[Federal Register Volume 59, Number 177 (Wednesday, September 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-22731]


[[Page Unknown]]

[Federal Register: September 14, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-3647; International Series Release No. 712; File No. 
SR-PSE-94-15]

 

Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 3 to a 
Proposed Rule Change by the Pacific Stock Exchange, Inc., Relating to 
the Listing of Options and Long-Term Options on the Telegraph Ltd. 
Israel Index

September 8, 1994.

I. Introduction

    On June 13, 1994, the Pacific Stock Exchange, Inc. (``PSE'' 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 Telegraph Ltd. Israel Index (``Israel 
Index'' or ``Index'').\3\ The Exchange filed Amendment No. 1 to the 
proposed rule change on June 27, 1994, and Amendment No. 2 on June 28, 
1994.\4\ Notice of the proposal and of Amendment Nos. 1 and 2 appeared 
in the Federal Register on July 26, 1994.\5\ On September 6, 1994, the 
Exchange filed Amendment No. 3 to the proposed rule change.\6\ No 
comment letters were received on the proposed rule change. 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\The name of the Index, as originally proposed, was the ``PSE 
Israel Index.'' See Amendment No. 3, infra note 6.
    \4\In Amendment No. 1, the Exchange proposed to: (1) reconfigure 
the Index so that it is initially composed of 12 components; (2) 
provide that the Index will be equal dollar-weighted instead of 
capitalization-weighted, as originally proposed; and (3) provide 
that any security added to the Index must be a security that is 
traded in the United States either on a securities exchange or as a 
National Market security traded through Nasdaq. See Letter from 
Michael Pierson, Senior Attorney, PSE, to Brad Ritter, Attorney, 
Office of Market Supervision (``OMS''), Division of Market 
Regulation (``Division''), Commission, dated June 24, 1994. In 
Amendment No. 2, the PSE proposed: (1) to maintain the Index so that 
at least 85% of the Index, by weight, and at least 80% of the number 
of components of the Index are eligible for standardized options 
trading pursuant to PSE Rule 3.6; (2) to clarify that any 
replacement securities will be securities representing Israeli 
companies; and (3) to consider the market capitalization, liquidity, 
volatility, and name recognition of proposed replacement securities 
for the Index. See Letter from Michael Pierson, Senior Attorney, 
PSE, to Brad Ritter, Attorney, OMS, Division, Commission, dated June 
28, 1994.
    \5\See Securities Exchange Act Release No. 34410 (July 20, 
1994), 59 FR 38007 (July 26, 1994).
    \6\In Amendment No. 3, the PSE proposes to: (1) change the name 
of the Index to the ``Telegraph Ltd. Israel Index;'' (2) clarify 
that all present and future components of the Index will be subject 
to last sale reporting pursuant to Rule 11Aa3-1 of the Act; (3) 
provide that the Index will be initialized at a level of 150 as of 
the close of trading on May 31, 1994, rather than at 200 as 
originally proposed; and (4) change the Index cycle from the January 
cycle to the March cycle. See Letter from Michael Pierson, Senior 
Attorney, Market Regulation, PSE, to Brad Ritter, Attorney, Office 
of Market Supervision, Division of Market Regulation, Commission, 
dated September 6, 1994 (``Amendment No. 3'').
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II. Description of Proposal

A. General

    The PSE proposes to list for trading options on the Israel Index, a 
new securities index developed by the PSE and based on Israeli stocks 
and ADRs\7\ that are traded on the American Stock Exchange (``Amex''), 
the New York Stock Exchange (``NYSE''), or are National Market (``NM'') 
securities traded through Nasdaq. The PSE also proposes to list long-
term options on the full-value Index (``Israel LEAPS'' or ``Index 
LEAPS'').\8\ Israel LEAPS will trade independent of and in addition to 
regular Israel Index options traded on the Exchange,\9\ however, as 
discussed below, position and exercise limits of Index LEAPS and 
regular Index options will be aggregated.
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    \7\An ADR is a negotiable receipt which is issued by a 
depositary, generally a bank, representing shares of a foreign 
issuer that have been deposited and are held, on behalf of holders 
of the ADRs, at a custodian bank in the foreign issuer's home 
country. See discussion of standards for ADR components, infra notes 
10 and 27.
    \8\LEAPS are long-term index option series that expire from 
twelve to thirty-six months from their date of issuance. See PSE 
Rule 6.4(d).
    \9\According to the PSE, the Israel Index represents a segment 
of the U.S. equity market that is not currently represented in the 
derivative markets and, as such, the PSE concludes, should offer 
investors a low-cost means of achieving diversification of their 
portfolios toward or away from Israeli securities. The PSE believes 
the Index will provide retail and institutional investors with a 
means of benefitting from their forecasts of the performance of 
Israeli securities. Options on the Index also can be utilized by 
portfolio managers and investors as a means of hedging the risks of 
investing in Israeli securities.
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B. Composition of the Index

    The Index was designed by the Exchange and is presently based on 
securities representing 12 Israeli companies that the Exchange believes 
are representative of the Israeli economy, all of which trade in the 
U.S. as either stocks or ADRs. Ten of these securities currently trade 
through Nasdaq as NM securities, one trades on the NYSE, and one trades 
on the Amex. The Index is equal dollar-weighted and will be calculated 
on a real-time basis using last sale prices.
    As of May 31, 1994, the market capitalizations of the individual 
securities in the Index ranged from a high of $1.22 billion to a low of 
$59.03 million, with an average capitalization of $386 million. The 
market capitalization of all the securities in the Index was $4.63 
billion. The total number of shares outstanding for the securities in 
the Index ranged from a high of 60.74 million shares to a low of 9.37 
million shares. The average monthly trading volume in the U.S. of the 
securities in the Index, for the six-month period between December 1, 
1993, and May 31, 1994, ranged from a high of 9.98 million shares per 
month to a low of 726,667 shares per month. Lastly, because the Index 
is equal dollar-weighted, each component accounts for 8.33% of the 
Index's total value and thus, no five components accounted for more 
than 41.65% of the total weight of the Index.

C. Maintenance

    The Index will be maintained by the PSE. The PSE 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 
market for Israeli securities. If it becomes necessary to replace an 
Index component, the Exchange represents that it will only add new 
Israeli component securities that are traded in the U.S. securities 
markets and will take into account a security's capitalization, 
liquidity, volatility, and name recognition of the proposed 
replacement. Further, Index components 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 16 or 
reduce the number of Index component securities to fewer than nine, the 
proposal provides that the PSE 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 PSE will be required 
to ensure that at least 85% of the weight of the Index and at least 80% 
of the number of components continues to be made up of securities that 
are eligible for standardized options trading.\10\ Finally, the PSE 
will be required to ensure that each component of the Index is subject 
to last sale reporting pursuant to Rule 11Aa3-1 of the Act.\11\
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    \10\The PSE'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 PSE Rule 3.6. With respect to ADRs, in addition to the 
above standards: (1) the Exchange must have in place 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.
    \11\See Amendment No. 3, supra note 6.
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D. Applicability of PSE Rules Regarding Index Options

    Except as modified by this order, PSE Rules 6 and 7 will be 
applicable to Israel 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 Israel Index is an equal dollar-weighted index and reflects 
changes in the prices of the Index component securities relative to the 
Index's base date of May 31, 1994.
    The Index will be calculated using an ``equal dollar-weighting'' 
methodology designed to ensure that each of the component securities 
are represented in approximately ``equal'' dollar amounts in the Index. 
In calculating the initial ``equal dollar-weighting'' of component 
securities, the PSE, using closing prices on May 31, 1994, calculated 
the number of shares that would represent an investment of $83,333 in 
each of the securities contained in the Index (to the nearest whole 
share). The value of the Index equals the current market value (i.e., 
based on U.S. primary market prices) of the assigned number of shares 
of each of the securities in the Index portfolio divided by the current 
Index divisor. The Index divisor was initially calculated to yield a 
benchmark value of 150 at the close of trading on May 31, 1994.\12\ 
Each quarter thereafter, following the close of trading on the third 
Friday of January, April, July and October, the Index portfolio is 
adjusted by changing the number of shares of each component security so 
that each company is again represented in $83,333 ``equal'' dollar 
amounts. If necessary, a divisor adjustment is made to ensure 
continuity of the Index's value. The newly adjusted portfolio becomes 
the basis for the Index's value on the first trading day following the 
quarterly adjustment.
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    \12\Id.
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    The Exchange does not believe that there will be investor confusion 
regarding the adjustments because they will be done on a regular and 
timely basis, with adequate advance notice given. An information 
circular will be distributed to all Exchange members notifying them of 
the quarterly changes. This circular will also be sent by facsimile to 
the Exchange's contacts at the major options firms, mailed to 
recipients of the Exchange's options-related information circulars, and 
made available to subscribers of the Options News Network. In addition, 
the Exchange will include in its promotional and marketing materials 
for the Index a description of the equal dollar-weighting methodology.
    The number of shares of each component security in the Index 
portfolio will remain fixed between quarterly reviews except in the 
event of certain types of corporate actions, such as the payment of a 
dividend, other than an ordinary cash dividend, stock distributions, 
stock splits, reverse stock splits, rights offerings, or a 
distribution, reorganization, recapitalization, or some such similar 
event with respect to an Index component security. The number of shares 
will also be adjusted in the event of a merger, consolidation, 
dissolution or liquidation of an issuer of a component security. When 
the Index is adjusted between quarterly reviews, the number of shares 
of the relevant security in the portfolio will be adjusted, to the 
nearest whole share, to maintain the component's relative weight in the 
Index at the level immediately prior to the corporate action. In the 
event of a component security replacement, the average dollar value of 
the remaining portfolio components will be calculated and that amount 
invested in the new component security to the nearest whole share. In 
both cases, the divisor will be adjusted, if necessary, to ensure Index 
continuity.
    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 through Nasdaq, 
the first reported sale price will be used. Once all of the component 
securities 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 contracts. If any of the component securities 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 PSE will wait until 
the end of the trading day on expiration Friday.

F. Contract Specifications

    The proposed options on the Index will be cash-settled, European-
style options.\13\ Standard options trading hours (9:30 a.m. to 4:15 
p.m. Eastern Standard time) will apply to the contracts. The Index 
multiplier will be 100. The strike price interval will be $2.50 for 
Index options with a duration of one year or less to expiration. If, 
however, the value of the Index rises to 200 or greater, the Exchange 
will use strike prices at $5.00 intervals. In addition, pursuant to PSE 
Rule 6.4, 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\14\ plus up to 
three additional near-term months so that the two nearest term months 
will always be available.
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    \13\A European-style option can be exercised only during a 
specified period before the option expires.
    \14\See Amendment No. 3, supra note 6.
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    Furthermore, the options on the Index will expire on the Saturday 
following the third Friday of the expiration month (``Expiration 
Friday''). Accordingly, since options on the Index will settle based 
upon opening prices of the component securities on the last trading day 
before expiration (normally a Friday), the last trading day for an 
expiring Index option series will normally be the second to the last 
business day before expiration (normally a Thursday).
    Finally, the proposal also provides that the Exchange may list 
long-term Index options that expire from 12 to 36 months from listing 
based on the full-value Israeli Index. Exchange rules regarding strike 
price intervals bid/ask differentials, and continuity shall not apply 
to such series until the time to expiration is less than 12 months.\15\
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    \15\See PSE Rule 6.4(d).
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G. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Exchange rules that are applicable to the trading of options on 
narrow-based indexes will apply to the trading of Israel Index options 
and Israel Index LEAPS. Specifically, Exchange rules governing margin 
requirements,\16\ position and exercise limits,\17\ and trading halt 
procedures\18\ that are applicable to the trading of narrow-based index 
options will apply to options traded on the Index.
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    \16\Pursuant to PSE Rule 7.16, 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.
    \17\Pursuant to PSE Rules 7.6 and 7.7, respectively, the 
position and exercise limits for the Index options will be 7,500 
contracts, unless the Exchange determines, pursuant to Rules 7.6 and 
7.7, that a lower limit is warranted.
    \18\Pursuant to PSE Rule 7.11, the trading on the PSE 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 regular Index options and in 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.\19\
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    \19\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 PSI; and the 
Philadelphia Stock Exchange, Inc. 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).\20\ Specifically, the 
Commission finds that the trading of Israeli 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 Israeli securities.\21\
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    \20\15 U.S.C. 78f(b)(5) (1988).
    \21\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 Israeli 
securities in the U.S. securities markets.
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    The trading of options on the Israel Index, including Index LEAPS, 
however, raises several concerns, namely issues related to index 
design, customer protection, surveillance, and market impact. The 
Commission believes, for the reasons discussed below, that the PSE 
adequately has addressed these concerns.

A. Index Design and Structure

    The Commission finds that the Israeli Index is a narrow-based 
index. The Israel Index is composed of only 12 securities, all of which 
represent Israeli companies. Accordingly, in light of the limited 
number of securities in the Index, the Commission believes it is proper 
to classify the Israeli Index as narrow-based and apply PSE's rules 
governing narrow-based index options to trading in the Index 
options.\22\
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    \22\See supra notes 16 through 18, 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 monthly trading volume for 
the period from December 1, 1993 through May 31, 1994, ranging from a 
high of 9.98 million shares per month to a low of 726,667 shares per 
month. Secondly, the market capitalizations of the securities in the 
Index are very large, ranging from a high of $1.22 billion to a low of 
$59.03 million as of May 31, 1994, with an average capitalization of 
$386 million. Third, although the Index is only composed of 12 
component securities, no one particular security or group of securities 
dominates the Index. Specifically, because the Index is equal dollar-
weighted, each component security accounts for only 8.33% of the total 
weight of the Index. Fourth, at least 85% of the securities in the 
Index, by weight, and at least 80% of the number of components of the 
Index, 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 PSE increases 
the number of component securities to more than 16 or decreases that 
number to less than nine, the PSE 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 Israeli Index options and 
Index LEAPS. This will help protect against material changes in the 
composition and design of the Index that might adversely affect the 
PSE's obligations to protect investors and to maintain fair and orderly 
markets in Israeli Index options and Index LEAPS. Sixth, the PSE will 
be required to ensure that each component of the Index is subject to 
last sale reporting pursuant to Rule 11Aa3-1 of the Act.\23\ 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 Israeli Index in any significant way 
through trading in component stocks, ADRs, or securities underlying 
ADRs (or options on those securities) coupled with, as discussed below, 
existing mechanisms to monitor trading activity in those securities, 
will help deter such illegal activity.
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    \23\See Amendment No. 3, supra note 6.
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    In addition, the Commission does not believe that the fact that the 
Index is equal dollar-weighted instead of market-weighted or price-
weighted results in the Index being readily susceptible to 
manipulation. Because the use of an equal dollar-weighting method could 
give securities with relatively small floats or prices a greater weight 
in the Index than if the Index were capitalization weighted or price 
weighted, the Commission is concerned that this calculation method 
could make the Index more readily susceptible to manipulation. The PSE, 
however, has developed several composition and maintenance criteria for 
the Index that the Commission believes will minimize the possibility 
that the Index could be manipulated through trading in less actively 
traded securities or securities with smaller prices or floats. First, 
after each quarterly rebalancing, the PSE proposal requires that 85% of 
the weighting of the Index and 80% of the number of components of the 
Index be accounted for by securities that are eligible for standardized 
options trading. The Commission believes that this requirement will 
ensure that the Index will be almost entirely made up of securities 
with large public floats that are actively traded, thus reducing the 
likelihood that the Index could be manipulated by abusive trading in 
the smaller securities contained in the Index. Secondly, the Commission 
believes that the quarterly rebalancing of the Index will further serve 
to reduce the susceptibility of the Index to manipulation. Through the 
quarterly rebalancing, any ``overweight'' component security\24\ will 
be brought back into line with the other securities, thus ensuring that 
less capitalized securities do not become excessively weighted. Third, 
because the Index is narrow-based, the applicable position and exercise 
limits and margin requirements will further reduce the susceptibility 
of the Index to manipulation. Lastly, the PSE will only add new 
component securities to the Index that are representative of the 
Israeli economy, are traded in the U.S., are subject to last sale 
reporting pursuant to Rule 11Aa3-1 of the Act, and, as discussed above, 
the PSE will take into account a security's capitalization, liquidity, 
and volatility before adding the security to the Index.
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    \24\A security would be ``overweight'' if its weight in the 
Index were greater than the average weight of all of the securities 
in the Index. This would occur, for example, if the price of a 
component security significantly increased relative to the other 
securities in the Index during a particular quarter and prior to the 
rebalancing.
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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 Israeli Index options 
(including Israel 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 risk 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 PSE, the Commission believes that 
adequate safeguards are in place to ensure the protection of investors 
in Israel Index options and Israel Index LEAPS.
    The Commission also has some concern that the quarterly rebalancing 
of the Index could result in investor confusion because the number of 
shares of each component security in the Index could fluctuate each 
quarter. Such fluctuation, among other things, could make it difficult 
for investors to maintain any corresponding cash positions in the 
securities underlying the Index. The Commission, however, does not 
believe that the quarterly rebalancing will result in dramatic changes 
in the weightings of the component securities. Moreover, the Commission 
believes the benefits to be derived from using a quarterly rebalancing 
will more than offset the potential confusion for investors. 
Specifically, the Commission believes the quarterly rebalancing will 
ensure that no security or group of securities will have a 
disproportionate impact on the Index. Additionally, the Commission has 
approved several indexes that use an equal dollar-weighting system and 
has not been made aware of any problems with respect to investor 
confusion arising from the use of this weighting method.\25\
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    \25\See, e.g., Securities Exchange Act Release Nos. 31245 
(September 28, 1992), 57 FR 45844 (October 5, 1992) (options on the 
Amex Biotechnology Index); and 33720 (March 7, 1994), 59 FR 11630 
(March 11, 1994) (options on the Amex Natural Gas Index).
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    Finally, the PSE has developed procedures to ensure that investors 
are adequately notified of any changes due to the quarterly rebalancing 
of the Index. In particular, the PSE represents that it will send 
informational circulars to its members notifying them of any changes to 
the Index as a result of the quarterly rebalancing prior to the 
implementation of those changes. In addition, the PSE has stated that 
it will include a description of the equal dollar-weighting methodology 
in all its promotional and marketing materials for the Index. The 
Commission believes these procedures should help to avoid any investor 
confusion, while providing important information about the special 
characteristics of the Index.

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 the 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.\26\ In this 
regard, the PSE, NYSE, Amex, and NASD are all members of the ISG, which 
provides for the exchange of all necessary surveillance 
information.\27\ Further, as to present and future ADR components of 
the Index,\28\ either the Exchange will have comprehensive surveillance 
sharing agreements with the primary foreign markets for the securities 
underlying the ADRs or the U.S. will be the relevant market for 
surveillance purposes.\29\
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    \26\Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \27\See note 19, supra. If the prices of the ADR components, or 
the composition of the Index, should change so that greater than 20% 
of the weight of the Index would be represented by ADRs whose 
underlying securities were not the subject of a comprehensive 
surveillance sharing agreement with the CBOE, 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 CBOE should, accordingly, notify the Commission 
immediately if more than 20% of the numerical value of the Index is 
represented by ADRs whose underlying securities are not subject to a 
comprehensive surveillance sharing agreement. 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 
subject to a comprehensive surveillance sharing agreement 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).
    \28\Presently, Teva Pharmaceuticals is the only ADR component of 
the Index.
    \29\See Securities Exchange Act Release Nos. 31530 (November 27, 
1992) 57 FR 57262 (December 3, 1992); and 33551 (January 31, 1994), 
59 FR 5631 (February 7, 1994).
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D. Market Impact

    The Commission believes that the listing and trading of Israel 
Index options, including Index LEAPS, on the PSE will not adversely 
impact the underlying securities markets.\30\ First, as described 
above, for the most part, no one security or group of securities 
dominates the Index. Second, because at least 85 of the numerical value 
of the Index and at least 80% of the components of the Index must be 
accounted for by securities that meet the Exchange's options listing 
standards, and because each of the component securities must be subject 
to last sale reporting pursuant to Rule 11Aa3-1 of the Act, 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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    \30\In addition, the PSE has represented that the PSE and the 
OPRA have the necessary systems capacity to support those new series 
of index options that would result from the introduction of Index 
options and Index LEAPS. See Letter from Michael Pierson, Senior 
Attorney, Market Regulation, from Michael Pierson, Senior Attorney, 
Market Regulation, PSE, to Brad Ritter, Attorney, OMS, Division, 
Commission, dated August 10, 1994; and Memorandum from Joe Corrigan, 
Executive Director, OPRA, to Kim Koppien, PSE, dated August 5, 1994.
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    Lastly, the Commission believes that settling expiring Israeli 
Index options (including 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.\31\
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    \31\See  Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
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    The Commission finds good cause for approving Amendment No. 3 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register in 
order to allow the Exchange to list without delay options on the Index. 
Specifically, the Commission believes that the proposal changing the 
name of the Index to the Telegraph Ltd. Israel Index, initializing the 
value of the Index at a level of 150, and changing the Index cycle to 
the March cycle, are non-substantive changes that will not alter the 
terms of the Index options, as discussed herein, and will not cause 
investor confusion because the changes are being made prior to the 
beginning of dissemination of the Index value and prior to trading of 
the Index options and Index LEAPS. Additionally, the clarification that 
all components of the Index must be subject to last sale reporting 
pursuant to Rule 11Aa3-1 of the Act should help to ensure that current 
pricing information regarding the components of the Index will be 
available, thereby minimizing any potential for manipulation of the 
Index. Accordingly the Commission believes that good cause exists for 
approving Amendment No. 3 to the proposed rule change on an accelerated 
basis.
    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 3. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 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. Sec. 552, will be available for inspection and 
copying at the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. Copies of such filing will also be available for 
inspection and copying at the principal office of the PSE. All 
submissions should refer to the File Number SR-PSE-94-15 and should be 
submitted by [insert date 21 days after the date of this publication].
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\32\ that the proposed rule change (SR-PSE-94-15), as amended, is 
approved.
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    \32\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-22731 Filed 9-13-94; 8:45 am]
BILLING CODE 8010-01-M