[Federal Register Volume 61, Number 143 (Wednesday, July 24, 1996)]
[Notices]
[Pages 38500-38503]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-18722]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37438; File No. SR-OCC-96-05]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Relating to the Issuance, 
Clearance, and Settlement of DIVS, OWLS, and RISKS

July 15, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on March 19, 1996, The 
Options Clearing Corporation (``OCC'') 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 
primarily by OCC. On June 20, 1996, OCC filed an amendment to the 
proposed rule change.\2\ The Commission is publishing this notice to 
solicit comments from interested persons.
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    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ Letter from Michael G. Vitek, OCC, to Jerry W. Carpenter, 
Assistant Director, Division of Market Regulation, Commission (June 
19, 1996).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The purpose of the proposed rule change is to amend certain OCC by-
laws and rules and to append new sections to OCC's by-laws and rules to 
provide for the issuance, clearance, and settlement of new equity 
derivative products referred to as Dividend Value of Stock (``DIVS'') 
sm, Options with Limited Stock (``OWLS'') sm, and Residual 
Interest in Stock (``RISKS'') sm.

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

    In its filing with the Commission, OCC 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. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\3\
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    \3\ The Commission has modified the text of the summaries 
prepared by OCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The proposed rule change will amend certain OCC by-laws and rules 
and will append new sections to OCC's by-laws and rules to permit the 
issuance, clearance, and settlement of new equity derivative products 
referred to as DIVS, OWLS, and RISKS. DIVS, OWLS, and RISKS are 
proposed to be listed and traded on the Philadelphia Stock Exchange 
(``PHLX'').\4\
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    \4\ For description of the PHLX proposal to list and trade DIVS, 
OWLS, and RISKS, refer to Securities Exchange Act Release No. 36127 
(August 28, 1995), 60 FR 44533 [File No. SR-PHLX-95-19] (notice of 
proposed rule change relating to DIVS, OWLS, and RISKS). To the 
extent that discrepancies exist between the present filing and SR-
PHLX-95-19, OCC believes that this fling represents the current 
intentions of PHLX, and OCC anticipates that PHLX will amend its 
filing to eliminate any inconsistencies.
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1. Description of DIVS, OWLS, and RISKS
    Each of these three new options-related products will be traded 
separately on the PHLX equity option floor. It is intended that an 
investor who owns all three will be in an economic position similar to 
an investor who owns the underlying stock except that ownership of 
DIVS, OWLS, and RISKS will not give the holder voting rights. PHLX has 
indicated that it intends to introduce new series of DIVS, OWLS, and 
RISKS in a coordinated way so that whenever a series of DIVS on a 
particular underlying stock is opened for trading a series of OWLS and 
a series of RISKS with the same termination date also will be open for 
trading.\5\ In addition, OWLS and RISKS in the coordinated series will 
have the same termination claim, which is a concept similar to the 
strike price of an option. OWLS and RISKS will be considered European 
style products in that they cannot be exercised prior to expiration.
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    \5\ The expiration date of a series of DIVS, OWLS, and RISKS may 
have an expiration date up to 60 months following the issuance date 
of such series.
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    Each DIVS given the holder the right to receive and obligates the 
writer to pay on the termination date dividend equivalents on a per 
share basis equal to any regular dividends distributed to stockholders 
by the issuer of the underlying stock. However, certain distributions 
may be reflected in an adjustment to the unit of trading or to the 
number of outstanding DIVS rather than in a dividend equivalent 
payment.
    Specifically, each OWLS gives the holder the right to receive and 
obligates the writer to pay on the termination date either (i) the 
number of shares of the security underlying the OWLS (i.e., the unit of 
trading, which usually is 100 shares) if the closing price of the 
underlying security at expiration of the OWLS is less than or equal to 
the termination claim or (ii) the number of shares of the underlying 
security equal in value to the termination claim times the unit of 
trading if the closing price is greater than the termination claim. In 
other words, the maximum value that the OWLS holder will receive is 
fixed at the aggregate amount of the termination claim, but that value 
always will be paid in stock rather than in cash. Accordingly, if the 
closing price at expiration is greater than the termination claim, the 
number of shares received by the holder will be less than the unit of 
trading for the OWLS, and if the closing price at expiration is less 
than or equal to the termination claim, the holder will receive the 
number of shares of the underlying security represented by the unit of 
trading.\6\ Therefore, holding an OWLS functionally resembles a covered 
call writing transaction (i.e., a purchase of the underlying stock 
combined with the sale of a European style call option on that stock). 
However, unlike the writer of a covered call that expires in the money, 
the OWLS holder will receive stock instead of cash upon settlement.
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    \6\ For example, if the termination claim for a series of OWLS 
is $50, the unit of trading is 100 shares, and the closing price for 
the underlying stock at termination of the OWLS is $80, holders of 
OWLS would be entitled to receive the number of shares of the 
underlying stock having an aggregate market value of 100  x  $50 = 
$5000 per OWLS held. Accordingly, since $5000/$80 = 62.5 shares, the 
holder would be entitled to receive 62 whole shares per OWLS held 
and a cash payment in lieu of any fractional share. However, if the 
closing price of the stock had been $50 or less (i.e., equal to or 
less than the termination claim of the OWLS), the OWLS holder would 
receive 100 shares per OWLS held.
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    Each RISKS gives the holder the right to receive a number of shares 
of the stock underlying the RISKS equal in value to the excess, if any, 
of the closing price of the underlying security at the termination date 
over the termination claim of the RISKS times the unit of trading.\7\ 
If the closing price of the underlying security is less than or equal 
to the termination claim, the RISKS will expire worthless, and the 
holder will

[[Page 38501]]

receive nothing. Accordingly, holding a RISKS functionally resembles 
holding a call option except that the RISKS holder receives any in-the-
money value of the option in kind, (i.e., by receipt of a number of 
shares of the underlying security equal to the in-the-money value) as 
differentiated from a call option holder who either will (i) pay an 
exercise price to purchase the underlying shares and then sell such 
shares or (ii) enter into a closing transaction to capture the in-the-
money value.
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    \7\ For example, a holder of RISKS in a series corresponding to 
the series of OWLS referred to in the preceding example would be 
entitled to receive an aggregate number of shares of stock 
underlying the RISKS equal in value to: 100  x  ($80 - $50) = $3000. 
Since $3000/$80 = 37.5 shares, a RISKS holder would be entitled to 
receive 37 shares per RISKS held and a cash payment in lieu of any 
fractional share.
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    Writers of OWLS and RISKS will have obligations corresponding to 
the rights of holders. With respect to OWLS, some performance, which 
will ordinarily be delivery of some amount of the underlying stock, 
will always be due at termination. However, RISKS that expire at-the-
money or out-of-the-money will terminate without any performance being 
required. RISKS that are in-the-money at expiration automatically will 
require writers to deliver and entitle holders to receive the 
underlying stock without regard to any notice of exercise. Similarly, 
no exercise of DIVS will be required in order to entitle the holder to 
receive and to obligate the writer to pay dividend equivalents during 
the term of the DIVS. Accordingly, the concepts of exercise and 
assignment are not used in relation to DIVS, OWLS, and RISKS.
2. Proposed Amendments to OCC's By-Laws
    The proposed rule change will make amendments to Article I of OCC's 
by-laws regarding definitions that will include minor changes and 
additions to several defined terms in order to indicate how such terms 
will apply to DIVS, OWLS, and RISKS. In certain cases where DIVS, OWLS, 
and RISKS are simple to be included with other OCC-issued securities, 
this has been done by substituting the general term ``cleared 
security'' for an existing list of products rather than adding three 
more product names to the list. Definitions of the terms DIVS, OWLS, 
and RISKS also have been added.
    The proposed rule change also will amend Article VI of the by-laws 
regarding clearance of exchange transactions to make minor changes and 
additions to several sections in order to make these by-laws applicable 
to transactions in DIVS, OWLS, and RISKS. Interpretation .01 to Article 
VI, Section 9 of the by-laws will be amended to make clear that 
subsections (a) and (b) of Section 9 apply only to stock options.\8\ 
Provisions parallel to those found in Section 9 that will be applicable 
to DIVS, OWLS, and RISKS appear in new Article XXV of OCC's by-laws.
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    \8\ Section 9(a) relates to the rights and obligations of call 
option holders and writers. Section 9(b) concerns the rights and 
obligations of put option holders and writers.
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    Section 11 of Article VI regarding adjustments will be amended to 
provide that the OCC Securities Committee shall have the authority to 
make adjustments to DIVS, OWLS, and RISKS pursuant to the same 
procedures utilized for adjustments to other options. Although other 
provisions of Section 11 may also be applicable to DIVS, OWLS, and 
RISKS, the precise way in which those provisions will be applied will 
be set forth in new Article XXV of the by-laws. Article VIII of the by-
laws regarding the stock clearing fund also will be amended to include 
minor additions to several sections to include DIVS, OWLS, and RISKS.
3. Proposed Article XXV of OCC's By-Laws
    The introduction to proposed Article XXV makes clear tht OCC's by-
laws in Articles I through XI also are applicable to DIVS, OWLS, and 
RISKS, except where expressly modified or made inapplicable by Article 
XXV. Following the convention observed in the by-laws relating to other 
products, the effect of each by-law section in Article XXV on other by-
laws will be stated in brackets at the end of each section in Article 
XXV.
    Proposed Article XXV, Section 1 adds certain new definitions 
relevant to DIVS, OWLS, and RISKS and redefines certain terms defined 
in Article I of the by-laws to assign different meanings when those 
terms are used with respect to DIVS, OWLS, and RISKS. With respect to 
DIVS, the term ``dividend payable date'' has been defined to mean the 
date on which the dividend equivalent is required to be paid by the 
writer of a DIVS to OCC and by OCC to the holder of a DIVS. The term 
``ex dividend date'' has been defined to mean the ``ex'' date for the 
corresponding dividend on the underlying security.
    As a result of the foregoing definitions, the right of a DIVS 
holder to receive and the obligation of a DIVS writer to pay a dividend 
equivalent will be fixed at the close of trading on the business day 
preceding the ex dividend date. The actual payment may occur days or 
weeks later to coincide with the payable date for the corresponding 
dividend on the underlying stock. It is desirable to harmonize these 
payable dates in order to make hedging and other strategies involving 
combined positions in DIVS and the underlying stock most efficient. As 
a result, it is possible that an obligation to pay or right to receive 
a dividend equivalent that accrued prior to the termination date of a 
DIVS will remain outstanding after the termination date. OCC simply 
will continue to carry the dividend equivalent right or obligation in a 
manner similar to a settlement obligation of an exercised option.
    As defined in Article XXV of OCC's by-laws, the ``termination 
settlement date'' for a particular series of OWLS and RISKS is the date 
on which performance is to be rendered with respect to the terminated 
OWLS and, if any settlement is due, the terminated RISKS. OCC Rule 2602 
specifies that the settlement date will be the third business day 
following the termination date.
    The term ``closing price'' will be defined to mean the closing 
price for the underlying security on the primary market on the business 
day prior to the termination date of OWLS or RISKS. However, the 
exchange may provide that the closing price be based on an average of 
prices of the underlying security near the close of business on that 
day. The exchange must specify that it intends to use an average of 
prices prior to the opening of trading in any series of OWLS or RISKS.
    The proposed definition of ``termination claim'' provides that any 
reference to the term ``exercise price'' will refer to the termination 
claim of OWLS or RISKS. As stated earlier, because notice of exercise 
is not required at the termination of an OWLS or RISKS, the concept of 
``exercise'' has no relevance to OWLS or RISKS.
    As proposed, Article XXV, Section 2 sets forth the general rights 
and obligations of holders and writers of DIVS, OWLS, and RISKS. 
Article XXV, Section 3 sets forth the agreements of a writing clearing 
member when effecting an opening writing transaction in DIVS, OWLS, or 
RISKS.
    As proposed, Section 4 of Article XXV describes the application of 
the adjustment rules of Article VI, Section 11 of OCC's by-laws to 
DIVS, OWLS, and RISKS. In addition, Section 4 provides general and 
discretionary guidelines as to how the OCC securities committee will 
ordinarily make adjustments for DIVS, OWLS, and RISKS.
    Proposed Section 5 of Article XXV provides that Section 19 of 
Article VI relating to the shortage of underlying securities is 
applicable to OWLS and RISKS except that restrictions on exercises, an 
action that can be taken with respect to put options, cannot be

[[Page 38502]]

applied to OWLS or RISKS because OWLS and RISKS are not exercisable.
    Article XXV, Section 6 sets forth the steps OCC may take in the 
event the closing price for an underlying security is unavailable. In 
addition to any other actions OCC may be entitled to take under its by-
laws and rules, OCC may suspend settlement obligations for the affected 
OWLS and RISKS. OCC also will have the authority to fix the closing 
price for purposes of termination settlement of OWLS and RISKS by means 
of a panel consisting of exchange representatives and the chairman of 
OCC. Provisions in paragraph (b) and Interpretation .01 of Article XXV, 
Section 6, which relates to the finality of the closing price as 
officially announced by OCC, are similar to provisions applicable to 
closing index values for index options.
4. Proposed Amendments to Existing Rules
    Proposed amendments to existing rules include minor additions to 
several rules in order to include how those rules will apply to DIVS, 
OWLS, and RISKS. Many changes are self-explanatory and therefore are 
not described in this notice. \9\
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    \9\ The text of the specific changes being made to OCC's rules 
is set forth in Exhibit A to OCC's proposed rule change which is 
available through OCC or the Commission's Public Reference Room.
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    Proposed amendments to Rule 601 regarding margins sets forth that 
DIVS, OWLS, and RISKS will be margined in the same manner as equity 
options and will utilize the OCC Theoretical Intermarket Margining 
System (``TIMS''). \10\
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    \10\ Equity TIMS is used to calculate clearing margin for 
participants' positions in equity options. For a complete 
description of equity TIMS, refer to Securities Exchange Act Release 
No. 36003 (July 21, 1995), 60 FR 38880 [File No. SR-OCC-95-07] 
(order approving use of equity TIMS on a temporary basis).
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    Proposed changes to Rule 1001, which relates to clearing fund 
contributions, provide that positions in DIVS, OWLS, and RISKS will be 
included in the formula to determine clearing members' proportionate 
contributions to the stock clearing fund. This is consistent with DIVS, 
OWLS, and RISKS also being included with stock options for purposes of 
margin calculations and clearing member qualifications.
    Rules 1104 and 1106 regarding the liquidation of an account of a 
clearing member upon suspension of that clearing member are being 
amended to include reference to positions in DIVS, OWLS, and RISKS. 
Rule 1106(b)(2) will be amended to contain a reference to specific or 
escrow deposits with respect to DIVS, OWLS, and RISKS. No provisions 
for such deposits are included in the present filing; therefore, these 
references will have no application until such time as OCC provides for 
escrow deposits with respect to DIVS, OWLS, and RISKS.\11\
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    \11\ Prior to providing for specific or escrow deposits with 
respect to DIVS, OWLS, or RISKS, OCC will be required to file a 
proposed rule change with the Commission under Section 19(b) of the 
Act.
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5. Proposed Chapter XXVI of the Rules
    The introduction to proposed Chapter XXVI makes it clear that the 
rules in Chapters I through VII and IX through XII also are applicable 
to DIVS, OWLS, and RISKS except where expressly modified or made 
inapplicable by Chapter XXVI. The effect on other rules by each section 
in Chapter XXVI is stated in brackets at the end of each section in 
Chapter XXVI.
    Proposed Rule 2601 of Chapter XXVI sets forth the rights and 
obligations of holders and writers of DIVS with respect to the payment 
of dividend equivalents. Under the proposed rule, the holder of a DIVS 
is entitled to the equivalent of the regular dividend payments that a 
shareholder of the underlying security with a comparable position 
(i.e., one hundred shares) would receive. The writer is obligated to 
pay or deliver the dividend equivalent of an ordinary dividend or a 
non-cash dividend distribution to the holder of the DIVS. Certain 
distributions may result in an adjustment of the DIVS in lieu of a 
dividend equivalent while other distributions may give rise to only a 
dividend equivalent or both a dividend equivalent and an adjustment. 
Proposed Rule 2601 specifies that on the dividend payable date, OCC 
will notify each clearing member having a position in DIVS of the net 
sum it is required to pay or entitled to receive.
    Proposed Rule 2602 provides that the termination settlement date 
for a particular series of OWLS and RISKS will be the third business 
day following the termination date. Rule 2603 sets forth the 
termination settlement procedures for OWLS and RISKS. The number of 
shares of the underlying stock that are deliverable upon termination of 
OWLS is determined under paragraph (a) of Rule 2603. The number of 
shares, if any, deliverable upon termination of RISKS is determined 
under paragraph (b) of Rule 2603. The procedures applicable to both 
OWLS and RISKS for delivery of shares and payment of cash settlements 
in lieu of fractional shares are set forth in paragraphs (c) and (d), 
respectively, of Rule 2603.
    Rule 2603(c) sets forth the procedures for the delivery of stock in 
settlement of OWLS and RISKS. Settlement for OWLS and RISKS will be 
effected in the same way that stock is delivered in the settlement of 
exercised stock options which ordinarily occurs through stock clearing 
corporations. Rule 2603(d) provides that cash in lieu of fractional 
shares will be paid through OCC's regular cash settlement system. In 
the event the OWLS and RISKS cannot be settled through regular-way 
settlement, they will be settled on a broker-to-broker basis as 
governed by Rule 902.
    OCC believes the proposed rule change is consistent with the 
requirements of Section 17A of the Act and the rules and regulations 
thereunder because the rule proposal should facilitate the prompt and 
accurate clearance and settlement of transactions in DIVS, OWLS, and 
RISKS. OCC also believes the proposed change is consistent with the 
safeguarding of funds and securities in OCC's custody or control or for 
which OCC is responsible because OCC will apply to DIVS, OWLS, and 
RISKS a system of safeguards which is substantially the same as that 
which OCC currently uses for options and other OCC-issued products.

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

    OCC does not believe that the proposed rule change will impose any 
burden on competition.

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

    Comments were not and are not intended to be solicited by OCC with 
respect to the proposed rule change, and none were received.

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

    Within thirty-five 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 ninety 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 OCC 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.

[[Page 38503]]

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submission 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549. 
Copies of the submissions, 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 Room, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filings will also be available 
for inspection and copying at the principal office of OCC. All 
submissions should refer to the file number SR-OCC-96-05 and should be 
submitted by August 14, 1996.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \1\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-18722 Filed 7-23-96; 8:45 am]
BILLING CODE 8010-01-M