[Federal Register Volume 61, Number 62 (Friday, March 29, 1996)]
[Notices]
[Pages 14187-14188]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7700]



-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37005; File No. SR-Phlx-95-69]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Approving and Notice of Filing and Order Granting Accelerated 
Approval of Proposed Rule Change Relating to the Bid Test Exemption

March 21, 1996.

I. Introduction

    On January 2, 1996, the Philadelphia Stock Exchange, Inc. ``Phlx'' 
or ``Exchange'') submitted to 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 
proposal to extend its market maker bid test exemption. The proposed 
rule change was published for comment in the Federal Register on 
February 7, 1996.\3\ On March 20, 1996, the Phlx filed Amendment No. 1 
to its proposal.\4\ No comments were received on the proposed rule 
change. This order approves the proposal.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ See Securities Exchange Act Release No. 36785 (January 29, 
1996), 61 FR 4697.
    \4\ In Amendment No. 1, the Phlx clarifies that proposed Phlx 
Rule 1072(c)(ii)(2) applies only to option orders that do not have a 
stock component. Letter from Gerald D. O'Connell, First Vice 
President, Market Regulation and Trading Operations, Phlx, to 
Michael Walinskas, Branch Chief, Office of Market Supervision, 
Division of Market Regulation, Commission, dated March 20, 1996 
(``Amendment No. 1'').
---------------------------------------------------------------------------

II. Description of the Proposal

    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 Nasdaq National Market 
(``NM'') securities.\5\ Specifically, the Phlx proposes to extend its 
market maker exemption to: (1) permit a ROT to facilitate an off-floor 
options or combination order hedged contemporaneously with a short sale 
in a designated NM security, with prior Floor Official approval and the 
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. The Exchange has represented that its 
proposed exemptions are similar to rule provisions of other options 
exchanges.\6\

    \5\ ``Bid test'' or ``short sale'' rule.
    \6\ Respecting facilitation orders, see Securities Exchange Act 
Release No. 35281 (January 26, 1995), 60 FR 6575 (Chicago Board 
Options Exchange (``CBOE'')); and respecting M&A securities, see 
Securities Exchange Act Release Nos. 35211 (January 10, 1995), 60 FR 
3887 (American Stock Exchange (``Amex'')), CBOE, and Pacific Stock 
Exchange (``PSE'') as well as 36019 (July 24, 1995), 60 FR 39035 
(New York Stock Exchange (``NYSE'')).
---------------------------------------------------------------------------

    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.\7\ An exemption from this rule exists for 
option market makers hedging positions with the underlying securites 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.\8\ Generally, option specialists may designate as exempt short 
sales in NM securites underlying their specialist equity options, and 
index options if at least 10% of the value of the index is comprised of 
NM securites. A ROT only may designate as exempt short sales in NM 
securites underlying no more than 20 of the options or index options to 
which the ROT has been assigned.

    \7\ Securities Exchange Act Release No. 34277 (June 6, 1994), 59 
FR 34885 (granting temporary approval). NASD Rules of Fair Practice, 
Art. III, Section 48.
    \8\ Securities Exchange Act Release No. 34632 (September 2, 
1994), 59 FR 46999. In general, an ``exempt hedge transaction'' is a 
short sale in an NM security that is effected to hedge, and in fact 
serves to hedge, an existing offsetting options position or an 
offsetting options position that was created in one or more 
transactions contemporaneous with the short sale. Phlx Rule 
1072(c)(2)(i).
    The other options exchanges adopted rules similar to Phlx Rule 
1072. See CBOE Rule 15.10, NYSE Rule 759A, Amex Rule 957, and PSE 
Rule 4.19. Securities Exchange Act Release No. 34632.
---------------------------------------------------------------------------

Facilitating Orders

    Proposed Phlx Rule 1072(c)(2)(ii)(A) would permit a ROT to 
facilitate an off-floor options order and contemporaneously hedge the 
resulting option position with a short sale in applicable NM securites 
as if such securities were designated securities pursuant to the 
Rule.\9\ To ensure that the transaction qualifies for the proposed 
provision, a ROT must file a written report with the Market 
Surveillance Department of the Exchange, indicating Floor Official 
approval. Such ROT also must retain a copy of the report to demonstrate 
that the transaction was bid test exempt.

    \9\ The exemption would apply to option-only orders. Thus, the 
exemption would not apply to combination orders that contain a stock 
component. Amendment No. 1, supra note 4.
---------------------------------------------------------------------------

M&A Transactions

    Proposed Phlx Rule 1072(c)(2)(ii)(B) would extend the bid test 
exemption to include a short sale in an M&A security 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.\10\ The M&A exemption only would be 
available to securities involved in an M&A that is publicly announced.

    \10\ M&A securities are 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.
---------------------------------------------------------------------------

    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 specialty 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.

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

[[Page 14188]]
requirements of Section 6(b)(5) \11\ that the rules of an exchange be 
designed to promote just and equitable principles of trade, prevent 
fraudulent and manipulative acts, and, in general, protect investors 
and the public interest. The Commission approved the NASD's short sale 
rule proposal on June 29, 1994,\12\ 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 Exchange's 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.

    \11\ 15 U.S.C. 78f(b)(5) (1988).
    \12\ Securities Exchange Act Release No. 34277, supra note 7.
---------------------------------------------------------------------------

    Proposed Phlx Rule 1072(c)(2)(ii)(A) will allow a ROT, with prior 
Floor Official approval, to facilitate an off-floor options order, and 
contemporaneously hedge the resulting options position with a short 
sale in an applicable Nasdaq/NM security as if such security were a 
designated Nasdaq/NM security. The exemption would not apply to orders 
that contain a stock component.\13\ The ROT must file a report 
describing the transaction with the Exchange's Market Surveillance 
Department and must retain a copy of the report to demonstrate the 
transaction was bid test exempt. The Commission believes that this 
provision is consistent with the NASD's interpretation regarding 
hedging activities associated with the facilitation of customer 
transactions in options and that the procedures for reporting a 
transaction under the provision will ensure adequate monitoring.\14\

    \13\ Amendment No. 1, supra note 4.
    \14\ See letter from Richard G. Ketchum, Chief Operating Officer 
and Executive Vice President, NASD, to David A. Dami, First Vice 
President & Associate General Counsel, Global Derivatives, Paine 
Webber, Inc., dated September 13, 1994.
---------------------------------------------------------------------------

    Proposed Phlx Rule 1072(c)(2)(ii)(B) would 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 a designated Nasdaq/NM 
security. The Commission believes that when a designated Nasdaq/NM 
security becomes involved in an M&A, options specialists and ROTs may 
need to hedge positions in options overlying the 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 an options specialist or ROT 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 options 
specialists and ROTs 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 Exchange's proposal will enhance the ability of its 
specialists and ROTs to perform their 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, options specialists and ROTs 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 options 
specialist or ROT is registered, and the short sales are or will be 
``exempt hedge transactions'' as defined in the Exchange's rules.
    The Commission finds good cause for approving Amendment No. 1 prior 
to the thirtieth day after the date of publication of notice of filing 
thereof in the Federal Register. Amendment No. 1 clarifies that the 
Exchange's proposed exemption for facilitating off-floor options orders 
does not extend to orders with a stock component. The Commission 
believes that this change does not raise new or unique regulatory 
issues, as it is consistent with a similar provision previously 
approved by the Commission.\15\ Therefore, the Commission believes it 
is consistent with Sections 6(b)(5) and 19(b)(2) of the Act \16\ to 
approve Amendment No. 1 to the proposal on an accelerated basis.

    \15\ See Securities Exchange Act Release No. 35281, Supra note 
6.
    \16\ 15 U.S.C. Sec. Sec. 78f(b)(5) and 78s(b)(2) (1988).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1. 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. Sec. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-Phlx-95-69 and should be 
submitted by April 19, 1996.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-Phx-95-69), as amended, is 
approved.

    \17\ 15 U.S.C. 78s(b)(2) (1988).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\

    \18\ 17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 96-7700 Filed 3-28-96; 8:45 am]
BILLING CODE 8010-01-M