On September 12, 2000, the International Securities Exchange LLC (“ISE” or “Exchange”) submitted to the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, a proposed rule change to amend ISE Rule 810 relating to Chinese Wall procedures. The proposed rule change was published for comment in the Federal Register on November 13, 2000. The Commission received no comments on the proposed rule change and this order approves the proposal.
I. Description of the Proposal
ISE Rule 810 requires that ISE market makers erect a “Chinese Wall” between their market making activity and certain other business activities, including their trading as an Electronic Access Member (“EAM”). The wall is intended prevent any real-time communication between the various business lines. Without the wall, a trader entering an order as an EAM could potentially inform the person making markets about the pending order. The market maker could then, based on this knowledge, move its quotation either (i) to “intercept” an order against which the firm wants to trade, or (ii) to avoid an order against which it does not want to trade. The Exchange adopted ISE Rule 810 because such behavior would be inconsistent with the agency auction market structure of the Exchange.
The ISE noted, however, that the broad restrictions of ISE Rule 810 limit the ability of certain market makers to send proprietary order flow to the ISE in options outside of their assigned groups of options (“bins”). In particular, many market makers do not have the facilities to establish a “Chinese Wall,” which requires physical separation of functions (generally on separate floors), between their proprietary traders and individuals performing ISE market making activities.
The proposed rule change, therefore, will allow members to conduct proprietary trading in the same physical space as their market making activities, but only: (i) In options that are not within their market making assignments; or (ii) in options which, pursuant to regulatory requirements, the member is prohibited from making markets. This latter provision is intended to apply to market makers that are specialists in the underlying stock on the New York Stock Exchange, Inc. (“NYSE”), whose rules limit the options trading of specialists and affiliated firms to “hedging activities,” thus prohibiting them from making markets in options. In addition, the proposed rule change would permit only proprietary trading without the Chinese Wall and would not permit the market maker to enter agency orders (except with respect to proprietary orders for its affiliates) without complying with the full restrictions of ISE Rule 810.
The Commission has reviewed the ISE's proposed rule change and finds, for the reasons set forth below, that the proposal is consistent with the requirements of Section 6 of the Act  and the rules and regulations thereunder applicable to a national securities exchange. Specifically, the Commission believes the proposal is consistent with Section 6(b)(5) of the Act, because it promotes just and equitable principles of trade, removes impediments to and perfects the mechanism of a free and open market and a national market system, and protects investors and the public interest, by maintaining an information barrier that respects the integrity of the ISE while still permitting members, under certain circumstances, to conduct proprietary trading in the same physical space as their market making activities.
The Commission notes that amending ISE Rule 810 will help attract proprietary order flow to the ISE. Although members will be allowed to conduct proprietary trading in the same physical space as their market making acitivites, they may do so only in options that are not within their market making assignments or in options which, pursuant to regulatory requirements, the member is prohibited from making markets. In addition, the proposed rule change would permit only proprietary trading without the Chinese Wall and would not permit the market maker to enter agency orders (except with respect to proprietary orders for its affiliates) without complying with the full restrictions of ISE Rule 810. Limiting such activity to these specific situations reduces the potential for the type of harm against which ISE Rule 810 is intended to protect, since the member will not be making markets in the stocks in which it is engaging in proprietary trading. The Commission emphasizes, however, that the information barrier between a market maker and affiliated EAM should protect against any inappropriate sharing of information that could result in market manipulation. The Commission continues to expect the ISE to be vigilant in monitoring for possible abuses in this context.Start Printed Page 81552
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SE-ISE-00-09) is approved.Start Signature
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Maragret H. McFarland,
3. See Securities Exchange Act Release No. 43508 (November 2, 2000), 65 FR 67784 (November 13, 2000).Back to Citation
4. The ISE assigns market makers to bins of options. There are 10 bins, and each bin has one Primary Market Maker (“PMM”) and up to 10 Competitive Market Makers (“CMM”) assigned to each.Back to Citation
5. See NYSE Rule 105. This applies solely to CMMs. Because CMMs are required to provide continuous quotes in only 60 percent of the options in a bin, it is possible that a CMM could be assigned a bin in which it is not permitted to make markets in certain options classes. Such a CMM simply would not quote in these “restricted” options. PMMs must provide continuous quotes in all options in a bin and thus were not assigned bins where these regulatory restrictions apply.Back to Citation
8. In approving the proposal, the Commission has considered the rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).Back to Citation
[FR Doc. 00-32806 Filed 12-22-00; 8:45 am]
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