[Federal Register Volume 59, Number 34 (Friday, February 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3701]


[[Page Unknown]]

[Federal Register: February 18, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33610; File No. SR-Phlx-93-37]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc., Relating to the 
Exercise Cut-Off Procedure for Equity Options Contracts

February 9, 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 
20, 1993, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Phlx. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Rule 196-4 of the Act, proposes to amend Phlx 
Rule 1042 (Exercise of Option Contracts) by incorporating a new 
exercise cut-off procedure.
    Specifically, the Exchange proposes to require that an option 
holder's final exercise decision (i.e., whether or not to exercise an 
expiring equity option)\1\ be indicated to the Exchange by either 
submitting a Contrary Exercise Advice (``Advice'') form (to a 
designated place at the Exchange or to the Options Clearing Corporation 
(``OCC'') pursuant to OCC procedures) or by choosing to rely on OCC's 
exercise-by-exception procedure, which automatically makes an exercise 
determination for applicable option holders.\2\ The deadline for the 
submission of a final exercise decision would remain at 5:30 p.m. 
Eastern Standard Time on the business day immediately preceding the 
expiration date (``exercise cut-off time'').
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    \1\The term ``final exercise decision'' would generally replace 
the term ``exercise instructions'' in the amended rule.
    \2\Specifically, exercise-by-exception is the system which 
allows OCC clearing members to exercise in-the-money options at 
expiration which are at or above the predetermined threshold without 
submitting input entries into OCC. See OCC Rule 805.
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    To implement this new procedure, proposed Rule 1042(b) would 
require members and member organizations to take steps to ensure that 
final exercise decisions respecting their proprietary positions, and 
the positions of members and non-members for whom the responsibility to 
make such indications has been accepted by them, are properly indicated 
to the Exchange. In addition, to allow time for processing, each member 
organization would be required to establish a deadline prior to the 
exercise cut-off time after which it will no longer accept final 
exercise decisions in expiring equity options from customers.
    Rule 1042(b) will continue to provide the following exceptions to 
the exercise cut-off procedure: (i) To remedy mistakes made in good 
faith; (ii) to respond to a failure to reconcile an unmatched Exchange 
option transaction; and (iii) where exceptional circumstances 
restricted either a customer's ability to inform the respective member 
organization or a member organization's ability to receive final 
exercise decisions before the exercise cut-off time.\3\ The current 
exception respecting foreign currency options is proposed to be deleted 
and replaced with Commentary .03 to Rule 1042, which provides that Rule 
1042(b) does not apply to foreign currency options or index options. In 
this regard, the following new title to Rule 1042 is proposed: 
``Exercise of Equity Option Contracts.''
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    \3\Under the current rule, only a customer's ability to send and 
a member's ability to receive final exercise decisions could serve 
as an exception. Because a customer can submit exercise decisions to 
a member organization who in turn submits them to OCC, that member 
organization's ability to receive the customer's decision can also 
qualify as an exemption under the rule. Under the proposal, a 
member's ability to send decisions could also qualify as an 
exception.
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    In addition, Rule 1042 as amended would require that a memorandum 
setting forth the circumstances surrounding the exercise be prepared 
and a copy filed with the Exchange's Market Surveillance Department in 
any instance of an equity option exercise not submitted 
``automatically'' through OCC's exercise-by-exception procedure, and 
for which a Contrary Exercise Advice was either not timely submitted or 
amended after the exercise cut-off time. Each such memorandum must 
reflect the time the final exercise decision was made, or in the case 
of a customer, the time the final exercise decision was received, and 
must be kept in accordance with SEC Rules 17a-3(a)(6) and 17a-4. Under 
the proposal, all of the exceptions listed in Rule 1042(b) would 
require a written memorandum setting forth the circumstances giving 
rise to the exception.\4\
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    \4\Rule 1042 currently only requires a memorandum with respect 
to the first and third exception to the Rule. See Rule 1042, 
Commentary .02.
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    Pursuant to the proposed rule change, the burden of establishing an 
exception would rest solely on the member or member organization 
seeking to rely on one of the exemptive provisions. Current procedure 
requires clearing organizations to record the receipt of exercise 
decisions in connection with the exercise cut-off rule. The proposed 
procedure would allow members to either submit Contrary Exercise 
Advices directly to the Exchange or to the firm responsible for 
processing such Advices on their behalf. Thus, since members would have 
the ability to submit Advices directly to the Exchange, it is the 
member (and not necessarily the clearing agent) who must establish that 
an exception relied upon by that member is consistent with the rule. To 
address possible instances where no Advice is submitted while an 
exercise notice is nonetheless tendered for a strike price outside the 
exercise-by-exception parameters and where none of the exceptions 
apply, Commentary .02 specifies that such exercises would be deemed 
conduct inconsistent with just and equitable principles of trade if 
effected on the basis of material information obtained after the 
exercise cut-off time.
    The Exchange notes that the exercise cut-off time as well as the 
actual exercise procedure remain unchanged, including the submission of 
exercise notices to OCC contained in Rule 1042(a), which would still be 
governed by OCC rules.\5\ In this regard, Commentary .01 as amended 
expressly states that the reporting of final exercise decisions 
pursuant to Rule 1042 does not serve to substitute as the effective 
``exercise notice'' to OCC regarding the exercise or non-exercise of 
expiring equity options. A technical amendment changing several 
references in Rule 1042(a) to read ``OCC'' is also proposed herein.
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    \5\See generally OCC rules and Phlx Rules 1002, 1004, and 1005.
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    The text of the proposed rule change is available at the Office of 
the Secretary, the Phlx, 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 Exchange 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 Phlx 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 the 
Statutory Basis for, the Proposed Rule Change

    Phlx Rule 1042 governs the exercise of option contracts traded on 
the Exchange. Specifically, Rule 1042(a) refers to OCC rules and 
procedures regarding the actual exercise of option contracts as well as 
the submission of exercise notices to OCC for trade dates prior to the 
last day of business prior to expiration. Rule 1042(b) concerns the 
exercise cut-off time and submission of exercise instructions to the 
Exchange for expiring options on the last day of trading in such 
options. At this time, the Phlx proposes to incorporate a new exercise 
cut-off procedure into Rule 1042, featuring the use of a Contrary 
Exercise Advice for the submission of final exercise decisions and the 
ability to submit such Advices directly to the Exchange. The Exchange 
represents that the purposes behind these amendments are to bolster the 
audit trail requirements of Rule 1042, to incorporate a more convenient 
process for members to indicate exercise intentions to the Exchange, 
and to further ensure that the exercise cut-off time efficiently 
provides a level playing field among market participants with respect 
to final exercise decisions.
    The new procedure would enable option holders to bypass the 
clearing firm when submitting a Contrary Exercise Advice directly to 
the Exchange. The Exchange will designate a place on the trading floor 
for the submission of these Advices, similar to the current procedure 
for the submission of index option exercise notices.\6\ In those 
instances where a member holding an expiring option submits an Advice 
directly to the Exchange, the responsibility for the timely and proper 
submission of such Advice shifts from the option holder's clearing 
agent to the option holder himself. For example, a Registered Option 
Trader's (``ROT'') clearing agent would not be held responsible for 
direct submissions by the ROT to the Exchange.
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    \6\See Phlx Rule 1042A and Floor Procedure Advice G-1.
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    Under the proposal, Exchange members would still be able to submit 
their final exercise decisions, on a Contrary Exercise Advice, to the 
respective clearing member. The clearing member would then be required 
to either submit the Advice directly to the Exchange at the designated 
place or to OCC pursuant to OCC procedures, and would be required to do 
so prior to the exercise cut-off time. Regardless of to whom the 
submission is made, the Exchange believes that the proposed changes 
would result in an efficient audit trail being generated for purposes 
of identifying late entries. The Exchange believes the proposal would 
constitute an important change in current procedures by enabling a 
self-regulatory organization (``SRO'') to confirm the timeliness of 
option exercise instruction submissions.
    The Exchange further believes that the proposed memorandum 
requirement of Rule 1042 should also bolster the Exchange's audit trail 
by requiring that a memorandum be prepared and filed with the 
Exchange's Market Surveillance Department detailing the circumstances 
surrounding any non-automatic exercise that was not submitted on a 
Contrary Exercise Advice in a timely manner. In addition, with respect 
to the exceptions to the exercise cut-off procedure, the Exchange 
believes that the proposed change expressly stating that the burden of 
establishing such an exception lies with the person seeking the 
exception should also improve the Exchange's ability to surveil for 
violations of the procedure.
    The Exchange believes that the proposed changes to the exercise 
cut-off procedure for expiring equity options reflect a coordinated 
effort among the options exchanges and OCC. Accordingly, because the 
Phlx expects similar proposed rule changes to be filed with the 
Commission in the near future,7 uniformity among options exchanges 
should help option holders and other members adjust to the new 
procedure and incorporate the changes into their respective procedures. 
In this regard, the Exchange will recognize Contrary Exercise Advices 
submitted to other national options exchanges for any option listed 
both on the Phlx and that other exchange.
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    \7\See, e.g., File No. SR-Amex-94-01.
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    The Exchange believes that the proposed rule change is consistent 
with section 6 of the Act in general, and with 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, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, and to protect investors and the public interest. 
Specifically, the Exchange believes that consistent with section 
6(b)(5) of the Act, the proposed change to Rule 1042 should improve the 
Exchange's ability to surveil for violations of the exercise cut-off 
time because the submission of Contrary Exercise Advices directly to 
the Exchange as well to OCC should provide an accurate audit trail to 
identify late entries. In addition, the Exchange believes that the 
proposed procedure should reduce the onus on clearing firms of 
collecting exercise instructions, because the new procedure will enable 
option holders to bypass the clearing firm by submitting a Contrary 
Exercise Advice directly to the Exchange.
    In summary, the Exchange believes that Phlx investigations into 
late entries of exercise decisions should ensure compliance with Rule 
1042, and, accordingly, promote just and equitable principles of trade.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any burden on competition.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. 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 Phlx. All 
submissions should refer to File No. SR-Phlx-93-37 and should be 
submitted March 11, 1994.

    For the Commission, by the Division of market Regulation, 
pursuant to delegated authority.8
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    \8\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-3701 Filed 2-17-94; 8:45 am]
BILLING CODE 8010-01-M