Self-Regulatory Organizations; International Securities Exchange, LLC; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of the Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto, Relating to Professional Account Holders, 5694-5704 [E9-1979]

Download as PDF 5694 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices Paper Comments • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–DTC–2008–15. 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 Section, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of DTC and on DTC’s Web site at https://www.dtcc.com/ downloads/legal/rule_filings/2008/dtc/ 2008–15.pdf. 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–DTC– 2008–15 and should be submitted on or before February 20, 2009. It is therefore ordered, pursuant to Section 19(b)(2) of the Act,12 that the proposed rule change (File No. SR– DTC–2008–15) be and hereby is approved.13 For the Commission by the Division of Trading and Markets, pursuant to delegated authority.14 Florence E. Harmon, Deputy Secretary. [FR Doc. E9–1983 Filed 1–29–09; 8:45 am] mstockstill on PROD1PC66 with NOTICES BILLING CODE 8011–01–P 12 15 U.S.C. 78s(b)(2). approving the proposed rule change, the Commission considered the proposal’s impact on efficiency, competition and capital formation. 15 U.S.C. 78c(f). 14 17 CFR 200.30–3(a)(12). 13 In VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–59287; File No. SR–ISE– 2006–26] Self-Regulatory Organizations; International Securities Exchange, LLC; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of the Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto, Relating to Professional Account Holders January 23, 2009. I. Introduction On May 5, 2006, the International Securities Exchange, LLC (‘‘ISE’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’) a proposed rule change pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder 2 to amend ISE rules to give certain nonbroker-dealer orders, identified as ‘‘professional orders,’’ the priority given broker-dealer orders and market maker quotes rather than the priority currently given all public customer orders and to charge the same transaction fees for professional orders as charged for the orders of broker-dealers and market makers. On January 25, 2008, the Exchange filed Amendment No. 1 to the proposed rule change. The proposed rule change, as modified by Amendment No. 1, was published for comment in the Federal Register on February 7, 2008.3 The Commission received ten comment letters on the proposal.4 The Exchange filed Amendment No. 2 to the proposed rule change on June 17, 2008,5 and submitted a response to the SIFMA 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 57254 (February 1, 2008), 73 FR 7345 (February 7, 2008) (‘‘Notice’’). 4 See letters from Abe Lampert, dated May 25, 2006 (‘‘Lampert Letter’’); Charles B. Cox III, dated May 26, 2006 (‘‘Cox Letter I’’); B. Thomas Rule, dated May 28, 2006 (‘‘Rule Letter’’); Bryan Weisberg, dated May 31, 2006 (‘‘Weisberg Letter’’); Andrea Schneider, dated June 18, 2006 (‘‘A. Schneider Letter’’); Gerald Schneider, dated February 6, 2008 (‘‘G. Schneider Letter’’); Andrew Carr, dated March 4, 2008 (‘‘Carr Letter’’); Charles B. Cox III, dated March 4, 2008 (‘‘Cox Letter II’’); Charles B. Cox III, dated April 16, 2008 (‘‘Cox Letter III’’); and Securities Industry and Financial Markets Association (‘‘SIFMA’’), dated July 23, 2008 (‘‘SIFMA Letter’’). 5 In Amendment No. 2, ISE deleted proposed changes to ISE Rules 715 and 723 (d)(2). These revisions clarify that the proposed rule change would not limit a Public Customer’s access to the Exchange’s Price Improvement Mechanism (‘‘PIM’’). See infra note 75. 2 17 PO 00000 Frm 00061 Fmt 4703 Sfmt 4703 Letter on January 12, 2009.6 This order provides notice of Amendment No. 2 and approves the proposal, as modified by Amendment Nos. 1 and 2, on an accelerated basis. II. Description of ISE’s Proposal Currently, ISE grants certain advantages to Public Customer Orders 7 over Non-Customer Orders.8 In particular, Public Customer Orders receive priority over Non-Customer Orders and market maker quotes at the same price. In addition, subject to certain exceptions, Public Customer Orders do not incur transaction charges.9 The ISE states that the purpose, generally, of providing these marketplace advantages to Public Customer Orders is to attract retail investor order flow to the Exchange by leveling the playing field for retail investors over market professionals and providing competitive pricing.10 According to the Exchange, market professionals have access to sophisticated trading systems that contain functionality not available to a retail customer, including things such as continuously updated pricing models based upon real-time streaming data, access to multiple markets simultaneously, and order and risk management tools.11 With respect to the marketplace advantages of priority in trading and waiver of fees, the Exchange does not believe at this time that the definitions of Public Customer and Non-Customer properly distinguish between the kind of non-professional retail investors for whom these advantages were intended and certain professionals. The Exchange believes that distinguishing solely between registered broker-dealers and non-broker-dealers with respect to these 6 See letter from Michael J. Simon, Secretary, ISE, to Florence Harmon, Acting Secretary, Commission, dated January 12, 2009 (‘‘ISE Response Letter’’). 7 A ‘‘Public Customer’’ is defined in ISE’s rules as ‘‘a person that is not a broker or dealer in securities.’’ A ‘‘Public Customer Order’’ is defined as ‘‘an order for the account of a Public Customer.’’ ISE Rules 100(a)(38) and (39). 8 A ‘‘Non-Customer’’ is defined in ISE’s rules as ‘‘a person or entity that is a broker or dealer in securities.’’ A ‘‘Non-Customer Order’’ is defined as ‘‘any order that is not a Public Customer Order.’’ ISE Rules 100(a)(27) and (28). 9 For example, Public Customer Orders currently incur fees for certain transactions in ‘‘Premium Products’’ (defined in the ISE Schedule of Fees) and Complex Orders that take liquidity on the Exchange’s complex order book. In addition, transaction fees are charged for Public Customer Orders entered in response to special order broadcasts, such as Facilitation orders, Solicitation orders, Block orders, and orders entered in the Exchange’s PIM. Public Customer Orders also are subject to fees for order cancellations. See ISE Schedule of Fees. 10 See Notice, supra note 3, at 73 FR 7346. 11 See Notice, supra note 3, at 73 FR 7346 n.7. E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices mstockstill on PROD1PC66 with NOTICES advantages is no longer appropriate in today’s marketplace, because some nonbroker-dealer individuals and entities have access to information and technology that enables them to trade listed options in the same manner as a broker or dealer in securities. The Exchange maintains that these individual traders and entities (collectively, ‘‘professional account holders’’) have the same technological and informational advantages as brokerdealers trading for their own accounts, which enables professional account holders to compete effectively with broker-dealer orders and market maker quotes for execution opportunities in the ISE marketplace.12 The Exchange therefore does not believe that it is consistent with fair competition for these professional accounts holders to continue to receive the same marketplace advantages that retail investors have over broker-dealers trading on the ISE.13 ISE thus proposes to create two new order types: Priority Customer Orders and Professional Orders. Priority Customer Orders would be orders for the account of a Priority Customer, which would be defined as a person or entity that is not a broker-dealer in securities and that does not place more than 390 orders 14 in listed options per day on average during a calendar month for its own beneficial account(s). Professional Orders would be defined as orders for the account of a person or entity that is not a Priority Customer, 12 The Exchange also maintains that, under its current rules, retail investors are prevented from fully benefiting from the priority advantage when professional account holders are afforded the same Public Customer Order priority that retail investors enjoy. See Notice, supra note 3, at 73 FR 7346. 13 Id. 14 The Exchange states that 390 orders is equal to the total number of orders that a person would place in a day if that person entered one order every minute from market open to market close. According to ISE, a study of one of the largest retailoriented options brokerage firms indicated that on a typical trading day, options orders were entered with respect to each of 5,922 different customer accounts. There was only one order entered with respect to 3,765 of the 5,922 different customer accounts on this day, and there were only 17 customer accounts with respect to which more than 10 orders were entered. The highest number of orders entered with respect to any one account over the course of an entire week was 27. In addition, many of the largest retail-oriented electronic brokers offer lower commission rates to customers they define as ‘‘active traders.’’ The Exchange reviewed the publicly available information from the Web sites for Charles Schwab & Co., Inc.; Fidelity Investments; TD Ameritrade, Inc.; and optionsXpress, Inc., and found all of them define an ‘‘active trader’’ as someone who executes only a relatively small number of options trades per month. The highest required trading activity to qualify as an active trader among these four firms was 35 trades per quarter. See Notice, supra note 3, at 73 FR 7347 n.10–11. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 and would include proprietary orders of ISE members and non-member brokerdealers.15 Priority Customer Orders would have priority over Professional Orders at the same price. Thus, Public Customers who now have priority over market makers and broker-dealers at the same price would be on parity with market markers and broker-dealers at the same price, if those Public Customers placed more than 390 orders in listed options per day on average during a calendar month. These Professional Orders also would be assessed the same fees that ISE charges for broker-dealer transactions. The Exchange believes that the use of these new terms in the execution rules and fee schedule would result in professional account holders participating in the ISE’s allocation process on equal terms with brokerdealer orders and market maker quotes. It would also result in members paying the same transaction fees for the execution of orders for a professional account as they do for broker-dealer orders. The Exchange believes that identifying professional account holders as participants who place more than one order per minute on average per day during a calendar month is an appropriately objective approach that would reasonably distinguish such persons and entities from retail investors. The Exchange proposes the threshold of 390 orders per day on average over a calendar month because it believes this amount far exceeds the number of orders that are entered by retail investors in a single day, while being a sufficiently low number of orders to cover the professional account holders that are competing with brokerdealers in the ISE marketplace. ISE further notes that basing the standard on the number of orders that are entered in listed options for a beneficial account(s) assures that professional account holders could not inappropriately avoid the purpose of the rule by spreading their trading activity over multiple exchanges, and using an average number over a calendar month would prevent gaming of the 390 order threshold.16 ISE’s proposal would require Electronic Access Members (‘‘EAMs’’) to indicate whether Public Customer Orders are Priority Customer Orders or Professional Orders. EAMs would be 15 Members would be required to represent as Professional Orders for the next calendar quarter the orders for any customer that had an average of more than 390 orders per day during any month of a calendar quarter. See proposed Text of Regulatory Circular filed by ISE as part of the proposed rule change (‘‘Proposed Regulatory Circular’’). 16 See Notice, supra note 3, at 73 FR 7346–47. PO 00000 Frm 00062 Fmt 4703 Sfmt 4703 5695 required to review their customers’ activity on at least a quarterly basis to determine whether orders that are not for the account of a broker or dealer should be represented as Priority Customer Orders or Professional Orders. Members would be required to make any appropriate changes to the way in which they are representing orders within five days after the end of each calendar quarter. If during a calendar quarter the Exchange identified a customer for which orders are being represented as Priority Customer Orders, but that customer has averaged more than 390 orders per day during a month, the Exchange would notify the member and the member would be required to change the manner in which it is representing the customer’s orders within five days.17 All Public Customers would continue to be treated in the same manner under all ISE rules, other than those rules for priority and transaction fees. For example, ISE rules relating to the Intermarket Linkage affecting Public Customers 18 would continue to apply to all customers who are not brokerdealers—even those customers whose orders are identified as Professional Orders. Similarly, rules regarding customer suitability and other protections for customers would continue to apply with respect to all customers who are not broker-dealers.19 III. Commission Findings and Order Granting Accelerated Approval to the Proposed Rule Change as Modified by Amendment Nos. 1 and 2 After careful consideration of the proposed rule change, as well as the comment letters and the ISE Response Letter, the Commission finds that the proposed rule change is consistent with the Act. As the options markets have become more electronic and more competitive over the last several years, the Commission believes that the distinction between a professional who is registered as a broker-dealer and a public customer who is not so registered, but who may trade to the same extent as a broker-dealer, has become blurred.20 Moreover, the 17 See Proposed Regulatory Circular, supra note 15. 18 See Chapter 19 of the ISE Rules. Chapter 6 of the ISE Rules. Telephone conversation between Nancy Burke-Sanow, Assistant Director, Division of Trading and Markets (‘‘Division’’), Commission, et al., and Katherine Simmons, Deputy General Counsel, ISE, on March 3, 2008. 20 See, e.g., Nina Mehta, Options Maker-Taker Markets Gain Steam, TRADERSmagazine.com, October 2007, https://www.tradersmagazine.com/ issues/20071004/2933–1.html. 19 See E:\FR\FM\30JAN1.SGM 30JAN1 5696 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices category of public customer today includes sophisticated algorithmic traders including former market makers and hedge funds that trade with a frequency resembling that of brokerdealers.21 The Commission believes that the Act does not require the ISE to treat those customers who meet the high level of trading activity established in the proposal identically to customers who do not meet that threshold.22 Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b) 23 of the Act and the rules thereunder,24 and in particular with: Section 6(b)(4) of the Act, which requires exchanges to provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities; 25 Section 6(b)(5) of the Act, which requires that the rules of a national securities exchange, among other things, be designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism for a free and open market and a national market system, and, in general, to protect investors and the public interest; and not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers; 26 and Section 6(b)(8) of the Act, which requires the rules of an exchange not to impose any burden on competition not necessary or appropriate in furtherance of the Act.27 In addition, the Commission finds that the proposed rule change is consistent with Section 11(a) of the Act.28 A. Customer Priority on the Options Exchanges Currently, the ISE accords priority to all Public Customer Orders at the best bid or offer on the basis of price-time mstockstill on PROD1PC66 with NOTICES 21 Id. 22 The Commission notes that one of the commenters, discussing the proposed rule change before the Exchange filed Amendment No. 1, stated that she placed an average of 170 orders per day. See A. Schneider Letter supra note 4. Under the proposed rule change, as amended, a Public Customer that places this number of orders would be substantially short of the proposed threshold of more than 390 orders per day and thus would not be affected by the rule. 23 15 U.S.C. 78f(b). 24 In approving the proposed rule change, the Commission notes that it has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). See also infra notes 50–71 and accompanying text. 25 15 U.S.C. 78f(b)(4). 26 15 U.S.C. 78f(b)(5). 27 15 U.S.C. 78f(b)(8). 28 15 U.S.C. 78k(a). See infra Section III.A.1. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 priority before allocating any remaining contracts among Non-Customer Orders and market maker quotes at the same best price. ISE now proposes that only Priority Customer Orders, as defined above, would receive such priority. In considering this aspect of the proposal, the Commission examined the basis upon which exchanges have granted priority to public customers in the past. The Commission further considered the threshold question of when and whether the orders of public customers must be entitled to priority over the orders of broker-dealers. In certain contexts, the Commission has characterized an exchange’s practice of according priority to public customers’ orders as a matter of ‘‘tradition.’’ 29 Alternatively, the Commission has referred to public customer priority as ‘‘the generally accepted auction trading principle of priority of public limit orders over member proprietary orders at the same price.’’ 30 These references in Commission releases support the Commission’s view that the customer priority rule under discussion was not a matter of public customer entitlement derived from the Act, but rather a matter of convention to accommodate public customer orders, or an auction principle applied as a matter of longstanding practice by exchanges. In addition, public customer orders are a source of liquidity in the market, and exchanges have sought to attract such orders by providing public customers certain guarantees that their orders would be executed even in the face of competition from broker-dealers. The Commission previously has approved exchange rules that apply this ‘‘traditional priority’’ as consistent with 29 See, e.g., Securities Exchange Act Release Nos. 21695 (January 28, 1985), 50 FR 4823 (February 1, 1985) (in considering Chicago Board Options Exchange’s (‘‘CBOE’’) proposal to implement a retail automatic execution system (‘‘RAES’’) pilot program, the Commission referred to ‘‘the traditional priority accorded to public customer orders’’); and 22610 (November 8, 1985), 50 FR 47480 (November 18, 1985) (in considering a proposal by the American Stock Exchange (‘‘Amex’’) to implement an automatic execution feature of its AUTOAMOS system on a pilot basis, the Commission stated that the pilot ‘‘ensures the traditional priority accorded public customer orders’’). In each of these instances, the Commission was referring specifically to public customer orders that are placed on the book. Such placements may affect the application of priority principles. See, e.g., infra Section III.A.3. 30 See, e.g., Securities Exchange Act Release No. 22817 (January 21, 1986), 51 FR 3547 (January 28, 1986) (notice of CBOE’s proposal to implement RAES on a permanent basis for options on the Standard and Poor’s 100 Index (‘‘OEX’’) (SR–CBOE– 85–32) and to extend RAES to selected classes of individual stock options on a six-month pilot basis (SR–CBOE–85–16) (‘‘January 1986 Release’’). See also infra note 40. PO 00000 Frm 00063 Fmt 4703 Sfmt 4703 the Act but, as discussed below, has approved exchange rules that do not accord priority to public customer orders.31 In analyzing the concept of public customer priority, the Commission has considered whether public customer priority, or the absence of such priority, is consistent with Section 11(a) of the Act, the agency obligations of the specialist, the protection of investors and the public interest, and the Act, in general. 1. Section 11(a) of the Act Section 11(a) of the Act prohibits any member of a national securities exchange from effecting transactions on that exchange for its own account, the account of an associated person, or an account over which it or its associated person exercises discretion unless an exception applies.32 Thus, in some contexts, the Commission has cited Section 11(a) of the Act as a basis for exchange rules that accord customer orders priority, referring to ‘‘the traditional auction market concepts of customer priority embodied in Section 11(a) of the Act.’’ 33 Section 11(a)(1) contains a number of exceptions for principal transactions by members and their associated persons. One such exception, set forth in subparagraph (G) of Section 11(a)(1) and in Rule 11a1–1(T), permits any transaction for a member’s own account provided, among other things, that the transaction yields priority, parity, and precedence to orders for the account of persons who are not members or associated with members of the exchange. Exchange rules, therefore, may require members to yield priority to the orders of public customers to satisfy this exception to Section 11(a). Another exception permits market makers to effect transactions on exchanges in which they are members.34 In addition to the exceptions noted above, Rule 11a2–2(T) under the Act 35 provides exchange members with an exception from the prohibitions in Section 11(a). Rule 11a2–2(T), known as the ‘‘effect versus execute’’ rule, permits an exchange member, subject to certain 31 See infra notes 41–44 and accompanying text. U.S.C. 78k(a). 33 See, e.g., Securities Exchange Act Release No. 27205 (August 31, 1989), 54 FR 37180 (September 7, 1989) (Commission order approving a proposal of the Philadelphia Stock Exchange (‘‘Phlx’’) relating to the crossing of agency orders). See also, e.g., Securities Exchange Act Release No. 33708 (March 3, 1994), 59 FR 11339 (March 10, 1994) (Commission order approving a proposal of the Midwest Stock Exchange, Inc. relating to agency crosses between the disseminated exchange market). 34 Section 11(a)(1)(A). 35 17 CFR 240.11a2–2(T). 32 15 E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices mstockstill on PROD1PC66 with NOTICES conditions, to effect transactions for its own account, the account of an associated person, or an account with respect to which it or an associated person thereof exercises investment discretion (collectively, ‘‘covered accounts’’) by arranging for an unaffiliated member to execute the transactions on the exchange. To comply with the ‘‘effect versus execute’’ rule’s conditions, a member: (i) Must transmit the order from off the exchange floor; (ii) may not participate in the execution of the transaction once it has been transmitted to the member performing the execution; 36 (iii) may not be affiliated with the executing member; and (iv) with respect to an account over which the member has investment discretion, neither the member nor its associated person may retain any compensation in connection with effecting the transaction except as provided in the rule.37 The Commission previously has found that the manner of operation of ISE’s Facilitation Mechanism enables Exchange members to meet the conditions of the effect versus execute rule and thereby avail themselves of the exception that the rule provides from the prohibitions of Section 11(a).38 Similarly, the Commission believes that the manner of operation of ISE’s overall electronic trading system, not only the Facilitation Mechanism, enables members to meet the four conditions of the effect versus execute rule and would continue to do so under the proposal.39 36 The member, however, may participate in clearing and settling the transaction. See Securities Exchange Act Release No. 14563 (March 14, 1978), 43 FR 11542 (March 17, 1978). 37 17 CFR 240.11a2–2(T). 38 See, e.g., Securities Exchange Act Release No. 51666 (May 9, 2005), 70 FR 25631 (May 13, 2005). 39 The Commission notes that, first, all orders are electronically submitted to the ISE through remote terminals. Second, because a member relinquishes control of its order after it is submitted to the system, the member does not receive special or unique trading advantages. Third, although the effect-versus-execute rule contemplates having an order executed by an exchange member who is not affiliated with the member initiating the order, the Commission recognizes that this requirement is satisfied when automated exchange facilities are used. (In considering the operation of automated execution systems operated by an exchange, the Commission has noted that while there is no independent executing exchange member, the execution of an order is automatic once it has been transmitted into the systems. Because the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the exchange, the Commission has stated that executions obtained through these systems satisfy the independent execution requirement of Rule 11a2–2(T). See Securities Exchange Act Release No. 15533 (January 29, 1979).) Finally, to the extent that ISE members rely on Rule 11a2–2(T) for a managed account transaction, they must comply with the limitations on compensation set forth in the rule. See id., at note 20. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 For this reason, the Commission believes that the proposed rule change, which would permit orders of ISE members to be executed under certain circumstances even if a Professional Order is on the ISE’s book, is consistent with the requirements of Section 11(a) of the Act and Rule 11a2–2(T) thereunder. 2. Protecting Investors and the Public Interest In analyzing the merits of exchange proposals affecting public customer order priority, the Commission has considered whether the proposed rule change is consistent with Section 6(b)(5) of the Act, which requires that the rules of an exchange, among other things, be designed ‘‘to protect investors and the public interest.’’ 40 The Commission does not believe that this provision of Section 6(b)(5) requires that ISE give priority to Public Customers whose orders would be considered Professional Orders under the proposal. The Commission has indicated in the past that it does not believe that priority for public customer orders is an essential attribute of an exchange. In particular, the Commission has approved options exchanges’ trading rules that do not give priority to orders of public customers that are priced no better than the orders of other market participants. 40 For example, in January 1986, in publishing for public comment two proposed rule changes relating to the operation of RAES, see supra note 30, the Commission raised the question of whether the proposals were inconsistent with the provision in Section 6(b)(5) of the Act relating to the protection of investors and the public interest. The Commission also asked whether RAES was inconsistent with Section 11A of the Act, which states that it is in the public interest and appropriate for the protection of investors to assure ‘‘economically efficient execution of securities transactions,’’ ‘‘the practicability of brokers executing investors’ orders in the best market,’’ and ‘‘an opportunity * * * for investors’ orders to be executed without the participation of a dealer.’’ 15 U.S.C. 78k–1(a)(1)(C)(i), (iv) and (v). On August 1, 1986, the Commission approved the proposal to make the RAES pilot program in OEX options permanent and a modified version of the pilot proposal for RAES in equity options, concluding that the proposed rule changes were consistent with the requirements of the Act, and, in particular, with Sections 6 and 11A of the Act. See Securities Exchange Act Release No. 23490 (August 1, 1986), 51 FR 28788 (August 11, 1986). In its approval order, the Commission stated that it was ‘‘cognizant of the substantial benefits provided by RAES to public customers of OEX and firms using the system’’ and noted that RAES had increased the efficiencies of the OEX market and added to the confidence of public customers. The Commission indicated that it expected CBOE to modify RAES for OEX options in the future, although it stated that its approval of the rule change was not tied to this expectation. Noting the technical impediments to modifying the system for such options, the Commission expressed its belief that ‘‘on balance, the benefits of RAES for the market in OEX weigh in favor of permanent approval.’’ PO 00000 Frm 00064 Fmt 4703 Sfmt 4703 5697 For example, in approving proposed rules governing CBOEdirect, CBOE’s electronic screen-based trading system (‘‘SBT’’), the Commission concluded that it was consistent with the Act for the CBOEdirect rules not to provide priority to public customer orders over market maker quotes and orders in all instances.41 Significantly, the Commission noted in its approval order for the SBT rules that, in the rules governing trades on CBOE’s floor, customer orders displayed on the limit order book are given priority over broker-dealer orders and market maker quotes, but distinguished the operation of CBOEdirect. On the floor, the Commission noted, the priority of booked customer limit orders was essential because (at the time) the DPM was the agent for orders resting in the limit order book and, therefore, consistent with general agency law principles, CBOE’s rules accorded priority to those resting limit orders.42 In contrast, an SBT market maker was not required to act as agent with respect to a limit order entered into CBOEdirect. Furthermore, on the Boston Options Exchange (‘‘BOX’’), the options facility of the Boston Stock Exchange, Inc., orders generally are executed according to price-time priority, with no distinctions made with regard to account designation (Public Customer, Broker/Dealer or Market Maker).43 On the options facility of NYSE Arca, Inc. (‘‘NYSE Arca’’), all non-marketable limit orders and quotes also are ranked in an electronic limit order file and matched for execution according to price-time priority.44 On these exchanges, all options orders at the best price are executed based on the time the order was entered. In approving these 41 CBOE had proposed alternative priority methodologies for its SBT system including public customer priority, market turner priority, and trade participation rights for Designated Primary Market Makers (‘‘DPMs’’) and Lead Market Makers. See Securities Exchange Act Release No. 47628 (April 3, 2003), 68 FR 17697 (April 10, 2003) (Commission order approving rules for CBOEdirect). 42 In 2005, the Commission approved a proposal by the CBOE to eliminate the requirement that DPMs act as the agent in the options in which it is registered as the DPM on the Exchange. See Securities Exchange Act Release No. 52798 (November 18, 2005), 70 FR 71344 (November 28, 2005) (Commission order approving removing agency responsibilities of DPMs). 43 The Commission stated that the ‘‘contention that all existing options exchanges provide strict customer priority is an overstatement.’’ The Commission noted that several options exchanges had rules to permit market makers to be on parity with customer orders in certain circumstances. See Securities Exchange Act Release No. 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004). 44 See Securities Exchange Act Release No. 54238, (July 28, 2006), 71 FR 44758 (August 7, 2006) (Commission order approving NYSE Arca’s OX Trading Platform). E:\FR\FM\30JAN1.SGM 30JAN1 5698 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices exchanges’ rules, the Commission found them to be consistent with the Act. The Commission believed that the BOX’s and NYSE Arca’s rules, which accord no priority to any public customer orders, are consistent with the Act’s requirement that exchange rules be designed to protect investors and the public interest. 45 Similarly, the Commission believes that the ISE’s proposal, which reasonably eliminates priority treatment of Professional Orders of Public Customers, is consistent with the statutory requirement. 3. Agency Obligations In approving the proposed rule change, the Commission notes that, historically, exchange specialists have had substantial agency responsibilities in obtaining executions for customer limit orders. A specialist’s responsibility to a customer in his or her role as agent for the limit order book was based on common law notions of fiduciary duty and incorporated in the rules of some exchanges. As exchanges increasingly have implemented automated trading systems, however, the specialist’s role in handling limit orders has diminished.46 On the ISE, market makers do not act as agent for incoming orders that are executable on the exchange. Orders submitted to the ISE are matched by an automated trading system and generally are not represented by a specialist acting as agent.47 The Commission’s approval of ISE’s proposal to no longer accord priority to Professional Orders is based solely on its determination that this proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities mstockstill on PROD1PC66 with NOTICES 45 Id. 46 On several options exchanges, including BOX and CBOE, the exchange market makers have no responsibility for executing book orders, do not receive any fees for execution of book orders, and, accordingly, have no agency responsibilities for book orders. See e.g., BOX Rules, Chapter V and CBOE Rules Chapter VIII. 47 The Commission recognizes that ISE’s rules mandate that a Public Customer Order be represented by an agent in a discrete situation. ISE Rule 803(c) requires Primary Market Makers (‘‘PMMs’’), as soon as practical, to address Public Customer Orders that are not automatically executed because there is a displayed bid or offer on another exchange trading the same option contract that is better than the best bid or offer on the Exchange. In such cases, PMMs are required to execute at a price that matches the best price displayed on another exchange and/or send a Linkage Order. However, ISE Rule 803(c), which pertains to Intermarket Linkage, would not be affected by the proposed rule change. As noted above, ISE rules relating to the Intermarket Linkage affecting Public Customers would continue to apply to all Public Customers—even those customers whose orders are identified as Professional Orders. See supra note 18 and accompanying text. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 exchange. The Commission is making no determination as to whether the failure of any market participant (e.g., a specialist managing an exchange’s order book) to accord priority, as appropriate, to any order entrusted to that participant as an agent is consistent with the federal securities laws or any other applicable law. Accordingly, the Commission’s approval of ISE’s proposal does not affect fiduciary obligations under the federal securities laws or agency law principles. B. Issues Raised by Commenters As noted above, the Commission has received ten comment letters regarding the proposed rule change. 48 Nine of these commenters opposed the proposal. One commenter endorsed the ultimate goal of the proposal, but expressed concerns regarding its implementation.49 The Commission acknowledges the arguments and concerns that have been raised by the commenters, but believes that the arguments and concerns do not support the conclusion that the proposal is inconsistent with the Act. The commenters raise essentially five main issues: (1) That the proposal is anti-competitive; (2) that it unfairly discriminates against certain Public Customers who no longer would have priority over Non-Customers; (3) that it raises technical and operational issues for firms; (4) that it is vague and therefore unenforceable; and (5) that the imposition of transaction fees for the execution of Professional Orders is unfair. In its review of the proposal, the Commission has carefully considered these issues and has evaluated them in light of the Act’s provisions, as discussed below. 1. ISE’s Proposal Does Not Impose an Unnecessary or Inappropriate Burden on Competition Some commenters believed that the proposed rule change would thwart competition by treating the orders of certain Public Customers on a par with orders of broker-dealers, despite the inability of those customers to participate in the market on an equal footing with broker-dealers and market makers.50 These commenters argued that broker-dealers and market makers have substantial marketplace advantages over Public Customers, including lower margin and commission rates, better access to information, and superior 48 See supra note 4. SIFMA Letter, supra note 4. 50 See, e.g., Cox Letter I supra note 4 and Weisberg Letter supra note 4. 49 See PO 00000 Frm 00065 Fmt 4703 Sfmt 4703 technology,51 and, in the case of market makers, the ability to stream quotes electronically on both sides of the market.52 As discussed above, the Act does not require that the order of a public customer or any other market participant be granted priority. The objective of promoting competition and the requirement that the rules of an exchange not impose an unnecessary or inappropriate burden upon competition do not necessarily mandate that a Professional Order be granted priority while the order of a broker-dealer should not be granted the same right. As a general matter, in developing their trading and business models, exchanges have adopted rules, with Commission approval, that grant priority to certain participants over others, or to waive fees or provide discounts for certain kinds of transactions, in order to attract order flow or create more competitive markets. The Act itself recognizes that the operation of a marketplace can warrant exceptions to general allocation principles, for example, by exempting specialists and market makers from the requirement that a member of an exchange yield to the order of a nonmember.53 ‘‘Specialist entitlements’’ 54 and facilitation and solicited order guarantees,55 adopted by exchanges with Commission approval, also are instances in which the need to attract 51 See, e.g., Carr Letter supra note 4, G. Schneider Letter supra note 4 and Rule Letter supra note 4. 52 See, e.g., Carr Letter supra note 4, Cox Letter II supra note 4 and Rule Letter supra note 4. 53 See Section 11(a) of the Act, 15 U.S.C. 78k(a), and the rules thereunder. 54 A ‘‘specialist entitlement’’ as used here is an options exchange rule that under certain circumstances guarantees a specialist (or designated primary market maker) the right to trade ahead of other participants in the trading crowd with a certain percentage of every order—when the specialist is quoting at the best price—even when the specialist has not otherwise established priority. See, e.g., ISE Rule 713, Supplementary Material .01(b); Amex Rule 935–ANTE(a)(5); CBOE Rule 8.87; NYSE Arca Rule 6.82(d)(2); Phlx Rule 1014(g)(ii). 55 A ‘‘facilitation guarantee’’ as used here is an options exchange rule that under certain circumstances guarantees an order entry firm that has submitted a public customer order for execution on the exchange to trade with a certain percentage of that public customer order itself, ahead of other participants in the trading crowd that are prepared to trade at the same price. See, e.g., ISE Rule 716(d); Amex Rule 950–ANTE, Commentary .02; CBOE Rule 6.74(b); NYSE Arca Rule 6.47(b); A ‘‘solicited order guarantee’’ is an options exchange rule that entitles a broker or firm that has solicited an order from a third party to trade against its customer’s order to execute a certain percentage of the customer’s order against the solicited order ahead of other participants in the trading crowd that are prepared to trade at the same price. See, e.g., ISE Rule 716(e) (Solicited Order Mechanism). E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices mstockstill on PROD1PC66 with NOTICES order flow or provide incentives to one group of participants based on their role in the marketplace has been viewed as a valid reason to adjust the otherwiseestablished priority principles of an exchange. Other examples include options trading rules that adjust allocation principles under certain condition in the execution of larger orders 56 and the small order automatic execution systems created by options exchanges in the past.57 Notably, in some prior proposals to waive or reduce customer fees, exchanges cited their need to remain competitive and attract order flow.58 The Commission believes that ISE’s proposal to grant priority only to Priority Customers and no longer to waive fees for transactions involving Professional Orders likewise does not necessarily place an inappropriate burden on competition and should most reasonably be viewed as within the discretion of the Exchange,59 so long as 56 See, e.g., CBOE Rule 6.74(f) (Open Outcry SizeQuote Mechanism). 57 In the past, options exchanges that generally operated on an open-outcry trading model adopted systems that automatically executed orders of public customers below a certain size without exposing them to the auction on the floor. These systems were designed to give investors speed, efficiency, and accuracy in the execution of their small orders, which were executed at the exchange’s disseminated quotation on a rotational basis against the accounts of participating market makers. Auto-ex orders were thus not executed according to auction principles and priority rules, but were allocated to market makers on the system by turn, regardless of who was first to bid or offer the disseminated price. For descriptions of such systems, see, e.g., Securities Exchange Act Release Nos. 48975 (December 23, 2003), 68 FR 75667 (December 31, 2003) (Amex); 44829 (September 21, 2001), 66 FR 49730 (September 28, 2001) (Phlx); 41823 (September 1, 1999), 64 FR 49265 (September 10, 1999) (Pacific Exchange); and 44104 (March 26, 2001), 66 FR 18127 (April 5, 2001) (CBOE). 58 See, e.g., Securities Exchange Act Release Nos. 50469 (September 29, 2004), 69 FR 59628 (October 5, 2004) (CBOE reduction of public customer transaction fees on options on ETFs and HOLDRs); 49957 (July 1, 2004), 69 FR 41318 (July 8, 2004) (ISE waiver of surcharge on public customer transactions in certain licensed products); 44654 (August 3, 2001), 66 FR 42574 (August 13, 2001) (CBOE waiver of fees for public customer transactions in options on Standard & Poor’s 100 European-style index). See also infra, note 101. 59 The Commission previously has articulated its position regarding its application of Section 6 of the Act in evaluating distinctions among market participants proposed by exchanges and the leeway granted to an exchange to set an appropriate level of advantages and responsibilities of persons in its marketplace. See Securities Exchange Act Release No. 50484 (October 1, 2004), 69 FR 60440 (October 8, 2004), stating, inter alia: [Section (b)(5)] sets forth the purposes or objectives that the rules of a national securities exchange should be designed to achieve. Those purposes or objectives, which take the form of positive goals, such as to protect investors and the public interest, or prohibitions, such as to not permit unfair discrimination among customers, issuers, brokers or dealers or to not permit any unnecessary or inappropriate burden on VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 these changes do not unfairly discriminate among participants.60 In fact, the ISE’s proposal simply restores the treatment of Professional Orders to a base line where no special priority benefits and fee waivers are granted. Moreover, with respect to commenters’ contention that brokerdealers have substantial marketplace advantages over Public Customers, it should be noted that broker-dealers, unlike Public Customers, pay significant sums for registration and membership in self-regulatory organizations (‘‘SROs’’), and incur significant costs to comply, and ensure that their associated persons comply, with the Act and the rules thereunder and SRO rules. Moreover, Public Customers who would not be Priority Customers on ISE because they place options orders on the scale contemplated by the proposal could choose to become registered brokerdealers and receive the same advantages. With regard to commenters’ contentions relating to market-maker advantages, the Commission notes that ISE market makers have obligations that customers who seek to compete with them do not have, including the responsibility to make continuous markets; to engage in a course of dealings reasonably calculated to contribute to the maintenance of a fair and orderly market; and not to make bids or offers or enter into transactions that are inconsistent with such a course of dealings.61 Generally, the advantages of market makers noted by commenters, such as the ability to stream quotes on two sides of the market, are granted by exchanges as the quid pro quo for the market makers’ assumption of these obligations, in addition to the application of other rules and restrictions relating to their activities.62 competition, are stated as broad and elastic concepts. They afford the Commission considerable discretion to use its judgment and knowledge in determining whether a proposed rule change complies with the requirements of the Act. Furthermore, the subsections of Section 6(b) of the Act must be read with reference to one another and to other applicable provisions of the Act and the rules thereunder. Within this framework, the Commission must weigh and balance the proposed rule change, assess the views and arguments of commenters, and make predictive judgments about the consequences of approving the proposed rule. (citations omitted) 60 See infra Section III.B.2 for a discussion of whether ISE’s proposal is unfairly discriminatory. 61 See ISE Rule 803. 62 For example, pursuant to ISE Rule 803(b), a market maker on ISE has a continuous obligation to engage, to a reasonable degree under the existing circumstances, in dealings for the market maker’s own account when there exists, or it is reasonably anticipated that there will exist, a lack of price continuity, a temporary disparity between the supply of and demand for a particular options PO 00000 Frm 00066 Fmt 4703 Sfmt 4703 5699 In addition, the proposal could provide an advantage to Public Customers who would not be Priority Customers. Under the proposed rule change, Professional Orders would not be subject to cancellation fees,63 which could result in partially reduced costs for those customers who place orders on an average of one order per minute and frequently cancel such orders.64 Several commenters stated that active traders provide valuable liquidity to the market and pose significant competition to market makers. According to some commenters, the proposed rule change would punish these customers who contribute liquidity,65 and would force such traders from the market.66 The Commission acknowledges that Public Customers, including sophisticated algorithmic traders, provide valuable liquidity to the options markets and compete with market makers. In the Commission’s view, however, the contribution of these participants to the market does not mean that their orders are entitled to favorable priority and fee treatment, even if—as commenters argue—they would not be able to supply this liquidity without being granted such priority and fee advantages. Market makers and broker-dealers also provide valuable liquidity to the marketplace and do not have priority. Thus, the Commission believes that it is consistent with the Act for the ISE to amend its rules so that Professional Orders, like the orders of broker-dealers and market makers, are not granted special priority. Two commenters appeared to acknowledge that customers who enter orders on the scale that the proposed rule change would establish likely have contract, or a temporary distortion of the price relationships between options contracts of the same class. Public Customers, including customers who seek to compete with market makers, have no such obligations. Under ISE’s proposal, Public Customers who submit Professional Orders would not be subject to market maker obligations. 63 The Exchange charges a cancellation fee, currently $2.00 per cancellation, on each clearing EAM that cancels at least 500 Public Customer orders in a month for itself or for an introducing broker, for each cancelled order in excess of the total number of orders executed for itself or for such introducing broker that month. The cancellation fee does not apply to the cancellation of Public Customer Orders that improve ISE’s disseminated quote at the time the orders were entered. There currently are no fees for the cancellation of NonCustomer Orders, and Professional Orders would not incur such fees under the proposed rule change. 64 The Commission notes that, contrary to the apparent belief of some commenters, the proposal would not impose cancellation fees on Professional Orders. See Cox Letter II supra note 4 and Carr Letter supra note 4. 65 See, e.g., A. Schneider Letter supra note 4 and Weisberg Letter supra note 4. 66 See, e.g., Lampert Letter supra note 4. E:\FR\FM\30JAN1.SGM 30JAN1 5700 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices mstockstill on PROD1PC66 with NOTICES information and technology that allows them to compete in a sophisticated manner.67 However, they argued that the proposal’s creation of the category of Professional Orders suggests that ‘‘any person who wishes to consider themselves a retail customer [must] forego any type of trading technology, which of course is widely available in today’s market.* * *’’ 68 The Commission disagrees with this contention. The proposed rule does not ask Public Customers to forego technology and does not limit the technology that Public Customers who would not be Priority Customers can use to access the ISE’s marketplace. Rather, it establishes that customers who place orders at the level proposed by the ISE—irrespective of their use of trading technology—are engaged in a course of active trading that need not be accorded the special deference paid to those customers who do not place orders as frequently. In support of its proposal, the ISE contends that traders who place orders on the scale set forth in the proposal have the same technological and informational advantages over retail investors as broker-dealers trading for their own account—which enables them to compete effectively with brokerdealer orders and market maker quotes for execution opportunities in the ISE marketplace.69 The Commission, however, does not believe that access to or use of sophisticated technology is the key issue in considering whether it is consistent with the Act for ISE to treat Professional Orders in the same manner as broker-dealer orders in specified circumstances. Instead, the Commission believes that the pivotal issue is whether, under the Act, the exchange can grant certain advantages, which it initially established for all public customers, to only those public customers who place no more than 390 orders per day. The Commission notes that currently customers who are positioned to place orders in the number and frequency specified in the proposed rule change are treated on a par with customers who may not have this ability, or even if they have this ability, do not place orders on the average of one order per minute per over the trading day. Under the Exchange’s proposal, customers who place orders less frequently would be advantaged by the Exchange’s grant of 67 See, e.g., Carr Letter supra note 4 and Cox Letter II supra note 4. 68 See Carr Letter supra note 4. The commenter believed that the proposal, as a result, would require retail customers who forego technology to ‘‘wander into the marketplace blind and helpless.’’ 69 See Notice, supra note 3, at 73 FR 7346. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 priority over Non-Customer Orders and market maker quotes at the same price, even if they have access to sophisticated options trading technology. Further, the Commission disagrees with the argument that customers would have to forego using trading technology under the Exchange’s proposal. The ISE’s proposal does not limit, prohibit, or proscribe the type of technology any customer uses. Customers could still use sophisticated technology to trade options and their orders would not be considered Professional Orders, as long as those customers placed fewer than one order per minute per day on average during a calendar month for their own beneficial account(s). One commenter believed that the proposed rule change limited competition and was collusive because ‘‘it requires the cooperation of other competing exchanges. * * *’’ 70 The Commission notes, however, that the proposed rule change requires EAMs to conduct a quarterly review of customer activity only as reflected in the EAM’s own records. The proposal does not require either EAMs or the Exchange to seek information from other brokerdealer firms or exchanges regarding a customer’s activity.71 2. ISE’s Proposal Is Not Unfairly Discriminatory Many of the commenters argued that the proposed rule change is unfairly discriminatory against those Public Customers who would not be Priority Customers by denying them priority rights and imposing transaction fees on their orders.72 In the ISE’s view, public customers today range from individuals who infrequently place options orders to sophisticated algorithmic traders that trade many options classes on a daily basis.73 ISE proposes to continue to grant priority to, and waive transaction fees for, individuals who place orders below the threshold, as a means to encourage their participation. The Exchange believes, however, that priority rights and fee waivers are no 70 See Cox Letter III supra note 4. The commenter stated further: ‘‘ * * * I fail to see how the ISE can request trading information from a person or entity trading from another exchange, particularly when other exchanges have business models that promote order entry: the exact behavior the ISE is attempting to punish with its rule.’’ 71 Confirmed in telephone conversation between Ira Brandriss, Special Counsel, Division, Commission, and Katherine Simmons, Deputy General Counsel, ISE, on April 29, 2008. See also supra note 17 and accompanying text. See also ISE Rules 401, 706, and 712. 72 See, e.g., G. Schneider Letter supra note 4, Lampert Letter supra note 4, Rule Letter supra note 4, Cox Letter II supra note 4 and Cox Letter III supra note 4. 73 See Notice, supra note 3, at 73 FR 7346. PO 00000 Frm 00067 Fmt 4703 Sfmt 4703 longer warranted for market participants who place more than one order per minute on average during a calendar month, a level of activity that it believes is akin to that of broker-dealers. The Exchange therefore proposes to refrain from providing priority and fee incentives for such participants. The Commission notes that the Act does not require that the Exchange’s rules be designed to prohibit all discrimination, but rather they must not permit unfair discrimination.74 With regard to public customer priority, the Commission has noted above ample precedent demonstrating that public customer orders are not entitled per se to priority treatment over the orders of other market participants. The Commission similarly believes that the ISE’s proposal to grant such priority treatment only to Priority Customers is consistent with the Act and, in particular, is not unfairly discriminatory. As discussed above, the Commission does not believe that the current rules of ISE and other exchanges that accord priority to all public customers over broker-dealers and market makers are unfairly discriminatory. Nor does the Commission believe that it is unfairly discriminatory to accord priority to only those customers who on average do not place more than one order per minute as ISE proposes. Because, as discussed in Section III.A.1. above, the Commission believes that ISE’s proposal is consistent with the Act in that it does not impose an undue burden on competition, the Commission believes that a grant of such priority is an exchange’s prerogative and within the exchange’s business judgment. As such, a decision to grant priority—which, after all, is a special benefit—to the orders of one type of customer (for example, a retail customer) and not to the orders of another (for example, an institutional investor) may be an economic decision that an exchange may make to provide some customers with incentives and fee waivers. In the Commission’s view, nothing in the Act requires an exchange to provide the same incentives and discounts to all market participants equally, as long as the exchange does not unfairly discriminate among participants with regard to access to exchange systems.75 74 15 U.S.C. 78f(b)(5). See also Securities Exchange Act Release No. 50484, supra note 59. 75 In this regard, the Commission notes that ISE amended the proposal to remove the changes it had originally proposed to ISE Rules 715 and 723(c), which would have prevented access by all Public Customers to the Exchange’s PIM. See Amendment No. 2, supra note 5. E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices mstockstill on PROD1PC66 with NOTICES The Commission believes that the line that the ISE seeks to draw between Priority Customers and Public Customers whose orders would be treated as Professional Orders most simply reflects a belief—from the point of view of operating a marketplace—that the orders of a person who submits, on average, more than one order every minute of the trading day need not (or should not) be granted the same benefit or incentive that is granted to Public Customers who do not utilize the marketplace on such a scale. The same can be said with regard to relief from transaction fees. Exchanges can and do have fee structures that vary depending on the market participant.76 Various fee structures are permitted provided that they are consistent with the Act (including the requirement that the fees not be unfairly discriminatory). Such differing fee structures are based on the judgment of those responsible for the financial operation of the exchange, and are tied to exchange assumptions about market participant behavior, the impact of incentives and discounts, and other factors relating to the specific business model adopted by the exchange. A decision to waive or discount fees for orders of one kind of participant and not another, based on the extent of their participation in the market, is a reasonable decision for an exchange, provided it is otherwise consistent with the Act.77 76 For example, some exchanges impose different fees for different market participants, depending on whether the market participant adds liquidity by posting a quote or order, or takes liquidity by executing against a quote or order that is already posted on the exchange. Some exchanges’ transaction fees, before additional charges are assessed, are identical for market makers and member firms, while on other exchanges market makers and member firms are charged at different rates. Some exchanges provide volume discounts; some place a cap on charges to particular participants. Some impose transaction fees upon certain participants for complex orders; others do not. As a result, the fees imposed upon various market participants can vary significantly from exchange to exchange. Each exchange’s schedule of fees is available on the exchange’s Web site. See e.g., the fee schedule of CBOE at https:// www.cboe.com/AboutCBOE/FeeSchedule.aspx; the fee schedule of BOX at https:// www.bostonoptions.com/box_regulations/PDF/ feeschedjan06.pdf; and the fee schedule of NYSE Arca at https://www.nyse.com/futuresoptions/ nysearcaoptions/1147128317287.html. 77 Similar to other exchanges, ISE charges different fees depending on whether an individual is a Public Customer, Non-Member Broker-Dealer, EAM, ISE Market Maker or Non-ISE Market Maker. For example, ISE charges Public Customers a $0.05 fee for Non-Premium Products and the $0.03 Comparison Fee for the orders of Public Customers are currently waived while Non-Member BrokerDealers and EAMs pay a $0.15 fee for orders in Premium and Non-Premium Products (subject to volume discounts) and a $0.03 Comparison Fee. Comparatively, ISE market makers are subject to a fee for transactions in Premium and Non-Premium VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 3. The Proposal Can Be Implemented on a Technical and Operational Level One commenter, SIFMA, endorsed the underlying goal of the proposed rule change, but expressed concern about various aspects of the proposal. First, SIFMA was concerned that, under the proposed rule, EAMs would ‘‘have no ability to identify the end-user customer and count orders.’’ 78 SIFMA’s comment letter noted that EAMs would have to rely on the broker-dealers that route orders to them and have the customer relationship to identify the professional customer and code orders correctly. Moreover, SIFMA stated that, in general, firms do not count the number of orders directed by customers under the same beneficial owners and do not have the ability to break down, by beneficial owner, the number of orders placed. SIFMA further believed that EAMs would need to rely on the Options Clearing Corporation (‘‘OCC’’) member firm that ultimately clears the professional customer to identify such accounts. SIFMA stated, however, that such reliance would not be possible because OCC member clearing firms see only the number of cleared contracts at the end of the day, and not the number of executions. Moreover, SIFMA noted the lack of access by clearing firms to information regarding a customer’s cancellations, replacements, modifications, or corrections of orders, and the resulting inability of such firms to accurately determine the number of orders a customer has placed.79 In its response, ISE stated that these concerns were based on the erroneous assumption that compliance with the proposal would require analysis by an ISE member’s clearing firm of cleared data provided by the OCC to determine whether a customer had crossed the threshold of placing more than 390 orders per day, on average, over the course of a calendar month.80 ISE clarified that only broker-dealers that received orders from the ultimate customers—not clearing firms—would be required under the proposal to monitor the number of orders they receive from each such customer and to mark the orders correctly. ‘‘These types of activities are routinely performed by broker-dealers who deal directly with customers,’’ the ISE maintained, adding that broker-dealers have a regulatory Products between $0.12–$0.21 (subject to volume discounts). The amount of this fee is based on the average daily volume of transactions on the Exchange, and is currently $0.13 per contract. See ISE Schedule of Fees. See also discussion infra note 105. 78 See SIFMA Letter supra note 4. 79 Id. 80 See ISE Response Letter supra note 6. PO 00000 Frm 00068 Fmt 4703 Sfmt 4703 5701 responsibility to know their customer, ‘‘and, in fact, do know if they have customers that conduct this high level of activity.’’ 81 With regard to ISE members that submit customer orders to the Exchange when those orders were routed to them by other, non-ISE-member brokerdealers, SIFMA indicated its concern that such members ‘‘will be forced to rely on the good faith and effort of its broker-dealer client * * * to identify the professional customer and code the order correctly.’’ 82 In response, the ISE noted that the Exchange and all other options exchanges currently have a variety of order marking requirements for which ISE members that route orders on behalf of other broker-dealers have regulatory responsibility. The ISE further noted that its EAMs would need to have reasonable procedures in place to confirm that their broker-dealer customers had implemented the appropriate procedures to monitor their customers’ trading activity in a way that would enable them to code orders properly to comply with the proposal.83 The Commission believes that the ISE’s response clarifies its proposal and addresses the concerns raised by SIFMA regarding the counting and marking of customer orders. The proposal would require any ISE member submitting a Public Customer Order to the ISE to identify such order as either a Priority Customer Order or a Professional Customer Order. Based on the ISE’s representations, the Commission believes that ISE members that directly submit their Public Customers’ orders to the Exchange for execution can readily determine the number of orders that their customers place and can mark those orders accordingly. The Commission notes that the Exchange has stated that EAMs would need to have reasonable procedures in place to confirm that their broker-dealer customers have instituted policies and procedures to enable them to monitor their customers’ trading activity in a 81 Id. The ISE also stated that it consulted with a variety of firms that accept orders directly from customers, and that these firms did not believe it would be difficult for them to determine, on a quarterly look-back basis, whether a customer had on average entered more than 390 orders per day during any month. Id. 82 See SIFMA Letter supra note 4. 83 Id. According to the Exchange, an EAM would be required to have such procedures in place to comply with its obligation under ISE Rule 712(a) to properly mark orders. Telephone conversation between Katherine Simmons, Deputy General Counsel, ISE, and Nancy J. Burke-Sanow, Assistant Director, Division, Commission, on December 15, 2008. E:\FR\FM\30JAN1.SGM 30JAN1 mstockstill on PROD1PC66 with NOTICES 5702 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices way that would allow them to mark their customer orders properly.84 The Commission believes that ISE members, as well as non-member broker-dealers who accept customer orders and route them to EAMs for execution on the Exchange, have the ability to ascertain for each customer account, by beneficial owner, the number of orders placed by a customer. As the ISE points out, the proposal requires the broker-dealer that has a relationship with, and knows, the ultimate customer to monitor the number of orders it is entering on the customer’s behalf and to conduct a quarterly review to assure that the firm is marking the orders appropriately. This monitoring is accomplished by the ISE member directly in the case of its own customers or by the ISE member contractually requiring that its brokerdealer customers have reasonable procedures in place to ascertain whether their customers are submitting orders that should be marked as Professional Orders. Second, SIFMA expressed concern that professional customers could ‘‘ ‘game’ the system and inappropriately take advantage and avoid the purpose of the rule.’’ SIFMA noted the frequent use by Professional Customers of multiple firms for execution and clearing purposes, which would limit the review by any one EAM or OCC clearing member of a customer’s activity. SIFMA further noted that customers could electronically route orders to an exchange without a Professional Order designation and, due to linkage and best execution requirements, these orders could be sent to the ISE without the proper coding.85 ISE acknowledged that customers could place orders at multiple firms, such that each individual broker-dealer would not know the full extent of its customer’s trading activity, making it impossible for a particular firm to measure the total number of orders entered by a particular customer through multiple firms. ISE stated, however, that it believed that ‘‘it might be impractical for a customer to conduct professional trading activities through multiple broker-dealer platforms.’’ The Exchange also stated that it would conduct surveillance designed to identify any such behavior, and that if it does detect such activity, it would alert the relevant ISE members. In addition, ISE agreed that, through the operation of the options linkage rules, an order for the account of a customer that ISE otherwise would consider a Professional Order might be routed to 84 Id. 85 See SIFMA Letter supra note 4. VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 other exchanges that do not have the same order designation and ultimately receive the price available on the ISE indirectly.86 The Commission believes that the rule change, as proposed, meets the Exchange’s aim with regard to those customers who do not employ such stratagems, and thus the potential for a customer to circumvent the proposed rule, does not, in this instance, make it inconsistent with the Act. Third, SIFMA believed that, for the proposed rule change to be properly implemented, customer trading information would need to be disseminated across desks within a single firm that typically are separated by information barriers. Regarding this issue, SIFMA requested specific guidance on how to implement the proposed requirements without violating applicable privacy regulations.87 ISE responded that putting procedures in place to comply with its proposal would not result in disclosure of information about particular orders entered by a customer either pre- or post-trade, nor would it result in disclosures about any positions held by a customer. The Exchange stated that it is not aware of any information barrier rule or privacy regulations that would prevent a firm from marking an order as required under the proposal.88 The Commission agrees with the ISE’s position in this regard. The Commission believes that the determination of whether a Public Customer’s orders are categorized as Priority Customer Orders or Professional Orders, which would be based on information compiled retrospectively each quarter, can be made at a level in the firm that is ‘‘above’’ the information barrier, and in any case does not require disclosure of any particular orders placed by a customer or any positions held by a customer. Finally, one commenter expressed the concern that the proposal would be burdensome because it would require EAMs to purchase expensive technology to track the number of orders a person entered per day.89 Another commenter, SIFMA, believed that the ISE’s proposal would require broker-dealers to expend significant resources to comply with the rule and potentially would present large retail firms with difficulties in implementing a new order origin code within the proposal’s timeframe.90 ISE acknowledged that systems changes to accommodate new coding of 86 See ISE Response Letter supra note 6. SIFMA Letter supra note 4. 88 See ISE Response Letter supra note 6. 89 See Cox Letter III supra note 4. 90 See SIFMA Letter, supra note 4. 87 See PO 00000 Frm 00069 Fmt 4703 Sfmt 4703 orders could be required for some broker-dealers, but did not believe that such systems changes would be particularly costly ‘‘relative to other rule changes routinely made by the ISE and other exchanges.’’ 91 SIFMA also expressed a concern that the proposal could require significant revisions to the customer option account agreements used by firms, because customers could be designated as professional customers.92 The Commission believes that it is within the business judgment of the Exchange to accept orders for execution in its marketplace contingent upon their submission with a particular order marking, even when that marking may require additional expense on the part of member firms. Exchanges routinely add new order types 93 and the ISE’s proposal is no different in this regard. Thus, the Commission believes that the new order designations in the proposed rule change are consistent with the Act, even though they will require members to incur costs associated with systems changes and customer account agreements may need to be revised to reflect these new order designations. As a general matter, the Commission notes that membership in an exchange comes with the expectation that rule changes will be made by the exchange that could require member firms to make adjustments in their systems and procedures. SIFMA further noted that the proposal would require additional systemic and procedural enhancements for firms to track the new fees that would be established under the proposal.94 In response, the Exchange maintained that fees vary widely among exchanges and are changed frequently, and that firms routinely make changes in their systems to accommodate exchange fee changes.95 The Commission notes that fee changes are commonly introduced by exchanges, and members can expect that they will need to adjust their tracking systems as needed when changes are made. Finally, SIFMA further expressed a concern that the five-day timeframe allotted at the end of a quarter for firms to start coding for Priority Customer and Professional Orders is unrealistic.96 In response, the ISE acknowledged that it may take more than five days for a 91 See ISE Response Letter supra note 6. SIFMA Letter supra note 4. 93 See, e.g., Securities Exchange Act Release Nos. 58546 (September 15, 2008), 73 FR 54440 (September 19, 2008); 57441 (March 6, 2008), 73 FR 13267 (March 20, 2008); and 56072 (July 13, 2007), 72 FR 39867 (July 20, 2007). 94 See SIFMA Letter supra note 4. 95 See ISE Response Letter supra note 6. 96 See SIFMA Letter supra note 4. 92 See E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices broker-dealer to make the system changes necessary to accommodate the new order code, and stated that it would give members at least one full quarter, following Commission approval of the proposal to make these changes. The Exchange stated, however, that once the initial systems changes were implemented, five days would be sufficient to change the order code associated with a particular customer account.97 The Commission notes that the Exchange has committed to working with its members to assure that there is adequate time to make the initial systems changes necessary to implement the new coding,98 and believes that not less than one full quarter is a reasonable amount of time to achieve this aim. The Commission, however, will monitor whether any issues may arise that would require the ISE to postpone the proposal’s implementation timeframe. 4. ISE’s Proposal Is Not Vague One commenter contended that the proposal was vague and unenforceable.99 The Commission believes that the ISE’s proposed rule change is amply clear regarding the kind of order that would not receive priority at the same price and would incur transaction fees as a result of the proposal. The proposal sets forth specific and objective numeric thresholds in its provisions, defining ‘‘Priority Customer’’ as ‘‘a person or entity that (i) is not a broker or dealer in securities, and (ii) does not place more than 390 orders in listed options per day on average during a calendar month for its own beneficial account(s).’’ It further defines the term ‘‘Professional Order’’ as ‘‘an order that is for the account of a person or entity that is not a Priority Customer.’’ The Commission believes that these definitions are clear and provide notice of the parameters of the rule. 5. Transaction Fees for Professional Orders Are Not Inequitable As noted above, Section 6(b)(4) of the Act requires that the rules of an exchange must provide for the equitable allocation of reasonable dues, fees, and 97 See ISE Response Letter supra note 6. Exchange stated that it would work with its members to assure that there is adequate time to implement systems changes as necessary. ISE Response Letter, supra note 6, n.6. The Exchange further advised that it would issue a notice to its members informing them of the implementation date of the proposed rule change. Telephone conversation between Katherine Simmons, Deputy General Counsel, ISE, and Nancy J. Burke-Sanow, Assistant Director, Division, Commission, on December 15, 2008. 99 See Cox Letter III, supra note 4. mstockstill on PROD1PC66 with NOTICES 98 The VerDate Nov<24>2008 16:54 Jan 29, 2009 Jkt 217001 other charges among its members and issuers and other persons using its facilities. In evaluating whether a proposed fee can be considered an equitable allocation of a reasonable fee, the Commission considers all of the relevant factors including, among others, the amount of the fee and whether the fee is an increase or decrease, the classes of persons subject to the fee, the basis for any distinctions in classes of persons subject to the fee, the potential impact on competition, and the impact of any disparate treatment on the goals of the Act.100 Under the proposed rule change, transaction fees would be charged for the execution of certain Public Customer Orders that currently are not subject to such fees. The Commission notes, however, that options exchanges have charged transaction fees for the execution of public customer orders in the past,101 and in many cases continue to do so when necessary to defray the costs of maintaining a market and associated expenses for a particular product or category of products.102 The ISE itself currently imposes fees on certain Public Customer Orders.103 Moreover, Public Customer Orders that today incur no transaction fees on the ISE are not indefinitely excepted from such fees. The Exchange’s Fee Schedule specifically sets forth transaction fees for customer orders, while indicating that these fees (other than fees for ‘‘Premium Products’’) currently are waived.104 The 100 See, e.g., Securities Exchange Act Release No. 50484 (October 1, 2004), 69 FR 60440 (October 8, 2004). 101 Subsequently, however, some exchanges have rescinded transaction fees for manually executed equity options orders for public customers. See, e.g., Securities Exchange Act Release Nos. 42798 (May 18, 2000), 65 FR 34239 (May 26, 2000); and 43343 (September 26, 2000), 65 FR 59243 (October 4, 2000). 102 For example, the exchanges generally charge transaction fees for executions of public customer orders in index options. See, e.g., Securities Exchange Act Release No. 52983 (December 20, 2005), 70 FR 76475 (December 27, 2005) (Commission notice of filing and immediate effectiveness of a proposed rule change adopting a flat execution fee for Public Customer Orders in premium products). 103 As noted at supra note 9, Public Customer Orders incur fees for certain transactions in Premium Products and Complex Orders, orders entered in response to special order broadcasts, and orders entered in PIM. Public Customer Orders also are subject to fees for cancellation. 104 See Securities Exchange Act Release Nos. 42370 (April 28, 2000), 65 FR 26256 (May 5, 2000) (Commission order adopting original ISE Fee Schedule), in which the Commission found that the fee schedule was ‘‘not unreasonable’’ and ‘‘should not discriminate unfairly among market participants.’’ See also the current ISE Fee Schedule, dated August 12, 2008 and Securities Exchange Act Release No. 58139 (July 10, 2008), 73 FR 41142 (July 17, 2008) (customer fees, except PO 00000 Frm 00070 Fmt 4703 Sfmt 4703 5703 Commission notes that different market participants pay fees based on their status on the Exchange (e.g., Public Customer, non-member broker-dealer, EAM, non-ISE market maker and ISE market maker).105 Under the proposal, customers whose orders are identified as Professional Orders would pay the same fees as non-member brokerdealers. The Commission notes that the customers who enter more than 390 orders per day on average during a calendar month are using the Exchange’s facilities to place approximately 8,000 orders, on average one order for every minute of every trading day, over the course of the month and nearly 100,000 orders per year. The Commission believes that it is consistent with the Act for ISE to allocate to customers who participate in the market at this level of activity— those for ‘‘Premium Products,’’ currently waived until June 30, 2009). 105 Public Customers—The $0.05 fee for NonPremium Products and the $0.03 Comparison Fee for the orders of Public Customers are currently waived. Public Customers currently pay a fee of $0.15 for certain orders in Premium Products and Complex Orders, orders entered in response to special order broadcasts and orders entered in PIM. Public Customers are also subject to an order cancellation fee of $1.75 per order. See supra notes 9 and 64. Non-member Broker-Dealers—Non-member broker-dealers pay a $0.15 fee for orders in Premium and Non-Premium Products (subject to volume discounts) and a $0.03 Comparison Fee. Customers whose orders are identified as Professional Orders would incur these fees under the proposal. EAMs—EAMs pay the same fees for orders as non-member broker-dealers. In addition to nonmember broker-dealer fees, EAMs also pay a one time application fee of $3500, a regulatory fee of $5000 per year and a monthly access fee of $500. ISE Market Makers—ISE market makers are subject to a fee for transactions in Premium and Non-Premium Products between $0.12–$0.21 (subject to volume discounts). The amount of this fee is based on the average daily volume of transactions on the Exchange, and is currently $0.13 per contract. See Fee Notice to ISE Members dated March 3, 2008, available at https:// www.iseoptions.com. In addition, ISE market makers pay a $0.03 Comparison Fee, a fee for payment for order flow (only for customer orders) of $0.65 per contract and $0.10 per contract for options on issues that are participating in the Penny Pilot (subject to available rebates). In addition to these market maker fees, PMMs and Competitive Market Makers (‘‘CMMs’’) pay additional fees including, but not limited to, the fees described below. PMMs have a minimum monthly transaction fee of $50,000, a one time application fee of $7500, a regulatory fee of $7500 per year, a monthly access fee of $4000 and an inactivity fee of $100,000 per month. CMMs have a one time application fee of $5500, a regulatory fee of $5000 per year, a monthly access fee of $2000 and an inactivity fee of $5,000 per month. Non-ISE Market Makers—Non-ISE market makers pay a $0.37 fee for transactions in Premium and Non-Premium Products (subject to volume discounts) except for a $0.16 fee for orders entered in the Facilitation and Solicitation Mechanisms and a $0.03 Comparison Fee. E:\FR\FM\30JAN1.SGM 30JAN1 5704 Federal Register / Vol. 74, No. 19 / Friday, January 30, 2009 / Notices 100 F Street, NE., Washington, DC 20549–1090. which enables them to compete with Non-Customers who are registered broker-dealers—the same transaction fees that it charges to such NonCustomers. C. Accelerated Approval of Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Pursuant to Section 19(b)(2) of the Act,106 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 modified by Amendment Nos. 1 and 2, before the 30th day after the date of publication of notice of filing thereof in the Federal Register.107 The Commission notes that the proposal, as modified by Amendment No. 1, was published for comment in the Federal Register on February 7, 2008. The revisions made to the proposal in Amendment No. 2 deleted proposed changes to ISE Rules 715 and ISE Rule 723(d)(2). These revisions appropriately clarify that the proposed rule change would not limit a Public Customer’s access to the Exchange’s PIM. Accordingly, pursuant to Section 19(b)(2) of the Act,108 the Commission finds good cause to approve the proposed rule change, as modified by Amendment Nos. 1 and 2, on an accelerated basis. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as modified by Amendment Nos. 1 and 2, is consistent with the Act. 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 rulecomments@sec.gov. Please include File Number SR–ISE–2006–26 on the subject line. SECURITIES AND EXCHANGE COMMISSION All submissions should refer to File Number SR–ISE–2006–26. 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, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. 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–2006–26 and should be submitted on or before February 20, 2009. [Release No. 34–59288; File No. SR–ISE– 2009–03] IV. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,109 that the proposed rule change (SR–ISE–2006– 26), as modified by Amendment Nos. 1 and 2, be, and it hereby is, approved on an accelerated basis. By the Commission. Florence E. Harmon, Deputy Secretary. [FR Doc. E9–1979 Filed 1–29–09; 8:45 am] BILLING CODE 8011–01–P January 23, 2009. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on January 15, 2009, the International Securities Exchange, LLC (the ‘‘Exchange’’ or the ‘‘ISE’’) filed with the Securities and Exchange Commission the proposed rule change, as described in Items I, II, and III below, which items have been prepared by the self-regulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The ISE is proposing to amend its Schedule of Fees to establish fees for transactions in options on 4 Premium Products.3 The text of the proposed rule change is available on the Exchange’s Web site (https://www.ise.com), at the principal office of the Exchange, and at the Commission’s Public Reference Room. 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 self-regulatory organization included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The self-regulatory organization has prepared summaries, set forth in sections A, B and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change Paper Comments mstockstill on PROD1PC66 with NOTICES Self-Regulatory Organizations; International Securities Exchange, LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Fee Changes • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 1. Purpose—The Exchange is proposing to amend its Schedule of Fees 1 15 U.S.C. 78s(b)(2). 107 See supra note 3. 108 15 U.S.C. 78s(b)(2). U.S.C. 78s(b)(1). CFR 240.19b–4. 3 Premium Products is defined in the Schedule of Fees as the products enumerated therein. 106 15 VerDate Nov<24>2008 16:54 Jan 29, 2009 2 17 109 15 Jkt 217001 PO 00000 U.S.C. 78s(b)(2). Frm 00071 Fmt 4703 Sfmt 4703 E:\FR\FM\30JAN1.SGM 30JAN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 74, Number 19 (Friday, January 30, 2009)]
[Notices]
[Pages 5694-5704]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-1979]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59287; File No. SR-ISE-2006-26]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Notice of Filing of Amendment No. 2 and Order Granting Accelerated 
Approval of the Proposed Rule Change, as Modified by Amendment Nos. 1 
and 2 Thereto, Relating to Professional Account Holders

January 23, 2009.

I. Introduction

    On May 5, 2006, the International Securities Exchange, LLC (``ISE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder \2\ to amend ISE rules to give certain non-broker-dealer 
orders, identified as ``professional orders,'' the priority given 
broker-dealer orders and market maker quotes rather than the priority 
currently given all public customer orders and to charge the same 
transaction fees for professional orders as charged for the orders of 
broker-dealers and market makers. On January 25, 2008, the Exchange 
filed Amendment No. 1 to the proposed rule change. The proposed rule 
change, as modified by Amendment No. 1, was published for comment in 
the Federal Register on February 7, 2008.\3\ The Commission received 
ten comment letters on the proposal.\4\ The Exchange filed Amendment 
No. 2 to the proposed rule change on June 17, 2008,\5\ and submitted a 
response to the SIFMA Letter on January 12, 2009.\6\ This order 
provides notice of Amendment No. 2 and approves the proposal, as 
modified by Amendment Nos. 1 and 2, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 57254 (February 1, 
2008), 73 FR 7345 (February 7, 2008) (``Notice'').
    \4\ See letters from Abe Lampert, dated May 25, 2006 (``Lampert 
Letter''); Charles B. Cox III, dated May 26, 2006 (``Cox Letter 
I''); B. Thomas Rule, dated May 28, 2006 (``Rule Letter''); Bryan 
Weisberg, dated May 31, 2006 (``Weisberg Letter''); Andrea 
Schneider, dated June 18, 2006 (``A. Schneider Letter''); Gerald 
Schneider, dated February 6, 2008 (``G. Schneider Letter''); Andrew 
Carr, dated March 4, 2008 (``Carr Letter''); Charles B. Cox III, 
dated March 4, 2008 (``Cox Letter II''); Charles B. Cox III, dated 
April 16, 2008 (``Cox Letter III''); and Securities Industry and 
Financial Markets Association (``SIFMA''), dated July 23, 2008 
(``SIFMA Letter'').
    \5\ In Amendment No. 2, ISE deleted proposed changes to ISE 
Rules 715 and 723 (d)(2). These revisions clarify that the proposed 
rule change would not limit a Public Customer's access to the 
Exchange's Price Improvement Mechanism (``PIM''). See infra note 75.
    \6\ See letter from Michael J. Simon, Secretary, ISE, to 
Florence Harmon, Acting Secretary, Commission, dated January 12, 
2009 (``ISE Response Letter'').
---------------------------------------------------------------------------

II. Description of ISE's Proposal

    Currently, ISE grants certain advantages to Public Customer Orders 
\7\ over Non-Customer Orders.\8\ In particular, Public Customer Orders 
receive priority over Non-Customer Orders and market maker quotes at 
the same price. In addition, subject to certain exceptions, Public 
Customer Orders do not incur transaction charges.\9\ The ISE states 
that the purpose, generally, of providing these marketplace advantages 
to Public Customer Orders is to attract retail investor order flow to 
the Exchange by leveling the playing field for retail investors over 
market professionals and providing competitive pricing.\10\ According 
to the Exchange, market professionals have access to sophisticated 
trading systems that contain functionality not available to a retail 
customer, including things such as continuously updated pricing models 
based upon real-time streaming data, access to multiple markets 
simultaneously, and order and risk management tools.\11\
---------------------------------------------------------------------------

    \7\ A ``Public Customer'' is defined in ISE's rules as ``a 
person that is not a broker or dealer in securities.'' A ``Public 
Customer Order'' is defined as ``an order for the account of a 
Public Customer.'' ISE Rules 100(a)(38) and (39).
    \8\ A ``Non-Customer'' is defined in ISE's rules as ``a person 
or entity that is a broker or dealer in securities.'' A ``Non-
Customer Order'' is defined as ``any order that is not a Public 
Customer Order.'' ISE Rules 100(a)(27) and (28).
    \9\ For example, Public Customer Orders currently incur fees for 
certain transactions in ``Premium Products'' (defined in the ISE 
Schedule of Fees) and Complex Orders that take liquidity on the 
Exchange's complex order book. In addition, transaction fees are 
charged for Public Customer Orders entered in response to special 
order broadcasts, such as Facilitation orders, Solicitation orders, 
Block orders, and orders entered in the Exchange's PIM. Public 
Customer Orders also are subject to fees for order cancellations. 
See ISE Schedule of Fees.
    \10\ See Notice, supra note 3, at 73 FR 7346.
    \11\ See Notice, supra note 3, at 73 FR 7346 n.7.
---------------------------------------------------------------------------

    With respect to the marketplace advantages of priority in trading 
and waiver of fees, the Exchange does not believe at this time that the 
definitions of Public Customer and Non-Customer properly distinguish 
between the kind of non-professional retail investors for whom these 
advantages were intended and certain professionals. The Exchange 
believes that distinguishing solely between registered broker-dealers 
and non-broker-dealers with respect to these

[[Page 5695]]

advantages is no longer appropriate in today's marketplace, because 
some non-broker-dealer individuals and entities have access to 
information and technology that enables them to trade listed options in 
the same manner as a broker or dealer in securities. The Exchange 
maintains that these individual traders and entities (collectively, 
``professional account holders'') have the same technological and 
informational advantages as broker-dealers trading for their own 
accounts, which enables professional account holders to compete 
effectively with broker-dealer orders and market maker quotes for 
execution opportunities in the ISE marketplace.\12\ The Exchange 
therefore does not believe that it is consistent with fair competition 
for these professional accounts holders to continue to receive the same 
marketplace advantages that retail investors have over broker-dealers 
trading on the ISE.\13\
---------------------------------------------------------------------------

    \12\ The Exchange also maintains that, under its current rules, 
retail investors are prevented from fully benefiting from the 
priority advantage when professional account holders are afforded 
the same Public Customer Order priority that retail investors enjoy. 
See Notice, supra note 3, at 73 FR 7346.
    \13\ Id.
---------------------------------------------------------------------------

    ISE thus proposes to create two new order types: Priority Customer 
Orders and Professional Orders. Priority Customer Orders would be 
orders for the account of a Priority Customer, which would be defined 
as a person or entity that is not a broker-dealer in securities and 
that does not place more than 390 orders \14\ in listed options per day 
on average during a calendar month for its own beneficial account(s). 
Professional Orders would be defined as orders for the account of a 
person or entity that is not a Priority Customer, and would include 
proprietary orders of ISE members and non-member broker-dealers.\15\ 
Priority Customer Orders would have priority over Professional Orders 
at the same price. Thus, Public Customers who now have priority over 
market makers and broker-dealers at the same price would be on parity 
with market markers and broker-dealers at the same price, if those 
Public Customers placed more than 390 orders in listed options per day 
on average during a calendar month. These Professional Orders also 
would be assessed the same fees that ISE charges for broker-dealer 
transactions.
---------------------------------------------------------------------------

    \14\ The Exchange states that 390 orders is equal to the total 
number of orders that a person would place in a day if that person 
entered one order every minute from market open to market close. 
According to ISE, a study of one of the largest retail-oriented 
options brokerage firms indicated that on a typical trading day, 
options orders were entered with respect to each of 5,922 different 
customer accounts. There was only one order entered with respect to 
3,765 of the 5,922 different customer accounts on this day, and 
there were only 17 customer accounts with respect to which more than 
10 orders were entered. The highest number of orders entered with 
respect to any one account over the course of an entire week was 27. 
In addition, many of the largest retail-oriented electronic brokers 
offer lower commission rates to customers they define as ``active 
traders.'' The Exchange reviewed the publicly available information 
from the Web sites for Charles Schwab & Co., Inc.; Fidelity 
Investments; TD Ameritrade, Inc.; and optionsXpress, Inc., and found 
all of them define an ``active trader'' as someone who executes only 
a relatively small number of options trades per month. The highest 
required trading activity to qualify as an active trader among these 
four firms was 35 trades per quarter. See Notice, supra note 3, at 
73 FR 7347 n.10-11.
    \15\ Members would be required to represent as Professional 
Orders for the next calendar quarter the orders for any customer 
that had an average of more than 390 orders per day during any month 
of a calendar quarter. See proposed Text of Regulatory Circular 
filed by ISE as part of the proposed rule change (``Proposed 
Regulatory Circular'').
---------------------------------------------------------------------------

    The Exchange believes that the use of these new terms in the 
execution rules and fee schedule would result in professional account 
holders participating in the ISE's allocation process on equal terms 
with broker-dealer orders and market maker quotes. It would also result 
in members paying the same transaction fees for the execution of orders 
for a professional account as they do for broker-dealer orders. The 
Exchange believes that identifying professional account holders as 
participants who place more than one order per minute on average per 
day during a calendar month is an appropriately objective approach that 
would reasonably distinguish such persons and entities from retail 
investors. The Exchange proposes the threshold of 390 orders per day on 
average over a calendar month because it believes this amount far 
exceeds the number of orders that are entered by retail investors in a 
single day, while being a sufficiently low number of orders to cover 
the professional account holders that are competing with broker-dealers 
in the ISE marketplace. ISE further notes that basing the standard on 
the number of orders that are entered in listed options for a 
beneficial account(s) assures that professional account holders could 
not inappropriately avoid the purpose of the rule by spreading their 
trading activity over multiple exchanges, and using an average number 
over a calendar month would prevent gaming of the 390 order 
threshold.\16\
---------------------------------------------------------------------------

    \16\ See Notice, supra note 3, at 73 FR 7346-47.
---------------------------------------------------------------------------

    ISE's proposal would require Electronic Access Members (``EAMs'') 
to indicate whether Public Customer Orders are Priority Customer Orders 
or Professional Orders. EAMs would be required to review their 
customers' activity on at least a quarterly basis to determine whether 
orders that are not for the account of a broker or dealer should be 
represented as Priority Customer Orders or Professional Orders. Members 
would be required to make any appropriate changes to the way in which 
they are representing orders within five days after the end of each 
calendar quarter. If during a calendar quarter the Exchange identified 
a customer for which orders are being represented as Priority Customer 
Orders, but that customer has averaged more than 390 orders per day 
during a month, the Exchange would notify the member and the member 
would be required to change the manner in which it is representing the 
customer's orders within five days.\17\
---------------------------------------------------------------------------

    \17\ See Proposed Regulatory Circular, supra note 15.
---------------------------------------------------------------------------

    All Public Customers would continue to be treated in the same 
manner under all ISE rules, other than those rules for priority and 
transaction fees. For example, ISE rules relating to the Intermarket 
Linkage affecting Public Customers \18\ would continue to apply to all 
customers who are not broker-dealers--even those customers whose orders 
are identified as Professional Orders. Similarly, rules regarding 
customer suitability and other protections for customers would continue 
to apply with respect to all customers who are not broker-dealers.\19\
---------------------------------------------------------------------------

    \18\ See Chapter 19 of the ISE Rules.
    \19\ See Chapter 6 of the ISE Rules. Telephone conversation 
between Nancy Burke-Sanow, Assistant Director, Division of Trading 
and Markets (``Division''), Commission, et al., and Katherine 
Simmons, Deputy General Counsel, ISE, on March 3, 2008.
---------------------------------------------------------------------------

III. Commission Findings and Order Granting Accelerated Approval to the 
Proposed Rule Change as Modified by Amendment Nos. 1 and 2

    After careful consideration of the proposed rule change, as well as 
the comment letters and the ISE Response Letter, the Commission finds 
that the proposed rule change is consistent with the Act. As the 
options markets have become more electronic and more competitive over 
the last several years, the Commission believes that the distinction 
between a professional who is registered as a broker-dealer and a 
public customer who is not so registered, but who may trade to the same 
extent as a broker-dealer, has become blurred.\20\ Moreover, the

[[Page 5696]]

category of public customer today includes sophisticated algorithmic 
traders including former market makers and hedge funds that trade with 
a frequency resembling that of broker-dealers.\21\ The Commission 
believes that the Act does not require the ISE to treat those customers 
who meet the high level of trading activity established in the proposal 
identically to customers who do not meet that threshold.\22\
---------------------------------------------------------------------------

    \20\ See, e.g., Nina Mehta, Options Maker-Taker Markets Gain 
Steam, TRADERSmagazine.com, October 2007, https://
www.tradersmagazine.com/issues/20071004/2933-1.html.
    \21\ Id.
    \22\ The Commission notes that one of the commenters, discussing 
the proposed rule change before the Exchange filed Amendment No. 1, 
stated that she placed an average of 170 orders per day. See A. 
Schneider Letter supra note 4. Under the proposed rule change, as 
amended, a Public Customer that places this number of orders would 
be substantially short of the proposed threshold of more than 390 
orders per day and thus would not be affected by the rule.
---------------------------------------------------------------------------

    Specifically, the Commission finds that the proposed rule change is 
consistent with Section 6(b) \23\ of the Act and the rules 
thereunder,\24\ and in particular with:
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78f(b).
    \24\ In approving the proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f). See also 
infra notes 50-71 and accompanying text.
---------------------------------------------------------------------------

    Section 6(b)(4) of the Act, which requires exchanges to provide for 
the equitable allocation of reasonable dues, fees, and other charges 
among its members and issuers and other persons using its facilities; 
\25\
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78f(b)(4).
---------------------------------------------------------------------------

    Section 6(b)(5) of the Act, which requires that the rules of a 
national securities exchange, among other things, be designed to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism for a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest; and not be designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers; \26\ and
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Section 6(b)(8) of the Act, which requires the rules of an exchange 
not to impose any burden on competition not necessary or appropriate in 
furtherance of the Act.\27\
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    In addition, the Commission finds that the proposed rule change is 
consistent with Section 11(a) of the Act.\28\
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78k(a). See infra Section III.A.1.
---------------------------------------------------------------------------

A. Customer Priority on the Options Exchanges

    Currently, the ISE accords priority to all Public Customer Orders 
at the best bid or offer on the basis of price-time priority before 
allocating any remaining contracts among Non-Customer Orders and market 
maker quotes at the same best price. ISE now proposes that only 
Priority Customer Orders, as defined above, would receive such 
priority.
    In considering this aspect of the proposal, the Commission examined 
the basis upon which exchanges have granted priority to public 
customers in the past. The Commission further considered the threshold 
question of when and whether the orders of public customers must be 
entitled to priority over the orders of broker-dealers.
    In certain contexts, the Commission has characterized an exchange's 
practice of according priority to public customers' orders as a matter 
of ``tradition.'' \29\ Alternatively, the Commission has referred to 
public customer priority as ``the generally accepted auction trading 
principle of priority of public limit orders over member proprietary 
orders at the same price.'' \30\
---------------------------------------------------------------------------

    \29\ See, e.g., Securities Exchange Act Release Nos. 21695 
(January 28, 1985), 50 FR 4823 (February 1, 1985) (in considering 
Chicago Board Options Exchange's (``CBOE'') proposal to implement a 
retail automatic execution system (``RAES'') pilot program, the 
Commission referred to ``the traditional priority accorded to public 
customer orders''); and 22610 (November 8, 1985), 50 FR 47480 
(November 18, 1985) (in considering a proposal by the American Stock 
Exchange (``Amex'') to implement an automatic execution feature of 
its AUTOAMOS system on a pilot basis, the Commission stated that the 
pilot ``ensures the traditional priority accorded public customer 
orders''). In each of these instances, the Commission was referring 
specifically to public customer orders that are placed on the book. 
Such placements may affect the application of priority principles. 
See, e.g., infra Section III.A.3.
    \30\ See, e.g., Securities Exchange Act Release No. 22817 
(January 21, 1986), 51 FR 3547 (January 28, 1986) (notice of CBOE's 
proposal to implement RAES on a permanent basis for options on the 
Standard and Poor's 100 Index (``OEX'') (SR-CBOE-85-32) and to 
extend RAES to selected classes of individual stock options on a 
six-month pilot basis (SR-CBOE-85-16) (``January 1986 Release''). 
See also infra note 40.
---------------------------------------------------------------------------

    These references in Commission releases support the Commission's 
view that the customer priority rule under discussion was not a matter 
of public customer entitlement derived from the Act, but rather a 
matter of convention to accommodate public customer orders, or an 
auction principle applied as a matter of longstanding practice by 
exchanges. In addition, public customer orders are a source of 
liquidity in the market, and exchanges have sought to attract such 
orders by providing public customers certain guarantees that their 
orders would be executed even in the face of competition from broker-
dealers.
    The Commission previously has approved exchange rules that apply 
this ``traditional priority'' as consistent with the Act but, as 
discussed below, has approved exchange rules that do not accord 
priority to public customer orders.\31\ In analyzing the concept of 
public customer priority, the Commission has considered whether public 
customer priority, or the absence of such priority, is consistent with 
Section 11(a) of the Act, the agency obligations of the specialist, the 
protection of investors and the public interest, and the Act, in 
general.
---------------------------------------------------------------------------

    \31\ See infra notes 41-44 and accompanying text.
---------------------------------------------------------------------------

1. Section 11(a) of the Act
    Section 11(a) of the Act prohibits any member of a national 
securities exchange from effecting transactions on that exchange for 
its own account, the account of an associated person, or an account 
over which it or its associated person exercises discretion unless an 
exception applies.\32\ Thus, in some contexts, the Commission has cited 
Section 11(a) of the Act as a basis for exchange rules that accord 
customer orders priority, referring to ``the traditional auction market 
concepts of customer priority embodied in Section 11(a) of the Act.'' 
\33\
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78k(a).
    \33\ See, e.g., Securities Exchange Act Release No. 27205 
(August 31, 1989), 54 FR 37180 (September 7, 1989) (Commission order 
approving a proposal of the Philadelphia Stock Exchange (``Phlx'') 
relating to the crossing of agency orders). See also, e.g., 
Securities Exchange Act Release No. 33708 (March 3, 1994), 59 FR 
11339 (March 10, 1994) (Commission order approving a proposal of the 
Midwest Stock Exchange, Inc. relating to agency crosses between the 
disseminated exchange market).
---------------------------------------------------------------------------

    Section 11(a)(1) contains a number of exceptions for principal 
transactions by members and their associated persons. One such 
exception, set forth in subparagraph (G) of Section 11(a)(1) and in 
Rule 11a1-1(T), permits any transaction for a member's own account 
provided, among other things, that the transaction yields priority, 
parity, and precedence to orders for the account of persons who are not 
members or associated with members of the exchange. Exchange rules, 
therefore, may require members to yield priority to the orders of 
public customers to satisfy this exception to Section 11(a). Another 
exception permits market makers to effect transactions on exchanges in 
which they are members.\34\
---------------------------------------------------------------------------

    \34\ Section 11(a)(1)(A).
---------------------------------------------------------------------------

    In addition to the exceptions noted above, Rule 11a2-2(T) under the 
Act \35\ provides exchange members with an exception from the 
prohibitions in Section 11(a). Rule 11a2-2(T), known as the ``effect 
versus execute'' rule, permits an exchange member, subject to certain

[[Page 5697]]

conditions, to effect transactions for its own account, the account of 
an associated person, or an account with respect to which it or an 
associated person thereof exercises investment discretion 
(collectively, ``covered accounts'') by arranging for an unaffiliated 
member to execute the transactions on the exchange.
---------------------------------------------------------------------------

    \35\ 17 CFR 240.11a2-2(T).
---------------------------------------------------------------------------

    To comply with the ``effect versus execute'' rule's conditions, a 
member: (i) Must transmit the order from off the exchange floor; (ii) 
may not participate in the execution of the transaction once it has 
been transmitted to the member performing the execution; \36\ (iii) may 
not be affiliated with the executing member; and (iv) with respect to 
an account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in 
connection with effecting the transaction except as provided in the 
rule.\37\
---------------------------------------------------------------------------

    \36\ The member, however, may participate in clearing and 
settling the transaction. See Securities Exchange Act Release No. 
14563 (March 14, 1978), 43 FR 11542 (March 17, 1978).
    \37\ 17 CFR 240.11a2-2(T).
---------------------------------------------------------------------------

    The Commission previously has found that the manner of operation of 
ISE's Facilitation Mechanism enables Exchange members to meet the 
conditions of the effect versus execute rule and thereby avail 
themselves of the exception that the rule provides from the 
prohibitions of Section 11(a).\38\ Similarly, the Commission believes 
that the manner of operation of ISE's overall electronic trading 
system, not only the Facilitation Mechanism, enables members to meet 
the four conditions of the effect versus execute rule and would 
continue to do so under the proposal.\39\ For this reason, the 
Commission believes that the proposed rule change, which would permit 
orders of ISE members to be executed under certain circumstances even 
if a Professional Order is on the ISE's book, is consistent with the 
requirements of Section 11(a) of the Act and Rule 11a2-2(T) thereunder.
---------------------------------------------------------------------------

    \38\ See, e.g., Securities Exchange Act Release No. 51666 (May 
9, 2005), 70 FR 25631 (May 13, 2005).
    \39\ The Commission notes that, first, all orders are 
electronically submitted to the ISE through remote terminals. 
Second, because a member relinquishes control of its order after it 
is submitted to the system, the member does not receive special or 
unique trading advantages. Third, although the effect-versus-execute 
rule contemplates having an order executed by an exchange member who 
is not affiliated with the member initiating the order, the 
Commission recognizes that this requirement is satisfied when 
automated exchange facilities are used. (In considering the 
operation of automated execution systems operated by an exchange, 
the Commission has noted that while there is no independent 
executing exchange member, the execution of an order is automatic 
once it has been transmitted into the systems. Because the design of 
these systems ensures that members do not possess any special or 
unique trading advantages in handling their orders after 
transmitting them to the exchange, the Commission has stated that 
executions obtained through these systems satisfy the independent 
execution requirement of Rule 11a2-2(T). See Securities Exchange Act 
Release No. 15533 (January 29, 1979).) Finally, to the extent that 
ISE members rely on Rule 11a2-2(T) for a managed account 
transaction, they must comply with the limitations on compensation 
set forth in the rule. See id., at note 20.
---------------------------------------------------------------------------

2. Protecting Investors and the Public Interest
    In analyzing the merits of exchange proposals affecting public 
customer order priority, the Commission has considered whether the 
proposed rule change is consistent with Section 6(b)(5) of the Act, 
which requires that the rules of an exchange, among other things, be 
designed ``to protect investors and the public interest.'' \40\
---------------------------------------------------------------------------

    \40\ For example, in January 1986, in publishing for public 
comment two proposed rule changes relating to the operation of RAES, 
see supra note 30, the Commission raised the question of whether the 
proposals were inconsistent with the provision in Section 6(b)(5) of 
the Act relating to the protection of investors and the public 
interest. The Commission also asked whether RAES was inconsistent 
with Section 11A of the Act, which states that it is in the public 
interest and appropriate for the protection of investors to assure 
``economically efficient execution of securities transactions,'' 
``the practicability of brokers executing investors' orders in the 
best market,'' and ``an opportunity * * * for investors' orders to 
be executed without the participation of a dealer.'' 15 U.S.C. 78k-
1(a)(1)(C)(i), (iv) and (v). On August 1, 1986, the Commission 
approved the proposal to make the RAES pilot program in OEX options 
permanent and a modified version of the pilot proposal for RAES in 
equity options, concluding that the proposed rule changes were 
consistent with the requirements of the Act, and, in particular, 
with Sections 6 and 11A of the Act. See Securities Exchange Act 
Release No. 23490 (August 1, 1986), 51 FR 28788 (August 11, 1986). 
In its approval order, the Commission stated that it was ``cognizant 
of the substantial benefits provided by RAES to public customers of 
OEX and firms using the system'' and noted that RAES had increased 
the efficiencies of the OEX market and added to the confidence of 
public customers. The Commission indicated that it expected CBOE to 
modify RAES for OEX options in the future, although it stated that 
its approval of the rule change was not tied to this expectation. 
Noting the technical impediments to modifying the system for such 
options, the Commission expressed its belief that ``on balance, the 
benefits of RAES for the market in OEX weigh in favor of permanent 
approval.''
---------------------------------------------------------------------------

    The Commission does not believe that this provision of Section 
6(b)(5) requires that ISE give priority to Public Customers whose 
orders would be considered Professional Orders under the proposal. The 
Commission has indicated in the past that it does not believe that 
priority for public customer orders is an essential attribute of an 
exchange. In particular, the Commission has approved options exchanges' 
trading rules that do not give priority to orders of public customers 
that are priced no better than the orders of other market participants.
    For example, in approving proposed rules governing CBOEdirect, 
CBOE's electronic screen-based trading system (``SBT''), the Commission 
concluded that it was consistent with the Act for the CBOEdirect rules 
not to provide priority to public customer orders over market maker 
quotes and orders in all instances.\41\ Significantly, the Commission 
noted in its approval order for the SBT rules that, in the rules 
governing trades on CBOE's floor, customer orders displayed on the 
limit order book are given priority over broker-dealer orders and 
market maker quotes, but distinguished the operation of CBOEdirect. On 
the floor, the Commission noted, the priority of booked customer limit 
orders was essential because (at the time) the DPM was the agent for 
orders resting in the limit order book and, therefore, consistent with 
general agency law principles, CBOE's rules accorded priority to those 
resting limit orders.\42\ In contrast, an SBT market maker was not 
required to act as agent with respect to a limit order entered into 
CBOEdirect.
---------------------------------------------------------------------------

    \41\ CBOE had proposed alternative priority methodologies for 
its SBT system including public customer priority, market turner 
priority, and trade participation rights for Designated Primary 
Market Makers (``DPMs'') and Lead Market Makers. See Securities 
Exchange Act Release No. 47628 (April 3, 2003), 68 FR 17697 (April 
10, 2003) (Commission order approving rules for CBOEdirect).
    \42\ In 2005, the Commission approved a proposal by the CBOE to 
eliminate the requirement that DPMs act as the agent in the options 
in which it is registered as the DPM on the Exchange. See Securities 
Exchange Act Release No. 52798 (November 18, 2005), 70 FR 71344 
(November 28, 2005) (Commission order approving removing agency 
responsibilities of DPMs).
---------------------------------------------------------------------------

    Furthermore, on the Boston Options Exchange (``BOX''), the options 
facility of the Boston Stock Exchange, Inc., orders generally are 
executed according to price-time priority, with no distinctions made 
with regard to account designation (Public Customer, Broker/Dealer or 
Market Maker).\43\ On the options facility of NYSE Arca, Inc. (``NYSE 
Arca''), all non-marketable limit orders and quotes also are ranked in 
an electronic limit order file and matched for execution according to 
price-time priority.\44\ On these exchanges, all options orders at the 
best price are executed based on the time the order was entered. In 
approving these

[[Page 5698]]

exchanges' rules, the Commission found them to be consistent with the 
Act.
---------------------------------------------------------------------------

    \43\ The Commission stated that the ``contention that all 
existing options exchanges provide strict customer priority is an 
overstatement.'' The Commission noted that several options exchanges 
had rules to permit market makers to be on parity with customer 
orders in certain circumstances. See Securities Exchange Act Release 
No. 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004).
    \44\ See Securities Exchange Act Release No. 54238, (July 28, 
2006), 71 FR 44758 (August 7, 2006) (Commission order approving NYSE 
Arca's OX Trading Platform).
---------------------------------------------------------------------------

    The Commission believed that the BOX's and NYSE Arca's rules, which 
accord no priority to any public customer orders, are consistent with 
the Act's requirement that exchange rules be designed to protect 
investors and the public interest.\ 45\ Similarly, the Commission 
believes that the ISE's proposal, which reasonably eliminates priority 
treatment of Professional Orders of Public Customers, is consistent 
with the statutory requirement.
---------------------------------------------------------------------------

    \45\ Id.
---------------------------------------------------------------------------

3. Agency Obligations
    In approving the proposed rule change, the Commission notes that, 
historically, exchange specialists have had substantial agency 
responsibilities in obtaining executions for customer limit orders. A 
specialist's responsibility to a customer in his or her role as agent 
for the limit order book was based on common law notions of fiduciary 
duty and incorporated in the rules of some exchanges. As exchanges 
increasingly have implemented automated trading systems, however, the 
specialist's role in handling limit orders has diminished.\46\ On the 
ISE, market makers do not act as agent for incoming orders that are 
executable on the exchange. Orders submitted to the ISE are matched by 
an automated trading system and generally are not represented by a 
specialist acting as agent.\47\
---------------------------------------------------------------------------

    \46\ On several options exchanges, including BOX and CBOE, the 
exchange market makers have no responsibility for executing book 
orders, do not receive any fees for execution of book orders, and, 
accordingly, have no agency responsibilities for book orders. See 
e.g., BOX Rules, Chapter V and CBOE Rules Chapter VIII.
    \47\ The Commission recognizes that ISE's rules mandate that a 
Public Customer Order be represented by an agent in a discrete 
situation. ISE Rule 803(c) requires Primary Market Makers 
(``PMMs''), as soon as practical, to address Public Customer Orders 
that are not automatically executed because there is a displayed bid 
or offer on another exchange trading the same option contract that 
is better than the best bid or offer on the Exchange. In such cases, 
PMMs are required to execute at a price that matches the best price 
displayed on another exchange and/or send a Linkage Order. However, 
ISE Rule 803(c), which pertains to Intermarket Linkage, would not be 
affected by the proposed rule change. As noted above, ISE rules 
relating to the Intermarket Linkage affecting Public Customers would 
continue to apply to all Public Customers--even those customers 
whose orders are identified as Professional Orders. See supra note 
18 and accompanying text.
---------------------------------------------------------------------------

    The Commission's approval of ISE's proposal to no longer accord 
priority to Professional Orders is based solely on its determination 
that this proposed rule change is consistent with the Act and the rules 
and regulations thereunder applicable to a national securities 
exchange. The Commission is making no determination as to whether the 
failure of any market participant (e.g., a specialist managing an 
exchange's order book) to accord priority, as appropriate, to any order 
entrusted to that participant as an agent is consistent with the 
federal securities laws or any other applicable law. Accordingly, the 
Commission's approval of ISE's proposal does not affect fiduciary 
obligations under the federal securities laws or agency law principles.

B. Issues Raised by Commenters

    As noted above, the Commission has received ten comment letters 
regarding the proposed rule change.\ 48\ Nine of these commenters 
opposed the proposal. One commenter endorsed the ultimate goal of the 
proposal, but expressed concerns regarding its implementation.\49\ The 
Commission acknowledges the arguments and concerns that have been 
raised by the commenters, but believes that the arguments and concerns 
do not support the conclusion that the proposal is inconsistent with 
the Act.
---------------------------------------------------------------------------

    \48\ See supra note 4.
    \49\ See SIFMA Letter, supra note 4.
---------------------------------------------------------------------------

    The commenters raise essentially five main issues: (1) That the 
proposal is anti-competitive; (2) that it unfairly discriminates 
against certain Public Customers who no longer would have priority over 
Non-Customers; (3) that it raises technical and operational issues for 
firms; (4) that it is vague and therefore unenforceable; and (5) that 
the imposition of transaction fees for the execution of Professional 
Orders is unfair. In its review of the proposal, the Commission has 
carefully considered these issues and has evaluated them in light of 
the Act's provisions, as discussed below.
1. ISE's Proposal Does Not Impose an Unnecessary or Inappropriate 
Burden on Competition
    Some commenters believed that the proposed rule change would thwart 
competition by treating the orders of certain Public Customers on a par 
with orders of broker-dealers, despite the inability of those customers 
to participate in the market on an equal footing with broker-dealers 
and market makers.\50\ These commenters argued that broker-dealers and 
market makers have substantial marketplace advantages over Public 
Customers, including lower margin and commission rates, better access 
to information, and superior technology,\51\ and, in the case of market 
makers, the ability to stream quotes electronically on both sides of 
the market.\52\
---------------------------------------------------------------------------

    \50\ See, e.g., Cox Letter I supra note 4 and Weisberg Letter 
supra note 4.
    \51\ See, e.g., Carr Letter supra note 4, G. Schneider Letter 
supra note 4 and Rule Letter supra note 4.
    \52\ See, e.g., Carr Letter supra note 4, Cox Letter II supra 
note 4 and Rule Letter supra note 4.
---------------------------------------------------------------------------

    As discussed above, the Act does not require that the order of a 
public customer or any other market participant be granted priority. 
The objective of promoting competition and the requirement that the 
rules of an exchange not impose an unnecessary or inappropriate burden 
upon competition do not necessarily mandate that a Professional Order 
be granted priority while the order of a broker-dealer should not be 
granted the same right.
    As a general matter, in developing their trading and business 
models, exchanges have adopted rules, with Commission approval, that 
grant priority to certain participants over others, or to waive fees or 
provide discounts for certain kinds of transactions, in order to 
attract order flow or create more competitive markets.
    The Act itself recognizes that the operation of a marketplace can 
warrant exceptions to general allocation principles, for example, by 
exempting specialists and market makers from the requirement that a 
member of an exchange yield to the order of a non-member.\53\ 
``Specialist entitlements'' \54\ and facilitation and solicited order 
guarantees,\55\ adopted by exchanges with Commission approval, also are 
instances in which the need to attract

[[Page 5699]]

order flow or provide incentives to one group of participants based on 
their role in the marketplace has been viewed as a valid reason to 
adjust the otherwise-established priority principles of an exchange. 
Other examples include options trading rules that adjust allocation 
principles under certain condition in the execution of larger orders 
\56\ and the small order automatic execution systems created by options 
exchanges in the past.\57\ Notably, in some prior proposals to waive or 
reduce customer fees, exchanges cited their need to remain competitive 
and attract order flow.\58\
---------------------------------------------------------------------------

    \53\ See Section 11(a) of the Act, 15 U.S.C. 78k(a), and the 
rules thereunder.
    \54\ A ``specialist entitlement'' as used here is an options 
exchange rule that under certain circumstances guarantees a 
specialist (or designated primary market maker) the right to trade 
ahead of other participants in the trading crowd with a certain 
percentage of every order--when the specialist is quoting at the 
best price--even when the specialist has not otherwise established 
priority. See, e.g., ISE Rule 713, Supplementary Material .01(b); 
Amex Rule 935-ANTE(a)(5); CBOE Rule 8.87; NYSE Arca Rule 6.82(d)(2); 
Phlx Rule 1014(g)(ii).
    \55\ A ``facilitation guarantee'' as used here is an options 
exchange rule that under certain circumstances guarantees an order 
entry firm that has submitted a public customer order for execution 
on the exchange to trade with a certain percentage of that public 
customer order itself, ahead of other participants in the trading 
crowd that are prepared to trade at the same price. See, e.g., ISE 
Rule 716(d); Amex Rule 950-ANTE, Commentary .02; CBOE Rule 6.74(b); 
NYSE Arca Rule 6.47(b); A ``solicited order guarantee'' is an 
options exchange rule that entitles a broker or firm that has 
solicited an order from a third party to trade against its 
customer's order to execute a certain percentage of the customer's 
order against the solicited order ahead of other participants in the 
trading crowd that are prepared to trade at the same price. See, 
e.g., ISE Rule 716(e) (Solicited Order Mechanism).
    \56\ See, e.g., CBOE Rule 6.74(f) (Open Outcry SizeQuote 
Mechanism).
    \57\ In the past, options exchanges that generally operated on 
an open-outcry trading model adopted systems that automatically 
executed orders of public customers below a certain size without 
exposing them to the auction on the floor. These systems were 
designed to give investors speed, efficiency, and accuracy in the 
execution of their small orders, which were executed at the 
exchange's disseminated quotation on a rotational basis against the 
accounts of participating market makers. Auto-ex orders were thus 
not executed according to auction principles and priority rules, but 
were allocated to market makers on the system by turn, regardless of 
who was first to bid or offer the disseminated price. For 
descriptions of such systems, see, e.g., Securities Exchange Act 
Release Nos. 48975 (December 23, 2003), 68 FR 75667 (December 31, 
2003) (Amex); 44829 (September 21, 2001), 66 FR 49730 (September 28, 
2001) (Phlx); 41823 (September 1, 1999), 64 FR 49265 (September 10, 
1999) (Pacific Exchange); and 44104 (March 26, 2001), 66 FR 18127 
(April 5, 2001) (CBOE).
    \58\ See, e.g., Securities Exchange Act Release Nos. 50469 
(September 29, 2004), 69 FR 59628 (October 5, 2004) (CBOE reduction 
of public customer transaction fees on options on ETFs and HOLDRs); 
49957 (July 1, 2004), 69 FR 41318 (July 8, 2004) (ISE waiver of 
surcharge on public customer transactions in certain licensed 
products); 44654 (August 3, 2001), 66 FR 42574 (August 13, 2001) 
(CBOE waiver of fees for public customer transactions in options on 
Standard & Poor's 100 European-style index). See also infra, note 
101.
---------------------------------------------------------------------------

    The Commission believes that ISE's proposal to grant priority only 
to Priority Customers and no longer to waive fees for transactions 
involving Professional Orders likewise does not necessarily place an 
inappropriate burden on competition and should most reasonably be 
viewed as within the discretion of the Exchange,\59\ so long as these 
changes do not unfairly discriminate among participants.\60\ In fact, 
the ISE's proposal simply restores the treatment of Professional Orders 
to a base line where no special priority benefits and fee waivers are 
granted.
---------------------------------------------------------------------------

    \59\ The Commission previously has articulated its position 
regarding its application of Section 6 of the Act in evaluating 
distinctions among market participants proposed by exchanges and the 
leeway granted to an exchange to set an appropriate level of 
advantages and responsibilities of persons in its marketplace. See 
Securities Exchange Act Release No. 50484 (October 1, 2004), 69 FR 
60440 (October 8, 2004), stating, inter alia:
    [Section (b)(5)] sets forth the purposes or objectives that the 
rules of a national securities exchange should be designed to 
achieve. Those purposes or objectives, which take the form of 
positive goals, such as to protect investors and the public 
interest, or prohibitions, such as to not permit unfair 
discrimination among customers, issuers, brokers or dealers or to 
not permit any unnecessary or inappropriate burden on competition, 
are stated as broad and elastic concepts. They afford the Commission 
considerable discretion to use its judgment and knowledge in 
determining whether a proposed rule change complies with the 
requirements of the Act. Furthermore, the subsections of Section 
6(b) of the Act must be read with reference to one another and to 
other applicable provisions of the Act and the rules thereunder. 
Within this framework, the Commission must weigh and balance the 
proposed rule change, assess the views and arguments of commenters, 
and make predictive judgments about the consequences of approving 
the proposed rule. (citations omitted)
    \60\ See infra Section III.B.2 for a discussion of whether ISE's 
proposal is unfairly discriminatory.
---------------------------------------------------------------------------

    Moreover, with respect to commenters' contention that broker-
dealers have substantial marketplace advantages over Public Customers, 
it should be noted that broker-dealers, unlike Public Customers, pay 
significant sums for registration and membership in self-regulatory 
organizations (``SROs''), and incur significant costs to comply, and 
ensure that their associated persons comply, with the Act and the rules 
thereunder and SRO rules. Moreover, Public Customers who would not be 
Priority Customers on ISE because they place options orders on the 
scale contemplated by the proposal could choose to become registered 
broker-dealers and receive the same advantages.
    With regard to commenters' contentions relating to market-maker 
advantages, the Commission notes that ISE market makers have 
obligations that customers who seek to compete with them do not have, 
including the responsibility to make continuous markets; to engage in a 
course of dealings reasonably calculated to contribute to the 
maintenance of a fair and orderly market; and not to make bids or 
offers or enter into transactions that are inconsistent with such a 
course of dealings.\61\ Generally, the advantages of market makers 
noted by commenters, such as the ability to stream quotes on two sides 
of the market, are granted by exchanges as the quid pro quo for the 
market makers' assumption of these obligations, in addition to the 
application of other rules and restrictions relating to their 
activities.\62\
---------------------------------------------------------------------------

    \61\ See ISE Rule 803.
    \62\ For example, pursuant to ISE Rule 803(b), a market maker on 
ISE has a continuous obligation to engage, to a reasonable degree 
under the existing circumstances, in dealings for the market maker's 
own account when there exists, or it is reasonably anticipated that 
there will exist, a lack of price continuity, a temporary disparity 
between the supply of and demand for a particular options contract, 
or a temporary distortion of the price relationships between options 
contracts of the same class. Public Customers, including customers 
who seek to compete with market makers, have no such obligations. 
Under ISE's proposal, Public Customers who submit Professional 
Orders would not be subject to market maker obligations.
---------------------------------------------------------------------------

    In addition, the proposal could provide an advantage to Public 
Customers who would not be Priority Customers. Under the proposed rule 
change, Professional Orders would not be subject to cancellation 
fees,\63\ which could result in partially reduced costs for those 
customers who place orders on an average of one order per minute and 
frequently cancel such orders.\64\
---------------------------------------------------------------------------

    \63\ The Exchange charges a cancellation fee, currently $2.00 
per cancellation, on each clearing EAM that cancels at least 500 
Public Customer orders in a month for itself or for an introducing 
broker, for each cancelled order in excess of the total number of 
orders executed for itself or for such introducing broker that 
month. The cancellation fee does not apply to the cancellation of 
Public Customer Orders that improve ISE's disseminated quote at the 
time the orders were entered. There currently are no fees for the 
cancellation of Non-Customer Orders, and Professional Orders would 
not incur such fees under the proposed rule change.
    \64\ The Commission notes that, contrary to the apparent belief 
of some commenters, the proposal would not impose cancellation fees 
on Professional Orders. See Cox Letter II supra note 4 and Carr 
Letter supra note 4.
---------------------------------------------------------------------------

    Several commenters stated that active traders provide valuable 
liquidity to the market and pose significant competition to market 
makers. According to some commenters, the proposed rule change would 
punish these customers who contribute liquidity,\65\ and would force 
such traders from the market.\66\
---------------------------------------------------------------------------

    \65\ See, e.g., A. Schneider Letter supra note 4 and Weisberg 
Letter supra note 4.
    \66\ See, e.g., Lampert Letter supra note 4.
---------------------------------------------------------------------------

    The Commission acknowledges that Public Customers, including 
sophisticated algorithmic traders, provide valuable liquidity to the 
options markets and compete with market makers. In the Commission's 
view, however, the contribution of these participants to the market 
does not mean that their orders are entitled to favorable priority and 
fee treatment, even if--as commenters argue--they would not be able to 
supply this liquidity without being granted such priority and fee 
advantages. Market makers and broker-dealers also provide valuable 
liquidity to the marketplace and do not have priority. Thus, the 
Commission believes that it is consistent with the Act for the ISE to 
amend its rules so that Professional Orders, like the orders of broker-
dealers and market makers, are not granted special priority.
    Two commenters appeared to acknowledge that customers who enter 
orders on the scale that the proposed rule change would establish 
likely have

[[Page 5700]]

information and technology that allows them to compete in a 
sophisticated manner.\67\ However, they argued that the proposal's 
creation of the category of Professional Orders suggests that ``any 
person who wishes to consider themselves a retail customer [must] 
forego any type of trading technology, which of course is widely 
available in today's market.* * *'' \68\
---------------------------------------------------------------------------

    \67\ See, e.g., Carr Letter supra note 4 and Cox Letter II supra 
note 4.
    \68\ See Carr Letter supra note 4. The commenter believed that 
the proposal, as a result, would require retail customers who forego 
technology to ``wander into the marketplace blind and helpless.''
---------------------------------------------------------------------------

    The Commission disagrees with this contention. The proposed rule 
does not ask Public Customers to forego technology and does not limit 
the technology that Public Customers who would not be Priority 
Customers can use to access the ISE's marketplace. Rather, it 
establishes that customers who place orders at the level proposed by 
the ISE--irrespective of their use of trading technology--are engaged 
in a course of active trading that need not be accorded the special 
deference paid to those customers who do not place orders as 
frequently.
    In support of its proposal, the ISE contends that traders who place 
orders on the scale set forth in the proposal have the same 
technological and informational advantages over retail investors as 
broker-dealers trading for their own account--which enables them to 
compete effectively with broker-dealer orders and market maker quotes 
for execution opportunities in the ISE marketplace.\69\ The Commission, 
however, does not believe that access to or use of sophisticated 
technology is the key issue in considering whether it is consistent 
with the Act for ISE to treat Professional Orders in the same manner as 
broker-dealer orders in specified circumstances. Instead, the 
Commission believes that the pivotal issue is whether, under the Act, 
the exchange can grant certain advantages, which it initially 
established for all public customers, to only those public customers 
who place no more than 390 orders per day.
---------------------------------------------------------------------------

    \69\ See Notice, supra note 3, at 73 FR 7346.
---------------------------------------------------------------------------

    The Commission notes that currently customers who are positioned to 
place orders in the number and frequency specified in the proposed rule 
change are treated on a par with customers who may not have this 
ability, or even if they have this ability, do not place orders on the 
average of one order per minute per over the trading day. Under the 
Exchange's proposal, customers who place orders less frequently would 
be advantaged by the Exchange's grant of priority over Non-Customer 
Orders and market maker quotes at the same price, even if they have 
access to sophisticated options trading technology. Further, the 
Commission disagrees with the argument that customers would have to 
forego using trading technology under the Exchange's proposal. The 
ISE's proposal does not limit, prohibit, or proscribe the type of 
technology any customer uses. Customers could still use sophisticated 
technology to trade options and their orders would not be considered 
Professional Orders, as long as those customers placed fewer than one 
order per minute per day on average during a calendar month for their 
own beneficial account(s).
    One commenter believed that the proposed rule change limited 
competition and was collusive because ``it requires the cooperation of 
other competing exchanges. * * *'' \70\ The Commission notes, however, 
that the proposed rule change requires EAMs to conduct a quarterly 
review of customer activity only as reflected in the EAM's own records. 
The proposal does not require either EAMs or the Exchange to seek 
information from other broker-dealer firms or exchanges regarding a 
customer's activity.\71\
---------------------------------------------------------------------------

    \70\ See Cox Letter III supra note 4. The commenter stated 
further: `` * * * I fail to see how the ISE can request trading 
information from a person or entity trading from another exchange, 
particularly when other exchanges have business models that promote 
order entry: the exact behavior the ISE is attempting to punish with 
its rule.''
    \71\ Confirmed in telephone conversation between Ira Brandriss, 
Special Counsel, Division, Commission, and Katherine Simmons, Deputy 
General Counsel, ISE, on April 29, 2008. See also supra note 17 and 
accompanying text. See also ISE Rules 401, 706, and 712.
---------------------------------------------------------------------------

2. ISE's Proposal Is Not Unfairly Discriminatory
    Many of the commenters argued that the proposed rule change is 
unfairly discriminatory against those Public Customers who would not be 
Priority Customers by denying them priority rights and imposing 
transaction fees on their orders.\72\ In the ISE's view, public 
customers today range from individuals who infrequently place options 
orders to sophisticated algorithmic traders that trade many options 
classes on a daily basis.\73\ ISE proposes to continue to grant 
priority to, and waive transaction fees for, individuals who place 
orders below the threshold, as a means to encourage their 
participation. The Exchange believes, however, that priority rights and 
fee waivers are no longer warranted for market participants who place 
more than one order per minute on average during a calendar month, a 
level of activity that it believes is akin to that of broker-dealers. 
The Exchange therefore proposes to refrain from providing priority and 
fee incentives for such participants.
---------------------------------------------------------------------------

    \72\ See, e.g., G. Schneider Letter supra note 4, Lampert Letter 
supra note 4, Rule Letter supra note 4, Cox Letter II supra note 4 
and Cox Letter III supra note 4.
    \73\ See Notice, supra note 3, at 73 FR 7346.
---------------------------------------------------------------------------

    The Commission notes that the Act does not require that the 
Exchange's rules be designed to prohibit all discrimination, but rather 
they must not permit unfair discrimination.\74\ With regard to public 
customer priority, the Commission has noted above ample precedent 
demonstrating that public customer orders are not entitled per se to 
priority treatment over the orders of other market participants. The 
Commission similarly believes that the ISE's proposal to grant such 
priority treatment only to Priority Customers is consistent with the 
Act and, in particular, is not unfairly discriminatory.
---------------------------------------------------------------------------

    \74\ 15 U.S.C. 78f(b)(5). See also Securities Exchange Act 
Release No. 50484, supra note 59.
---------------------------------------------------------------------------

    As discussed above, the Commission does not believe that the 
current rules of ISE and other exchanges that accord priority to all 
public customers over broker-dealers and market makers are unfairly 
discriminatory. Nor does the Commission believe that it is unfairly 
discriminatory to accord priority to only those customers who on 
average do not place more than one order per minute as ISE proposes.
    Because, as discussed in Section III.A.1. above, the Commission 
believes that ISE's proposal is consistent with the Act in that it does 
not impose an undue burden on competition, the Commission believes that 
a grant of such priority is an exchange's prerogative and within the 
exchange's business judgment. As such, a decision to grant priority--
which, after all, is a special benefit--to the orders of one type of 
customer (for example, a retail customer) and not to the orders of 
another (for example, an institutional investor) may be an economic 
decision that an exchange may make to provide some customers with 
incentives and fee waivers. In the Commission's view, nothing in the 
Act requires an exchange to provide the same incentives and discounts 
to all market participants equally, as long as the exchange does not 
unfairly discriminate among participants with regard to access to 
exchange systems.\75\
---------------------------------------------------------------------------

    \75\ In this regard, the Commission notes that ISE amended the 
proposal to remove the changes it had originally proposed to ISE 
Rules 715 and 723(c), which would have prevented access by all 
Public Customers to the Exchange's PIM. See Amendment No. 2, supra 
note 5.

---------------------------------------------------------------------------

[[Page 5701]]

    The Commission believes that the line that the ISE seeks to draw 
between Priority Customers and Public Customers whose orders would be 
treated as Professional Orders most simply reflects a belief--from the 
point of view of operating a marketplace--that the orders of a person 
who submits, on average, more than one order every minute of the 
trading day need not (or should not) be granted the same benefit or 
incentive that is granted to Public Customers who do not utilize the 
marketplace on such a scale.
    The same can be said with regard to relief from transaction fees. 
Exchanges can and do have fee structures that vary depending on the 
market participant.\76\ Various fee structures are permitted provided 
that they are consistent with the Act (including the requirement that 
the fees not be unfairly discriminatory). Such differing fee structures 
are based on the judgment of those responsible for the financial 
operation of the exchange, and are tied to exchange assumptions about 
market participant behavior, the impact of incentives and discounts, 
and other factors relating to the specific business model adopted by 
the exchange. A decision to waive or discount fees for orders of one 
kind of participant and not another, based on the extent of their 
participation in the market, is a reasonable decision for an exchange, 
provided it is otherwise consistent with the Act.\77\
---------------------------------------------------

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.