Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, notice is hereby given that on May 23, 2001, the International Securities Exchange LLC (the “Exchange” or the “ISE”) filed with the Securities and Exchange Commission (“Commission”), a proposed rule change requesting permanent approval of its allocation algorithm pilot.
The proposed rule change was published for comment in the Federal Register on July 11, 2001. No comments were received on the proposal. This order approves the proposal on an accelerated basis.
II. Description of the Proposal
The Exchange is proposing to amend Supplementary Material .01 to Rule 713 to adopt the Exchange's current allocation algorithm pilot program on a permanent basis. The Exchange's allocation algorithm pilot was approved by the Commission on May 22, 2000, and recently was extended until August 1, 2001.
ISE Rule 713 provides that customer orders have priority, based on the time priority of such orders. ISE Rule 713(e) provides that if there are two or more non-customer orders or market maker quotations at the Exchange's inside market, after filling all customers at that Start Printed Page 41644price, executions will be allocated between the non-customer orders and market maker quotations “pursuant to an allocation procedure to be determined by the Exchange from time to time * * * .” ISE Rule 713(e) also states that, if the primary market maker (“PMM”) is quoting at the Exchange's inside market, it will have precedence over non-customer orders and competitive market maker (“CMM”) quotes for execution of orders that are up to a specified number of contracts. Supplementary Material .01 to ISE Rule 713 specifies the ISE's allocation procedure for non-customer orders and market maker quotations and defines the size of orders for which the PMM has priority to be those of five contracts or fewer.
The allocation procedure is a trading algorithm programmed in the ISE's electronic auction market system (the “System”) that determines how to split the execution of incoming orders among professional trading interests at the same price. All public customer orders at a given price are always executed fully before the trading algorithm is applied. Moreover, because the algorithm is applied automatically by the System upon the receipt of an executable order, only those non-customer orders and market maker quotes at the best price that are in the System participate in the algorithm. Thus, there is no opportunity for a market participant to receive an allocation unless it had an order or quote in the System at the execution price at the time the incoming order was received by the System.
Subject to the PMM's participation rights discussed below, allocation of executions to non-customer orders and market maker quotes is based on the size associated with the order or quote relative to the total size available at the execution price. According to the Exchange, because PMMs have unique obligations tot he ISE market, they are provided with certain participation rights. If the PMM is one of the participants with a quote at the best price, it has participation rights equal to the greater of (1) the proportion of the total size at the best price represented by the size of its quote, or (2) 60 percent of the contracts to be allocated if there is only one other non-customer order or market maker quotation at the best price, 40 percent if there are two other non-customer orders and/or market maker quotes at the best price, and 30 percent if there are more than two other non-customer orders and/or market maker quotes at the best price. This allocation procedure has been approved by the Commission on a permanent basis, and the Exchange did not propose any changes to the procedure at this time.
The allocation procedure further provides that the PMM has precedence to execute orders of five contracts or fewer. This means that such orders will be executed first by the primary market maker if it is quoting at the best price. This aspect of the allocation procedure was approved by the Commission on a one-year pilot basis. In its temporary approval of this PMM preference for the pilot period, the Commission stated its intent to monitor the rule's impact on competition during the pilot period and the ISE agreed to provide four types of specific confidential data to the Commission on a quarterly basis. The ISE also committed to lowering the size of the orders to which the PMM is given a preference if the execution of orders for five contracts or fewer by PMMs exceeded 40 percent of total exchange volume (excluding volume from the execution of facilitation orders).
III. Commission's Findings and Order Granting Accelerated Approval of Proposed Rule Change
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 that the proposal to provide PMMs with the preference for orders of five contracts or fewer is consistent with Section 6(b)(5) of the Act. Section 6(b)(5) requires that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, 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.
In its original approval order for the ISE's allocation algorithm, the Commission, responding to various issues raised by commenters, stated that it intended to use the one-year pilot period to monitor the rule's impact on competition by reviewing the four types of specific data that ISE provided to the Commission on a quarterly basis. During the pilot period and the pilot extension period, the Exchange has provided the statistics required under the terms of the pilot and has monitored the percentage of total ISE volume resulting from execution of orders of five contracts of fewer by the PMMs. The Commission notes that the 40% threshold was not reached during the pilot program and pilot extension period; indeed, the total percentage was substantially lower than 40%. In particular, the Commission notes that throughout the pilot program and pilot extension, a large percentage or orders of five contracts or fewer were executed by participants other than the PMM, and a large percentage of all the volume on Start Printed Page 41645the Exchange were executed by participants other than the PMM.
The Commission does not believe that the small order participation right for PMMs (i.e., five contracts of fewer preference) will necessarily result in a significant portion of the Exchange's volume being executed by the PMM, especially in light of the fact that the PMM executes against such orders only if it is quoting at the best price, and only for the number of contracts associated with its quotation. In order to provide a safeguard against the potential for increased PMM executions in the future in excess of the proposed 40% threshold, however, the ISE agrees to continue to maintain the technological capability to compile the sort of data it provided to the Commission during the pilot period and pilot extension, and agrees to compile and provide such data to the Commission at its request. The Commission further notes that the Exchange will continue to evaluate periodically the percentage of the volume executed on the Exchange that is comprised of orders for five contracts or fewer executed by primary market makers, and will reduce the size of the orders included in this provision if such percentage is over 40 percent. Given the existence of these continued safeguards, as well as the lack of anticompetitive statistical trends observed by the Commission during the pilot period and pilot extension, the Commission finds that the proposed rule change is consistent with Section 6(b)(5).
The Commission finds good cause for approving the proposed rule change prior to the thirtieth day after the date of publication of notice of filing thereof in the Federal Register. The original filing proposing the ISE's pilot program for small order participation right for PMMs was subject to a full notice and comment period. In addition, this proposal requesting permanent approval of the same provision will, as of the date of this order, have been subject to a full notice and comment period and no comment letters were received by the Commission. Moreover, the one-year pilot period and related reporting obligations by ISE were responsive to the issues raised by commenters to ISE's earlier filing regarding its allocation algorithm. Accordingly, the Commission finds good cause for approving the proposed rule change (SR-ISE-2001-17) prior to the thirtieth day after the date of publication of notice thereof in the Federal Register.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-ISE-2001-17) is approved on an accelerated basis.Start Signature
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Margaret H. McFarland,
4. See Securities Exchange Act Release No. 42808 (May 22, 2000), 65 FR 34515 (May 30, 2000) (“Release No. 42808”).Back to Citation
5. See Securities Exchange Act Release No. 44340 (May 22, 2001), 66 FR 29373 (May 30, 2001) (“Release No. 44340”).Back to Citation
6. For example, PMMs are responsible for: (1) Ensuring that all ISE disseminated quotations are for at least 10 contracts; (2) addressing customer orders that cannot be automatically executed when another market is disseminating a better quotation; and (3) opening the market. See ISE Rule 803(c).Back to Citation
7. The participation rights are programmed into the trading algorithm, so that they are applied automatically by the System when splitting executions among non-customer orders and market maker quotes after public customer orders at the same price are fully executed, as described above. Consequently, like any other market participant, the PMM cannot receive any portion of an allocation, regardless of its participation rights, unless it is quoting at the best price at the time the executable order is received by the System. Moreover, the size associated with the PMMS quote must be sufficient to fill the portion of the order that would be allocated to it according tot he participation rights. For example, if a PMM would be allocated 30 contracts according to its participation rights, but the size of its quote is only 20 contracts, the PMM would receive an allocation of only 20 contracts. If the size associated with a PMM's quote is only three contracts when an executable order for five contracts is received (assuming there are no public customer orders), the PMM would execute only three contracts.Back to Citation
8. According to the participation rights, a PMM quoting at the inside market generally is allocated the plurality of an order. For example, if a both a PMM and CMM are quoting at the inside market for 50 contracts each, an incoming order for 10 contracts will be allocated between the two for six and four contracts respectively (a 60% allocation to the PMM). If the PMM is quoting for 50 contracts and there are two CMMs each quoting for 50 contracts, the PMM is allocated four contracts and the two CMMs are allocated three each (40 percent for the PMM, and the remaining 60 percent split equally between the CMMs because they are quoting an equal size.) At a minimum, a PMM will be allocated 30 percent of an order, regardless of the number of other quotes or orders at that price.Back to Citation
9. See Release No. 42808, supra note 4.Back to Citation
10. Id. The Commission extended the pilot to August 1, 2001 in order to consider this proposed rule change requesting permanent approval. See Release No. 44340, supra note 5.Back to Citation
12. In approving this rule, the Commission notes that it has also considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).Back to Citation
14. See Release No. 42808, supra note 4.Back to Citation
15. Telephone conversation between Katherine Simmons, Vice President and Associate General Counsel, ISE, Deborah Flynn, Assistant Director, Division of Market Regulation, Commission and Geoffrey, Pemble, Attorney, Division of Market Regulation, Commission, on July 25, 2001.Back to Citation
16. See Release No. 42808, Supra note 4.Back to Citation
17. Id.Back to Citation
[FR Doc. 01-19857 Filed 8-7-01; 8:45 am]
BILLING CODE 8010-01-M