Self-Regulatory Organizations; International Securities Exchange, Inc.; Notice of Filing and Order Granting Accelerated Approval of a Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Relating to the Preferencing of Orders to Exchange Market Makers, 35146-35151 [E5-3095]
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35146
Federal Register / Vol. 70, No. 115 / Thursday, June 16, 2005 / Notices
Order or BOX-Top Order interacts with
a PIP Order before the PIP’s conclusion.
This data should aid the Commission in
evaluating the effect of these rules. The
following information will be provided:
(1) The number of times that a Market
Order or BOX-Top Order in the same
series on the same side of the market as
the PIP Order prematurely terminated
the PIP, and (a) the number of times
such orders were entered by the same
(or affiliated) firm that initiated the PIP
that was terminated, and (b) the number
of times such orders were entered by a
firm (or an affiliate of such firm) that
participated in the execution of the PIP
Order;
(2) For the orders addressed in each
of 1(a) and 1(b) above, the percentage of
PIP premature terminations due to the
receipt of a Market Order or BOX-Top
Order in the same series on the same
side of the market as the PIP Order that
occurred within one second of the start
of the PIP; the percentage that occurred
between one and two seconds of the
start of the PIP; and the percentage that
occurred between two and three
seconds of the start of the PIP; and the
average amount of price improvement
provided to the PIP Order where the PIP
is prematurely terminated during each
of these time periods;
(3) The number of times that a Market
Order or BOX-Top Order in the same
series on the opposite side of the market
as the PIP Order immediately executed
against the PIP Order, and (a) the
number of times such orders were
entered by the same (or affiliated) firm
that initiated the PIP, and (b) the
number of times such orders were
entered by a firm (or an affiliate of such
firm) that participated in the execution
of the PIP Order;
(4) For the orders addressed in each
of 3(a) and 3(b) above, the percentage of
PIP early executions due to the receipt
of a Market Order or BOX-Top Order in
the same series on the opposite side of
the market as the PIP Order that
occurred within one second of the start
of the PIP; the percentage that occurred
between one and two seconds of the
start of the PIP; and the percentage that
occurred between two and three
seconds of the start of the PIP; and the
average amount of price improvement
provided to the PIP Order where the PIP
Order is immediately executed during
each of these time periods; and
(5) The average amount of price
improvement provided to the PIP Order
when the PIP runs the full three
seconds.
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V. Accelerated Approval of
Amendment No. 4
SECURITIES AND EXCHANGE
COMMISSION
Pursuant to Section 19(b)(2) of the
Act,21 the Commission may not approve
any proposed rule change, or
amendment thereto, prior to the 30th
day after the date of publication of
notice of the filing thereof, unless the
Commission finds good cause for so
doing and do publishes its reasons for
so finding. The Commission hereby
finds good cause for approving
Amendment No. 4 to the proposal prior
to the 30th day after publishing notice
of Amendment No. 4 in the Federal
Register. The Commission believes that
the proposed revisions made by
Amendment No. 4 simplify and clarify
the proposed rule change and do not
change its substance. As such, the
Commission believes it is appropriate to
accelerate approval of Amendment No.
4 so that BSE can implement the
proposed rule change without delay. In
addition, in Amendment No. 4, BSE
represents that it will provide specified
information each month that the
Commission believes will aid it in its
evaluation of the PIP. Accordingly,
pursuant to Section 19(b)(2) of the
Act,22 the Commission finds good cause
to approve Amendment No. 4 prior to
the 30th day after notice of Amendment
No. 4 is published in the Federal
Register.
[Release No. 34–51818; File No. SR–ISE–
2005–18]
VI. Conclusion
For the foregoing reasons, the
Commission finds that the proposed
rule change, as amended, is consistent
with the Act and the rules and
regulations thereunder applicable to a
national securities exchange, and, in
particular, with Section 6(b)(5) of the
Act.23
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,24 that the
proposed rule change (SR–BSE–2004–
51) and Amendment Nos. 1, 2, and 3 are
approved; and that Amendment No. 4
thereto is approved on an accelerated
basis.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.25
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5–3093 Filed 6–15–05; 8:45 am]
BILLING CODE 8010–01–P
PO 00000
21 15
U.S.C. 78s(b)(2).
U.S.C. 78s(b)(2).
23 15 U.S.C. 78f(b)(5).
24 15 U.S.C. 78s(b)(2).
25 17 CFR 200.30–3(a)(12).
22 15
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Self-Regulatory Organizations;
International Securities Exchange, Inc.;
Notice of Filing and Order Granting
Accelerated Approval of a Proposed
Rule Change and Amendment Nos. 1
and 2 Thereto Relating to the
Preferencing of Orders to Exchange
Market Makers
June 10, 2005.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on March 31,
2005, the International Securities
Exchange, Inc. (‘‘ISE’’ or ‘‘Exchange’’)
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. On May
31, 2005, the Exchange filed
Amendment No. 1 to the proposed rule
change.3 On June 7, 2005, the Exchange
filed Amendment No. 2.4 The
Commission is publishing this notice to
solicit comments on the proposed rule
change, as amended, from interested
persons and is approving the proposal,
as amended, on an accelerated basis, for
a pilot period through July 22, 2005.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange proposes to amend the
allocation procedures contained in
Exchange Rule 713 to allow Electronic
Access Members to designate ‘‘Preferred
Market Makers’’ on the Electronic
Access Members’’ orders (i.e.,
‘‘preference’’ orders to a particular
market maker), who would receive an
enhanced allocation if such market
maker is quoting at the national best bid
or offer (‘‘NBBO’’) at the time such order
is received by the Exchange. The text of
the proposed rule change is set forth
below. Italics indicate additions;
[brackets] indicate deletions.
*
*
*
*
*
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Form 19b–4 dated May 31, 2005
(‘‘Amendment No. 1’’). Amendment No. 1 replaced
and superseded the original filing in its entirety.
4 See Partial Amendment dated June 6, 2005
(‘‘Amendment No. 2’’). In Amendment No. 2, the
Exchange proposed that the length of the pilot
period for the proposed rule change be reduced
from one year from the date of approval to six
weeks from the date of approval. Amendment No.
2 also modified the Exchange’s representations
regarding surveillance in note 10 infra.
2 17
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Rule 713. Priority of Quotes and Orders
No change.
Supplementary Material to Rule 713
.01 no change.
(a) Subject to the two limitations in
subparagraphs (b) and (c) below and
subject to paragraph .03 (Preferenced
Orders), Non-Customer Orders and
market maker quotes at the best price
receive allocations based upon the
percentage of the total number of
contracts available at the best price that
is represented by the size of the NonCustomer Order or quote;
(b) no change.
(c) no change.
.02 no change.
.03 Preferenced Orders. For a pilot
period ending [insert date six-weeks
from approval], an Electronic Access
Member may designate a ‘‘Preferred
Market Maker’’ on orders it enters into
the System (‘‘Preferenced Orders’’).
(a) A Preferred Market Maker may be
the Primary Market Maker appointed to
the options class or any Competitive
Market Maker appointed to the options
class.
(b) If the Preferred Market Maker is
not quoting at a price equal to the NBBO
at the time the Preferenced Order is
received, the allocation procedure
contained in paragraph .01 shall be
applied to the execution of the
Preferenced Order.
(c) If the Preferred Market Maker is
quoting at the NBBO at the time the
Preferenced Order is received, the
allocation procedure contained in
paragraph .01 shall be applied to the
execution of the Preferenced Order
except that the Primary Market Maker
will not receive the participation rights
described in paragraphs .01(b) and (c),
and instead the Preferred Market Maker
shall have participation rights equal to
the greater of:
(i) the proportion of the total size at
the best price represented by the size of
its quote, or
(ii) sixty percent (60%) of the
contracts to be allocated if there is only
one (1) other Non-Customer Order or
market maker quotation at the best price
and forty percent (40%) if there are two
(2) or more other Non-Customer Orders
and/or market maker quotes at the best
price.
*
*
*
*
*
Rule 804. Market Maker Quotations
(a) through (d) no change.
(e) Continuous Quotes. A market
maker must enter continuous quotations
for the options classes to which it is
appointed pursuant to the following:
(1) Primary Market Makers. Primary
Market Makers must enter continuous
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quotations and enter into any resulting
transactions in all of the series listed on
the Exchange of the options classes to
which he is appointed on a daily basis.
(2) Competitive Market Makers. (i) On
any given day, a Competitive Market
Maker must participate in the opening
rotation and make markets and enter
into any resulting transactions on a
continuous basis in all of the series
listed on the Exchange of at least sixty
percent (60%) of the options classes for
the Group to which the Competitive
Market Maker is appointed or 60
options classes in the Group, whichever
is lesser. [and all the series of such
options classes listed on the Exchange.]
(ii) Whenever a Competitive Market
Maker enters a quote [or order] in an
options class to which it is appointed,
it must maintain continuous quotations
for all series of the options class listed
on the Exchange [within the same
expiration month] until the close of
trading that day[; provided, however, if
such quote or order is entered in an
options series during the month in
which such series expires, the
Competitive Market Maker must
participate in the opening rotation and
maintain continuous quotations for all
series in that month each day through
their expiration].
(iii) A Competitive Market Maker may
be called upon by an Exchange official
designated by the Board to submit a
single quote or maintain continuous
quotes in one or more of the series of an
options class to which the Competitive
Market Maker is appointed whenever, in
the judgment of such official, it is
necessary to do so in the interest of fair
and orderly markets.
*
*
*
*
*
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 III below. The
Exchange has prepared summaries, set
forth in Sections A, B, and C below, of
the most significant aspects of such
statements.
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35147
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
According to the Exchange, the
purpose of the proposed rule change is
to assure that the Exchange remains
competitive with other options
exchanges that have proposed to allow
order-flow providers to designate or
‘‘preference’’ non-specialist market
makers, and to provide enhanced
allocations to those preferenced market
makers in order to reward them for
attracting order flow to the Exchange.5
The Exchange proposes to implement
the rule change on a six-week pilot
basis.
The proposal amends the Exchange’s
procedure for allocating trades among
market makers and non-customer orders
under Exchange Rule 713 to provide an
enhanced allocation to a ‘‘Preferred
Market Maker’’ when the Preferred
Market Maker is quoting at the NBBO.
Specifically, under the proposal, an
Electronic Access Member may
designate any market maker appointed
to an options class to be a Preferred
Market Maker on orders the Electronic
Access Member enters into the
Exchange’s system (‘‘Preferenced
Orders’’). If the Preferred Market Maker
is not quoting at the NBBO at the time
the Preferenced Order is received, the
Exchange’s existing allocation and
execution procedures would be applied
to the execution.6
Under existing Exchange Rule 713,
Supplementary Material .01, no market
participant can execute a greater
number of contracts than is associated
with the price of the market
participant’s existing interest. After all
Public Customer Orders are filled, NonCustomer Orders and market maker
quotes at the best price automatically
receive allocations based upon the
percentage of the total number of
contracts available at the best price that
is represented by the size of the NonCustomer Order or quote (i.e., pro-rata
based on size). However, if the Primary
Market Maker is quoting at the best
price, it automatically receives an
enhanced participation equal to the
greater of: (i) The proportion of the total
5 See Securities Exchange Act Release Nos. 51759
(May 27, 2005), 70 FR 32860 (June 6, 2005) (order
approving SR–Phlx–2004–91); and 51779 (June 2,
2005), 70 FR 33564 (June 8, 2005) (order approving
SR–CBOE–2004–71).
6 Marketable customer orders are not
automatically executed at prices inferior to the
NBBO. If the Exchange’s best bid or offer is inferior
to the NBBO, the marketable customer order is
handled by the Primary Market Maker according to
Exchange Rule 803(c).
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Federal Register / Vol. 70, No. 115 / Thursday, June 16, 2005 / Notices
size at the best price represented by the
size of the Primary Market Maker’s
quote, or (ii) 60 percent of the contracts
to be allocated if there is only one other
Non-Customer Order or market maker
quote at the best price, 40 percent if
there are two other Non-Customer
Orders and/or market maker quotes at
the best price, and 30 percent if there
are more than two other Non-Customer
Orders and/or market maker quotes at
the best price. In addition, the Primary
Market Maker has priority to execute
orders for five contracts or fewer if the
Primary Market Maker is quoting at the
best price.7
Under the proposal, if a Preferred
Market Maker is quoting at the NBBO at
the time a Preferenced Order is
received, the allocation procedure
would be modified so that the Preferred
Market Maker—instead of the Primary
Market Maker 8—would receive an
enhanced 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 (ii) 60 percent of the
contracts to be allocated if there is only
one other Non-Customer Order or
market maker quote at the best price and
40 percent if there are two or more other
Non-Customer Orders and/or market
maker quotes at the best price.9
Unexecuted contracts remaining after
the Preferred Market Maker’s allocation
would be allocated pro-rata based on
size as described above.10
As part of this proposal, the Exchange
also proposes to increase the quotation
obligations of Competitive Market
Makers. Pursuant to current Exchange
Rule 802, the Exchange allocates
options classes into ten Groups and then
appoints Primary Market Makers and
Competitive Market Makers to the
Groups. Under current Exchange Rule
804(e), a Primary Market Maker is
required to maintain continuous
quotations in all of the series of all of
the options classes to which the Primary
Market Maker is appointed, i.e., all of
the series in all of the options classes in
the Primary Market Maker’s appointed
Group. Competitive Market Makers are
required to maintain continuous
quotations in all of the series in at least
60 percent of the options classes in the
Group to which they are appointed.
However, a Competitive Market Maker
may enter continuous quotes in less
than all of the series in the remaining 40
percent of the classes in its appointed
Group, subject to a requirement to
maintain continuous quotes in those
and related series through the end of the
day and, in certain circumstances,
through expiration of the series.
Because under the proposal, all
Competitive Market Makers would be
eligible to be designated as a Preferred
Market Maker by Electronic Access
Members and receive an enhanced
allocation in any options series in
which the Competitive Market Maker is
quoting at the NBBO, the Exchange
proposes to amend Exchange Rule
804(e) to require that a Competitive
Market Maker maintain continuous
quotes in all of the series of any options
class it is quoting. Specifically, under
the proposed amendment to Exchange
Rule 804(e), a Competitive Market
Maker would continue to be required to
make markets in all of the series of a
minimum number of options classes in
its appointed Group, but also would be
required to enter continuous quotes in
all of the series of any options class in
which it seeks to make markets above
the minimum requirement. Accordingly,
a Competitive Market Maker would be
required to maintain continuous
quotations in all of the series of any
options classes in which it might
receive an enhanced participation as the
result of being designated as a Preferred
Market Maker.11
The proposal also seeks to amend the
60 percent requirement to more fairly
apply the minimum quotation
requirement on Competitive Market
Makers. The number of options classes
allocated to the ten different Groups
changes as options classes are listed and
delisted by the Exchange. Because the
minimum requirement is a percentage of
the number of options classes in a
Group, some Competitive Market
7 According to the Exchange, all allocations are
automatically performed by the Exchange’s system.
8 A Primary Market Maker may be the Preferred
Market Maker, in which case such market maker
would receive the enhanced allocation for Preferred
Market Makers.
9 According to the Exchange, all allocations are
automatically performed by the Exchange’s system.
10 In Amendment No. 2, the Exchange stated that
Electronic Access Members and Preferred Market
Makers may not coordinate their actions. Such
conduct would be a violation of Exchange Rule 400
(Just and Equitable Principles of Trade). The
Exchange represented that it will proactively
conduct surveillance for, and enforce against, such
violations.
11 The Exchange proposes to eliminate the
requirement that a market maker start quoting if the
market maker enters an order in an options series.
Under Exchange Rule 805(a), Competitive Market
Makers are not permitted to enter limit orders that
would sit on the limit order book in options in their
appointed Group. The entry of an immediate-orcancel limit order, which either executes
immediately against existing bids or offers in the
market or is cancelled, does not cause a market
maker to disseminate a bid or offer. Accordingly, a
Competitive Market Maker that enters an order
would not become eligible to receive an enhanced
allocation as a Preferred Market Maker, and
therefore should not become subject to the
increased obligation to quote all of the series of an
options class.
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Makers are required to maintain
continuous quotes in a much larger
number of options classes than others.
While the Exchange believes a
percentage-based minimum requirement
remains appropriate, it believes there
should be a limit to the number of
options classes a Competitive Market
Maker is required to continuously
quote. Accordingly, the Exchange
proposes to amend Exchange Rule
804(e)(2) to provide that a Competitive
Market Maker must quote at least 60
percent of the options classes in the
Group or 60 options classes, whichever
is lesser. The Exchange believes that
this change would assure that
Competitive Market Makers appointed
to Groups with more than 100 options
classes would not be required to quote
more than 60 options classes. The
proposed amendment would not change
the minimum requirement for any
Competitive Market Maker appointed to
a Group with less than 100 options
classes, which, according to the
Exchange, currently is the case in eight
of the ten Groups.
The Exchange believes the proposed
rule change is a necessary competitive
response to the preferencing proposals
filed by other options exchanges and
will help the Exchange attract and retain
order flow. The Exchange further
believes that such order flow will add
depth and liquidity to the Exchange’s
markets and enable the Exchange to
continue to compete effectively with
other options exchanges.
2. Statutory Basis
The Exchange believes that the
proposed rule change is consistent with
Section 6(b)(5) of the Act,12 in that the
proposed rule change is designed to
promote just and equitable principles of
trade, remove impediments to and
perfect the mechanism of a free and
open market and a national market
system because a Preferred Market
Maker must be quoting at the NBBO in
order to receive the proposed enhanced
allocation.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
The Exchange believes that 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.
12 15
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U.S.C. 78f(b)(5).
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Federal Register / Vol. 70, No. 115 / Thursday, June 16, 2005 / Notices
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
the proposed rule change. The Exchange
has not received any written comments
from members or other interested
parties. However, on April 6, 2005,
written comments were submitted to the
Commission by a member regarding the
proposed rule change.13 This written
comment opposed the proposed rule
change, as well as similar proposals by
the Philadelphia Stock Exchange, Inc.
(‘‘Phlx’’) and the Chicago Board Options
Exchange, Incorporated (‘‘CBOE’’).14
III. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change, as amended, is consistent with
the Act and whether the pilot time
frame is appropriate. Comments may be
submitted by any of the following
methods:
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for inspection and copying in
the Commission’s Public Reference
Room. Copies of such filing 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–2005–18 and should be
submitted on or before July 7, 2005.
IV. Commission’s Findings and Order
Granting Accelerated Approval of the
Proposed Rule Change
The Exchange has asked the
Commission to approve the proposed
rule change on an accelerated basis for
six weeks while the Commission seeks
comment on the proposed rule change.
The Exchange believes the proposed
rule change is substantially similar to
rule changes by Phlx and CBOE that
were recently approved by the
Electronic Comments
Commission.15 After careful
consideration, the Commission finds
• Use the Commission’s Internet
that the proposed rule change is
comment form (https://www.sec.gov/
consistent with the requirements of
rules/sro.shtml); or
• Send an e-mail to ruleSection 6 of the Act16 and the rules and
comments@sec.gov. Please include File
regulations thereunder applicable to a
Number SR–ISE–2005–18 on the subject national securities exchange17, and, in
line.
particular, the requirements of Section
6(b)(5) of the Act.18 Section 6(b)(5)
Paper Comments
requires, among other things, that the
• Send paper comments in triplicate
rules of a national securities exchange
to Jonathan G. Katz, Secretary,
be designed to prevent fraudulent and
Securities and Exchange Commission,
manipulative acts and practices, to
100 F Street, NE., Washington, DC
promote just and equitable principles of
20549–9303. All submissions should
trade, to remove impediments to and
refer to File Number SR–ISE–2005–18.
perfect the mechanism of a free and
This file number should be included on open market and a national market
the subject line if e-mail is used. To help system, and, in general, to protect
the Commission process and review
investors and the public interest.
your comments more efficiently, please
Pursuant to Section 19(b)(2) of the
use only one method. The Commission
Act,19 the Commission may not approve
will post all comments on the
any proposed rule change, or
Commission’s Internet Web site (https://
www.sec.gov/rules/sro.shtml). Copies of amendment thereto, prior to the 30th
day after the date of publication of
the submission, all subsequent
notice of the filing thereof, unless the
amendments, all written statements
Commission finds good cause for so
with respect to the proposed rule
doing and publishes its reasons for so
change that are filed with the
finding. The Commission hereby finds
Commission, and all written
good cause for approving the proposed
communications relating to the
rule change, as amended, prior to the
proposed rule change between the
Commission and any person, other than
15 Supra note 5.
those that may be withheld from the
16 15
13 Letter
from Matthew B. Hinerfeld, Managing
Director and Deputy General Counsel, Citadel
Investment Group, L.L.C., on behalf of Citadel
Derivatives Group LLC, to Jonathan G. Katz,
Secretary, Commission, dated April 6, 2005.
14 Supra note 5.
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U.S.C. 78f.
approving this proposal, the commission has
considered the proposed rule’s impact on
efficiency, competition, and capital formation. 15
U.S.C. 78c(f).
18 15 U.S.C. 78f(b)(5).
19 15 U.S.C. 78s(b)(2).
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35149
30th day after publishing notice thereof
in the Federal Register.
The Commission received one
comment letter opposing the proposal.20
This commenter criticized the proposal
because the commenter believes the
proposal would grant a Preferred Market
Maker a guarantee based solely on being
at the NBBO rather than on such
Preferred Market Maker’s obligations.21
The commenter asserts that the proposal
would reward a Preferred Market Maker
for the Preferred Market Maker’s
relationships with order flow providers
rather than the quality of the Preferred
Market Maker’s quotes, and therefore
the proposal would have a negative
impact on price competition.22 In
addition, this commenter notes that the
proposal would extend the allocation
entitlement to Competitive Market
Makers, who have fewer obligations to
the market than Primary Market
Makers.23
The Commission has previously
approved rules that guarantee a Primary
Market Maker a portion of each order
when the Primary Market Maker’s quote
is equal to the NBBO.24 The
Commission has closely scrutinized
exchange rule proposals to adopt or
amend a participation guarantee where
the percentage of participation would
rise to a level that could have a material
adverse impact on quote competition
within a particular exchange.25 Because
the proposal would not increase the
overall percentage of an order that is
guaranteed beyond the currently
acceptable threshold, but instead would
allow any Competitive Market Maker
appointed to an options class to be
designated as a Preferred Market Maker
and be eligible to receive a participation
guarantee instead of the Primary Market
Maker, the Commission does not believe
that the proposal will negatively impact
quote competition on the Exchange.
Under the proposal, the remaining
portion of each order will still be
allocated based on the competitive
bidding of market participants.
In addition, a Preferred Market Maker
will have to be quoting at the NBBO at
20 See supra note 13. This written comment
opposed the proposed rule change, as well as
similar proposals by the Phlx and the CBOE. See
supra note 5.
21 See supra note 13 at 1 and 2.
22 See supra note 13 at 2.
23 See supra note 13 at 2. The Exchange refers to
its specialists as ‘‘Primary Market Makers.’’
24 See Securities Exchange Act Release Nos.
42808 (May 22, 2000), 65 FR 34515 (May 30, 2000)
(SR–ISSE–2000–01); 44340 (May 22, 2001), 66 FR
29373 (May 30, 2001) (SR–ISE–2001–46); and 44641
(August 2, 2001), 65 FR 41643 (August 8, 2001)
(SR–ISE–2001–17).
25 See, e.g., Securities Exchange Act Release No.
43100 (July 31, 2000), 65 FR 48788 (August 9,
2000).
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Federal Register / Vol. 70, No. 115 / Thursday, June 16, 2005 / Notices
the time the Preferenced Order is
received to capitalize on the
participation guarantee. The
Commission believes it is critical that
the Preferred Market Maker cannot step
up and match the NBBO after it receives
an order, but must be publicly quoting
at that price when the order is received.
In this regard, the Exchange’s proposal
prohibits Electronic Access Members
and Preferred Market Makers from
coordinating their actions. The
Exchange has stated that such
coordinated actions would violate
Exchange Rule 400, Just and Equitable
Principles of Trade, and will proactively
conduct surveillance for, and enforce
against, such violations.26
The commenter also states that
specialists (i.e., Primary Market Makers)
currently receive participation
entitlements based on their obligations
to the market. The commenter believes
that the proposal, by allowing any
market maker quoting at the NBBO to
receive a guaranteed percentage of an
order without in turn increasing the
market maker’s obligations to the
market, would ‘‘eliminate the incentive
to be a specialist, thereby potentially
leaving the obligations of the specialist
to the market unfulfilled.’’ 27 The
Commission does not believe that the
proposal will result in the role of the
specialist going unfulfilled, and notes
that it recently approved an options
exchange without specialists.28
Moreover, specialists’ obligations to the
market have been reduced through other
changes, including greater automation
of functions previously handled
manually by the specialist. While this
proposal may reduce the incentive to be
a specialist, the Commission does not
believe that makes the proposal
inconsistent with the Act. Finally, the
Commission notes that, as part of this
proposal, the Exchange proposes to
increase the quotation obligations of
Competitive Market Makers. Currently,
a Primary Market Maker is required to
maintain continuous quotations in all of
the series of all of the options classes to
which the Primary Market Maker is
appointed. Competitive Market Makers
are required to maintain continuous
quotations in all of the series in at least
60 percent of the options classes in the
Group to which they are appointed.
However, a Competitive Market Maker
may enter continuous quotes in less
than all of the series in the remaining 40
percent of the classes in its appointed
Group, subject to a requirement to
maintain continuous quotes in those
and related series through the end of the
day and, in certain circumstances,
through expiration of the series.29
Under the proposal, since all
Competitive Market Makers would be
eligible to be designated as a Preferred
Market Maker by Electronic Access
Members and receive an enhanced
allocation in any options series in
which the Competitive Market Maker is
quoting at the NBBO, the Exchange
proposes to require that a Competitive
Market Maker maintain continuous
quotes in all of the series of any options
class it is quoting. Specifically, with
respect to any series of any options class
in which a Competitive Market Maker
seeks to make markets above the
minimum requirement, the proposal
would require a Competitive Market
Maker to enter continuous quotes in all
of the series of any options class in
which it enters quotes. Accordingly, the
proposed rule change would require a
Competitive Market Maker to maintain
continuous quotations in all of the
series of any options classes in which it
might receive an enhanced participation
as the result of being designated as a
Preferred Market Maker.30
The proposal also seeks to amend the
minimum quotation requirement on
Competitive Market Makers to provide
that a Competitive Market Maker must
quote at least 60 percent of the options
classes in the Group or 60 options
classes, whichever is lesser.31 Under the
current rule, because the minimum
quotation requirement is 60 percent of
the number of options classes in a
Group, and the number of options
classes in a Group varies, according to
the Exchange, some Competitive Market
Makers are required to maintain
continuous quotes in a much larger
number of options classes than other
Competitive Market Makers. The
Commission notes that this change to
the quotation requirement only affects
Competitive Market Makers appointed
to Groups with more than 100 options
classes and that such Competitive
Market Makers would still be required
to quote continuous in 60 options
classes.32 The Commission also notes
that the proposed change to the
quotation requirement does not affect
the proposed requirement that a
Competitive Market Maker maintain
29 See
26 See
Amendment No. 2.
27 Supra note 13 at 2.
28 See Securities Exchange Act Release No. 49068
(January 13, 2004), 69 FR 2775 (January 20, 2004)
(SR–BSE–2002–15) (order approving trading rules
for the Boston Options Exchange Facility).
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Exchange Rule 804(e).
proposed Exchange Rule 804(e).
31 See proposed Exchange Rule 804(e)(2).
32 The proposed amendment would not change
the minimum requirement for any Competitive
Market Maker appointed to a Group with less than
100 options classes.
PO 00000
30 See
Frm 00089
Fmt 4703
Sfmt 4703
continuous quotes in a series in order to
be eligible to receive a participation
guarantee for that series.
The Commission emphasizes that
approval of this proposal does not affect
a broker-dealer’s duty of best execution.
A broker-dealer has a legal duty to seek
to obtain best execution of customer
orders, and any decision to preference a
particular Primary Market Maker or
Competitive Market Maker must be
consistent with this duty.33 A brokerdealer’s duty of best execution derives
from common law agency principles
and fiduciary obligations, and is
incorporated in SRO rules and, through
judicial and Commission decisions, the
antifraud provisions of the federal
securities laws.34
The duty of best execution requires
broker-dealers to execute customers’
trades at the most favorable terms
reasonably available under the
circumstances, i.e., at the best
reasonably available price.35 The duty
of best execution requires broker-dealers
33 See, e.g., Newton v. Merrille, Lynch, Pierce,
Fenner & Smith, Inc., 135 F.3d 266, 269–70, 274 (3d
Cir.), cert. denied, 525 U.S. 811 (1998); Certain
Market Making Activities on Nasdaq, Securities
Exchange Act Release No. 40900 (January 11, 1999)
(settled case) (citing Sinclair v. SEC, 444 F.2d 399
(2d Cir. 1971); Arleen Hughes, 27 SEC 629.636
(1948), aff’d sub nom. Hughes v. SEC. 174 F.2d 969
(D.C. Cir. 1949)). See also Order Execution
Obligations, Securities Exchange Act Release No.
37619A (September 6, 1996), 61 FR 48290
(September 12, 1996) (‘‘Order Handling Rules
Release’’).
34 Order Handling Rules Release, 61 FR at 48322,
See also Newton, 135 F.3d at 270. Failure to satisfy
the duty of best execution can constitute fraud
because a broker-dealer, in agreeing to execute a
customer’s order, makes an implied representation
that it will execute it in a manner that maximizes
the customer’s economic gain in the transaction.
See Newton, 135 F.3d at 273 (‘‘[T]he basis for the
duty of best execution is the mutual understanding
that the client is engaging in the trade-and retaining
the services of the broker as his agent-solely for the
purpose of maximizing his own economic benefit,
and that the broker receives her compensation
because she assists the client in reaching that
goal.’’); Marc N. Geman, Securities Exchange Act
Release No. 43963 (February 14, 2001) (citing
Newton, but concluding that respondent fulfilled
his duty of best execution). See also Payment for
Order Flow, Securities Exchange Act Release No.
34902 (October 27, 1994), 59 FR 55006, 55009
(November 2, 1994) (‘‘Payment for Order Flow Final
Rules’’). If the broker-dealer intends not to act in a
manner that maximizes the customer’s benefit when
he accepts the order and does not disclose this to
the customer, the broker-dealer’s implied
representation is false. See Newton, 135 F.3d at
273–274.
35 Newton, 135 F.3d at 270. Newton also noted
certain factors relevant to best execution-order size,
trading characteristics of the security, speed of
execution, clearing costs, and the cost and difficulty
of executing an order in a particular market. Id. at
270 n. 2 (citing Payment for Order Flow, Securities
Exchange Act Release No. 33026 (October 6, 1993),
58 FR 52934, 52937–38 (October 13, 1993)
(Proposed Rules)). See In re E.F. Hutton & Co.
(‘‘Manning’’), Securities Exchange Act Release No.
25887 (July 6, 1988). See also Payment for Order
Flow Final Rules, 59 FR at 55008–55009.
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Federal Register / Vol. 70, No. 115 / Thursday, June 16, 2005 / Notices
to periodically assess the quality of
competing markets to assure that order
flow is directed to the markets
providing the most beneficial terms for
their customer orders.36 Broker-dealers
must examine their procedures for
seeking to obtain best execution in light
of market and technology changes and
modify those practices if necessary to
enable their customers to obtain the best
reasonably available prices.37 In doing
so, broker-dealers must take into
account price improvement
opportunities, and whether different
markets may be more suitable for
different types of orders or particular
securities.38
The Commission notes that the
proposed rule change would be
implemented on a pilot basis for six
weeks. During this time, the
Commission intends to evaluate the
impact of the proposal on the options
markets to determine whether it would
be beneficial to customers and to the
options markets as a whole before
approving any request to extend the
pilot program. The Commission believes
that the proposed rule change’s sixweek pilot period will allow the
Commission an opportunity of solicit
comments on the proposed rule change
prior to considering whether the
approve such pilot program for an
extended period. Therefore, the
Commission finds good cause,
consistent with Section 19(b)(2) of the
Act,39 to approve the proposal, as
amended, on an accelerated basis.
36 Order Handling Rules Release, 61 FR at 48322–
48333 (‘‘In conducting the requisite evaluation of its
internal order handling procedures, a broker-dealer
must regularly and rigorously examine execution
quality likely to be obtained from different markets
or market makers trading a security.’’). See also
Newton, 135 F.3d at 271; Market 2000; An
Examination of Current Equity Market
Developments V–4 (SEC Division of Market
Regulation January 1994) (‘‘Without specific
instructions from a customer, however, a brokerdealer should periodically assess the quality of
competing markets to ensure that its order flow is
directed to markets providing the most
advantageous terms for the customer’s order.’’);
Payment for Order Flow Final Rules, 59 FR at
55009.
37 Order Handling Rules, 61 FR at 48323.
38 Order Handling Rules, 61 FR at 48323. For
example, in connection with orders that are to be
executed at a market opening price, ‘‘[b]rokerdealers are subject to a best execution duty in
executing customer orders at the opening, and
should take into account the alternative methods in
determining how to obtain best execution for their
customer orders.’’ Disclosure of order Execution
and Routing Practices, Securities Exchange Act
Release No. 43590 (November 17, 2000), 65 FR
75414, 75422 (December 1, 2000) (adopting new
Rules 11Ac1–5 and 11Ac1–6 under the Act and
noting that alternative methods offered by some
Nasdaq market centers for pre-open orders included
the mid-point of the spread or at the bid or offer).
39 15 U.S.C. 78s(b)(2).
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For these reasons, the Commission
believes that the proposal is consistent
with the requirements of Section 6(b)(5)
of the Act,40 and will not jeopardize
market integrity or the incentive for
market participants to post competitive
quotes.41
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,42 that the
proposed rule change (SR–ISE–2005–
18), as amended, which institutes the
pilot program until July 22, 2005, is
hereby approved on an accelerated
basis.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.43
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5–3095 Filed 6–15–05; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–51814; File No. SR–NASD–
2004–185]
Self-Regulatory Organizations;
National Association of Securities
Dealers, Inc.; Order Approving a
Proposed Rule Change and
Amendment Nos. 1 and 2 Thereto To
Establish a Unitary Fee Schedule for
Distribution of Real Time Data Feed
Products Containing Nasdaq Market
Center Data
June 9, 2005.
I. Introduction
On December 14, 2004, the National
Association of Securities Dealers, Inc.
(‘‘NASD’’), through its subsidiary, the
Nasdaq Stock Market, Inc. (’’Nasdaq’’),
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 establish a unitary fee
schedule for distribution of real time
data feed products containing Nasdaq
market center data. On February 17,
2005, Nasdaq filed Amendment No. 1 to
the original filing.3 Nasdaq filed
U.S.C. 78f(b)(5).
of this proposal is in no way an
endorsement of payment for order flow by the
Commission.
42 15 U.S.C. 78s(b)(2).
43 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 Amendment No. 1 replaced and superseded the
original proposed rule change in its entirety.
PO 00000
40 15
41 Approval
Frm 00090
Fmt 4703
Sfmt 4703
35151
Amendment No. 2 on April 14, 2005.4
The proposed rule change, as amended,
was published for comment in the
Federal Register on April 28, 2005.5
The Commission received one comment
on the proposed rule change.6 This
order approves the proposed rule
change, as amended.
II. Description of the Proposal
Nasdaq proposes to modify NASD
Rule 7010 to establish a unitary fee
schedule for the distribution of Nasdaq
Market Center real time data feed
products. Nasdaq offers various data
products that firms may purchase and
redistribute either within their own
organizations or to outside parties.
According to Nasdaq, ‘‘distributor fees’’
are designed to encourage broad
distribution of the data, and allow
Nasdaq to recover what it describes as
the relatively high fixed costs associated
with supporting connectivity and
contractual relationships with
distributors. Nasdaq believes that
because the data products and
associated fees were established over
many years, the method of calculating
such fees should be updated.
Accordingly, Nasdaq proposes to
establish a revised monthly distributor
pricing structure for its real time data
feed products that it believes will
allocate equitably data fees across the
customer base of data distributors and
consumers of Nasdaq market data.
Specifically, the proposed rule change
will establish a distributor fee pricing
structure for four real time data feed
products: TotalView, OpenView,
Mutual Fund Quotation Service
(‘‘MFQS’’), and Real Time Index. The
proposed fees will be assessed to
distributors of these real time data feed
products, defined in the proposed rule
change to include any entity that
receives a feed or data file of Nasdaq
data directly from Nasdaq or indirectly
through another entity and then
distributes it either internally (within
that entity) or externally (outside the
entity). The new distributor fees would
not apply to Nasdaq’s Web-based
historical data products, which are
governed by NASD Rule 7010(p), and
they would not apply to data feeds that
are produced pursuant to the national
market system plan governing Nasdaq
stocks (‘‘Nasdaq UTP Plan’’). The
proposed distributor pricing is also
distinct from any per display device or
4 Amendment No. 2 replaced and superseded the
original proposed rule change, as amended.
5 See Securities Exchange Act Release No. 51598
(Apr. 21, 2005), 70 FR 22162.
6 See letter from Gene L. Finn to Jonathan Katz,
Secretary, Securities and Exchange Commission
dated May 17, 2005 (‘‘Finn Letter’’).
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]]>Agencies
[Federal Register Volume 70, Number 115 (Thursday, June 16, 2005)]
[Notices]
[Pages 35146-35151]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-3095]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-51818; File No. SR-ISE-2005-18]
Self-Regulatory Organizations; International Securities Exchange,
Inc.; Notice of Filing and Order Granting Accelerated Approval of a
Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Relating to the
Preferencing of Orders to Exchange Market Makers
June 10, 2005.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on March 31, 2005, the International Securities Exchange, Inc. (``ISE''
or ``Exchange'') 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. On May 31,
2005, the Exchange filed Amendment No. 1 to the proposed rule
change.\3\ On June 7, 2005, the Exchange filed Amendment No. 2.\4\ The
Commission is publishing this notice to solicit comments on the
proposed rule change, as amended, from interested persons and is
approving the proposal, as amended, on an accelerated basis, for a
pilot period through July 22, 2005.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Form 19b-4 dated May 31, 2005 (``Amendment No. 1'').
Amendment No. 1 replaced and superseded the original filing in its
entirety.
\4\ See Partial Amendment dated June 6, 2005 (``Amendment No.
2''). In Amendment No. 2, the Exchange proposed that the length of
the pilot period for the proposed rule change be reduced from one
year from the date of approval to six weeks from the date of
approval. Amendment No. 2 also modified the Exchange's
representations regarding surveillance in note 10 infra.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend the allocation procedures contained
in Exchange Rule 713 to allow Electronic Access Members to designate
``Preferred Market Makers'' on the Electronic Access Members'' orders
(i.e., ``preference'' orders to a particular market maker), who would
receive an enhanced allocation if such market maker is quoting at the
national best bid or offer (``NBBO'') at the time such order is
received by the Exchange. The text of the proposed rule change is set
forth below. Italics indicate additions; [brackets] indicate deletions.
* * * * *
[[Page 35147]]
Rule 713. Priority of Quotes and Orders
No change.
Supplementary Material to Rule 713
.01 no change.
(a) Subject to the two limitations in subparagraphs (b) and (c)
below and subject to paragraph .03 (Preferenced Orders), Non-Customer
Orders and market maker quotes at the best price receive allocations
based upon the percentage of the total number of contracts available at
the best price that is represented by the size of the Non-Customer
Order or quote;
(b) no change.
(c) no change.
.02 no change.
.03 Preferenced Orders. For a pilot period ending [insert date six-
weeks from approval], an Electronic Access Member may designate a
``Preferred Market Maker'' on orders it enters into the System
(``Preferenced Orders'').
(a) A Preferred Market Maker may be the Primary Market Maker
appointed to the options class or any Competitive Market Maker
appointed to the options class.
(b) If the Preferred Market Maker is not quoting at a price equal
to the NBBO at the time the Preferenced Order is received, the
allocation procedure contained in paragraph .01 shall be applied to the
execution of the Preferenced Order.
(c) If the Preferred Market Maker is quoting at the NBBO at the
time the Preferenced Order is received, the allocation procedure
contained in paragraph .01 shall be applied to the execution of the
Preferenced Order except that the Primary Market Maker will not receive
the participation rights described in paragraphs .01(b) and (c), and
instead the Preferred Market Maker shall have participation rights
equal to the greater of:
(i) the proportion of the total size at the best price represented
by the size of its quote, or
(ii) sixty percent (60%) of the contracts to be allocated if there
is only one (1) other Non-Customer Order or market maker quotation at
the best price and forty percent (40%) if there are two (2) or more
other Non-Customer Orders and/or market maker quotes at the best price.
* * * * *
Rule 804. Market Maker Quotations
(a) through (d) no change.
(e) Continuous Quotes. A market maker must enter continuous
quotations for the options classes to which it is appointed pursuant to
the following:
(1) Primary Market Makers. Primary Market Makers must enter
continuous quotations and enter into any resulting transactions in all
of the series listed on the Exchange of the options classes to which he
is appointed on a daily basis.
(2) Competitive Market Makers. (i) On any given day, a Competitive
Market Maker must participate in the opening rotation and make markets
and enter into any resulting transactions on a continuous basis in all
of the series listed on the Exchange of at least sixty percent (60%) of
the options classes for the Group to which the Competitive Market Maker
is appointed or 60 options classes in the Group, whichever is lesser.
[and all the series of such options classes listed on the Exchange.]
(ii) Whenever a Competitive Market Maker enters a quote [or order]
in an options class to which it is appointed, it must maintain
continuous quotations for all series of the options class listed on the
Exchange [within the same expiration month] until the close of trading
that day[; provided, however, if such quote or order is entered in an
options series during the month in which such series expires, the
Competitive Market Maker must participate in the opening rotation and
maintain continuous quotations for all series in that month each day
through their expiration].
(iii) A Competitive Market Maker may be called upon by an Exchange
official designated by the Board to submit a single quote or maintain
continuous quotes in one or more of the series of an options class to
which the Competitive Market Maker is appointed whenever, in the
judgment of such official, it is necessary to do so in the interest of
fair and orderly markets.
* * * * *
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 III below. The Exchange 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
According to the Exchange, the purpose of the proposed rule change
is to assure that the Exchange remains competitive with other options
exchanges that have proposed to allow order-flow providers to designate
or ``preference'' non-specialist market makers, and to provide enhanced
allocations to those preferenced market makers in order to reward them
for attracting order flow to the Exchange.\5\ The Exchange proposes to
implement the rule change on a six-week pilot basis.
---------------------------------------------------------------------------
\5\ See Securities Exchange Act Release Nos. 51759 (May 27,
2005), 70 FR 32860 (June 6, 2005) (order approving SR-Phlx-2004-91);
and 51779 (June 2, 2005), 70 FR 33564 (June 8, 2005) (order
approving SR-CBOE-2004-71).
---------------------------------------------------------------------------
The proposal amends the Exchange's procedure for allocating trades
among market makers and non-customer orders under Exchange Rule 713 to
provide an enhanced allocation to a ``Preferred Market Maker'' when the
Preferred Market Maker is quoting at the NBBO. Specifically, under the
proposal, an Electronic Access Member may designate any market maker
appointed to an options class to be a Preferred Market Maker on orders
the Electronic Access Member enters into the Exchange's system
(``Preferenced Orders''). If the Preferred Market Maker is not quoting
at the NBBO at the time the Preferenced Order is received, the
Exchange's existing allocation and execution procedures would be
applied to the execution.\6\
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\6\ Marketable customer orders are not automatically executed at
prices inferior to the NBBO. If the Exchange's best bid or offer is
inferior to the NBBO, the marketable customer order is handled by
the Primary Market Maker according to Exchange Rule 803(c).
---------------------------------------------------------------------------
Under existing Exchange Rule 713, Supplementary Material .01, no
market participant can execute a greater number of contracts than is
associated with the price of the market participant's existing
interest. After all Public Customer Orders are filled, Non-Customer
Orders and market maker quotes at the best price automatically receive
allocations based upon the percentage of the total number of contracts
available at the best price that is represented by the size of the Non-
Customer Order or quote (i.e., pro-rata based on size). However, if the
Primary Market Maker is quoting at the best price, it automatically
receives an enhanced participation equal to the greater of: (i) The
proportion of the total
[[Page 35148]]
size at the best price represented by the size of the Primary Market
Maker's quote, or (ii) 60 percent of the contracts to be allocated if
there is only one other Non-Customer Order or market maker quote at the
best price, 40 percent if there are two other Non-Customer Orders and/
or market maker quotes at the best price, and 30 percent if there are
more than two other Non-Customer Orders and/or market maker quotes at
the best price. In addition, the Primary Market Maker has priority to
execute orders for five contracts or fewer if the Primary Market Maker
is quoting at the best price.\7\
---------------------------------------------------------------------------
\7\ According to the Exchange, all allocations are automatically
performed by the Exchange's system.
---------------------------------------------------------------------------
Under the proposal, if a Preferred Market Maker is quoting at the
NBBO at the time a Preferenced Order is received, the allocation
procedure would be modified so that the Preferred Market Maker--instead
of the Primary Market Maker \8\--would receive an enhanced 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 (ii) 60 percent of
the contracts to be allocated if there is only one other Non-Customer
Order or market maker quote at the best price and 40 percent if there
are two or more other Non-Customer Orders and/or market maker quotes at
the best price.\9\ Unexecuted contracts remaining after the Preferred
Market Maker's allocation would be allocated pro-rata based on size as
described above.\10\
---------------------------------------------------------------------------
\8\ A Primary Market Maker may be the Preferred Market Maker, in
which case such market maker would receive the enhanced allocation
for Preferred Market Makers.
\9\ According to the Exchange, all allocations are automatically
performed by the Exchange's system.
\10\ In Amendment No. 2, the Exchange stated that Electronic
Access Members and Preferred Market Makers may not coordinate their
actions. Such conduct would be a violation of Exchange Rule 400
(Just and Equitable Principles of Trade). The Exchange represented
that it will proactively conduct surveillance for, and enforce
against, such violations.
---------------------------------------------------------------------------
As part of this proposal, the Exchange also proposes to increase
the quotation obligations of Competitive Market Makers. Pursuant to
current Exchange Rule 802, the Exchange allocates options classes into
ten Groups and then appoints Primary Market Makers and Competitive
Market Makers to the Groups. Under current Exchange Rule 804(e), a
Primary Market Maker is required to maintain continuous quotations in
all of the series of all of the options classes to which the Primary
Market Maker is appointed, i.e., all of the series in all of the
options classes in the Primary Market Maker's appointed Group.
Competitive Market Makers are required to maintain continuous
quotations in all of the series in at least 60 percent of the options
classes in the Group to which they are appointed. However, a
Competitive Market Maker may enter continuous quotes in less than all
of the series in the remaining 40 percent of the classes in its
appointed Group, subject to a requirement to maintain continuous quotes
in those and related series through the end of the day and, in certain
circumstances, through expiration of the series.
Because under the proposal, all Competitive Market Makers would be
eligible to be designated as a Preferred Market Maker by Electronic
Access Members and receive an enhanced allocation in any options series
in which the Competitive Market Maker is quoting at the NBBO, the
Exchange proposes to amend Exchange Rule 804(e) to require that a
Competitive Market Maker maintain continuous quotes in all of the
series of any options class it is quoting. Specifically, under the
proposed amendment to Exchange Rule 804(e), a Competitive Market Maker
would continue to be required to make markets in all of the series of a
minimum number of options classes in its appointed Group, but also
would be required to enter continuous quotes in all of the series of
any options class in which it seeks to make markets above the minimum
requirement. Accordingly, a Competitive Market Maker would be required
to maintain continuous quotations in all of the series of any options
classes in which it might receive an enhanced participation as the
result of being designated as a Preferred Market Maker.\11\
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\11\ The Exchange proposes to eliminate the requirement that a
market maker start quoting if the market maker enters an order in an
options series. Under Exchange Rule 805(a), Competitive Market
Makers are not permitted to enter limit orders that would sit on the
limit order book in options in their appointed Group. The entry of
an immediate-or-cancel limit order, which either executes
immediately against existing bids or offers in the market or is
cancelled, does not cause a market maker to disseminate a bid or
offer. Accordingly, a Competitive Market Maker that enters an order
would not become eligible to receive an enhanced allocation as a
Preferred Market Maker, and therefore should not become subject to
the increased obligation to quote all of the series of an options
class.
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The proposal also seeks to amend the 60 percent requirement to more
fairly apply the minimum quotation requirement on Competitive Market
Makers. The number of options classes allocated to the ten different
Groups changes as options classes are listed and delisted by the
Exchange. Because the minimum requirement is a percentage of the number
of options classes in a Group, some Competitive Market Makers are
required to maintain continuous quotes in a much larger number of
options classes than others. While the Exchange believes a percentage-
based minimum requirement remains appropriate, it believes there should
be a limit to the number of options classes a Competitive Market Maker
is required to continuously quote. Accordingly, the Exchange proposes
to amend Exchange Rule 804(e)(2) to provide that a Competitive Market
Maker must quote at least 60 percent of the options classes in the
Group or 60 options classes, whichever is lesser. The Exchange believes
that this change would assure that Competitive Market Makers appointed
to Groups with more than 100 options classes would not be required to
quote more than 60 options classes. The proposed amendment would not
change the minimum requirement for any Competitive Market Maker
appointed to a Group with less than 100 options classes, which,
according to the Exchange, currently is the case in eight of the ten
Groups.
The Exchange believes the proposed rule change is a necessary
competitive response to the preferencing proposals filed by other
options exchanges and will help the Exchange attract and retain order
flow. The Exchange further believes that such order flow will add depth
and liquidity to the Exchange's markets and enable the Exchange to
continue to compete effectively with other options exchanges.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with Section 6(b)(5) of the Act,\12\ in that the proposed rule change
is designed to promote just and equitable principles of trade, remove
impediments to and perfect the mechanism of a free and open market and
a national market system because a Preferred Market Maker must be
quoting at the NBBO in order to receive the proposed enhanced
allocation.
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\12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange believes that 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.
[[Page 35149]]
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 the proposed rule change. The Exchange has not received any
written comments from members or other interested parties. However, on
April 6, 2005, written comments were submitted to the Commission by a
member regarding the proposed rule change.\13\ This written comment
opposed the proposed rule change, as well as similar proposals by the
Philadelphia Stock Exchange, Inc. (``Phlx'') and the Chicago Board
Options Exchange, Incorporated (``CBOE'').\14\
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\13\ Letter from Matthew B. Hinerfeld, Managing Director and
Deputy General Counsel, Citadel Investment Group, L.L.C., on behalf
of Citadel Derivatives Group LLC, to Jonathan G. Katz, Secretary,
Commission, dated April 6, 2005.
\14\ Supra note 5.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as amended, is consistent with the Act and whether the pilot
time frame is appropriate. Comments may be submitted by any of the
following methods:
Electronic Comments
Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-ISE-2005-18 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-9303. All submissions should refer to File Number
SR-ISE-2005-18. 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 (https://
www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying in the Commission's Public
Reference Room. Copies of such filing 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-2005-18 and should be
submitted on or before July 7, 2005.
IV. Commission's Findings and Order Granting Accelerated Approval of
the Proposed Rule Change
The Exchange has asked the Commission to approve the proposed rule
change on an accelerated basis for six weeks while the Commission seeks
comment on the proposed rule change. The Exchange believes the proposed
rule change is substantially similar to rule changes by Phlx and CBOE
that were recently approved by the Commission.\15\ After careful
consideration, the Commission finds that the proposed rule change is
consistent with the requirements of Section 6 of the Act\16\ and the
rules and regulations thereunder applicable to a national securities
exchange\17\, and, in particular, the requirements of Section 6(b)(5)
of the Act.\18\ Section 6(b)(5) 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 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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\15\ Supra note 5.
\16\ 15 U.S.C. 78f.
\17\ In approving this proposal, the commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\18\ 15 U.S.C. 78f(b)(5).
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Pursuant to Section 19(b)(2) of the Act,\19\ the Commission may not
approve any proposed rule change, or amendment thereto, prior to the
30th day after the date of publication of notice of the filing thereof,
unless the Commission finds good cause for so doing and publishes its
reasons for so finding. The Commission hereby finds good cause for
approving the proposed rule change, as amended, prior to the 30th day
after publishing notice thereof in the Federal Register.
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\19\ 15 U.S.C. 78s(b)(2).
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The Commission received one comment letter opposing the
proposal.\20\ This commenter criticized the proposal because the
commenter believes the proposal would grant a Preferred Market Maker a
guarantee based solely on being at the NBBO rather than on such
Preferred Market Maker's obligations.\21\ The commenter asserts that
the proposal would reward a Preferred Market Maker for the Preferred
Market Maker's relationships with order flow providers rather than the
quality of the Preferred Market Maker's quotes, and therefore the
proposal would have a negative impact on price competition.\22\ In
addition, this commenter notes that the proposal would extend the
allocation entitlement to Competitive Market Makers, who have fewer
obligations to the market than Primary Market Makers.\23\
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\20\ See supra note 13. This written comment opposed the
proposed rule change, as well as similar proposals by the Phlx and
the CBOE. See supra note 5.
\21\ See supra note 13 at 1 and 2.
\22\ See supra note 13 at 2.
\23\ See supra note 13 at 2. The Exchange refers to its
specialists as ``Primary Market Makers.''
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The Commission has previously approved rules that guarantee a
Primary Market Maker a portion of each order when the Primary Market
Maker's quote is equal to the NBBO.\24\ The Commission has closely
scrutinized exchange rule proposals to adopt or amend a participation
guarantee where the percentage of participation would rise to a level
that could have a material adverse impact on quote competition within a
particular exchange.\25\ Because the proposal would not increase the
overall percentage of an order that is guaranteed beyond the currently
acceptable threshold, but instead would allow any Competitive Market
Maker appointed to an options class to be designated as a Preferred
Market Maker and be eligible to receive a participation guarantee
instead of the Primary Market Maker, the Commission does not believe
that the proposal will negatively impact quote competition on the
Exchange. Under the proposal, the remaining portion of each order will
still be allocated based on the competitive bidding of market
participants.
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\24\ See Securities Exchange Act Release Nos. 42808 (May 22,
2000), 65 FR 34515 (May 30, 2000) (SR-ISSE-2000-01); 44340 (May 22,
2001), 66 FR 29373 (May 30, 2001) (SR-ISE-2001-46); and 44641
(August 2, 2001), 65 FR 41643 (August 8, 2001) (SR-ISE-2001-17).
\25\ See, e.g., Securities Exchange Act Release No. 43100 (July
31, 2000), 65 FR 48788 (August 9, 2000).
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In addition, a Preferred Market Maker will have to be quoting at
the NBBO at
[[Page 35150]]
the time the Preferenced Order is received to capitalize on the
participation guarantee. The Commission believes it is critical that
the Preferred Market Maker cannot step up and match the NBBO after it
receives an order, but must be publicly quoting at that price when the
order is received. In this regard, the Exchange's proposal prohibits
Electronic Access Members and Preferred Market Makers from coordinating
their actions. The Exchange has stated that such coordinated actions
would violate Exchange Rule 400, Just and Equitable Principles of
Trade, and will proactively conduct surveillance for, and enforce
against, such violations.\26\
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\26\ See Amendment No. 2.
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The commenter also states that specialists (i.e., Primary Market
Makers) currently receive participation entitlements based on their
obligations to the market. The commenter believes that the proposal, by
allowing any market maker quoting at the NBBO to receive a guaranteed
percentage of an order without in turn increasing the market maker's
obligations to the market, would ``eliminate the incentive to be a
specialist, thereby potentially leaving the obligations of the
specialist to the market unfulfilled.'' \27\ The Commission does not
believe that the proposal will result in the role of the specialist
going unfulfilled, and notes that it recently approved an options
exchange without specialists.\28\ Moreover, specialists' obligations to
the market have been reduced through other changes, including greater
automation of functions previously handled manually by the specialist.
While this proposal may reduce the incentive to be a specialist, the
Commission does not believe that makes the proposal inconsistent with
the Act. Finally, the Commission notes that, as part of this proposal,
the Exchange proposes to increase the quotation obligations of
Competitive Market Makers. Currently, a Primary Market Maker is
required to maintain continuous quotations in all of the series of all
of the options classes to which the Primary Market Maker is appointed.
Competitive Market Makers are required to maintain continuous
quotations in all of the series in at least 60 percent of the options
classes in the Group to which they are appointed. However, a
Competitive Market Maker may enter continuous quotes in less than all
of the series in the remaining 40 percent of the classes in its
appointed Group, subject to a requirement to maintain continuous quotes
in those and related series through the end of the day and, in certain
circumstances, through expiration of the series.\29\
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\27\ Supra note 13 at 2.
\28\ See Securities Exchange Act Release No. 49068 (January 13,
2004), 69 FR 2775 (January 20, 2004) (SR-BSE-2002-15) (order
approving trading rules for the Boston Options Exchange Facility).
\29\ See Exchange Rule 804(e).
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Under the proposal, since all Competitive Market Makers would be
eligible to be designated as a Preferred Market Maker by Electronic
Access Members and receive an enhanced allocation in any options series
in which the Competitive Market Maker is quoting at the NBBO, the
Exchange proposes to require that a Competitive Market Maker maintain
continuous quotes in all of the series of any options class it is
quoting. Specifically, with respect to any series of any options class
in which a Competitive Market Maker seeks to make markets above the
minimum requirement, the proposal would require a Competitive Market
Maker to enter continuous quotes in all of the series of any options
class in which it enters quotes. Accordingly, the proposed rule change
would require a Competitive Market Maker to maintain continuous
quotations in all of the series of any options classes in which it
might receive an enhanced participation as the result of being
designated as a Preferred Market Maker.\30\
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\30\ See proposed Exchange Rule 804(e).
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The proposal also seeks to amend the minimum quotation requirement
on Competitive Market Makers to provide that a Competitive Market Maker
must quote at least 60 percent of the options classes in the Group or
60 options classes, whichever is lesser.\31\ Under the current rule,
because the minimum quotation requirement is 60 percent of the number
of options classes in a Group, and the number of options classes in a
Group varies, according to the Exchange, some Competitive Market Makers
are required to maintain continuous quotes in a much larger number of
options classes than other Competitive Market Makers. The Commission
notes that this change to the quotation requirement only affects
Competitive Market Makers appointed to Groups with more than 100
options classes and that such Competitive Market Makers would still be
required to quote continuous in 60 options classes.\32\ The Commission
also notes that the proposed change to the quotation requirement does
not affect the proposed requirement that a Competitive Market Maker
maintain continuous quotes in a series in order to be eligible to
receive a participation guarantee for that series.
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\31\ See proposed Exchange Rule 804(e)(2).
\32\ The proposed amendment would not change the minimum
requirement for any Competitive Market Maker appointed to a Group
with less than 100 options classes.
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The Commission emphasizes that approval of this proposal does not
affect a broker-dealer's duty of best execution. A broker-dealer has a
legal duty to seek to obtain best execution of customer orders, and any
decision to preference a particular Primary Market Maker or Competitive
Market Maker must be consistent with this duty.\33\ A broker-dealer's
duty of best execution derives from common law agency principles and
fiduciary obligations, and is incorporated in SRO rules and, through
judicial and Commission decisions, the antifraud provisions of the
federal securities laws.\34\
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\33\ See, e.g., Newton v. Merrille, Lynch, Pierce, Fenner &
Smith, Inc., 135 F.3d 266, 269-70, 274 (3d Cir.), cert. denied, 525
U.S. 811 (1998); Certain Market Making Activities on Nasdaq,
Securities Exchange Act Release No. 40900 (January 11, 1999)
(settled case) (citing Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971);
Arleen Hughes, 27 SEC 629.636 (1948), aff'd sub nom. Hughes v. SEC.
174 F.2d 969 (D.C. Cir. 1949)). See also Order Execution
Obligations, Securities Exchange Act Release No. 37619A (September
6, 1996), 61 FR 48290 (September 12, 1996) (``Order Handling Rules
Release'').
\34\ Order Handling Rules Release, 61 FR at 48322, See also
Newton, 135 F.3d at 270. Failure to satisfy the duty of best
execution can constitute fraud because a broker-dealer, in agreeing
to execute a customer's order, makes an implied representation that
it will execute it in a manner that maximizes the customer's
economic gain in the transaction. See Newton, 135 F.3d at 273
(``[T]he basis for the duty of best execution is the mutual
understanding that the client is engaging in the trade-and retaining
the services of the broker as his agent-solely for the purpose of
maximizing his own economic benefit, and that the broker receives
her compensation because she assists the client in reaching that
goal.''); Marc N. Geman, Securities Exchange Act Release No. 43963
(February 14, 2001) (citing Newton, but concluding that respondent
fulfilled his duty of best execution). See also Payment for Order
Flow, Securities Exchange Act Release No. 34902 (October 27, 1994),
59 FR 55006, 55009 (November 2, 1994) (``Payment for Order Flow
Final Rules''). If the broker-dealer intends not to act in a manner
that maximizes the customer's benefit when he accepts the order and
does not disclose this to the customer, the broker-dealer's implied
representation is false. See Newton, 135 F.3d at 273-274.
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The duty of best execution requires broker-dealers to execute
customers' trades at the most favorable terms reasonably available
under the circumstances, i.e., at the best reasonably available
price.\35\ The duty of best execution requires broker-dealers
[[Page 35151]]
to periodically assess the quality of competing markets to assure that
order flow is directed to the markets providing the most beneficial
terms for their customer orders.\36\ Broker-dealers must examine their
procedures for seeking to obtain best execution in light of market and
technology changes and modify those practices if necessary to enable
their customers to obtain the best reasonably available prices.\37\ In
doing so, broker-dealers must take into account price improvement
opportunities, and whether different markets may be more suitable for
different types of orders or particular securities.\38\
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\35\ Newton, 135 F.3d at 270. Newton also noted certain factors
relevant to best execution-order size, trading characteristics of
the security, speed of execution, clearing costs, and the cost and
difficulty of executing an order in a particular market. Id. at 270
n. 2 (citing Payment for Order Flow, Securities Exchange Act Release
No. 33026 (October 6, 1993), 58 FR 52934, 52937-38 (October 13,
1993) (Proposed Rules)). See In re E.F. Hutton & Co. (``Manning''),
Securities Exchange Act Release No. 25887 (July 6, 1988). See also
Payment for Order Flow Final Rules, 59 FR at 55008-55009.
\36\ Order Handling Rules Release, 61 FR at 48322-48333 (``In
conducting the requisite evaluation of its internal order handling
procedures, a broker-dealer must regularly and rigorously examine
execution quality likely to be obtained from different markets or
market makers trading a security.''). See also Newton, 135 F.3d at
271; Market 2000; An Examination of Current Equity Market
Developments V-4 (SEC Division of Market Regulation January 1994)
(``Without specific instructions from a customer, however, a broker-
dealer should periodically assess the quality of competing markets
to ensure that its order flow is directed to markets providing the
most advantageous terms for the customer's order.''); Payment for
Order Flow Final Rules, 59 FR at 55009.
\37\ Order Handling Rules, 61 FR at 48323.
\38\ Order Handling Rules, 61 FR at 48323. For example, in
connection with orders that are to be executed at a market opening
price, ``[b]roker-dealers are subject to a best execution duty in
executing customer orders at the opening, and should take into
account the alternative methods in determining how to obtain best
execution for their customer orders.'' Disclosure of order Execution
and Routing Practices, Securities Exchange Act Release No. 43590
(November 17, 2000), 65 FR 75414, 75422 (December 1, 2000) (adopting
new Rules 11Ac1-5 and 11Ac1-6 under the Act and noting that
alternative methods offered by some Nasdaq market centers for pre-
open orders included the mid-point of the spread or at the bid or
offer).
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The Commission notes that the proposed rule change would be
implemented on a pilot basis for six weeks. During this time, the
Commission intends to evaluate the impact of the proposal on the
options markets to determine whether it would be beneficial to
customers and to the options markets as a whole before approving any
request to extend the pilot program. The Commission believes that the
proposed rule change's six-week pilot period will allow the Commission
an opportunity of solicit comments on the proposed rule change prior to
considering whether the approve such pilot program for an extended
period. Therefore, the Commission finds good cause, consistent with
Section 19(b)(2) of the Act,\39\ to approve the proposal, as amended,
on an accelerated basis.
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\39\ 15 U.S.C. 78s(b)(2).
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For these reasons, the Commission believes that the proposal is
consistent with the requirements of Section 6(b)(5) of the Act,\40\ and
will not jeopardize market integrity or the incentive for market
participants to post competitive quotes.\41\
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\40\ 15 U.S.C. 78f(b)(5).
\41\ Approval of this proposal is in no way an endorsement of
payment for order flow by the Commission.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\42\ that the proposed rule change (SR-ISE-2005-18), as amended,
which institutes the pilot program until July 22, 2005, is hereby
approved on an accelerated basis.
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\42\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\43\
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\43\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-3095 Filed 6-15-05; 8:45 am]
BILLING CODE 8010-01-P
