[Federal Register Volume 59, Number 58 (Friday, March 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-7077]


[[Page Unknown]]

[Federal Register: March 25, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33783; File No. SR-NASD-94-07]

 

Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc., Relating to an Extension and 
Expansion of a Position Limit Hedge Exemption Pilot Program

March 18, 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 February 
9, 1994, the National Association of Securities Dealers, Inc. 
(``NASD''), filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change as described in Items I and II 
below, which items have been prepared by the NASD. 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 NASD is proposing to amend Section 3 of Appendix E (``Section 
3'') to the NASD's Rules of Fair Practice (``Rules'') to extend, until 
December 31, 1995, the NASD's pilot program for exemptions from equity 
option position limits for certain hedged positions (``hedge exemption 
pilot program''). The NASD also proposes to amend section 3 of the 
Rules to expand the hedge exemption pilot program to provide that the 
underlying hedged equity position may be comprised of securities 
readily convertible into or economically equivalent to the stock 
underlying the corresponding hedging options position. In addition, the 
NASD proposes to add a new example to the list of examples contained at 
the end of section 3(a) of the Rules to illustrate the operation of the 
position limit hedge exemption. The text of the proposed rule change is 
available at the Office of the Secretary, NASD, 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 NASD included statements 
concerning the purpose of and basis for the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in section 
(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 February 9, 1990, the Commission approved an NASD proposal to 
implement a two-year pilot program during which certain fully hedged 
equity option positions would be automatically exempt from established 
position and exercise limits.\1\ Specifically, the hedge exemption 
pilot program provides for an automatic exemption from equity option 
position limits for accounts that have established one of the four most 
commonly used hedged positions on a limited one-for-one basis (i.e., 
the number of shares represented by one options contract). The exempted 
positions are: (1) Long stock and short calls; (2) long stock and long 
puts; (3) short stock and long calls; and (4) short stock and short 
puts. Under the hedge exemption pilot program, the largest options 
position (combining hedged and unhedged positions) that may be 
established may not exceed twice the basic position limit.\2\ In 
addition, the hedge exemption pilot program does not change the 
exercise limits contained in the Rules.\3\ Therefore, market 
participants are allowed to exercise, during any five consecutive 
business days, the same number of options contracts set forth as the 
position limit for that option, including those options positions that 
are hedged.
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    \1\See Securities Exchange Act Release No. 27697 (February 9, 
1990), 55 FR 5535 (February 15, 1990). Position limits impose a 
ceiling on the number of equity option contracts in each class on 
the same side of the market (i.e., aggregating long calls and short 
puts, and long puts and short calls) that can be held or written by 
an investor or group of investors acting in concert. Exercise limits 
restrict the number of options contracts which an investor or group 
of investors acting in concern can exercise within five consecutive 
business days.
    \2\See Section 3 of the NASD Rules.
    \3\See Section 4 of Appendix E of the Rules.
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    The NASD is proposing three amendments to the hedge exemption pilot 
program. First, because the hedge exemption pilot program expired on 
February 9, 1992, the NASD is proposing to re-implement the pilot 
program until December 31, 1995. In addition, in order to avoid future 
lapses in the hedge exemption pilot program, the NASD proposes to 
incorporate this expiration date into its Rules in a new subsection (c) 
to section 3.
    Second, the NASD proposes to amend Section 3 of the Rules to expand 
the hedge exemption pilot program to provide that in addition to stock, 
the underlying hedged security position may be comprised of securities 
readily convertible into or economically equivalent to the security 
underlying the corresponding hedging options position. The NASD 
believes that expanding the hedge exemption pilot program in this 
manner is appropriate and consistent with the Act because it would 
allow investors to hedge instruments that are economically equivalent 
to stocks more efficiently and effectively. Specifically, because the 
NASD believes that the value of such a security likely will fluctuate 
in tandem with the value of the security into which it is convertible 
or economically equivalent, the NASD believes investors with positions 
in these securities should be able to hedge their positions with equity 
options to the same extent that investors with long or short positions 
in the underlying security can.\4\ In addition, because the hedge 
exemption pilot program requires the positions in the convertible or 
economically equivalent securities and the corresponding options to be 
fully hedged, the NASD believes that the expansion of the pilot program 
will not significantly increase concerns regarding intermarket 
manipulations or disruptions of either the options markets or the 
underlying stock market.
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    \4\In this connection, the NASD will determine on a case-by-case 
basis whether an instrument that is being used as the basis for the 
underlying hedged position is readily convertible into or 
economically equivalent to the security underlying the corresponding 
options position. Further, the NASD will find that an instrument 
that is not presently convertible into a security, but which will be 
at a future date, is not a ``convertible'' security for purposes of 
the hedge exemption pilot program. In addition, the NASD notes that 
if a convertible security used to hedge an options position is 
called for redemption by the issuer, the security would have to be 
converted into the underlying security immediately or the 
corresponding option position reduced accordingly.
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    Third, the NASD proposes to add a new example to the list of 
examples contained at the end of Section 3 of the Rules to illustrate 
the operation of the position limit hedge exemption. The NASD believes 
that this example will serve to avoid investor confusion concerning the 
hedge exemption pilot program.
    The NASD believes that the proposed rule change is consistent with 
section 15A(b)(6) of the Act\5\ in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. Specifically, 
the NASD believes that the proposed extension and expansion of the 
hedge exemption pilot program may increase the depth and liquidity of 
the options markets by permitting investors to hedge greater amounts of 
stock than would otherwise be the case without the hedge exemption. At 
the same time, the NASD represents that the higher position limits 
available by virtue of the hedge exemption pilot program have not 
resulted in disruptions of the underlying stock markets due to 
restrictions in those markets and the NASD's surveillance program. In 
this connection, the NASD will continue to monitor the use of the 
position limit hedge exemption to ensure that NASD members are 
complying with the requirements of the exemption. The NASD also will 
continue to monitor the market effects, if any, from the position limit 
hedge exemptions.
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    \5\15 U.S.C. 78o-3(b)(6) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD 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 by the NASD with 
respect to the proposed rule change.

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

    The NASD has requested that the proposed rule change be given 
accelerated effectiveness pursuant to Section 19(b)(2) of the Act.
    The Commission finds that the proposed rule change to extend the 
hedge exemption pilot program 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 15A(b)(6) thereunder.\6\ Specifically, the Commission 
concludes, as it did when originally approving the hedge exemption 
pilot program that providing for increased position and exercise limits 
for equity options in circumstances where those excess positions are 
fully hedged with offsetting stock positions will provide greater depth 
and liquidity to the market and allow investors to hedge their stock 
portfolios more effectively, without significantly increasing concerns 
regarding intermarket manipulations or disruptions of either the 
options market or the underlying stock market.
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    \6\Id.
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    In addition, with respect to the NASD's proposal to expand the 
types of securities eligible to serve as the basis for the underlying 
hedge position to include convertible securities and securities 
economically equivalent to the stock underlying the corresponding 
hedging options position, the Commission continues to believes, as it 
did in approving similar proposals by the options exchanges,\7\ that 
such expansion is consistent with the Act because it will allow 
investors to use instruments that are economically equivalent to stocks 
more efficiently and effectively for purposes of hedging their equity 
options positions.\8\ Specifically, the Commission concurs with the 
NASD's belief that because the value of a convertible security or a 
security economically equivalent to the stock underlying a 
corresponding hedging options position likely will fluctuate in tandem 
with the value of the security that it is convertible into or 
economically equivalent to, investors with positions in such securities 
should be able to hedge their positions in equity options with those 
securities to the same extent that investors with long or short 
positions in the underlying securities can. Moreover, as with the 
original hedge exemption pilot program,\9\ the Commission believes the 
expansion of the pilot program in this manner likely will enhance the 
depth and liquidity in the options markets. In addition, because the 
hedge exemption pilot program still requires the positions in the 
securities and the corresponding options to be fully hedged, the 
Commission believes the expansion will not significantly increase 
concerns regarding intermarket manipulation or disruption of either the 
options markets or the underlying stock market.
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    \7\See, e.g., Securities Exchange Act Release No. 32904 
(September 14, 1993), 58 FR 49339.
    \8\See supra note 4.
    \9\See supra note 1.
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    With respect to the proposed example to be added to section 3 of 
the Rules, the Commission believes the example may serve to avoid 
investor confusion concerning the hedge exemption pilot program.
    The Commission also notes that before the hedge exemption pilot 
program can be approved on a permanent basis, the NASD Must provide the 
Commission with a report on the operation of the pilot program. 
Specifically, the NASD must provide the Commission with details on (1) 
the frequency with which the exemptions have been used; (2) the types 
of investors using the exemptions; (3) the size of the positions 
established pursuant to the hedge exemption pilot program; (4) what 
types of convertible or economically equivalent securities are being 
used to hedge positions and how frequently such securities have been 
used to hedge; (5) whether the NASD has received any complaints on the 
operation of the hedge exemption pilot program; (6) whether the NASD 
has taken any disciplinary action against, or commenced any 
investigations, examinations, or inquiries concerning, any of its 
members for any violation of any term or condition of the hedge 
exemption pilot program; (7) the market impact, if any, of the hedge 
exemption pilot program; and (8) how the NASD has implemented 
surveillance procedures to ensure compliance with the terms and 
conditions of the hedge exemption pilot program. In addition, the 
Commission expects the NASD to inform the Commission of the results of 
any surveillance investigations undertaken for apparent violations of 
the provisions of the hedge exemption pilot program.
    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register so that the hedge 
exemption pilot program can be re-implemented without further delay and 
to help avoid any potential investor confusion concerning the 
availability of the hedge exemption as a result of the lapse of the 
pilot program. The Commission notes that the NASD has not experienced 
any significant problems with the hedge exemption pilot program since 
its inception and that the NASD will continue to monitor the pilot 
program to ensure that no problems arise. Moreover, no adverse comments 
have been received by the NASD concerning the hedge exemption pilot 
program since its implementation. Additionally, the proposal to expand 
the hedge exemption pilot program to include convertible securities and 
securities economically equivalent to the stock underlying the 
corresponding hedging options position is substantively similar to 
proposals previously approved by the Commission for the options 
exchanges.\10\ Finally, the proposed example to be added to section 3 
of the Rules merely serves to clarify the operation of the hedge 
exemption pilot program and is not a substantive rule change. As a 
result, because of the importance of maintaining the quality and 
efficiency of the securities markets, the Commission believes good 
cause exists for approving the extension and expansion of the NASD's 
hedge exemption pilot program on an accelerated basis.
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    \10\See supra note 7.
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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 at the 
Commission's Public Reference Section, 450 Fifth Street, NW., 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-94-07 and should be 
submitted by April 15, 1994.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\11\ that the proposed rule change (File Nos. SR-NASD-94-07), is 
approved and, accordingly, the hedge exemption pilot program as 
expanded herein, is extended until December 31, 1995.

    \11\15 U.S.C. 78s(b)(2) (1982).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\17 CFR 200.30-3(a)(12) (1992).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-7077 Filed 3-24-94; 8:45 am]
BILLING CODE 8010-01-M