January 27, 2014.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the “Act”),
and Rule 19b-4 thereunder,
notice is hereby given that, on January 17, 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, II, and III below, which items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change
The Exchange proposes to amend its rules to specify in its rules certain system protections contained in the trading system. The text of the proposed rule change is available on the Exchange's Web site 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 Exchange 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
The purpose of the proposal is to specify in the Exchange's rules certain existing trading system protections that prevent the entry and/or execution of orders in certain circumstances. These protections are in addition to the system protection currently described in Rule 714 that prevents orders from being automatically executed at prices that are inferior to a protected bid or offer on another exchange (“trade through protection”) pursuant to the requirements of the Intermarket Linkage Plan (the “Plan”) and ISE Rules adopted to implement the Plan (the “Linkage Rules”).
Specifically, ISE Rule 714 provides that incoming orders will not be automatically executed at prices that are inferior to the national best bid or offer (“NBBO”). Thus, the language currently contained in Rule 714 reflects how the trading system assures compliance with the prohibition on trading through the NBBO contained in ISE Rule 1901. Rule 714 also indicates that the prohibition on trade-throughs does not apply with respect to non-firm quotations as provided in ISE Rule 1900(k). The Exchange proposes to make several non-substantive changes to the text and format of ISE Rule 714 with respect to these linkage-related provisions for clarity,
and to add a reference to intermarket sweep orders (“ISOs”). Pursuant to ISE Rule 1901, ISOs are eligible to be executed at a price that is inferior to the NBBO. For clarity, the Exchange believes it is appropriate to specify in Rule 714 that the system does not prevent the automatic execution of an ISO at a price that is inferior to the NBBO.
The Exchange also is proposing to amend Rule 714 to add additional circumstances in which the trading system does not provide automatic executions as follows:
Price Level Protection. There is a limit on the number of price levels at which an incoming order to sell (buy) will be executed automatically when there are no bids (offers) from other exchanges at any price for the options series. In such a circumstance, incoming orders are automatically executed at each successive price level until the maximum number of price levels is reached,
and any balance is either handled by the primary market maker (“PMM”) (in the case of Priority Customer Orders)
or canceled (in the case of Professional Orders).
The number of price levels, which may be between 1 and 10, is determined by the Exchange from time-to-time on a class-by-class basis. Currently, this limit is set to three price levels.
Limit Order Price Protection. There is a limit on the amount by which incoming limit orders to buy may be priced above the Exchange's best offer and by which incoming limit orders to sell may be priced below the Exchange's best bid. Limit orders that exceed the pricing limit are rejected upon entry. The limit is established by the Exchange from time-to-time, on a class-by-class basis, as the greater of: (i) An absolute amount not to exceed $2.00, or (ii) a percentage of the Exchange's best bid/offer not to exceed 10 percent.
The Exchange currently has these limits set to $1.00 and 1 percent respectively.
Size Limitation. There is a limit on the number of contracts an incoming order may specify. Orders or quotes that exceed the maximum number of Start Printed Page 5496contracts are rejected upon entry.
The maximum number of contracts, which shall not be less than 10,000, is established by the Exchange from time-to-time on a class-by-class basis. Currently, this limit is set to 999,999 contracts.
The Exchange further proposes that, in the event of unusual market conditions and in the interest of a fair and orderly market, the Exchange may temporarily establish the levels at which the order protections are triggered as necessary and appropriate.
When the PMM handles Priority Customer orders that are not automatically executed or canceled pursuant to the price level protection described above, they must do so pursuant to their obligations under ISE Rule 803 and consistent with Rule 400 (Just and Equitable Principles of Trade). Rule 803 states, among other things, that market makers have a continuous obligation to engage, to a reasonable degree under the existing circumstances, in dealings for his own account when there exists, or it is reasonably anticipated that there will exist, a lack of price continuity, a temporary disparity between the supply of and demand for a particular options contract, or a temporary distortion of the price relationships between options contracts of the same class.
The Rule also specifies that a PMM must act with due diligence in handling orders and must accord priority to such orders over the PMM's principal orders.
In addition to these existing provisions, the Exchange proposes to specify in Rule 803(c) that PMMs are required to address orders they handle as soon as practical by either (i) executing all or a portion of the orders at a price that at least matches the NBBO and that improves upon the Exchange's best bid (in the case of a sell order) or the Exchange's best offer (in the case of a buy order); 
or (ii) releasing all or a portion of the order for execution against bids and offers on the Exchange.
The Exchange also proposes to specify in Rule 722 (Complex Orders) the following pricing limits for complex orders and quotes:
Trade-through limit: Rule 722 permits the legs of a complex order to be executed at prices that are inferior to the prices available on other exchanges trading the same options series.
Notwithstanding, the system will not permit the legs of a complex order to trade through the best bids and offers from other exchanges by more than a configurable amount calculated as the lessor of: (i) An absolute amount not to exceed $0.10; and (ii) a percentage of the NBBO not to exceed 500 percent, as determined by the Exchange on a class or series basis. Effectively, the limit currently is an absolute amount of $0.05,
as the parameters are set to $0.05 and 500 percent respectively.
A member can also include an instruction on a complex order entered on the complex order book that the legs of the order are to be executed only at prices that are equal to or better than the national best bid or offer for the options series and any stock component.
Minimum net price: The system will reject any complex order strategy where all legs are to buy if it is entered at a price that is less than the minimum price, which is calculated as the sum of the ratio times $0.01 per leg.
Vertical spread price: The system will reject a vertical spread order (i.e., an order to buy a call (put) option and to sell another call (put) option in the same security with the same expiration but a higher (lower) strike price) when entered with a net price of less than zero, and will prevent the execution of a vertical spread order at a price that is less than zero when entered as a market order to sell.
Complex Limit Order Price Protection: There is a limit on the amount by which the net price of an incoming complex limit order to buy may exceed the net price available from the individual options series on the Exchange and by which the net price of an incoming complex limit order to sell may be below the net price available from the individual options series on the Exchange.
Limit orders that exceed the pricing limit are rejected. The limit is established by the Exchange from Start Printed Page 5497time-to-time, on a class-by-class basis, as the greater of: (i) An absolute amount not to exceed $2.00, or (ii) a percentage of the Exchange's best bid/offer not to exceed 10%. The Exchange currently has these limits set to $1.00 and 1 percent respectively.
This limit order price protection applies only to orders and does not apply to quotes.
Complex Order Size Limitation: There is a limit on the number of contracts (and shares in the case of a stock-option order) any single leg of an incoming complex order may specify. Orders that exceed the maximum number of contracts (or shares as applicable) are rejected.
The maximum number of contracts (or shares), which shall not be less than 10,000 contracts (or 100,000 shares), is established by the Exchange from time-to-time on a class-by-class basis. Currently, this limit is set to the maximum value of 999,999 contracts and 9,999,999 shares.
2. Statutory Basis
The Exchange believes that its proposal is consistent with Section 6(b) of the Securities Exchange Act of 1934 (the “Act”) 
in general, and furthers the objectives of Section 6(b)(5) of the Act 
in particular, in that it is designed 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. The system protections described above were implemented in the interest of protecting investors and to assure fair and orderly markets on the Exchange.
Specifically, the Exchange operates an electronic marketplace in which orders are processed and executed in less than one second. Without any safeguards, orders that outsize the liquidity available at the displayed best bid or offer on the Exchange could potentially trade at prices far below the best bid and far above the best offer, creating extreme volatility in the marketplace and poor executions for investors. The primary safeguard in the national market system that protects against such occurrences is the prohibition against trading through protected bids and offers on other options exchanges, as this links the liquidity available across markets and in most circumstances, provides a stop-gap on each individual exchange. However, not all products are multiply traded, and even in multiply-traded options series, it is possible that ISE could be the only exchange disseminating a protected bid and/or offer in a particular options series at any given sub-second during the trading day.
Accordingly, the Exchange designed its system to provide the price level protection described above when there are no other protected bids and offers in the national market system. The Exchange believes that limiting the number of price levels at which an incoming order will execute in these circumstances appropriately balances the interests of investors seeking execution of their orders and the Exchange's obligations to provide a fair and orderly market. While Professional Orders are canceled in these circumstances, the Exchange seeks to provide a higher level of service for Priority Customer orders by having them handled by the PMM, which has an affirmative obligation to provide liquidity and price continuity. This procedure also provides an opportunity for liquidity to refresh in the market, further providing better execution potential for Priority Customer orders. The Exchange believes that providing this service for Priority Customer orders is appropriate and consistent with feedback from members that enter Priority Customer orders on the Exchange, who prefer that Priority Customer orders not be canceled in this circumstance.
Similarly, the Exchange's experience and member feedback indicates that the current limit of three price levels has worked well to balance the interests of investors receiving execution of their orders while protecting them from being executed at unreasonable prices. Nevertheless, the Exchange believes it is appropriate to maintain some flexibility to adjust the number of price level so that it can continually evaluate market conditions and investor needs. In this respect, under the proposal, the Exchange has the flexibility to adjust the number of price levels up to ten. The Exchange believes this limit is sufficient to give it the ability to make appropriate adjustments as necessary and appropriate to maintain fair and orderly markets.
The Exchange also represents that the proposal merely clarifies the existing PMM obligations by specifying that the PMM must address orders it handles by either providing an execution or releasing orders for execution against bids and offers on the Exchange. The proposal further specifies that the price at which a PMM may execute an order must be at least equal to the NBBO and improve upon the best bid (offer) on the Exchange.
While this was not previously stated explicitly in the Rules for this specific circumstance, the Exchange has always applied the obligations contained in ISE Rule 803(b) and Supplementary Material .01 thereto, as well as Rule 400 and Rule 713, consistent with the additional proposed language and has enforced compliance accordingly.
Moreover, the Exchange believes the specified order handling provisions are appropriate to assure compliance with all applicable Exchange Rules with respect to the handling of orders by the PMM.
With respect to the trade through limit for complex orders, the Exchange believes it is consistent with the protection of investors to limit the amount by which the legs of a complex order are allowed to trade through the NBBO for the series. Pursuant to ISE Rule 722(b), the legs of a complex order are not permitted to trade at prices that are inferior to the ISE best bid or offer.
It is possible, however, that the ISE best bid and/or offer are not at or near the NBBO for the options series.
Investors understand that there is a benefit to executing certain trading strategies using complex orders, which assures that all parts of the strategy are executed and if applicable, at a specified net price. They also understand that the benefit of using a complex order may come at a “cost” because complex orders may be executed at prices that are inferior to the net price that might have been achieved if the individual legs of the complex order were executed at the NBBO.
However, the Exchange believes it is necessary to protect investors from executing complex orders when such “cost” becomes Start Printed Page 5498economically irrational. Indeed, such pricing discrepancies indicate that there likely is an error, such as the wrong symbol, series or price was entered on the order.
The Exchange believes that providing the trade-through limit protection to complex orders is appropriate and consistent with feedback from members that enter complex orders on the Exchange, who prefer that their complex orders not be executed in this circumstance. In this respect, the Exchange's experience and member feedback indicates that the current limit of $0.05 is appropriate to balance the interests of investors receiving execution of their complex orders while protecting them from being executed at unreasonable prices.
Nevertheless, the Exchange believes it is appropriate to maintain some flexibility to adjust the amount by which a complex order may trade through the NBBO, so that it can continually evaluate market conditions and investor needs. In this respect, under the proposal, the Exchange has the flexibility to adjust the absolute value up to $0.10 and the percentage up to 500 percent.
The Exchange believes this will be sufficient to give it the ability to make appropriate adjustments should market conditions so require.
As discussed, the complex order trade-through limit is designed to prevent investors from erroneously executing complex orders at unreasonable prices while not unreasonably restricting the ability for investors to price complex orders. In some instances, however, investors may prefer that the Exchange further restrict the execution of complex orders by not allowing them to trade through the NBBO at all. Accordingly, the Exchange proposes to offer the optional ability for investors to instruct the Exchange not to execute the legs of a complex orders through the NBBO for the individual series. While the Exchange does not believe it would be appropriate to impose such a restriction on all investors, it believes that offering this optional limitation on complex orders is reasonable and appropriate for investors that prefer only to execute complex orders at net prices that equal or better the NBBO for the component series.
The limit order price protection and size limitation for both regular and complex orders were designed to reject orders upon entry that were likely submitted in error. Limit orders that are entered with prices that cross the market by a large amount are likely to have been entered in the wrong options series, on the wrong side of the market, or with an erroneous price (e.g., a bid of $15 rather than $1.50). Similarly, orders entered with an unreasonably large size (e.g., 1 million contracts or more) are likely to have been entered in error. The Exchange believes that it is in the interest of fair and orderly markets and the protection of investors to reject these orders upon entry, and thereby prevent erroneous transactions from occurring.
The Exchange further believes that the Exchange's experience and member feedback indicates that the current limits of $1.00 and 1 percent for the limit order price protection, and 999,999 contracts (and 9,999,999 shares in the case of a stock-option order) for the size limitation, has worked well to provide the protection of rejecting orders that have been entered in error while assuring that valid orders are not rejected. In this respect, the Exchange notes that orders below the established limits may well have been entered in error, but that it is highly unlikely that orders entered above the current limits were not entered in error. The Exchange believes it is appropriate to maintain some flexibility to adjust the limits so that it can continually evaluate the extent to which such limits could be reduced to prevent the entry of additional erroneous orders without rejecting legitimate orders. In this respect, under the proposal, the Exchange has specified that the limit order price protection limits shall not exceed $2.00 and 10 percent respectively. The Exchange believes that these limits provide sufficient flexibility for the Exchange to make appropriate adjustments in the interest of maintaining fair and orderly markets. The Exchange also notes that it has specified that the order size limitation shall not be less than 10,000 contracts (and 100,000 shares in the case of a stock-option order). The Exchange notes in this respect that a block-size options order is defined as an order of at least 50 contracts,
and that an order of 500 contracts is considered a very large institutional-size order (a block-size order in the equities market is an order of at least 10,000 shares).
Accordingly, the Exchange believes that it would not be unreasonable to set a size limit as low as 10,000 contracts (and 100,000 shares in the case of a stock-option order) should the Exchange determine that it was necessary to maintain fair and orderly markets and to protect investors from executing orders entered with an erroneously large size.
As discussed above, a complex order strategy where all legs are to buy will be rejected if it is entered at a price that is less than the minimum price. The Exchange believes it is reasonable to reject such orders upon entry as they are not executable.
Allowing such orders to be entered would create investor confusion; as such orders would not receive an execution and would remain pending until canceled. Similarly, the Exchange believes that rejecting vertical spread orders that are entered at a negative price protects investors from executing orders that were entered in error, and that preventing the execution of single-sided vertical spread orders at negative prices when they are entered as a sell market order, protects investors from paying to sell a strategy when they expected to receive payment for selling the strategy. These restrictions help the Exchange to maintain a fair and orderly market, and provide a valuable service to investors.
Finally, the Exchange notes that it will give members at least a two week notice prior to changing the level at which the system protections are triggered to allow members to perform any system changes, and that the Exchange provides these protections for the benefit of, and in consultation with, its members. Notwithstanding, the Exchange also recognizes that the applicable protections may not be appropriate in unusual market conditions. In this respect, the Exchange has included in the proposal a provision providing that, in the event of unusual market conditions and in the interest of a fair and orderly market, the Exchange may temporarily establish the levels at which the system protections are triggered that are beyond those specified in the rule. The Exchange believes this is consistent with its obligation to assure a fair and orderly market, and that the need for such flexibility is recognized in other Exchange rules, such as those related to position limits, quote-width differentials and market maker risk parameters.
In the event that the Exchange temporarily revises the levels at which the protections are triggered, it will immediately notify all members.
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B. Self-Regulatory Organization's Statement on Burden on Competition
The proposed rule change specifies circumstances in which the trading system does not provide an automatic execution in the interest of protecting investors against the execution of erroneous orders or the execution of orders at erroneous prices. As such, the proposal does not impose any burden on competition.
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 unsolicited written comments from members or other interested parties.
III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action
Because the foregoing proposed rule change does not significantly affect the protection of investors or the public interest, does not impose any significant burden on competition, and, by its terms, does not become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate, it has become effective pursuant to Section 19(b)(3)(A) 
of the Act and Rule 19b-4(f)(6) 
thereunder. The Exchange provided the Commission with written notice of its intent to file the proposed rule change, along with a brief description and text of the proposed rule change, at least five business days prior to the date of filing the proposed rule change.
At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.
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. Comments may be submitted by any of the following methods:
- Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-ISE-2014-05. 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 the 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 available publicly. All submissions should refer to File Number SR-ISE-2014-05 and should be submitted on or before February 21, 2014.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.
Kevin M. O'Neill,
[FR Doc. 2014-01966 Filed 1-30-14; 8:45 am]
BILLING CODE 8011-01-P