
[Federal Register Volume 82, Number 30 (Wednesday, February 15, 2017)]
[Notices]
[Pages 10837-10842]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-02991]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79994; File No. SR-ISE-2016-27]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Granting Approval of Proposed Rule Change, as Modified by 
Amendment No. 1 Thereto, To Amend the Exchange's Rules Regarding 
Routing of Orders, Cancellation of Orders, and Handling of Error 
Positions, and Permit Nasdaq Execution Services, LLC To Become an 
Affiliated Member of the Exchange To Perform Certain Routing and Other 
Functions

February 9, 2017.

I. Introduction

    On December 9, 2016, 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 related to the routing of orders, 
cancellation of orders, and handling of error positions. The proposed 
rule change would also permit Nasdaq Execution Services, LLC (``NES'') 
to become an affiliated Member \3\ of the Exchange to perform certain 
routing and other functions. On December 20, 2016, the Exchange filed 
Amendment No. 1 to the proposed rule change, which amended and replaced 
the original filing in its entirety. The proposed rule change, as 
modified by Amendment No. 1, was published for comment in the Federal 
Register on December 29, 2016.\4\ The Commission received no comments 
on the proposed rule change. This order grants approval of 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\ A ``Member'' is an organization that has been approved to 
exercise certain trading rights on the Exchange. See ISE Rule 
100(a)(23).
    \4\ See Securities Exchange Act Release No. 79665 (December 22, 
2016), 81 FR 96092 (``ISE Notice'').
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II. Background

    On June 21, 2016, the Commission approved a proposed rule change 
relating to a corporate transaction in which Nasdaq, Inc. would become 
the ultimate parent of ISE, ISE Gemini, LLC (``ISE Gemini''), and ISE 
Mercury, LLC (``ISE Mercury'' and, together with ISE and ISE Gemini, 
the ``ISE Exchanges'').\5\ The transaction closed on June 30, 2016.\6\ 
Nasdaq, Inc. is also the ultimate parent of NASDAQ BX, Inc. (``BX''), 
The NASDAQ Stock Market LLC (``Nasdaq''), and NASDAQ PHLX LLC (``Phlx'' 
and, together with Nasdaq and BX, the ``Nasdaq Exchanges'').\7\ Nasdaq, 
Inc. is also the ultimate parent of NES,\8\ a broker-dealer that is a 
member, and affiliate, of each of the Nasdaq Exchanges.\9\ As a result 
of this transaction, the ISE Exchanges and the Nasdaq Exchanges became 
affiliates,\10\ and NES became an affiliate of the ISE Exchanges.\11\
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    \5\ See Securities Exchange Act Release No. 78119 (June 21, 
2016), 81 FR 41611 (June 27, 2016) (SR-ISE-2016-11; SR-ISE Gemini-
2016-05; SR-ISE Mercury-2016-10) (order approving Nasdaq, Inc.'s 
acquisition of ISE, ISE Gemini, and ISE Mercury) (``Nasdaq 
Acquisition Order'').
    \6\ See http://ir.nasdaq.com/releasedetail.cfm?releaseid=977785 
(Nasdaq press release announcing completion of its acquisition).
    \7\ See Nasdaq Acquisition Order, supra note 5, at 41611.
    \8\ See Securities Exchange Act Release No. 69233 (March 25, 
2013), 78 FR 19352 (March 29, 2013) (SR-NASDAQ-2013-028) (order 
approving a proposed rule change to make permanent a pilot program 
to permit Nasdaq to accept inbound orders routed by NES from the BX 
Equities market and PSX) at 19352 n.6 and accompanying text (``BX 
Equity Routing Approval''). See also ISE Notice, supra note 4, at 
96093.
    \9\ See Securities Exchange Act Release Nos. 79661 (December 22, 
2016), 81 FR 96100 (December 29, 2016) (SR-BX-2016-068) at 96100; 
79662 (December 22, 2016), 81 FR 96087 (December 29, 2016) (SR-
NASDAQ-2016-169) at 96087; and 79660 (December 22, 2016), 81 FR 
96060 (December 29, 2016) (SR-Phlx-2016-120) at 96061. See also ISE 
Notice, supra note 4, at 96093.
    \10\ See Nasdaq Acquisition Order, supra note 5, at 41611 n.8. 
The Nasdaq Exchanges, together with ISE Gemini and ISE Mercury, are 
referred to herein as ISE's ``Affiliated Exchanges.''
    \11\ See generally ISE Notice, supra note 4, at 96093 
(discussing that NES is a broker-dealer owned and operated by 
Nasdaq, Inc. and affiliated with ISE and the Affiliated Exchanges).
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    The Exchange has now proposed a rule change to amend its rules 
relating to order routing, cancellation of orders, and handling of 
error positions, and to permit NES to become a Member of the Exchange 
to perform certain routing and other functions. ISE's proposed rules 
are similar to rules of Phlx,\12\ as well as the other Nasdaq 
Exchanges.\13\ Specifically, and as described in more detail below, the 
Exchange proposed to: (1) Route outbound orders in options listed and 
open for trading on the Exchange's system to away markets through NES, 
either directly or through a third-party routing broker-dealer; (2) 
permit the Exchange to receive inbound orders in options routed through 
NES from the Affiliated Exchanges, pursuant to

[[Page 10838]]

certain limitations and conditions; (3) adopt rules regarding the 
cancellation of orders and the handling of certain error positions, 
including maintenance by NES of an error account; and (4) make related 
conforming changes.\14\ In addition, the Exchange requested that the 
Commission approve its proposal to permit NES to become a Member of the 
Exchange, as required by ISE Rule 312,\15\ to perform certain functions 
relating to the outbound routing of orders to away markets, routing 
orders inbound from the Affiliated Exchanges, cancellation of orders, 
and the maintenance of an error account.
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    \12\ See ISE Notice, supra note 4, at 96093, 96094-96096. See 
also Phlx Rules 985(c)(2), 1080(m)(ii), (iii), and (v).
    \13\ See Nasdaq Rule 2160(c) and Nasdaq Options Rules, Chapter 
VI, Section 11(d)-(g); and BX Rule 2140(c) and BX Options Rules, 
Chapter VI, Section 11(d)-(g).
    \14\ See ISE Notice, supra note 4, at 96093.
    \15\ Id.
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III. Discussion and Commission Findings

    After careful review, the Commission finds, as discussed in more 
detail below, that the proposed rule change, as modified by Amendment 
No. 1, is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\16\ In particular, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with Section 
6(b)(1) of the Act,\17\ which requires, among other things, that a 
national securities exchange be so organized and have the capacity to 
carry out the purpose of the Act, and to comply and enforce compliance 
by its members and persons associated with its members, with the 
provisions of the Act, the rules and regulations thereunder, and the 
rules of the Exchange. Further, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with Section 
6(b)(5) of the Act,\18\ which requires, among other things, that the 
rules of a national securities exchange be designed to prevent 
fraudulent and manipulative acts and practices; to promote just and 
equitable principles of trade; to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, and processing 
information with respect to, and facilitating transactions in 
securities; to remove impediments to and perfect the mechanism of a 
free and open market and a national market system; and, in general, to 
protect investors and the public interest. Section 6(b)(5) also 
requires that the rules of an exchange not be designed to permit unfair 
discrimination among customers, issuers, brokers, or dealers.
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    \16\ 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).
    \17\ 15 U.S.C. 78f(b)(1).
    \18\ 15 U.S.C. 78f(b)(5).
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A. Restriction on Affiliation

    As noted above, ISE proposed that NES be permitted to become a 
Member of the Exchange to perform certain routing and other functions, 
as described in more detail below.\19\ Absent Commission approval, ISE 
Rule 312 would prohibit NES from becoming a Member of ISE because of 
its affiliation with the Exchange and its affiliation with affiliates 
of the Exchange. Specifically, pursuant to ISE Rule 312, without prior 
Commission approval, a Member of the Exchange ``shall not be or become 
an affiliate of the Exchange, or any facility of the Exchange, or any 
entity with which the Exchange or any facility of the Exchange is 
affiliated.'' \20\
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    \19\ See ISE Notice, supra note 4, at 96093. See also infra, 
Sections III.B-D.
    \20\ See ISE Rule 312. See also ISE Notice, supra note 4, at 
96093.
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    In the past, the Commission has expressed concern that the 
affiliation of an exchange with one of its members raises potential 
conflicts of interest and the potential for unfair competitive 
advantage.\21\ Although the Commission continues to be concerned about 
potential unfair competition and conflicts of interest between an 
exchange's self-regulatory obligations and its commercial interest when 
the exchange is affiliated with one of its members, the Commission 
believes that it is consistent with the Act, as discussed in more 
detail below, to permit NES, an affiliate of the Exchange, to be a 
Member of the Exchange to perform each of the proposed functions, 
subject to the proposed limitations and conditions. The Commission also 
believes that the proposed limitations and conditions will mitigate its 
concerns about potential conflicts of interest and unfair competitive 
advantage,\22\ and that the Exchange's proposed rules are designed to 
ensure that NES cannot use any information advantage it may have 
because of its affiliation with ISE.\23\
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    \21\ See, e.g., Securities Exchange Act Release Nos. 54170 (July 
18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order 
approving Nasdaq's proposal to adopt Nasdaq Rule 2140, restricting 
affiliations between Nasdaq and its members); 53382 (February 27, 
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order 
approving the combination of the New York Stock Exchange, Inc. and 
Archipelago Holdings, Inc.); 58673 (September 29, 2008), 73 FR 57707 
(October 3, 2008) (SR-Amex-2008-62 and SR-NYSE-2008-60) (order 
approving the combination of NYSE Euronext and the American Stock 
Exchange LLC); 59135 (December 22, 2008), 73 FR 79954 (December 30, 
2008) (SR-ISE-2008-85) (order approving the purchase by ISE Holdings 
of an ownership interest in Direct Edge Holdings LLC); 59281 
(January 22, 2009), 74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120) 
(order approving a joint venture between NYSE and BIDS Holdings 
L.P.); 58375 (August 18, 2008), 73 FR 49498 (August 21, 2008) (File 
No. 10-182) (order granting the exchange registration of BATS 
Exchange, Inc.); 61698 (March 12, 2010), 75 FR 13151 (March 18, 
2010) (File Nos. 10-194 and 10-196) (order granting the exchange 
registration of EDGX Exchange, Inc. and EDGA Exchange, Inc.); and 
62716 (August 13, 2010), 75 FR 51295 (August 19, 2010) (File No. 10-
198) (order granting the exchange registration of BATS-Y Exchange, 
Inc.).
    \22\ See infra note 59 and accompanying text and Section III.D.
    \23\ See infra note 60 and accompanying text. The Commission 
also notes that the functions to be performed by NES for ISE, as 
well as the related limitations and conditions, are consistent with 
those previously approved by the Commission for other exchanges. 
See, e.g., Securities Exchange Act Release Nos. 67256 (June 26, 
2012), 77 FR 39277 (July 2, 2012) (SR-BX-2012-030) (order approving 
rules relating to the establishment of the BX options market, 
including the use of an affiliated member for outbound and inbound 
routing of options orders) at 39280-82; and 67280 (June 27, 2012), 
77 FR 39552 (July 3, 2012) (SR-BX-2012-034) (order approving a 
proposed rule change with respect to the authority of the BX or NES 
to cancel orders when a technical or systems issue occurs and the 
operation of an error account); and BX Equity Routing Approval, 
supra note 8.
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B. Outbound Routing

    ISE has proposed to establish NES as the Exchange's exclusive order 
router.\24\ Currently, ISE utilizes Linkage Handlers \25\ unaffiliated 
with the Exchange to route outbound orders.\26\ ISE has proposed to 
amend ISE Rule 1903 to provide that ISE will no longer use Linkage 
Handlers and instead, NES will route orders to other options exchanges, 
either directly, or indirectly through unaffiliated third-party routing 
brokers, on behalf of ISE.\27\ ISE explained that the Exchange will 
have the option to direct NES to route orders

[[Page 10839]]

to certain exchanges through a third-party routing broker, in which 
case NES will submit the orders to the third-party routing broker and 
the third-party routing broker will route the orders in the third-party 
routing broker's name.\28\ ISE noted that its proposed use of NES to 
handle outbound routing for the Exchange is similar to the arrangement 
utilized by Phlx.\29\
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    \24\ See proposed ISE Rule 1903(a).
    \25\ A ``Linkage Handler'' is a broker that is unaffiliated with 
the Exchange with which the Exchange has contracted to provide 
Routing Services, as that term is defined in ISE Rule 1903, by 
routing ISO(s) to other exchange(s) as an agent on behalf of Public 
Customer and Non-Customer Orders according to the requirements of 
Rule 1901 (prohibition on trade-throughs) and Rule 1902 (prohibition 
on locked and crossed markets). See ISE Rule 1901, Supplementary 
Material .03. ISE Rules 100(a)(28) and (39) define ``Non-Customer 
Order'' and ``Public Customer Order,'' respectively.
    \26\ See ISE Rule 1903(a).
    \27\ See proposed ISE Rule 1903(a). ISE has proposed to retain 
the first portion of ISE Rule 1903, which provides that the Exchange 
may automatically route ISOs to other exchanges under certain 
circumstances, including pursuant to Supplementary Material .02 to 
Rule 1901, which discusses the handling of orders when the automatic 
execution of an incoming order would result in an impermissible 
trade through. See proposed ISE Rule 1903. ISE noted that this 
provision provides context to the proposed rule and is consistent 
with the practice on Phlx, even though it is not contained in Phlx's 
comparable rule. See ISE Notice, supra note 4, at 96094. ISE has 
proposed to remove from this provision a reference to Supplementary 
Material .03 to Rule 1901, which defines Linkage Handlers. See 
proposed ISE Rule 1903.
    \28\ See ISE Notice, supra note 4, at 96094.
    \29\ See id. (citing Phlx Rule 1080(m)). The Commission notes 
that ISE's proposal is also similar to Nasdaq's and BX's rules. See 
Nasdaq Options Rules, Chapter VI, Section 11(d)-(f); BX Options 
Rules, Chapter VI, Section 11(d)-(f).
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    Pursuant to the proposal, NES will serve as the routing facility of 
the Exchange (``Routing Facility). The sole use of the Routing Facility 
by the system will be to route orders in options listed and open for 
trading on the system to away markets either directly or through one or 
more third-party unaffiliated routing broker-dealers pursuant to 
Exchange rules on behalf of the Exchange. The Routing Facility will be 
subject to regulation as a facility of the Exchange, including the 
requirement to file proposed rule changes under Section 19 of the Act, 
as amended.\30\
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    \30\ See proposed ISE Rule 1903(a).
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    NES will be a member of an SRO unaffiliated with ISE that is its 
designated examining authority.\31\ Also, the Exchange and NES will not 
be permitted to use a routing broker for which the Exchange or any 
affiliate of the Exchange is the designated examining authority.\32\ 
The use of NES to route orders to other market centers will be 
optional.\33\ Parties that do not desire to use NES will need to 
designate orders as Do-No-Route-Orders pursuant to ISE Rule 715(m).\34\
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    \31\ See id.
    \32\ See proposed ISE Rule 1903(c)(2). ISE noted that this 
provision is intended to prevent any conflicts of interest that 
might arise if an entity with regulatory oversight of ISE was privy 
to trades conducted on ISE. See ISE Notice, supra note 4, at 96095.
    \33\ See proposed ISE Rule 1903(b).
    \34\ See id. See also ISE Notice, supra note 4, at 96095.
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    The Exchange will establish and maintain procedures and internal 
controls reasonably designed to adequately restrict the flow of 
confidential and proprietary information between the Exchange and the 
Routing Facility, and any other entity, including any affiliate of the 
Routing Facility; or, where there is a routing broker, the Exchange, 
the Routing Facility and any routing broker, and any other entity, 
including any affiliate of the routing broker.\35\ The books, records, 
premises, officers, directors, agents, and employees of the Routing 
Facility, as a facility of the Exchange, will 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. Also, the books and records of the Routing Facility, as a facility 
of the Exchange, will be subject at all times to inspection and copying 
by the Exchange and the Commission.\36\
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    \35\ See proposed ISE Rule 1903(c). If the routing broker or any 
of its affiliates engages in any other business activities other 
than providing routing services to the Exchange, this provision will 
apply to the flow of confidential and proprietary information 
between the segment of the routing broker or affiliate that provides 
the other business activities and the segment of the routing broker 
that provides the routing services. See id.
    \36\ See proposed ISE Rule 1903(c)(1).
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    The Exchange will determine the logic that provides when, how, and 
where orders are routed to other exchanges. Except as provided, the 
routing broker(s) will not be able to change the terms of an order or 
the routing instructions, nor will the routing broker have any 
discretion about where to route an order.\37\ ISE explained that it may 
choose to use a different routing broker by destination exchange, 
depending upon the costs and technological efficiencies involved.\38\ 
ISE stated that, at a minimum, it anticipates using a third-party 
routing broker to access certain markets where the costs of maintaining 
a membership for NES or the costs of connectivity and execution do not 
make sense based on the number or types of orders that the Exchange 
typically routes to a particular market. ISE added that it will also 
consider the ease of connectivity and execution and general reliability 
when selecting a third-party routing broker.\39\ Entering Members whose 
orders are routed to away markets will be obligated to honor such 
trades that are executed on away markets to the same extent they would 
be obligated to honor a trade executed on the Exchange.\40\
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    \37\ See proposed ISE Rule 1903(e).
    \38\ For such indirect routing, ISE stated that it would route 
orders through NES to another routing broker where the Exchange 
determines that it is appropriate. See ISE Notice, supra note 4, at 
96095.
    \39\ See ISE Notice, supra note 4, at 96095.
    \40\ See proposed ISE Rule 1903(f). ISE noted that this 
provision is substantively the same as its current Rule 1903(f), but 
it is amending the provision to conform the text to Phlx Rule 
1080(m)(ii).
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    In addition to the Exchange rules regarding routing away to trading 
centers, NES will, pursuant to Rule 15c3-5 under the Act, implement 
certain tests designed to mitigate risks associated with providing the 
Exchange's Members with access to such away trading centers. Pursuant 
to the policies and procedures developed by NES to comply with Rule 
15c3-5, if an order or series of orders are deemed to be violative of 
applicable pre-trade requirements of Rule 15c3-5, the order will be 
rejected prior to routing and/or NES will seek to cancel any orders 
that had been routed.\41\
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    \41\ See proposed ISE Rule 1903(d).
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    ISE also has proposed to make conforming changes to remove the term 
Linkage Handler from its rules and replace it with references to NES or 
third-party unaffiliated routing broker-dealers used by NES, as 
appropriate.\42\ Further, ISE has proposed to remove ISE Rule 
705(d)(4), which provides an exception to the limits on compensation in 
ISE Rule 705(d) for Members to the extent such Members are acting as 
Linkage Handlers.\43\ ISE explained that, unlike NES, Linkage Handlers 
are not affiliated with ISE and the Exchange does not believe that such 
an exception to compensation limits is necessary for NES.\44\
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    \42\ See proposed ISE Rule 1901, Supplementary Material .02(d), 
.04(a), and .05(a); proposed ISE Rule 1903, Supplementary Material 
.01, .02, and .03. ISE has proposed to delete its definition of 
Linkage Handler at Rule 1901, Supplementary Material .03, and 
reserve this provision. See proposed ISE Rule 1901, Supplementary 
Material .03. With respect to the references to Linkage Handler in 
ISE Rules 1904 and 1905, as discussed further below, ISE has 
proposed to replace ISE Rule 1904 in its entirety and reserve ISE 
Rule 1905. See proposed ISE Rules 1904 and 1905.
    \43\ See proposed ISE Rule 705(d).
    \44\ See ISE Notice, supra note 4, at 96095.
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    As a facility of ISE (as defined in Section 3(a)(2) \45\ of the 
Act), NES will be subject to Exchange oversight, as well as Commission 
oversight, and the Exchange will be responsible for ensuring that NES's 
outbound routing function is operated consistent with Section 6 of the 
Act and the Exchange's rules.\46\ A participant in ISE's system will be 
free to route its orders to other market centers through alternative 
means. The Commission notes that ISE's proposed rules for the operation 
of NES as an affiliated outbound router on behalf of the Exchange are 
consistent with the rules and conditions approved by the Commission for 
other exchanges.\47\ In light of the protections

[[Page 10840]]

discussed above, including the regulation of NES as a facility of the 
Exchange with respect to the routing of orders, the Commission believes 
that ISE's proposed rules and use of NES to route orders to away 
markets are consistent with the Act.
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    \45\ 15 U.S.C. 78c(a)(2).
    \46\ Further, the Commission notes that the Exchange will be 
responsible for filing with the Commission proposed rule changes and 
fees relating to NES's outbound routing function and NES's outbound 
routing function will be subject to exchange non-discrimination 
requirements.
    \47\ See, e.g., Securities Exchange Act Release No. 62716, supra 
note 21 at 51303-04. The proposed rules are also consistent with the 
rules of the Nasdaq Exchanges. See, e.g., Phlx Rule 1080(m)(ii) and 
(iii); Nasdaq Options Rules, Chapter VI, Section 11(d)-(f); BX 
Options Rules, Chapter VI, Section 11(d)-(f). See also Securities 
Exchange Act Release No. 59995 (May 28, 2009), 74 FR 26750 (June 3, 
2009) (SR-Phlx-2009-32) (order approving enhancements to Phlx's 
trading system, including use of outbound routing facility) at 
26756-57.
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C. Inbound Routing

    As discussed above, NES is currently a member of each Nasdaq 
Exchange. NES also operates as a facility of each of Nasdaq, Phlx, and 
BX that provides outbound options routing to other market centers, 
subject to certain conditions.\48\ ISE Gemini and ISE Mercury have also 
proposed that NES operate as a facility of each that provides outbound 
options routing to other market centers, subject to similar 
conditions.\49\ The operation of NES as a facility of each of the 
Affiliated Exchanges providing outbound routing services will be 
subject to oversight by ISE Gemini, ISE Mercury, Nasdaq, BX, and Phlx, 
respectively, as well as Commission oversight. Each of the Affiliated 
Exchanges will be responsible for ensuring that NES's outbound options 
routing services are operated consistent with Section 6 of the Act and 
with the respective Affiliated Exchange's rules. In addition, the 
Affiliated Exchanges must each file with the Commission rule changes 
and fees relating to their outbound options routing services provided 
by NES.
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    \48\ See supra note 47 (citing Phlx Rule 1080(m)(ii) and (iii); 
Nasdaq Options Rules, Chapter VI, Section 11(d)-(f); and BX Options 
Rules, Chapter VI, Section 11(d)-(f)). The Commission notes that 
these conditions are consistent with the conditions the Commission 
is approving today for ISE's operation of NES as a facility of the 
Exchange for outbound options routing to other market centers. See 
supra Section III.B.
    \49\ See Securities Exchange Act Release Nos. 79664 (December 
22, 2016), 81 FR 96136 (December 29, 2016) (SR-ISEGemini-2016-16); 
and 79663 (December 22, 2016), 81 FR 96089 (December 29, 2016) (SR-
ISEMercury-2016-22). The Commission is also today approving these 
proposed rules changes. See Securities Exchange Act Release No. 
79995 (February 9, 2017) (``ISE Gemini and ISE Mercury Exchange 
Routing Order'').
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    Recognizing that the Commission previously expressed concern that 
the affiliation of an exchange with one of its members raises the 
potential for unfair competitive advantage and potential conflicts of 
interest between an exchange's self-regulatory obligations and its 
commercial interest, ISE proposed the following limitations and 
conditions to permit the Exchange to accept inbound options orders that 
NES routes in its capacity as a facility of the Affiliated Exchanges: 
\50\
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    \50\ See ISE Notice, supra note 4, at 96093-96094.
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     First, ISE and the Financial Industry Regulatory Authority 
(``FINRA'') will maintain a Regulatory Services Agreement (``RSA''), as 
well as an agreement pursuant to Rule 17d-2 under the Act (``17d-2 
Agreement'').\51\ Pursuant to the RSA and the 17d-2 Agreement, FINRA 
will be allocated regulatory responsibilities to review NES's 
compliance with certain Exchange rules.\52\ Pursuant to the RSA, 
however, the Exchange retains ultimate responsibility for enforcing its 
rules with respect to NES.
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    \51\ 17 CFR 240.17d-2.
    \52\ NES is also subject to independent oversight by FINRA, its 
designated examining authority, for compliance with financial 
responsibility requirements.
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     Second, FINRA will monitor NES for compliance with the 
Exchange's trading rules, and will collect and maintain certain related 
information.\53\
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    \53\ Pursuant to the RSA, both FINRA and the Exchange will 
collect and maintain all alerts, complaints, investigations and 
enforcement actions in which NES (in its capacity as a facility of 
each of the Affiliated Exchanges routing orders to the Exchange) is 
identified as a participant that has potentially violated applicable 
Commission or Exchange rules. The Exchange and FINRA will retain 
these records in an easily accessible manner in order to facilitate 
any potential review conducted by the Commission's Office of 
Compliance Inspections and Examinations. See ISE Notice, supra note 
4, at 96094 n.13 and accompanying text.
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     Third, FINRA will provide a report to the Exchange's chief 
regulatory officer (``CRO''), on a quarterly basis, that: (i) 
Quantifies all alerts (of which the Exchange or FINRA is aware) that 
identify NES as a participant that has potentially violated Commission 
or Exchange rules, and (ii) lists all investigations that identify NES 
as a participant that has potentially violated Commission or Exchange 
rules.
     Fourth, ISE proposed to amend ISE Rule 312 to add ISE Rule 
312(c), which will provide that Nasdaq, Inc., as the holding company 
owning both the Exchange and NES, shall establish and maintain 
procedures and internal controls reasonably designed to ensure that NES 
does not develop or implement changes to its system, based on non-
public information obtained regarding planned changes to the Exchange's 
systems as a result of its affiliation with the Exchange, until such 
information is available generally to similarly situated Exchange 
Members, in connection with the provision of inbound routing to the 
Exchange.\54\
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    \54\ See proposed ISE Rule 312(c).
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    The Commission finds that ISE's proposed rule change to permit the 
Exchange to accept inbound options orders routed by NES from its 
Affiliated Exchanges, including the related change to ISE Rule 312, are 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange. 
Specifically, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(1) of the Act \55\ and Section 6(b)(5) of 
the Act.\56\
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    \55\ 15 U.S.C. 78f(b)(1). See also supra note 17 and 
accompanying text.
    \56\ 15 U.S.C. 78f(b)(5). See also supra note 18 and 
accompanying text.
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    In the past, the Commission has expressed concern that the 
affiliation of an exchange with one of its members raises potential 
conflicts of interest and the potential for unfair competitive 
advantage.\57\ Although the Commission continues to be concerned about 
potential unfair competition and conflicts of interest between an 
exchange's self-regulatory obligations and its commercial interest when 
the exchange is affiliated with one of its members, for the reasons 
discussed below, the Commission believes that it is consistent with the 
Act to permit NES, in its capacity as a facility of each of the 
Affiliated Exchanges, to route options orders inbound to ISE, subject 
to the limitations and conditions described above.\58\
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    \57\ See supra note 21 and accompanying text.
    \58\ The Commission notes that these limitations and conditions 
are consistent with those previously approved by the Commission for 
other exchanges. See, e.g., Securities Exchange Act Release Nos. 
67256, supra note 23, at 39281-82; and 69229 (March 25, 2013), 78 FR 
19337 (March 29, 2013) (SR-Phlx-2013-15) (order approving a proposed 
rule change to make permanent a pilot program to permit PSX to 
accept inbound orders routed by NES from BX); and BX Equity Routing 
Approval, supra note 8.
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    The Commission believes that these limitations and conditions will 
mitigate its concerns about potential conflicts of interest and unfair 
competitive advantage. In particular, the Commission believes that a 
non-affiliated SRO's oversight of NES,\59\ combined with a non-
affiliated SRO's monitoring of NES's compliance with the Exchange's 
rules and quarterly reporting to the Exchange, will help to protect the 
independence of ISE's regulatory responsibilities with respect to NES. 
The Commission also believes that the Exchange's proposed ISE Rule 
312(c) is designed to ensure that NES cannot use any information 
advantage it may have because of its affiliation with ISE.\60\
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    \59\ This oversight will be accomplished through the 17d-2 
Agreement between FINRA and the Exchange and the RSA.
    \60\ See supra note 54 and accompanying text.
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D. Cancellation of Orders and Error Accounts

    ISE has proposed to amend its rules concerning the cancellation of 
orders

[[Page 10841]]

and error accounts. Currently, the Exchange may cancel orders as it 
deems necessary to maintain fair and orderly markets if a technical or 
systems issue occurs at the Exchange, a Linkage Handler in connection 
with the routing services provided under ISE Rule 1903, or another 
exchange to which an Exchange order has been routed.\61\ ISE permits 
Linkage Handlers to maintain one or more accounts for the purpose of 
liquidating unmatched trade positions that may occur in connection with 
their routing of outbound orders.\62\
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    \61\ See ISE Rule 1904. See also ISE Notice, supra note 4, at 
96096.
    \62\ See ISE Rule 1905. See also ISE Notice, supra note 4, at 
96096.
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    As described above, ISE will no longer utilize Linkage Handlers and 
will instead utilize NES as its Routing Facility to route orders to 
away markets either directly or through one or more third-party 
unaffiliated routing broker-dealers on behalf of the Exchange.\63\ In 
its proposal, ISE stated that a technical or systems issue may occur at 
the Exchange, NES, or a routing destination that causes the Exchange or 
NES to cancel orders, if the Exchange or NES determines that such 
action is necessary to maintain a fair and orderly market.\64\ ISE also 
stated that a technical or systems issue that occurs at the Exchange, 
NES, a routing destination, or a third-party unaffiliated routing 
broker may result in NES acquiring an error position that it must 
resolve.\65\ In conjunction with the proposed changes to outbound 
routing described above, ISE has proposed to revise its rules 
concerning the cancellation of orders and handling of error positions 
and adopt proposed ISE Rule 1904.\66\ ISE noted that proposed ISE Rule 
1904 is similar to Phlx's rule on this subject.\67\
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    \63\ See supra notes 27-28 and accompanying text.
    \64\ See ISE Notice, supra note 4, at 96096. For examples of 
some of the circumstances in which the Exchange or NES may decide to 
cancel orders, see id., at 96096-97.
    \65\ See ISE Notice, supra note 4, at 96097. Specifically, 
proposed ISE Rule 1904(b) defines ``error positions'' as ``positions 
that result from a technical or systems issue at NES, the Exchange, 
a routing destination, or a non-affiliate third-party Routing Broker 
that affects one or more orders.'' For examples of some of the 
circumstances that may lead to error positions, see ISE Notice, 
supra note 4, at 96097.
    \66\ See proposed ISE Rules 1904 and 1905. ISE has proposed to 
(i) combine its rules concerning cancellation of orders and error 
accounts into proposed ISE Rule 1904, which it will retitle; and 
(ii) remove and reserve ISE Rule 1905. See ISE Notice, supra note 4, 
at 96095-96.
    \67\ See ISE Notice, supra note 4, at 96095-96 (citing Phlx Rule 
1080(m)(v)). The Commission notes that ISE's proposed rule is also 
similar to Nasdaq's and BX's rules. See Nasdaq Options Rules, 
Chapter VI, Section 11(g); BX Options Rules, Chapter VI, Section 
11(g).
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    ISE has proposed to provide the Exchange or NES with general 
authority to cancel orders to maintain fair and orderly markets when a 
technical or systems issue occurs at the Exchange, NES, or a routing 
destination.\68\ NES will maintain an error account for the purpose of 
addressing error positions, according to the specified procedures for 
resolving such error positions.\69\ Specifically, the Exchange or NES 
will be able to cancel orders as either deems necessary to maintain 
fair and orderly markets if a technical or systems issue occurs at the 
Exchange, NES, or a routing destination.\70\ The Exchange or NES will 
be required to provide notice of the cancelation to all affected 
Members as soon as practicable.\71\
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    \68\ See proposed ISE Rule 1904(a).
    \69\ See proposed ISE Rule 1904(b).
    \70\ See proposed ISE Rule 1904(a).
    \71\ See id.
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    Pursuant to the proposal, NES will be required to maintain an error 
account for the purpose of addressing error positions that result from 
a technical or systems issue at the Exchange, NES, a routing 
destination, or an unaffiliated third-party routing broker.\72\ For 
purposes of this rule, an error position will not include any position 
that results from an order submitted by a Member to the Exchange that 
is executed on the Exchange and automatically processed for clearance 
and settlement on a locked-in basis.\73\ NES will not be permitted to 
(i) accept any positions in its error account from a Member's account 
or (ii) permit any Member to transfer any positions from the Member's 
account to NES's error account.\74\ In other words, NES may not accept 
from a Member positions that are delivered to the Member through the 
clearance and settlement process, even if those positions may have been 
related to a technical or systems issue at the Exchange, NES, a routing 
destination of NES, or an unaffiliated third-party routing broker.\75\ 
If, however, a technical or systems issue results in the Exchange not 
having valid clearing instructions for a Member to a trade, NES may 
assume that Member's side of the trade so that the trade can be 
automatically processed for clearance and settlement on a locked-in 
basis.\76\
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    \72\ See proposed ISE Rule 1904(b).
    \73\ See proposed ISE Rule 1904(b)(1).
    \74\ See proposed ISE Rule 1904(b)(2).
    \75\ See ISE Notice, supra note 4, at 96097-98 n.30. This 
provision would not apply if NES incurred a short position to settle 
a Member's purchase, as the Member would not have had a position in 
its account as a result of the purchase at the time of NES's action. 
Similarly, if a systems issue occurred that caused one Member to 
receive an execution for which there is not an available 
counterparty, action by NES would be required for the positions to 
settle into that Member's account. See id.
     If error positions result in connection with the Exchange's use 
of a third-party routing broker for outbound routing and those 
positions are delivered to NES through the clearance and settlement 
process, NES would be permitted to resolve those positions. If, 
however, such positions were not delivered to NES through the 
clearance and settlement process, then the third-party routing 
broker would resolve the error positions itself, and NES would not 
be permitted to accept the positions. See ISE Notice, supra note 4, 
at 96096 n.23.
    \76\ See proposed ISE Rule 1904(b)(3).
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    In connection with a particular technical or systems issue, the 
Exchange or NES will be required to either (i) assign all resulting 
error positions to Members or (ii) have all resulting error positions 
liquidated. Any determination to assign or liquidate error positions, 
as well as any resulting assignments, will be made in a 
nondiscriminatory fashion.\77\ The Exchange or NES will be required to 
assign all error positions resulting from a particular technical or 
systems issue to the Members affected by that technical or systems 
issue if the Exchange or NES:
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    \77\ See proposed ISE Rule 1904(c).
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    (i) Determines that it has accurate and sufficient information 
(including valid clearing information) to assign the positions to all 
of the Members affected by that technical or systems issue;
    (ii) Determines that it has sufficient time pursuant to normal 
clearance and settlement deadlines to evaluate the information 
necessary to assign the positions to all of the Members affected by 
that technical or systems issue; and
    (iii) Has not determined to cancel all orders affected by that 
technical or systems issue in accordance with proposed ISE Rule 
1904(a).\78\
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    \78\ See proposed ISE Rule 1904(c)(A)(i)-(iii).
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    If the Exchange or NES is unable to assign all error positions 
resulting from a particular technical or systems issue to all of the 
affected Members, or if the Exchange or NES determines to cancel all 
orders affected by the technical or systems issue, then NES will be 
required to liquidate the error positions as soon as practicable.\79\ 
NES will be required to provide complete time and price discretion for 
the trading to liquidate the error positions to a third-party broker-
dealer, and would be prohibited from attempting to exercise any 
influence or control over the timing or methods of such trading.\80\ 
Further, NES will be required to establish and enforce policies and 
procedures that are reasonably designed to restrict the flow of 
confidential and proprietary information between the third-party 
broker-dealer, on one hand, and the Exchange and NES, on the other, 
associated with the liquidation of the

[[Page 10842]]

error positions.\81\ Also, the Exchange and NES will be required to 
make and keep records to document all determinations to treat positions 
as error positions; all determinations to assign error positions to 
Members or to liquidate error positions; and the liquidation of error 
positions through the third-party broker-dealer.\82\
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    \79\ See proposed ISE Rule 1904(c)(B).
    \80\ See proposed ISE Rule 1904(c)(B)(i).
    \81\ See proposed ISE Rule 1904(c)(B)(ii).
    \82\ See proposed ISE Rule 1904(d).
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    The Commission recognizes that technical or systems issues may 
occur, and believes that proposed ISE Rule 1904, in allowing the 
Exchange or NES to cancel orders affected by technical or systems 
issues, should provide a reasonably efficient means for the Exchange to 
handle such orders, and appears reasonably designed to permit the 
Exchange to maintain fair and orderly markets.\83\ The Commission also 
believes that allowing the Exchange to resolve error positions through 
the use of an error account maintained by NES pursuant to the 
procedures set forth in the rule, and as described above, is consistent 
with the Act. The Commission notes that the rule establishes criteria 
for determining which positions are error positions,\84\ and that the 
Exchange or NES, in connection with a particular technical or systems 
issue, will be required to either assign or liquidate all resulting 
error positions.\85\ Also, the Exchange or NES will assign error 
positions that result from a particular technical or systems issue to 
Members only if all such error positions can be assigned to all of the 
Members affected by that technical or systems issue.\86\ If the 
Exchange or NES cannot assign all error positions to all Members, NES 
will liquidate all of those error positions.\87\ In this regard, the 
Commission believes that the new rule appears reasonably designed to 
further just and equitable principles of trade and the protection of 
investors and the public interest, and to help prevent unfair 
discrimination, in that it should help assure the handling of error 
positions will be based on clear and objective criteria, and that the 
resolution of those positions will occur promptly through a transparent 
process.
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    \83\ The Commission notes that ISE stated that the proposed 
amendments to ISE Rule 1904 are designed to maintain fair and 
orderly markets, ensure full trade certainty for market 
participants, and avoid disrupting the clearance and settlement 
process. See ISE Notice, supra note 4, at 96099. The Commission also 
notes that ISE stated that a decision to cancel orders due to a 
technical or systems issue is not equivalent to the Exchange 
declaring self-help against a routing destination pursuant to ISE 
Rule 1901(b)(1)(i). See id. at 96097 n.29.
    \84\ See proposed ISE Rule 1904(b).
    \85\ See proposed ISE Rule 1904(c).
    \86\ See proposed ISE Rule 1904(c)(A).
    \87\ See proposed ISE Rule 1904(c)(B).
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    In addition, the Commission notes that it has previously expressed 
concern about the potential for unfair competition and conflicts of 
interest between an exchange's self-regulatory obligations and its 
commercial interest when the exchange is affiliated with one of its 
members.\88\ The Commission has also previously expressed its concern 
about the potential for misuse of confidential and proprietary 
information.\89\ The Commission believes that the requirement that NES 
provide complete time and price discretion for the liquidation of error 
positions to a third-party broker-dealer, including that NES not 
attempt to exercise any influence or control over the timing or methods 
of such trading, combined with the requirement that the Exchange 
establish and enforce policies and procedures that are reasonably 
designed to restrict the flow of confidential and proprietary 
information to the third-party broker-dealer liquidating such 
positions, should help mitigate the Commission's concerns. In 
particular, the Commission believes that these requirements should help 
assure that none of the Exchange, NES, or the third-party broker-dealer 
is able to misuse confidential or proprietary information obtained in 
connection with the liquidation of error positions for its own benefit. 
The Commission also notes that the Exchange and NES would be required 
to make and keep records to document all determinations concerning 
error positions and resulting assignments or liquidations.\90\ In 
addition, the Commission notes that the proposed procedures for 
cancelling orders and the handling of error positions are consistent 
with procedures the Commission has approved for other exchanges.\91\
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    \88\ See supra notes 21 and 57 and accompanying text.
    \89\ See, e.g., Securities Exchange Act Release No. 67280, supra 
note 23, at 39554.
    \90\ See proposed ISE Rule 1904(d).
    \91\ See, e.g., Securities Exchange Act Release Nos. 66963 (May 
10, 2012), 77 FR 28919 (May 16, 2012) (SR-NYSEArca-2012-22); 67010 
(May 17, 2012), 77 FR 30564 (May 23, 2012) (SR-EDGX-2012-08); 67011 
(May 17, 2012), 77 FR 30562 (May 23, 2012) (SR-EDGA-2012-09); and 
67280, supra note 23. The Commission also notes that ISE's proposed 
rule is consistent with the corresponding rules of the Nasdaq 
Exchanges. See Phlx Rule 1080(m)(v); Nasdaq Options Rules, Chapter 
VI, Section 11(g); BX Options Rules, Chapter VI, Section 11(g).
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IV. Implementation of Proposed Rule Change

    ISE stated that it intends to begin implementation of the proposed 
rule change in the second quarter of 2017, in tandem with a technology 
migration to Nasdaq INET architecture, and that the migration will be 
on a symbol-by-symbol basis. ISE has represented that it will issue an 
alert to Members to announce the relevant migration date for specific 
symbols.\92\ ISE explained that the rules in ISE Chapter 19, including 
ISE Rules 1901, 1903, 1904, and 1905, are incorporated by reference 
into the rulebooks of ISE Gemini and ISE Mercury.\93\ ISE Gemini and 
ISE Mercury submitted proposed rule changes that, among other things, 
would permit ISE Gemini and ISE Mercury to each use NES to route 
options orders outbound to away markets, route options orders inbound 
from the Affiliated Exchanges, and utilize the same procedures for 
cancellation of orders and handling of error accounts described 
herein.\94\ ISE stated that it intends to begin implementation of the 
proposed rule changes for ISE Gemini and ISE Mercury in the first 
quarter and third quarter of 2017, respectively, on a symbol-by-symbol 
basis. ISE further represented that it will add notations in each 
rulebook to cross-reference the amended rule text and clarify the 
respective implementation dates.\95\
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    \92\ See ISE Notice, supra note 4, at 96098.
    \93\ See id.
    \94\ See Securities Exchange Act Release Nos. 79664, supra note 
49; and 79663, supra note 49. The Commission is also today approving 
these proposed rule changes. See ISE Gemini and ISE Mercury Exchange 
Routing Order, supra note 49.
    \95\ See ISE Notice, supra note 4, at 96098.
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III. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\96\ that the proposed rule change (SR-ISE-2016-27), as modified by 
Amendment No. 1, be, and hereby is, approved.
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    \96\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\97\
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    \97\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-02991 Filed 2-14-17; 8:45 am]
 BILLING CODE 8011-01-P


