[Federal Register Volume 61, Number 26 (Wednesday, February 7, 1996)]
[Notices]
[Pages 4697-4698]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-2541]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36785; File No. SR-Phlx-95-69]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc; Relating to the Bid 
Test Exemption

January 29, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on January 2, 1996, the 
Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'') filed with 
the Securities and Exchange Commission (``Commission'') the proposed 
rule change as described in Items I, II, and III below, which Items 
have been prepared by the self-regulatory organization. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organizations' Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx proposes to amend its Rule 1072, Reporting Requirements 
Applicable to Short Sales in NASD/NM Securities, which establishes 
specific criteria exempting Phlx specialists and Registered Option 
Traders (``ROTs'') from the National Association of Securities Dealers, 
Inc. (``NASD'') ``bid test'' applicable to National Market (``NM'') 
securities. The NASD bid test, with certain exceptions, prohibits short 
sales at or below the current insider bid when that bid is below the 
previous inside bid.\2\ Specifically, the Phlx proposes to extend its 
market maker exemption to: (1) Permit an off-floor option or stock 
option order hedged contemporaneously with an NM security to be 
eligible for the exemption, with prior Floor Official approval and 
filing of a written report; and (2) allow the exemption to apply to a 
company that is involved in a publicly announced merger or acquisition 
(``M&A'') with an NM security.

    \2\ NASD Rules of Fair Practice, Art. III, Section 48.
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    First, sub-paragraph (A) of Phlx Rule 1072(c)(2)(ii) is proposed to 
be added to permit a ROT to facilitate an off-floor options or 
combination order and contemporaneously hedge the resulting option 
position with a short sale in the applicable NM securities as if such 
securities were designated securities pursuant to the Rule. The ROT 
must obtain written Floor Official approval and file with the Market 
Surveillance Department of the Exchange a written report in a form 
required by the Exchange. Such ROT must retain a copy of the report to 
demonstrate that the transaction was bid test exempt.
    Second, sub-paragraph (B) of Phlx Rule 1072(c)(2)(ii) is proposed 
to be added to state that exempt hedge transactions include short sales 
in M&A securities effected by a qualified Exchange options market maker 
to hedge, and which in fact serves to hedge, an existing or prospective 
position in an Exchange-listed option overlying a designated NM 
security of another company that is a party to the M&A. M&A securities 
are defined as the securities of a company that is a party or 
prospective party to a publicly announced merger or acquisition with an 
issuer of an NM security that underlies an Exchange-listed option.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in sections (A), (B), and (C) below, 
of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In 1994, the NASD adopted a bid test rule applicable to NM 
securities traded through Nasdaq prohibiting short sales of NM 
securities at or below the current inside bid when that bid is below 
the previous inside bid.\3\ An exemption from this rule exists for 
option market makers hedging positions with the underlying securities 
of that option; qualifying short sales are referred to as ``exempt 
hedge transactions.'' Pursuant to this market maker exemption, the Phlx 
adopted Rule 1072 establishing specific criteria for a short sale to 
qualify as an ``exempt hedge transaction'' in ``designated'' NM 
issues.\4\ Generally, option specialists may rely on the exemption for 
short sales in NM securities underlying their specialist equity 
options, and index options if at least 10% of the value of the index is 
comprised of NM securities. In addition, ROTs must be assigned in that 
option to rely on the exemption and may only use the exemption in 20 
designated NM issues.

    \3\ Securities Exchange Act Release No. 34277 (June 6, 1994), 59 
FR 34885 (granting temporary approval).
    \4\ Securities Exchange Act Release No. 34632 (September 2, 
1994), 59 FR 46999. The other options exchanges adopted rules 
similar to Phlx Rule 1072. See Chicago Board Options Exchange 
(``CBOE'') Rule 15.10, New York Stock Exchange (``NYSE'') Rule 759A, 
American Stock Exchange (``Amex'') Rule 957, and Pacific Stock 
Exchange (``PSE'') Rule 4.19. Id.
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    The Phlx now proposes to permit the facilitation of certain off-
floor orders pursuant to the market maker exemption. The Phlx also 
proposes to expand the definition of ``exempt hedge transaction'' to 
include securities involved in an M&A transaction with NM securities. 
These amendments to the Exchange's exemptive rule are similar to recent 
changes by other options exchanges.\5\

    \5\ Respecting facilitation orders, see Securities Exchange Act 
Release No. 35281 (January 26, 1995), 60 FR 6575 (``CBOE''); and 
respecting M&A securities, see Securities Exchange Act Release Nos. 
35211 (January 10, 1995), 60 FR 3887 (Amex, CBOE, and PSE) as well 
as 36019 (July 24, 1995), 60 FR 39035 (NYSE).
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Facilitating Orders

    The Phlx proposes to permit certain hedge transactions in NM 
securities by a ROT to be considered executed in ``designated'' issues 
for purposes of qualifying as exempt hedge transactions. 

[[Page 4698]]
Such a transaction must contemporaneously hedge an option position 
resulting from the facilitation of an option or stock-option order 
originating from off-floor. The Exchange believes that this provision 
is consistent with the NASD's interpretation regarding hedging 
activities associated with the facilitation of customer transactions in 
options, as cited by the Commission in its approval of a similar CBOE 
provision.\6\ To ensure that the transaction qualifies for the proposed 
provision, the filing of a written report with the Market Surveillance 
Department of the Exchange, indicating Floor Official approval, is 
required. Floor Official approval is intended as a monitoring 
technique. Similarly, the Phlx believes that the written report should 
aid surveillance efforts regarding Rule 1072 in general, and, more 
specifically, the requirements of this proposed provision. Surveillance 
capabilities should be further enhanced by the requirement that a ROT 
relying on this provision maintain a copy of the report. Thus, the Phlx 
believes that this facilitation provision should operate consistently 
with the purposes of the market maker exemption contained in the Rule. 
Exempting such hedge transactions should promote facilitation orders in 
the option marketplace as well as liquidity in the underlying NM 
security.

    \6\ See Securities Exchange Act Release No. 35281, supra note 5.
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M&A Transactions
    The Phlx proposes to expand the definition of ``exempt hedge 
transaction'' in its market maker exemption to permit short sales in 
securities involved in a publicly announced M&A with a designated NM 
security in order to foster liquidity and promote effective hedging. 
The Exchange notes that the proposed expansion of the market maker 
exemption must involve a publicly announced M&A.\7\ The Exchange also 
notes that the NASD provides an exemption from the bid test for risk 
arbitragers who take positions in stocks involved in M&A 
transactions,\8\ and that the other option exchanges have adopted this 
change to their respective rules.\9\

    \7\ Once an M&A has been publicly announced, a qualified market 
maker in one of the two affected securities may immediately register 
as a qualified market maker in the other security, and thus rely on 
the market maker exemption in such other security. See NASD Rules, 
Art. III, Section 48(1)(3)(iii).
    \8\ See Securities Exchange Act Release No. 34277, supra note 3.
    \9\ See Securities Exchange Act Release Nos. 35211 and 36019, 
supra note 5.
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    As applied to the Phlx specialist, the proposed exemption would 
apply to short sales of a company that is party to an M&A with a 
company whose NM security underlies a speciality stock option (or 
qualified index option). As applied to a Phlx ROT, the exemption would 
extend to a company that is party to an M&A with a company whose NM 
security underlies an option designated by such ROT. The Phlx believes 
that specialists and ROTs may need to hedge option positions with the 
securities involved in an M&A with the underlying security, whether or 
not the security of such other company has overlying listed options. 
This ability to hedge is central to the market making function, and 
should thereby promote liquidity in the markets for the option as well 
as both securities.
    The Exchange believes that the proposal is consistent with the 
NASD's bid test rule and addresses the limitations established by the 
NASD concerning the applicability of the market maker exemption. 
Specifically, the Phlx believes that the ability to hedge facilitated 
off-floor option orders constitutes legitimate hedging activity by a 
ROT with resulting benefits to the marketplace, while restricting the 
expansion of the exemption to bona fide, Exchange-monitored 
transactions. The Exchange also believes that expanding the definition 
of exempt hedge transaction to include M&A securities should enable 
effective hedging in the often-volatile markets surrounding M&A events, 
which should, in turn, promote liquidity.
    For these reasons, the Exchange believes that its proposal is 
consistent with Section 6 of the Act in general, and, in particular, 
with Section 6(b)(5), in that it is designed to promote just and 
equitable principals of trade, prevent fraudulent and manipulative acts 
and practices, to remove impediments to and perfect the mechanism of a 
free and open market as well as to protect investors and the public 
interest by promoting options trading where an M&A is involved or an 
off-floor order seeks facilitation, which, in turn, creates a hedging 
need, thereby promoting liquidity and the essence of the market making 
function.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) By order approve such proposed rule change, or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. 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 NW., 
Washington, D.C. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to File No. 
SR-Phlx-95-69 and should be submitted by February 28, 1996.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\

    \10\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-2541 Filed 2-6-96; 8:45 am]
BILLING CODE 8010-01-M