[Federal Register Volume 59, Number 215 (Tuesday, November 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-27632]


[[Page Unknown]]

[Federal Register: November 8, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34925; International Series No. 738; File No. SR-Phlx-
94-18]

 

Self-Regulatory Organizations; Order Granting Approval of a 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 3 to the Proposed Rule Change by 
the Philadelphia Stock Exchange, Inc., Relating to Customized Foreign 
Currency Options

November 1, 1994.

I. Introduction

    On April 12, 1994, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``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 
customized foreign currency options (``FCOs''), specifically, 
customized inverse FCOs (``Customized Inverses'')\3\ and customized 
cross-rate FCOs (``Customized Cross-Rates''). (Customized Inverses, 
Customized Cross-Rates, and Customized Strikes (as defined herein) are 
collectively referred to as ``Customized FCOs''.) Notice of the 
proposed rule change appeared in the Federal Register on July 12, 
1994.\4\ No comment letters were received on the proposed rule change. 
The Exchange subsequently filed Amendment No. 1 to the proposal on 
August 15, 1994,\5\ Amendment No. 2 on September 20, 1994,\6\ and 
Amendment No. 3 on November 1, 1994.\7\ 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\See infra Section II.A (Characteristics of Customized FCOs).
    \4\See Securities Exchange Act Release No. 34308 (July 5, 1994), 
59 FR 35551 (July 12, 1994).
    \5\In Amendment No. 1 the Exchange proposed several substantive 
and clarifying amendments to the proposed rule change. See Letter 
from Michele Weisbaum, Associate General Counsel, Phlx, to Michael 
Walinskas, Branch Chief, Office of Market Supervision (``OMS''), 
Division of Market Regulation (``Division''), Commission, dated 
August 12, 1994.
    \6\The Exchange previously submitted a proposed rule change to 
list and trade FCOs with customized strike prices (``Customized 
Strikes''). Customized Strikes will provide FCO traders and their 
customers with the ability, within certain limits, to trade an FCO 
with any exercise price it chooses on a specific Approved Currency 
(as defined herein) even if that price does not correspond to an 
exercise price of a listed non-Customized FCO. See Securities 
Exchange Act Release No. 33959 (April 25, 1994), 59 FR 22698 (May 2, 
1994) (``File No. SR-Phlx-94-11''). Because of the overlap between 
that proposal and the current proposal, the Exchange withdrew File 
No. SR-Phlx-94-11 and, in Amendment No. 2, the Exchange incorporated 
the substance of File No. SR-Phlx-94-11, as amended and 
supplemented, into the current proposed rule change. In Amendment 
No. 2, the Exchange also established how bids and offers for 
Customized FCOs will be expressed pursuant to Phlx Rule 1033, and 
the minimum fractional changes that will be applicable to Customized 
FCOs pursuant to Phlx Rule 1034. See Letter from Michele Weisbaum, 
Associate General Counsel, Phlx, to Michael Walinskas, Branch Chief, 
OMS, Division, Commission, dated September 20, 1994.
    \7\Amendment No. 3 incorporates the substance of and withdraws 
Amendment Nos. 1 and 2. In Amendment No. 3, the Exchange also 
proposes several additional substantive and clarifying amendments to 
the proposed rule change, as discussed herein, that were not 
contained in Amendment Nos. 1 and 2. See Letter from Michele 
Weisbaum, Associate General Counsel, Phlx, to Michael Walinskas, 
Branch Chief, OMS, Division, Commission, dated November 1, 1994 
(``Amendment No. 3'').
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II. Description of the Proposal

    Pursuant to the proposed rule change, the Exchange will be able to 
offer the ability for its participants to trade: (1) Customized Strikes 
on any of the existing eight currencies on which the Exchange presently 
lists FCOs, i.e., the British pound, Swiss frank, French franc, 
Deutsche mark, Japanese yen, Australian dollar, Canadian dollar, and 
European Currency Unit (``ECU'') (collectively, ``Approved 
Currencies''); (2) Customized Inverses on any Approved Currency; and 
(3) Customized Cross-Rates on any two Approved Currencies. 
Additionally, the proposed rule change will allow FCO participants\8\ 
to express quotes for Customized FCOs as a percentage of the underlying 
currency,\9\ in addition to the current method of quoting ``regular'' 
FCOs\10\ in terms of the base currency\11\ per unit of the relevant 
underlying currency.
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    \8\FCO participants include Exchange members, and non-members 
who have been admitted to the Exchange as FCO participants. See Phlx 
Rule 13.
    \9\The underlying currency is the currency in which an FCO 
settles. All non-Customized FCOs currently traded on the Exchange 
settle in one of the Approved Currencies.
    \10\The terms regular FCOs and non-Customized FCOs, as used 
herein, refer to the standardized FCOs currently approved for 
listing and trading by the Exchange.
    \11\Presently, the base currency is the currency in which 
premiums are quoted and paid. For the Exchange's existing non-
Customized FCOs (other than regular cross-rate FCOs) the base 
currency is the U.S. dollar.
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A. Characteristics of Customized FCOs

    The characteristics of and procedures for trading Customized FCOs 
are contained in new Phlx Rule 1069 (Customized Foreign Currency 
Options). Rule 1069(a) sets forth the parameters applicable to 
Customized FCOs. Specifically, Customized Strikes may be traded on any 
Approved Currency,\12\ and Customized Cross-Rates may be traded on any 
two Approved Currencies, exclusive of the U.S. dollar. The contract 
size for Customized Strikes and Cross-Rates will be the same as those 
for non-Customized FCOs on the same underlying Approved Currency.
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    \12\The proposal also adds the U.S. dollar to list of Approved 
Currencies.
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    Additionally, Rule 1069(a) provides for the trading of Customized 
Inverses on any Approved Currency.\13\ A Customized Inverse is a 
Customized FCO where the underlying currency is the U.S. dollar. When 
trading a Customized Inverse, bids and offers will be quoted in, and 
premium will be paid in, the base currency (i.e., an Approved Currency 
other than the U.S. dollar), and the contract will be settled in the 
underlying currency (i.e., U.S. dollars).\14\ The contract size for a 
Customized Inverse will be US$50,000.
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    \13\The Exchange also sometimes refers to Customized Inverses as 
``European-Term'' Customized FCOs.
    \14\As the name suggests, a Customized Inverse merely inverts 
the terms of the Exchange's non-Customized FCOs (other than the 
regular cross-rate FCOs). For example, the existing non-Customized 
U.S. dollar/German mark contract is quoted in the base currency 
(cents) per unit of the underlying currency (marks), the premium is 
paid in U.S. dollars, and the contract is settled in German marks. 
In a Customized Inverse (e.g., German mark/U.S. dollar), the U.S. 
dollar becomes the underlying currency and the German mark becomes 
the base currency. As a result, when trading this Customized 
Inverse, the premium would be quoted in German marks per U.S. 
dollar, the premium would be paid in German marks, and the contract 
would be settled in U.S. dollars.
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    Rule 1069(a) further provides an alternative quote format for 
Customized FCOs. Presently, the Exchange's non-Customized FCOs are 
quoted in terms of the base currency per unit of underlying currency, 
in which case premium is quoted and paid in the base currency. The 
proposal provides an alternative quoting format whereby quotes for 
Customized FCOs may be quoted as a percentage of the underlying 
currency (``Percentage Quoting''). In Percentage Quoting, the contract 
will be quoted in, the premium will be paid in, and the contract will 
settle in, the underlying currency.
    Finally, Rule 1069(a) provides that Customized FCOs (1) may be 
either put or call contracts, (2) must be European-style,\15\ (3) must 
have a standardized expiration date as provided in Phlx Rule 
1000(b)(21), and (4) may have any listed or non-listed exercise price 
determined by the requesting FCO participant.\16\
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    \15\European-style options may only be exercised during a 
specified time period immediately prior to expiration of the option.
    \16\See Amendment No. 3, supra note 7.
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B. Procedures for Trading Customized FCOs

    The procedures for requesting and obtaining quotes for Customized 
FCOs are provided in Phlx Rule 1069 (a) and (b). First, Rule 1069(a) 
provides minimum sizes for trades in Customized FCOs. Specifically, (1) 
the minimum size for an opening transaction in any series in which 
there is no open interest at the time a request for quote (``RFQ'') is 
submitted will be 300 contracts, (2) the minimum size for an opening 
transaction in any series with open interest will be 100 contracts, and 
(3) the minimum size for a closing transaction will be the lesser of 
100 contracts or the remaining number of contracts. The minimum size 
for quotes responsive to a RFQ will be the lesser of 100 contracts or 
the remaining number of contracts on a closing transaction, provided, 
however, that assigned registered options traders (``ROT'') must 
provide responsive quotes for at least 300 contracts or the number of 
contracts requested, whichever is less.\17\
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    \17\Assigned ROTs are not specifically required to provide a 
responsive quote for each RFQ. The Phlx maintains, however, that an 
assigned ROT can be required by a Floor Broker or Floor Official 
(each as defined in the Phlx's rules), pursuant to Phlx Rule 
1014(c), to provide a responsive quote to a party submitting a RFQ. 
See Amendment No. 3, supra note 7, and Phlx Floor Procedure Advice 
B-1.
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    Rule 1069(b) provides that any FCO participant may request a quote 
for a Customized FCO from the trading crowd, with the characteristics 
as specified in Rule 1069(a). The FRQ may include the number of 
contracts for which the quote is being requested.\18\ If neither the 
RFQ nor any responsive quote specifies the number of contracts for 
which it applies, responsive quotes will be firm only for the minimum 
transaction sizes discussed above.\19\
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    \18\All RFQs, in addition to all responsive quotes and completed 
trades, will be promptly reported to the Options Price Reporting 
Authority (``OPRA'') and disseminated as administrative text 
messages. See Phlx Rule 1069(h). The Exchange has represented that 
the OPRA has the capacity to, and will, disseminate this information 
to vendors in a manner clearly indicating the type of Customized FCO 
involved (i.e., Customized Strike, Cross-Rate, or Inverse), the 
quoting format (i.e., either base currency per unit of underlying 
currency or Percentage Quoting), and the Approved Currency in which 
premiums are quoted and paid. Telephone conversation between Michele 
Weisbaum, Associate General Counsel, Phlx, and Brad Ritter, Senior 
Counsel, OMS, Division, Commission, on October 31, 1994.
    \19\Id.
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    Once a RFQ has been submitted and disseminated, all FCO 
participants will be given a reasonable opportunity to request a 
response time period during which time any participant may provide a 
responsive quote.\20\ If a response time period is requested, no trades 
may be executed until the response time period has elapsed, provided, 
however, that if two or more assigned ROTs provide responsive quotes 
prior to the end of the response time period, at the option of the 
party who submitted the RFQ or any other FCO participant, the order may 
trade at that time either in whole or in part.\21\
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    \20\The length of the response time period will be fixed and set 
by the Exchange's Foreign Currency Options Committee and will be 
within a range between one and ten minutes. Neither the party 
submitting the RFQ nor any other FCO participant will have any 
ability to adjust the length of the response period. See Amendment 
No. 3, supra note 7.
    \21\Responsive quotes cannot be made specific for acceptance by 
particular participants. Id.
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    Rule 1069(b) further provides that responsive quotes which become 
the best bid (offer) are entitled to participate in resulting trades on 
a parity/priority basis in accordance with Rule 1014(h),\22\ provided, 
however, that any assigned ROT who previously responded with a 
responsive quote which was thereafter improved upon during the response 
time period by another participant is entitled to participate on a 
parity basis with that other participant by announcing immediately 
thereafter, and prior to the execution of the order, that he or she is 
matching that best bid (offer). This ability to match on parity is 
available to assigned ROTs until the execution of the trade or the end 
of the response time period, whichever occurs first.\23\ When a 
response time period is requested, the party submitting the RFQ may not 
cross any portion of the order until after the earlier of the end of 
the response time period, if any, or the receipt of responsive quotes 
from two or more assigned ROTs. An order may be executed after the 
response time period has elapsed regardless of how many assigned ROTs 
have previously responded. After the response time period has elapsed, 
Phlx Rule 1014(h) governs priority/parity except that priority and 
parity obtained during the response time period, as discussed above, 
are retained unless or until the best bid (offer) established during 
the response time period is improved.\24\
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    \22\Phlx Rule 1014(h) generally sets forth the priority and 
parity rules applicable to FCOs traded on the Phlx.
    \23\See Amendment No. 3, supra note 7.
    \24\Id.
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C. Additional Rules Contained in Phlx Rule 1069

    Rule 1069 also contains additional rules applicable to the trading 
of Customized FCOs. Rule 1069(d) provides that ROTs must apply to the 
Exchange in order to obtain an assignment in Customized FCOs in one or 
more Approved Currencies. Further, all ROTs assigned to trade 
Customized FCOs are subject to the general obligations and restrictions 
applicable to ROTs as specified in Phlx Rule 1014(c).\25\
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    \25\ROTs will be subject to Exchange disciplinary actions for 
failing to meet their responsibility of making two-sided markets 
when requested to do so. See Phlx Rule 1014(c) and Phlx Floor 
Procedure Advice B-1. Additionally, Phlx ROTs are required to trade 
in person, and not through the use of orders, the greater of 1,000 
contracts or 50% of their contract volume on the Exchange in each 
quarter. Also, at least 50% of a ROT's trading activity in each 
quarter must be in assigned options. See Phlx Floor Procedure Advice 
B-3. For purposes of determining whether these trading requirements 
have been satisfied, trading in Customized FCOs will be treated the 
same as non-Customized FCOs. Telephone conversation with Michele 
Weisbaum, Associate General Counsel, Phlx, and Brad Ritter, Senior 
Counsel, OMS, Division, Commission, on October 20, 1994.
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    Rule 1069(d) sets forth the financial requirements for ROTs trading 
Customized FCOs. Specifically, assigned ROTs will be required to 
maintain a minimum of $1 million in net liquid assets. Further, non-
assigned ROTs may not execute transactions in Customized FCOs unless 
the non-assigned ROT has a minimum of $250,000 in net liquid assets. 
All ROTs trading Customized FCOs, both assigned and non-assigned ROTs, 
will be required to immediately inform the Exchange's Examination 
Department whenever the ROT fails to be in compliance with these 
requirements.\26\
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    \26\See Amendment No. 3, supra note 7. The Exchange represents 
that this affirmative obligation is being added to supplement the 
Exchange's current surveillance and monitoring procedures pursuant 
to which the Exchange monitors compliance with, among other things, 
the Exchange's financial requirements. Telephone conversation 
between Michele Weisbaum, Associate General Counsel, Phlx, and Brad 
Ritter, OSM, Division, Commission, on October 17, 1994.
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    Phlx Rule 1069(e) specifies that ROTs may not effect a transaction 
in Customized FCOs unless a letter of guarantee has been issued by a 
Phlx clearing member organization and filed with the Exchange pursuant 
to Phlx Rule 703 specifically accepting financial responsibility for 
all Customized FCO transactions entered into by the ROT. Additionally, 
a ROT cannot engage in Customized FCO transactions if the letter of 
guarantee is revoked.
    Phlx Rule 1069(f) provides that transactions in Customized FCOs may 
be effected during normal Exchange FCO trading hours on any business 
day. Rule 1069(f) further provides that there will be no trading 
rotations in Customized FCOs, either at the opening or at the close of 
trading.
    Finally, Rule 1069(j) provides that for Customized Strikes, the 
quote spread parameters will be twice those specified in Phlx Rule 
1014(c) for the relevant underlying Approved Currency. The rule further 
provides that Customized Inverses and Customized Cross-Rates will be 
exempt from quote spread parameters.\27\
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    \27\The Exchange will conduct a study of the markets for 
Customized Inverses and Cross-Rates to build an historical pricing 
reference database on which to analyze whether quotation parameter 
rules should be imposed in the future for these Customized FCOs. See 
Amendment No. 3, supra note 7.
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D. Position and Exercise Limits

    Phlx Rule 1001 (Position Limits) is being amended to provide 
position limits for Customized FCOs. Rule 1001 presently provides that 
the position limit for non-Customized FCOs on a particular Approved 
Currency, other than the U.S. dollar, is 150,000 contracts on the same 
side-of-the-market, provided that annual trading volume in FCOs on that 
Approved Currency is at least 3,500,000 contracts. In all other cases, 
the position limit for non-Customized FCOs is 100,000 contracts on the 
same side-of-the-market.\28\
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    \28\See Phlx Rule 1001, Commentary .05(b).
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    Customized FCOs will be subject to these same position limits; 
however, positions in Customized FCOs will be aggregated with positions 
in non-Customized FCOs and, in some cases, with other Customized FCOs. 
Specifically, Customized Strikes will be aggregated with positions in 
regular FCO contracts having the same underlying currency.\29\ For 
Customized Inverses, the position limit applicable to the base currency 
of the Customized Inverse will apply.\30\ Except as provided below, 
position limits applicable to Customized Cross-Rates will be the same 
as position limits applicable to regular cross-rate FCOs pursuant to 
Phlx Rule 1001, Commentary 05. For aggregation purposes, positions in 
Customized Cross-Rates will be aggregated with positions in regular 
cross-rate FCOs and other Customized Cross-Rates (1) with the same base 
and underlying currencies and (2) where the base and underlying 
currencies are reversed.\31\
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    \29\See Amendment No. 3, supra note 7.
    \30\For example, if the position limit for the U.S. dollar/
German mark non-Customized FCO is 150,000 contracts, the position 
limit for German mark/U.S. dollar Customized Inverses will also be 
150,000 contracts. Further, positions in U.S. dollar/German mark 
non-Customized FCO contracts will be aggregated with positions in 
German mark/U.S. dollar Customized Inverse contracts on the same 
side of the market. In the case of the German mark, positions in the 
Exchange's cash/spot German mark FCOs must also be aggregated with 
the above positions and with positions in Customized Strikes where 
the German mark is the underlying currency. See infra note 32.
    \31\For example, positions in the German mark/Japanese yen 
Customized Cross-Rate will be aggregated with positions in the non-
Customized German mark/Japanese yen contracts and with positions in 
the Japanese yen/German mark Customized Cross-Rate.
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    Additionally, Phlx Rule 1001, Commentary .05(c)(4), provides that 
for purposes of aggregating positions, long positions in Customized 
Inverse calls, short positions in Customized Inverse puts, short 
positions in non-Customized FCO calls, short positions in Customized 
Strike calls, long positions in non-Customized FCO puts, and long 
positions in Customized Strike puts will be aggrgated. Similarly long 
positions in Customized Inverse puts, short positions in Customized 
Inverse calls, short positions in non-Customized FCO puts, short 
positions in Customized Strike puts, long positions in non-Customized 
FCO calls, and long positions in Customized Strike calls will be 
aggregated.\32\ This is consistent with the aggregation procedures 
currently provided in Phlx Rule 1001, Commentary .02, for positions on 
the same side of the market.
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    \32\For example, the following positions related to the German 
mark would be aggregated for purposes of Rule 1001: (1) Long Inverse 
German mark/U.S. dollar calls; (2) short Inverse German mark/U.S. 
dollar puts; (3) short standardized U.S. dollar/German mark calls; 
(4) short Customized Strike U.S. dollar/German mark calls; (5) long 
standardized U.S. dollar/German market puts; and (6) long Customized 
Strike U.S. dollar/German market puts. In addition, positions in the 
Exchange's cash/spot U.S. dollar/German mark contract on the same 
side of the market as the foregoing positions must also be 
aggregated.
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    Furthermore, for purposes of determining whether the 3,500,000 
contract annual trading volume level has been satisfied for purposes of 
applying the 150,000 contract position limit pursuant to Rule 1001, 
Commentary .05(b), trading volume in Customized FCOs will not be 
considered.\33\ Customized FCOs will be eligible for the 150,000 
position limit level if: (1) In the case of Customized Strikes, non-
Customized FCOs on the same underlying currency, when considered alone, 
would be so eligible; (2) in the case of Customized Inverses, if non-
Customized FCOs on the same base currency, when considered alone, would 
be so eligible; and (3) in the case of Customized Cross-Rates, if 
regular cross-rate FCOs on the same base and underlying currencies, 
when considered alone, would be so eligible. The higher position limit 
will not be available for Customized Cross-Rates where there are no 
regular cross-rate FCOs trading on the same or the reverse base and 
underlying currencies.
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    \33\See Amendment No. 3, supra note 7.
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    Finally, Rule 1069(i) provides that the exercise limits set forth 
in Rule 1002 applicable to non-Customized FCOs also apply to Customized 
FCOs.\34\ Moreover, when Customized FCOs are exercised, the lesser of 
100 contracts or the remaining number of open contracts must be 
exercised.
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    \34\Id.
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E. Margin Requirements Applicable to Customized FCOs

    Customized Inverses and Customized Strikes will be margined at the 
same levels as the Exchange's non-Customized FCOs.\35\ Customized 
Cross-Rates, however, will be margined using a two tier system. Tier I 
will consist of all pairings of Approved Currencies (not involving the 
U.S. dollar) whose daily price changes have a correlation greater than 
or equal to .25, and Tier II will consist of all remaining pairings of 
Approved Currencies. The initial and/or maintenance margin requirements 
for Customized Cross-Rates will be 100% of the value of the underlying 
position plus: (1) 4% for Tier I Approved Currency pairings; and (2) 6% 
for Tier II Approved Currency Pairings.\36\
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    \35\See Phlx Rule 722.
    \36\The minimum margin for Tiers I and II will be reduced by the 
amount by which the position is out-of-the-money, subject to a floor 
of 100% of the value of the underlying position plus \3/4\% Id.
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    The Exchange will conduct a regular two-step review of the margin 
levels for Customized Cross-Rates. The first review, to be conducted at 
least monthly,\37\ will determine the correlations between all of the 
possible combinations of Approved Currencies for the most recent 24 
month period. If a monthly or any special review reveals that a 
combination of Approved Currencies should be in another tier based on 
the correlation of those Approved Currencies, the change will 
immediately be implemented and the membership, the public, and the 
Commission will be promptly notified.
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    \37\The Exchange also has the ability to conduct more frequent 
reviews in the event of major price movements in any of the 
underlying currencies.
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    The second review will determine whether the actual margin levels 
are adequate to cover seven day price changes for all possible cross-
rate combinations within a tier. Frequency distributions of seven day 
price movements for all currency combinations will be reviewed on a 
monthly basis to determine whether the percentage of margin ``add-on'' 
is sufficient to cover 95% of all instances over the preceding two year 
period within the tier group for those combinations. If the percentage 
falls to less than 95%, the Exchange will take steps to increase the 
margin level for those pairings to one which will cover at least 97.5% 
of all instances. If the margin adequacy level is greater than 99%, the 
Exchange will take steps to lower the margin requirements for those 
pairings to one which will cover 99%. In no event, however, will the 
initial and/or maintenance margin levels for any pairing of Approved 
Currencies be reduced below the 4% and 6% levels discussed above.\38\
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    \38\See Amendment No. 3, supra note 7.
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    The OCC will clear and settle all trades in Customized FCOs. 
Because quotes in these options will not be continuously updated or 
otherwise priced by the Exchange, the OCC will generate a theoretical 
price based on the prices and quotes of the Customized FCOs, prices of 
non-Customized FCO series, and the closing value of the relevant 
underlying Approved Currency. The OCC will use this price to mark the 
Customized FCO contracts daily and calculate margin requirements.\39\
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    \39\See infra note 55.
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F. Other Applicable Exchange Rules

    The Phlx is also amending certain other Exchange rules to 
accommodate the trading of Customized FCOs. Several of these amendments 
are necessary because of the fact that for purposes of trading 
Customized FCOs, the U.S. dollar is now included as an Approved 
Currency.\40\
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    \40\See Phlx Rules 1000 (Applicability, Definitions and 
References), 1001 (Position Limits), 1009 (Criteria for Underlying 
Stocks), and 1034 (Minimum Fractional Changes).
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    Other rule amendments are also necessary in order to incorporate 
Customized FCOs into the Exchange's rules. First, Rule 1002 (Exercise 
Limits) is being amended to add a cross-reference to Rule 1069 to 
specify that when exercised, there is both a maximum and a minimum 
number of Customized FCOs that can be exercised pursuant to the 
Rule.\41\ Second, Rule 1014 (Obligations and Restrictions Applicable to 
Specialists and Registered Options Traders) is being amended to add a 
cross-reference to Rule 1069(j) to indicate that separate bid/ask 
differentials are applicable to Customized FCOs. Third, Rule 1033 (Bids 
and Offers--Premium) and Rule 1034 (Minimum Fractional Changes) are 
being amended in order to provide rules for quoting Customized Inverses 
and Cross-Rates and for the minimum fractional changes applicable to 
Customized Inverses and Cross-Rates, respectively. Fourth, Rule 1047 
(Trading Rotations, Halts and Suspensions) is being amended to specify 
that there will be no trading rotations for Customized FCOs. 
Additionally, because the proposed rule change will alter language in 
Rules 1009 (Criteria for Underlying Stocks) and 1033 (Bids and Offers--
Premium), the Exchange is proposing to correct some inaccurate or 
redundant information presently contained in those rules.
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    \41\See supra Section II.C (Additional Rules Contained in Phlx 
Rule 1069).
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    Furthermore, except as modified or amended herein, Customized FCOs 
will be subject to all Exchange rules applicable to non-Customized FCOs 
and will be subject to all Exchange rules regarding surveillance and 
sale practices. Finally, unless specifically exempted, all floor 
trading procedures will also apply to the trading of Customized FCOs.

III. Discussion

    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 Sections 6(b)(5)\42\ and 11A\43\ of the 
Act. In particular, the Commission believes that the proposed rule 
change is designed to provide institutional investors with exchange-
traded customized FCOs that may be more suitable to their investment 
needs.\44\
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    \42\ 15 U.S.C. 78f(b)(5) (1988).
    \43\ 15 U.S.C. 78k-1 (1982).
    \44\ The Commission notes that in many respects, the Phlx 
proposal to trade Customized FCOs raises many of the same issues 
that were raised and addressed in connection with proposals by 
certain of the options exchanges to trade flexible exchange options 
on broad-based indexes (``FLEX Options''). See Securities Exchange 
Act Release Nos. 31920 (February 24, 1993), 58 FR 12280 (March 3, 
1993) (order approving the trading of FLEX Options on the S&P 100 
and 500 stock indexes), 32694 (July 29, 1993) 58 FR 41814 (August 5, 
1993) (order approving the trading of FLEX Options on the Russell 
2000 stock index), 32781 (August 20, 1993), 58 FR 45360 (August 27, 
1993) (order approving the trading of FLEX Options on the Major 
Market, Institutional, and S&P MidCap 400 stock indexes), and 34364 
(July 13, 1994), 59 FR 36813 (July 19, 1994) (order approving the 
trading of FLEX Options on the Wilshire Small Cap and PSE Technology 
stock indexes) (collectively, ``FLEX Options Approval Orders'').
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    Moreover, consistent with Section 11A of the Act, the proposal 
should encourage fair competition among brokers and dealers and 
exchange markets by allowing the Phlx to compete more effectively with 
the over-the-counter (``OTC'') derivatives market in FCOs. For 
instance, as noted by the Phlx, FCO market participants traditionally 
have been able to customize FCOs in the OTC derivatives market, 
designating many if not all of the terms of the FCOs. By trading in the 
OTC derivatives market, however, these users, who are almost 
exclusively institutional investors, do not benefit from the advantages 
of an organized exchange. These benefits include, but are not limited 
to, a centralized market center, an auction market with posted 
transparent market quotations and transaction reporting, standardized 
contract specifications, parameters and procedures for clearance and 
settlement, and the guarantee of the OCC that will apply for all 
Customized FCOs traded on the Exchange. The Commission believes that 
the Phlx proposal will provide these benefits to investors. 
Accordingly, the Commission believes that Phlx proposal is a reasonable 
response by the Exchange to meet the demands of sophisticated portfolio 
managers and other institutional investors who currently rely 
predominantly on the OTC derivatives market to satisfy their foreign 
currency hedging needs.

A. Proposed Framework for Trading Customized FCOs

    In general, transactions in Customized FCOs will be subject to many 
of the same rules that apply to non-Customized FCOs traded on the Phlx. 
In order to provide investors with the flexibility to designate terms 
of the Customized FCOs and to accommodate the special trading of 
Customized FCOs, however, several new rules will apply solely to 
Customized FCOs.
    Due to the customized nature of these options, Customized FCOs will 
not have trading rotations at either the opening or closing of trading. 
In addition, the auction process outlined above in proposed Rule 1069 
sets forth a procedure of customized negotiation for those investors 
seeking particular flexibility in setting certain FCO terms. 
Accordingly, the Phlx proposed rules specific to Customized FCOs vary 
from the traditional procedures for trading non-Customized FCOs. The 
Commission believes that the Customized FCO auction process, as 
outlined above, appears reasonably designed to provide investors with 
the benefits of an exchange auction environment for FCOs with features 
of a negotiated transaction between investors. The Commission believes 
that this is particularly true in view of the fact that most 
participants in the FCO market are institutional investors and that the 
proposed rule change is geared specifically to these investors. 
Further, the auction process proposed for Customized FCOs is similar to 
that previously approved by the Commission for exchange-trading of FLEX 
Options.\45\
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    \45\ Id. In addition, based on representations from the Phlx and 
the OPRA, the Commission believes that the Exchange and the OPRA 
will have adequate systems processing capacity to accommodate the 
additional options listed in connection with customized strike 
options. See Letter from Steven Watson, Data Processing, Phlx, to 
Richard Cangelosi, Director of New Products, Phlx, dated July 27, 
1994, and letter from Joseph Corrigan, Executive Director, OPRA, to 
Richard Cangelosi, Director of New Products, Phlx, dated July 21, 
1994. See also, supra note 18.
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    Moreover, the proposal offers flexibility to institutional 
investors in the FCO market without raising significant market 
manipulation concerns. First, as noted above, transactions in 
Customized FCOs will be subject to many of the same rules that apply to 
non-Customized FCOs traded on the Exchange, including all Exchange 
rules regarding surveillance and sales practices. Additionally, 
position limits for Customized FCOs, as described above, are the same 
as those for non-Customized FCOs with the additional protection that 
positions in Customized FCOs will be aggregated with positions in non-
Customized FCOs.\46\ The Commission believes that these provisions will 
help to ensure that the Exchange has the ability to adequately surveil 
the market for Customized FCOs and to take prompt actions (including 
timely communications with the Commission) should any unanticipated 
adverse market effects develop.
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    \46\The Commission notes that in contrast to FLEX Options which 
have position limits substantially higher than those applicable to 
non-FLEX Options on the same underlying indexes, positions in 
Customized FCOs will be aggregated with positions in non-Customized 
FCOs for position limit purposes. As a result, the Commission is not 
requiring that the trading of Customized FCOs be implemented as a 
pilot program nor will the Exchange be required to submit reports to 
the Commission similar to those required from the exchanges that are 
trading FLEX Options. See FLEX Options Approved Orders, supra note 
44.
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B. Customized Strikes and Inverses

    The Commission believes that the listing and trading of Customized 
Strikes and Inverses does not raise any significant regulatory issues 
that were not addressed by the Phlx when the Commission originally 
approved the trading of non-Customized FCOs.\47\ Specifically, while 
Customized Strikes and Inverses are new FCO products, they are very 
similar to non-Customized FCOs in that investors will still be taking 
positions based on their expectations of the future relationship 
between an Approved Currency (other than the U.S. dollar) and the U.S. 
dollar. The proposal, as with FLEX Options that currently trade on 
several of the other options exchanges,\48\ merely allows investors to 
more closely tailor the current Exchange-traded FCOs to their 
particular investment needs. As a result, the Commission believes that 
the listing and trading of Customized Strikes and Customized Inverses, 
in the context of the framework described above, is appropriate and 
consistent with the Act.
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    \47\See Securities Exchange Act Release No. 19133 (October 14, 
1982), 47 FR 46946 (October 21, 1982).
    \48\See FLEX Options Approved Orders, supra note 44.
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C. Customized Cross-Rates

    The discussion above regarding Customized Strikes and Inverses also 
applies to the listing of Customized Cross-Rates. Customized Cross-
Rates, however, raise additional issues in that with Customized Cross-
Rates, investors will be able to trade options on combinations of 
Approved Currencies that currently cannot be traded on the Exchange. 
The Exchange believes, however, that the concerns raised by this 
portion of the proposal are not any different from those that were 
raised and addressed by the Exchange when the Commission approved the 
listing and trading of regular cross-rate FCOs.\49\ In the Cross-Rate 
Approval Order, the Commission stated that regular cross-rate FCOs are 
riskier and more complex than non-Customized FCOs where the U.S. dollar 
is the base currency. The Commission, however, found that those risks 
were adequately disclosed in the Options Disclosure Document (``ODD'') 
which is required to be delivered to all options investors.\50\ 
Similarly, the Commission notes here that the ODD was recently amended 
so that the discussion of FCOs now also discloses the risks of 
Customized Cross-Rates, in particular, and Customized FCOs, in 
general.\51\
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    \49\See Securities Exchange Act Release No. 29919 (November 7, 
1991), 56 FR 58109 (November 15, 1991) (``Cross-Rate Approval 
Order'').
    \50\Id.
    \51\See Securities Exchange Act Release No. 33582 (February 4, 
1994), 59 FR 661 (February 11, 1994).
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    Further, the Commission notes that the proposed margin levels for 
Customized Cross-Rates are more stringent than those approved for 
regular cross-rate FCOs. Specifically, for regular cross-rate FCOs, the 
Exchange requires a margin of 100% of the option premium plus 4% of the 
value of the underlying foreign currency, with an adjustment for out-
of-the-money options of not less than 100% of the options premiums plus 
\3/4\% of the value of the underlying foreign currency. As described 
above, the proposed rule change provides two tiers for purposes of 
determining the applicable margin for Customized Cross-Rates based on 
historical correlation rates between particular combinations of 
Approved Currencies (other than the U.S. dollar). The lower tier 
requires margin of not less than 100% of the options premium plus 4% of 
the value of the underlying currency, and the higher tier requires 
margin of not less than 100% of the options premium plus 6% of the 
value of the underlying currency. The Commission notes that the Phlx 
must raise these levels, if during a review of margin levels and tier 
classifications,\52\ the Phlx determines that the 4% and 6% margin 
levels for Tiers I and II, respectively, fail to meet certain specified 
criteria designed to ensure coverage of most expected market moves in 
the relevant currencies.\53\ The Commission, therefore, believes that 
the proposed margin levels for Customized Cross-Rates will result in 
adequate coverage of contract obligations, and are designed to preclude 
systemic risks arising from excessively low margin levels.\54\ 
Accordingly, the Commission believes that the listing and trading of 
Customized Cross-Rates, within the framework described above, is 
appropriate and consistent with the Act.
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    \52\See supra Section II.E (Margin Requirements Applicable to 
Customized FCOs).
    \53\While the proposed margin levels cannot account for every 
unexpected market movement in each particular Approved Currency 
pairing, it is important that the margin levels contain some ``add-
on'' provision to cover a short-term sharp movement beyond a two 
standard deviation coverage of expected movements. The Phlx has 
attempted to provide this ``add-on'' through the 4% and 6% margin 
floors. Id.
    \54\See Cross-Rate Approval Order, supra note 49.
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D. Percentage Quoting

    The Commission also believes that allowing Customized FCOs to be 
quoted as a percentage of the particular underlying currency does not 
raise any significant regulatory issues. As in the discussion above 
with regard to Customized Strikes and Inverses, Percentage Quoting does 
not change the basic structure of non-Customized FCOs now trading on 
the Exchange. Investors currently can mathematically convert a premium 
expressed in terms of U.S. dollars per unit of underlying currency into 
a percentage of the underlying currency by applying a particular 
exchange rate. The real significance of percentage quoting is that it 
allows investors to quote, pay premium, and settle, Customized FCOS 
solely in the underlying currency instead of having to quote and pay 
premiums in the base currency, and settle the options in the underlying 
currency. Because the OCC has the ability to settle FCOs in any of the 
Approved Currencies, allowing investors to also pay the premiums in an 
Approved Currency does not raise any new market or investor protection 
concerns.\55\
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    \55\The Commission notes that simultaneously with this approval 
order, the Commission is also approving rule changes proposed by the 
OCC by which the OCC is adopting the framework necessary to clear 
and settle Customized FCOs. See Securities Exchange Act Release No. 
34926 (November 1, 1994) (order approving File Nos. SR-OCC-94-04, 
SR-OCC-94-05, and SR-OCC-94-07).
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E. Procedures for Trading Customized FCOs

    As stated above, the Commission believes that the procedures 
outlined above for the trading of Customized FCOs are reasonably 
designed to provide the benefits of an exchange auction market with 
features of a negotiated transaction between investors. The Commission 
recognizes that the Phlx's proposal will permit the trading of FCO 
contracts of substantial value for which continuous quotation may be 
difficult to sustain. Accordingly, the Phlx has established procedures 
for quotes upon request which will be publicly disseminated through the 
OPRA.\56\
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    \56\See supra note 18. The Commission notes that the proposed 
procedures for disseminating RFQs, responsive quotes, and completed 
transactions, through OPRA as administrative text messages are the 
same procedures used by the options exchanges that trade FLEX 
Options (see supra note 44). By making these administrative text 
messages available to vendors, transparency in the market for 
Customized FCOs will be significantly greater than the transparency 
that exists in the OTC FCO derivatives market.
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    Additionally, the Commission believes that allowing assigned ROTs 
who have previously provided responsive quotes to be able to achieve 
parity during a response period is a reasonable means by the Phlx of 
attempting to add liquidity to the market. By making this benefit 
available to assigned ROTs, the Phlx may be able to encourage ROTs to 
become assigned to trade Customized FCOs and, once assigned, to act in 
a manner to create liquid Customized FCO markets. Specifically, 
assigned ROTs will only be able to benefit from this feature if they 
act quickly to provide responsive quotes during the response time 
period which, in turn, may facilitate trading in the Customized FCOs.
    In addition, the Commission believes that the requirement that 
assigned ROTs must respond to a RFQ and must honor their quoted markets 
for a certain minimum number of a contracts is appropriate. The 
Commission recognizes that although assigned ROTs are not required to 
respond to RFQs, the market making obligations under the Phlx's rules, 
as discussed above, in addition to the ability of Floor Officials and 
Floor Brokers to require a ROT to respond to RFQs, should help to 
ensure that assigned ROTs provide adequate liquidity in the market for 
Customized FCOs. In this regard, the Commission will expect the Phlx to 
take action against assigned ROTs that fail, on an on-going basis, to 
provide responsive quotes.\57\
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    \57\In addition, the Commission notes that even if a ROT 
provides responsive quotes, the Exchange can take disciplinary 
action against the ROT pursuant to Phlx Rule 960 if the ROT quotes 
markets that the Exchange deems inconsistent with the maintenance of 
fair and orderly markets.
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    In summary, the Commission believes that based on the unique nature 
of the FCO market (i.e., that participants are largely institutional 
investors) that the Phlx has set forth a reasonable proposal that 
blends the customized nature of the OTC FCO derivatives market with 
exchange auction market principles. In approving the proposed rule 
change, the Commission recognizes that some of the procedures, such as 
the ability of assigned ROTs to establish parity, in some instances, 
during a request response time, and the minimum contract requirements, 
deviate from existing rules that apply to Phlx's non-Customized FCO 
market. Nevertheless, the Commission believes the proposal adequately 
balances the Exchange's need to attract liquidity to its trading floor 
with the specialized institutional characteristics of the FCO market. 
Moreover, to the extent that the Phlx proposal attracts transactions to 
the Exchange floor that would otherwise be completed in the OTC 
derivatives market, the investors participating in those transactions 
will receive the benefits of an exchange auction market, such as full 
transaction reporting and the clearance and settlement features 
provided by the OCC. Based on the above, the Commission finds that the 
proposed rule change is appropriate.

F. Amendment No. 3

    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 begin trading Customized FCOs, which 
have been under review by the Commission for several months, without 
further delay.\58\ The Commission believes that the majority of the 
changes contained in Amendment No. 3 strengthen the Exchange's original 
proposal to trade Customized FCOs and serve to minimize the potential 
for confusion as to the application of the Exchange's rules regarding 
Customized FCOs. Additionally, each of these changes clarifies the 
Exchange's original proposal which, the Commission notes, was published 
for the full comment period without any comments being received.
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    \58\As noted previously, Amendment No. 3 incorporates the 
substance of, and withdrew, Amendment Nos. 1 and 2. See supra note 
7.
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    The Commission also believes that the changes to Rule 1069 proposed 
in Amendment No. 3 do not raise any significant new issues that require 
notice prior to approval. Most of the changes to Rule 1069 contained in 
amendment No. 3 are nonsubstantive and are designed to reflect more 
clearly the intent of the Exchange's original proposal in order to 
minimize any potential for confusion among participants in the market 
for Customized FCOs. The amendment to subsection (d) requiring all ROTs 
to notify the Exchange's Examination Department immediately if they are 
not in compliance with the financial requirements of the rule should 
serve to strengthen the proposal and promote the creation of a fair and 
orderly market for Customized FCOs. The amendment withdrawing the 
request for spread margin treatment simply removes a potential 
reduction in margin for spread transactions.
    Similarly, the amendment to Rule 1001 provides certainty as to the 
exclusion of trading volume in Customized FCOs when determining whether 
the 150,000 contract position limit is available. The remaining 
amendment to Rule 1001, Commentary .05, merely clarifies which 
positions are considered to be on the same side of the market for 
aggregation purposes.
    The changes to Rule 722 contained in Amendment No. 3 are also more 
restrictive than the proposal as originally noticed. The original 
proposal provided for three margin tiers applicable to Customized 
Inverses with the margin for the lowest tier being only 2%. In 
Amendment No. 3 the Exchange provides that only two tiers will exist 
and that the lowest applicable margin level will be 4%. As discussed 
above, the Commission believes that this two-tiered structure and the 
margin levels proposed are appropriate.\59\ The amendments to Rule 722 
also merely codify this two-tier approach and clarify the manner by 
which applicable margin will be determined for each specific Approved 
Currency combination for Customized Cross-Rates.
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    \59\See supra Section III.C (Customized Cross-Rates).
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    The other substantive changes proposed in Amendment No. 3 are 
merely for the purpose of conforming existing Exchange rules to the 
procedures provided in new Rule 1069, thus eliminating inconsistencies 
in the Phlx's rules. The remaining changes contained in Amendment No. 
3, as discussed above, correct inaccurate or redundant information 
presently contained in Phlx Rules 1009 and 1033 and thus raise no new 
issues.
    Accordingly, the Commission believes it is consistent with Section 
6(b)(5) of the Act to approve 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. 552, will be available for inspection and 
copying in 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 Phlx. All 
submissions should refer to the File No. SR-Phlx-94-18 and should be 
submitted by November 29, 1994.

IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal, as amended, is consistent with the Act and Sections 6 and 11A 
of the Act in particular. In addition, the Commission also finds 
pursuant to Rule 9b-1 under the Act that Customized FCOs are 
standardized options for purposes of the options disclosure framework 
established under Rule 9b-1 of the Act.\60\
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    \60\As part of the original approval process of the FLEX Options 
framework (see, e.g., supra note 44), the Commission delegated to 
the Director of the Division of Market Regulation the authority to 
authorize the issuance of orders designating securities as 
standardized options pursuant to Rule 9b-1(a)(4) under the Act. See 
Securities Exchange Act Release No. 31911 (February 23, 1993), 58 FR 
11792 (March 1, 1993). On May 4, 1993, Chairman Breeden, pursuant to 
Public Law 87-592, 76 Stat. 394 [15 U.S.C. 78d-1, 78d-2], and 
Article 30-3 of the Commission's Statement of Organization; Conduct 
and Ethics; and Information and Requests [17 CFR 200.30-3], 
designated that persons serving in the position of Deputy Director, 
Associate Director, and Assistant Director, in the Division of 
Market Regulation, be authorized to issue orders designating 
securities as ``standardized options'' pursuant to Rule 9b-1(a)(4). 
Accordingly, this subdelegation provides the necessary authority for 
Customized FCOs to be designated as ``standardized options'' by the 
Division of Market Regulation. See Designation of Personnel to 
Perform Delegated Functions in the Division of Market Regulation, 
dated May 4, 1993.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\61\ that the proposed rule change (SR-Phlx-94-18), as amended, is 
hereby approved.
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    \61\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\62\
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    \62\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-27632 Filed 11-7-94; 8:45 am]
BILLING CODE 8010-01-M