Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the International Securities Exchange LLC, Relating to a Pilot Program for Quotation Spreads

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 25, 2001, the International Securities Exchange LLC (“ISE” or “Exchange”) filed with the Securities and Exchange Commission (“Commission” or “SEC”) the proposed rule change as described in items I, II, and III below, which items have been prepared by the ISE. 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 ISE proposes to amend Supplementary Material .01 to ISE Rule 803, “Obligations of Market Makers,” to establish a six-month pilot program in which the allowable quotation spread for options on up to 50 underlying securities will be $5, regardless of the price of the bid.

The text of the proposed rule change is available at the ISE and at the Commission.

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 ISE 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 ISE 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

(1) Purpose

The purpose of the proposed rule change is to establish a six-month pilot program to substantially relax the quotation spread requirements on the ISE in options on up to 50 underlying securities. Currently, the ISE's rules contain maximum quotation spread requirements that vary from $.25 to $1, depending on the price of the option. Each ISE market maker independently is subject to these requirements. According to the ISE, although the primary purpose of the spread requirements is to help to maintain narrow spreads, the spread requirements also result in individual market makers sometimes quoting at prices that they believe are unnecessarily narrow, potentially exposing them to greater risk if markets move quickly. The ISE believes that, due to its unique electronic competitive market making system, the quotation spread requirements may not be necessary to ensure tight and competitive quotations on the ISE.

In this regard, the ISE states that its market structure creates strong incentives for competing market makers and other market participants to disseminate competitive prices. In the ISE's trading system, each market maker quotes independently and customers and professional traders can enter limit orders on the ISE's book. The ISE automatically collects this trading interest, calculates an ISE best bid and offer (“BBO”), and disseminates the BBO to the investing public. Furthermore, the ISE allocates trading interest based upon the price and size of trading interest. Under the ISE's trading algorithm, the ISE allocates volume to trading interest at the best price. The larger the size of a person's quote or order at the best price, the more trading interest that person receives. The ISE believes that this provides strong incentives for market makers and other market participants to enter quotes and orders that improve the price and depth of the market. The ISE believes that in this model, market forces provide sufficient discipline to maintain narrow and competitive quotation spreads.

Accordingly, the ISE proposes to expand the allowable spread in a pilot group of up to 50 options (up to five per each of the ISE's ten groups of options) to $5. The ISE states that it will monitor the quotation quality of the selected options for a six-month pilot period and, based on the results, recommend either relaxing the spread requirements for all options, ending the pilot, or adjusting the spread requirements.

(2) Basis

The ISE believes that the proposed rule change is consistent with the requirement under section 6(b)(5) of the Act 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.

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

The ISE believes that the proposed rule change does not impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others

The ISE has not solicited, and does not intend to solicit, comments on the proposed rule change. The ISE 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 Exchange 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. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.

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 inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the ISE. All submissions should refer to file number SR-ISE-2001-15 and should be submitted by December 18, 2002.