[Federal Register Volume 60, Number 204 (Monday, October 23, 1995)]
[Notices]
[Pages 54395-54398]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26182]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36381; File No. SR-CBOE-95-38]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving Proposed Rule Change Relating to the Listing and 
Trading of Warrants on the CBOE Technology 50 Index

October 17, 1995.
    On August 1, 1995, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to list and trade warrants based 
on the CBOE Technology 50 Index (``Tech 50 Index'' or ``Index''). The 
Exchange subsequently filed Amendment No. 1 to the proposal on August 
2, 1995,\3\ Amendment No. 2 on August 3, 1995,\4\ and Amendment No. 3 
on August 29, 1995.\5\

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988 & Supp. V 1993).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ As a result of the Commission's approval of the Exchange's 
Generic Warrant Listing Standards (as defined herein), Amendment No. 
1 has been rendered moot.
    \4\ In Amendment No. 2, as discussed herein, the CBOE amended 
certain of the objective standards set forth in the section of its 
proposal entitled ``Classification of the Index as Broad-Based.'' 
See Letter from Timothy Thompson, CBOE, to Michael Walinskas, SEC, 
dated August 3, 1995 (``Amendment No. 2'').
    \5\ In Amendment No. 3, as discussed herein, the Exchange 
amended the composition of the Index to, in the Exchange's opinion, 
provide better balance between the technology industry subsectors 
represented in the Index. See Letter from William Speth, Jr., Senior 
Research Analyst, Research Department, CBOE, to Brad Ritter, Senior 
Counsel, SEC, dated August 29, 1995 (``Amendment No. 3'').
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    Notice of the proposed rule change and Amendment Nos. 1, 2, and 3 
thereto were published for comment and appeared in the Federal Register 
on 

[[Page 54396]]
September 15, 1995.\6\ No comments were received on the proposal. This 
order approves the proposal, as amended.

    \6\ See Securities Exchange Act Release No. 36207 (Sept. 8, 
1995), 60 FR 47970.
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I. Description of the Proposal

    The purpose of the proposed rule change is to permit the Exchange 
to list and trade cash-settled index warrants based on the Tech 50 
Index (``Index Warrants''). On August 29, 1995, the Commission approved 
an Exchange proposal that established uniform listing and trading 
guidelines for stock index, currency and currency index warrants 
(``Generic Warrant Listing Standards Approval Order'').\7\ The Exchange 
states that the listing and trading of warrants based on the Tech 50 
Index will comply in all respects with the Generic Warrant Listing 
Standards Approval Order.

    \7\ See Securities Exchange Act Release No. 36169 (August 29, 
1995).
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Index Design

    The Exchange represents that the Tech 50 Index is a broad-based 
index comprised of stocks of 50 of the largest domestic technology 
companies, representing various industry groups. The Index was designed 
by and will be maintained by the CBOE. The Index is price-weighted and 
reflects changes in the prices of the component stocks relative to the 
Index base date, January 3, 1995, when the Index was set to an initial 
level of 200.00.
    On August 15, 1995, the 50 stocks in the Index ranged in market 
capitalization from a low of approximately $829.28 million to a high of 
approximately $82.47 billion. Total market capitalization for the Index 
on August 15, 1995, was approximately $578.53 billion. The highest 
weighted stock in the Index on that date accounted for 5.62% of the 
weight of the Index and the lowest weighted security in the Index 
accounted for 0.68% of the weight of the Index. In aggregate, the five 
highest weighted components on that date accounted for 21.45% of the 
weight of the Index. Currently, the Exchange represents that all of the 
component stocks are eligible for the listing of standardized options 
on the Exchange pursuant to CBOE Rule 5.3.
    As of August 15, 1995, the Exchange represents that the industry 
breakdown for the Index, by weight, was as follows: (1) Computer 
hardware--8.20%; (2) computer software--14.63%; (3) computers systems 
and services--11.12%; (4) integrated circuit components--10.43%; (5) 
semiconductors--12.66%; (6) precision instrumentation--3.15%; (7) 
medical technology--8.74%; (8) network and server systems--10.14%; (9) 
telecommunication components--12.62%; and (10) telecommunications--
8.31%.\8\

    \8\ Id.
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Warrant Terms

    Index Warrants will be direct obligations of their issuer, subject 
to cash-settlement in U.S. dollars and either exercisable throughout 
their life (i.e., American-style) or exercisable only immediately prior 
to their expiration date (i.e., European-style). Upon exercise (or at 
the warrant expiration date in the case of warrants with European-style 
exercise), the holder of an Index Warrant structured as a ``put'' will 
receive payment in U.S. dollars to the extent that the value of the 
Index has declined below a pre-stated cash settlement value. 
Conversely, upon exercise (or at the warrant expiration date in the 
case of warrants with European-style exercise), the holder of an Index 
Warrant structured as a ``call'' will receive payment in U.S. dollars 
to the extent that the Index value has increased above a pre-stated 
cash settlement value. Index Warrants that are out-of-the-money at the 
time of expiration will expire worthless.

Maintenance of the Index

    The Index will be maintained by the Exchange and will be reviewed 
monthly.\9\ The CBOE may change the composition of the Index at any 
time to reflect changes affecting the components of the Index or the 
various technology industry subsectors represented in the Index. If it 
becomes necessary to remove a stock from the Index (e.g., because of a 
takeover or merger), the CBOE will take into account the 
capitalization, liquidity, volatility, and name recognition of any 
proposed replacement security.\10\

    \9\ These reviews are mainly for the purpose of determining 
whether to make composition changes to the Index and generally are 
not for the purpose of applying the proposed objective standards for 
ensuring that the Index remains broad-based (see ``Classification of 
the Index as Broad-Based,'' infra). Telephone conversation among 
Timothy Thompson, CBOE, Eileen Smith, CBOE, and Brad Ritter, SEC, on 
August 3, 1995.
    \10\ Whenever a new component is added to the Index, the CBOE 
will apply those objective standards proposed for ensuring that the 
Index remains broad-based (see ``Classification of the Index as 
Broad-Based,'' infra) that could be affected by the addition of a 
new component security to the Index. Telephone conversation between 
Timothy Thompson, CBOE, and Brad Ritter, SEC, on August 4, 1995.
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    The Exchange intends to maintain the Index with 50 components, 
however, the Exchange may increase the number of components in the 
Index by up to 33%, i.e., 66 stocks.\11\

    \11\ The Commission notes that the Exchange will be required to 
distribute a circular to members notifying them of any change in the 
components of the Index. Further, if the Exchange determines to 
maintain the Index with some number of components other than 50, the 
Exchange will be required to change the name of the Index. In such 
an event, the Exchange should immediately notify the Commission to 
determine whether a rule filing pursuant to Section 19(b) of the Act 
will be required.
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Calculation and Dissemination of the Value of the Index

    The Index value will be calculated by the CBOE or its designee on a 
real-time base using last-sale prices, and will be publicly 
disseminated every 15 seconds. If a component stock is not currently 
being traded, the most recent price at which the stock traded will be 
used in the Index value calculation. The value of the Index as of the 
close of trading on September 29, 1995, was 335.22.
    The Index is price-weighted and reflects changes in the prices of 
the component stocks relative to the base date of January 3, 1995, when 
the Index was set to an initial value of 200.00. Specifically, the 
Index value is calculated by adding the prices of the component stocks 
and then dividing this sum by the Index divisor.\12\ The Index divisor 
is adjusted to reflect non-market changes in the prices of the 
component securities as well as changes in the composition of the 
Index. Changes that may result in divisor changes include, but are not 
limited to, stock splits and dividends (other than ordinary cash 
dividends), spin-offs, certain issuances, and mergers and acquisitions.

    \12\ As of August 15, 1995, the share prices of the Index 
components ranged from a high of $158.13 to a low of $19.00. See 
Amendment No. 3.
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Classification of the Index as Broad-Based

    The CBOE has designed the Index to meet certain objective criteria 
which it believes are appropriate to classify the Index as broad-based 
for warrant trading.\13\ To ensure that the Index remains 
representative of a broad spectrum of the various high technology 
industries and is comprised of relatively actively-traded stocks, the 
Exchange will maintain the Index according to the following guidelines: 
(1) Each underlying security selected for inclusion in the Index must 
have an average daily trading volume of at least 75,000 shares during 
the preceding six months; (2) each underlying security included in the 
Index must thereafter maintain an average daily trading volume of at 
least 50,000 shares during 

[[Page 54397]]
the preceding six months; (3) no underlying security will represent 
more than 15% of the total weight of the Index; (4) the five most 
heavily weighted securities in the Index will not represent more than 
40% of the total weight of the Index; (5) the Index will be comprised 
of at least ten technology industry subsectors (i.e., Standard Industry 
Classification (``SIC'') codes) representing a total of no less than 50 
underlying securities; and (6) at least 75% of the total weight of the 
Index will be represented by underlying securities that are eligible 
for the listing of standardized options pursuant to CBOE Rule 5.3. The 
Exchange will conduct semi-annual reviews of the underlying securities 
included in the Index to assure that the Index continues to meet the 
standards set forth above. The Exchange represents that the above 
guidelines are similar to the requirements set forth in Interpretation 
.01 to Rule 7.3 of the Pacific Stock Exchange (``PSE'') regarding the 
designation of the PSE's High Technology Index as a broad-based index 
for purposes of the trading of standardized options.\14\

    \13\ See Amendment No. 2.
    \14\ Securities Exchange Act Release No. 29994, 56 FR 63536 
(Dec. 4, 1991).
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Warrant Listing Standards and Customer Safeguards

    As discussed earlier, the Exchange has established Generic Warrant 
Listing Standards.\15\ The Exchange represents that the Generic Warrant 
Listing Standards will be applicable to the listing and trading of 
index warrants generally, including Tech 50 Index warrants. These 
standards will govern all aspects of the listing and trading of index 
warrants, including, issuer eligibility,\16\ position and exercise 
limits,\17\ reportable positions,\18\ automatic exercise,\19\ 
settlement,\20\ margin,\21\ and trading halts and suspensions.\22\

    \15\ See supra note 7 and accompanying text.
    \16\ See CBOE Rule 31.5E (1) and (4). Issuers are required to 
have a minimum tangible net worth in excess of $250 million or, in 
the alternative, have a minimum tangible net worth in excess of $150 
million, provided that the issuer does not have (including as a 
result of the proposed issuance) issued and outstanding warrants 
where the aggregate original issue price of all such warrant 
offerings (combined with offerings by its affiliates) listed on a 
national securities exchange or securities association exceeds 25% 
of the issuer's net worth.
    \17\ See CBOE Rule 30.35. In particular, under CBOE Rule 30.35, 
no member can control an aggregate position in a stock index warrant 
issue, or in all warrants issued on the same stock index, on the 
same side of the market, in excess of 15,000,000 warrants 
(12,500,000 warrants with respect to warrants on the Russell 2000 
Index) with an original issue price of ten dollars or less. Stock 
index warrants with an original issue price greater than ten dollars 
will be weighted more heavily in calculating position limits.
    CBOE Rule 30.35 also establishes exercise limits on stock index 
warrants which are analogous to those found in stock index options. 
The rule prohibits holders from exercising, within any five 
consecutive business days, long positions in warrants in excess of 
the base position limit set forth above.
    \18\ See CBOE Rules 30.50(d) and 4.13.
    \19\ See CBOE Rule 31.5E(6).
    \20\ See CBOE Rule 31.5E(5).
    \21\ See CBOE Rule 30.53. In general, the margin requirements 
for long and short positions in stock index warrants are the same as 
margin requirements for long and short positions in stock index 
options. Accordingly, all purchases of warrants will require payment 
in full, an short sales of stock index warrants will require initial 
margin of: (i) 100 percent of the current value of the warrant plus 
(ii) 15 percent of the current value of the underlying broad stock 
index less the amount by which the warrant is out of the money, but 
with a minimum of ten percent of the index value.
    \22\ See CBOE Rules 30.36 and 24.7.
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    Additionally, these warrants will be sold only to accounts approved 
for the trading of standardized options\23\ and, the Exchange's options 
suitability standards will apply to recommendations in Index 
warrants.\24\ The Exchange's rules regarding discretionary orders will 
also apply to transactions in Index warrants.\25\ Finally, prior to the 
commencement of trading, the Exchange will distribute a circular to its 
membership calling attention to certain compliance responsibilities 
when handling transactions in Tech 50 Index warrants.

    \23\ See CBOE Rules 30.52(c) and 9.7.
    \24\ See CBOE Rules 30.52(d) and 9.9.
    \25\ See CBOE Rule 30.50, Interpretation .03 (requiring that the 
standards of Rule 9.10 be applied to index warrant transactions).
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II. 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 Section 6(b)(5) of the Act.\26\ 
Specifically, the Commission finds that the trading of warrants based 
on the Tech 50 Index will serve to protect investors, promote the 
public interest, and help to remove impediments to a free and open 
securities market by providing investors holding positions in some or 
all of the securities underlying the Index with a means to hedge 
exposure to market risk associated with their portfolios.\27\ The 
trading of warrants based on the Tech 50 Index should provide investors 
with a valuable hedging vehicle that should reflect accurately the 
overall movement of technology industry securities.

    \26\ 15 U.S.C. 78f(b) (5).
    \27\ Pursuant to Section 6(b) (5) of the Act, the Commission 
must predicate approval of any new securities product upon a finding 
that the introduction of such product is in the public interest. 
Such a finding would be difficult with respect to a warrant 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.
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    Nevertheless, the trading of warrants on the Tech 50 Index raises 
several concerns related to index design, customer protection, 
surveillance, and market impact. The Commission believes, however, for 
the reasons discussed below, that the CBOE has adequately addressed 
these concerns.

A. Index Design and Structure

    The Commission finds that it is appropriate and consistent with the 
Act for the CBOE to designate the Index as a broad-based index for 
warrant trading. First, the high-technology sector is a substantial 
segment of the U.S. equities market, and the Index reflects that 
segment. Second, the Index includes multiple industries within the 
high-tech sector, such as medical technology, telecommunications and 
telecommunication components, and does not rely solely on computer-
related companies. Third, the Index consists of 50 actively traded 
stock (all options eligible), of which 25 trade on Nasdaq and 25 trade 
on the NYSE. Fourth, the market capitalization of the stocks comprising 
the Index are very large. Specifically, the total capitalization of the 
Index, as of August 15, 1995, was approximately $578.5 billion, with 
the market capitalization of the individual stocks in the Index ranging 
from a high of $82.47 billion to a low of $829.28 million, with a mean 
value of $11.57 billion. Fifth, no one particular stock or group of 
stocks dominates the weight of the Index. Specifically, as of August 
15, 1995, no single stock accounted for more than 5.62% of the Index's 
total value, and the percentage weighting of the five largest issues in 
the Index accounted for 21.45% of the Index's value. Additionally, the 
lowest weighted stock in the Index accounted for 0.68% of the Index's 
value. Accordingly, the Commission believes it is appropriate to 
classify the Index as broad-based so that the CBOE may list 

[[Page 54398]]
warrants for trading pursuant to the Generic Warrant Listing 
Standards.\28\

    \28\ See supra note 7 and accompanying text.
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B. Customer Protection

    Special customer protection concerns are presented by Tech 50 Index 
warrants because they are leveraged derivative securities. The CBOE has 
addressed these concerns, however, by applying the special suitability, 
account approval, disclosure, and compliance requirements adopted in 
the Generic Warrant Listing Standards Approval Order. Moreover, the 
CBOE plans to distribute a circular to its membership identifying the 
specific risks associated with Tech 50 Index warrants. Finally, 
pursuant to the Exchange's listing guidelines, only substantial 
companies capable of meeting CBOE index warrant issuer standards will 
be eligible to issue Index warrants.

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.\29\ In this 
regard, the CBOE, NYSE, and NASD are all members of the Intermarket 
Surveillance Group, which provides for the exchange of all necessary 
surveillance information.\30\

    \29\ Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \30\ 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 
American Stock Exchange, Inc.; the Boston Stock Exchange, Inc.; 
CBOE; the Chicago Stock Exchange Inc.; the National Association of 
Securities Dealers, Inc. (``NASD''); the NYSE; the Pacific Stock 
Exchange, Inc.; 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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D. Market Impact

    The Commission believes that the listing and trading of Tech 50 
Index warrants on the CBOE will not adversely impact the underlying 
securities. First, the existing index warrants surveillance procedures 
of the CBOE will apply to warrants on the Index. In addition, the 
Commission notes that the Index is broad-based and diversified and 
includes highly capitalized securities that are actively traded. 
Additionally, the CBOE has established reasonable position and exercise 
limits for stock index warrants, which will serve to minimize potential 
manipulation and other market impact concerns.
    It Therefore is Ordered, pursuant to Section 19(b) (2) of the 
Act,\31\ that the proposed rule change (SR-CBOE-95-38) is approved, as 
amended.

    \31\ 15 U.S.C. Sec. 78s(b) (2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\32\

    \32\ 17 CFR 200.30-3(a) (12) (1994)
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[FR Doc. 95-26182 Filed 10-20-95; 8:45 am]
BILLING CODE 8010-01-M