkage proposed by the 
American Stock Exchange LLC (n/k/a NYSE Amex), CBOE, and ISE. See 
Securities Exchange Act Release No. 43086 (July 28, 2000), 65 FR 
48023 (August 4, 2000). Subsequently, Philadelphia Stock Exchange, 
Inc. (n/k/a Phlx), Pacific Exchange, Inc. (n/k/a NYSE Arca), Boston 
Stock Exchange, Inc. (n/k/a BOX), and Nasdaq joined the Linkage 
Plan. See Securities Exchange Act Release Nos. 43573 (November 16, 
2000), 65 FR 70851 (November 28, 2000); 43574 (November 16, 2000), 
65 FR 70850 (November 28, 2000); 49198 (February 5, 2004), 69 FR 
7029 (February 12, 2004); and 57545 (March 21, 2008), 73 FR 16394 
(March 27, 2008).
    \7\ Section 8(c) of the Old Plan.
    \8\ The Linkage Hub is a centralized data communications network 
that electronically links the Participating Options Exchanges to one 
another. The Options Clearing Corporation (``OCC'') operates the 
Linkage Hub.
    \9\ Section 2(16) of the Old Plan.
    \10\ Section 7(a)(i)(C) of the Old Plan.
    \11\ See Securities Exchange Act Release No. 60360 (July 21, 
2009) 74 FR 37265 (July 28, 2009) (File No. 4-429).
    \12\ 17 CFR 242.608.
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The Plan

    The Plan does not require a central linkage mechanism akin to the 
Old Plan's Linkage Hub. Instead, the Plan includes the framework for 
routing

[[Page 44426]]

orders via private linkages that exist for NMS stocks under Regulation 
NMS.\13\ The Plan requires the Participating Options Exchanges to adopt 
rules ``reasonably designed to prevent Trade-Throughs.''\14\ 
Participating Options Exchanges are also required to conduct 
surveillance of their respective markets on a regular basis to 
ascertain the effectiveness of the policies and procedures to prevent 
Trade-Throughs and to take prompt action to remedy deficiencies in such 
policies and procedures.\15\ As further described below, the Plan 
incorporates a number of exceptions to trade-through liability.\16\ 
Some of these exceptions are carried over from the Old Plan, including 
exceptions for trading rotations, non-firm quotes, and complex 
trades.\17\ Others are substantially similar to exceptions available 
for NMS stocks under Regulation NMS, such as exceptions for systems 
issues, crossed markets, quote flickering, customer stopped orders, 
benchmark trades and, notably, intermarket sweep orders (``ISOs'').\18\ 
In addition, the Plan contains a new exception for stopped orders and 
price improvement.\19\
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    \13\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005) (File No. S7-10-04); 17 CFR 
242.600 et seq. For discussions of the similarities between the 
provisions of Regulation NMS and the provisions in the Plan, see the 
Plan Notice and Plan Approval, supra note 5.
    \14\ Under the Plan, a ``Trade-Through'' is generally defined as 
a transaction in an option series, either as principal or agent, at 
a price that is lower than a Protected Bid or higher than a 
Protected Offer.'' See Section 2(21) of the Plan. A ``Protected 
Bid'' and ``Protected Offer'' generally means a bid or offer in an 
option series, respectively, that is displayed by a Participant, is 
disseminated pursuant to the Options Price Reporting Authority 
(``OPRA'') Plan, and is the Best Bid or Best Offer. See Section 
2(17) of the Plan. A ``Best Bid'' or ``Best Offer'' means the 
highest bid price and the lowest offer price. Section (2)(1) of the 
Plan. ``Protected Bid'' and ``Protected Offer,'' together are 
referred to herein as ``Protected Quotation.'' See Section 2(18) of 
the Plan.
    \15\ Section 5(a)(ii) of the Plan.
    \16\ Section 5(b) of the Plan.
    \17\ Subparagraphs (ii), (vii), and (viii), respectively, of 
Section 5(b) of the Plan.
    \18\ Subparagraphs (i), (iii), (vi), (ix), (xi), and (iv)-(v), 
respectively, of Section 5(b) of the Plan.
    \19\ Subparagraph (x) of Section 5(b) of the Plan.
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    The Plan also requires each Participant to establish, maintain, and 
enforce written rules that: Require its members reasonably to avoid 
displaying locked and crossed markets; assure the reconciliation of 
locked and crossed markets; and prohibit its members from engaging in a 
pattern or practice of displaying locked and crossed markets; subject 
to exceptions as may be contained in the rules of the Participant, as 
approved by the Commission.\20\
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    \20\ Section 6 of the Plan. The Plan also contains provisions 
relating to the operation of the Plan including, for example, 
provisions relating to the entry of new parties to the Plan; 
withdrawal from the Plan; and amendments to the Plan.
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The Exchange's Proposal

    To implement the Plan, the Exchange proposes to replace its current 
rules relating to the Old Plan with new rules relating to the Plan, and 
makes amendments to other rules as necessary to conform to the 
requirements of the Plan.\21\ As such, the Exchange proposes to adopt 
all applicable definitions from the Plan into the Exchange's rules.\22\
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    \21\ A more detailed description of the Exchange's proposed rule 
change may be found in the Notice, supra note 3.
    \22\ Proposed ISE Rule 1900.
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    In addition, the Exchange proposes to prohibit its members from 
effecting Trade-Throughs, unless an exception applies.\23\ Consistent 
with the Plan, the Exchange also proposes exceptions to the prohibition 
on trade-throughs relating to: System issues; trading rotations; 
crossed markets; intermarket sweep orders; quote flickering; non-firm 
quotes; complex trades; customer stopped orders; stopped orders and 
price improvement; and benchmark trades.\24\
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    \23\ Proposed ISE Rule 1901(a).
    \24\ Proposed ISE Rule 1901(b)(1)-(10). In addition, the 
Exchange proposes to add ISOs as a new type of order under proposed 
ISE Rule 715(b)(5).
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    The Exchange also proposes a rule to address locked and crossed 
markets, as required by the Plan.\25\ Specifically, the Exchange 
proposes that, except for quotations that fall within a stated 
exception, members shall reasonably avoid displaying, and shall not 
engage in a pattern or practice of displaying, any quotations that lock 
or cross a Protected Quote.\26\
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    \25\ A ``locked market'' is defined as a quoted market in which 
a Protected Bid is equal to a Protected Offer. Proposed ISE Rule 
1900(i). A ``crossed market'' is defined as a quoted market in which 
a Protected Bid is higher than a Protected Offer. Proposed ISE Rule 
1900(e).
    \26\ Proposed ISE Rule 1902(a).
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    The Exchange proposes four exceptions to the prohibition against 
locked and crossed markets: When the Exchange is experiencing a 
failure, material delay, or malfunction of its systems or equipment; 
when the locking or crossing quotation was displayed at a time where 
there is a crossed market; when an Exchange member simultaneously 
routes an ISO to execute against the full displayed size of any locked 
or crossed Protected Bid or Protected Offer; and, with respect to a 
locking quotation, when the order entered on the Exchange that will 
lock a Protected Bid or Protected Offer, is (i) not a customer order, 
and the Exchange can determine via identification available pursuant to 
the OPRA Plan that such Protected Bid or Protected Offer does not 
represent, in whole or in part, a customer order; or (ii) a customer 
order, and the Exchange can determine via identification available 
pursuant to the OPRA Plan that such Protected Bid or Protected Offer 
does not represent, in whole or in part, a customer order, and, on a 
case-by-case basis, the customer specifically authorizes the member to 
lock such Protected Bid or Protected Offer.\27\ The Exchange believes 
that, in most cases, locked market maker quotes are good for the 
investing public, but recognizes that the benefits of a locked market 
become more complicated when one or both of the locking quotations 
represent a customer order. Where there is market interest willing to 
trade with a customer, the Exchange believes that the customer order 
should be filled. Thus, the Exchange proposes that it would not exempt 
from the locked market prohibition situations involving customer orders 
unless the customer entering the locking order specifically authorizes 
the lock on a case-by-case basis.\28\ As a result, its members would 
not be permitted to lock another Participant's quotation unless the 
Exchange can establish that the quotation on the other Participant's 
market is not for the account of a customer.
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    \27\ Proposed ISE Rule 1902(b)(1)-(4).
    \28\ ISE noted that it can envision a customer authorizing a 
lock when the fees associated with trading against the locked market 
make the execution price uneconomical to the customer. See Notice, 
supra note 3, at 27226.
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    The Exchange also proposes rules to permit it to continue to accept 
P/A Orders and Principal Orders from Participating Options Exchanges 
that are not able to send ISOs in order to avoid Trade-Throughs.\29\ 
The Exchange noted that, even upon the approvals of the Plan and the 
implementing rules of the various Participating Options Exchanges, it 
is possible that not all the Participants will be functionally able to 
operate pursuant to the Plan. Thus, the Exchange has proposed to retain 
certain rules governing the receipt of P/A Orders and Principal Orders 
until such time that all Participating Options Exchanges are operating 
pursuant to the Plan.
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    \29\ Proposed ISE Temporary Rule 1903.
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    The Exchange also proposes changes to its rules relating to an ISE 
Primary Market Maker's (``PMM'') obligation to address customer orders 
when there is a better market displayed on another exchange. The 
Exchange proposes changes to ISE Rule 803(c) and the Supplementary 
Material to Rule 803 to specify that ISE will discharge its obligations 
under the Plan to ``establish,

[[Page 44427]]

maintain and enforce written policies and procedures * * * reasonably 
designed to prevent Trade-Throughs'' \30\ by requiring PMMs to address 
customer orders when there is a better market away via the use of 
ISOs.\31\ ISE proposes that a PMM could comply with their obligation 
either by (i) executing a customer order at a price that at least 
matches the best price displayed or (ii) sending ISO(s) as agent for 
the customer to any other exchange(s) displaying a superior price and, 
with respect to any remaining portion of the customer order, either (a) 
releasing the remaining portion of the order for execution in the 
Exchange's auction market or (b) executing the remaining portion of the 
order at a price superior to the best price in the Exchange's auction 
market.\32\
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    \30\ Section 5(a) of the Plan.
    \31\ Proposed ISE Rule 803(c)(2)(ii). ISE noted that the routing 
of public customer orders to another exchange when the ISE is not at 
the best price is, in effect, voluntary. See Notice, supra note 3, 
at 27227. ISE stated that a customer could avoid such routing by 
entering an Immediate or Cancel order (``IOC'') or Fill or Kill 
(``FOK'') order. See ISE Rule 715(b)(3) and ISE Rule 715(b)(2) 
respectively. If ISE cannot immediately execute such orders, it 
would cancel all of the order (FOK orders) or the unexecuted portion 
of the order (IOC orders) without routing such orders to another 
exchange. See Notice, supra note 3, at 27227.
    \32\ Proposed ISE Rule 803(c)(2).
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    ISE further proposes that, in addressing customer orders that are 
not automatically executed because there is a displayed bid or offer on 
another exchange trading the same option that is better than the best 
bid or offer on the Exchange, ISE would act in compliance with its 
rules and 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 \33\ that the rules of national securities exchange 
provide for the equitable allocation of reasonable dues, fees, and 
other charges among its members and issuers and other persons using its 
facilities, and not be designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers.\34\ ISE also proposes to make 
clear that all orders entered on ISE and routed by the PMM to another 
exchange via an ISO pursuant to proposed ISE Rule 803(c)(2) and that 
result in an execution are binding on the member that entered such 
orders.\35\
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    \33\ 15 U.S.C. 78(f)(b)(4) and (5).
    \34\ Proposed ISE Rule 803, Supplementary Material, .04.
    \35\ Proposed ISE Rule 803, Supplementary Material, .05.
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    The Exchange also proposes changes to ISE Rule 810, which governs 
``informational barriers'' that ISE market makers must maintain within 
their firms. ISE stated that these barriers restrict the flow of 
information between personnel handling market making activities on the 
one hand, and personnel performing other functions, including acting as 
agent for customer orders, on the other hand. ISE noted that, under the 
Old Plan, when there was a better market on another exchange, a PMM 
could send a P/A Order to that exchange in an attempt to access that 
better price for the customer. ISE believes that this was consistent 
with Rule 810 under the Old Plan because a P/A Order is a principal 
order, and a firm is permitted to send such an order from the market-
making side of the information barrier. Under the Plan and ISE's 
proposed rules, PMMs would send ISOs representing the underlying 
customer orders, rather than P/A Orders, when there is a better market 
away. Because these ISOs would be orders on behalf of a public 
customer, ISE notes that current ISE Rule 810 would prohibit a PMM from 
sending such an order. The Exchange therefore proposes a carve-out to 
Rule 810 that would permit a PMM to send ISOs solely to comply with its 
obligation under Rule 803 to address public customer orders when there 
is a better market on another exchange. ISE states that PMMs would act 
as agent in these circumstances, and would send the ISOs from the 
market making side of the information barrier. The Exchange represents 
that, in all other respects, PMMs would be subject to proposed Rule 
810.\36\
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    \36\ Proposed ISE Rule 810.
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    Pursuant to Rule 811(b), which governs Directed Orders, ISE market 
makers may act as agent for customer orders only when handling such 
orders. ISE proposes to amend that rule to reflect the ability of PMMs 
to act as agent when sending ISOs under proposed ISE Rule 803(c)(2). 
The Exchange also proposes a rule to clarify that all public customer 
ISOs entered by an Electronic Access Member (``EAM'') on behalf of 
another options exchange shall be represented on the Exchange as 
Priority Customer Orders, defined in ISE Rule 100(37B), and that an EAM 
does not have an obligation to determine whether the public customer 
for whom such other exchange is routing an ISO meets the definition of 
a Priority Customer.\37\
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    \37\ The Exchange stated that, because other options exchanges 
have not adopted a distinction between Priority Customer and 
Professional Orders, ISE does not believe it is practical or 
appropriate to require ISOs representing customer orders sent from 
other exchanges to be marked as Professional Orders. See Notice, 
supra note 3, at 27227.
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    The Exchange proposes to amend certain other rules to reflect the 
Plan and its related terms. In particular, the Exchange proposes to 
amend Rule 714 to reflect terminology under the Plan. The Exchange is 
also proposing to delete provisions that are no longer applicable under 
the Plan. Specifically, ISE is deleting current ISE Rule 701(a)(5), 
which relates to the sending of P/A Orders through the Linkage Hub 
during the opening, and is deleting Supplemental Material .07 to 
current ISE Rule 716, relating to block trades and away market prices.

II. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\38\ In particular, the Commission finds that the 
proposal is consistent with Section 6(b)(5) of the Act \39\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
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. The Commission also finds that the 
proposal is consistent with Rule 608(c) of Regulation NMS under the 
Act, which requires that each exchange comply with the terms of any 
effective national market system plan of which it is a participant.\40\ 
Finally, the Commission finds that the proposed rule change is 
consistent with the requirements of the Plan.\41\
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    \38\ 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).
    \39\ 15 U.S.C. 78f(b)(5).
    \40\ 17 CFR 242.608(c). Section 1 of the Plan provides in 
pertinent part that, ``The Participants will submit to the 
[Commission] for approval their respective rules that will implement 
the framework of the Plan.''
    \41\ See supra note 5.
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    Proposed ISE Rule 1900 would define applicable terms in a manner 
that is substantively identical to the defined terms of the Plan.\42\ 
As such, the Commission finds that proposed ISE Rule 1900 is consistent 
with the Act and the Plan.
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    \42\ The Commission notes that the Exchange's proposed 
definition of ``Complex Trade'' under proposed ISE Rule 1900(d) is 
identical to the definition of ``Complex Trade'' under old ISE Rule 
1900(3), which is being deleted.
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    Proposed ISE Rule 1901(a) would prohibit members from effecting 
Trade-Throughs unless an exception applies. Proposed ISE Rule 1901(b) 
would

[[Page 44428]]

provide for ten exceptions to the general Trade-Through prohibition, 
relating to systems issues, trading rotations, crossed markets, ISOs, 
quote flickering, non-firm quotes, complex trades, customer stopped 
orders, stopped orders and price improvement, and benchmark trades.\43\ 
Aside from the proposed exception relating to systems issues, each 
proposed exception would be substantively identical to the parallel 
exception under Section 5(b) of the Plan.
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    \43\ Proposed ISE Rule 1901(b)(1)-(10).
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    The systems issues exception under proposed ISE Rule 1901(b)(1) 
would implement the parallel exception available under Section 5(b)(i) 
of the Plan and would permit the Exchange to bypass the Protected 
Quotation of another Participant if such other Participant repeatedly 
fails to respond within one second to incoming orders attempting to 
access its Protected Quotations. The Exchange's rule would require the 
Exchange to notify such non-responding Participant immediately after 
(or at the same time as) electing self-help, and assess whether the 
cause of the problem lies with the Exchange's own systems and, if so, 
take immediate steps to resolve the problem. Finally, the Exchange 
would be required to promptly document its reasons supporting any such 
determination to bypass a Protected Quotation. The Commission believes 
that this exception should provide the Exchange with the necessary 
flexibility for dealing with problems that occur on an away market 
during the trading day. At the same time, the exception's requirements 
to immediately notify such away market of its determination and also 
assess its own system should help prevent the use of this exception 
when there in fact is a problem with the Exchange's own systems, rather 
than those of an away market.
    The Commission notes that included among the exception in proposed 
ISE Rule 1901(b) would be an exception for certain transactions 
involving ISOs.\44\ An order identified as an ISO would be immediately 
executable by the Exchange (or any other Plan Participant that received 
such an order) based on the premise that the market participant sending 
the ISO has already attempted to access all better-priced Protected 
Quotations up to their displayed size. The Commission believes that 
this exception should help ensure more efficient and faster executions 
in the options markets.
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    \44\ Proposed ISE Rule 1901(b)(4).
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    Finally, proposed Supplementary Material .01 to ISE Rule 1901 would 
ensure that all public customer ISOs routed from another Participant 
and entered by an Electronic Access Member (``EAM'') would be Priority 
Customer Orders, rather than ``Professional Orders,'' \45\ and would 
not obligate such EAM to determine whether the public customer for whom 
the away market is routing the ISO meets the definition of Priority 
Customer. The Commission believes that this provision clarifies the 
obligations of EAMs for such orders.
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    \45\ See Securities Exchange Act Release No. 59287 (January 23, 
2009), 74 FR 5694 (January 1, 2009) (SR-ISE-2006-26).
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    The Commission notes that, in addition to these rules regarding 
Trade-Throughs, the Plan requires that each Participant establish, 
maintain and enforce written policies and procedures that are 
reasonably designed to prevent Trade-Throughs in that Participant's 
market that do not fall within an applicable exception and, if relying 
on such exception, that are reasonably designed to assure compliance 
with the terms of the exception. In addition, the Commission notes that 
the Plan requires each Participant to conduct surveillance of its 
market on a regular basis to ascertain the effectiveness of such 
policies and procedures and to take prompt action to remedy any 
deficiencies in such policies and procedures.
    Accordingly, the Commission finds that proposed ISE Rule 1901 is 
consistent with Section 5 of the Plan and Section 6(b)(5) of the Act 
\46\ which requires, among other things, that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, 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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    \46\ 15 U.S.C. 78f(b)(5).
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    Proposed ISE Rule 1902(a) would require Exchange members to 
reasonably avoid displaying, and not engage in a pattern or practice of 
displaying, any quotation that locks or crosses a Protected Quotation, 
subject to certain exceptions delineated in proposed ISE Rule 1902(b). 
The Commission recognizes that locked and crossed markets may occur 
accidentally and cannot always be avoided. However, the Commission 
believes that giving priority to the first-displayed Protected Bid or 
Protected Offer, particularly when it includes a public customer's 
order, will encourage price discovery and contribute to fair and 
orderly markets. Therefore, the Commission believes that the proposed 
rule, which corresponds to the Plan's language, to require members to 
reasonably avoid displaying, and not engaging in a pattern or practice 
of, locks and crosses is appropriate.
    Proposed ISE Rule 1902(b) would permit four exceptions to the 
Exchange's general rule relating to locked and crossed markets.\47\ The 
first three would be similar to analogous certain trade-through 
exceptions under proposed ISE Rule 1901(b), and relate to when the 
Exchange is experiencing systems issues, when there exists a crossed 
market, and when a member simultaneously routes ISOs against the full 
displayed size of any locked or crossed Protected Bid or Protected 
Offer.
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    \47\ Section 6 of the Plan permits exceptions to the Plan's 
locked and crossed market rules as may be contained in the rules of 
a Participant approved by the Commission.
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    The fourth exception would permit an order entered onto the 
Exchange to lock a Protected Bid or Protected Offer when such order is: 
(1) Not a customer order, and the Exchange can determine that such 
Protected Bid or Protected Offer does not represent, in whole or in 
part, a customer order; or (2) a customer order, and the Exchange can 
determine that such Protected Bid or Protected Offer does not 
represent, in whole or in part, a customer order and, on a case-by-case 
basis, the customer specifically authorizes the Exchange's member to 
lock such Protected Bid or Protected Offer. This exception would not 
protect a market maker quote or broker-dealer order from being locked.
    The Commission believes that the Exchange's proposed rules relating 
to locked and crossed markets are consistent with the Plan and the Act 
and should help ensure that the display of locked or crossed markets 
will be limited and that any such display will be promptly reconciled. 
The Commission also believes that each of the proposed exceptions to 
locked and crossed markets relate to circumstances when it is 
appropriate to permit a limited, narrow exception to the general locked 
and crossed market rule.
    In particular, the Commission believes that the fourth exception is 
appropriate because it would protect customer orders that are Protected 
Bids or Protected Offers from being locked, and would only permit a 
customer order entered onto the Exchange to lock a Protected Bid or 
Protected Offer when a customer specifically authorizes an Exchange 
member, and only when such Protected Bid or Protected Offer itself does 
not represent, in whole or in part, a customer order. Because of the 
rapidity with which options quotes are

[[Page 44429]]

often updated today, particularly in response to changes in the 
underlying, there is an increasing likelihood that market maker 
quotations will lock each other. The proposed exception accounts for 
this dynamic by not prohibiting such locking instances. Importantly, 
the proposed exception in the Exchange's rules that the Commission is 
approving would allow non-customer orders to lock an away market's 
Protected Quotation only if the Exchange is able to affirmatively 
determine that the Protected Quotation on the away market is not, in 
whole or in part, for the account of a customer. If any portion of such 
away market's Protected Quotation is for the account of a customer, 
such Protected Quotation may not be locked. In addition, the Commission 
notes that the rule requires that such determination be made via 
identification available pursuant to the OPRA Plan, which is working 
with the participating options exchanges on a method to so identify 
customer quotations through OPRA. The Exchange has represented that, 
absent the ability to identify a customer quote as part of an 
exchange's BBO, the Exchange would assume that the quote represents, in 
whole or in part, a customer order. As such, the Exchange has 
represented that it would not permit its members to avail themselves of 
this exemption unless the away market has informed the Exchange that it 
would designate all customer orders as such in OPRA and such exchange's 
quotation does not contain such designation. Finally, the Exchange has 
represented that if an exchange chooses not to identify its customer 
quotations, the Exchange would treat all of such exchange's quotations 
as customer orders and, absent application of another exception, would 
not permit locks of such quotations.
    Therefore, the Commission finds that Exchange's rule regarding 
locked and crossed markets appropriately implements Section 6 of the 
Plan, and is consistent with Section 6(b)(5) of the Act \48\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
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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    \48\ 15 U.S.C. 78f(b)(5).
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    The Commission also finds that proposed ISE Temporary Rule 1903, 
which facilitates the participation of certain Participating Options 
Exchanges who may require the use of P/A Orders and Principal Orders 
after implementation of the Plan, is consistent with the Act. Although 
the Commission has already approved the Plan,\49\ the Commission also 
recognizes that there may be one or more Participating Options 
Exchanges that may require a temporary transition period during which 
they may want to continue to utilize these order types that exist 
currently under the Old Plan.\50\ The Exchange and each of the other 
Participating Options Exchanges have proposed substantially identical 
temporary provisions to accommodate this possibility.\51\ Thus, the 
Commission finds that the proposed rule relating to the Exchange's 
receipt and handling of P/A Orders and Principal Orders, and imposing 
certain obligations on the Exchange with respect to such orders that 
are similar to those that exist under the Old Plan, is appropriate and 
consistent with Section 6(b)(5) of the Act \52\ which requires, among 
other things, that the rules of a national securities exchange be 
designed to promote just and equitable principles of trade, 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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    \49\ See Plan Approval, supra note 5.
    \50\ The Commission notes that any Participating Options 
Exchange that wishes to utilize such order types in a manner that 
would result in a Trade-Through would need to separately request an 
exemption from the Plan for such use.
    \51\ The Commission notes that the rules contained in ISE 
Temporary Rule 1903 are not required by the Plan, but rather are 
rules proposed by the Exchange in order to facilitate the 
participation in the Plan of certain exchanges during an initial 
transition period.
    \52\ 15 U.S.C. 78f(b)(5).
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    The Commission also finds that the amendments to ISE's rules 
requiring ISE PMMs to execute or route customer orders when another 
exchange is displaying a better price are consistent with the Act, and 
in particular with Section 6(b)(5) of the Act.\53\ In this regard, ISE 
proposes to discharge its obligations under the Plan to ``establish, 
maintain and enforce written policies and procedures * * * reasonably 
designed to prevent Trade-Throughs'' \54\ by requiring its PMMs to 
address customer orders when there is a better away market.\55\ 
Pursuant to amended ISE Rule 803(c)(2), PMMs would be required to 
either: (i) Execute the customer's order at a price that at least 
matches the best price displayed or (ii) send ISO(s) as agent for the 
customer order to any exchange(s) displaying a better price and, with 
respect to any remaining portion of the customer order, either (a) 
releasing such portion for execution on ISE's auction market or (b) 
executing such portion at a price better than the best price available 
on ISE's auction market.
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    \53\ 15 U.S.C. 78f(b)(5).
    \54\ See Section 5(a) of the Plan.
    \55\ See Notice, supra note 3, at 27227.
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    In addressing customer orders that are not automatically executed 
because there is a better price displayed on another exchange, pursuant 
to proposed Commentary .04 to Rule 803, ISE will act in compliance with 
its rules, the Act, and the rules thereunder. In particular, ISE will 
act in compliance with Sections 6(b)(4) and (5) of the Act \56\ which 
require the Exchange to: (1) Provide for the equitable allocation of 
reasonable dues, fees, and other charges among its participants and 
other persons using its facilities; and (2) prohibit unfair 
discrimination among customers, issuers, brokers or dealers. Customers 
may choose to avoid having their orders routed away by a PMM by 
entering their order with an Immediate or Cancel or Fill or Kill 
designation.\57\
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    \56\ 15 U.S.C. 78f(b)(4) and (5).
    \57\ See Notice, supra note 3, at 27227.
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    Any PMM that handles customer orders pursuant to ISE Rule 803(c)(2) 
will be subject to oversight and enforcement responsibilities of a 
self-regulatory organization (``SRO'') other than ISE.\58\ 
Additionally, ISE Rule 810 imposes certain restrictions on the business 
activities of ISE market makers, including PMMs. These restrictions 
prohibit a PMM from, among other things, handling orders as agent on 
behalf of customers unless there is an information barrier between its 
market making activities, on the one hand, and certain other 
activities, including handling customer orders as agent, on the other 
hand.\59\ ISE proposes to amend ISE Rule 810 to permit PMMs to handle 
public customer orders when ISE is not at the best price. ISE 
represented that, under the Old Plan, PMMs were not subject to the 
information barrier requirement between market making activities and 
agency activities because PMMs sending P/A Orders seeking a better 
market away were sending a principal order.\60\ The Commission finds 
that it is consistent with the Act to permit an exception to ISE's 
information barrier rule when a PMM

[[Page 44430]]

sends an ISO as agent for a customer order to comply with its 
obligations under ISE Rule 803(c)(2), because such activity is limited 
by ISE's rules, as described above, and does not provide the potential 
for the type of harm against which ISE Rule 810 is intended to protect, 
specifically the inappropriate sharing of information that could result 
in market manipulation. The Commission also finds that the proposed 
change to ISE Rule 811, governing the Exchange's Directed Order 
program, to permit ISE PMMs that also handle Directed Orders on an 
agency basis, to act as agent when routing ISOs under ISE Rule 
803(c)(2) is consistent with the Plan and the Act.
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    \58\ See Securities Exchange Act Release No. 42455 (February 24, 
2000), 65 FR 11388, 11389 (March 2, 2000) (File No. 10-127). A PMM 
must have as their examining authority designated by the Commission 
pursuant to Rule 17d-1 of the Act, a SRO other than ISE. As such, 
such SRO is responsible for the oversight and enforcement of the PMM 
for compliance with the applicable financial responsibility rules.
    \59\ See ISE Rule 810(a).
    \60\ See Notice, supra note 3, at 27227.
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    The Commission finds that ISE's proposed arrangements with respect 
to the handling of customer orders when ISE is not at the best price, 
and related amendment to its information barrier rules and Directed 
Order program, are designed to comply with its responsibility under the 
Plan to establish, maintain and enforce written policies and procedures 
reasonably designed to prevent Trade-Through. Accordingly, the 
Commission finds ISE's proposed arrangements consistent with the Plan 
and the Act.
    Finally, the Commission finds that ISE's proposed amendments to 
certain other ISE rules to reflect the provision of the Plan, and to 
delete provisions of ISE's rules rendered unnecessary due to the Plan, 
are appropriate and consistent with the Act and the Plan.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\61\ that the proposed rule change (SR-ISE-2009-27), as modified by 
Amendment No. 1, be, and it hereby is, approved.
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    \61\ 15 U.S.C. 78s(b)(2).
    \62\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\62\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-20788 Filed 8-27-09; 8:45 am]

BILLING CODE 8010-01-P
