[Federal Register Volume 59, Number 25 (Monday, February 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-2711]
[[Page Unknown]]
[Federal Register: February 7, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33553; International Series Release No. 632; File No.
SR-Phlx-93-54]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Approving, and Notice of Filing and Order Granting Accelerated
Approval of Amendment No. 1 to, a Proposed Rule Change Relating to the
Listing of Options on American Depositary Receipts
January 31, 1994.
I. Introduction
On November 15, 1993, the Philadelphia Stock Exchange, Inc.
(``Phlx'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``Commission'' or SEC''), pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for the listing and
trading of options on American Depositary Receipts (``ADRs'') where 50%
or more of the world-wide trading volume of the underlying foreign
security occurs in the U.S. ADR market.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 33252 (November 26, 1993), 58 FR 63604
(December 2, 1993). No comments were received on the proposed rule
change.\3\
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\3\The proposal was amended on January 5, 1994 to clarify the
procedure the Phlx would use to determine whether 50% or more of the
world-wide trading volume of the underlying foreign security occurs
in the U.S. ADR market. Letter from Michele R. Weisbaum, Associate
General Counsel, Phlx, to Monica C. Michelizzi, Staff Attorney,
Office of Derivatives Regulation, Division of Market Regulation
(``Division''), Commission, dated January 5, 1994 (``Amendment No.
1``).
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II. Description
On November 27, 1992, the Commission approved a Phlx proposal to
list and trade ADR options where the underlying foreign security is
subject to a comprehensive surveillance sharing agreement and the
underlying ADR meets or exceeds the Exchange's established uniform
options listing standards.\4\ First, the ADR Approval Order provides
that for ADR options to be eligible for listing and continued trading,
the Phlx must have comprehensive surveillance sharing agreements in
place with the foreign exchanges that serve as the primary markets for
the foreign securities underlying the ADRs, unless the Commission
otherwise approves the options' listing without an agreement. Second,
the Phlx's initial listing standards require that the ADRs underlying
the Exchange-listed options have a ``float'' of 7,000,000 ADRs
outstanding, 2,000 shareholders, trading volume of at least 2,400,000
over the prior twelve month period, and a minimum price of $7\1/2\ for
a majority of the business days during the preceding three month
period. Moreover, options on ADRs must meet or exceed the maintenance
criteria for continued listing under the Phlx rules. Those criteria
require that the ADRs underlying Exchange-listed options maintain a
``float'' of 6,300,000 ADRs, 1,600 shareholders, trading volume of at
least 1,800,000 over the prior twelve month period, and a minimum price
of $5 on a majority of the business days during the preceding six month
period. Additionally, the ADR Approval Order requires the Phlx to make
reasonable inquiry to evaluate the securities underlying the ADRs to
ensure that these securities are generally consistent with the above-
noted listing requirements.
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\4\Securities Exchange Act Release No. 31532 (November 27,
1992), 57 FR 57264 (December 3, 1992) (``ADR Approval Order''). A
comprehensive surveillance sharing agreement provides, among other
things, for the exchange of market trading activity, clearing
activity, and the identity of the ultimate purchaser or seller of
the securities traded.
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Furthermore, the Phlx options initial listing standards require
that the ADR underlying an ADR option be registered and listed on a
national securities exchange or traded through the facilities of a
national securities association and be reported as a national market
system security. The issuers of the ADRs also must be in compliance
with any other applicable requirements of the Act.
The current proposal would authorize the Phlx to list and trade
options on ADRs where 50% or more of the world-wide trading volume in
the underlying foreign security occurs in the U.S. ADR market. The
proposal also provides that the percentage of the world-wide trading
volume that occurs in the U.S. ADR market meet a maintenance standard
of 30% for the ADR options to continue to be trading on the Exchange.
Under the proposal, if the ADR options meet the above-noted criteria,
the options may be listed without the existence of a surveillance
sharing agreement between the Phlx and the primary exchange on which
the foreign securities underlying the ADRs trade.\5\
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\5\Under the proposal, should the ADR option not meet this
numerical standard, the Exchange could not list the ADR option
unless there is a surveillance sharing agreement between the
Exchange and the primary exchange on which the foreign securities
underlying the ADRs trade or the Commission specifically authorized
the listing. The Commission would give such authorization in the
context of approving a rule filing submitted under section 19 of the
Act and Rule 19b-4, thereunder.
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The proposal provides that to determine whether 50% or more of the
world-wide trading volume in the underlying foreign security occurs in
the U.S. ADR market, the Phlx will calculate the trading volume for the
previous three months in the related securities which can affect the
pricing of the foreign security underlying the ADR option.\6\ Under the
proposal, the Phlx will determine that at least 50% of the world-wide
trading volume in a particular foreign security occurs in the U.S. ADR
market if the combined trading volume for ADRs overlying any class of
the foreign issuer's common stock, occurring in the U.S. ADR market, is
not less than 50% of the sum of (1) the combined trading volume for all
classes of the foreign issuer's common stock, and (2) the combined
trading volume for all ADRs overlying any of these classes of stock.\7\
The above-noted calculation also will be used to determine if the
trading volume in the U.S. ADR market falls below 30% of the world-wide
trading volume for the underlying foreign security.\8\
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\6\Under the proposal, such related securities include all
classes of common stock issued by the foreign issuer and ADRs that
overlie any one of these classes of common stock. See Amendment No.
1, supra note 3.
\7\See Amendment No. 1, supra note 3, and telephone conversation
between Michele R. Weisbaum, Associate General Counsel, Phlx, and
Brad Ritter, Attorney, Office of Derivatives Regulation, Division,
Commission, on January 27, 1994.
\8\See Amendment No. 1, supra note 3. Under this calculation,
the trading volume for any U.S. ADR trading on an exchange that is
not part of the U.S. ADR market will be included in the
determination of world-wide trading volume , but not in the
determination of U.S. ADR market trading volume. The Phlx also
represents that it will use its best efforts to discover all markets
(foreign and U.S.) on which the foreign security (and any related
securities) underlying the ADR options trades.
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The proposal also defines the U.S. ADR market as the U.S. self-
regulatory organizations that are members of the Intermarket
Surveillance Group (``ISG'')\9\ and whose markets are linked together
by the Intermarket Trading System (``ITS'').\10\ The U.S. self-
regulatory organizations that currently make up the U.S. ADR market are
the Amex, the BSE, the CBOE, the CHX, the CSE, the NASD, the NYSE, the
PSE, and the Phlx.\11\
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\9\ISG was formed on July 14, 1983 to, among other things,
coordinate more effectively surveillance and investigative
information sharing arrangements in the stock and options markets.
See Intermarket Surveillance Group Agreement, July 14, 1983. The
most recent amendment to the ISG Agreement which incorporates the
original agreement and all amendments made thereafter, was signed by
ISG members on January 29, 1990. See Second Amendment to the
Intermarket Surveillance Group Agreement, January 29, 1990. The
members of the ISG are: the American Stock Exchange, Inc.
(``Amex''), the Boston Stock Exchange, Inc. (``BSE''), the Chicago
Board Options Exchange, Inc. (``CBOE''), the Chicago Stock Exchange,
Inc. (``CHX''), the Cincinnati Stock Exchange, Inc. (``CSE''), the
National Association of Securities Dealers, Inc. (``NASD''), the New
York Stock Exchange, Inc. (``NYSE''), the Pacific Stock Exchange,
Inc. (``PSE''), and the Phlx.
\10\ITS is a communications system designed to facilitate
trading among competing markets by providing each market with order
routing capabilities based on current quotation information. The
system links the participant markets and provides facilities and
procedures for: (1) The display of composite quotation information
at each participant market, so that brokers are able to determine
readily the best bid and offer available from any participant for
multiply trading securities; (2) efficient routing of orders and
sending administrative messages (on the functioning of the system)
to all participating markets; (3) participation, under certain
conditions, by members of all participating markets in opening
transactions in those markets; and (4) routing orders from a
participating market to a participating market with a better price.
The exchanges on which Empresas ADRs trade are ITS participant
markets. The NASD's Computer Assisted Execution System links NASD
market makers, for order routing and execution purposes, to ITS for
ADRs.
\11\See Amendment No. 1, supra note 3.
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III. Discussion
The Commission finds 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)(5).\12\ Specifically, the Commission finds
that allowing options to trade on ADRs, among other things, gives
investors a better means to hedge their positions in the ADRs, as well
as enhanced market timing opportunities.\13\ Further, the pricing of
the ADRs underlying ADR options may become more efficient and market
makers in these ADRs, by virtue of enhanced hedging opportunities, may
be able to provide deeper and more liquid markets.\14\ In sum, options
on ADRs likely engender the same benefits to investors and the market
place that exist with respect to options on common stock.\15\
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\12\15 U.S.C. 78f(b)(5) (1988).
\13\For example, if an investor wants to invest the ADRs but
does not have sufficient cash available until a future date, he can
purchase an ADR option now for less money and exercise the option to
purchase the ADRs at a later date.
\14\See e.g. Report of the Special Study of the Options Markets
to the Securities and Exchange Commission, 96th Cong., 1st Sess.
(Comm. Print No. 96-IFC3, December 22, 1978).
\15\Pursuant to section 6(b)(5) of the Act, the Commission must
predicate approval of any new securities product upon a finding that
the introduction of such new product is in the public interest. Such
a finding would be difficult for a derivative instrument that served
no hedging or other economic function, because any benefits that
might be derived by market participants likely would be outweighed
by the potential for manipulation, diminished public confidence in
the integrity of the markets, and other valid regulatory concerns.
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The Commission also believes that it is appropriate to permit the
Phlx to list and trade options on ADRs given that these options will be
subject to specific requirements related to the protection of
investors. First, Phlx rules require that the ADRs underlying these
options meet the Phlx's uniform options listing standards in all
respects. As described above, this would include the initial and
maintenance criteria. These criteria ensure, among other things, that
the underlying ADRs will maintain adequate price and float to prevent
the ADR options from being readily susceptible to manipulation.
Second, the ADR Approval Order requires that the Phlx make a
reasonable inquiry to evaluate foreign securities underlying the ADR
options to ensure that these securities are generally consistent with
the requirements set forth in the Exchange's options listing standards.
In the ADR Approval Order, the Commission recognized that in some
cases, an ADR underlying an option could meet the options listing
standards while the foreign security on which the ADR is based may not
meet these standards in every respect. For example, in the case of ADRs
overlying certain foreign securities, one ADR could represent several
shares of a specific stock. For this reason, it is possible that the
price of the ADR will meet exchange listing standards even though the
market price of the foreign security underlying the ADR may be less
than the Phlx standard. The Commission believes, however, that
requiring the Phlx to review the foreign securities underlying the ADR
options to ensure that they are generally consistent with the
Exchange's options listing standards, along with other market
safeguards, will adequately protect investors from the possibility that
these ADR options can be potentially manipulated.\16\
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\16\For example, we would expect the Exchange to consider
delisting an option on an ADR if the price and public float of the
underlying security did not meet trading or size maintenance
standards, or if the security underlying the ADR failed to meet
other standards that raised manipulative concerns.
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Third, the Phlx has in place an adequate mechanism for providing
for the exchange of the surveillance information necessary to
adequately detect and deter market manipulation or trading abuses
involving ADR options. Although the proposal does not require the Phlx
to have a comprehensive surveillance sharing agreement in place with
the foreign exchange on which the security underlying the ADR options
trade, the Commission believes that this does not impair the ability of
the Phlx to detect or deter manipulation because the proposal requires
that the 50% or more of the trading activity in the underlying foreign
securities occur in the U.S. ADR market. The Commission notes that
proposal requires the U.S. self-regulatory organizations that
constitute the U.S. ADR market to be members of the ISG, which will
provide for the exchange of necessary surveillance information
concerning trading activity in the ADR options, and the respective
underlying ADR market.\17\
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\17\See Amendment No. 1, supra note 3.
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As a general matter, the Commission believes that the existence of
a surveillance sharing agreement that effectively permits the sharing
of information between an exchange proposing to list an equity option
and the exchange trading the stock underlying the equity option is
necessary to detect and deter market manipulation and other trading
abuses. In particular, the Commission notes that surveillance sharing
agreements providing an important deterrent to manipulation because
they facilitate the availability of information needed to fully
investigate a potential manipulation if it were to occur. These
agreements are especially important in the context of derivative
products based on foreign securities because they facilitate the
collection of necessary regulatory, surveillance and other information
from foreign jurisdictions.
In the context of ADRs, the Commission believes that, in most
cases, the relevant underlying equity market is the primary market on
which the security underlying the ADR trades. This is because, in most
cases, the market for the security underlying the ADR generally is
larger in comparison to the ADR market, both in terms of share volume
and the value of trading. Because of the additional leverage provided
by an option on an ADR, the Commission generally believes that having a
comprehensive surveillance sharing agreement in place, between the
exchange where the ADR option trades and the exchange where the foreign
security underlying the ADR primarily trades, will ensure the integrity
of the marketplace.\18\ The Commission further believes that the
ability to obtain relevant surveillance information, including, among
other things, the identity of the ultimate purchasers and sellers of
securities, is an essential and necessary component of a comprehensive
surveillance sharing agreement.
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\18\See also Securities Exchange Act Release No. 26653 (March
21, 1989), 54 FR 12705 (order approving the trading of options on
the International Market Index (``IMI''), an index comprised of ADRs
traded in the United States based on foreign securities). In this
approval order, the Commission specifically required that there be
comprehensive surveillance sharing agreements in place between the
Amex and the foreign exchanges on which the securities underlying
the ADRs trade so that a substantial percentage of the Index was
covered by comprehensive surveillance sharing agreements.
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Under the current proposal, however, the Commission believes that
it is appropriate to permit the listing of options on an ADR without
the existence of a comprehensive surveillance sharing agreement with
the foreign market where the underlying security trades, as long as the
U.S. market for the underlying ADRs is at least as large as the market
for the underlying foreign security. Specifically, the proposed listing
standards require that a least 50% of the world-wide trading volume in
the underlying foreign security occur in the U.S. ADR market, which
consists of the Amex, the BSE, the CBOE, the CHX, the CSE, the NASD,
the NYSE, the PSE, and the Phlx. The proposal further requires that for
the continued trading of the ADR options the percentage of the world-
wide trading volume occurring in the U.S. ADR market must not fall
below 30%. The Commission believes these standards will ensure that the
relevant pricing market for the options on ADRs is the U.S. ADR market
rather than the foreign market where the security underlying the ADR
trades.
Moreover, the Commission believes that the proposed method for
determining whether the trading volume in the U.S. ADR market meets the
required percentages is adequate to ensure that the U.S. ADR market is
and continues to be the price discovery market for the foreign security
underlying the ADR option. Specifically, the Phlx has represented that
it will calculate the trading volume for the previous three months in
the underlying ADR, the underlying foreign security, and other related
securities which can affect the pricing of the underlying foreign
security.\19\ To list an ADR option without the existence of a
comprehensive surveillance sharing agreement, the proposal requires the
combined trading volume for ADRs overlying any class of the foreign
issuer's stock, occurring in the U.S. ADR market, to be not less than
50% of the combined world-wide trading volume for all classes of the
issuer's stock and all ADRs that overlie any of these classes.\20\
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\19\See supra note 6, and accompanying text.
\20\Id.
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In summary, the Commission believes that in cases where a
substantial percentage of the world-wide trading volume for the
underlying ADR, the underlying foreign security, and other securities
relevant to the pricing of these securities occurs in the U.S. ADR
market,\21\ the U.S. ADR market operates as the price discovery market
for the foreign securities (i.e., stocks and ADRs) underlying the ADR
options. In these cases, the Commission believes that the U.S. ADR
market is the instrumental market for purposes of deterring and
detecting potential manipulation or other abusive trading strategies in
conjunction with transactions in the overlying ADR options market.
Therefore, because the Phlx, and all the other U.S. self-regulatory
agencies which make up the U.S. ADR market are members of the ISG, the
Commission believes that there is an effective surveillance sharing
arrangement to permit the exchanges and the NASD to adequately
investigate any potential manipulations of the ADR options or their
underlying securities.
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\21\We note that it is appropriate to view the U.S. ADR market
as a single market even though it is made up of several national
securities exchanges and the NASD. The Commission notes that all of
the markets on which or through which these ADRs could trade are
linked together by ITS. The Commission further notes that, one
market, the NYSE, typically operates as the primary exchange on
which trades in U.S. ADRs are executed.
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The Commission finds good cause for approving Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Amendment No. 1 merely clarifies how the Phlx will determine whether
not less than 50% (or less than 30%, in the case of the maintenance
standard) of the world-wide trading volume in the underlying foreign
security (as represented by ADRs, common stock and any other related
securities) occurs in the U.S. ADR market. The Commission believes that
this amendment strengthens the proposal by ensuring that the standard
will be applied consistently by all the markets seeking to list ADR
options and raises no new issues.
Accordingly, because the Commission believes that the amendment
makes clarifying, non-substantive changes to the proposal, the
Commission finds that it is consistent with sections 19(b)(2) and
6(b)(5) of the Act\22\ to approve Amendment No. 1 to the Amex's
proposal on an accelerated basis.
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\22\15 U.S.C. 78s(b)(2) and 78f(b)(5) (1988).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 20549. 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 Section, 450 Fifth Street, NW., Washington, DC. Copies of
such filing will also be available for inspection and copying at the
principal office of the above-mentioned self-regulatory organization.
All submissions should refer to the file number in the caption above
and should be submitted by February 28, 1994.
It is therefore ordered, Pursuant to section 19(b)(2) of the
Act,\23\ that the proposed rule change (File No. SR-Phlx-93-54) is
approved, effective February 7, 1994. Accordingly, the Exchange may
submit listing certificates for ADR options as specified herein on
February 7, 1994 pursuant to Rule 12d1-3 under the Act and commence
trading in the options according to the time parameters established in
the Joint Options Listing Procedures Plan.
\23\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\24\
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\24\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2711 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M