Self-Regulatory Organizations; International Securities Exchange, LLC; Order Granting Approval of a Proposed Rule Change To Modify Qualified Contingent Cross Order Rules, 11533-11541 [2011-4574]
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Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices
of the Commission (Public
Representative) to represent the
interests of the general public in this
proceeding.
3. Comments by interested persons in
this proceeding are due no later than
March 3, 2011.
4. The current contract filed in Docket
No. CP2010–22 for International
Business Reply Service Competitive
Contract 2 is authorized to continue in
effect through March 31, 2011.
5. The Secretary shall arrange for
publication of this order in the Federal
Register.
By the Commission.
Shoshana M. Grove,
Secretary.
[FR Doc. 2011–4684 Filed 3–1–11; 8:45 am]
BILLING CODE 7710–FW–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 63954; File No. SR–ISE–2009–
35]
Securities Exchange Act of 1934; In the
Matter of Chicago Board Options
Exchange, Incorporated, 400 South
LaSalle Street, Chicago, IL 60605;
Order Setting Aside the Order by
Delegated Authority Approving SR–
ISE–2009–35 and Dismissing CBOE’s
Petition for Review
emcdonald on DSK2BSOYB1PROD with NOTICES
February 24, 2011.
On June 15, 2009, the International
Securities Exchange, LLC (‘‘ISE’’) filed a
proposed rule change with the
Commission seeking to establish a
Qualified Contingent Cross (‘‘QCC’’)
Order. The proposed rule change was
published for comment on June 26,
2009.1 On August 28, 2009, the
Commission approved, by authority
delegated to the Division of Trading and
Markets, the proposed rule change
(‘‘Approval Order’’).2 On September 4,
2009, the Chicago Board Options
Exchange (‘‘CBOE’’) filed a notice of
intention to file a petition for review of
the Approval Order and, on September
14, 2009, CBOE filed a petition for
review with the Commission (‘‘Petition
for Review’’). Under the Commission’s
Rules of Practice, the filing of CBOE’s
Petition for Review automatically stayed
the Approval Order.3 On September 11,
2009, ISE filed a motion to lift the
automatic stay. On November 12, 2009,
the Commission granted CBOE’s
1 See Securities Exchange Act Release No. 60147
(June 19, 2009), 74 FR 30651 (June 26, 2009).
2 See Securities Exchange Act Release No. 60584
(August 28, 2009), 74 FR 45663 (September 3,
2009).
3 17 CFR § 201.431(e).
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Petition for Review and denied a motion
filed by ISE to lift the automatic stay.4
On March 17, 2010, the Commission
approved the placement in the public
file of a memorandum by its Division of
Risk, Strategy, and Financial Innovation
(‘‘RiskFin’’) analyzing certain data
relating to ISE’s proposed rule change
(‘‘RiskFin Memo’’). At the same time that
the Commission approved placement of
the RiskFin Memo in the public file, the
Commission also issued an order
extending the time to file statements in
support of or in opposition to the
Approval Order to give the public an
opportunity to review the data and
analysis in the RiskFin Memo.5
On July 14, 2010, ISE filed a new
proposed rule change to modify the
requirements for QCC Orders (file
number SR–ISE–2010–73). The
Commission published for public
comment the modified proposal.6 Also
on July 14, 2010, ISE submitted a letter
requesting that the Commission vacate
the Approval Order concurrently with
the approval of the new proposed rule,
SR–ISE–2010–73.7
We have determined to construe ISE’s
request as a petition to vacate the
Approval Order pursuant to
Commission Rule of Practice 431(a),
which permits us to ‘‘affirm, reverse,
modify, set aside or remand for further
proceedings, in whole or in part, any
action made pursuant to’’ delegated
authority.8 We find that, in light of the
filing of ISE’s modified proposal
regarding the QCC Orders,9 it is
appropriate to grant ISE’s request and
set aside the Approval Order. We also
find that, given this disposition of the
Approval Order, CBOE’s petition for
review of that order has become moot.
Accordingly, it is ordered that the
August 28, 2009 order approving by
delegated authority ISE’s proposed rule
change number SR–ISE–2009–35, be,
and it hereby is, set aside; and
It is further ordered that the petition
for review, filed by the Chicago Board
Options Exchange on September 14,
2009, of the August 28, 2009 order
approving by delegated authority ISE’s
proposed rule change number SR–ISE–
2009–35 be, and it hereby is, dismissed.
4 See Securities Exchange Act Release Nos. 60988
and 60989.
5 See Securities Exchange Act Release No. 61722.
6 See Securities Exchange Act Release No. 62523
(July 16, 2010), 75 FR 43211 (July 23, 2010).
7 See letter from Michael J. Simon, Secretary and
General Counsel, ISE, to Elizabeth M. Murphy,
Secretary, Commission, dated July 14, 2010.
8 17 CFR 201.431(a).
9 The Commission has this day issued a separate
order approving SR–ISE–2010–73.
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11533
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011–4575 Filed 3–1–11; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–63955; File No. SR–ISE–
2010–73]
Self-Regulatory Organizations;
International Securities Exchange,
LLC; Order Granting Approval of a
Proposed Rule Change To Modify
Qualified Contingent Cross Order
Rules
February 24, 2011.
I. Introduction
On July 14, 2010, the International
Securities Exchange, LLC (‘‘ISE’’ or
‘‘Exchange’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’),1 and Rule 19b–4
thereunder,2 a proposed rule change to
modify rules for Qualified Contingent
Cross (‘‘QCC’’) Orders. The proposed
rule change was published for comment
in the Federal Register on July 23,
2010.3 The Commission received eight
comment letters on the proposed rule
change 4 and a response letter from ISE.5
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 62523
(July 16, 2010), 75 FR 43211 (‘‘Notice’’).
4 See Letters from Anthony J. Saliba, Chief
Executive Officer, LiquidPoint, LLC, to Elizabeth M.
Murphy, Secretary, Commission dated, July 30,
2010 (‘‘LiquidPoint Letter 2’’); William J. Brodsky,
Chairman and Chief Executive Officer, Chicago
Board Options Exchange, Incorporated (‘‘CBOE’’), to
Elizabeth M. Murphy, Secretary, Commission, dated
August 9, 2010 (‘‘CBOE Letter 1’’); Ben Londergan
and John Gilmartin, Co-Chief Executive Officers,
Group One Trading, LP, to Elizabeth M. Murphy,
Secretary, Commission, dated August 9, 2010
(‘‘Group One Letter 2’’); Janet M. Kissane, Senior
Vice President—Legal and Corporate Secretary,
NYSE Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated August 9, 2010 (‘‘NYSE Letter
2’’); Thomas Wittman, President, NASDAQ OMX
PHLX, Inc. (‘‘Phlx’’), to Elizabeth M. Murphy,
Secretary, Commission, dated August 13, 2010
(‘‘Phlx Letter 2’’); J. Micah Glick, Chief Compliance
Officer, Cutler Group LP to Elizabeth M. Murphy,
Secretary, Commission, dated September 3, 2010
(‘‘Cutler Letter’’); Janet L. McGinness, Senior Vice
President—Legal and Corporate Secretary, NYSE
Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated October 21, 2010 (‘‘NYSE Letter
3’’); and Gerald D. O’Connell, Chief Compliance
Officer, Susquehanna International Group, LLP, to
Elizabeth M. Murphy, Secretary, Commission, dated
October 22, 2010 (‘‘Susquehanna Letter 2’’).
5 See Letter from Michael J. Simon, Secretary and
General Counsel, ISE, to Elizabeth M. Murphy,
Secretary, Commission, dated, August 25, 2010
(‘‘ISE Response’’).
2 17
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Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices
This order approves the proposed rule
change.
II. Background
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A. Regulation NMS and Qualified
Contingent Trades
The Commission adopted Regulation
NMS in June 2005.6 Among other
things, Regulation NMS addressed
intermarket trade-throughs of quotations
in NMS stocks.7 In 2006, pursuant to
Rule 611(d) of Regulation NMS,8 the
Commission provided an exemption 9
for each NMS stock component of
certain qualified contingent trades (as
defined below) from Rule 611(a) of
Regulation NMS for any trade-throughs
caused by the execution of an order
involving one or more NMS stocks (each
an ‘‘Exempted NMS Stock Transaction’’)
that are components of a qualified
contingent trade.
The Original QCT Exemption defined
a ‘‘qualified contingent trade’’ to be a
transaction consisting of two or more
component orders, executed as agent or
principal, where: (1) At least one
component is in an NMS stock; (2) all
components are effected with a product
or price contingency that either has
been agreed to by the respective
counterparties or arranged for by a
broker-dealer as principal or agent;
(3) the execution of one component is
contingent upon the execution of all
other components at or near the same
time; (4) the specific relationship
between the component orders (e.g., the
spread between the prices of the
component orders) is determined at the
time the contingent order is placed;
(5) the component orders bear a
derivative relationship to one another,
represent different classes of shares of
the same issuer, or involve the securities
of participants in mergers or with
intentions to merge that have been
announced or since cancelled; 10 (6) the
6 See Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496 (June 29, 2005).
7 See 17 CFR 242.611. An ‘‘NMS stock’’ means any
security or class of securities, other than an option,
for which transaction reports are collected,
processed, and made available pursuant to an
effective transaction reporting plan. See 17 CFR
242.600(b)(46) and (47).
8 17 CFR 242.611(d). See also 15 U.S.C.
78mm(a)(1) (providing general authority for the
Commission to grant exemptions from provisions of
the Act and the rules thereunder).
9 See Securities Exchange Act Release No. 54389
(August 31, 2006), 71 FR 52829 (September 7, 2006)
(‘‘Original QCT Exemption’’). The Securities
Industry Association (‘‘SIA,’’ n/k/a Securities
Industry and Financial Markets Association)
requested the exemption. See Letter to Nancy M.
Morris, Secretary, Commission, from Andrew
Madoff, SIA Trading Committee, SIA, dated June
21, 2006.
10 Transactions involving securities of
participants in mergers or with intentions to merge
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Exempted NMS Stock Transaction is
fully hedged (without regard to any
prior existing position) as a result of the
other components of the contingent
trade; 11 and (7) the Exempted NMS
Stock Transaction that is part of a
contingent trade involves at least 10,000
shares or has a market value of at least
$200,000.12
In 2008, in response to a request from
the CBOE, the Commission modified the
Original QCT Exemption to remove the
‘‘block size’’ requirement of the
exemption (i.e., that the Exempted NMS
Stock Transaction be part of a
contingent trade involving at least
10,000 shares or having a market value
of at least $200,000).13
B. Background of ISE’s Proposal
In August 2009, the Commission
approved the Order Protection and
Locked/Crossed Market Plan 14 which,
among other things, required the
options exchanges to adopt written
policies and procedures reasonably
designed to prevent trade-throughs.15
Unlike its predecessor plan,16 the New
Linkage Plan does not include a tradethrough exemption for ‘‘Block Trades,’’
defined to be trades of 500 or more
contracts with a premium value of at
least $150,000.17 However, because the
that have been announced would meet this aspect
of the requested exemption. Transactions involving
cancelled mergers, however, would constitute
qualified contingent trades only to the extent they
involve the unwinding of a pre-existing position in
the merger participants’ shares. Statistical arbitrage
transactions, absent some other derivative or merger
arbitrage relationship between component orders,
would not satisfy this element of the definition of
a qualified contingent trade. See Original QCT
Exemption, supra, note 9.
11 A trading center may demonstrate that an
Exempted NMS Stock Transaction is fully hedged
under the circumstances based on the use of
reasonable risk-valuation methodologies. Id.
12 See 17 CFR 242.600(b)(9) (defining ‘‘block size’’
with respect to an order as at least 10,000 shares
or $200,000 in market value).
13 See Securities Exchange Act Release No. 57620
(April 4, 2008) 73 FR 19271 (April 9, 2008) (‘‘CBOE
QCT Exemption’’). The current QCT Exemption (i.e.,
as modified by the CBOE QCT Exemption) is
referred to herein as the ‘‘NMS QCT Exemption.’’
14 See Securities Exchange Act Release No. 60405
(July 30, 2009), 74 FR 39362 (August 6, 2009) (File
No. 4–546) (‘‘New Linkage Plan’’). ISE also proposed
revisions to its rules to implement the New Linkage
Plan (‘‘New Linkage Rules’’). See Securities
Exchange Act Release No. 60559 (August 21, 2009),
74 FR 44425 (August 28, 2009) (SR–ISE–2009–27).
15 A trade-through is a transaction in a given
option series at a price that is inferior to the best
price available in the market.
16 The former options linkage plan, the Plan for
the Purpose of Creating and Operating an
Intermarket Option Linkage (‘‘Former Linkage
Plan’’), was approved by the Commission in 2000
and was operative until August 31, 2009, when the
New Linkage Plan took effect. See Securities
Exchange Act Release No. 43086 (July 28, 2000), 65
FR 48023 (August 4, 2000) (File No. 4–429).
17 See Sections 2(3) and 8(c)(i)(C) of the Former
Linkage Plan and old ISE Rule 1902(d)(2).
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New Linkage Plan does not provide a
Block Trade exemption, the Exchange
was concerned that the loss of the Block
Trade exemption would adversely affect
the ability of its members to effect large
trades that are tied to stock.
Accordingly, the Exchange proposed the
Original QCC Order (defined below) as
a limited substitute for the Block Trade
exemption to facilitate the execution of
large stock/option combination orders,
to be implemented contemporaneously
with the New Linkage Rules.
C. SR–ISE–2009–35
1. ISE’s Original Qualified Contingent
Cross Order Proposal
In SR–ISE–2009–35,18 ISE proposed a
new order type, the QCC Order. The
QCC Order as proposed in SR–ISE–
2009–35 (‘‘Original QCC Order’’)
permitted an ISE member to cross the
options leg of a Qualified Contingent
Trade (‘‘QCT’’) (as defined below) on ISE
immediately upon entry, without
exposure, if the order: (i) Was for at least
500 contracts; (ii) met the six
requirements of the NMS QCT
Exemption; and (iii) was executed at a
price at or between the national best bid
or offer (‘‘NBBO’’). Proposed
Supplementary Material .01 to ISE Rule
715 defined a QCT as a transaction
composed of two or more orders,
executed as agent or principal, where:
(i) At least one component is in an NMS
stock; (ii) all components are effected
with a product or price contingency that
either has been agreed to by all the
respective counterparties or arranged for
by a broker-dealer as principal or agent;
(iii) the execution of one component is
contingent upon the execution of all
other components at or near the same
time; (iv) the specific relationship
between the component orders (e.g., the
spread between the prices of the
component orders) is determined by the
time the contingent order is placed; (v)
the component orders bear a derivative
relationship to one another, represent
different classes of shares of the same
issuer, or involve the securities of
participants in mergers or with
intentions to merge that have been
announced or cancelled; and (vi) the
transaction is fully hedged (without
regard to any prior existing position) as
a result of other components of the
contingent trade.19
On August 28, 2009, the Commission
approved, by authority delegated to the
18 See Securities Exchange Act Release No. 60147
(June 19, 2009), 74 FR 30651 (June 26, 2009) (SR–
ISE–2009–35 Notice).
19 The six requirements are substantively
identical to the six elements of a QCT under the
NMS QCT Exemption. See supra notes 9 and 13.
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Division of Trading and Markets, ISE’s
Original QCC Order proposal.20 On
September 4, 2009, CBOE filed with the
Commission a notice of intention to file
a petition for review of the
Commission’s approval by delegated
authority 21 and, on September 14, 2009,
CBOE filed a petition for review, which
automatically stayed the delegated
approval of the Original QCC Order.22
On September 11, 2009, ISE filed a
motion to lift the automatic stay.23 On
September 17, 2009, CBOE filed a
response to ISE’s Motion.24 On
September 22, 2009, ISE filed a reply in
support of its motion to lift the
automatic stay.25 In addition to the
submissions from CBOE and ISE, the
Commission received eight comment
letters requesting that the Commission
grant CBOE’s Petition for Review.26
On November 12, 2009, the
Commission granted CBOE’s Petition for
20 See Securities Exchange Act Release No. 60584
(August 28, 2009), 74 FR 45663 (September 3, 2009)
(‘‘Original Approval Order’’).
21 See Letter from Paul E. Dengel, Counsel for
CBOE, Schiff Hardin LLP, to Elizabeth M. Murphy,
Secretary, Commission, dated September 4, 2009.
22 See Letter from Joanne Moffic-Silver, General
Counsel and Corporate Secretary, CBOE, to
Elizabeth M. Murphy, Secretary, Commission, dated
September 14, 2009 (‘‘Petition for Review’’).
23 See Brief in Support of ISE’s Motion to Lift the
Commission Rule 431(e) Automatic Stay of
Delegated Action Triggered by CBOE’s Notice of
Intention to Petition for Review, dated September
11, 2009 (‘‘ISE’s Motion’’).
24 See Response of CBOE to Motion of ISE to Lift
Automatic Stay, dated September 17, 2009
(‘‘Response to Motion’’).
25 See Reply in Support of ISE’s Motion to Lift the
Commission Rule 431(e) Automatic Stay of
Delegated Action Triggered by CBOE’s Notice of
Intention to Petition for Review, dated September
22, 2009 (‘‘ISE Reply’’).
26 See Letters from Jeffrey S. Davis, Vice President
and Deputy General Counsel, NASDAQ OMX
PHLX, Inc., to Elizabeth M. Murphy, Secretary,
Commission, dated September 22, 2009 (‘‘Phlx
Letter’’); Gerald D. O’Connell, Chief Compliance
Officer, Susquehanna International Group, LLP, to
Elizabeth M. Murphy, Secretary, Commission, dated
September 30, 2009 (‘‘Susquehanna Letter’’); Megan
A. Flaherty, Chief Legal Counsel, Wolverine
Trading, LLC, to Elizabeth M. Murphy, Secretary,
Commission, dated October 2, 2009 (‘‘Wolverine
Letter’’); Janet M. Kissane, Senior Vice President—
Legal and Corporate Secretary, NYSE Euronext, to
Elizabeth M. Murphy, Secretary, Commission, dated
October 5, 2009 (‘‘NYSE Letter’’); Ben Londergan,
Co-CEO, Group One Trading, L.P., to Elizabeth M.
Murphy, Secretary, Commission, dated October 5,
2009 (‘‘Group One Letter’’); Anthony J. Saliba, Chief
Executive Officer, LiquidPoint, LLC, to Elizabeth M.
Murphy, Secretary, Commission, dated October 7,
2009 (‘‘LiquidPoint Letter’’); Kimberly Unger,
Executive Director, The Security Traders
Association of New York, Inc., to Elizabeth M.
Murphy, Secretary, Commission, dated October 29,
2009 (‘‘STA Letter’’); and Peter Schwarz, Integral
Derivatives, LLC, to Elizabeth M. Murphy,
Secretary, Commission, dated November 25, 2009
(‘‘Integral Derivatives Letter’’). In addition, ISE
submitted certain market volume and share
statistics. See E-mail from Michael J. Simon, ISE, to
Elizabeth King, Associate Director, Division of
Trading and Markets, Commission, dated
September 30, 2009.
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Review and denied ISE’s motion to lift
the automatic stay.27 In connection with
the Order Granting Petition, the
Commission received three statements
in support of the Original Approval
Order (two of which were submitted by
ISE) 28 and five statements in opposition
to the Original Approval Order (two of
which were submitted by CBOE).29
2. Commenter’s to ISE’s Original QCC
Order Proposal
In its Petition for Review and
statements in support thereof, CBOE
argued that ISE’s Original QCC Order
proposal was inconsistent with the
Act 30 and raised important policy
concerns that the Commission should
address, including whether crossing
straight or complex option orders
without exposure is appropriate and
whether permitting a ‘‘clean’’ cross in
front of public customer orders is
appropriate. CBOE believed that ISE’s
proposal was inconsistent with the Act
because ‘‘it effectively establishes ISE as
a print facility for large options orders
rather than an exchange where orders
are able to interact in an auction
setting.’’ 31 CBOE and certain
27 See Commission Order Granting Petition for
Review and Scheduling Filing of Statements, dated
November 12, 2009 and Commission Order Denying
ISE’s Motion to Lift the Commission Rule 431(e)
Automatic Stay of Delegate Action Triggered by
CBOE’s Notice of Intention to Petition for Review,
dated November 12, 2009 (‘‘Order Granting
Petition’’).
28 See Letters from Michael J. Simon, Secretary,
ISE, to Elizabeth M. Murphy, Secretary,
Commission, dated December 3, 2009 (‘‘ISE
Statement 1’’); from Leonard Ellis, Head of Capital
Markets, Capstone Global Markets, LLC, to
Elizabeth Murphy, Secretary, Commission, dated
December 3, 2009 (‘‘Capstone Statement’’); and
Michael J. Simon, Secretary, ISE, to Elizabeth M.
Murphy, Secretary, Commission, dated December
16, 2009 (‘‘ISE Statement 2’’).
29 See Letters from Joanne Moffic-Silver,
Executive Vice President, General Counsel &
Corporate Secretary, CBOE, to Elizabeth M.
Murphy, Secretary, Commission, dated December 3,
2009 (‘‘CBOE Statement 1’’); Michael Goodwin,
Senior Managing Member, Bluefin Trading, LLC, to
Elizabeth M. Murphy, Secretary, Commission, dated
December 2, 2009 (‘‘Bluefin Statement’’); John C.
Nagel, Managing Director and Deputy General
Counsel, Citadel, to Elizabeth M. Murphy,
Commission, dated December 3, 2009 (‘‘Citadel
Statement’’); Janet M. Kissane, Senior Vice
President—Legal & Corporate Secretary, NYSE
Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated December 3, 2009 (‘‘NYSE
Statement 1’’); and Angelo Evangelou, Assistant
General Counsel, CBOE, to Elizabeth M. Murphy,
Secretary, Commission, dated January 20, 2010
(‘‘CBOE Statement 2’’). The Commission also
received a statement from ISE responding to the
CBOE Statement 2 regarding its statistical claim and
number of trade-throughs. See Letter from Michael
J. Simon, Secretary, ISE, to Elizabeth M. Murphy,
Secretary, Commission, dated March 1, 2010.
30 See e.g., Petition for Review, supra note 22, at
11. See also CBOE Statement 1, supra note 29, at
5–6, 15–16.
31 See Petition for Review, supra note 22, at 13.
See also Bluefin Statement, supra note 29; Citadel
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commenters objected to the Original
QCC Order proposal because, for crosses
that satisfy the QCC’s requirements, a
member of ISE could execute a clean
cross without exposing the cross to
other ISE participants, which CBOE
stated would represent a significant
change from historical and current
market practices in the options
markets.32 CBOE contended that the
Commission’s policy and practice had
been to limit the percentage of the
crossing entitlement to an amount
below 50% of the order being executed,
and then only after ensuring that all
crossing entitlements are exposed and
yield to public customer orders.33 CBOE
stated that the policies requiring
exposure and yielding to public
customer interest balance ‘‘the desire to
permit internalization/solicitations to
some degree while at the same time
ensuring competition and price
discovery and, to some degree,
protecting public customers (including
retail investors).’’ 34 Without an
exposure requirement, CBOE contended
that the proposal would have a major
adverse impact on options market
structure, and result in a trading
environment that is ‘‘sluggish,
nontransparent, and noncompetitive.’’ 35
CBOE and many of the commenters to
the Original QCC Order proposal
believed that the lack of any exposure
requirement in ISE’s Original QCC
Order would have a detrimental effect
on the options market as it would
provide a disincentive to ISE’s market
makers to quote competitively, undercut
their market making function and could
result in market makers migrating off
other exchanges that do not offer a QCC
Order type to ISE, to take advantage of
potentially wider spreads and where
greater margins might be available with
Statement, supra note 29, at 2; and LiquidPoint
Letter, supra note 26, at 4. See also Wolverine
Letter, supra note 26 and CBOE Statement 1, supra
note 29, at 8.
32 See Petition for Review, supra note 22, at 5, 9,
13–15. See also Bluefin Statement, supra note 29;
Citadel Statement, supra note 29, at 2; NYSE
Statement 1, supra note 29, at 2; Wolverine Letter,
supra note 26; and LiquidPoint Letter, supra note
26, at 2.
33 See Petition for Review, supra note 22, at 5, 17.
CBOE also noted ISE’s investment in an entity that
CBOE asserted is ‘‘geared towards the nontransparent execution of block size stock-option
transactions,’’ which CBOE contended would
benefit from the ISE’s proposal. Id. at 11. See also
CBOE Statement 1, supra note 29, at 13–14.
34 See Petition for Review, supra note 22, at 15.
35 Id. at 10, 14. CBOE and some commenters also
noted their belief that the lack of exposure also
degrades market transparency, which they believe
is related to the Commission’s concerns relating to
dark pools. Id. at 16. See also, e.g., NYSE Statement
1, supra note 29, at 1, 4.
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less competitive quoting.36 One
commenter stated that the Original QCC
Order, by preventing market makers
from participating in trades occurring at
their quoted prices, would cause market
makers to spread their quotes wider to
increase their profit margins in
compensation for the lower volume of
trading in which they participate.37 This
commenter further stated that,
eventually, such market makers might
very well question the wisdom of
committing capital to make firm markets
in the thousands of options series in
which they have continuous quoting
obligations.38 Another commenter noted
that, ultimately, this would ‘‘increase
the costs and decrease the availability of
proven, effective risk management
through derivatives’’ and harm options
market participants, as their ability ‘‘to
execute their myriad strategies would
disappear.’’ 39 Thus, some commenters
believed that permitting the
implementation of the QCC Order
would harm the growth prospects of the
overall options industry.40
However, ISE argued that the QCC
Order type would not impact the
options markets, and that large-size
contingency orders are executed on
floor-based exchanges in a manner very
similar to the new order type proposed
by ISE. In addition, ISE noted that there
is no meaningful transparency on floors
because there is no requirement that
information on orders presented to the
floor be announced electronically to all
exchange members or the public.41 ISE
also noted that some floor-based options
exchanges have eliminated the
requirement that market makers have a
physical presence on the floor, which it
believes undermines the claim that
price discovery and transparency occur
on the trading floor.42 One commenter
to the Original QCC Order proposal
agreed and stated that the exposurerelated concerns of other commenters
‘‘do not adequately recognize the reality
of how this business is conducted today
and seem to simply endorse a manual
trading environment that prevents
competition from electronic
exchanges.’’ 43
36 See CBOE Statement 1, supra note 29, at 8;
NYSE Statement 1, supra note 29 at 2, 3; and
LiquidPoint Letter, supra note 26, at 3, 5. See also
Petition for Review, supra note 22, at 13.
37 See NYSE Statement 1, supra note 29 at 3.
38 Id.
39 See LiquidPoint Letter, supra note 26, at 3, 5.
40 See NYSE Statement 1, supra note 29, at 2 and
LiquidPoint Letter, supra note 26, at 3–5. See also
CBOE Statement 1, supra note 29, at 8.
41 See ISE Statement 1, supra note 28, at 2, 6.
42 Id.
43 See Capstone Statement, supra note 28, at 2.
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In addition to CBOE’s opposition to
the Original QCC Order because of its
lack of an exposure requirement, CBOE
also argued that public customers that
have previously placed limit orders at
the execution price of a QCC Order
would be harmed because those
customers would lose priority and
would not receive executions of their
resting orders.44 CBOE expressed
concern that, because certain customer
orders would not receive priority, the
proposal would create a disincentive to
placing limit orders.45 CBOE
maintained that, with respect to intramarket priority in the exchange-listed
options markets, the long-standing
industry policy and practice has been to
require public customer priority for
simple option orders.46 Two
commenters also expressed concern that
the Original QCC Order would cause
public customers with existing orders to
be disadvantaged in the executions that
they receive and would be a direct
disincentive to market makers and
would likely encourage wider quoted
markets.47
ISE disagreed with the commenters’
claims that public customers with
resting limit orders would be harmed by
its QCC proposal. ISE stated that largesize contingency trades that would
qualify as QCC Orders are currently
almost exclusively executed on floorbased exchanges, thus ‘‘the occasional
customer limit order resting on ISE’s
book * * * has no opportunity to
interact with [such orders].’’ 48
In addition, CBOE stated that no
execution entitlements have been
permitted thus far, unless there is first
yielding to public customer interest.49
CBOE contrasted the Original QCC
Order with the rules of all options
exchanges relating to net-priced
complex orders, which require that each
options leg(s) of the complex order trade
at or inside the NBBO and, at a
minimum, price improve public
customer orders in at least one
component options leg.50 CBOE also
noted that, in a stock-option order netpriced package, it has been the
Commission policy to require that the
option leg of the stock-option order
either yield to the same priced public
customer order represented in the
individual options series or trade at a
44 See
Response to Motion, supra note 24, at 4.
Petition for Review, supra note 22, at 13.
46 Id. at 17. See also CBOE Statement 1, supra
note 29, at 5, 9.
47 See Bluefin Statement, supra note 29 and NYSE
Statement 1, supra note 29 at 2.
48 See ISE Statement 1, supra note 28, at 2, 5.
49 See Petition for Review, supra note 22, at 15.
50 Id. at 18.
45 See
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better price.51 CBOE argued that the
Original QCC Order, in contrast, would
be given special priority that goes
beyond the priority afforded to
packaged stock-option orders by
permitting it to be crossed without
giving priority to public customers.52
In response, ISE noted that there are
many examples of exception to rules to
accommodate specific trading
strategies.53 ISE further argued that
there is no basis under the Act to
prevent exchanges from adopting
market structures and priority rules that
are tailored for large-size contingent
orders and that customer priority is not
required in all circumstances.54
Commenters to the Original QCC
Order also questioned whether the
customer involved in the QCC Order
would be able to receive the best price
for its order because, without a
requirement for the order to be exposed,
the submitting member’s customer
would not have the opportunity to
receive price improvement for the
options leg of the order.55 Specifically,
CBOE expressed concern that, because
the QCC Order would eliminate the
requirement of market exposure, the
customer whose order is submitted
through the QCC Order mechanism
might receive a fill at a price that is
inferior to the price the customer would
have received if the full package or even
the options component had been
represented to the market.56
ISE responded to these concerns by
explaining that, when negotiating a
stock-option order, market participants
agree to a ‘‘net price,’’ i.e., a price that
reflects the total price of both the
options and stock legs of the transaction
which are executed separately in the
options and equity markets.57
Accordingly, ISE believed that, for such
trades, the actual execution price of
each component is not as material to the
parties to the trade as is the net price of
the transaction.58
51 Id.
52 Id.
at 19.
ISE Statement 1, supra note 28, at 2, 5. For
example, ISE pointed to the existing rules of the
options exchanges that permit the execution of one
leg of a complex trade at the same price as a public
customer order on the limit order book if another
leg of the order is executed at an improved price.
See CBOE Rule 6.45A.
54 Id.
55 See CBOE Statement 1, supra note 29, at 7–8
and Petition for Review, supra note 22, at 13. See
also Bluefin Statement, supra note 29; Group One
Letter, supra note 26, at 1–2; and Integral
Derivatives Letter, supra note 26.
56 See CBOE Statement 1, supra note 29, at 7.
57 See ISE Statement 1, supra note 28, at 2, 6.
58 See id.
53 See
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3. RiskFin Analysis of Large-Size
Contingency Orders
In support of the Original QCC Order,
ISE stated that its proposed QCC Order
provided an all-electronic alternative to
the open-outcry execution of large
stock-option trades on floor-based
exchanges. While both all-electronic
exchanges and floor-based exchanges
have rules that require exposure of an
order before a member is permitted to
trade with such order, ISE believes that
the requirement under ISE’s rules is
significantly more onerous than the
similar requirement of floor-based
exchanges, where such exchanges are
only required to expose such orders to
their members on the floor and not
electronically to all members.
Accordingly, ISE asserted, among other
things, that it needed the QCC Order to
remain competitive with other
exchanges, particularly floor-based
exchanges, because although these
orders are exposed on the floor-based
exchanges, they are rarely broken up.59
In order to examine ISE’s contention
with respect to activity on floor-based
exchanges regarding large-sized
contingent trades, in October 2009, the
Commission’s Division of Risk, Strategy
and Financial Innovation (‘‘RiskFin’’)
requested Consolidated Options Audit
Trail System (‘‘COATS’’) data from
certain options exchanges for each
Tuesday in August and September of
2009. On March 17, 2010, RiskFin
placed in the public file a memorandum
analyzing the COATS data, in which it
presented the findings of its analysis of
ISE’s contention that large-size
contingency orders on floor-based
exchanges were never or nearly never
broken up.60 The RiskFin Analysis
provided some support for ISE’s
contention that large orders are broken
up less frequently on floor-based
exchanges than on an electronic
exchange, though it did not definitively
confirm ISE’s contention. Specifically,
in examining the percentage of trades
that are either fully or near-fully
executed against a single contra-party,
the RiskFin Analysis showed that, for
trades with a size of 2,000 contracts or
more, only 12% were completely
executed with only one execution on
ISE, compared to 26% and 29% of
trades that were filled with only one
execution on two floor-based exchanges.
Similarly, the data also showed that for
59 See
ISE Reply, supra note 25, at 5.
Memorandum Regarding ISE Qualified
Contingent Cross Proposal from Division of Risk,
Strategy and Financial Innovation, dated March 1,
2010 (‘‘RiskFin Analysis’’) (available at https://
www.sec.gov/rules/other/2010/sr-ise-2009–35/
riskfinmemo030110.pdf). The RiskFin Analysis
reviewed COATS data from ISE, CBOE and Phlx.
60 See
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orders of 2,000 contacts or more, only
16% of orders on ISE were 90% filled
against a single contra-party, while the
comparable figures for two floor-based
exchanges were 35% and 37%.
While the RiskFin Analysis provided
the percentage of orders on each
exchange that were filled in a single
execution versus multiple executions,
the COATS data used for the analysis
was not limited to facilitation orders.61
Thus, the RiskFin Analysis was not
dispositive with respect to ISE’s
contention because it contained orders
unrelated to ISE’s proposed order type.
Concurrently with the placement of the
RiskFin Analysis in the public file, the
Commission issued an order extending
the time to file a statement in support
of or in opposition to the Original
Approval Order.62 Subsequently, the
Commission received three statements
relating to the RiskFin Analysis.63
Both CBOE and ISE focused on the
RiskFin Analysis and noted that the
‘‘analysis did not confirm ISE’s
contention that large orders are brokenup less frequently on floor-based
exchanges, though certain data did
provide support for ISE’s position.’’
Although CBOE believed that the
conclusion was favorable to its opposing
position on ISE’s QCC Order type, it
clarified that it did not believe the study
was necessary and that the policy
question of exposure and whether it
would benefit investors or not was the
critical concern.64
Alternatively, ISE believed that the
RiskFin Analysis conclusion strongly
supported ISE’s position that the QCC
Order type is an appropriate and
necessary competitive tool for the ISE.65
In support of its belief, ISE noted that
the most critical statistic in determining
whether exchange members can affect a
trade without being broken up is to look
at how often large trades are executed in
61 For example, ISE notes that the inclusion of
index options trading in the data distorts the extent
to which there is ‘‘break-up’’ of large crosses on the
floor-based exchanges and believes that excluding
index options from the RiskFin Analysis would
significantly increase the number of floor-based
exchanges’ large orders that were executed without
break-up. See ISE Statement 3, infra note 63, at 2–
3.
62 See Commission Order Extending Time to File
Statements, dated March 17, 2010.
63 See Letters from Edward J. Joyce, President and
Chief Operating Officer, CBOE, to Elizabeth M.
Murphy, Secretary, Commission, dated April 7,
2010 (‘‘CBOE Statement 3’’); Pia K. Bennett,
Associate Corporate Secretary, NYSE Euronext, to
Elizabeth M. Murphy, Secretary, Commission, dated
April 7, 2010 (‘‘NYSE Statement 2’’); and Michael
J. Simon, Secretary, ISE, to Elizabeth M. Murphy,
Secretary, Commission, dated April 7, 2010 (‘‘ISE
Statement 3’’).
64 See CBOE Statement 3, supra note 63, at 1 and
4.
65 See ISE Statement 3, supra note 63, at 2.
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11537
a single execution. ISE points to the
RiskFin Analysis data that demonstrates
that for the largest trades (2,000 or more
contracts) only 12% of such trades were
executed without a break-up on the ISE,
while the percentages for the two floorbased exchanges were more than twice
as high.66
Another commenter reiterated its
concern that the proposed QCC Order
type creates a disincentive to
competitively quote by limiting price
discovery opportunities and dampens
transparency in the options markets.67
In response to the RiskFin Analysis
data, the commenter stated that the
crossing of two orders on or within the
best bid or offer of the options markets,
with no interference from other
participants despite exposure to the
market, indicated that the cross was
fairly priced as part of the off-exchange
negotiation and that without exposure,
there is no such comfort that the best
possible price was obtained.68
4. Request To Vacate SR–ISE–2009–35
Original Approval Order
On July 14, 2010, concurrently with
the filing of the current proposal to
modify the rules for QCC Orders (i.e.,
SR–ISE–2010–73), the Commission
received a letter from ISE requesting the
Commission to vacate the Original
Approval Order concurrently with an
approval of SR–ISE–2010–73.69
Specifically, the Vacate Letter stated
that ISE submitted its current proposal
to address the most significant issues
that commenters raised regarding the
Original QCC Order.
D. Description of Current Proposal To
Modify QCC Order Rules
As noted above, among their
objections to ISE’s Original QCC Order,
CBOE and some commenters argued
that public customers with limit orders
resting on ISE’s book at the execution
price of a QCC Order would be harmed
because the QCC Order would execute
ahead of their resting orders and that,
because certain customer orders would
not receive priority, the proposal would
create a disincentive to placing limit
orders.70 CBOE and some commenters
also questioned whether the customer
involved in the QCC Order would be
able to receive the best price for its
66 Id.
at 2.
NYSE Statement 2, supra note 63, at 1.
68 Id. at 3.
69 See Letter from Michael J. Simon, Secretary,
ISE, to Elizabeth M. Murphy, Secretary,
Commission, dated July 14, 2010 (‘‘Vacate Letter’’).
70 See, e.g., Petition for Review, supra note 22, at
13, 15, 17. See also Bluefin Statement, supra note
29; Phlx Letter, supra note 26; Wolverine Letter,
supra note 26; Group One Letter, supra note 26, at
1; and Integral Derivatives Letter, supra note 26.
67 See
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order because, without a requirement
for the order to be exposed, the
submitting member’s customer would
not have the opportunity to receive
price improvement for the options leg of
the order.71
Though ISE believes that there is
nothing novel about granting or not
granting customer priority, that the
Commission had approved exchange
rules that do not provide customer
priority, and that there is no statutory
requirement that customer orders
receive priority,72 in SR–ISE–2010–73
the Exchange proposes to modify the
Original QCC Order rules to require that
a QCC Order be automatically cancelled
if there are any Priority Customer 73
orders on the Exchange’s limit order
book at the same price. This
modification thus prohibits QCC Orders
from trading ahead of Priority Customer
orders. In addition, in SR–ISE–2010–73,
ISE proposes to increase the minimum
size requirement for a QCC Order from
500 contracts to 1,000 contracts. ISE
contends that such an increase supports
the Exchange’s intention to permit the
crossing of only large-sized institutional
stock-option orders.74
Thus, as modified, an ISE member
effecting a trade pursuant to the NMS
QCT Exemption could cross the options
leg of the trade on ISE as a QCC Order
immediately upon entry, without
exposure, only if there are no Priority
Customer orders on the Exchange’s limit
order book at the same price and if the
order: (i) Is for at least 1,000 contracts;
(ii) meets the six requirements of the
NMS QCT Exemption; 75 and (iii) is
executed at a price at or between the
NBBO (‘‘Modified QCC Order’’).76 In the
Notice, ISE stated that the modifications
to the Original QCC Order (i.e., to
prevent the execution of a QCC if there
is a Priority Customer on its book and
to increase the minimum size of a QCC
Order) remove the appearance that such
71 See, e.g., CBOE Statement 1, supra note 29, at
7–8 and Petition for Review, supra note 22, at 13.
See also Bluefin Statement, supra note 29; Group
One Letter, supra note 26, at 1–2; and Integral
Derivatives Letter, supra note 26.
72 See ISE Statement 1, supra note 28, at 4. See
also Capstone Statement, supra note 28, at 2.
73 Under ISE Rule 100(37A), a priority customer
is 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).
Pursuant to ISE Rule 713, priority customer orders
are executed before other trading interest at the
same price.
74 See Vacate Letter, supra note 69, at 1.
75 See supra notes 9 and 13 and accompanying
text.
76 If there are Priority Customer orders on ISE’s
limit order book at the same price, the QCC Order
would be automatically canceled. See proposed ISE
Rule 721(b)(1).
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orders are trading ahead of Priority
Customer orders or that the QCC Order
could be used to disadvantage retail
customers.77
E. Commenters to ISE’s Modified QCC
Order Proposal
The Commission received eight
comment letters opposing ISE’s
Modified QCC Order proposal and a
response letter from ISE.78 While some
commenters noted that ISE had
addressed their prior objections relating
to customer priority,79 commenters
objected to ISE’s modified proposal
because it remained unchanged from the
original proposal with respect to
exposure, in that QCC Orders would
still be crossed without exposure.80
Commenters noted that exposure is
especially critical in the options market,
which is quote-driven and relies on
market makers to ensure that two-sided
quotations are available for hundreds of
thousands of different options series.81
Commenters argued that exposure, in
addition to allowing for the possibility
of price improvement, provides market
makers an opportunity to participate in
trades, which in turn provides them
incentives to quote aggressively, thus
benefiting the market as a whole.82
Relatedly, several commenters
warned against removing incentives for
liquidity providers in light of the market
events of May 6, 2010.83 One
commenter noted that any tightening of
market maker obligations could only
77 See
Notice, supra note 3.
supra notes 4 and 5.
79 See CBOE Letter 1, supra note 4, at 1, NYSE
Letter 2, supra note 4, at 7, and Susquehanna Letter
2, supra note 4, at 1. See also supra notes 44–54
and accompanying text.
80 See CBOE Letter 1, supra note 4, at 1; Phlx
Letter 2, supra note 4, at 1; LiquidPoint Letter 2,
supra note 4, at 1–2; Group One Letter 2, supra note
4, at 1; NYSE Letter 2, supra note 4, at 1–2, 7–8;
and Susquehanna Letter 2, supra note 4, at 1.
81 See CBOE Letter 1, supra note 4, at 1–2; Phlx
Letter 2, supra note 4, at 1; LiquidPoint Letter 2,
supra note 4, at 1, 2; Group One Letter 2, supra note
4, at 2; NYSE Letter 2, supra note 4, at 3, 7–8; NYSE
Letter 3, supra note 4, at 2; and Susquehanna Letter
2, supra note 4, at 3.
82 See CBOE Letter 1, supra note 4, at 2–3 and
Phlx Letter 2, supra note 4, at 1. See also Cutler
Letter, supra note 4 (stating that without exposure,
there is no incentive for market makers to display
liquidity, provide liquidity or offer price
improvement) and LiquidPoint Letter 2, supra note
4, at 2 (stating that if market makers are not able
to participate in all price discovery opportunities,
they would be left to participate in only price
discovery opportunities that are less-desirable and
that the result of this negative selection would be
‘‘increased risk, a higher probability of unprofitable
trades and a reticence to post their best markets. See
also Group One Letter 2, supra note 4, at 2; NYSE
Letter 2, supra note 4, at 2, 3; and Susquehanna
Letter 2, supra note 4, at 3.
83 See CBOE Letter 1, supra note 4, at 1, 3–4;
Group One Letter 2, supra note 4, at 2; and NYSE
Letter 2, supra note 4, at 2.
78 See
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succeed if market maker benefits were
correspondingly aligned, and argued
that ISE’s proposal would withdraw
significant options order flow and, thus,
the opportunity for market makers to
interact with that order flow via
exposure.84
In addition, CBOE stated that order
exposure and the opportunity for market
participant interaction was integrally
related to what constitutes an exchange
and stressed that the Commission
should not abandon such long-held
standards to permit ‘‘print’’ mechanisms
on options exchanges, which it believed
the ISE proposal to be.85 CBOE and
NYSE also noted that the Commission
has generally not permitted 100%
participation guarantees, as the QCC
Order would provide for.86
CBOE also noted that the component
legs of stock-option orders are exposed
on options exchanges as a package (e.g.,
through complex order mechanisms)
with all terms of the complete order
being transparent to the marketplace.87
This commenter noted that such stockoption orders, while still requiring
exposure, are granted intermarket tradethrough relief. In contrast, this
commenter saw no reason why QCC
Orders should receive any special
treatment (i.e., not be required to be
exposed) and noted that they are not
represented as a package and thus do
not provide the same transparency as
stock-option orders, with only upstairs
parties to these trades aware of the
complete terms of the total
transaction.88 In response, ISE reiterated
its belief that the crossing of large-size
contingency orders on a floor today is
not transparent because ‘‘there are very
few traders (if any) on the floor to hear
an order ‘announced’’’ and are executed
with little, if any. interruption.89 ISE
stated that commenters opposed to its
proposal were arguing about the
theoretical benefits of exposure and
ignoring the realities of what is
occurring in the markets.90 Further, ISE
stated that, currently, members arrange
large stock-option trades upstairs and
then bring them to an exchange for
execution. Floor exchanges, ISE argued,
accommodate these trades by providing
a market structure where there is little
84 See
CBOE Letter 1, supra note 4, at 3.
CBOE Letter 1, supra note 4, at 3, 5.
86 See NYSE Letter 2, supra note 4, at 3; NYSE
Letter 3, supra note 4, at 1–2; and CBOE Letter 1,
supra note 4, at 2.
87 See CBOE Letter 1, supra note 4, at 4–5. See
also NYSE Letter 2, supra note 4, at 4.
88 See CBOE Letter 1, supra note 4, at 4–5. See
also Cutler Letter, supra note 4; and NYSE Letter
2, supra note 4, at 4.
89 See ISE Statement 1, supra note 28, at 3.
90 See ISE Response, supra note 5, at 2.
85 See
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or no chance that members will break
up the pre-arranged trade.91 Another
commenter believed that splitting a
stock-option order into separate
executions for the individual stock and
options legs, rather than representing
the stock-option order as a package, was
generally not in the best interest of the
customer from a best execution point of
view.92
Another commenter reiterated its
belief that the benefits of price
discovery and transparency afforded by
exposure were especially crucial for
broker facilitated crosses such as QCC
Orders because of the inherent conflict
of interest for such orders since a broker
is ‘‘betting against the customer’’ in such
trades.93 Commenters also contended
that ISE’s claim that it needed the QCC
Order to compete with trading on floorbased exchanges is erroneous and
disingenuous, and that it ignored the
broader ramification of QCC Orders that,
whereas trading floors require exposure
of orders before any executions can
occur, the QCC Order would ensure that
exposure was eliminated altogether.94
With respect to the increase in
contract size for QCC Orders from 500
contracts (as originally proposed in SR–
ISE–2009–35) to 1,000 contracts, NYSE
questioned whether the change was
meaningful in limiting the scope of the
proposed QCC Order type, as it believed
that market participants could game the
rule to meet this requirement,95 while
another commenter believed that the
1,000 contract requirement was a
relatively low threshold that would
permit large broker-dealers to shut out
other market participants on relatively
small trades.96
In its response letter, ISE reiterated its
argument that its QCC Order proposals
were simply a way for ISE to compete
against floor-based options exchanges
for the execution of large stock-option
orders.97 ISE countered commenters’
arguments regarding the lack of
exposure of QCC Orders by stating that
the required exposure of orders on floorbased exchanges was nominal and
theoretical, and ignores the realities of
what is occurring on those markets.98
One commenter agreed with ISE’s
91 Id.
92 See
Susquehanna Letter 2, supra note 4, at 4–
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5.
93 See Group One Letter 2, supra note 4, at 1–2.
See also supra note 55 and accompanying text.
94 See CBOE Letter 1, supra note 4, at 4–5. See
also NYSE Letter 2, supra note 4, at 3–4 and NYSE
Letter 3, supra note 4, at 2.
95 See NYSE Letter 2, supra note 4, at 5–7 and
NYSE Letter 3, supra note 4, at 3.
96 See Cutler Letter, supra note 4.
97 See ISE Response, supra note 5, at 1–2.
98 Id. at 2.
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assertion that floor-based options
exchanges enjoy an unfair competitive
advantage over all-electronic options
exchanges for executing clean blocks,
noting that, in its own experience,
‘‘institutional brokers are much more apt
to use a trading floor when the primary
intention is to execute as clean a cross
as possible.’’ 99 ISE stated its belief that
floor-based options markets
accommodate such trades by ‘‘providing
a market structure in which there is
little or no chance that members will
break up the pre-arranged trade’’ by
structuring their markets to provide
such trades with the least amount of
‘‘friction.’’ 100 ISE contended that, if
floor-based exchanges were serious
about exposure, they would expose such
orders to their entire marketplace, rather
than limiting exposure to ‘‘those few (if
any) members physically present in the
floor-based trading crowd.’’ 101 One
commenter echoed ISE’s contention and
suggested that a common rule for all
block crosses on all options exchanges
should be adopted to require all prenegotiated option block crosses,
including floor crosses, to be entered
into an electronic crossing mechanism.
This commenter believed that such a
requirement would ensure that market
makers could compete for such orders
and thus provide the orders a greater
chance at price improvement, as well as
act as a check to ensure that the brokers
facilitating these orders priced them
competitively.102
ISE also countered commenters’
arguments that the QCC Order proposal,
because it does not provide for
exposure, would not allow for price
improvement by reiterating its prior
explanation that those parties involved
in a stock-option order negotiate such
transactions on a ‘‘net price’’ basis,
reflecting the total price of both the
stock and options legs of the trade.
Thus, ISE argued, the actual execution
price of each individual component is
not as material to the parties involved
as is the net price of the entire
transaction, which ISE believes means
that price improvement of the
individual legs of the trade is not a
critical issue in the execution of a QCC
Order.103
In addition, ISE argued that its QCC
Order proposal has no relevance to the
market events of May 6, 2010, despite
commenters’ attempts to link the two.
ISE again noted that large stock-options
trades are currently arranged upstairs
99 See
Susquehanna Letter 2, supra note 4, at 2.
100 Id.
101 Id.
102 See
103 See
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11539
and then shopped among exchanges to
achieve a clean cross.104 ISE argued
that, accordingly, large stock-option
trades today ‘‘rely on the liquidity that
firms can provide in arranging these
trades and do not now include
exchange-provided liquidity.’’ 105 ISE
believed that the QCC Order type would
simply provide a competitive electronic
vehicle for such trades and will have no
effect on available liquidity.106
In response to NYSE’s contention that
the QCC Order’s contract size
requirement could be gamed, ISE noted
that any member creating ‘‘fake
customer orders’’ would be
misrepresenting its order in violation of
ISE’s rules and expressed confidence
that its surveillance program would be
able to catch any such attempt.107 In
addition, ISE clarified the calculation of
the 1,000 contract minimum size for a
QCC Order noting that, in order to meet
this requirement, an order must be for
at least 1,000 contracts and could not
be, for example, two 500 contract orders
or two 500 contract legs.108
III. Discussion and Commission
Findings
After careful review, the Commission
finds that the proposed rule change is
consistent with the requirements of the
Act and the rules and regulations
thereunder applicable to a national
securities exchange and, in particular,
with Section 6(b) of the Act.109
Specifically, the Commission finds that
the proposal is consistent with Sections
6(b)(5) 110 and 6(b)(8),111 which require,
among other things, that the rules of a
national securities exchange be
designed to promote just and equitable
principles of trade, to remove
impediments to and perfect the
mechanism of a free and open market
and a national market system, and, in
general, to protect investors and the
public interest and that the rules of an
exchange do not impose any burden on
competition not necessary or
appropriate in furtherance of the
purposes of the Act. In addition, the
Commission finds that the proposed
rule change is consistent with Section
11A(a)(1)(C) of the Act,112 in which
Congress found that it is in the public
104 See
ISE Response, supra note 5, at 4.
105 Id.
106 Id.
107 Id.
at 5–6.
at 6.
109 15 U.S.C. 78f(b). In approving this proposed
rule change, the Commission has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
110 15 U.S.C. 78f(b)(5).
111 15 U.S.C. 78f(b)(8).
112 15 U.S.C. 78k–1(a)(1)(C).
108 Id.
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interest and appropriate for the
protection of investors and the
maintenance of fair and orderly markets
to assure, among other things, the
economically efficient execution of
securities transactions.
A. Consistency With the NMS QCT
Exemption
In approving the Original QCT
Exemption, the Commission recognized
that contingent trades can be ‘‘useful
trading tools for investors and other
market participants, particularly those
who trade the securities of issuers
involved in mergers, different classes of
shares of the same issuer, convertible
securities, and equity derivatives such
as options [italics added].’’ 113 The
Commission stated that ‘‘[t]hose who
engage in contingent trades can benefit
the market as a whole by studying the
relationships between the prices of such
securities and executing contingent
trades when they believe such
relationships are out of line with what
they believe to be fair value.’’ 114 As
such, the Commission stated that
transactions that meet the specified
requirements of the NMS QCT
Exemption could be of benefit to the
market as a whole, contributing to the
efficient functioning of the securities
markets and the price discovery
process.115
The parties to a contingent trade are
focused on the spread or ratio between
the transaction prices for each of the
component instruments (i.e., the net
price of the entire contingent trade),
rather than on the absolute price of any
single component.116 Pursuant to the
requirements of the NMS QCT
Exemption, the spread or ratio between
the relevant instruments must be
determined at the time the order is
placed, and this spread or ratio stands
regardless of the market prices of the
individual orders at their time of
execution. As the Commission noted in
the Original QCT Exemption, ‘‘the
difficulty of maintaining a hedge, and
the risk of falling out of hedge, could
dissuade participants from engaging in
contingent trades, or at least raise the
cost of such trades.’’ 117 Thus, the
Commission found that, if each stock leg
of a qualified contingent trade were
required to meet the trade-through
provisions of Rule 611 of Regulation
NMS, such trades could become too
113 See Original QCT Exemption, supra note 9, at
52830.
114 Id. at 52831.
115 See CBOE QCT Exemption, supra note 13.
116 See Original QCT Exemption, supra note 9, at
52829 (explaining SIA’s position on the need for the
Original QCT Exemption).
117 Id. at 52831.
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risky and costly to be employed
successfully and noted that the
elimination or reduction of this trading
strategy potentially could remove
liquidity from the market.118
The Commission believes that ISE’s
proposal, which would permit a clean
cross of the options leg of a subset of
qualified contingent trades (i.e., a stockoption qualified contingent trade that
meets the requirements of the NMS QCT
Exemption), is appropriate and
consistent with the Act in that it would
facilitate the execution of qualified
contingent trades, for which the
Commission found in the Original QCT
Exemption to be of benefit to the market
as a whole, contributing to the efficient
functioning of the securities markets
and the price discovery process.119 The
QCC Order would provide assurance to
parties to stock-option qualified
contingent trades that their hedge would
be maintained by allowing the options
component to be executed as a clean
cross.
B. Exposure and Qualified Contingent
Trades
Commenters believed that ISE’s
modifications to the Original QCC Order
did not adequately address their main
objection regarding the QCC Order,
particularly in that it would continue to
permit option crosses to occur without
prior exposure to the marketplace.
Commenters generally reiterated their
prior comments that exposing options
orders promotes price competition,
increases order interaction, and leads to
better quality executions for investors
by providing opportunities for price
improvement.120 These commenters
continued to argue that, without
exposure, the Modified QCC Order
would cause significant harm to the
options market because it would
eliminate valuable incentive for
dedicated liquidity provider
participation.121
In response to commenters’ concerns
that the Modified QCC Order would
have a detrimental effect on the options
markets because of the lack of any
exposure requirement, ISE stated that
exchange members arrange large stockoption trades upstairs and then bring
them to an exchange for execution, and
that exchange floors accommodate the
trades by providing a market structure
in which there is little or no chance that
members will break up the pre-arranged
118 Id.
119 Id.
120 See supra notes 70 and 85–94 and
accompanying text.
121 See supra notes 81–84 and accompanying text.
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Fmt 4703
Sfmt 4703
trade.122 ISE believed that, rather than
harming the options markets, the QCC
proposal would permit fair competition
to occur between floor-based and allelectronic options exchanges by
providing an all-electronic execution
alternative to floor-based executions.123
The Commission recognizes that
significant liquidity on options
exchanges is derived from quotations
submitted by members of an exchange
that are registered as market makers.124
Pursuant to the options exchanges’
rules, market makers generally are
required to maintain continuous twosided quotations in their registered
options for a specified percentage of the
time, or in a specified number of series
or classes. One of the perceived benefits
for market makers with such obligations
is the opportunity to participate in
transactions through the exposure
requirement. As noted above, some
commenters argue that the lack of
exposure for QCC Orders would act as
a disincentive for market maker
participation.125
While the Commission believes that
order exposure is generally beneficial to
options markets in that it provides an
incentive to options market makers to
provide liquidity and therefore plays an
important role in ensuring competition
and price discovery in the options
markets, it also has recognized that
contingent trades can be ‘‘useful trading
tools for investors and other market
participants, particularly those who
trade the securities of issuers involved
in mergers, different classes of shares of
the same issuer, convertible securities,
and equity derivatives such as options
[italics added]’’.126 and that ‘‘[t]hose who
engage in contingent trades can benefit
the market as a whole by studying the
relationships between the prices of such
securities and executing contingent
trades when they believe such
relationships are out of line with what
they believe to be fair value.’’ 127 As
such, the Commission stated that
transactions that meet the specified
requirements of the NMS QCT
Exemption could be of benefit to the
market as a whole, contributing to the
efficient functioning of the securities
122 See
supra notes 97–100 and accompanying
text.
123 See
ISE Response, supra note 5, at 3.
e.g., Susquehanna Letter 2, supra note 4,
at 3 (noting that, in the options market, market
makers provide over 90% of the liquidity).
125 See supra notes 81–82 and accompanying text.
126 See Original QCT Exemption, supra note 9, at
52830–52831.
127 Id.
124 See,
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markets and the price discovery
process.128
Thus, in light of the benefits provided
by both the requirement for exposure as
well as by qualified contingent trades
such as QCC Orders, the Commission
must weigh the relative merits of both
for the options markets.129 The
Commission believes that the proposal,
in requiring a QCC Order to be: (1) Part
of a qualified contingent trade under
Regulation NMS; (2) for at least 1,000
contracts; (3) executed at a price at or
between the national best bid or offer;
and (4) cancelled if there is a Priority
Customer Order on ISE’s limit order
book, strikes an appropriate balance for
the options market in that it is narrowly
drawn 130 and establishes a limited
exception to the general principle of
exposure and retains the general
principle of customer priority in the
options markets. Furthermore, not only
must a QCC Order be part of a qualified
contingent trade by satisfying each of
the six underlying requirements of the
NMS QCT Exemption, the requirement
that a QCC Order be for a minimum size
of 1,000 contracts provides another limit
to its use by ensuring only transactions
of significant size may avail themselves
of this order type.131
As noted above, some commenters
argue that the concerns regarding the
impact of the QCC Order on the
incentives for liquidity providers are
heightened by the events of May 6,
2010.132 Specifically, commenters
argued that in light of the events of May
6, 2010, the Commission should not
improve measures that would create
disincentives for market makers to
provide liquidity to the markets.133 The
Commission recognizes the important
role liquidity providers play,
particularly in the options markets,
which tend to be more quote driven
than the cash equities markets. In
128 See CBOE QCT Exemption, supra note 13, at
19273.
129 The Commission notes that it has previously
permitted the crossing of two public customer
orders, for which no exposure is required on ISE
and CBOE. See CBOE Rule 6.74A.09 and ISE Rules
715(i) and 721.
130 The Commission notes that, in its request to
remove the block-size requirement of the Original
QCT Exemption, CBOE stated that the NMS QCT
Exemption’s other requirements would ensure that
the exemption was narrowly drawn and limited to
a small number of transactions. See Letter, dated
November 28, 2007, from Edward J. Joyce, President
and Chief Operating Officer, CBOE, to Nancy M.
Morris, Secretary, Commission, at 1, 4.
131 The Commission notes that the requirement
that clean crosses be of a certain minimum size is
not unique to the QCC Order. See, e.g., NSX Rule
11.12(d), which requires, among other things, that
a Clean Cross be for at least 5,000 shares and have
an aggregate value of at least $100,000.
132 See supra notes 83–84 and accompanying text.
133 Id.
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addition, the Commission is cognizant
of the concerns raised by some
commenters with regard to the events of
May 6, 2010. However, as discussed
above, the Commission has weighed the
relative merits of the QCC Order and of
the exposure of such orders and believes
that ISE’s proposal is consistent with
the Act.
C. Customer Protection
In response to concerns that the
Original QCC Order did not provide
adequate customer protection because
the QCC Order would have priority over
resting customer orders on ISE’s
books,134 ISE proposes to modify the
QCC Order to provide for automatic
cancellation of a QCC Order if there is
a Priority Customer order on the
Exchange’s limit order book at the same
price. The Commission believes that
this modification to yield to a Priority
Customer order on the book would
ensure that QCC Orders do not trade
ahead of Priority Customer orders at the
same price, and thus should alleviate
commenters’ concerns regarding the
Original QCC Order that customers
would not receive executions of their
resting orders, which could also create
a disincentive to placing limit orders.
Some commenters objected to the
Modified QCC Order because they
believed that a customer order
submitted as a QCC Order risks
receiving a fill at an inferior price to the
price it could have received if it has
been exposed to the market.135 Another
commenter was concerned that, while
the option trade would be within the
NBBO, the stock trade may be priced
outside of the market and that ‘‘[t]he
effect is a valuation for the stock/option
package * * * unrestricted by
competition * * * . ’’ 136 In response to
commenters concerns regarding price
improvement, ISE argued that the actual
execution price of each component is
not as material to the parties as is the
net price of the transaction and
accordingly, price improvement of the
individual legs of the trade is not a
critical issue in executing the QCC
Order.137
As discussed above, QCC Orders must
be for 1,000 or more contracts, in
addition to meeting all of the
requirements of the NMS QCT
Exemption. The Commission believes
that those customers participating in
QCC Orders will likely be sophisticated
investors who should understand that,
without a requirement of exposure for
QCC Orders, their order would not be
given an opportunity for price
improvement on the Exchange. These
customers should be able to assess
whether the net prices they are
receiving for their QCC Order are
competitive, and who will have the
ability to choose among broker-dealers if
they believe the net price one brokerdealer provides is not competitive.
Further, broker-dealers are subject to a
duty of best execution for their
customers’ orders, and that duty does
not change for QCC Orders.
IV. Conclusion
In sum, the Commission believes that
ISE’s Modified QCC Order is consistent
with the NMS QCT Exemption, which
found that qualified contingent trades
are of benefit to the market as a whole
and a contribution to the efficient
functioning of the securities markets
and the price discovery process.138 In
addition, the Exchange’s Modified QCC
Order is narrowly drawn to provide a
limited exception to the general
principle of exposure, and retains the
general principle of customer priority.
Accordingly, the Commission finds that
the proposed rule change is consistent
with the requirements of the Act and the
rules and regulations thereunder
applicable to a national securities
exchange and, in particular, with
Section 6(b) of the Act.139 Specifically,
the Commission finds that the proposal
is consistent with Sections 6(b)(5) 140
and 6(b)(8) of the Act.141 Further, the
Commission finds that the proposed
rule change is consistent with Section
11A(a)(1)(C) of the Act.142
It is therefore ordered, the proposed
rule change (SR–ISE–2010–73) is
approved pursuant to Section 19(b)(2) of
the Act.143
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011–4574 Filed 3–1–11; 8:45 am]
BILLING CODE 8011–01–P
138 See
134 See
Petition for Review, supra note 22, at 15,
17. See also Bluefin Statement, supra note 29; Phlx
Letter, supra note 26; Wolverine Letter, supra note
26; Group One Letter, supra note 26, at 1; and
Integral Derivatives Letter, supra note 26.
135 See Group One Letter 2, supra note 4, at 1; and
CBOE Letter 1, supra note 4, at 2.
136 See LiquidPoint Letter 2, supra note 4, at 2.
137 See supra note 103 and accompanying text.
PO 00000
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Fmt 4703
Sfmt 9990
11541
supra note 13.
U.S.C. 78f(b). In approving this proposed
rule change, the Commission has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
140 15 U.S.C. 78f(b)(5).
141 15 U.S.C. 78f(b)(8).
142 15 U.S.C. 78k–1(a)(1)(C).
143 15 U.S.C. 78s(b)(2).
139 15
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]]>Agencies
[Federal Register Volume 76, Number 41 (Wednesday, March 2, 2011)]
[Notices]
[Pages 11533-11541]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-4574]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-63955; File No. SR-ISE-2010-73]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Order Granting Approval of a Proposed Rule Change To Modify
Qualified Contingent Cross Order Rules
February 24, 2011.
I. Introduction
On July 14, 2010, the International Securities Exchange, LLC
(``ISE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to modify rules for Qualified
Contingent Cross (``QCC'') Orders. The proposed rule change was
published for comment in the Federal Register on July 23, 2010.\3\ The
Commission received eight comment letters on the proposed rule change
\4\ and a response letter from ISE.\5\
[[Page 11534]]
This order approves the proposed rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 62523 (July 16,
2010), 75 FR 43211 (``Notice'').
\4\ See Letters from Anthony J. Saliba, Chief Executive Officer,
LiquidPoint, LLC, to Elizabeth M. Murphy, Secretary, Commission
dated, July 30, 2010 (``LiquidPoint Letter 2''); William J. Brodsky,
Chairman and Chief Executive Officer, Chicago Board Options
Exchange, Incorporated (``CBOE''), to Elizabeth M. Murphy,
Secretary, Commission, dated August 9, 2010 (``CBOE Letter 1''); Ben
Londergan and John Gilmartin, Co-Chief Executive Officers, Group One
Trading, LP, to Elizabeth M. Murphy, Secretary, Commission, dated
August 9, 2010 (``Group One Letter 2''); Janet M. Kissane, Senior
Vice President--Legal and Corporate Secretary, NYSE Euronext, to
Elizabeth M. Murphy, Secretary, Commission, dated August 9, 2010
(``NYSE Letter 2''); Thomas Wittman, President, NASDAQ OMX PHLX,
Inc. (``Phlx''), to Elizabeth M. Murphy, Secretary, Commission,
dated August 13, 2010 (``Phlx Letter 2''); J. Micah Glick, Chief
Compliance Officer, Cutler Group LP to Elizabeth M. Murphy,
Secretary, Commission, dated September 3, 2010 (``Cutler Letter'');
Janet L. McGinness, Senior Vice President--Legal and Corporate
Secretary, NYSE Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated October 21, 2010 (``NYSE Letter 3''); and Gerald
D. O'Connell, Chief Compliance Officer, Susquehanna International
Group, LLP, to Elizabeth M. Murphy, Secretary, Commission, dated
October 22, 2010 (``Susquehanna Letter 2'').
\5\ See Letter from Michael J. Simon, Secretary and General
Counsel, ISE, to Elizabeth M. Murphy, Secretary, Commission, dated,
August 25, 2010 (``ISE Response'').
---------------------------------------------------------------------------
II. Background
A. Regulation NMS and Qualified Contingent Trades
The Commission adopted Regulation NMS in June 2005.\6\ Among other
things, Regulation NMS addressed intermarket trade-throughs of
quotations in NMS stocks.\7\ In 2006, pursuant to Rule 611(d) of
Regulation NMS,\8\ the Commission provided an exemption \9\ for each
NMS stock component of certain qualified contingent trades (as defined
below) from Rule 611(a) of Regulation NMS for any trade-throughs caused
by the execution of an order involving one or more NMS stocks (each an
``Exempted NMS Stock Transaction'') that are components of a qualified
contingent trade.
---------------------------------------------------------------------------
\6\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496 (June 29, 2005).
\7\ See 17 CFR 242.611. An ``NMS stock'' means any security or
class of securities, other than an option, for which transaction
reports are collected, processed, and made available pursuant to an
effective transaction reporting plan. See 17 CFR 242.600(b)(46) and
(47).
\8\ 17 CFR 242.611(d). See also 15 U.S.C. 78mm(a)(1) (providing
general authority for the Commission to grant exemptions from
provisions of the Act and the rules thereunder).
\9\ See Securities Exchange Act Release No. 54389 (August 31,
2006), 71 FR 52829 (September 7, 2006) (``Original QCT Exemption'').
The Securities Industry Association (``SIA,'' n/k/a Securities
Industry and Financial Markets Association) requested the exemption.
See Letter to Nancy M. Morris, Secretary, Commission, from Andrew
Madoff, SIA Trading Committee, SIA, dated June 21, 2006.
---------------------------------------------------------------------------
The Original QCT Exemption defined a ``qualified contingent trade''
to be a transaction consisting of two or more component orders,
executed as agent or principal, where: (1) At least one component is in
an NMS stock; (2) all components are effected with a product or price
contingency that either has been agreed to by the respective
counterparties or arranged for by a broker-dealer as principal or
agent; (3) the execution of one component is contingent upon the
execution of all other components at or near the same time; (4) the
specific relationship between the component orders (e.g., the spread
between the prices of the component orders) is determined at the time
the contingent order is placed; (5) the component orders bear a
derivative relationship to one another, represent different classes of
shares of the same issuer, or involve the securities of participants in
mergers or with intentions to merge that have been announced or since
cancelled; \10\ (6) the Exempted NMS Stock Transaction is fully hedged
(without regard to any prior existing position) as a result of the
other components of the contingent trade; \11\ and (7) the Exempted NMS
Stock Transaction that is part of a contingent trade involves at least
10,000 shares or has a market value of at least $200,000.\12\
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\10\ Transactions involving securities of participants in
mergers or with intentions to merge that have been announced would
meet this aspect of the requested exemption. Transactions involving
cancelled mergers, however, would constitute qualified contingent
trades only to the extent they involve the unwinding of a pre-
existing position in the merger participants' shares. Statistical
arbitrage transactions, absent some other derivative or merger
arbitrage relationship between component orders, would not satisfy
this element of the definition of a qualified contingent trade. See
Original QCT Exemption, supra, note 9.
\11\ A trading center may demonstrate that an Exempted NMS Stock
Transaction is fully hedged under the circumstances based on the use
of reasonable risk-valuation methodologies. Id.
\12\ See 17 CFR 242.600(b)(9) (defining ``block size'' with
respect to an order as at least 10,000 shares or $200,000 in market
value).
---------------------------------------------------------------------------
In 2008, in response to a request from the CBOE, the Commission
modified the Original QCT Exemption to remove the ``block size''
requirement of the exemption (i.e., that the Exempted NMS Stock
Transaction be part of a contingent trade involving at least 10,000
shares or having a market value of at least $200,000).\13\
---------------------------------------------------------------------------
\13\ See Securities Exchange Act Release No. 57620 (April 4,
2008) 73 FR 19271 (April 9, 2008) (``CBOE QCT Exemption''). The
current QCT Exemption (i.e., as modified by the CBOE QCT Exemption)
is referred to herein as the ``NMS QCT Exemption.''
---------------------------------------------------------------------------
B. Background of ISE's Proposal
In August 2009, the Commission approved the Order Protection and
Locked/Crossed Market Plan \14\ which, among other things, required the
options exchanges to adopt written policies and procedures reasonably
designed to prevent trade-throughs.\15\ Unlike its predecessor
plan,\16\ the New Linkage Plan does not include a trade-through
exemption for ``Block Trades,'' defined to be trades of 500 or more
contracts with a premium value of at least $150,000.\17\ However,
because the New Linkage Plan does not provide a Block Trade exemption,
the Exchange was concerned that the loss of the Block Trade exemption
would adversely affect the ability of its members to effect large
trades that are tied to stock. Accordingly, the Exchange proposed the
Original QCC Order (defined below) as a limited substitute for the
Block Trade exemption to facilitate the execution of large stock/option
combination orders, to be implemented contemporaneously with the New
Linkage Rules.
---------------------------------------------------------------------------
\14\ See Securities Exchange Act Release No. 60405 (July 30,
2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) (``New Linkage
Plan''). ISE also proposed revisions to its rules to implement the
New Linkage Plan (``New Linkage Rules''). See Securities Exchange
Act Release No. 60559 (August 21, 2009), 74 FR 44425 (August 28,
2009) (SR-ISE-2009-27).
\15\ A trade-through is a transaction in a given option series
at a price that is inferior to the best price available in the
market.
\16\ The former options linkage plan, the Plan for the Purpose
of Creating and Operating an Intermarket Option Linkage (``Former
Linkage Plan''), was approved by the Commission in 2000 and was
operative until August 31, 2009, when the New Linkage Plan took
effect. See Securities Exchange Act Release No. 43086 (July 28,
2000), 65 FR 48023 (August 4, 2000) (File No. 4-429).
\17\ See Sections 2(3) and 8(c)(i)(C) of the Former Linkage Plan
and old ISE Rule 1902(d)(2).
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C. SR-ISE-2009-35
1. ISE's Original Qualified Contingent Cross Order Proposal
In SR-ISE-2009-35,\18\ ISE proposed a new order type, the QCC
Order. The QCC Order as proposed in SR-ISE-2009-35 (``Original QCC
Order'') permitted an ISE member to cross the options leg of a
Qualified Contingent Trade (``QCT'') (as defined below) on ISE
immediately upon entry, without exposure, if the order: (i) Was for at
least 500 contracts; (ii) met the six requirements of the NMS QCT
Exemption; and (iii) was executed at a price at or between the national
best bid or offer (``NBBO''). Proposed Supplementary Material .01 to
ISE Rule 715 defined a QCT as a transaction composed of two or more
orders, executed as agent or principal, where: (i) At least one
component is in an NMS stock; (ii) all components are effected with a
product or price contingency that either has been agreed to by all the
respective counterparties or arranged for by a broker-dealer as
principal or agent; (iii) the execution of one component is contingent
upon the execution of all other components at or near the same time;
(iv) the specific relationship between the component orders (e.g., the
spread between the prices of the component orders) is determined by the
time the contingent order is placed; (v) the component orders bear a
derivative relationship to one another, represent different classes of
shares of the same issuer, or involve the securities of participants in
mergers or with intentions to merge that have been announced or
cancelled; and (vi) the transaction is fully hedged (without regard to
any prior existing position) as a result of other components of the
contingent trade.\19\
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\18\ See Securities Exchange Act Release No. 60147 (June 19,
2009), 74 FR 30651 (June 26, 2009) (SR-ISE-2009-35 Notice).
\19\ The six requirements are substantively identical to the six
elements of a QCT under the NMS QCT Exemption. See supra notes 9 and
13.
---------------------------------------------------------------------------
On August 28, 2009, the Commission approved, by authority delegated
to the
[[Page 11535]]
Division of Trading and Markets, ISE's Original QCC Order proposal.\20\
On September 4, 2009, CBOE filed with the Commission a notice of
intention to file a petition for review of the Commission's approval by
delegated authority \21\ and, on September 14, 2009, CBOE filed a
petition for review, which automatically stayed the delegated approval
of the Original QCC Order.\22\ On September 11, 2009, ISE filed a
motion to lift the automatic stay.\23\ On September 17, 2009, CBOE
filed a response to ISE's Motion.\24\ On September 22, 2009, ISE filed
a reply in support of its motion to lift the automatic stay.\25\ In
addition to the submissions from CBOE and ISE, the Commission received
eight comment letters requesting that the Commission grant CBOE's
Petition for Review.\26\
---------------------------------------------------------------------------
\20\ See Securities Exchange Act Release No. 60584 (August 28,
2009), 74 FR 45663 (September 3, 2009) (``Original Approval
Order'').
\21\ See Letter from Paul E. Dengel, Counsel for CBOE, Schiff
Hardin LLP, to Elizabeth M. Murphy, Secretary, Commission, dated
September 4, 2009.
\22\ See Letter from Joanne Moffic-Silver, General Counsel and
Corporate Secretary, CBOE, to Elizabeth M. Murphy, Secretary,
Commission, dated September 14, 2009 (``Petition for Review'').
\23\ See Brief in Support of ISE's Motion to Lift the Commission
Rule 431(e) Automatic Stay of Delegated Action Triggered by CBOE's
Notice of Intention to Petition for Review, dated September 11, 2009
(``ISE's Motion'').
\24\ See Response of CBOE to Motion of ISE to Lift Automatic
Stay, dated September 17, 2009 (``Response to Motion'').
\25\ See Reply in Support of ISE's Motion to Lift the Commission
Rule 431(e) Automatic Stay of Delegated Action Triggered by CBOE's
Notice of Intention to Petition for Review, dated September 22, 2009
(``ISE Reply'').
\26\ See Letters from Jeffrey S. Davis, Vice President and
Deputy General Counsel, NASDAQ OMX PHLX, Inc., to Elizabeth M.
Murphy, Secretary, Commission, dated September 22, 2009 (``Phlx
Letter''); Gerald D. O'Connell, Chief Compliance Officer,
Susquehanna International Group, LLP, to Elizabeth M. Murphy,
Secretary, Commission, dated September 30, 2009 (``Susquehanna
Letter''); Megan A. Flaherty, Chief Legal Counsel, Wolverine
Trading, LLC, to Elizabeth M. Murphy, Secretary, Commission, dated
October 2, 2009 (``Wolverine Letter''); Janet M. Kissane, Senior
Vice President--Legal and Corporate Secretary, NYSE Euronext, to
Elizabeth M. Murphy, Secretary, Commission, dated October 5, 2009
(``NYSE Letter''); Ben Londergan, Co-CEO, Group One Trading, L.P.,
to Elizabeth M. Murphy, Secretary, Commission, dated October 5, 2009
(``Group One Letter''); Anthony J. Saliba, Chief Executive Officer,
LiquidPoint, LLC, to Elizabeth M. Murphy, Secretary, Commission,
dated October 7, 2009 (``LiquidPoint Letter''); Kimberly Unger,
Executive Director, The Security Traders Association of New York,
Inc., to Elizabeth M. Murphy, Secretary, Commission, dated October
29, 2009 (``STA Letter''); and Peter Schwarz, Integral Derivatives,
LLC, to Elizabeth M. Murphy, Secretary, Commission, dated November
25, 2009 (``Integral Derivatives Letter''). In addition, ISE
submitted certain market volume and share statistics. See E-mail
from Michael J. Simon, ISE, to Elizabeth King, Associate Director,
Division of Trading and Markets, Commission, dated September 30,
2009.
---------------------------------------------------------------------------
On November 12, 2009, the Commission granted CBOE's Petition for
Review and denied ISE's motion to lift the automatic stay.\27\ In
connection with the Order Granting Petition, the Commission received
three statements in support of the Original Approval Order (two of
which were submitted by ISE) \28\ and five statements in opposition to
the Original Approval Order (two of which were submitted by CBOE).\29\
---------------------------------------------------------------------------
\27\ See Commission Order Granting Petition for Review and
Scheduling Filing of Statements, dated November 12, 2009 and
Commission Order Denying ISE's Motion to Lift the Commission Rule
431(e) Automatic Stay of Delegate Action Triggered by CBOE's Notice
of Intention to Petition for Review, dated November 12, 2009
(``Order Granting Petition'').
\28\ See Letters from Michael J. Simon, Secretary, ISE, to
Elizabeth M. Murphy, Secretary, Commission, dated December 3, 2009
(``ISE Statement 1''); from Leonard Ellis, Head of Capital Markets,
Capstone Global Markets, LLC, to Elizabeth Murphy, Secretary,
Commission, dated December 3, 2009 (``Capstone Statement''); and
Michael J. Simon, Secretary, ISE, to Elizabeth M. Murphy, Secretary,
Commission, dated December 16, 2009 (``ISE Statement 2'').
\29\ See Letters from Joanne Moffic-Silver, Executive Vice
President, General Counsel & Corporate Secretary, CBOE, to Elizabeth
M. Murphy, Secretary, Commission, dated December 3, 2009 (``CBOE
Statement 1''); Michael Goodwin, Senior Managing Member, Bluefin
Trading, LLC, to Elizabeth M. Murphy, Secretary, Commission, dated
December 2, 2009 (``Bluefin Statement''); John C. Nagel, Managing
Director and Deputy General Counsel, Citadel, to Elizabeth M.
Murphy, Commission, dated December 3, 2009 (``Citadel Statement'');
Janet M. Kissane, Senior Vice President--Legal & Corporate
Secretary, NYSE Euronext, to Elizabeth M. Murphy, Secretary,
Commission, dated December 3, 2009 (``NYSE Statement 1''); and
Angelo Evangelou, Assistant General Counsel, CBOE, to Elizabeth M.
Murphy, Secretary, Commission, dated January 20, 2010 (``CBOE
Statement 2''). The Commission also received a statement from ISE
responding to the CBOE Statement 2 regarding its statistical claim
and number of trade-throughs. See Letter from Michael J. Simon,
Secretary, ISE, to Elizabeth M. Murphy, Secretary, Commission, dated
March 1, 2010.
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2. Commenter's to ISE's Original QCC Order Proposal
In its Petition for Review and statements in support thereof, CBOE
argued that ISE's Original QCC Order proposal was inconsistent with the
Act \30\ and raised important policy concerns that the Commission
should address, including whether crossing straight or complex option
orders without exposure is appropriate and whether permitting a
``clean'' cross in front of public customer orders is appropriate. CBOE
believed that ISE's proposal was inconsistent with the Act because ``it
effectively establishes ISE as a print facility for large options
orders rather than an exchange where orders are able to interact in an
auction setting.'' \31\ CBOE and certain commenters objected to the
Original QCC Order proposal because, for crosses that satisfy the QCC's
requirements, a member of ISE could execute a clean cross without
exposing the cross to other ISE participants, which CBOE stated would
represent a significant change from historical and current market
practices in the options markets.\32\ CBOE contended that the
Commission's policy and practice had been to limit the percentage of
the crossing entitlement to an amount below 50% of the order being
executed, and then only after ensuring that all crossing entitlements
are exposed and yield to public customer orders.\33\ CBOE stated that
the policies requiring exposure and yielding to public customer
interest balance ``the desire to permit internalization/solicitations
to some degree while at the same time ensuring competition and price
discovery and, to some degree, protecting public customers (including
retail investors).'' \34\ Without an exposure requirement, CBOE
contended that the proposal would have a major adverse impact on
options market structure, and result in a trading environment that is
``sluggish, nontransparent, and noncompetitive.'' \35\
---------------------------------------------------------------------------
\30\ See e.g., Petition for Review, supra note 22, at 11. See
also CBOE Statement 1, supra note 29, at 5-6, 15-16.
\31\ See Petition for Review, supra note 22, at 13. See also
Bluefin Statement, supra note 29; Citadel Statement, supra note 29,
at 2; and LiquidPoint Letter, supra note 26, at 4. See also
Wolverine Letter, supra note 26 and CBOE Statement 1, supra note 29,
at 8.
\32\ See Petition for Review, supra note 22, at 5, 9, 13-15. See
also Bluefin Statement, supra note 29; Citadel Statement, supra note
29, at 2; NYSE Statement 1, supra note 29, at 2; Wolverine Letter,
supra note 26; and LiquidPoint Letter, supra note 26, at 2.
\33\ See Petition for Review, supra note 22, at 5, 17. CBOE also
noted ISE's investment in an entity that CBOE asserted is ``geared
towards the non-transparent execution of block size stock-option
transactions,'' which CBOE contended would benefit from the ISE's
proposal. Id. at 11. See also CBOE Statement 1, supra note 29, at
13-14.
\34\ See Petition for Review, supra note 22, at 15.
\35\ Id. at 10, 14. CBOE and some commenters also noted their
belief that the lack of exposure also degrades market transparency,
which they believe is related to the Commission's concerns relating
to dark pools. Id. at 16. See also, e.g., NYSE Statement 1, supra
note 29, at 1, 4.
---------------------------------------------------------------------------
CBOE and many of the commenters to the Original QCC Order proposal
believed that the lack of any exposure requirement in ISE's Original
QCC Order would have a detrimental effect on the options market as it
would provide a disincentive to ISE's market makers to quote
competitively, undercut their market making function and could result
in market makers migrating off other exchanges that do not offer a QCC
Order type to ISE, to take advantage of potentially wider spreads and
where greater margins might be available with
[[Page 11536]]
less competitive quoting.\36\ One commenter stated that the Original
QCC Order, by preventing market makers from participating in trades
occurring at their quoted prices, would cause market makers to spread
their quotes wider to increase their profit margins in compensation for
the lower volume of trading in which they participate.\37\ This
commenter further stated that, eventually, such market makers might
very well question the wisdom of committing capital to make firm
markets in the thousands of options series in which they have
continuous quoting obligations.\38\ Another commenter noted that,
ultimately, this would ``increase the costs and decrease the
availability of proven, effective risk management through derivatives''
and harm options market participants, as their ability ``to execute
their myriad strategies would disappear.'' \39\ Thus, some commenters
believed that permitting the implementation of the QCC Order would harm
the growth prospects of the overall options industry.\40\
---------------------------------------------------------------------------
\36\ See CBOE Statement 1, supra note 29, at 8; NYSE Statement
1, supra note 29 at 2, 3; and LiquidPoint Letter, supra note 26, at
3, 5. See also Petition for Review, supra note 22, at 13.
\37\ See NYSE Statement 1, supra note 29 at 3.
\38\ Id.
\39\ See LiquidPoint Letter, supra note 26, at 3, 5.
\40\ See NYSE Statement 1, supra note 29, at 2 and LiquidPoint
Letter, supra note 26, at 3-5. See also CBOE Statement 1, supra note
29, at 8.
---------------------------------------------------------------------------
However, ISE argued that the QCC Order type would not impact the
options markets, and that large-size contingency orders are executed on
floor-based exchanges in a manner very similar to the new order type
proposed by ISE. In addition, ISE noted that there is no meaningful
transparency on floors because there is no requirement that information
on orders presented to the floor be announced electronically to all
exchange members or the public.\41\ ISE also noted that some floor-
based options exchanges have eliminated the requirement that market
makers have a physical presence on the floor, which it believes
undermines the claim that price discovery and transparency occur on the
trading floor.\42\ One commenter to the Original QCC Order proposal
agreed and stated that the exposure-related concerns of other
commenters ``do not adequately recognize the reality of how this
business is conducted today and seem to simply endorse a manual trading
environment that prevents competition from electronic exchanges.'' \43\
---------------------------------------------------------------------------
\41\ See ISE Statement 1, supra note 28, at 2, 6.
\42\ Id.
\43\ See Capstone Statement, supra note 28, at 2.
---------------------------------------------------------------------------
In addition to CBOE's opposition to the Original QCC Order because
of its lack of an exposure requirement, CBOE also argued that public
customers that have previously placed limit orders at the execution
price of a QCC Order would be harmed because those customers would lose
priority and would not receive executions of their resting orders.\44\
CBOE expressed concern that, because certain customer orders would not
receive priority, the proposal would create a disincentive to placing
limit orders.\45\ CBOE maintained that, with respect to intra-market
priority in the exchange-listed options markets, the long-standing
industry policy and practice has been to require public customer
priority for simple option orders.\46\ Two commenters also expressed
concern that the Original QCC Order would cause public customers with
existing orders to be disadvantaged in the executions that they receive
and would be a direct disincentive to market makers and would likely
encourage wider quoted markets.\47\
---------------------------------------------------------------------------
\44\ See Response to Motion, supra note 24, at 4.
\45\ See Petition for Review, supra note 22, at 13.
\46\ Id. at 17. See also CBOE Statement 1, supra note 29, at 5,
9.
\47\ See Bluefin Statement, supra note 29 and NYSE Statement 1,
supra note 29 at 2.
---------------------------------------------------------------------------
ISE disagreed with the commenters' claims that public customers
with resting limit orders would be harmed by its QCC proposal. ISE
stated that large-size contingency trades that would qualify as QCC
Orders are currently almost exclusively executed on floor-based
exchanges, thus ``the occasional customer limit order resting on ISE's
book * * * has no opportunity to interact with [such orders].'' \48\
---------------------------------------------------------------------------
\48\ See ISE Statement 1, supra note 28, at 2, 5.
---------------------------------------------------------------------------
In addition, CBOE stated that no execution entitlements have been
permitted thus far, unless there is first yielding to public customer
interest.\49\ CBOE contrasted the Original QCC Order with the rules of
all options exchanges relating to net-priced complex orders, which
require that each options leg(s) of the complex order trade at or
inside the NBBO and, at a minimum, price improve public customer orders
in at least one component options leg.\50\ CBOE also noted that, in a
stock-option order net-priced package, it has been the Commission
policy to require that the option leg of the stock-option order either
yield to the same priced public customer order represented in the
individual options series or trade at a better price.\51\ CBOE argued
that the Original QCC Order, in contrast, would be given special
priority that goes beyond the priority afforded to packaged stock-
option orders by permitting it to be crossed without giving priority to
public customers.\52\
---------------------------------------------------------------------------
\49\ See Petition for Review, supra note 22, at 15.
\50\ Id. at 18.
\51\ Id.
\52\ Id. at 19.
---------------------------------------------------------------------------
In response, ISE noted that there are many examples of exception to
rules to accommodate specific trading strategies.\53\ ISE further
argued that there is no basis under the Act to prevent exchanges from
adopting market structures and priority rules that are tailored for
large-size contingent orders and that customer priority is not required
in all circumstances.\54\
---------------------------------------------------------------------------
\53\ See ISE Statement 1, supra note 28, at 2, 5. For example,
ISE pointed to the existing rules of the options exchanges that
permit the execution of one leg of a complex trade at the same price
as a public customer order on the limit order book if another leg of
the order is executed at an improved price. See CBOE Rule 6.45A.
\54\ Id.
---------------------------------------------------------------------------
Commenters to the Original QCC Order also questioned whether the
customer involved in the QCC Order would be able to receive the best
price for its order because, without a requirement for the order to be
exposed, the submitting member's customer would not have the
opportunity to receive price improvement for the options leg of the
order.\55\ Specifically, CBOE expressed concern that, because the QCC
Order would eliminate the requirement of market exposure, the customer
whose order is submitted through the QCC Order mechanism might receive
a fill at a price that is inferior to the price the customer would have
received if the full package or even the options component had been
represented to the market.\56\
---------------------------------------------------------------------------
\55\ See CBOE Statement 1, supra note 29, at 7-8 and Petition
for Review, supra note 22, at 13. See also Bluefin Statement, supra
note 29; Group One Letter, supra note 26, at 1-2; and Integral
Derivatives Letter, supra note 26.
\56\ See CBOE Statement 1, supra note 29, at 7.
---------------------------------------------------------------------------
ISE responded to these concerns by explaining that, when
negotiating a stock-option order, market participants agree to a ``net
price,'' i.e., a price that reflects the total price of both the
options and stock legs of the transaction which are executed separately
in the options and equity markets.\57\ Accordingly, ISE believed that,
for such trades, the actual execution price of each component is not as
material to the parties to the trade as is the net price of the
transaction.\58\
---------------------------------------------------------------------------
\57\ See ISE Statement 1, supra note 28, at 2, 6.
\58\ See id.
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[[Page 11537]]
3. RiskFin Analysis of Large-Size Contingency Orders
In support of the Original QCC Order, ISE stated that its proposed
QCC Order provided an all-electronic alternative to the open-outcry
execution of large stock-option trades on floor-based exchanges. While
both all-electronic exchanges and floor-based exchanges have rules that
require exposure of an order before a member is permitted to trade with
such order, ISE believes that the requirement under ISE's rules is
significantly more onerous than the similar requirement of floor-based
exchanges, where such exchanges are only required to expose such orders
to their members on the floor and not electronically to all members.
Accordingly, ISE asserted, among other things, that it needed the QCC
Order to remain competitive with other exchanges, particularly floor-
based exchanges, because although these orders are exposed on the
floor-based exchanges, they are rarely broken up.\59\
---------------------------------------------------------------------------
\59\ See ISE Reply, supra note 25, at 5.
---------------------------------------------------------------------------
In order to examine ISE's contention with respect to activity on
floor-based exchanges regarding large-sized contingent trades, in
October 2009, the Commission's Division of Risk, Strategy and Financial
Innovation (``RiskFin'') requested Consolidated Options Audit Trail
System (``COATS'') data from certain options exchanges for each Tuesday
in August and September of 2009. On March 17, 2010, RiskFin placed in
the public file a memorandum analyzing the COATS data, in which it
presented the findings of its analysis of ISE's contention that large-
size contingency orders on floor-based exchanges were never or nearly
never broken up.\60\ The RiskFin Analysis provided some support for
ISE's contention that large orders are broken up less frequently on
floor-based exchanges than on an electronic exchange, though it did not
definitively confirm ISE's contention. Specifically, in examining the
percentage of trades that are either fully or near-fully executed
against a single contra-party, the RiskFin Analysis showed that, for
trades with a size of 2,000 contracts or more, only 12% were completely
executed with only one execution on ISE, compared to 26% and 29% of
trades that were filled with only one execution on two floor-based
exchanges. Similarly, the data also showed that for orders of 2,000
contacts or more, only 16% of orders on ISE were 90% filled against a
single contra-party, while the comparable figures for two floor-based
exchanges were 35% and 37%.
---------------------------------------------------------------------------
\60\ See Memorandum Regarding ISE Qualified Contingent Cross
Proposal from Division of Risk, Strategy and Financial Innovation,
dated March 1, 2010 (``RiskFin Analysis'') (available at https://www.sec.gov/rules/other/2010/sr-ise-2009-35/riskfinmemo030110.pdf).
The RiskFin Analysis reviewed COATS data from ISE, CBOE and Phlx.
---------------------------------------------------------------------------
While the RiskFin Analysis provided the percentage of orders on
each exchange that were filled in a single execution versus multiple
executions, the COATS data used for the analysis was not limited to
facilitation orders.\61\ Thus, the RiskFin Analysis was not dispositive
with respect to ISE's contention because it contained orders unrelated
to ISE's proposed order type. Concurrently with the placement of the
RiskFin Analysis in the public file, the Commission issued an order
extending the time to file a statement in support of or in opposition
to the Original Approval Order.\62\ Subsequently, the Commission
received three statements relating to the RiskFin Analysis.\63\
---------------------------------------------------------------------------
\61\ For example, ISE notes that the inclusion of index options
trading in the data distorts the extent to which there is ``break-
up'' of large crosses on the floor-based exchanges and believes that
excluding index options from the RiskFin Analysis would
significantly increase the number of floor-based exchanges' large
orders that were executed without break-up. See ISE Statement 3,
infra note 63, at 2-3.
\62\ See Commission Order Extending Time to File Statements,
dated March 17, 2010.
\63\ See Letters from Edward J. Joyce, President and Chief
Operating Officer, CBOE, to Elizabeth M. Murphy, Secretary,
Commission, dated April 7, 2010 (``CBOE Statement 3''); Pia K.
Bennett, Associate Corporate Secretary, NYSE Euronext, to Elizabeth
M. Murphy, Secretary, Commission, dated April 7, 2010 (``NYSE
Statement 2''); and Michael J. Simon, Secretary, ISE, to Elizabeth
M. Murphy, Secretary, Commission, dated April 7, 2010 (``ISE
Statement 3'').
---------------------------------------------------------------------------
Both CBOE and ISE focused on the RiskFin Analysis and noted that
the ``analysis did not confirm ISE's contention that large orders are
broken-up less frequently on floor-based exchanges, though certain data
did provide support for ISE's position.'' Although CBOE believed that
the conclusion was favorable to its opposing position on ISE's QCC
Order type, it clarified that it did not believe the study was
necessary and that the policy question of exposure and whether it would
benefit investors or not was the critical concern.\64\
---------------------------------------------------------------------------
\64\ See CBOE Statement 3, supra note 63, at 1 and 4.
---------------------------------------------------------------------------
Alternatively, ISE believed that the RiskFin Analysis conclusion
strongly supported ISE's position that the QCC Order type is an
appropriate and necessary competitive tool for the ISE.\65\ In support
of its belief, ISE noted that the most critical statistic in
determining whether exchange members can affect a trade without being
broken up is to look at how often large trades are executed in a single
execution. ISE points to the RiskFin Analysis data that demonstrates
that for the largest trades (2,000 or more contracts) only 12% of such
trades were executed without a break-up on the ISE, while the
percentages for the two floor-based exchanges were more than twice as
high.\66\
---------------------------------------------------------------------------
\65\ See ISE Statement 3, supra note 63, at 2.
\66\ Id. at 2.
---------------------------------------------------------------------------
Another commenter reiterated its concern that the proposed QCC
Order type creates a disincentive to competitively quote by limiting
price discovery opportunities and dampens transparency in the options
markets.\67\ In response to the RiskFin Analysis data, the commenter
stated that the crossing of two orders on or within the best bid or
offer of the options markets, with no interference from other
participants despite exposure to the market, indicated that the cross
was fairly priced as part of the off-exchange negotiation and that
without exposure, there is no such comfort that the best possible price
was obtained.\68\
---------------------------------------------------------------------------
\67\ See NYSE Statement 2, supra note 63, at 1.
\68\ Id. at 3.
---------------------------------------------------------------------------
4. Request To Vacate SR-ISE-2009-35 Original Approval Order
On July 14, 2010, concurrently with the filing of the current
proposal to modify the rules for QCC Orders (i.e., SR-ISE-2010-73), the
Commission received a letter from ISE requesting the Commission to
vacate the Original Approval Order concurrently with an approval of SR-
ISE-2010-73.\69\ Specifically, the Vacate Letter stated that ISE
submitted its current proposal to address the most significant issues
that commenters raised regarding the Original QCC Order.
---------------------------------------------------------------------------
\69\ See Letter from Michael J. Simon, Secretary, ISE, to
Elizabeth M. Murphy, Secretary, Commission, dated July 14, 2010
(``Vacate Letter'').
---------------------------------------------------------------------------
D. Description of Current Proposal To Modify QCC Order Rules
As noted above, among their objections to ISE's Original QCC Order,
CBOE and some commenters argued that public customers with limit orders
resting on ISE's book at the execution price of a QCC Order would be
harmed because the QCC Order would execute ahead of their resting
orders and that, because certain customer orders would not receive
priority, the proposal would create a disincentive to placing limit
orders.\70\ CBOE and some commenters also questioned whether the
customer involved in the QCC Order would be able to receive the best
price for its
[[Page 11538]]
order because, without a requirement for the order to be exposed, the
submitting member's customer would not have the opportunity to receive
price improvement for the options leg of the order.\71\
---------------------------------------------------------------------------
\70\ See, e.g., Petition for Review, supra note 22, at 13, 15,
17. See also Bluefin Statement, supra note 29; Phlx Letter, supra
note 26; Wolverine Letter, supra note 26; Group One Letter, supra
note 26, at 1; and Integral Derivatives Letter, supra note 26.
\71\ See, e.g., CBOE Statement 1, supra note 29, at 7-8 and
Petition for Review, supra note 22, at 13. See also Bluefin
Statement, supra note 29; Group One Letter, supra note 26, at 1-2;
and Integral Derivatives Letter, supra note 26.
---------------------------------------------------------------------------
Though ISE believes that there is nothing novel about granting or
not granting customer priority, that the Commission had approved
exchange rules that do not provide customer priority, and that there is
no statutory requirement that customer orders receive priority,\72\ in
SR-ISE-2010-73 the Exchange proposes to modify the Original QCC Order
rules to require that a QCC Order be automatically cancelled if there
are any Priority Customer \73\ orders on the Exchange's limit order
book at the same price. This modification thus prohibits QCC Orders
from trading ahead of Priority Customer orders. In addition, in SR-ISE-
2010-73, ISE proposes to increase the minimum size requirement for a
QCC Order from 500 contracts to 1,000 contracts. ISE contends that such
an increase supports the Exchange's intention to permit the crossing of
only large-sized institutional stock-option orders.\74\
---------------------------------------------------------------------------
\72\ See ISE Statement 1, supra note 28, at 4. See also Capstone
Statement, supra note 28, at 2.
\73\ Under ISE Rule 100(37A), a priority customer is 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).
Pursuant to ISE Rule 713, priority customer orders are executed
before other trading interest at the same price.
\74\ See Vacate Letter, supra note 69, at 1.
---------------------------------------------------------------------------
Thus, as modified, an ISE member effecting a trade pursuant to the
NMS QCT Exemption could cross the options leg of the trade on ISE as a
QCC Order immediately upon entry, without exposure, only if there are
no Priority Customer orders on the Exchange's limit order book at the
same price and if the order: (i) Is for at least 1,000 contracts; (ii)
meets the six requirements of the NMS QCT Exemption; \75\ and (iii) is
executed at a price at or between the NBBO (``Modified QCC
Order'').\76\ In the Notice, ISE stated that the modifications to the
Original QCC Order (i.e., to prevent the execution of a QCC if there is
a Priority Customer on its book and to increase the minimum size of a
QCC Order) remove the appearance that such orders are trading ahead of
Priority Customer orders or that the QCC Order could be used to
disadvantage retail customers.\77\
---------------------------------------------------------------------------
\75\ See supra notes 9 and 13 and accompanying text.
\76\ If there are Priority Customer orders on ISE's limit order
book at the same price, the QCC Order would be automatically
canceled. See proposed ISE Rule 721(b)(1).
\77\ See Notice, supra note 3.
---------------------------------------------------------------------------
E. Commenters to ISE's Modified QCC Order Proposal
The Commission received eight comment letters opposing ISE's
Modified QCC Order proposal and a response letter from ISE.\78\ While
some commenters noted that ISE had addressed their prior objections
relating to customer priority,\79\ commenters objected to ISE's
modified proposal because it remained unchanged from the original
proposal with respect to exposure, in that QCC Orders would still be
crossed without exposure.\80\ Commenters noted that exposure is
especially critical in the options market, which is quote-driven and
relies on market makers to ensure that two-sided quotations are
available for hundreds of thousands of different options series.\81\
Commenters argued that exposure, in addition to allowing for the
possibility of price improvement, provides market makers an opportunity
to participate in trades, which in turn provides them incentives to
quote aggressively, thus benefiting the market as a whole.\82\
---------------------------------------------------------------------------
\78\ See supra notes 4 and 5.
\79\ See CBOE Letter 1, supra note 4, at 1, NYSE Letter 2, supra
note 4, at 7, and Susquehanna Letter 2, supra note 4, at 1. See also
supra notes 44-54 and accompanying text.
\80\ See CBOE Letter 1, supra note 4, at 1; Phlx Letter 2, supra
note 4, at 1; LiquidPoint Letter 2, supra note 4, at 1-2; Group One
Letter 2, supra note 4, at 1; NYSE Letter 2, supra note 4, at 1-2,
7-8; and Susquehanna Letter 2, supra note 4, at 1.
\81\ See CBOE Letter 1, supra note 4, at 1-2; Phlx Letter 2,
supra note 4, at 1; LiquidPoint Letter 2, supra note 4, at 1, 2;
Group One Letter 2, supra note 4, at 2; NYSE Letter 2, supra note 4,
at 3, 7-8; NYSE Letter 3, supra note 4, at 2; and Susquehanna Letter
2, supra note 4, at 3.
\82\ See CBOE Letter 1, supra note 4, at 2-3 and Phlx Letter 2,
supra note 4, at 1. See also Cutler Letter, supra note 4 (stating
that without exposure, there is no incentive for market makers to
display liquidity, provide liquidity or offer price improvement) and
LiquidPoint Letter 2, supra note 4, at 2 (stating that if market
makers are not able to participate in all price discovery
opportunities, they would be left to participate in only price
discovery opportunities that are less-desirable and that the result
of this negative selection would be ``increased risk, a higher
probability of unprofitable trades and a reticence to post their
best markets. See also Group One Letter 2, supra note 4, at 2; NYSE
Letter 2, supra note 4, at 2, 3; and Susquehanna Letter 2, supra
note 4, at 3.
---------------------------------------------------------------------------
Relatedly, several commenters warned against removing incentives
for liquidity providers in light of the market events of May 6,
2010.\83\ One commenter noted that any tightening of market maker
obligations could only succeed if market maker benefits were
correspondingly aligned, and argued that ISE's proposal would withdraw
significant options order flow and, thus, the opportunity for market
makers to interact with that order flow via exposure.\84\
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\83\ See CBOE Letter 1, supra note 4, at 1, 3-4; Group One
Letter 2, supra note 4, at 2; and NYSE Letter 2, supra note 4, at 2.
\84\ See CBOE Letter 1, supra note 4, at 3.
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In addition, CBOE stated that order exposure and the opportunity
for market participant interaction was integrally related to what
constitutes an exchange and stressed that the Commission should not
abandon such long-held standards to permit ``print'' mechanisms on
options exchanges, which it believed the ISE proposal to be.\85\ CBOE
and NYSE also noted that the Commission has generally not permitted
100% participation guarantees, as the QCC Order would provide for.\86\
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\85\ See CBOE Letter 1, supra note 4, at 3, 5.
\86\ See NYSE Letter 2, supra note 4, at 3; NYSE Letter 3, supra
note 4, at 1-2; and CBOE Letter 1, supra note 4, at 2.
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CBOE also noted that the component legs of stock-option orders are
exposed on options exchanges as a package (e.g., through complex order
mechanisms) with all terms of the complete order being transparent to
the marketplace.\87\ This commenter noted that such stock-option
orders, while still requiring exposure, are granted intermarket trade-
through relief. In contrast, this commenter saw no reason why QCC
Orders should receive any special treatment (i.e., not be required to
be exposed) and noted that they are not represented as a package and
thus do not provide the same transparency as stock-option orders, with
only upstairs parties to these trades aware of the complete terms of
the total transaction.\88\ In response, ISE reiterated its belief that
the crossing of large-size contingency orders on a floor today is not
transparent because ``there are very few traders (if any) on the floor
to hear an order `announced''' and are executed with little, if any.
interruption.\89\ ISE stated that commenters opposed to its proposal
were arguing about the theoretical benefits of exposure and ignoring
the realities of what is occurring in the markets.\90\ Further, ISE
stated that, currently, members arrange large stock-option trades
upstairs and then bring them to an exchange for execution. Floor
exchanges, ISE argued, accommodate these trades by providing a market
structure where there is little
[[Page 11539]]
or no chance that members will break up the pre-arranged trade.\91\
Another commenter believed that splitting a stock-option order into
separate executions for the individual stock and options legs, rather
than representing the stock-option order as a package, was generally
not in the best interest of the customer from a best execution point of
view.\92\
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\87\ See CBOE Letter 1, supra note 4, at 4-5. See also NYSE
Letter 2, supra note 4, at 4.
\88\ See CBOE Letter 1, supra note 4, at 4-5. See also Cutler
Letter, supra note 4; and NYSE Letter 2, supra note 4, at 4.
\89\ See ISE Statement 1, supra note 28, at 3.
\90\ See ISE Response, supra note 5, at 2.
\91\ Id.
\92\ See Susquehanna Letter 2, supra note 4, at 4-5.
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Another commenter reiterated its belief that the benefits of price
discovery and transparency afforded by exposure were especially crucial
for broker facilitated crosses such as QCC Orders because of the
inherent conflict of interest for such orders since a broker is
``betting against the customer'' in such trades.\93\ Commenters also
contended that ISE's claim that it needed the QCC Order to compete with
trading on floor-based exchanges is erroneous and disingenuous, and
that it ignored the broader ramification of QCC Orders that, whereas
trading floors require exposure of orders before any executions can
occur, the QCC Order would ensure that exposure was eliminated
altogether.\94\
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\93\ See Group One Letter 2, supra note 4, at 1-2. See also
supra note 55 and accompanying text.
\94\ See CBOE Letter 1, supra note 4, at 4-5. See also NYSE
Letter 2, supra note 4, at 3-4 and NYSE Letter 3, supra note 4, at
2.
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With respect to the increase in contract size for QCC Orders from
500 contracts (as originally proposed in SR-ISE-2009-35) to 1,000
contracts, NYSE questioned whether the change was meaningful in
limiting the scope of the proposed QCC Order type, as it believed that
market participants could game the rule to meet this requirement,\95\
while another commenter believed that the 1,000 contract requirement
was a relatively low threshold that would permit large broker-dealers
to shut out other market participants on relatively small trades.\96\
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\95\ See NYSE Letter 2, supra note 4, at 5-7 and NYSE Letter 3,
supra note 4, at 3.
\96\ See Cutler Letter, supra note 4.
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In its response letter, ISE reiterated its argument that its QCC
Order proposals were simply a way for ISE to compete against floor-
based options exchanges for the execution of large stock-option
orders.\97\ ISE countered commenters' arguments regarding the lack of
exposure of QCC Orders by stating that the required exposure of orders
on floor-based exchanges was nominal and theoretical, and ignores the
realities of what is occurring on those markets.\98\ One commenter
agreed with ISE's assertion that floor-based options exchanges enjoy an
unfair competitive advantage over all-electronic options exchanges for
executing clean blocks, noting that, in its own experience,
``institutional brokers are much more apt to use a trading floor when
the primary intention is to execute as clean a cross as possible.''
\99\ ISE stated its belief that floor-based options markets accommodate
such trades by ``providing a market structure in which there is little
or no chance that members will break up the pre-arranged trade'' by
structuring their markets to provide such trades with the least amount
of ``friction.'' \100\ ISE contended that, if floor-based exchanges
were serious about exposure, they would expose such orders to their
entire marketplace, rather than limiting exposure to ``those few (if
any) members physically present in the floor-based trading crowd.''
\101\ One commenter echoed ISE's contention and suggested that a common
rule for all block crosses on all options exchanges should be adopted
to require all pre-negotiated option block crosses, including floor
crosses, to be entered into an electronic crossing mechanism. This
commenter believed that such a requirement would ensure that market
makers could compete for such orders and thus provide the orders a
greater chance at price improvement, as well as act as a check to
ensure that the brokers facilitating these orders priced them
competitively.\102\
---------------------------------------------------------------------------
\97\ See ISE Response, supra note 5, at 1-2.
\98\ Id. at 2.
\99\ See Susquehanna Letter 2, supra note 4, at 2.
\100\ Id.
\101\ Id.
\102\ See Susquehanna Letter 2, supra note 4, at 2.
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ISE also countered commenters' arguments that the QCC Order
proposal, because it does not provide for exposure, would not allow for
price improvement by reiterating its prior explanation that those
parties involved in a stock-option order negotiate such transactions on
a ``net price'' basis, reflecting the total price of both the stock and
options legs of the trade. Thus, ISE argued, the actual execution price
of each individual component is not as material to the parties involved
as is the net price of the entire transaction, which ISE believes means
that price improvement of the individual legs of the trade is not a
critical issue in the execution of a QCC Order.\103\
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\103\ See ISE Response, supra note 5, at 3-4.
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In addition, ISE argued that its QCC Order proposal has no
relevance to the market events of May 6, 2010, despite commenters'
attempts to link the two. ISE again noted that large stock-options
trades are currently arranged upstairs and then shopped among exchanges
to achieve a clean cross.\104\ ISE argued that, accordingly, large
stock-option trades today ``rely on the liquidity that firms can
provide in arranging these trades and do not now include exchange-
provided liquidity.'' \105\ ISE believed that the QCC Order type would
simply provide a competitive electronic vehicle for such trades and
will have no effect on available liquidity.\106\
---------------------------------------------------------------------------
\104\ See ISE Response, supra note 5, at 4.
\105\ Id.
\106\ Id.
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In response to NYSE's contention that the QCC Order's contract size
requirement could be gamed, ISE noted that any member creating ``fake
customer orders'' would be misrepresenting its order in violation of
ISE's rules and expressed confidence that its surveillance program
would be able to catch any such attempt.\107\ In addition, ISE
clarified the calculation of the 1,000 contract minimum size for a QCC
Order noting that, in order to meet this requirement, an order must be
for at least 1,000 contracts and could not be, for example, two 500
contract orders or two 500 contract legs.\108\
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\107\ Id. at 5-6.
\108\ Id. at 6.
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III. Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities exchange
and, in particular, with Section 6(b) of the Act.\109\ Specifically,
the Commission finds that the proposal is consistent with Sections
6(b)(5) \110\ and 6(b)(8),\111\ which require, among other things, that
the rules of a national securities exchange be designed to promote just
and equitable principles of trade, to remove impediments to and perfect
the mechanism of a free and open market and a national market system,
and, in general, to protect investors and the public interest and that
the rules of an exchange do not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act. In
addition, the Commission finds that the proposed rule change is
consistent with Section 11A(a)(1)(C) of the Act,\112\ in which Congress
found that it is in the public
[[Page 11540]]
interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to assure, among other things,
the economically efficient execution of securities transactions.
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\109\ 15 U.S.C. 78f(b). In approving this proposed rule change,
the Commission has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
\110\ 15 U.S.C. 78f(b)(5).
\111\ 15 U.S.C. 78f(b)(8).
\112\ 15 U.S.C. 78k-1(a)(1)(C).
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A. Consistency With the NMS QCT Exemption
In approving the Original QCT Exemption, the Commission recognized
that contingent trades can be ``useful trading tools for investors and
other market participants, particularly those who trade the securities
of issuers involved in mergers, different classes of shares of the same
issuer, convertible securities, and equity derivatives such as options
[italics added].'' \113\ The Commission stated that ``[t]hose who
engage in contingent trades can benefit the market as a whole by
studying the relationships between the prices of such securities and
executing contingent trades when they believe such relationships are
out of line with what they believe to be fair value.'' \114\ As such,
the Commission stated that transactions that meet the specified
requirements of the NMS QCT Exemption could be of benefit to the market
as a whole, contributing to the efficient functioning of the securities
markets and the price discovery process.\115\
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\113\ See Original QCT Exemption, supra note 9, at 52830.
\114\ Id. at 52831.
\115\ See CBOE QCT Exemption, supra note 13.
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The parties to a contingent trade are focused on the spread or
ratio between the transaction prices for each of the component
instruments (i.e., the net price of the entire contingent trade),
rather than on the absolute price of any single component.\116\
Pursuant to the requirements of the NMS QCT Exemption, the spread or
ratio between the relevant instruments must be determined at the time
the order is placed, and this spread or ratio stands regardless of the
market prices of the individual orders at their time of execution. As
the Commission noted in the Original QCT Exemption, ``the difficulty of
maintaining a hedge, and the risk of falling out of hedge, could
dissuade participants from engaging in contingent trades, or at least
raise the cost of such trades.'' \117\ Thus, the Commission found that,
if each stock leg of a qualified contingent trade were required to meet
the trade-through provisions of Rule 611 of Regulation NMS, such trades
could become too risky and costly to be employed successfully and noted
that the elimination or reduction of this trading strategy potentially
could remove liquidity from the market.\118\
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\116\ See Original QCT Exemption, supra note 9, at 52829
(explaining SIA's position on the need for the Original QCT
Exemption).
\117\ Id. at 52831.
\118\ Id.
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The Commission believes that ISE's proposal, which would permit a
clean cross of the options leg of a subset of qualified contingent
trades (i.e., a stock-option qualified contingent trade that meets the
requirements of the NMS QCT Exemption), is appropriate and consistent
with the Act in that it would facilitate the execution of qualified
contingent trades, for which the Commission found in the Original QCT
Exemption to be of benefit to the market as a whole, contributing to
the efficient functioning of the securities markets and the price
discovery process.\119\ The QCC Order would provide assurance to
parties to stock-option qualified contingent trades that their hedge
would be maintained by allowing the options component to be executed as
a clean cross.
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\119\ Id.
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B. Exposure and Qualified Contingent Trades
Commenters believed that ISE's modifications to the Original QCC
Order did not adequately address their main objection regarding the QCC
Order, particularly in that it would continue to permit option crosses
to occur without prior exposure to the marketplace. Commenters
generally reiterated their prior comments that exposing options orders
promotes price competition, increases order interaction, and leads to
better quality executions for investors by providing opportunities for
price improvement.\120\ These commenters continued to argue that,
without exposure, the Modified QCC Order would cause significant harm
to the options market because it would eliminate valuable incentive for
dedicated liquidity provider participation.\121\
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\120\ See supra notes 70 and 85-94 and accompanying text.
\121\ See supra notes 81-84 and accompanying text.
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In response to commenters' concerns that the Modified QCC Order
would have a detrimental effect on the options markets because of the
lack of any exposure requirement, ISE stated that exchange members
arrange large stock-option trades upstairs and then bring them to an
exchange for execution, and that exchange floors accommodate the trades
by providing a market structure in which there is little or no chance
that members will break up the pre-arranged trade.\122\ ISE believed
that, rather than harming the options markets, the QCC proposal would
permit fair competition to occur between floor-based and all-electronic
options exchanges by providing an all-electronic execution alternative
to floor-based executions.\123\
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\122\ See supra notes 97-100 and accompanying t
