[Federal Register Volume 60, Number 12 (Thursday, January 19, 1995)]
[Notices]
[Pages 3887-3888]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-1281]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35211; File Nos. SR-Amex-94-12, SR-CBOE-94-27; and SR-
PSE-94-23]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes by the American Stock Exchange, Inc., the Chicago Board Option 
Exchange, Inc., and Pacific Stock Exchange, Inc.; Relating to Short 
Sales of Nasdaq/NM Securities of Companies Involved in a Merger or 
Acquisition

January 10, 1995.

I. Introduction

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ on October 14, 1994, the 
American Stock Exchange, Inc. (``Amex''), on August 4, 1994, the 
Chicago board Options Exchange, Inc. (``CBOE''), and on August 8, 1994, 
the Pacific Stock Exchange, Inc. (``PSE''), respectively (each 
individually referred to herein as an ``Exchange'' and two or more 
collectively referred to as ``Exchange''), submitted to the Securities 
and Exchange Commission (``Commission'') proposed rule changes relating 
to extending the market maker exemption from the NASD's short sale rule 
to Nasdaq National Market (``Nasdaq/NM'' or ``NM'') securities involved 
in merger and acquisition (``NSA'') transactions. On September 29, 
1994, the CBOE filed Amendment No. 1 to its proposal,\3\ and on October 
14, 1994, the PSE filed Amendment No. 1 to its proposal.\4\ The 

[[Page 3888]]
Amex, CBOE, and PSE proposals were each published for comment in the 
Federal Register on November 21, 1994.\5\ No comments were received on 
the proposed rule changes. This order approves the Exchanges' 
proposals, as amended.

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
    \3\In Amendment No. 1, the CBOE adds the requirement that for a 
short sale in a Nasdaq/NM security involved in an M&A to qualify as 
an exempt hedge transaction pursuant to the current proposal, the 
M&A must be publicly announced. See letter from Michael L. Meyer, 
Schiff Hardin & Waite, to Francois Mazur, Attorney, Division of 
Market Regulation (``Division''), Commission, dated September 29, 
1994 (``CBOE Amendment No. 1'').
    \4\In Amendment No. 1, the PSE adds the requirement that for a 
short sale in a Nasdag/NM security involved in an M&A to qualify as 
an exempt hedge transaction pursuant to the current proposal, the 
M&A must be publicly announced. See letter from Michael D. Pierson, 
Senior Attorney, Market Regulation, PSE, to Francois Nazur, 
Attorney, Division, Commission (``PSE Amendment No. 1''). The 
Commission notes that the Amex proposal, as originally proposed 
requires the M&A to be publicly announced.
    \5\See Securities Exchange Act Release Nos. 34971 (November 14, 
1994), 59 FR 60027 (Amex); 34972 (November 14, 1994), 59 FR 60028 
(CBOE); and 34970 (November 14, 1994), 59 FR 60029 (PSE).
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II. Description of Proposals

    The Commission recently approved proposals submitted by the options 
exchange concerning a market maker exemption\6\ to the NASD bid test 
rule\7\ applicable to short sales to NM securities traded through 
Nasdaq. The purposes of the market maker exemption is to allow options 
market makers\8\ to hedge their options positions by buying or selling 
(including selling short) shares of underlying stock or underlying 
component stocks contained in stock indexes; such short sales are 
referred to as ``exempt hedge transactions.''\9\ The Exchange' 
proposals were approved on a temporary basis to remain in effect 
concurrently with the NASD's bid test rule pilot program.\10\

    \6\Securities Exchange Act Release No. 34632 (September 2, 
1994), 59 FR 46999 (approving proposals by the Amex, CBOE, New York 
Stock Exchange, Inc., PSE, and Philadelphia Stock Exchange, Inc.).
    \7\The NASD bid test rule prohibits broker-dealers from 
effecting short sales, for themselves or their customers, at or 
below the ``bid'' when the current ``inside'' or best bid is below 
the previous inside bid. NASD Rules of Fair Practice (``NASD 
Rules''), Art. III, Section 48. See Securities Exchange Act. Release 
No. 34277 (June 6, 1994), 59 FR 34885 (amending the NASD Rules to 
add the short sale rule).
    \8\For purposes of this order, a ``market Maker'' is a Market 
Maker as referred to in the CBOE and PSE Rules, and a Specialist or 
Registered Options Trader as referred to in the Amex Rules.
    \9\An ``exempt hedge transaction'' is a short sale in an NM 
security effected to hedge, and which in fact serves to hedge, an 
existing offsetting options positions or an offsetting 
contemporaraneous with the short sale. See Amex Rule 
957(d)(2)(b)(ii), CBOE Rule 15.10(c)(2)(iii)(A), and Rule 
4.19(c)(2)(B)(9).
    \10\See Securities Exchange Act Release No. 34277, supra note 6. 
The Commission approved the NASD's short sale rule on an eighteen 
month temporary basis, effective September 6, 1994, through March 5, 
1996. Id.
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    Currently, the NASDA provides an exemption from the short sale bid 
test for risk arbitragers (and other NASD members) who take positions 
in the stocks involved in M&G transactions.\11\ Consequently, the 
Exchange desire to amend their respective rules to extend the market 
maker exemption from the bid test rule to certain short sales of the 
stock of a company that is involved in a publicly announced M&A with a 
company whose stock is a designated Nasdaq/NM security.\12\

    \11\See Securities Exchange Act Release No. 34277, supra note 7. 
The NASD short sale rule states that once an M&A has been two 
affected securities may immediately reguister as a qualified market 
maker in the other M&A security. See NASD Rules, Article III, 
48(1)(3)(iii). Consequently, such a market maker may relay on the 
market maker exemption for short sales of the other M&A security.
    \12\Proposed Rule 957(d)(2)(b)(iv); Proposed CBOE Rule 
15.10(a)(2)(ii)(D); and Proposed PSE Rule 4.19(c)(2)(B)(iv). A 
``designated NM security'' is an NM security which the market maker 
has designated as qualifying for the bid test exemption. See e.q., 
CBOE Rule 15.10(c)(2)(B).
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III. Discussion

    The Commission believes that the Exchanges' proposed rule changes 
are consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to national securities exchanges. In 
particular, the Commission believes the Exchanges' proposals are 
consistent with the requirements of Section 6(b)(5) of the Act\13\ in 
that they are designed to remove impediments to, and perfect the 
mechanism of, a free and open market, and to protect investors and the 
public interest.

    \13\15 U.S.C. 78f(b)(5) (1988).
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    The Commission approved the NASD's short sale rule proposal on June 
29, 1994,\14\ and in so doing stated that the short sale rule, together 
with the market maker exemption, is a reasonable approach to regulating 
short sales of Nasdaq/NM securities. The Commission believes that the 
Exchanges' proposals are consistent with the NASD's bid test rule and 
address the limitations established by the NASD concerning the 
applicability of the market maker exemption.

    \14\Securities Exchange Act Release No. 34277, supra note 7.
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    Specifically, the Exchanges' proposals are designed to extend the 
market maker exemption to the stock of a company that is involved in a 
publicly announced M&A with a company whose stock is designated Nasdaq/
NM security. The Commission believes that when a designated Nasdaq/NM 
security becomes involved in an M&A, options market makers may need to 
hedge positions in options overlying such a designated Nasdaq/NM 
security by buying or selling the securities of the other company 
involved in the M&A, whether or not the other company's stock has 
listed overlying options. Indeed, where there are no options on the 
other company's stock, buying or selling that company's stock at times 
may be the only feasible way for a market maker to hedge positions in 
options on the designated Nasdaq/NM security, given the risk arbitrage 
relationship that is likely to exist between the two stocks. Therefore, 
the Commission believes that by allowing market makers to sell short, 
for hedging purposes, shares of a company that is involved in an M&A 
with a company whose stock is a designated Nasdaq/NM security, and to 
designate such sales as bid test exempt, the Exchanges' proposals will 
enhance the ability of their market makers perform their market making 
functions, thereby contributing to the liquidity of the market for 
options, as well as to the liquidity of the market for the stocks of 
both companies.
    The Commission notes that the proposed extension of the market 
maker exemption from the short sale rule is limited to publicly 
announced M&As. Moreover, market makers may avail themselves of the M&A 
extension to the exemption only when the short sales are made to hedge 
existing or prospective positions in options on a security of another 
company involved in the M&A, the options positions are or will be in a 
class of options for which the market maker is registered and are or 
will be an ``exempt hedge transaction'' as defined in the Exchanges' 
rules.\15\

    \15\See supra note 9.
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IV Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the Amex, CBOE, and PSE proposed rule changes (SR-Amex-
94-42, SR-CBOE-94-27, and SR-PSE-94-23, respectively), as amended, are 
approved on a temporary basis, to remain in effect so long as their 
respective rules regarding the market maker exemption\17\ to the NASD's 
bid test rule remain in effect.

    \16\15 U.S.C. 78s(b)(2) (1982).
    \17\Amex Rule 957, CBOE Rule 15.10, and PSE Rule 4.19.
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\

    \18\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-1281 Filed 1-18-95; 8:45 am]
BILLING CODE 8010-01-M1