Self-Regulatory Organizations; International Securities Exchange, LLC; Notice of Filing of Proposed Rule Change Relating to Modified Rules for Qualified Contingent Cross Orders

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 July 14, 2010, the International Securities Exchange, LLC (“Exchange” or “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 self-regulatory organization. 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 is proposing modified Qualified Contingent Cross Orders. The text of the proposed rule change is as follows, with deletions in [brackets] and additions in italics:

Rule 715. Types of Orders

(a) through (i) no change.

(j) Qualified Contingent Cross Order. A Qualified Contingent Cross Order is comprised of an order to buy or sell at least 1000 contracts that is identified as being part of a qualified contingent trade, as that term is defined in Supplementary Material .01 below, coupled with a contra-side order to buy or sell an equal number of contracts.

(k) through (l) no change.

Supplementary Material to Rule 715

.01 A “qualified continent trade” is a transaction consisting of two or more component orders, executed as agent or principal, where:

(a) At least one component is an NMS Stock, as defined in Rule 600 of Regulation NMS under the Exchange Act;

(b) all components are effected with a product or price contingency that either has been agreed to by all the respective counterparties or arranged for by a broker-dealer as principal or agent;

(c) the execution of one component is contingent upon the execution of all other components at or near the same time;

(d) the specific relationship between the component orders (e.g., the spread between the prices of the component orders) is determined by the time the contingent order is placed;

(e) the component orders bear a derivative relationship to one another, represent different classes of shares of the same issuer, or involve the securities of participants in mergers or with intentions to merge that have been announced or cancelled; and

(f) the transaction is fully hedged (without regard to any prior existing position) as a result of other components of the contingent trade.

Rule 721. [Customer Cross] Crossing Orders

(a) Customer Cross Orders are automatically executed upon entry provided that the execution is at or between the best bid and offer on the Exchange and (i) is not at the same price as a Public Customer Order on the Exchange's limit order book and (ii) will not trade through the NBBO.

[(a)] (1) Customer Cross Orders will be automatically canceled if they cannot be executed.

[(b)] (2) Customer Cross Orders may only be entered in the regular trading increments applicable to the options class under Rule 710.

[(c)] (3) Supplemental Material .01 to Rule 717 applies to the entry and execution of Customer Cross Orders.

(b) Qualified Contingent Cross Orders are automatically executed upon entry provided that the execution (i) is not at the same price as a Priority Customer Order on the Exchange's limit order book and (ii) is at or between the NBBO.

(1) Qualified Contingent Cross Orders will be automatically canceled if they cannot be executed.

(2) Qualified Contingent Cross Orders may only be entered in the regular trading increments applicable to the options class under Rule 710.

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

Purpose—The Exchange proposes to adopt modified rules related to Qualified Contingent Cross Orders (“QCC”). The Exchange first proposed the adoption of the QCC in conjunction with the effectiveness of the Order Protection and Locked/Crossed Market Plan (“Distributive Linkage Plan”) and the Exchange's rules to implement the distributive linkage (“Distributive Linkage Rules”). After a full notice and comment period, the Commission's Division of Trading and Markets (“Division”) approved the proposal on behalf of the Commission by delegated authority. However, this approval was automatically stayed by a petition submitted by the Chicago Board Options Exchange, Incorporated (“CBOE”) requesting review of the filing by the full Commission.

The Exchange has submitted extensive support for the approval of the QCC by the Division and the Commission, and believes that it has fully addressed all of the issues raised by the commenters and provided the basis needed for the Commission to affirm the Division's approval of QCC. Nevertheless, the Commission has not taken action on the petition, and as a result of the stay, the Exchange has been at an extreme competitive disadvantage since the adoption of the Distributive Linkage Rules nearly one year ago. While the Exchange continues to believe QCC as originally approved by the Division is consistent with the Exchange Act, the Exchange believes this modified proposal addresses the two primary concerns raised by commenters. Specifically, this modified QCC proposal does not permit a QCC to be executed at the same price as a priority customer order on the Exchange and increases the required minimum size from 500 to 1000 contracts.

Background

The Distributive Linkage Plan replaced the Plan for the Purpose of Creating and Operating an Intermarket Option Linkage (“Old Linkage Plan”), and the Exchange's Linkage Rules replaced the existing ISE rules implementing the Old Plan (the “Old Linkage Rules”). The Old Linkage Plan and the Old Linkage Rules provided a limited Trade-Through exemption for “Block Trades,” defined to be trades of 500 or more contracts with a premium value of at least $150,000. However, as with Regulation NMS, the Distributive Linkage Plan did not provide a Block Trade exemption. At the time that it adopted the Distributive Linkage Rules, the Exchange recognized that the loss of the Block Trade exemption would adversely affect the ability of ISE members to effect large trades that are tied to stock. Thus, the Exchange proposed the QCC as a limited substitute for the Block Trade exemption, to be implemented contemporaneously with the Linkage Rules.

Discussion

While Regulation NMS does not provide a Block Trade exemption from Trade-Through liability, the Commission, by order, has provided Trade-Through relief for “Qualified Contingent Trades” (“QCTs”). The QCT Release provides an exemption from Trade-Through liability in the equity market for multi-component, fully-hedged trades where one order is contingent on the execution of one or more additional orders. Building on this concept, we propose that when an ISE member effects a QCT trade in a Regulation NMS Stock that the member be permitted to cross the options leg of the trade on the ISE immediately upon entry if the order is for at least 1000 contracts, is part of a QCT, is executed at a price at least equal to the national best bid or offer (“NBBO”), and there are no priority customer orders on the Exchange's book at the same price.

The QCC addresses the dislocation resulting from elimination of the Block Trade exemption by permitting members to provide their customers a net price for the entire trade, and then allowing the members to execute the options leg of the trade on the ISE at a price at least equal to the NBBO while using the QCT exemption to effect the trade in the equities leg at a price necessary to achieve the net price. Under the proposal, ISE will not permit the options component of a stock-option order to trade through the national best bid and offer (“NBBO”). Because the equity component of a stock-option order can be executed at any price under the QCT exemption from Regulation NMS, the pricing of the options component can be flexible. Indeed, whether the options component is executed at or between the ISE BBO is not material because, in most cases, the stock trade can be executed at a price that achieves the desired net price. However, there are times when the quotation spread for the option on the ISE would not permit an execution of the options component between the ISE BBO, particularly in options that trade in increments greater than $0.01. In those cases, ISE proposes to permit an execution of the options component at a price that matches the ISE BBO. Moreover, under the modified proposal, ISE will not permit the execution of a QCC at the same price as a priority customer order. In such a case, the QCC will be rejected.

The ISE's proposal addresses the mechanics of executing the stock and options components of a net-price transaction in disparate markets with different execution rules, different trading increments and different intermarket trade-through provisions. On balance, we believe that providing members with the certainty that they could execute the options legs of the large complex orders for their customers, coupled with the flexibility members would have with respect to the price at which the equity legs are executed, would provide customers with the flexibility needed to achieve their investment objectives. Moreover, the modifications to the proposal to prevent the execution of a QCC if there is a priority customer on the book and to increase the minimum size of a QCC remove the appearance that such orders are trading-ahead of priority customer orders or that the QCC could be used to disadvantage retail customers, the two most significant issues raised by commenters on the initial proposal.

Basis—The basis under the Act for this proposed rule change is the requirement under Section 6(b)(5) 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 proposed changes to QCC will prevent executions from occurring when there is a priority customer order on the book at the same price and will assure that only large-size orders (i.e., of at least 1000 contracts) are eligible. The modified rules will facilitate the ability of ISE members to execute large options orders that are tied to stock in an efficient manner, while also protecting the national market system against trade-throughs.

B. Self-Regulatory Organization's Statement on Burden on Competition

This proposed rule change does not impose any burden on competition. Rather, approval of QCC as modified by the proposed rule change, will address a significant existing burden on competition. In particular, it will permit fair competition between floor-based and electronic options exchanges for large-size stock-option orders.

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

Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date 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 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. 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 E-mail to rule-comments@sec.gov. Please include File No. SR-ISE-2010-73 on the subject line.

Paper Comments

• 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-2010-73. This file number should be included on the subject line if e-mail 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 website viewing and printing in the Commission's Public Reference Room on official business days between the hours of 10 a.m. and 3 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-2010-73 and should be submitted by August 9, 2010.