[Federal Register Volume 61, Number 62 (Friday, March 29, 1996)]
[Notices]
[Pages 14165-14168]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7699]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37007; File No. SR-Amex-95-39, SR-CBOE-95-67, and SR-
Phlx-95-76]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes and Notice of Filing and Order Granting Accelerated Approval of 
Amendments Thereto by the American Stock Exchange, Inc., Chicago Board 
Options Exchange, Inc., and Philadelphia Stock Exchange, Inc., Relating 
to the Establishment of Uniform Listing and Trading Guidelines for 
Narrow-Based Stock Index Warrants

March 21, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ the American Stock 
Exchange, Inc. (``Amex''), Chicago Board Options Exchange, Inc. 
(``CBOE''), and Philadelphia Stock Exchange, Inc. (``Phlx'') 
(collectively ``Exchanges'') submitted to the Securities and Exchange 
Commission (``Commission'' or ``SEC'') proposed rule changes 
(``proposals'') to establish uniform listing and trading guidelines for 
narrow-based stock index warrants.\3\

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988 & Supp. V 1993).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ The Amex, CBOE, and Phlx rule filings were submitted on 
September 9, 1995, November 9, 1995, and October 27, 1995, 
respectively. On November 1, 1995, November 20, 1995, and November 
22, 1995, Amex, CBOE, and Phlx, respectively, each submitted 
Amendment No. 1 (``Amendment No. 1'') to their proposals to address 
issues relating to settlement value for warrants. See Letters from 
William Floyd-Jones, Amex, to Michael Walinskas, SEC, dated October 
30, 1995 (``Amex Amendment No. 1''), Timothy Thompson, CBOE, to 
Stephen M. Youhn, SEC, dated November 15, 1995 (``CBOE Amendment No. 
1''), and Shelle Weisbaum, Phlx, to Michael Walinskas, SEC, dated 
November 22, 1995 (``Phlx Amendment No. 1''). Amex and Phlx 
Amendment No. 1 also address issues relating to index maintenance 
standards.
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    Notice of the proposals, and Amendment No. 1 thereto, were 
published for comment and appeared in the Federal Register.\4\ No 
comment letters were received.

    \4\ See Securities Exchange Act Release Nos. 36448 (Nov. 1, 
1995), 60 FR 56180 (Nov. 7, 1995) (Amex); 36525 (Nov. 29, 1995), 60 
FR 62512 (Dec. 6, 1995) (CBOE); and 36524 (Nov. 29, 1995), 60 FR 
62521 (Dec. 6, 1995) (Phlx).
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    The Amex subsequently submitted Amendments No. 2, 3, and 4 to the 
proposal on January 22, 1996 (``Amex Amendment No. 2''), January 30, 
1996 (``Amex Amendment No. 3''), and January 31, 1996 (``Amex Amendment 
No. 4'').\5\ The CBOE subsequently submitted Amendments No. 2, 3, and 4 
to the proposal on December 27, 1995 (``CBOE Amendment No. 2''), 
February 2, 1996 (``CBOE Amendment No. 3''), and February 27, 1996 
(``CBOE Amendment No. 4'').\6\ The Phlx subsequently submitted 
Amendment No. 2 (``Phlx Amendment No. 2'') (collectively with all of 
the Exchange's Amendments that have not been noticed to date 
``Amendments'') to the proposal on January 31, 1996.\7\

    \5\ See Letters from William Floyd-Jones, Amex, to Stephen M. 
Youhn, SEC, dated January 19, 1996, January 29, 1996, and January 
30, 1996, respectively.
    \6\ See Letters from Timothy Thompson, CBOE, to Stephen M. 
Youhn, SEC, dated December 21, 1995, February 1, 1996, and February 
27, 1996, respectively.
    \7\ See Letter from Shelle Weisbaum, Phlx, to Michael Walinskas, 
SEC, dated January 30, 1996.
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    CBOE Amendment No. 2 addresses index maintenance standards. Amex 
Amendment No. 2 was superseded by Amex Amendment No. 3. Amex and CBOE 
Amendments No. 3 and Phlx Amendment No. 2 address position limit 
related issues. Amex Amendment No. 4 reduces the originally proposed 
position limit applicable to certain narrow-based index warrants and 
CBOE Amendment No. 4 clarifies an example contained in CBOE Amendment 
No. 3 with respect to position limit aggregation. This order approves 
the proposals, as amended, and solicits comments on the Amendments.

I. Description of the Proposal

    On August 29, 1995, the Commission approved rule changes for the 
Exchanges which established uniform listing and trading guidelines for 
broad-based stock index, currency, and currency index warrants 
(``broad-based regulatory framework'').\8\ Those standards govern all 
aspects of the listing and trading of index warrants, including issuer 
eligibility, customer suitability and account approval procedures, 
position and exercise limits, reportable positions, automatic exercise, 
settlement, margin, and trading halts and suspensions.

    \8\ On August 29, 1995, the Commission approved uniform listing 
and trading guidelines for stock index, currency and currency index 
warrants for the New York Stock Exchange (``NYSE''), Pacific Stock 
Exchange (``PSE''), Phlx, Amex, and CBOE. See Securiies Exchange Act 
Release Nos. 36165, 36166, 36167, 36168, and 36169 (Aug. 29, 1995), 
respectively. The PSE, to date, has not submitted a narrow-based 
index warrant filing and the NYSE is not being approved in this 
order.
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    The purpose of this proposal is to allow for the listing and 
trading of warrants on narrow-based stock index groups. With the 
exceptions of separate higher margin requirements and reduced position 
limits, the broad-based regulatory framework will fully apply to the 
listing, trading, and surveillance of narrow-based index warrants. This 
includes a heightened suitability standard for recommendations in index 
warrants as well as requiring all

[[Page 14166]]
purchasers of index warrants to be options approved. The proposed 
changes from the broad-based regulatory framework are outlined as 
follows:
    (a) Position Limits. The Exchanges note that position limits for 
broad-based index warrants were set at levels approximately equal to 75 
percent the then applicable corresponding limits applicable to options 
on the same index. In turn, the Exchanges propose to establish narrow-
based index warrant position limits at a level equal to 75 percent of 
those recently approved for narrow-based index options.\9\ As a result, 
narrow-based position limits would be governed by three tiers, using 
the same qualifications criteria as used for narrow-based index option 
position limits:

    \9\ Currently, depending on the characteristics of the index, 
position limits for narrow-based index options are either 12,000, 
9,000, or 6,000 contracts on the same side of the market.
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    (i) 4,500,000 warrants where one stock in the group accounts, on 
average, for 30% or more of the numerical index value during the 30-
day period immediately preceding the review.
    (ii) 6,750,000 warrants where either a single stock in the group 
accounts for 20 percent or more of the group's numerical index 
value, or any five stocks in the group together account for 50 
percent or more of the group's numerical index value, during the 
immediately preceding 30 days.
    (iii) 9,000,000 warrants if the underlying group does not fall 
within the criteria set forth in either of the other two tiers.

    The Exchanges propose to make the determinations described above 
when a particular issuance first commences trading the twice a year 
thereafter. An Exchange may establish uniform dates on which to make 
those semi-annual determinations in order to make them for all of its 
Exchange-listed narrow-based index warrants at the same time. After an 
issuance of warrants commences trading, an Exchange would begin to make 
the subsequent semi-annual determinations on the first of the uniform 
dates thereafter.
    If the subsequent semi-annual determinations indicate that an index 
qualifies for a larger position limit, an Exchange may increase the 
limit to the new number immediately. Once a position limit is 
established for a particular warrant issuance, however, it will not be 
reduced. As a result, position limits for issuances of warrants 
overlying the same index may be different. In the event there is more 
than one issuance overlying an index, the Exchanges have proposed that 
there be an additional position limit applicable to all those warrant 
issuances on the same narrow-based index in the aggregate (``overall 
position limit''). This overall position limit for warrants on a 
narrow-based index shall be equal to the largest individual position 
limit then applicable to any warrant issuance of that same narrow-based 
index.\10\

    \10\ For example, assume a firm issues warrants on a narrow-
based index in July 1996 (``Issuance 1'') and, at the time, the 
applicable position limit for that issuance is 9 million warrants. 
The following year, in July 1997, the same firm completes a new 
issuance of warrants on the same index (``Issuance 2''). At the time 
of the second issuance, however, the composition of the index has 
changed such that it now qualifies for a position limit of 6.75 
million warrants. An investor would still be permitted to hold 9 
million warrants of Issuance 1. Any aggregate position including 
warrants from Issuance 1 and 2 would be subject to an overall 9 
million warrant position limit, with no more than 6.75 million of 
those warrants coming from Issuance 2. Under no circumstances could 
an investor hold more than 6.75 million warrants from Issuance 2.
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    (b) Margin Requirements. Margin will be similar to that required 
for narrow-based index options. Accordingly, all purchases of narrow-
based index warrants must be paid in full. Additionally, the minimum 
margin required for each narrow-based index warrant carried short in a 
customer's account would be 100% of the current market value of each 
warrant plus 20% of the current index group value. Narrow-based index 
warrants would also be subject to the same spread margin treatment 
recently approved for broad-based index warrants.\11\

    \11\ See, e.g., Amex Rule 462(d)(2)(F) and (G).
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Listing Warrants on Approved Indexes

    The proposed narrow-based index warrant regulatory framework would 
also allow the Exchanges to list a warrant on a narrow-based stock 
index without prior Commission approval if the Commission has already 
approved the underlying stock index for warrant or options trading. 
Furthermore, the Exchanges propose to incorporate certain generic 
initial listing and maintenance criteria which, when satisfied, provide 
for the expedited approval of warrants based on narrow-based indexes. 
The expedited approval process is nearly identical to that approved for 
narrow-based index options \12\ except as provided below:

    \12\ See Securities Exchange Act Release No. 34157 (June 3, 
1994).
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    (i) the index must contain a minimum of nine stocks at all 
times; \13\ and

    \13\ The generic narrow-based index option standard requires ten 
stocks initially and nine stocks thereafter.
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    (ii) allow for the use of closing (``p.m.'') prices in 
determining the value of an index warrant except that, where 25 
percent or more of the value of an index underlying a warrant 
consists of stocks that trade primarily in the United States, 
opening price (``a.m. settlement'') must be used at (1) the 
warrant's expiration, and (2) on any date in which the warrant's 
settlement value will be based on prices on either of the two 
business days preceding expiration.\14\

    \14\ The generic index option standard requires the use of 
opening (``a.m.'') price settlement.
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II. Findings and Conclusions

    The Commission finds that the proposed rule changes are 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).\15\ Specifically, the 
Commission finds that the Exchanges' proposals to establish uniform 
listing and trading standards for narrow-based stock index warrants 
strike a reasonable balance between the Commission's mandates under 
Section 6(b)(5) to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, while protecting 
investors and the public interest. In addition, the proposed listing 
standards for warrants for warrants are consistent with the Section 
6(b)(5) requirements that rules of an exchange be designed to prevent 
fraudulent and manipulative acts, to promote just and equitable 
principles of trade, and are not designed to permit unfair 
discrimination among issuers.

    \15\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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    The Exchanges' proposed generic listing standards for narrow-based 
stock index warrants set forth a regulatory framework for the listing 
of such products. Generally, listing standards serve as a means for an 
exchange to screen issuers and to provide listed status only to bona 
fide issuances that will have sufficient public float, investor based, 
and trading interest to ensure that the market has the depth and 
liquidity necessary to maintain fair and orderly markets. Adequate 
standards are especially important for warrant issuances given the 
leveraged and contingent liability they represent.
    The Commission notes that, with certain exceptions listed below, 
the Exchanges will apply to narrow-based index warrants the same 
regulatory framework which recently was approved for broad-based index 
warrants. In approving the broad-based index warrant regulatory 
framework, the Commission found that the framework provides an adequate 
regulatory structure for the trading of such warrants, including 
appropriate trading rules, sales practice requirements, margin 
requirements, position and exercise limits and surveillance procedures. 
The Commission also found that the applicable framework is designed to 
minimize the potential for

[[Page 14167]]
manipulation, thereby helping to ensure that such index warrants do not 
have a negative market impact. Finally, the Commission also indicated 
that the framework adequately addressed the special risks to customers 
arising from the trading of such warrants.\16\

    \16\ Pursuant to Section 6(b)(5) of the Act, the Commission is 
required to find, among other things, that trading in warrants will 
serve to protect investors and contribute to the maintenance of fair 
and orderly markets. In this regard, the Commission must predicate 
approval of any new derivative product upon a finding that the 
introduction of such derivative instrument is in the public 
interest. Such a finding would be difficult for a derivative 
instrument that served no hedging or other economic function, 
because any benefits that might be derived by market participants 
likely would be outweighed by the potential for manipulation, 
diminished public confidence in the integrity of the markets, and 
other valid regulatory concerns. As discussed below, the Commission 
believes narrow-based index warrants will serve an economic purpose 
by providing an alternative product that will allow investors to 
participate in the price movements of the underlying securities in 
addition to allowing investors holding positions in some or all of 
such securities to hedge the risks associated with their portfolios.
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    The Commission believes it is reasonable for the Exchanges to apply 
a nearly identical regulatory structure to narrow-based index warrants 
as broad-based index warrants, particularly given the substantial 
similarities that exist between them.\17\ Both broad and narrow-based 
stock index warrants represent a leveraged investment in a portfolio or 
group of equity securities. However, broad-based index products 
generally have a large number of component securities and represent a 
certain overall equities market or a substantial segment thereof. 
Narrow-based index products, on the other hand, generally are comprised 
of fewer component securities that often are concentrated in a 
particular industry group. These differences heighten concerns with 
leveraged narrow-based index products regarding market impact, 
manipulation and volatility, dictating that narrow-based indexes be 
subject to lower position limits and more restrictive margin 
treatment.\18\

    \17\ The regulatory framework for broad-based index warrants is 
similar to the approach used in regulating index options. Because 
the same risks exist in trading of narrow-based index options, the 
Commission believes it is appropriate to utilize the same approach.
    \18\ This is similar to the approach taken in regulating narrow-
based and broad-based index options.
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    Accordingly, the Exchanges have proposed separate margin and 
position limit treatment for narrow-based index warrants. The proposed 
margin levels are analogous to those currently in place for narrow-
based stock index options. The Commission believes these requirements 
will provide adequate customer margin levels sufficient to account for 
the potential volatility of these products. In addition, the Commission 
believes that it is appropriate to apply options margin treatment given 
the options-like market risk posed by warrants.\19\

    \19\ The customer spread margin rules applicable to broad-based 
stock index and currency warrants were approved subject to a one 
year pilot program. The Commission notes that narrow-based index 
warrants will be subject to the same pilot program and, upon 
expiration of that program, it will determine whether to revise or 
approve on a permanent basis the proposed spread margin rules.
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    The proposed position limits are also similar to those in place for 
narrow-based index options.\20\ In addition, the Exchanges have 
proposed aggregation requirements to address multiple issuances of 
warrants on the same narrow-based index.\21\ The Commission believes 
that the position limits and aggregation requirements are reasonable 
and will serve to minimize potential manipulation and other market 
impact concerns while not unduly restricting liquidity in warrant 
issuances.

    \20\ The Commission notes that position limits for broad-based 
stock index warrants were set at a level roughly equivalent to 75% 
of broad-based index options. In the absence of trading experience 
with U.S. equities market based index warrants, the Commission 
believes it would be imprudent to establish position limits for 
positions greater than those currently applicable (on an equivalent 
basis) to stock index options on the same index.
    \21\ Because each individual warrant issuance is assigned a 
separate identification symbol, the Exchanges have the ability to 
monitor the aggregation of separate issuances of warrants on the 
same underlying index.
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    The Commission believes the Exchanges' existing surveillance 
procedures applicable to broad-based index warrants are adequate to 
surveil the trading of narrow-based index warrants. The Commission 
found that the Exchanges' broad-based surveillance procedures were 
adequate to surveil for manipulation and other abuses involving the 
warrant market and the underlying component securities. Given the 
functional similarities between narrow and broad-based index warrants, 
the Commission believes it is reasonable to apply the same surveillance 
procedures to both.
    Similarly, for the same reasons noted in our order approving broad-
based index warrants, the Commission believes that heightened customer 
suitability standards, options account approval requirements, and sales 
practice procedures which are modelled after index options should be 
extended to narrow-based index warrants. The Commission notes that, 
upon approval of this filing, the Exchanges may list a warrant upon any 
narrow-based index that the Commission has previously approved for 
options or warrant trading. Additionally, in order to expedite SEC 
review of a particular warrant issuance, the Exchanges have proposed 
employing accelerated listing procedures similar to those adopted for 
listing options on narrow-based indexes.\22\

    \22\ Accelerated listing procedures allow the Exchange to permit 
issuances of warrants on a particular narrow-based index pursuant to 
a filing submitted to the Commission for effectiveness immediately 
upon filing under Section 19(b)(3)(A) of the Act. In the event that 
a proposed index does not qualify for expedited approval under these 
standards, the Exchanges are not precluded from filing a proposed 
rule change for Commission review pursuant to Section 19(b)(2).
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    The Commission notes that these proposed accelerated listing 
standards for index warrants differ from the standards applicable to 
narrow-based index options in that there is a minimum nine stock 
requirement for index warrants (i.e., an index must initially and at 
all times thereafter be comprised of at least nine stocks) and that 
index warrants may, at certain times, utilize a p.m. settlement 
methodology, as discussed above. The Commission believes the proposed 
differences are reasonable in the warrant context for several reasons.
    With respect to p.m. settlement, index warrants are issuer-based 
products whose terms are individually set by the issuer, with the 
number of warrants on a given index being fixed at the time of 
issuance. Accordingly, it is not certain that there will be a 
significant number of warrants in indexes with similar components 
expiring on the same day. This may reduce pressure from liquidation of 
warrant hedges at settlement. Second, the Commission authorized the 
same settlement methodology for broad-based index warrants and believes 
it is reasonable that narrow-based index warrants operate in the same 
manner. With respect to the nine stock requirement, the Commission does 
not believe that this difference is such that it will subject narrow-
based index warrants to increased manipulation. In fact, narrow-based 
index options impose the same maintenance requirement of nine stocks. 
The Commission does not believe that the creation of a nine stock 
index, as opposed to a ten stock index, will lead to increased 
manipulation, per se, provided the other listing criteria are 
satisfied. The Commission notes that this requirement precludes the 
issuance of index warrants pursuant to the accelerated listing 
procedures upon any index comprised of less than nine stocks.
    The Commission believes that the accelerated listing procedures 
will provide a sufficient opportunity for it to examine narrow-based 
index warrant

[[Page 14168]]
products based on new indexes (which require that a filing be made 
pursuant to Section 19(b)(3)(A) of the Act). Specifically, the 
Commission believes that the seven day prefiling requirement gives the 
Commission staff an opportunity to discuss with an Exchange whether its 
proposal to list and trade particular narrow-based index warrants 
properly qualifies for effectiveness upon filing. In addition, the 
Commission finds that the 30 day delay in the commencement of trading 
of proposed narrow-based index warrants will provide a meaningful 
opportunity for public comment prior to the commencement of trading, 
while also providing an Exchange with the opportunity to inform market 
participants in advance of the proposed trade date for new index 
warrants. In accordance with Section 19(b)(3)(C) of the Act, if the 
Commission determines that the rule change proposal is inconsistent 
with the requirements of the Act and the rules and regulations 
thereunder, the 30 day delay would allow the Commission to abrogate the 
rule change before trading commences, which will minimize disruption on 
market participants. This authority could be utilized if, for example, 
it is determined that the proposed narrow-based index warrant does not 
satisfy the applicable accelerated listing standards.

III. Conclusion

    The Commission believes that the adoption of these proposed uniform 
listing and trading standards for narrow-based index warrants will 
provide an appropriate regulatory framework. These standards will also 
benefit the Exchanges by providing them with greater flexibility in 
structuring narrow-based index warrant issuances and a more expedient 
process for listing narrow-based index warrants without further 
Commission review pursuant to Section 19(b) of the Act. As noted above, 
additional Commission review of specific warrant issuances will 
generally only be required for warrants overlying any non-approved 
narrow-based index that has not been previously approved by the 
Commission for narrow-based index warrant or options trading. If 
Commission review of a particular warrant issuance is required, the 
Commission expects that, to the extent that the warrant issuance 
complies with the uniform criteria adopted herein, its review should 
generally be limited to issues concerning the newly proposed index. 
This should help ensure that such additional Commission review could be 
completed in a prompt manner without causing any unnecessary delay in 
listing new narrow-based index warrant products.
    The Commission finds good cause for approving the Exchanges' 
Amendments to the proposals prior to the thirtieth day after the date 
of publication of notice thereof in the Federal Register. The 
Commission notes that the Amendments primarily relate to position 
limits and aggregation of multiple issuances of warrants on the same 
index. The Commission notes that the Amendments ensure that multiple 
issuances of index warrants on the same narrow-based index will be 
aggregated together and subject to an overall limit. The Commission 
believes it is appropriate to aggregate holdings in multiple issuances 
together since, despite the difference in expiration dates, warrants 
which overlie the same index are fundamentally the same instrument. 
Furthermore, aggregation provisions will ensure that an investor (or 
group) may not circumvent the applicable position limits by merely 
purchasing warrants from different issuances.
    The Amendments also provide that once a position limit is 
established for a particular warrant issuance, it will not be reduced 
for the duration of that particular issuance. Given the limited 
duration of warrants (one to five years), and that any new index 
warrants on the same index could not exceed the lowered position 
limits, the Commission believes it is appropriate for position limits 
to not be reduced during their duration.
    CBOE Amendment No. 2 imposes a minimum nine stock requirement for 
all narrow-based indexes which underlie a warrant issuance. This 
provision brings CBOE into conformity with the other exchanges. The 
Amex and Phlx provisions regarding this requirement have already been 
noticed and no comments were received. Accordingly, this provision does 
not raise any new or unique regulatory issues. Finally, Amex Amendment 
No. 4 reduces the lowest position limit tier to 4.5 million warrants 
from 4.875 million. The Commission notes that this brings the Amex into 
conformity with the other Exchanges. Finally, CBOE Amendment No. 4 
clarifies an example contained in CBOE Amendment No. 3 with respect to 
position limit aggregation. Because this example is explanatory in 
nature and does not alter any of its rules, the provision does not 
raise any new or unique issues. For these reasons, the Commission 
believes there is good cause, consistent with Section 19(b)(2) \23\ of 
the Act, to approve the Exchanges' Amendments to the proposals on an 
accelerated basis.

    \23\ 15 U.S.C. Sec. 78s(b)(2) (1988).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the Exchanges' Amendments. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street NW., Washington, 
DC 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, DC. Copies of such filing will also be available for 
inspection and copying at the principal offices of the above-mentioned 
self-regulatory organizations. All submissions should refer to the file 
number in the caption above and should be submitted by April 19, 1996.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule changes (SR-Amex-95-39, SR-CBOE-95-67, 
and SR-Phlx-95-76) are approved, as amended.

    \24\ 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.\25\

    \25\ 17 CFR Sec. 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-7699 Filed 3-28-96; 8:45 am]
BILLING CODE 8010-01-M