[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: 94-2717]


[[Page Unknown]]

[Federal Register: February 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33551; International Series Release No. 630; File No. 
SR-PSE-93-33]

 

Self-Regulatory Organizations; Filing and Order Granting 
Accelerated Approval of Proposed Rule Change and Amendment No. 1 to the 
Proposed Rule Change by the Pacific Stock Exchange, Inc. Relating to 
the Listing of Options on American Depositary Receipts

January 31, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December 
2, 1993, the Pacific Stock Exchange, Inc., (``PSE'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by the self-regulatory organization. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.\1\
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    \1\The proposal was amended on December 28, 1993 to clarify the 
procedure the PSE 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 Michael D. Pierson, Senior 
Attorney, Market Regulation, PSE, to Richard Zack, Branch Chief, 
Office of Derivatives Regulation, Division of Market Regulation 
(``Division''), Commission, dated December 28, 1993 (``Amendment No. 
1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The PSE proposes to amend Rules 3.6 and 3.7 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. The text of 
the proposal is available at the Office of the Secretary, PSE 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 self-regulatory organization 
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 self-regulatory organization 
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

    On November 27, 1992, the Commission approved a PSE 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.\2\ First, the ADR Approval Order provides 
that for ADR options to be eligible for listing and continued trading, 
the PSE 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 PSE'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 PSE 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 PSE 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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    \2\Securities Exchange Act Release No. 31530 (November 27, 
1992), 57 FR 57262 (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 PSE 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 PSE 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 PSE and the primary exchange on which the 
foreign securities underlying the ADRs trade.\3\
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    \3\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 securities occurs 
in the U.S. ADR market, the PSE 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.\4\ Under 
the proposal, the PSE will determine that 50% or more 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.\5\ 
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.\6\
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    \4\Under the proposal, such related securities include all 
classes of common stock issued by the foreign issuer and ADRs that 
overly any one of these classes of common stock. See Regulation, 
PSE, to Richard Zack, Branch Chief, Office of Derivatives 
Regulation, Division, Commission, dated December 28, 1993 (``ADR 
Letter'').
    \5\See ADR Letter, supra note 4, and telephone conversation 
between Michael D. Pierson, Senior Attorney, Market Regulation, PSE, 
and Brad Ritter, Attorney, Office of Derivatives Regulation, 
Division, Commission, on January 27, 1994.
    \6\See ADR Letter, supra note 4. 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 PSE 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'')\7\ and whose markets are linked together 
by the Intermarket Trading System (``ITS'').\8\ 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.\9\
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    \7\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 PSE, and the Philadelphia 
Stock Exchange, Inc. (``Phlx'').
    \8\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.
    \9\See ADR Letter, supra note 4.
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    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act,\10\ in general, and furthers the 
objectives of Section 6(b)(5), in particular, in that it is designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system.
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    \10\15 U.S.C. 78f(b) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    The PSE believes that the proposed rule change will not impose a 
burden on competition.

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

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The Exchange has requested that the proposed rule change be given 
accelerated effectiveness pursuant to Section 19(b)(2) of the Act.\11\
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    \11\15 U.S.C. 78f(b)(2) (1988).
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    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 
PSE to list and trade options on ADRs given that these options will be 
subject to specific requirements related to the protection of 
investors. First, PSE rules require that the ADRs underlying these 
options meet the PSE'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 PSE 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 PSE standard. The Commission believes however, that requiring 
the PSE 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 PSE 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 PSE 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 PSE 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 4.
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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), 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 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 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 PSE 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 4, 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 PSE, 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 the proposed rule 
change, including 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.
    The PSE proposal to list and trade ADR options where 50% or more of 
the world-wide trading volume of the underlying foreign security occurs 
in the U.S. ADR market is identical to proposals by the Amex, CBOE, and 
Phlx to provide for the listing of ADR options that meet this uniform 
standard.\22\ The Amex, CBOE, and Phlx proposals were subject to a full 
notice and comment period and no comments were received.\23\
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    \22\Securities Exchange Act Release Nos. 33102 (October 25, 
1993), 58 FR 58356 (November 1, 1993) (SR-CBOE-93-38), 33103 
(October 25, 1993), 58 FR 58357 (November 1, 1993) (SR-Amex-93-28), 
and 33252 (November 26, 1993), 58 FR 63604 (December 2, 1993) (SR-
Phlx-93-54).
    \23\Although Amendment No. 1 to the proposal was not part of the 
Amex, CBOE, and Phlx proposals when they were noticed for comment, 
the Commission notes that Amendment No. 1 merely clarifies how the 
PSE 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 does not 
make a substantive change to the proposal and, thus, raises no new 
issues. Further, the Commission believes that the Amendment 
strengthens the proposal by ensuring that the standard will be 
applied consistently by all the markets seeking to list ADR options.
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    The Commission further notes that approving the current proposal, 
including Amendment No. 1, on an accelerated basis will permit the PSE 
to compete on an equal basis with the other options exchanges for 
orders in ADR options. Accordingly, since the Commission finds that the 
current proposal involves the exact same issues as the above-noted 
proposals, the Commission believes it is consistent with Sections 
19(b)(2) and 6(b)(5) of the Act\24\ to approve the PSE's proposal on an 
accelerated basis.
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    \24\  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 the proposed rule change, including 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,\25\ that the proposed rule change (SR-PSE-93-33) 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.

    \25\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.\26\
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    \26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2717 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M