[Federal Register Volume 59, Number 164 (Thursday, August 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20896]
[[Page Unknown]]
[Federal Register: August 25, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34546; File No. SR-Phlx-94-02]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to the
Listing and Trading of Options and Long-Terms Options on the Phlx
Semiconductor Index
August 18, 1994.
I. Introduction
On January 5, 1994, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), 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 index options on the Phlx Semiconductor Index
(``Semiconductor Index'' or ``Index''). The Exchange filed Amendment
No. 1 to the proposed rule change on January 14, 1994,\3\ Amendment No.
2 on April 26, 1994,\4\ and Amendment No.; 3 on May 20, 1994.\5\ Notice
of the proposal, as amended, appeared in the Federal Register on July
12, 1994.\6\ This order approves the Exchange's proposal, as amended.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\In Amendment No. 1, the Phlx proposes: (1) To correct the
description of the formula for calculating the value of the Index;
(2) to set the exercise prices at 5 point intervals instead of 2\1/
2\ point intervals; (3) to provide that if the number of components
in the Index increases to more than 21 components or decreases to
less than 11 components, the Exchange shall submit a rule filing to
the Commission pursuant to Section 19(b)(4) of the Act; (4) to
require that the components of the Index will be required to be
listed for trading on the New York Exchange (``NYSE'') or the
American Stock Exchange (``Amex'') (non-ECM), or traded as National
Market (``NM'') securities through the facilities of the National
Association of Securities Dealers, Inc. (``NASD'') Automated
Quotation system (``NASDAQ''); and (5) to list long-term options on
the Index that expire 12 to 36 months from the date of issuance
(``LEAPS''). See Letter from William Uchimoto, General Counsel,
Phlx, to Richard Zack, Branch Chief, Office of Market Supervision
(``OMS''), Division of Market Regulation (``Division''), SEC, dated
January 14, 1994.
\4\In Amendment No. 2, the Phlx proposes to: (1) Provide that
the index will be updated during the trading day at least once every
15 seconds, rather than once every minute; (2) specify that the
expiration cycle applicable to options of the index will be three
expiration months from the March, June, September, December cycle
plus two additional near-term months; (3) provide that additional
exercise prices will be added pursuant to Rule 1101A rather than
Rule 1012; and (4) clarify the Exchange's obligations with respect
to delisting and replacing components of the components of the
Index. See Letter from Michele R. Weisbaum, Associate General
Counsel, Phlx, to Michael Walinskas, Branch Chief, OMS, Division,
SEC, dated April 26, 1994.
\5\In Amendment No. 3 to the proposal, the Exchange provides
that the Index will be maintained so that if any time, less than 90%
of the component issues by weight are eligible for exchange options
trading, the Exchange will submit a Rule 19b-4 filing to the
Commission before opening any new series of options on the Index for
trading. See Letter from Michele R. Weisbaum, Associate General
Counsel, Phlx, to Brad Ritter, Attorney, OMS, Division, SEC, dated
May 20, 1994.
\6\See Securities Exchange Act Release No. 34307 (July 5, 1994),
59 FR 35549 (July 12, 1994).
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II. Description of Proposal
A. General
The Phlx proposes to list for trading options on the Phlx
Semiconductor Index, a new securities index developed by the Phlx and
based on U.S. stocks representing the semiconductor industry that are
traded on the NYSE or the AMEX, or are NM securities traded through the
facilities of NASDAQ. The Phlx also proposes to list LEAPS on the full-
value Index (``Index LEAPS''). Semiconductor Index LEAPS will trade
independent of and in addition to regular Semiconductor Index options
traded on the Exchange; however, as discussed below, position and
exercise limits of Index LEAPS and regular Index options will be
aggregated. The Phlx will use a price-weighted methodology to calculate
the value of the Index.\7\
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\7\See infra Section II.E, entitled ``Calculation of the
Index,'' for a description of this calculation method.
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B. Composition of the Index
The Index was designed by the Exchange and is presently composed of
16 highly capitalized and widely held common stocks of U.S. companies
that are primarily involved in the design, manufacture, sale, and
distribution of semiconductors used in computer and other electronic
device manufacturing. Six of these securities currently trade through
NASDAQ as NM securities, and ten trade on the NYSE. All component
stocks are ``reported securities,'' as that term is defined in Rule
11a3-1 of the Act.\8\ The Index is price-weighted and will be
calculated on a real-time basis using last sale prices.
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\8\See 17 CFR 240.11Aa3-1. A ``reported security'' is defined in
paragraph (a)(4) of this rule as ``any listed equity security or
NASDAQ security for which transaction reports are required to be
made on a real-time basis pursuant to an effective transaction
reporting plan.'' A ``transaction reporting plan'' is defined in
paragraph (a)(2) of this rule as ``any plan for collecting,
processing, making available or disseminating transaction reports
with respect to transactions in reported securities filed with the
Commission pursuant to, and meeting the requirements of, this
section.''
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As of the close of trading on July 21, 1994, the Index was valued
at 237.19. As of July 8, 1994, the market capitalizations of the
individual securities in the Index ranged from a high of $25.0 billion
to a low of $317.8 million, with the mean being $4.8 billion. The
market capitalization of all the securities in the Index was $76.8
billion. The total number of shares outstanding on that date for the
stocks in the Index ranged from a high of 557.2 million shares to a low
of 15.7 million shares. Also on that date, the price per share in the
U.S. of the securities in the Index ranged from a high of $83.88 to a
low of $14.50. In addition, the average daily trading volume in the
U.S. of the stocks in the Index, for the six-month period from January
1, 1994, through June 30, 1994, ranged from a high of 2.7 million
shares per day to a low of 107,000 shares per day. Lastly, no one
component accounted for more than 15.79% of the Index's total value and
the percentage weighting of the five largest issues in the Index
accounted for 51.01% of the Index's value. The percentage weighting of
the lowest weighted component was 2.73% of the Index and the percentage
weighting of the five smallest issues in the Index accounted for 17.41%
of the Index's value.
C. Maintenance
The Index will be maintained by the Phlx. The Phlx may change the
composition of the Index at any time, subject to compliance with the
maintenance criteria discussed herein, to reflect the conditions in the
semiconductor industry. In accordance with Phlx rule 1009A, if it
becomes necessary to replace a security in the Index, the Exchange
represents that it will be replaced with a stock which the Exchange, in
its discretion, believes would be compatible with the intended market
character of the Index.\9\ In making replacement determinations, the
Exchange will also take into account a security's capitalization,
liquidity, volatility, and name recognition of the proposed
replacement. Further, securities may be replaced in the event of
certain corporate events, such as takeovers or mergers, that change the
nature of the security. If, however, the Exchange determines to
increase the number of Index component securities to greater than 21 or
reduce the number of index component securities to fewer than 11, the
proposal provides that the Phlx will submit a rule filing with the
Commission pursuant to Section 19(b) of the Act. In addition, in
choosing replacement securities for the Index, the Phlx will be
required to ensure that at least 90% of the weight of the Index
continues to be made up of stocks that are eligible for standardized
options trading.\10\
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\9\The Exchange represents that any future replacement or added
component securities will be listed and traded on either the NYSE or
the Amex, or quoted on and traded through NASDAQ as NM securities.
\10\The Phlx's options listing standards, which are uniform
among the options exchanges, provide that a security underlying an
option must, among other things, meet the following requirements:
(1) the public float must be at least 7,000,000 shares; (2) there
must be a minimum of 2,000 stockholders; (3) trading volume in the
U.S. must have been at least 2.4 million over the preceding twelve
months; and (4) the U.S. market price must have been at least $7.50
for a majority of the business days during the preceding three
calendar months. See Phlx Rule 1009, Commentary .01. With respect to
ADRs, in addition to the above standards: (1) the Exchange must have
in place of a comprehensive surveillance agreement with the primary
exchange in the home country where the security underlying the ADR
is traded; or (2) the trading volume for the three month period
preceding the date of listing in the U.S. markets for ADRs overlying
any class of the foreign issuer's common stock (on a share-
equivalent basis) is at least 50% of the sum of the (i) combined
world wide trading volume for all classes of the foreign issuer's
common stock, and (ii) combined trading volume for all ADRs
overlying any of these classes of stock; or (3) the SEC must
otherwise authorize the listing. In addition, the percentage of the
world-wide trading volume for the security underlying an ADR that
occurs in the U.S. ADR market must meet a maintenance standard of
30% or more in order for options on that particular ADR to continue
to be traded on the Phlx. See, e.g., Securities Exchange Act Release
No. 33554 (January 31, 1994), 59 FR 5622 (February 7, 1994).
D. Applicability of Phlx Rules Regarding Index Options
Except as modified by this order, Phlx Rules 1000A through 1103A,
in particular, and Phlx Rules 1000 through 1070, in general, will be
applicable to Semiconductor Index options and Index LEAPS. Those rules
address, among other things, the applicable position and exercise
limits, policies regarding trading halts and suspensions, and margin
treatment for narrow-based index options.
E. Calculation of the Index
The Phlx Semiconductor Index is a price-weighted index and reflects
changes in the prices of the Index component securities relative to the
Index's base date of December 1, 1993. Specifically, the Index value is
calculated by adding the prices of the component stocks, dividing this
summation by a divisor that is equal to the number of the components of
the Index to get the average price, and multiplying the resulting
number by 100. To maintain the continuity of the Index, the divisor
will be adjusted to reflect non-market changes in the prices of the
component securities as well as changes in the composition of the
Index. Changes that may result in divisor adjustments include, but are
not limited to, stock splits and dividends, spin-offs, certain rights
issuances, and mergers and acquisitions.
The Index value will be updated dynamically at least once every 15
seconds during the trading day. The Phlx has retained Bridge Data, Inc.
to compute the value of the Index. Pursuant to Phlx Rule 1100A, updated
Index values will be disseminated and displayed by means of primary
market prints reported by the Consolidated Tape Association and over
the facilities of the Options Price Reporting Authority (``OPRA''). The
Index value will also be available on broker/dealer interrogation
devices to subscribers of the option information.
The Index value for purposes of settling outstanding regular Index
options and Index LEAPS contracts upon expiration will be calculated
based upon the regular way opening sale prices for each of the Index's
component securities in their primary market on the last trading day
prior to expiration. In the case of securities traded on and through
NASDAQ, the first reported sale price will be used. Once all of the
component stocks have opened, the value of the Index will be determined
and that value will be used as the final settlement value for expiring
Index options and Index LEAPS contracts. If any of the component stocks
do not open for trading on the last trading day before expiration, then
the prior trading day's (i.e., normally Thursday's) last sale price
will be used in the Index calculation. In this regard, before deciding
to use Thursday's closing value of a component security for purposes of
determining the settlement value of the Index, the Phlx will wait until
the end of the day on the last trading day before expiration.
F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\11\ Standard options trading hours (9:30 a.m. to 4:10
p.m. Eastern Standard time) will apply to the contracts. The Index
multiplier will be 100. The strike price interval will be $5.00 for
Index options with a duration of one year or less to expiration. In
addition, pursuant to Phlx Rule 1012(a), there may be up to six
expiration months outstanding at any given time. Specifically, there
may be up to three expiration months from the March, June, September,
and December cycle plus up to three additional near-term months so that
the two nearest term months will always be available. The Exchange also
intends to list several Index LEAPS series that expire from 12 to 36
months from the date of issuance pursuant to Phlx Rule 1101A(b)(iii).
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\11\A European-style option can be exercised only during a
specified period before the option expires.
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G. Position and Exercise Limits, Margin Requirements, and Trading Halts
Because the Index is classified as an ``industry index'' under Phlx
rules,\12\ Exchange rules that are applicable to the trading of options
on narrow-based indexes will apply to the trading of Semiconductor
Index options and Index LEAPS. Specifically, Exchange rules governing
margin requirements,\13\ position and exercise limits,\14\ and trading
halt procedures\15\ that are applicable to the trading of narrow-based
index options will apply to options traded on the Index. Positions in
Index LEAPS will be aggregated with positions in regular Index options
on a one-for-one basis for purposes of position and exercise limits.
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\12\See Phlx Rule 1000A(11).
\13\Pursuant to Phlx Rule 722, the margin requirements for the
Index options will be: (1) for short options positions, 100% of the
current market value of the options contract plus 20% of the
underlying aggregate Index value, less any out-of-the-money amount,
with a minimum requirement of the options premium plus 10% of the
underlying Index value; and (2) for long options positions, 100% of
the options premium paid.
\14\Pursuant to Phlx Rules 1001A and 1002A, respectively, the
position and exercise limits for the Index options will be 7,500
contracts, unless the Exchange determines, pursuant to those rules
that a higher or lower limit is warranted.
\15\Pursuant to Phlx Rule 1047A, the trading on the Phlx of
Index options may be halted or suspended whenever trading in
underlying securities whose weighted value represents more than 20%
of the Index value are halted or suspended.
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H. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in Index options and Index LEAPS. These procedures include
complete access to trading activity in the underlying securities.
Further, the Intermarket Surveillance Group Agreement, dated July 14,
1983, as amended on January 29, 1990, will be applicable to the trading
of options on the Index.\16\
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\16\The Intermarket Surveillance Group (``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 Amex;
the Boston Stock Exchange, Inc.; the Chicago Board Options Exchange,
Inc.; the Chicago Stock Exchange, Inc.; the National Association of
Securities Dealers, Inc. (``NASD''); the NYSE; the Pacific Stock
Exchange, Inc.; and the Phlx. Because of potential opportunities for
trading abuses involving stock index futures, stock options, and the
underlying stock and the need for greater sharing of surveillance
information for these potential intermarket trading abuses, the
major stock index futures exchanges (e.g., the Chicago Mercantile
Exchange and the Chicago Board of Trade) joined the ISG as affiliate
members in 1990.
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III. Findings and Conclusions
The Commission finds that 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).\17\ Specifically, the
Commission finds that the trading of Semiconductor Index options,
including Index LEAPS, will serve to promote the public interest and
help to remove impediments to a free and open securities market by
providing investors with a means of hedging exposure to market risk
associated with securities representing the semiconductor industry.\18\
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\17\15 U.S.C. Sec. 78f(b)(5) (1988).
\18\Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument 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. In this regard, the trading of
listed Index options and Index LEAPS will provide investors with a
hedging vehicle that should reflect the overall movement of stocks
representing the semiconductor industry.
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The trading of options of LEAPS on the Semiconductor Index,
however, raises several concerns, namely issues related to index
design, customer protection, surveillance, and market impact. The
Commission believes, however, for the reasons discussed below, that the
Phlx adequately has addressed these concerns.
A. Index Design and Structure
The Commission finds that the Semiconductor Index is a narrow-based
index. The Index is composed of only sixteen securities, all of which
represent the semiconductor industry. Accordingly, in light of the
limited number of stocks in the Index and that the Index represents one
industry sector, the Commission believes it is proper to classify the
Semiconductor Index as narrow-based and apply Phlx's rules governing
narrow-based index options to trading in the Index options and Index
LEAPS.\19\
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\19\See supra notes 12 through 15, and accompanying text.
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The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the Index's component securities
significantly minimize the potential for manipulation of the Index.
First, the overwhelming majority of the components that comprise the
Index are actively traded, with an average daily trading volume for the
period from January 1, 1994 through June 30, 1994, ranging from a high
of 2.7 million shares per day to a low of 107,000 shares per day.
Second, the market capitalizations of the securities in the Index are
very large, ranging from a high of $25.0 billion to a low of $317.8
million as of July 8, 1994, with the mean being $4.86 billion. Third,
although the Index is only comprised of sixteen component securities,
no one particular security or group of securities dominates the Index.
Specifically, as of July 8, 1994, no one stock accounted for more than
15.79% of the Index's total value and the percentage weighting of the
five largest issues in the Index accounted for 51.01% of the Index's
value. Fourth, at least 90% of the securities in the Index, by weight,
must be eligible for standardized options trading. This proposed
maintenance requirement will ensure that the Index is substantially
comprised of options eligible securities. Fifth, if the Phlx increases
the number of component securities to more than 21 or decreases that
number to less than 11, the Phlx will be required to seek Commission
approval pursuant to Section 19(b)(2) of the Act before listing new
strike price or expiration month series of Semiconductor Index options
or Index LEAPS. This will help protect against material changes in the
composition and design of the Index that might adversely affect the
Phlx's obligations to protect investors and to maintain fair and
orderly markets in Semiconductor Index options and Index LEAPS. This
will further reduce the potential for manipulation of the value of the
Index. Finally, the Commission believes that the expense of attempting
to manipulate the value of the Semiconductor Index in any significant
way through trading in component stocks (or options on those stocks)
coupled with, as discussed below, existing mechanisms to monitor
trading activity in those securities, will help deter such illegal
activity.
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as Semiconductor Index
options and Index LEAPS, can commence on a national securities
exchange. The Commission notes that the trading of standardized
exchange-traded options occurs in an environment that is designed to
ensure, among other things, that: (1) The special risks of options are
disclosed to public customers; (2) only investors capable of evaluating
and bearing the risks of options trading are engaged in such trading;
and (3) special compliance procedures are applicable to options
accounts. Accordingly, because the Index options and Index LEAPS will
be subject to the same regulatory regime as the other standardized
options currently traded on the Phlx, the Commission believes that
adequate safeguards are in place to ensure the protection of investors
in Semiconductor Index options and LEAPS.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a security index derivative
product and the exchange(s) trading to securities underlying the
derivative product is an important measure for surveillance of the
derivative and underlying securities markets. Such agreements ensure
the availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the security
index product less readily susceptible to manipulation.\20\ In this
regard, the Phlx, NYSE, Amex, and NASD are all members of the ISG,
which provides for the exchange of all necessary surveillance
information.\21\
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\20\Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\21\See note 16, supra. If the composition of the Index should
change so that greater than 10% of the weight of the Index would be
represented by ADRs ineligible for standardized options trading in
the U.S. either because the securities underlying the ADRs are not
the subject of a comprehensive surveillance sharing agreement with
the Phlx or because the U.S. market is not the primary market for
the ADRs, then it would be difficult for the Commission to reach the
conclusions reached in this order and the Commission would have to
determine whether it would be suitable for the Exchange to continue
to trade options on this Index. The Phlx should, accordingly, notify
the Commission immediately if more than 10% of the numerical value
of the Index is represented by ADRs not eligible for standardized
options trading in the U.S. Such a change in the current relative
weights of the Index or in the composition of the Index may warrant
the submission of a rule filing pursuant to Section 19 of the Act.
In determining whether a particular ADR is eligible for standardized
options trading see, e.g., Securities Exchange Act Release Nos.
31531 (November 27, 1992), 57 FR 57250 (December 3, 1992); and 33554
(January 31, 1994), 59 FR 5622 (February 7, 1994).
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D. Market Impact
The Commission believes that the listing and trading of
Semiconductor Index options and Index LEAPS on the Phlx will not
adversely impact the underlying securities markets.\22\ First, as
described above, for the most part, no one security or group of
securities dominates the Index. Second, because (i) at least 90% of the
numerical value of the Index must be accounted for by securities that
meet the Exchange's options listing standards, (ii) each of the
component securities must be traded on either the NYSE or the Amex, or
as NM securities traded through NASDAQ, and (iii) the component
securities must be subject to last sale reporting pursuant to Rule
11Aa3-1 of the Act,\23\ the component securities generally will be
actively-traded, highly-capitalized securities. Third, the 7,500
contract position and exercise limits applicable to Index options and
Index LEAPS will serve to minimize potential manipulation and market
impact concerns.
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\22\In addition, the Phlx has represented that the Phlx and the
OPRA have the necessary systems capacity to support those new series
of options that would result from the introduction of Index options
and Index LEAPS. See Letter from Michele Weisbaum, Associate General
Counsel, Phlx, to Thomas McManus, Attorney, OMS, Division,
Commission, dated June 24, 1994; and Memorandum from Joe Corrigan,
Executive Director, OPRA, to Richard Cangelosi, Assistant Vice
President, New Product Development, Phlx, dated April 18, 1994.
\23\See supra note 8.
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Lastly, the Commission believes that settling expiring
Semiconductor Index options and Index LEAPS based on the opening prices
of component securities is consistent with the Act. As noted in other
contexts, valuing options for exercise settlement on expiration based
on opening prices rather than closing prices may help reduce adverse
effects on markets for securities underlying options on the Index.\24\
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\24\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-Phlx-94-02), as amended, is
approved.
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\25\15 U.S.C. 78s(b)(2) (1988).
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. 94-20896 Filed 8-24-94; 8:45 am]
BILLING CODE 8010-01-M