[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: 94-2716]


[[Page Unknown]]

[Federal Register: February 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33554; International Series Release No. 633; File No. 
SR-CBOE-93-38]

 

Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving, and Notice of Filing and Order Granting 
Accelerated Approval of Amendment Nos. 1 and 2 to, a Proposed Rule 
Change Relating to the Listing of Options on American Depositary 
Receipts

January 31, 1994.

I. Introduction

    On September 21, 1993, the Chicago Board Options Exchange, Inc. 
(``CBOE'' 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. 78(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. 33102 (October 25, 1993), 58 FR 58356 
(November 1, 1993). No comments were received on the proposed rule 
change.\3\
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    \3\Two amendments were made to the proposal. First, the proposal 
was amended on October 25, 1993 to delete a sentence from the 
proposed rule that defined an ``effective surveillance agreement'' 
as an agreement that meets the standards for effectiveness 
established by the Commission. Letter from William J. Barclay, Vice 
President, Strategic Planning and International Development, CBOE, 
to Richard L. Zack, Branch Chief, Office of Derivatives Regulation, 
Division of Market Regulation (``Division''), Commission, dated 
October 25, 1993 (``Amendment No. 1''). Second, the proposal was 
amended on January 26, 1994 to clarify the procedure the CBOE would 
use to determine whether the 50% of the world-wide trading volume of 
the underlying foreign security occurs in the U.S. ADR market. 
Letter from Richard G. DuFour, Executive Vice President, CBOE, to 
Richard L. Zack, Branch Chief, Office of Derivatives Regulation, 
Division, Commission, dated January 26, 1994 (``Amendment No. 2'').
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II. Description

    On November 27, 1992, the Commission approved a CBOE 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 CBOE 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 CBOE'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 CBOE 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 CBOE 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. 31531 (November 27, 
1992), 57 FR 57250 (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 CBOE 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 CBOE 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 CBOE 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 CBOE 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 CBOE 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 letter from 
Richard G. DuFour, Executive Vice President, CBOE, to Richard L. 
Zack, Branch Chief, Office of Derivatives Regulation, Division, 
Commission, dated January 26, 1994 (``ADR Letter'').
    \7\See ADR Letter, supra note 6, and telephone conversation 
between Richard G. DuFour, Executive Vice President, CBOE, and Brad 
Ritter, Attorney, Office of Derivatives Regulation, Division, 
Commission, on January 27, 1994.
    \8\See ADR Letter, supra note 6. 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 CBOE 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 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 
Philadelphia Stock Exchange, Inc. (``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 
multiple 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 ADR Letter, supra note 6.
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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 in 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 
CBOE to list and trade options on ADRs given that these options will be 
subject to specific requirements related to the protection of 
investors. First, CBOE rules require that the ADRs underlying these 
options meet the CBOE'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 CBOE 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 CBOE standard. The Commission believes, however, however, that 
requiring the CBOE 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 CBOE 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 CBOE 
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 CBOE to detect or deter manipulation because the proposal requires 
that 50% or more of the trading activity in the underlying foreign 
securities occur in the U.S. ADR market. The Commission notes the 
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 ADR Letter, supra note 6.
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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 provide 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), 52 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 50% or more 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 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 CBOE 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 CBOE, 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 Amendments Nos. 1 and 
2 to the proposed rule change prior to the thirtieth day after the date 
of publication of notice of filing thereof in the Federal Register. 
First, Amendment No. 1 deletes, from the proposal, a sentence that 
defines an ``effective surveillance sharing agreement'' as an agreement 
that meets the standards for effectiveness established by the 
Commission. The Commission believes that this definition has little 
substantive effect on the proposal and could create confusion in light 
of the fact that the Division classifies surveillance sharing 
agreements as either comprehensive or market information agreements.
    Second, Amendment No. 2 merely clarifies how the CBOE 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 amendments 
make 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 Nos. 1 and 2 to the CBOE'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 Nos. 1 and 2 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-CBOE-93-38) 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. 94-2716 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M