[Federal Register Volume 61, Number 62 (Friday, March 29, 1996)]
[Notices]
[Pages 14172-14177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7705]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37008; Filed No. SR-Amex-95-53]


Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 2 Thereto by the 
American Stock Exchange, Inc., Relating to Options on the Morgan 
Stanley Healthcare Product Companies Index, the Morgan Stanley 
Healthcare Providers Index and the Morgan Stanley Healthcare Payors 
Index

March 21, 1996.

I. Introduction

    On December 19, 1995, the American Stock Exchange, Inc. (``Amex'' 
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 
proposed rule change to provide for the listing and trading of index 
options on three new indexes developed by Morgan Stanley & Co. 
Incorporated (``Morgan Stanley'') relating to three different 
subsectors within the healthcare sector: the Morgan Stanley Healthcare 
Providers Index (``Providers Index''); the Morgan Stanley Healthcare 
Payors Index (``Payors Index''); and the Morgan Stanley Healthcare 
Product Companies Index (``Product Companies Index'') (collectively the 
``Indexes''). On January 2, 1996, the Amex filed Amendment No. 1 to its 
proposal.\3\ Notice of the proposed rule change and Amendment No. 1 
appeared in the Federal Register on January 23, 1996.\4\ No comment 
letters were received on the proposed rule change. On March 20, 1996, 
the Exchange filed Amendment No. 2.\5\ This order approves the Amex's 
proposal as amended.

    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Amex states that for each of the 
Indexes, if at any time between annual rebalancings, the top five 
stocks in an Index by weight represent in the aggregate more than 60 
percent of the Index's value, the Exchange will rebalance the Index 
after the close of trading on Expiration Friday in the next month in 
the March cycle. See Letter from Claire P. McGrath, Managing 
Director and Special Counsel, Derivatives Securities, Amex, to 
Michael Walinskas, Branch Chief, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Division''), Commission, 
dated January 2, 1996 (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 36715 (January 16, 
1996), 61 FR 1796 (January 23, 1996).
    \5\ In Amendment No. 2 the Exchange clarifies that for each of 
the Indexes, both eligibility standards and maintenance criteria 
require that upon annual rebalancing, at least 90 percent of each 
Index's numerical value and 80 percent of the total number of 
component securities must meet the then current criteria for 
standardized options trading set forth in either Exchange Rule 915 
for component securities not currently the subject of standardized 
options trading or Exchange Rule 916 for components currently the 
subject to standardized options trading. In addition, stocks on each 
quarterly replacement list will be selected and ranked by Morgan 
Stanley based on a number of criteria, including conformity to 
Exchange Rule 915 for securities not currently the subject of 
standardized options trading and conformity to Rule 916 for 
securities currently the subject of standardized options trading. 
See Letter from Clifford J. Weber, Managing Director, New Products 
Development, Amex, to Michael Walinskas, Branch Chief, OMS, 
Division, Commission, dated March 20, 1996 (``Amendment No. 2'').
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II. Description of Proposal

A. General

    The Amex proposes to trade standardized options on the Indexes, 
each of which is comprised of stocks that are traded on the Amex, the 
New York Stock Exchange, Inc. (``NYSE''), or are National Market 
securities traded through Nasdaq. In addition, the Amex proposes to 
amend Amex Rule 902C(d) to include the Amex proposes to amend Amex Rule 
902C(d) to include the Indexes in the disclaimer provisions of that 
rule.\6\ The Amex also proposes to list long-term options on the 
Indexes having up to 36 months to expiration. In lieu of such long-term 
options on the full value of the Indexes, the Amex may instead list 
long-term options based on one-tenth of the value of each of the 
Indexes. These long-term options on either the full or reduced-value of 
the Indexes are referred to as ``LEAPS.'' LEAPS on the Indexes will 
trade independent of and in addition to regular Index options traded on 
the Exchange. However, as discussed below, position and exercise limits 
of LEAPS on the Indexes (both full and reduced-value) and regular 
options on the Indexes will be aggregated.

    \6\ Amex Rule 902C(d) provides, among other things, that Morgan 
Stanley does not guarantee the accuracy or completeness of the 
Indexes or any data included therein, nor does Morgan Stanley make 
any warranty, either express or implied, as to the results to be 
obtained by any person or entity from the use of the Indexes or any 
data included therein.
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B. Composition of the Indexes

    The Indexes have been developed by Morgan Stanley to represent a 
portfolio of large, actively traded, healthcare sector stocks. As of 
December 1, 1995, the Providers Index was comprised of 15 stocks of 
companies engaged in the hospital management and medical/nursing 
services industries, with market capitalizations ranging from $494 
million to $23 billion, and six month average daily trading volumes 
ranging from 95,000 to 995,000 shares. The market capitalization of all 
of the stocks in the Providers Index on that date was approximately 
$45.2 billion. The total number of shares outstanding for the stocks in 
the Providers Index ranged from 19 million shares to 445 million 
shares.
    The Payor's Index, as of December 1, 1995, was comprised of 12 
stocks of companies conducting business in the managed health care and 
health industry services industries, with market capitalizations 
ranging from $622 million to $10 billion and six month average daily 
trading volumes ranging from 170,000 to 1,700,000 shares. The market 
capitalization of all of the stocks in the Payor's Index on that date 
was approximately $36.3 billion. The total number of shares outstanding 
for the stocks in the Payor's Index ranged from 18 million shares to 
174 million shares.
    Finally, as of this same date, the Product Companies Index was 
comprised of 25 equity issues of companies engaged in the major 
pharmaceuticals, biotechnology, medical specialities, medical 
electronics, and medical/dental distributors industries. The market 
capitalizations of these 25 companies range from $1.6 billion to $56.1 
billion and the six month average daily trading volumes range from 
124,000 to 2,800,000 shares. The market capitalization of all the 
stocks in the Product Companies Index on that date was approximately 
$475 billion. The total number of shares outstanding for the stocks in 
the Product Companies Index ranged from 29 million shares to 1.5 
billion shares.
    The Exchange will use an ``equal dollar-weighted'' method to 
calculate the value of each of the Indexes.\7\ The

[[Page 14173]]
Indexes were each initialized at a level of 200 as of the close of 
trading on December 16, 1994. As of the close of trading on February 
27, 1996, the Providers Index, the Payors Index, and the Product 
Companies Index were valued at 306.66, 260.46, and 357.07, 
respectively.\8\

    \7\ See infra Section II.D entitled ``Calculation of the 
Indexes'' for a description of this calculation method.
    \8\ See Letter from Clarie P. McGrath, Managing Director and 
Special Counsel, Derivative Securities, to Michael Walinskas, Branch 
Chief, OMS, Division, Commission, dated February 28, 1996.
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C. Eligibility Standards for the Inclusion of Component Stocks in the 
Indexes

    The Amex represents that the Indexes conform with Exchange Rule 
901C, which specifies criteria for the inclusion of stocks in an index 
on which standardized options will be traded on the Exchange. In 
addition, for each of the Indexes, Morgan Stanley has included, and 
will include, only those stocks that initially meet the following 
standards: (1) a minimum price of $7.50 at the time of announcement of 
entry into the Index; (2) a minimum market capitalization of $75 
million; (3) average monthly trading volume in the component security 
of at least one million shares during the preceding six months; (4) 
each component security must be traded on the Amex, NYSE or must be a 
National Market security traded through the facility of Nasdaq; and (5) 
upon annual rebalancing, at least 90% of the Index numerical value and 
at least 80% of the total number of component securities must meet the 
then current criteria for standardized option trading set forth in 
Exchange Rule 915 for component securities not currently the subject of 
standardized options trading and Rule 916 for components which 
currently are the subject of standardized options trading.\9\ Also, 
because the Indexes are equal-dollar weighted, no component security 
will represent more than 25% of the weight of any of the Indexes, nor 
will the five highest weighted component securities in any of the 
Indexes, in the aggregate, account for more than 60% of the weight of 
that Index upon annual rebalancing. The criteria set forth above are 
the same as or exceed many of the criteria established for the 
expedited listing of options on stock industry indexes pursuant to 
Exchange Rule 901C Commentary .02.

    \9\ See Amendment No. 2, supra note 5.
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D. Calculation of the Indexes

    The Indexes will be calculated using an ``equal dollar-weighted'' 
methodology designed to ensure that each of the component stocks are 
represented in approximately ``equal'' dollar amounts in each Index. In 
calculating the initial ``equal dollar-weighting'' of component stocks, 
the Amex, using closing prices on December 16, 1994, calculated the 
number of shares that would represent an investment of $300,000 in each 
of the stocks contained in the Indexes (to the nearest whole share). 
The value of each Index equals the current market value (i.e., based on 
U.S. primary market prices) of the sum of the assigned number of shares 
of each of the stocks in the Index portfolio divided by the current 
Index divisor. Each Index divisor was initially calculated to yield a 
benchmark value of 200.00 at the close of trading on December 16, 1994. 
Annually thereafter, following the close of trading on the third Friday 
of December, each Index portfolio will be adjusted by changing the 
number of whole shares of each component stock so that each company is 
again represented in ``equal'' dollar amounts.\10\ If necessary, a 
divisor adjustment is made at the rebalancing to ensure continuity of 
an Index's value. The newly adjusted portfolio becomes the basis for 
the Index's value on the first trading day following the annual 
adjustment.

    \10\ In certain circumstances, each Index will be rebalanced 
prior to the end of a calendar year. See infra Section II.E. 
(Maintenance of the Indexes).
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    Subject to the maintenance criteria discussed below, for each Index 
the number of shares of each component stock in such Index will remain 
fixed between annual reviews except in the event of certain types of 
corporate actions, such as the payment of a dividend (other than an 
ordinary cash dividend), stock distribution, stock split, reverse stock 
split, rights offering, distribution, reorganization, recapitalization, 
or similar event with respect to an Index component stock. In a merger 
or consolidation of an issuer of a component security, if the security 
remains in the Index, the number of shares of that security will be 
adjusted, if necessary, to the nearest whole share, to maintain the 
component's relative weight in the Index at the level immediately prior 
to the corporate action. In the event of a stock replacement, the 
dollar value of the security being replaced will be calculated and that 
amount invested in the stock of the new component, to the nearest whole 
share. In all cases, the divisor will be adjusted, if necessary, to 
ensure Index continuity.
    Additionally, for each of the Indexes, if at any time between 
annual rebalancings, the top five stocks in the Index by weight 
represent in the aggregate more than 60% of the Index's value, the 
Exchange will rebalance the Index after the close of trading on 
expiration Friday in the next month in the March cycle. For example, if 
in July it is determined that the top five components in the Morgan 
Stanley Healthcare Product Companies Index account for more than 60% of 
the Index's weight, then the Index will be rebalanced after the close 
of trading on expiration Friday in September.\11\

    \11\ See Amendment No. 1, supra note 3.
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    Similar to other stock index values published by the Exchange, the 
value of each Index will be calculated continuously and disseminated 
every 15 seconds over the Consolidated Tape Association's Network B and 
to the Options Price Reporting Authority (``OPRA'').

E. Maintenance of the Indexes

    The Indexes will be calculated and maintained by the Amex in 
consultation with Morgan Stanley which may, from time to time, suggest 
changes in the industry categories represented in any or all of the 
Indexes or changes in the number of component stocks in an industry 
category to properly reflect the changing conditions in the healthcare 
sector. In addition, the Amex will replace component securities in each 
Index that fail to meet the following maintenance criteria on quarterly 
review: (1) a minimum market capitalization of $75 million; (2) average 
monthly trading volume in the component security of at least 500,000 
shares during the preceding six months; (3) at least 90% of the Index's 
numerical value and at least 80% of the total number of component 
securities meet the then current criteria for standardized option 
trading set forth in Exchange Rule 915 for securities not currently the 
subject of standardized options trading and Rule 916 for securities 
which are currently the subject of standardized options trading; 
12 and (4) a share price of $5.00 or greater for a majority of 
business days during the preceding quarter for those limited number of 
component securities that do not meet Rule 915 or 916.13

    \12\ See Amendment No. 2, supra Note 5.
    \13\ Telephone conversation between Clifford J. Weber, Managing 
Director, New Products Development, Amex, and James T. McHale, 
Attorney, OMS, Division, Commission, on March 19, 1996.
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    At the beginning of each calendar quarter, Morgan Stanley will 
provide the Amex with a current list of replacement stocks for each 
Index from which to draw in the event that a component in an Index must 
be replaced due to merger, takeover, failure to satisfy the above 
maintenance

[[Page 14174]]
criteria, or other similar event (each a ``Replacement List'').14 
The Amex will publicly distribute the Replacement Lists as soon as 
practicable following receipt from Morgan Stanley.

    \14\ See Letter from Carol Shahmoon, Counsel, Morgan Stanley, to 
Michael Walinskas, Branch Chief, OMS, Division, Commission, dated 
March 20, 1996 (``Morgan Stanley Letter'').
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    Stocks on each Replacement List will be selected and ranked by 
Morgan Stanley based on a number of criteria, including conformity to 
the eligibility requirements described above 15 and to Exchange 
Rule 915 for component securities not currently the subject of 
standardized options trading and Rule 916 for components which are 
currently the subject of standardized options trading.16 Rules 915 
and 916, respectively, set forth the criteria for the initial and 
continued listing of standardized options on equity securities. The 
replacement stocks will be categorized by Morgan Stanley by industry 
within the healthcare sector and ranked within their category based on 
the aforementioned criteria. The replacement stock for a security being 
removed from an Index will be selected solely by the Amex from the 
Replacement List based on industry category and liquidity.17 In 
the event no replacement stocks are available that meet the eligibility 
criteria and pass Morgan Stanley's selection process, then the security 
leaving the Index will be removed without replacement and the divisor 
adjusted to ensure Index continuity. It is expected that each Index 
will remain at the current number of components; however, if the number 
of components in an Index shall increase or decrease by more than one 
third, the Exchange must obtain additional approval from the Commission 
pursuant to Section 19(b) of the Act.

    \15\ See supra Section II.C entitled ``Eligibility Standards for 
the Inclusion of Component Stocks in the Indexes.''
    \16\ See Amendment No. 2, supra Note 5.
    \17\ The Amex will ensure that at the time of selection it will 
only select securities that continue to meet the eligibility 
requirements discussed above.
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    In addition, Morgan Stanley will advise the Exchange regarding the 
handling of unusual corporate actions which may arise from time to 
time. Routine corporate actions (e.g., stock splits, routine spinoffs, 
etc.) which require straightforward index divisor adjustments will be 
handled by the Exchange's staff without consultation with Morgan 
Stanley. All stock replacements and unusual divisor adjustments caused 
by the occurrence of extraordinary events such as dissolution, merger, 
bankruptcy, non-routine spinoffs, or extraordinary dividends will be 
made by Exchange staff in consultation with Morgan Stanley, although 
the Amex ultimately will select the actual replacement stock from the 
Replacement List without Morgan Stanley's assistance. All stock 
replacements and the handling of non-routine corporate actions will be 
announced at least ten business days in advance of such effective 
change, whenever practicable. As with all options currently trading on 
the Amex, the Exchange will make this information available to the 
public through the dissemination of an information circular.

F. Expiration and Settlement

    The Index value for purposes of settling outstanding Index options 
and Index LEAPS contracts upon expiration will be calculated based upon 
the regular way opening sale prices for each of an Index's component 
stocks in their primary market on the last trading day prior to 
expiration. In the case of National Market securities traded through 
Nasdaq, the first reported sale price will be used. Once all of the 
component stocks have opened for trading, the value of each Index will 
be determined and that value will be used as the final settlement value 
for expiring Index options contracts. If any of the component stocks do 
not open for trading on the last trading day before expiration, then 
the prior trading day's (i.e., Thursday's) last sale price will be used 
to calculate each Index. In this regard, before deciding to use 
Thursday's closing value of a component stock for purposes of 
determining the settlement value of an Index, the Amex will wait until 
the end of the trading day on expiration Friday.\18\

    \18\ For purposes of the daily dissemination of the Indexes 
value, if a stock included in an Index has not opened for trading, 
the Amex will use the closing value of that stock in its primary 
market on the prior trading day when calculating the value of the 
Index, until the stock opens for trading.
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G. Contract Specifications

    The proposed options on the Indexes will be cash-settled, European-
style options.\19\ Standard options trading hours for narrow-based 
index options (9:30 a.m. to 4:10 p.m. New York time) will apply to the 
contracts. The options on the Index will expire on the Saturday 
following the third Friday of the expiration month. The last trading 
day for an expiring option series will normally be the second to the 
last business day before expiration (normally a Thursday). The Exchange 
intends to list option series with expirations in the three near-term 
calendar months and the two additional calendar months in three month 
intervals in the March cycle. The Exchange also intends to list longer 
term option series having up to 36 months to expiration. The Exchange 
proposes to list near-the-money (i.e. strike prices within ten points 
above or below the current index value) option series on any of the 
Indexes at 2\1/2\ point strike price intervals when the value of that 
Index is below 200 points.

    \19\ A European-style option can be exercised only during a 
specified period before the option expires.
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H. Listing of Long-Term Options on the Full Value or the Reduced Value 
of the Indexes

    The proposal provides that the Exchange may list longer term index 
options series having up to 36 months to expiration on the full value 
of the Indexes. Alternatively, the Exchange may list long-term reduced-
value put and call options based on \1/10\th of the full value of the 
Indexes. In either event, the interval between expiration months for 
either a full value or reduced value long-term option will not be less 
than six months. The reduced-value Index LEAPS will also have a 
European-style exercise and will be subject to the same rules that 
govern the trading of all the Exchange's index options, including sales 
practice rules, margin requirements and floor trading procedures.

I. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Because the Indexes are Stock Index Options under Amex Rule 901C(a) 
and Stock Index Industry Groups under Rule 900C(b)(1), the proposal 
provides that Exchange rules that are applicable to the trading of 
narrow-based index options will apply to the trading of options on the 
Indexes. Specifically, Exchange rules governing margin 
requirements,\20\ position and exercise limits,\21\ and trading halt 
procedures \22\ that are

[[Page 14175]]
applicable to the trading of narrow-based index options will apply to 
options traded on the Indexes. Position limits on long-term reduced-
value Index options will be equivalent to the position limits for 
regular (full value) Index options and would be aggregated with such 
options. For aggregation purposes, ten reduced value contracts will 
equal one full value contract (for example, if the position limit for 
the full value options is 12,000 contracts on the same side of the 
market, then the position limit for the reduced value options will be 
120,000 contracts on the same aside of the market).

    \20\ Pursuant to Amex Rule 462(d)(2)(D)(iv), the margin 
requirements for each of the proposed Index options will be: (1) for 
each short options position, 100% of the current market value of the 
options contract plus 20% of the underlying aggregate Index value, 
less any out-of-the-money amount, with a minimum requirement of the 
options premium plus 10% of the underlying Index value; and (2) for 
long options positions, 100% of the options premium paid.
    \21\ Pursuant to Amex Rules 904C and 905C, respectively, the 
position and exercise limits for each of the proposed Index options 
will be 12,000 contracts, unless the Exchange determines, pursuant 
to Rules 904C and 905C, that a lower limit is warranted.
    \22\ Pursuant to Amex Rule 918C, the trading of options on each 
of the Indexes will be halted or suspended whenever trading in 
underlying securities whose weighted value represents more than 20% 
of an Index's value are halted or suspended.
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J. Surveillance

    Surveillance procedures currently used to monitor trading in each 
of the Exchange's other index options will also be used to monitor 
trading in options on the Indexes. These procedures include complete 
access to trading activity in the underlying securities. Further, the 
Intermarket Surveillance Group (``ISG'') Agreement, dated July 14, 
1983, as amended on January 29, 1990, will be applicable to the trading 
of options on the Indexes.\23\

    \23\ 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 Amex; the Boston Stock Exchange, Inc.; 
the Chicago Board Options Exchange, Inc.; the Chicago Stock 
Exchange, Inc.; the National Association of Securities Dealers, 
Inc.; 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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    Morgan Stanley has also adopted special procedures to prevent the 
potential misuse of material, non-public information by the research, 
sales, and trading divisions of the firm in connection with the 
maintenance of the Indexes.\24\ As discussed above, the Amex will 
publicly disseminate each Replacement List by issuing information 
circulars so that investors will know in advance which securities will 
be considered as replacements for the Index.\25\

    \24\ See Morgan Stanley Letter, supra note 14.
    \25\ Id.
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    In additional, Morgan Stanley will have a limited role in the stock 
replacement selection and substitution process. First, when a stock in 
an Index no longer meets the published criteria as determined following 
a quarterly review of the components by the Exchange, the Amex will 
determine, without consultation with Morgan Stanley, which security 
from the applicable Replacement List will be selected for addition to 
the Index. Second, The Amex will also make adjustments as a result of 
stock splits, routine spin-offs, and otherwise, without consultation 
with Morgan Stanley. Finally, even in those situations where the Amex 
consults with Morgan Stanley, upon the occurrence of certain events, 
the actual replacement sock will be selected solely by Amex from the 
stocks on the replacement list.

III. Findings and Conclusions

    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).\26\ Specifically, the 
Commission finds that the trading of options on the Indexes, including 
full-value and reduced-value Index LEAPS, will serve to promote the 
public interest and help to remove impediments to a free and open 
securities market by providing investors with an additional means to 
hedge exposure to market risk associated with stocks in the various 
healthcare subsectors.\27\

    \26\ 15 U.S.C. Sec. 78f(b)(5).
    \27\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option proposal upon a finding that 
the introduction of such new derivative instrument is in the public 
interest. Such a finding would be difficult for a derivate 
instrument that served no hedging or other economic function, 
because any benefits that might be derived by market participants 
likely would be out weighed by the potential for manipulation, 
diminished public confidence in the integrity of the markets, and 
other valid regulatory concerns. In this regard, the trading of 
listed options on the Index will provide investors with a hedging 
vehicle that should reflect the overall movement of the stocks 
representing companies in the healthcare sector in the U.S. stock 
markets.
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    The trading of options on the Indexes and reduced-value Indexes, 
however, raises several issues relating to index design, customer 
protection, surveillance, and market impact. The Commission believes, 
for the reasons discussed below, that the Amex adequately has assessed 
these issues.

A. Index Design and Structure

    The Commission believes it is appropriate for the Exchange to 
designate each of the Indexes as narrow-based for purposes of index 
options training. The indexes are each comprised of a limited number of 
stocks intended to track discrete subsectors of the healthcare sector 
of the stock market. Accordingly, the Commission believes it is 
appropriate for the Amex to apply its rules governing narrow-based 
index options to trading in the proposed Index options.\28\

    \28\ See supra Section II.I (Position and Exercise Limits, 
Margin Requirements, and Trading Halts).
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    The Commission also believes that the liquid markets, large 
capitalizations, and relative weighings of the Indexes' component 
stocks significantly minimize the potential for manipulation of the 
Index. First, the stocks that comprise each index are actively traded. 
Average month trading volume in the component stocks of the Indexes for 
the period between June 1, 1995 and December 1, 1995 ranged from 95,000 
to 995,000 shares for the Providers Index, 170,000 to 1,700,000 shares 
for the Payors Index, and 124,000 to 2,800,000 shares for the Product 
Companies Index. Second, the market capitalizations of the stocks in 
the Indexes are very large, ranging from $494 million to $23 billion in 
the Providers Index, $622 million to $10 billion in the Payors Index, 
and $1.6 billion to $56 billion in the Product Companies Index. Third, 
because the indexes are equal dollar-weighted, no one particular stock 
or group of stocks dominates the index. Specifically, as of December 1, 
1995, no one stock accounted for more than 12.13% of the total value of 
the Providers Index, 12.47% of the total value of the Payors Index, and 
6.38% of the total value of the Product Companies Index. Fourth, the 
Indexes will be maintained so that in addition to the other maintenance 
criteria discussed above, at each quarterly review and rebalancing 
(annual or otherwise), at least 90% of the Indexes numerical value and 
at least 80% of the total number of component securities will be 
composed of securities eligible for standardized options trading. 
Fifth, Morgan Stanley and the Amex will be required to ensure that each 
component of each Index is subject to last sale reporting requirements 
in the U.S. pursuant to Rule 11aA3-1 of the Act. This will further 
reduce the potential for manipulation of the value of the Indexes. 
Finally, the Commission believes that the existing mechanisms to 
monitor trading activity in the component stocks of the Indexes, or 
options on those stocks or the Indexes will help deter as well as 
detect any illegal activity.

[[Page 14176]]

    In addition, even though the Indexes are only scheduled to be 
rebalanced annually, the Commission believes that the Amex and Morgan 
Stanley have developed several composition and maintenance criteria for 
the Indexes that will minimize the possibility that the Indexes could 
be manipulated through trading in less actively traded securities or 
securities with smaller prices or floats. First, if at any time during 
the year the top five components in an Index, by weight, account for 
more than sixty percent of the weight of the Index, the Exchange will 
rebalance the Index following the close of trading on Expiration Friday 
in the next month in the March cycle. These rebalancing requirements 
will serve to ensure that any ``overweight'' stock \29\ will be brought 
back into line with the other stocks, thus ensuring that less 
capitalized stocks do not become excessively weighted in the Index.

    \29\ A stock would be ``overweight'' if its weight in the Index 
were greater than the average weight of all of the stocks in the 
Index. This would occur, for example, if the price of a component 
stock significantly increased relative to the other stocks in the 
Index during a particular quarter and prior to the rebalancing.
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    Second, after each quarterly review and each rebalancing (annual or 
otherwise), at least 90% of an Index's numerical value and at least 80% 
of the total number of component securities will be comprised of stocks 
that are eligible for standardized options trading. The Commission 
believes that this requirement will ensure that the Indexes will be 
almost entirely made up of stocks with large public floats that are 
actively traded, thus reducing the likelihood that the Indexes could be 
easily manipulated by abusive trading in the smaller stocks contained 
in the Indexes.
    Third, at each quarterly review of the Indexes, a component may 
only remain in an Index if it satisfies the remaining maintenance 
requirements which include market capitalization and minimum trading 
volume requirements.\30\ These requirements are similar to the 
continued listing requirements for options on individual equity 
securities and should ensure the Indexes are comprised of active and 
liquid securities.\31\

    \30\ See supra Section II.E (Maintenance of the Indexes).
    \31\ See Amex Rule 916.
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    Fourth, because the Indexes are narrow-based, the applicable 
position and exercise limits (currently 12,000) and margin requirements 
will further reduce the susceptibility of the Indexes to manipulation. 
Lastly, Morgan Stanley will only add stocks to a Replacement List that 
are representative of the healthcare sector and, as discussed 
above,\32\ satisfy the inclusion criteria.

    \32\ See supra Section II.C (Eligibility Standards for the 
Inclusion of Component Stocks in the Indexes).
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    The Commission notes that certain concerns are raised when a 
broker-dealer, such as Morgan Stanley, is involved in the development 
and maintenance of a stock index that underlies an exchange-traded 
derivative product. For several reasons, however, the Commission 
believes that the Amex has adequately addressed this concern with 
respect to options on the Indexes.
    First, the values of the Indexes are to be calculated and 
disseminated by the Amex so that unless a party independently 
calculates the Indexes' values, neither Morgan Stanley nor any other 
party will be in receipt of the values prior to the public 
dissemination of the Indexes' values. Second, routine corporate actions 
(e.g., stock splits, routine spinoffs, etc.) will be handled by the 
Amex without consultation with Morgan Stanley. Third, although stock 
replacements and unusual divisor adjustments caused by the occurrence 
of extraordinary events, such as dissolution, merger, bankruptcy, non-
routine spinoffs, or extraordinary dividends, will be made by Exchange 
staff in consultation with Morgan Stanley, Amex alone ultimately will 
select the actual replacement stock from the Replacement List without 
Morgan Stanley's assistance. Such replacement will be announced 
publicly at least 10 business days in advance of the effective change 
by the Amex through the dissemination of an information circular, 
whenever practicable. Fourth, the Commission believes that the 
procedures Morgan Stanley has established to detect and prevent 
material non-public information concerning the Indexes from being 
improperly used by the person or persons responsible for compiling the 
Replacement Lists, as well as other persons within Morgan Stanley, as 
discussed above,\33\ adequately serve to minimize the susceptibility to 
manipulation of the Indexes, the securities in the Indexes, and 
securities added to and deleted from any Replacement List. In summary, 
the Commission believes that the procedures outlined above help to 
ensure that Morgan Stanley will not have any informational advantages 
concerning modifications to the composition of the Indexes due to its 
limited role in consulting with Amex on the maintenance of the Indexes 
under certain circumstances.

    \33\ See Morgan Stanley Letter, supra note 14.
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B. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as options on the Indexes 
(including full-value and reduced value LEAPS), can commence on a 
national securities exchange. The Commission notes that the trading of 
standardized exchange-traded options occurs in an environment that is 
designed to ensure, among other things that: (1) the special risks of 
options are disclosed to public customers; (2) only investors capable 
of evaluating and bearing the risks of options trading are engaged in 
such trading; and (3) special compliance procedures are applicable to 
options accounts. Accordingly, because LEAPS and regular options on the 
Indexes will be subject to the same regulatory regime as the other 
standardized options currently traded on the Amex, the Commission 
believes that adequate safeguards are in place to ensure the protection 
of investors in options on the Indexes. Finally, the Amex has stated 
that it will distribute information circulars to members following 
rebalancings and prior to component changes to notify members of 
changes in the composition of the Indexes. Additionally, the Amex will 
publicly disseminate each Replacement List by means of information 
circulars. The Commission believes this should help to protect 
investors and avoid investor confusion.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing to list a stock index derivative product 
and the exchange(s) trading the stocks 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 stock index product less 
readily susceptible to manipulation.\34\ In this regard, the Amex, 
NYSE, and National Association of Securities Dealers, Inc. are all 
members of the ISG, which provides for the exchange of all necessary 
surveillance information.\35\

    \34\ See Securities Exchange Act Release No. 31243 (September 
28, 1992), 57 FR 45849 (October 5, 1992).
    \35\See supra note 23.
    
[[Page 14177]]

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D. Market Impact

    The Commission believes that the listing and trading of options on 
the Indexes, including full-value and reduced-value Index LEAPS, on the 
Amex will not adversely impact the underlying securities markets.\36\ 
First, as described above, due to the ``equal dollar-weighting'' 
methodology, no one stock or group of stocks dominates the Indexes. 
Second, because at each quarterly review and each rebalancing of the 
Indexes, at least 90% of an Index's numerical value and at least 80% of 
the total number of component securities must be accounted for by 
stocks that are eligible for standardized options trading, the 
component stocks generally will be actively-traded, highly-capitalized 
stocks. Third, the currently applicable 12,000 contract position and 
exercise limits will serve to minimize potential manipulation and 
market impact concerns. Fourth, the risk to investors of contra-party 
non-performance will be minimized because the options on the Indexes 
will be issued and guaranteed by the Options Clearing Corporation just 
like any other standardized option traded in the United States.

    \36\ In addition, the Amex and the OPRA have represented that 
the Amex and the OPRA have the necessary systems capacity to support 
those new series of index options that would result from the 
introduction of options on the Indexes. See Letter from Charles 
Faurot, Managing Director, Market Data Services, Amex, to Michael 
Walinskas, Branch Chief, OMS, Division, Commission, dated January 
22, 1996; letter from Edward Cook, Jr., Managing Director, 
Information Technology, Amex, to Michael Walinskas, Branch Chief, 
OMS, Division, Commission, dated February 8, 1996; and letter from 
Joe Corrigan, Executive Director, OPRA, to Michael Walinskas, Branch 
Chief, OMS, Division, Commission, dated January 22, 1996.
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    Lastly, the Commission believes that settling expiring options on 
the Indexes (including full-value and reduced-value Index LEAPS) based 
on the opening prices of component securities is reasonable and 
consistent with the Act. As noted in other contexts, valuing options 
for exercise settlement on expiration based on opening prices rather 
than closing prices may help reduce adverse effects on markets for 
stocks underlying options on the Index.\37\

    \37\ Securities Exchange Act Release No. 30944 (July 21, 1992), 
57 FR 33376 (July 28, 1992).
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    The Commission finds good cause for approving Amendment No. 2 to 
the proposal prior to the thirtieth day after the date of publication 
of the notice of filing thereof in the Federal Register. Specifically, 
Amendment No. 2 merely clarifies that for each of the Indexes, both 
eligibility standards and maintenance criteria require that upon annual 
rebalancing, at least 90% of each Index's numerical value and 80% of 
the total number of component securities must meet the then current 
criteria for standardized options trading set forth in either Rule 915 
for component securities not currently the subject of standardized 
options trading or Rule 916 components which are currently the subject 
of standardized options trading. Moreover, Amendment No. 2 provides 
that Morgan Stanley will select and rank any stocks to be included in 
each Replacement List based on a number of criteria, including 
conformity to the same eligibility standards and maintenance criteria 
set forth in Rules 915 and 916. The Commission believes that clarifying 
the applicable eligibility standards and maintenance criteria for the 
Indexes' component securities is consistent with maintaining a fair and 
orderly market and reduces the likelihood of investor confusion.
    Based on the above, the Commission finds good cause for approving 
Amendment No. 2 to the proposed rule change on an accelerated basis and 
believes that the proposal, as amended, is consistent with Sections 
6(b)(5) and 19(b)(2) of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2. 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 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the Amex. All 
submissions should refer to the File No. SR-Amex-95-53 and should be 
submitted by April 19, 1996.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\38\ that the proposed rule change (SR-Amex-95-53), as amended, is 
approved.

    \38\ 15 U.S.C. Sec. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\

    \39\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 96-7705 Filed 3-28-96; 8:45 am]
BILLING CODE 8010-01-M