[Federal Register Volume 80, Number 3 (Tuesday, January 6, 2015)]
[Notices]
[Pages 583-585]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-30979]
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SECURITIES AND EXCHANGE COMMISSION
Release No. 34-73973; File No. SR-ISE-2014-43]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Order Instituting Proceedings To Determine Whether To Approve or
Disapprove a Proposed Rule Change Amending its Information Barrier
Rules
December 31, 2014.
I. Introduction
On September 15, 2014, International Securities Exchange, LLC
(``Exchange'' or ``ISE'') 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 amending its information barrier
rules. The proposed rule change was published for comment in the
Federal Register on October 6, 2014.\3\ On November 17, 2014, the
Commission extended the time period in which to either approve the
Proposal, disapprove the Proposal, or institute proceedings to
determine whether to approve or disapprove the proposed rule change to
January 2, 2015.\4\ The Commission received one comment letter
regarding the proposed rule change \5\ and one response letter from
ISE.\6\ This order institutes proceedings under Section 19(b)(2)(B) of
the Act \7\ to determine whether to approve or disapprove 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. 73261 (September 30,
2014), 79 FR 60226 (``Notice'').
\4\ See Securities Exchange Act Release No. 73614 (November 17,
2014), 79 FR 69547 (November 21, 2014).
\5\ See Letter from John Kinahan, Chief Executive Officer, Group
One Trading, L.P., dated October 27, 2014 (``Group One Letter'').
\6\ See Letter from Michael J. Simon, Secretary and General
Counsel, International Securities Exchange, LLC, dated November 14,
2014 (``ISE Response Letter'').
\7\ 15 U.S.C. 78s(b)(2)(B).
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[[Page 584]]
II. Description of the Proposal
The Exchange proposes to amend ISE Rules 810 (Limitations on
Dealings) and 717 (Limitations on Orders) governing information
barriers. Specifically, the Exchange proposes to amend Rule 810 to
permit information to flow to a member's Electronic Access Member
(``EAM'') unit, which handles the customer/agency side of the business,
from its affiliated Primary Market Maker (``PMM'') and/or Competitive
Market Maker (``CMM'') (jointly, ``market makers'') unit. As amended,
ISE Rule 810 will allow EAMs to know where, and at what price, their
affiliated market makers are either quoting or have orders on the order
book \8\ and to use that information to influence routing decisions.
The Exchange represents that it currently provides guidance to its
members that ISE Rule 810 is to be interpreted as a two-way information
barrier between the EAM unit and its affiliated market maker unit.\9\
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\8\ According to ISE Rule 805(b)(1)(ii), market makers may only
have orders on the order book in option classes to which they are
not appointed.
\9\ See Notice, supra note 3, 79 FR at 60226.
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The Exchange also proposes to amend ISE Rule 717, Supplementary
Material .06 to specify that the orders of a EAM unit and its
affiliated PMM and/or CMM unit may interact within one second without
violating the ISE Rule 717(d) and (e) order exposure requirements when
the firm can demonstrate that: (1) The customer order was marketable
when routed; (2) the EAM was not handling the affiliated market maker
quote/order; and (3) the affiliated market maker quote/order was in
existence at the time the customer order(s) were entered into the ISE
system. In combination, the proposed amendments to ISE Rules 810 and
717 will make it possible for an EAM to route a customer order to the
ISE to immediately interact with the quote or an order of an affiliated
market maker, but only subject to the conditions stated above.
III. Comment Letter and ISE's Response
As noted above, the Commission received one comment letter \10\
opposing the proposed rule change.\11\ The commenter asserts that the
proposed one-way information barrier would introduce a conflict of
interest which could result in EAMs routing orders based on self-
interest as opposed to the customer's interest.\12\ The commenter
disagrees with the Exchange's premise that the proposal would not
compromise market integrity or cause customer harm.\13\ The commenter
also indicates that although other exchanges may interpret their rules
to permit the sharing of information between the various units of a
firm, such sharing only weakens a customer's chance of best execution.
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\10\ See Group One Letter, supra note 5.
\11\ See ISE Response Letter, supra note 6.
\12\ See Group One Letter at 1, supra note 5.
\13\ Id.
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The commenter believes there are two specific scenarios where a
costumer may be harmed under this proposed rule change. First, the
commenter states that EAMs could route customer orders to an affiliated
market maker's quote at an exchange's best bid or offer rather than to
an exchange with a better fill rate or price improvement mechanism.\14\
Second, the commenter argues that an EAM holding a large customer order
that could influence the price in the underlying could opt to route
away from the quote of its affiliated market maker to avoid the
potential risk of the trade and deprive the customer of a fill they
were otherwise entitled to.\15\
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\14\ Id.
\15\ Id. at 2.
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The commenter indicates that these routing scenarios are not ``mere
conjecture'' as broker-dealers ``openly admit'' that numerous factors
are built into routing decisions that are primarily beneficial to
broker-dealers.\16\ The commenter also notes that there are litigation
and academic studies that suggest that routing decisions are negatively
impacted by conflicts of interest. The commenter believes that the
erosion of information barriers would increase the likelihood that
customer orders are routed based on the firm's best interest as opposed
to duty of best execution owed to the customer.\17\ The commenter
concludes that two-way information barriers are the ``only way to truly
guard customer interests and protect against the misuse of material
non-public information,'' and a shift to a one-way information barrier
would not provide any benefits EAM customers.\18\ The commenter also
believes that exchange rules should be written and interpreted in a way
that prevents conflicts of interest from ever arising, and a two-way
information barrier takes the potential conflict of interest out of the
equation.\19\
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\16\ Id.
\17\ Id.
\18\ Id.
\19\ Id.
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The ISE responds that the commenter did not raise any new issues
and its concerns were addressed in the Notice. \20\ The ISE states that
nothing in the proposed rule change would relieve members of their best
execution obligation to obtain the most favorable terms reasonably
available for customer orders.\21\ The Exchange notes that, as a
national securities exchange, it has a comprehensive surveillance
program to monitor member compliance with applicable securities and
regulations, including best execution.\22\ ISE also represents that it
would continue to monitor for abnormalities in interaction rates
between members, and investigate and take appropriate regulatory action
against members that fail to comply with their best execution
obligations.\23\ ISE believes that its surveillance tools will allow it
to fulfill its regulatory responsibilities.\24\ ISE also suggests that
the filing is a competitive imperative as other options exchanges
currently interpret their information barrier rules to be one way
barriers that permit members to make routing decisions based on the
quotes and orders of affiliated business units.\25\
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\20\ See ISE Response Letter at 1, supra note 6.
\21\ Id.
\22\ Id.
\23\ Id.
\24\ Id.
\25\ Id. at 2.
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IV. Proceedings To Determine Whether To Approve or Disapprove SR-ISE-
2014-43 and Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act \26\ to determine whether the proposed rule
change should be approved or disapproved.\27\ Institution of such
proceedings is appropriate at this time in view of the legal and policy
issues that are raised by the proposal and are discussed below.
Institution of proceedings does not indicate that the Commission has
reached any conclusions with respect to any of the issues involved.
Rather, as described in greater detail below, the Commission seeks and
encourages interested persons to comment on the proposal, including the
comments received and the Exchange's response, and provide the
Commission with additional comment to inform the Commission's analysis
whether to approve or disapprove the proposed rule change.
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\26\ 15 U.S.C. 78s(b)(2)(B).
\27\ Section 19(b)(2)(B) of the Act provides that proceedings to
determine whether to disapprove a proposed rule change must be
concluded within 180 days of the date of publication of notice of
the filing of the proposed rule change. The time for conclusion of
the proceedings may be extended for up to an additional 60 days if
the Commission finds good cause for such extension and publishes its
reasons for so finding or if the self-regulatory organization
consents to the extension.
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[[Page 585]]
Pursuant to Section 19(b)(2)(B) of the Act, the Commission is
providing notice of the grounds for disapproval under consideration.
The Commission is instituting proceedings to allow for additional
analysis of, and input from, commenters with regard to the proposed
rule change's consistency with Section 6 of the Act, and in particular
Sections 6(b)(5).\28\ Section 6(b)(5) requires that the rules of an
exchange be designed, among other things, to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system and, in general,
to protect investors and the public interest; and are not designed to
permit unfair discrimination between customers, issuers, brokers, or
dealers.\29\
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\28\ 15 U.S.C. 78f(b)(5).
\29\ 15 U.S.C. 78f(b)(5).
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V. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data and arguments with respect to the
concerns identified above, as well as any others they may have with the
proposal. In particular, the Commission invites the written views of
interested persons concerning whether the proposed rule change is
inconsistent with Section 6 or any other provision, of the Act, or the
rules and regulations thereunder. Although there do not appear to be
any issues relevant to approval or disapproval that would be
facilitated by an oral presentation of views, data, and arguments, the
Commission will consider, pursuant to Rule 19b-4, any request for an
opportunity to make an oral presentation.\30\
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\30\ Section 19(b) (2) of the Act, as amended by the Securities
Act Amendments of 1975, Pub. L. 94-29 (June 4, 1975), grants the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
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Interested persons are invited to submit written data, views and
arguments regarding whether the proposed rule change should be approved
or disapproved by January 27, 2015. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
February 10, 2015.
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 Number 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 Commission's 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 Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make publicly available. All
submissions should refer to File Number SR-ISE-2014-43 and should be
submitted on or before January 27, 2015. If comments are received, any
rebuttal comments should be submitted by February 10, 2015.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\31\
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\31\ 17 CFR 200.30-3(a)(57).
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Brent J. Fields,
Secretary.
[FR Doc. 2014-30979 Filed 1-5-15; 8:45 am]
BILLING CODE 8011-01-P