[Federal Register Volume 79, Number 193 (Monday, October 6, 2014)]
[Notices]
[Pages 60226-60228]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-23701]
[[Page 60226]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-73261; File No. SR-ISE-2014-43]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of Proposed Rule Change Amending Its Information
Barrier Rules
September 30, 2014.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on September 15, 2014, the International Securities Exchange, LLC
(the ``Exchange'' or the ``ISE'') filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change, as
described in Items I and II below, which items have been prepared by
the self-regulatory organization. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The International Securities Exchange, LLC (the ``Exchange'' or the
``ISE'') is proposing to amend its Rules 810 (Limitations on Dealings)
and 717 (Limitations on Orders). The text of the proposed rule change
is available on the Exchange's Web site (http://www.ise.com), at the
principal office of the Exchange, and at the Commission's Public
Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of, and basis for, the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in sections A, B and C below, of the
most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange is proposing to amend its Rules 810 (Limitations on
Dealings) and 717 (Limitations on Orders) governing information
barriers. Specifically, the Exchange is proposing to amend the portion
of the rules that address the limitation on the flow of information
between a member's Electronic Access Member (``EAM'') unit, which
handles the customer/agency side of the business, and its affiliated
Primary Market Maker (``PMM'') and/or Competitive Market Maker
(``CMM'') (jointly, ``market makers'') unit, which handles the
proprietary side of the business.
ISE adopted its Rule 810 (Limitations on Dealings) on February 24,
2000 \3\ and over the years, the Exchange has frequently been asked by
its members to provide guidance as to what information can be shared
between an EAM and its affiliated market maker business under Rule
810.\4\ The Exchange's position on this issue has always been that the
information barrier between the EAM unit and its affiliated market
maker unit must restrict the flow of information in both directions. As
so interpreted, (i) the EAM unit cannot know where and at what price
its affiliated market makers are quoting and, therefore, cannot use
that information to influence their routing decisions, and (ii) the
market makers cannot know what customer orders its affiliated EAMs are
handling as agent and, therefore, cannot use that information to
influence their quotations.
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\3\ See Securities Exchange Act Release No. 34-4255 [sic]; File
No. 10-127 (February 24, 2000).
\4\ Rule 810 currently permits market makers to provide its
affiliated EAM, upon request, the same general quotation information
that it would provide to an unaffiliated entity. The intent of that
provision was an attempt in 2000 to replicate a floor-based market,
in which a broker could ask a floor-based specialist general
information on the market.
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The Exchange is now proposing to amend its Rule 810 to allow EAMs
to know where and at what price its affiliated market makers are either
quoting or have orders on the order book \5\ and to use that
information to influence their routing decisions. As such, an EAM may
route an order that it is handling on an agency basis to the ISE where
its affiliated market maker is either quoting or has an order on the
order book so that the two orders immediately interact. The Exchange
posits that these such members, in the context of risk management \6\
and consistent with the protections against the misuse of material
nonpublic information,\7\ should be able to consider the outstanding
quotes of their affiliated marker maker units for the purposes of
calculating net positions and making routing decisions to increase the
member's interaction rate between its EAM unit and affiliated market
making unit(s). Further, the Exchange asserts that a member should be
able to integrate its market makers' positions and quoting information
with its EAM unit(s) because this proposal, in tandem with existing ISE
conduct rules,\8\ ISE's review and approval of the information barrier
procedures submitted by market makers that will be conducting Other
Business Activities,\9\ ISE's ongoing surveillances for manipulative
conduct, and FINRA's exam program that reviews such members compliance
with such policies and procedures, should provide a regulatory
framework that guards customer interests and protects against the
misuse of material nonpublic information, while increasing the
operational flexibility of ISE members.
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\5\ According to Rule 805(b)(1)(i) and (ii) market makers may
only have orders on the order book in option classes to which they
are not appointed.
\6\ See, e.g., 17 CFR Part 240.15c3-5 (Risk Management Controls
for Brokers or Dealers with Market Access).
\7\ See, e.g., 15 U.S.C. 78o(g). Section 15(g) of the Securities
and Exchange Act of 1934 (the ``Act'') requires every broker or
dealer to ``establish, maintain, and enforce written policies and
procedures reasonably designed, taking into consideration the nature
of such broker's or dealer's business, to prevent the misuse . . .
of material, nonpublic information by such broker or dealer or any
person associated with such broker or dealer.''
\8\ See, e.g., ISE Rules 400 (Just and Equitable Principles of
Trade), 401 (Adherence to Law), 405 (Manipulation), 408 (Prevention
of the Misuse of Material, Nonpublic Information) and 713 (Priority
of Quotes and Orders).
\9\ ISE Rule 810 defines ``Other Business Activities'' as
meaning, (1) conducting an investment or banking or public
securities business; (2) making markets in the stocks underlying the
options in which it makes markets; (3) handling listed options
orders as agent on behalf of Public Customers or broker-dealers; or
(4) conducting non-market making proprietary listed options trading
activities.
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ISE Rule 717(d) and (e) requires members to expose certain orders
entered on the limit order book for at least one second before
executing them as principal or against orders that were solicited from
other broker-dealers. This requirement applies when the EAM is handling
both sides of a trade and not when an EAM is handling a marketable
order as agent and is routing that order to execute against a quote/
order resting on the order book. Accordingly, when customer order(s)
that an EAM is handling as agent executes against an affiliated market
maker's quote or order, it appears as though the EAM was in fact
handling both sides of the trade, and did not comply with the order
exposure requirements of ISE Rule 717(d) and (e). However, because the
Exchange does not publicly identify the member that entered an order on
the limit order book, orders from the same
[[Page 60227]]
firm may inadvertently execute against each other as a result of being
entered by disparate persons and/or systems at the same member firm.
Therefore, when enforcing Rule 717(d) and (e), the Exchange has never
considered the inadvertent interaction of orders from the same firm
within one second to be a violation of the exposure requirement.
On September 20, 2011 the Exchange codified this longstanding
policy in Supplementary Material .06 to Rule 717,\10\ which currently
specifies that members can demonstrate that orders were entered without
knowledge of a pre-existing order on the book represented by the same
firm by providing evidence that effective information barriers between
the persons, business units and/or systems entering the orders onto the
Exchange were in existence at the time the orders were entered.\11\
This rule requires that such information barriers be fully documented
and provided to the Exchange upon request.\12\
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\10\ See Securities Exchange Act Release No. 65361 (September
20, 2011), 76 FR 59472 (September 26, 2011) (SR-ISE-2011-42).
\11\ The Exchange conducts routine surveillance to identify
instances when an order on the limit order book is executed against
an order entered by the same firm within one second.
\12\ The Exchange reviews information barrier documentation to
evaluate whether a member has implemented processes that are
reasonably designed to prevent the flow of pre-trade order
information given the particular structure of the member firm.
Additionally, information barriers are reviewed as part of the
Exchange's examination program, which is administered by the
Financial Industry Regulatory Authority (``FINRA'') pursuant to a
regulatory services agreement.
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Given the proposed change to ISE Rule 810, the Exchange is also
proposing to make a corresponding change to Supplementary Material .06
to Rule 717 to specify that orders from the same member's EAM unit and
its affiliated PMM and/or CMM unit may interact within one second
without being a violation of the order exposure requirement of
paragraph (d) and (e) of Rule 717 when the firm can demonstrate that
the customer order that it routed was marketable, the EAM was not
handling the affiliated market maker quote/order and the affiliated
market maker quote/order was in existence at the time the customer
order(s) were entered into the ISE's system.
The Exchange believes that adopting these rule changes will allow
for the Exchange to provide its membership with increased operational
flexibility while keeping intact the original purpose of the rule,
which was intended to prevent market makers from using customer order
flow information to influence their quotations. The Exchange believes
that allowing information to flow from the market maker to the EAM
would not comprise the integrity of our market, nor would it introduce
customer harm, as discussed in more detail above. Additionally, the
Exchange believes that market quality will not be eroded due to these
changes because the information barrier preventing the flow of
information from the EAM to its' affiliated market maker remains
unchanged, meaning, market makers will continue to be unable to adjust
their quotes either to intercept or avoid orders since that side of the
barrier remains in force.
2. Statutory Basis
The basis under the Act for this proposed rule change is the
requirement under Section 6(b),\13\ in general, and Section 6(b)(5)
\14\ in particular, that an exchange have rules that are designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to remove impediments to and perfect
the mechanism for a free and open market and a national market system,
and, in general, to protect investors and the public interest. In
particular, the Exchange believes that amending its rules to allow
information to flow from the market maker to the EAM would not comprise
the integrity of the market as the information barrier preventing the
flow of information from the EAM to its affiliated market maker remains
unchanged. Meaning, a market maker cannot be privy to nonpublic
information about incoming customer orders and adjust their quotations
in response. The Exchange also believes that this rule change will not
introduce customer harm as this change does not impact the order
protection rules applicable to an EAM handling an order as agent,\15\
but rather allows the EAM to route to a specific destination to
interact with its affiliated market makers' quotations or orders in the
same manner that the EAM would route orders to access quotes and orders
of market makers that it is not affiliated with. In addition, members
will continue to be subject to federal and Exchange requirements for
protecting material nonpublic order information.\16\
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\13\ 15 U.S.C. 78f(b).
\14\ 15 U.S.C. 78f(b)(5).
\15\ See note 7.
\16\ See 15 U.S.C. 78o(g) and ISE Rule 408.
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Additionally, the Exchange notes that the rule will still require
that member organizations maintain and enforce policies and procedures
reasonably designed to ensure compliance with applicable federal
securities laws and regulations and with Exchange rules. Such written
policies and procedures will continue to be subject to oversight by the
Exchange and therefore allowing information to flow from the market
makers to their affiliated EAMs should not reduce the effectiveness of
the Exchange rules to protect against the misuse of material nonpublic
information. Rather the Exchange believes that a member should be able
to integrate its market makers' positions and quoting information with
its EAM unit(s) because this proposal, in tandem with existing ISE
conduct rules,\17\ ISE's review and approval of the information barrier
procedures submitted by market makers that will be conducting Other
Business Activities, ISE's ongoing surveillances for manipulative
conduct, and FINRA's exam program that reviews such members compliance
with such policies and procedures, should provide a regulatory
framework that guards customer interests and protects against the
misuse of material nonpublic information. The proposed changes do not
alter a member's best execution duty to get the best price for its
customer and, therefore, the Exchange does not believe that the
proposed changes provided any advantage or disadvantage to customers or
the markets in general.
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\17\ See note 7.
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act. However, the Exchange
believes that Rule 810 currently imposes a burden on competition for
the Exchange because it requires market makers that engage in Other
Business Activities to operate in a manner that the Exchange believes
is more restrictive than necessary for the protection of investors to
the public interest. The Exchange believes that the proposed rule
change is pro-competitive because it is consistent with how other
national securities exchanges are currently interpreting their rules
and should provide greater flexibility to allow member firms to make
routing decisions based on the same information across multiple
markets.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
The Exchange has not solicited, and does not intend to solicit,
comments on this proposed rule change. The Exchange has not received
any
[[Page 60228]]
unsolicited written comments from members or other interested parties.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the publication date of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(a) By order approve or disapprove such proposed rule change, or
(b) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. The Commission requests comments, in
particular, on the following:
1. If the proposed rule change is approved, an EAM will be able to
know where and at what price its affiliated market makers are either
quoting or have orders on the order book and to use that information to
influence its routing decisions. Do commenters agree with the
Exchange's assertion that the proposed rule change will not introduce
customer harm, as this change does not impact the order protection
rules applicable to an EAM handling an order as agent? Do commenters
have a view on whether permitting EAMs to make routing decisions, based
on knowledge of an affiliated market maker's quotes, would impact the
execution quality and handling of customer orders? Please explain.
2. Given that EAMs must maintain policies and procedures that are
reasonably designed to ensure against the misuse of material, nonpublic
information pursuant to ISE Rule 408, do commenters have any views
regarding a proposed rule that would permit an EAM to have non-public
information about where and at what price its affiliated market maker
is either quoting or has orders on the order book?
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an Email to [email protected]. Please include
File No. SR-ISE-2014-43 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-ISE-2014-43. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commissions Internet Web site (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street, NE., Washington,
DC 20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing also will be available for inspection
and copying at the principal office of the ISE. All comments received
will be posted without change; the Commission does not edit personal
identifying information from submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-ISE-2014-43 and should be submitted by
October 27, 2014.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-23701 Filed 10-3-14; 8:45 am]
BILLING CODE 8011-01-P