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]

Download as PDF 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). VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 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 E:\FR\FM\02MRN1.SGM 02MRN1 11534 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices This order approves the proposed rule change. II. Background emcdonald on DSK2BSOYB1PROD with NOTICES 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 VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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). PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 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. E:\FR\FM\02MRN1.SGM 02MRN1 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices emcdonald on DSK2BSOYB1PROD with NOTICES 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. VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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 PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 11535 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. E:\FR\FM\02MRN1.SGM 02MRN1 11536 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices emcdonald on DSK2BSOYB1PROD with NOTICES 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. VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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 PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 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 E:\FR\FM\02MRN1.SGM 02MRN1 emcdonald on DSK2BSOYB1PROD with NOTICES Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices 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 http:// 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 VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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. PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 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 E:\FR\FM\02MRN1.SGM 02MRN1 11538 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices emcdonald on DSK2BSOYB1PROD with NOTICES 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). VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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 PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 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 E:\FR\FM\02MRN1.SGM 02MRN1 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices 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– emcdonald on DSK2BSOYB1PROD with NOTICES 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. VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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 PO 00000 Susquehanna Letter 2, supra note 4, at 2. ISE Response, supra note 5, at 3–4. Frm 00116 Fmt 4703 Sfmt 4703 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. E:\FR\FM\02MRN1.SGM 02MRN1 11540 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices emcdonald on DSK2BSOYB1PROD with NOTICES 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. VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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. PO 00000 Frm 00117 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, E:\FR\FM\02MRN1.SGM 02MRN1 Federal Register / Vol. 76, No. 41 / Wednesday, March 2, 2011 / Notices emcdonald on DSK2BSOYB1PROD with NOTICES 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. VerDate Mar<15>2010 16:34 Mar 01, 2011 Jkt 223001 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 Frm 00118 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 E:\FR\FM\02MRN1.SGM 02MRN1

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]


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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.
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    \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'').
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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.
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    \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.
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    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).
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    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\
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    \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.''
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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.
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    \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.
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    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\
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    \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.

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

[[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 http://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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \103\ See ISE Response, supra note 5, at 3-4.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \107\ Id. at 5-6.
    \108\ Id. at 6.
---------------------------------------------------------------------------

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