[Federal Register Volume 61, Number 197 (Wednesday, October 9, 1996)]
[Notices]
[Pages 52982-52985]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-25925]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37773; File No. SR-Amex-96-05]


Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval of Amendments Thereto Relating to 
Assurances of Delivery for Short Sales of Derivative Securities into an 
Underwriting Syndicate's Stabilizing Bid

October 1, 1996.
    On January 31, 1996, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the 
Securities Exchange Act of 1934 (``Act''),1 and Rule 19b-4 
thereunder,2 a proposed rule change to require that members 
trading derivative securities as Registered Options Traders

[[Page 52983]]

(``ROTs'') pursuant to Amex Rule 958 make prior arrangements either to 
borrow the necessary securities or to obtain other affirmative 
assurances that delivery can be made on settlement date prior to 
effecting a short sale into an underwriting syndicate's stabilizing 
bid.
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    \1 \15 U.S.C. 78s(b)(1) (1988 & Supp. V 1993).
    \2 \17 CFR Sec. 240.19b-4 (1994).
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    Notice of the proposed rule change was published for comment and 
appeared in the Federal Register on March 20, 1996.3 No comments 
were received on the proposal. On June 12 and July 17, 1996, 
respectively, Amex submitted Amendments No. 1 and 2 to the 
proposal.4 This order approves the proposal, as amended, and 
solicits comments on the Amendments.
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    \3 \Securities Exchange Act Release No. 36956 (March 11, 1996), 
61 FR 11451.
    \4 \Letters from William Floyd Jones, Amex, to Stephen M. Youhn, 
SEC dated June 10, 1996 (``Amendment No. 1'') and to Ivette Lopez, 
SEC, dated July 17, 1996 (``Amendment No. 2,'' together with 
Amendment No. 1, ``Amendments'').
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I. Description of the Proposal

    Since 1989, the Exchange has required members and member 
organizations effecting short sales for both customer and proprietary 
accounts either to make prior arrangements to borrow the securities 
sold short or to obtain other acceptable assurances that delivery can 
be made on settlement date.5 Such assurances include knowledge 
that the security is available for borrowing, conversion privileges, 
rights exercises or other similar situations so long as the security 
needed for delivery can be timely obtained. Short sales by specialists, 
market makers and odd-lot dealers in fulfilling their market making 
responsibilities are excepted from this requirement. Arbitrageurs and 
other traders may not rely upon this ``market maker'' exception.
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    \5 \See Securities Exchange Act Release No. 27542 (Dec. 15, 
1989) (``Release No. 27542'').
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    In 1992, the Exchange amended its rules to permit Registered Equity 
Market Makers (``REMMs'') to register as ROTs in order to trade index 
warrants for their own account subject to Amex Rule 958.6 The 
Exchange deemed it desirable to enable members to trade these equity 
derivative securities 7 subject to Rule 958 (which affords 
specialist ``good faith'' margin treatment and an exemption from 
stabilization requirements) instead of the more restrictive provisions 
of Rules 111 and 114 applicable to REMMs because the Exchange believed 
that application of Rules 111 and 114 to index warrants would make it 
unlikely that members would trade such securities. The 1992 rule change 
also exempted members trading as ROTs from the short sale policy given 
their market making activities in index warrants.
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    \6 \See Securities Exchange Act Release No. 24277 (June 8, 1992) 
(``Release No. 24277''). The SEC has recently approved an Amex 
proposal to allow regular members to trade currency warrants for 
their own account subject to the provisions of Amex Rule 958. See 
Securities Exchange Act Release No. 36852 (Feb. 15, 1996).
    \7 \The term ``equity derivative security'' refers to an 
underwritten security the value of which is determined by reference 
to another security, or to a currency, commodity, interest rate or 
index of the foregoing. Such securities are commonly listed pursuant 
to Exchange Company Guide Sections 106, 107, 118 or Amex Rule 1102.
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    According to the Exchange, the purpose of exempting Floor based 
market makers from ``pre-borrowing'' is that such a requirement would 
unacceptably interfere with market making activities, thereby degrading 
liquidity. The exemptions from the ``pre-borrowing'' policy may, 
however, create situations in the ordinary course of secondary market 
trading where a market maker or ROT may be unable to borrow a security 
it has sold short in connection with its market making obligations and, 
therefore, fails to deliver the security within the normal settlement 
cycle.
    To prevent this result in one particular instance, the Exchange 
proposes to modify its short sale policy to require ROTs who trade 
equity derivatives pursuant to Rule 958 to make prior arrangements to 
borrow these securities or obtain other acceptable assurances that 
delivery can be made on settlement date in the limited situation where 
they are selling short into the stabilizing bid of an underwriting 
syndicate. Amex believes that implementation of this modified short 
sale policy will provide increased stability to the market for listed 
Amex equity derivative securities during a stabilized distribution. The 
result will be a reduction in the number of ``fails'' (i.e., failure to 
effect delivery of the security to the purchaser), and resulting ``buy-
ins'' (i.e., the purchase of the security of the account of the short 
seller after it fails to deliver in accordance with the procedures of 
the clearing corporation).
    The Amex asserts that this filing addresses only short selling in a 
distribution of equity derivatives that is being stabilized by the 
underwriter. The Exchange believes that there is little or no need for 
supplemental market making during a stabilized distribution since buy 
side investor interest, in all likelihood, has been accurately gauged 
and met by the underwriting syndicate either through the initial 
distribution or an overallotment option. Likewise, sell side investor 
interest will be met by the underwriting syndicate through the 
stabilizing bid. As is the case with any equity or equity derivative 
security, the Exchange notes that the specialist also is available to 
supply liquidity to investors.
    The Exchange notes that it does not seek to impose a pre-borrowing 
requirement on ROTs who sell short on the offer in connection with 
satisfying investor buying interest. The Exchange, moreover, does not 
seek to prohibit short selling by ROTs. It only seeks to require ROTs 
to obtain adequate assurances that an equity derivative such as an 
index or currency warrant is available for borrowing. This ensures the 
ROT's ability to settle the trade in accordance with their contractual 
obligations.
    According to the Exchange, selling into a stabilizing bid adds no 
liquidity to the market since it involves selling to a bidder who may 
prefer not to buy. The Exchange believes that to permit ROTs to sell 
short without pre-borrowing where the sale by definition does not 
provide liquidity and may result in a fail, is inconsistent with 
allowing stabilization by underwriters to facilitate a distribution. 
The Exchange believes that, while it is sound policy to permit market 
to sell short without pre-borrowing in circumstances where the short 
sale may add liquidity to the market, a short sale into a syndicate bid 
is not such a circumstance.
    Amex represents that a specialist, unlike a ROT, needs Floor 
Official approval if it wishes to across the market to hit a bid to 
establish or increase a short position. In such a circumstance, the 
specialist must satisfy the Floor Official that the short sale is 
appropriate relative to the condition of the general market, the market 
in the particular stock and the adequacy of the specialist's position 
to the immediate and reasonably anticipated needs of the full lot and 
the odd lot market.\8\ Amex expects that a Floor Official would not 
approve a specialist's short selling into an underwriting syndicate's 
stabilizing bid because it would be difficult to imagine a circumstance 
under which such a course of dealings would be necessary in relation to 
the needs of the market for the security. As such, Amex does not 
believe that a ROT would have any justification for selling short into 
a stabilizing bid. Therefore, rather than make his actions subject to 
Floor Official approval as could be required by the Exchange to address 
the problem identified in the instant proposal, Amex

[[Page 52984]]

believes it is more beneficial to impose a pre-borrowing 
requirement.\9\
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    \8\ See Amex Rule 170, Commentary .01.
    \9\ According to Amex, in one recent situation, a ROT sold short 
into an underwriter's stabilizing bid more than five percent of the 
total issuance of a currency warrant. When questioned by the 
Exchange's staff as to how he intended to settle these trades, the 
ROT responded that he did not know where he was going to obtain the 
security and, in fact, expected to fail on settlement date. Amex 
asserts that it frequently is difficult to borrow index or currency 
warrants for short sale purposes as these securities may not be 
marginable. As anticipated, the ROT failed to deliver the security 
sold short and ultimately was ``bought-in.''
    In the situation described above, the Exchange does not believe 
the ROT in question was providing liquidity to investors. Instead, 
the Exchange believes the ROT knowingly was taking advantage of the 
existence of a stabilizing bid of an underwriting syndicate in order 
to engage in a short sale speculation based on his opinion as to the 
appropriate price of the security. While short selling can be a 
perfectly proper strategy and can itself bring supply and demand 
into balance, Amex believes that it is appropriate to constrain 
potential excesses by rule.
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    Amex represents that the New York Stock Exchange (``NYSE'') also 
list equity derivative securities and that market makers on the NYSE 
are subject to rules analogous to those applicable to REMMs on the 
Amex, including rules relating to short selling (i.e., pre-borrowing 
requirement). As a result, Amex believes that potential underwriters 
may view this distinction between the rules of the NYSE and Amex as an 
incentive to list equity derivatives on the NYSE.

II. 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 requirements of Section 6(b)(5).\10\ In particular, the 
Commission believes the proposal is consistent with the Section 6(b)(5) 
requirement that the rules of an exchange be designated to promote just 
and equitable principles of trade and not to permit unfair 
discrimination between customers, issuers, brokers, and dealers.
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    \10\ 15 U.S.C. 78f(b)(5) (1982).
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    In approving the Amex's current short sale policy in 1982, the 
Commission noted that the imposition of a formal affirmative borrowing 
requirement on members effecting short sales for both customer and 
proprietary accounts was appropriate for the protection of investors 
and the maintenance of fair and orderly markets.\11\ By restricting 
naked short selling,\12\ the Commission noted that the affirmative 
borrowing requirement should curtail downward speculative selling 
pressures in stocks traded on the Amex. The Commission noted, however, 
that it was appropriate for the Exchange to exempt specialists, market 
makers and odd-lot dealers from the general borrowing requirement in 
fulfilling their market-making responsibilities, because their short 
selling often was undertaken passively pursuant to their market-making 
operations. In this connection, the Commission noted it was reasonable 
for the Exchange not to exempt arbitrageurs and other traders from the 
borrowing requirement because their short selling activities were not 
passive in nature.\13\
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    \11\ See Release No. 27542, supra note 5.
    \12\ A naked security position may be defined as an unhedged or 
uncovered security position that exposes the holder to the entire 
market risk associated with the position. A short sale becomes a 
naked short sale when the short seller or the short seller's broker 
fails to borrow and deliver stock to the broker's clearing agent. 
Brokers may fail to deliver stock to the clearing agent in long 
sales as well, but such fails are normally for short periods or for 
relatively small quantities of stock.
    \13\ See Release No. 27542, supra note 5.
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    When the Commission approved the Amex's 1992 proposal allowing 
REMMs to trade equity derivatives as ROTs pursuant to Amex Rule 958, 
these market makers assumed continuous affirmative market making 
obligations in their assigned securities and were treated as 
specialists.\14\ As a result, these ROTs were entitled to good faith 
margin treatment and also were exempted from the affirmative 
determination pre-borrowing requirement when engaging in short sales of 
their assigned securities. The Commission stated that the purpose of 
that rule change was to enhance supplemental market making activitiy in 
equity derivatives, thereby increasing the depth and liquidity of the 
market.\15\
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    \14\ See Release No. 24277, supra note 6.
    \15\ Id.
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    Consistent with that finding, the Commission believes it is 
reasonable for the Exchange to adopt this limited exception to its 
short sale policy in order to require ROTs to make an affirmative 
determination that an equity derivative security is available for 
borrowing prior to selling short into the stabilizing bid of an 
underwriting syndicate. The Commission believes that the imposition of 
a pre-borrowing requirement should help to reduce the number of times 
market makers sell short underwritten securities in distribution and 
are unable to deliver on settlement date. By improving the settlement 
mechanism of equity derivative securities which are sold short during 
stabilized distributions, the Commission believes the depth and 
liquidity of the equity derivative market will be enhanced.
    As was stated in Release No. 27542, the Commission believes that 
short selling by market makers in furtherance of bona-fide market 
making obligations should not be restricted by imposing a pre-borrowing 
requirement. The Commission does not believe, however, that market 
makers who sell short for reasons other than in furtherance of their 
market making responsibilities (e.g., speculation), should be relieved 
from the pre-borrowing requirement. As such, the Commission believes 
that the Amex proposal is a reasonable attempt to limit the 
availability of the exemption from the affirmative determination 
requirement to situations where a ROT is engaging in bona-fide market 
making transactions.
    In approving this proposal, the Commission notes that this policy 
is strictly limited to instances where a ROT sells short into the 
stabilizing bid of an underwriting syndicate. This policy does not 
apply to a ROT's short sales outside of an underwritten distribution. 
The Commission notes that a ROT may sell short in an ordinary secondary 
market transaction without being required to make an affirmative 
determination as to the security's availability for pare-borrowing. Nor 
does this Ampex policy impose an affirmative borrowing requirement upon 
every short sale undertaken by a ROT during an underwritten 
distribution. A ROT may sell short into the offer side of the market 
without a pre-borrowing requirement. Finally, the Commission notes that 
this Amex policy will not operate as an outright prohibition of short 
selling by a ROT. While ROTs may still engage in short sale 
transactions, the availability of the exemption from the pre-borrowing 
requirement will be limited strictly to short sales undertaken in the 
course of bona fide market making activities. Accordingly, ROTs will be 
required to comply with the affirmative pre-borrowing requirement prior 
to selling short into the stabilizing bid of an underwriting syndicate.
    The Commission finds good cause to approve the Amendments to the 
filing prior to the thirtieth date after the date of publication of 
notice thereof in the Federal Register. Although the Amendments clarify 
the original proposal and provide more detailed justification for 
adopting the instant policy, the Commission notes that they do not 
change the substance of the Amex proposal as originally filed. Although 
the filing results in an expansion of the applicability of the Amex 
short sale policy, the Commission notes that the underlying short sale 
policy is not changed by the Amendments. Accordingly, the

[[Page 52985]]

Commission believes that Amendments raise no new or unique issues that 
were not already presented in the original filing. The Commission notes 
also that the original proposal was subject to the full notice and 
comment period and no comment letters were received. Accordingly, 
consistent with Section 6(b)(5) of the Act, the Commission believes 
that good exists to approve the Amendments to the filing on an 
accelerated basis.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the Amendments. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying at 
the Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the Amex. All 
submission should refer to File No. SR-Amex-96-05 and should be 
submitted by October 30, 1996.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposal rule change (File No. SR-Amex-96-05) is 
approved, as amended.

    \16\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-25925 Filed 10-8-96; 8:45 am]
BILLING CODE 8010-01-M