Self-Regulatory Organizations; International Securities Exchange, Inc.; Order Granting Approval of a Proposed Rule Change and Amendments Nos. 1 and 2 Thereto Relating to Market Maker Quote Interaction

I. Introduction

On October 3, 2005, the International Securities Exchange, Inc. (“ISE” or “Exchange”) filed with 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 804(d) regarding a delay of up to one second before two market maker quotations interact. On October 21, 2005, the ISE submitted Amendment No. 1 to the proposed rule change. On November 3, 2005, the ISE submitted Amendment No. 2 to the proposed rule change. The proposed rule change and Amendments No. 1 and 2 were published for comment in the Federal Register on November 10, 2005. The Commission received no comments on the proposal. This order approves the proposed rule change, as amended.

II. Description

Currently, ISE Rule 804(d) provides for a one-second delay before the quotations of ISE market makers interact. As noted in SR-ISE-2004-24, the ISE treats orders and quotations differently, with ISE Rule 804(a) stating that only market makers may enter quotations on the ISE. Market makers use quotations to input and update prices on multiple series of options at the same time. Quotations generally are based on pricing models that rely on various factors, including the price and volatility of the underlying security. The ISE stated that as these variables change, a market maker's pricing model automatically updates quotations for some or all of an option's series. In contrast, an order is an interest to buy a stated number of contracts of one specific options series. The ISE noted that all ISE members, including ISE market makers, can enter orders.

According to the ISE, the purpose of the one-second delay was to allow a market maker to update its quotations to reflect price changes in an underlying stock before another market maker's quotation could “hit” the updating market maker's quotation. In SR-ISE-2004-24, the ISE represented that it promptly processes quotation updates when it receives them, but that there is invariably a lag between the time the underlying stock price first changes and the time by which the ISE can process all the corresponding quotation changes. In SR-ISE-2004-24, the ISE also stated its belief that the one-second delay would allow the ISE the time to process quotation updates, without effecting multiple executions during the update process. In the Notice, the ISE noted, however, that the one-second delay may no longer be necessary as the ISE trading system and its market maker members' quoting systems continue to advance technologically. Accordingly, the ISE proposes an amendment to ISE Rule 804(d) to give the ISE the flexibility to remove the one-second delay. In making a determination to remove the one-second delay, the ISE stated that it would take into consideration input from its market maker members, particularly through the ISE's Market Maker Advisory Committee. The ISE also noted that any change made to the one-second delay would be implemented on a uniform, market-wide basis (as opposed to, for example, a class-by-class basis). Further, the ISE stated that it would inform its members of any changes made to the one-second delay by distributing a Regulatory Information Circular prior to the implementation of any such change.

III. Discussion

The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange and, in particular, the requirements of Section 6(b) of the Act and the rules and regulations thereunder. Specifically, the Commission finds that the proposal is consistent with Section 6(b)(5) of the Act, in that it is designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanisms of a free and open market and a national market system, and, in general, to protect investors and the public interest.

In SR-ISE-2004-24, the Commission noted the ISE's belief that, without the proposed one-second “timer” function, pricing inefficiencies would result on the Exchange, and ISE market makers would widen their quotations or limit size to avoid multiple executions against other market makers. To the extent the ISE trading system and its market maker members' quoting systems continue to advance technologically to reduce the likelihood of market maker quotes interacting, the one-second delay may no longer be necessary. Accordingly, the Commission believes that granting the ISE the flexibility to remove the one-second delay in such circumstance is consistent with the Act. Additionally, the Commission believes that permitting the ISE to determine to reinstate the one-second delay also is consistent with the Act, if the reinstatement of the delay is necessary to avoid the interaction of market maker quotations. In determining whether to remove the one-second delay, the Commission understands that the ISE would consult with its market maker members, particularly through the Exchange's Market Maker Advisory Committee. Regardless of whether the ISE makes any changes to the one-second delay, the Commission notes that ISE market makers would be required to be firm for their quotations for the same size to customers and broker-dealer orders, including orders for the account of other ISE market makers.

IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-ISE-2005-48), as amended, is approved.