June 15, 2004

Mr. Michael J. Simon
Senior Vice President and General Counsel
International Stock Exchange, LLC
60 Broad Street
New York, NY 10004

Dear Mr. Simon:

This letter is to remind you of your obligations to enforce the prohibitions under Section 11(a) of the Securities Exchange Act of 1934 ("Exchange Act"). Specifically, Section 11(a) prohibits a member of a national securities exchange from effecting transactions on that exchange for its own account, the account of an associated person, or an account over which it or its associated person exercises discretion (collectively, covered accounts) unless an exception applies.¹ Among the transactions excepted are those by a dealer acting in the capacity of a market maker², bona fide arbitrage or hedge transactions³, transactions made to offset errors⁴, and proprietary transactions by certain members that yield priority, parity, and precedence to non-members (except those non-members who are affiliated with members).⁵

In addition, Rule 11a2-2(T) under the Exchange Act⁶ -- known as the "effect versus execute" rule -- provides exchange members with an exemption from the Section 11(a) prohibition. Rule 11a2-2(T) permits an exchange member, subject to certain conditions, to effect transactions for covered accounts by arranging for an unaffiliated member to execute the transactions on the exchange. Among the rule's conditions is a requirement that the member and its associated persons not participate in the execution of the transaction once it has been transmitted to the unaffiliated member performing the execution.

The staff of the Division of Market Regulation believes that when a member sends an order for its own account, coupled with a customer order, to the exchange with the understanding that its order will trade in whole or in part with its customer's order, ahead of other trading interest, that member participates in the execution of the transaction within the meaning of Rule 11a2-2(T). Accordingly, members trading with their own customers through such facilities may not rely on Rule 11a2-2(T) for an exemption from the prohibition set forth in Section 11(a)(1) of the Exchange Act.

If you have any question regarding this letter, please contact Kelly Riley at (202) 942-0752 or Hong-anh Tran at (202) 942-0088.

Endnotes

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¹ 15 U.S.C. 78k(a).

² 15 U.S. C. 78k(a)(1)(A).

³ 15 U.S.C. 78k(a)(1)(D).

⁴ 15 U.S.C. 78k(a)(1)(F).

⁵ 15 U.S.C. 78k(a)(1)(G). See also 17 CFR 240.11a1-1(T).

⁶ 17 CFR 240.11a2-2(T).

http://www.sec.gov/divisions/marketreg/mr-noaction/ise061504.htm