
[Federal Register Volume 76, Number 136 (Friday, July 15, 2011)]
[Notices]
[Pages 41850-41853]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-17797]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64853; File No. SR-ISE-2011-39]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Notice of Filing of Proposed Rule Change Relating to Complex 
Orders

July 11, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on July 1, 2011, the International Securities Exchange, LLC (the 
``Exchange'' or the ``ISE'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which items have been prepared by the Exchange. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to provide for market maker quotes for 
complex orders, add an additional methodology for execution priority on 
the complex order book, and provide for enhanced allocations to 
designated market makers in certain circumstances. The text of the 
proposed rule change is available on the Exchange's Web site http://www.ise.com, at the principal office of the Exchange, at the 
Commission's Public Reference Room, and on the Commission's Web site at 
http://www.sec.gov.

[[Page 41851]]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The self-regulatory organization has prepared summaries, 
set forth in Sections A, B and C below, of the most significant aspects 
of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to adopt enhancements to its complex order 
functionality that it believes will encourage market makers to provide 
additional liquidity in complex order strategies on the complex order 
book. First, the Exchange proposes to enable market makers to enter 
quotes for complex order strategies on the complex order book in the 
same manner as they do for single-leg orders in the regular market \3\ 
and to make the same risk management tools available for such quotes as 
are currently available in the regular market.\4\ The Exchange believes 
that market makers may prefer to use their existing quotation systems 
to enter quotes for complex order strategies rather than entering 
orders, thereby encouraging greater liquidity on the complex order 
book.\5\ Quoting on the complex order book would be completely 
voluntary and limited to options classes to which the market maker is 
appointed. In this respect, the Exchange notes that there are no 
existing requirements that market makers provide liquidity on the 
complex order book, and the proposed rule specifies that market makers 
who choose to enter quotes for complex order strategies in their 
appointed options classes are not subject to the market maker quotation 
requirements applicable in the regular market. The proposed rule also 
specifies that complex order volume executed by market makers is not 
taken into consideration when determining whether market makers are 
meeting their quotation obligations with respect to the regular market.
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    \3\ Quotes may only be entered by market makers. ISE Rule 
100(a)(42).
    \4\ The Exchange adopted changes to ISE Rule 804 to reflect the 
enhanced risk management tools that will be available for market 
maker quotes in the Optimise platform in the regular market. 
Securities Exchange Act Release No. 63117 (October 15, 2010), 75 FR 
65042 (October 21, 2010) (SR-ISE-2010-101).
    \5\ Quotes and orders are processed as they are received by the 
trading system. Quotes are not processed any more quickly than 
orders.
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    The Exchange seeks to encourage market makers to provide additional 
liquidity on the complex order book by providing them with the ability 
to quote complex order strategies on the complex order book. At the 
same time, the Exchange recognizes that market makers could encounter 
difficulties maintaining quotations on the complex order book if such 
quotes were allowed to execute against (i.e., ``leg-into'') the regular 
market. In particular, market maker pricing systems automatically 
update the price of a market maker's quotations when there is a move in 
the price of an underlying security. When such a change occurs, a 
market maker will need to send updates for its quotes in the regular 
market and also send updates for its quotes in the complex order book. 
Accordingly, it is possible that market makers could unintentionally 
trade with their own quotes or the quotes of other market makers in the 
regular market before the quote update in the complex order book is 
processed (or vice versa).\6\
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    \6\ Indeed, ISE has long recognized the need to ameliorate small 
timing differences in processing market maker quotation updates by 
delaying market maker quotations from executing against each other 
for up to one second. ISE Rule 804(d)(2). The Exchange believes the 
restriction on complex order quotes legging-into the regular market 
is directly analogous.
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    Therefore, under the proposal, the system will not automatically 
execute market maker quotes against bids and offers on the Exchange for 
the individual legs of the complex order strategy.\7\ The Exchange 
believes that this is a reasonable limitation on market maker 
quotations that will appropriately address an operational issue that 
would discourage market makers from offering additional liquidity on 
the complex order book to the benefit of customers that seek to execute 
such multi-leg strategies. The Exchange also notes that market maker 
quotes cannot be marked for price improvement, as that would further 
disrupt the quoting function.\8\ Market makers are not restricted in 
any way from entering orders marked for price improvement if they so 
chose [sic].
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    \7\ Pursuant to ISE Rule 722(b)(3)(ii), the ISE's trading system 
monitors the Exchange's regular market for the individual series 
that comprise the complex order and automatically executes the 
individual legs of a complex order against the ISE best bid or offer 
when the prices and sizes can satisfy the terms of the order.
    \8\ Pursuant to ISE Rule 722(b)(3)(iii), complex orders that are 
marked for price improvement are exposed on the complex order book 
for a period of up to one-second before being automatically 
executed.
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    The Exchange also proposes to add a third method of execution 
priority for bids and offers on the complex order book at the same 
price. Currently, the Exchange may designate on a class basis whether 
bids and offers at the same price are executed: (i) In time priority; 
or (2) pro-rata based on size after all Priority Customer Orders at the 
same price are executed in full.\9\ The Exchange proposes to also have 
the flexibility to determine, on a class basis, whether all bids and 
orders on the complex order book at the same price are executed pro-
rata based on size. Under this proposed method, Priority Customer 
Orders would receive a pro-rata allocation along with all other orders 
and quotes at the same price.
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    \9\ ISE Rule 722(b)(3)(i).
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    The Exchange believes that market participants may be encouraged to 
provide more liquidity for complex order strategies if all liquidity at 
the same price participates in the execution of incoming orders on an 
equal basis. Moreover, while the Exchange believes there is a basis 
under the Securities Exchange Act of 1934 (the ``Act'') for allowing 
Priority Customers to be treated differently than professional trading 
interest as the Exchange currently does in its regular market, such 
preferential treatment is not required under the Act. Indeed, under the 
Exchange's existing price-time execution methodology for orders on the 
complex order book, Priority Customers are not given preferential 
treatment. The Exchange further notes that this proposed rule change 
addresses priority among bids and offers for complex order strategies 
on the complex order book only, and does not affect the provisions of 
paragraph (b)(2) of Rule 722, which limits the execution of complex 
orders when there are Priority Customer Orders on the Exchange for the 
individual series of a complex order.
    Finally, for options classes that are allocated pro-rata based on 
size with Priority Customer Order priority, the Exchange proposes to 
provide enhanced allocations to market makers designated by the 
entering member (a ``Preferred Market Maker''). Under the proposal, a 
Preferred Market Maker would receive the same enhanced allocation on 
the complex order book provided for Preferred Market Makers in the 
regular market. Specifically, a Preferred Market Maker would receive an 
allocation equal to the greater of: (i) The proportion of the total 
size at the best price represented by the size of its quote, or

[[Page 41852]]

(ii) sixty percent of the contracts to be allocated if there is only 
one other professional complex order or market maker quotes at the best 
price, and forty percent if there are two or more other professional 
complex orders and/or market maker quotes at the best price. Preferred 
Market Makers on the complex book must comply with their quoting 
obligations in the regular market, including the enhanced quoting 
requirements in Rule 804(e)(2)(ii) applicable to Competitive Market 
Makers that receive Preferenced Orders.\10\ This means, among other 
things, that market makers must be quoting at least 90% of the series 
of an options class in the regular market to receive an enhanced 
allocation on the complex order book.\11\
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    \10\ Electronic Access Members and Preferred Market Makers may 
not coordinate their actions. Such conduct would be a violation of 
Rule 400 (Just and Equitable Principles of Trade). The Exchange will 
proactively conduct surveillance for, and enforce against, such 
violations. See Securities Exchange Act Release No. 51818 (June 10, 
2005), 70 FR 35146 (June 16, 2005) (Order Approving SR-ISE-2005-18) 
at footnote 10.
    \11\ The Chicago Board Options Exchange also permits 
preferencing of complex orders. CBOE Rule 8.13(d), Interpretations 
and Policies .01.
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2. Basis
    The basis under the Act for this proposed rule change is the 
requirement under Section 6(b),\12\ in general, and Section 6(b)(5) 
\13\ in particular, that an exchange have rules that are designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to remove impediments to and perfect 
the mechanism for a free and open market and a national market system, 
and, in general, to protect investors and the public interest. The 
Exchange Believes [sic] that customer [sic] would benefit from enhanced 
liquidity on the complex order book.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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    In particular, the Exchange believes that giving market makers the 
ability to enter quotes for complex order strategies on the complex 
order book and to utilize market maker risk management tools could 
increase the liquidity available for investors that place complex 
orders on the Exchange. The Exchange believes it is necessary to assure 
the smooth operation of quotes on the complex order [sic] by preventing 
such quotations from legging into the regular market like orders. In 
this respect, entering quotations will be completely voluntary, so that 
a market maker could choose to offer liquidity though the posting of 
orders if it wanted the opportunity to leg-into the market. Therefore, 
the Exchange does not think it is unreasonably discriminatory to 
prevent market makers from legging-into the market.
    Moreover, the Exchange does not believe it is unreasonably 
discriminatory to make the ability to quote on the complex order book 
available only to market makers that are appointed to the options class 
in the regular market. Indeed, under the ISE membership structure, only 
those members that own or lease market maker memberships are permitted 
to enter quotes in the regular market. Allowing other market 
participants to quote on the complex order book would be inconsistent 
with this membership structure. Notwithstanding, the Exchange is not 
aware of any demand from non-market maker participants to quote on the 
complex order book. Indeed, the Exchange is proposing to implement this 
rule change on a voluntary basis precisely because it believes a 
mandatory quoting requirement for complex order [sic] would discourage 
members from participating on the Exchange as market makers in the 
regular market.
    The Exchange also notes that orders resting on the book in the 
regular market may not receive an execution when quotes on the complex 
order book are prevented from legging in. Complex orders are 
contingency transactions, and prices posted on the complex order book 
are not firm, nor included in the national market system. The Exchange 
attempts to provide better execution quality for complex orders resting 
on the complex order book by seeking to satisfy the contingency with 
individual orders in the regular market when possible. The Exchange 
notes, however, that this is an enhanced execution service that has 
been developed only in the last few years. While exchanges have always 
prohibited the execution of complex orders at prices that would trade 
through the best bids and offers on the exchange, or at the same price 
as public customer orders on the regular book in certain circumstances, 
there has never been a regulatory requirement to integrate potential 
liquidity on the complex order book with the regular market. As 
discussed above, the Exchange believes it is operationally necessary to 
prevent market maker quotes from legging-into the regular market; 
otherwise, market makers will not be able to quote on the complex order 
book. Moreover, customers in the regular market are not being 
discriminated against, as the very same market makers provide liquidity 
in the regular market. Accordingly, the proposal will provide benefits 
to customers that use complex strategies, while not degrading the 
execution quality of customer orders in the regular market.
    The Exchange further believes that liquidity on the complex order 
book may be enhanced by executing all interest at the same price pro-
rata based on size. In this respect, the Exchange notes that Priority 
Customers are not given preferential treatment under the existing 
price-time methodology and that Priority Customer orders would be 
treated equally with all other trading interest at the same price under 
the pro-rata based on size methodology. Having the ability to determine 
on a class basis whether bids and offers on the complex order book at 
the same price will be executed in time priority, pro-rata based on 
size with Priority Customer Priority, or pro-rata based on size without 
Priority Customer Priority will give the Exchange greater flexibility 
to respond to market needs and enhance its ability to compete more 
effectively.
    Finally, the Exchange believes that its proposal to give Preferred 
Market Makers enhanced allocations is designed to protect priority 
customers and to be consistent with Commission policy with respect to 
execution guarantees. In particular, as in the regular market, 
Preferred Market Makers will only receive enhanced allocations of 
complex orders in options classes in which Priority Customer Orders are 
given priority over all other interest at the same price. Additionally, 
the potential for enhanced allocations is limited to only those market 
makers that are providing liquidity in at least 90% of the series in 
the options class in the regular market. The Exchange believes that 
providing the opportunity to receive enhanced allocations might 
incentivize market makers to provide additional liquidity on the 
complex order book and potentially provide incentive [sic] for 
additional market makers to quote at the higher requirement in the 
regular market for the options class.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any

[[Page 41853]]

unsolicited written comments from members or other interested parties.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) As the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-ISE-2011-39 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-ISE-2011-39. 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will 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 File Number SR-ISE-2011-39 and should be 
submitted on or before August 5, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-17797 Filed 7-14-11; 8:45 am]
BILLING CODE 8011-01-P


