[Federal Register Volume 62, Number 76 (Monday, April 21, 1997)]
[Notices]
[Pages 19364-19369]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-10161]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38501; File No. SR-CBOE-97-17]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Chicago Board Options Exchange, Incorporated Relating to
Changes to Its Margin Rules
April 14, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on March 21,
[[Page 19365]]
1997, the Chicago Board Options Exchange, Incorporated (``CBOE'' or the
``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II and III below, which Items have been prepared by the CBOE.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The CBOE proposes to make revisions to its rules governing margin
that will: (i) Establish CBOE rules to govern areas of margin
regulation that will no longer be addressed by Regulation T
(``Regulation T'') of the Board of Governors of the Federal Reserve
System (``Federal Reserve Board'' or ``Board''), (ii) conform certain
CBOE margin rules to those of the New York Stock Exchange (``NYSE''),
and (iii) correct or clarify current provisions of the CBOE margin
rules. The text of the proposed rule change is available at the Office
of the Secretary, CBOE and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the CBOE 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. The CBOE has prepared summaries, set forth in sections
A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, Proposed Rule Change
1. Purpose
The Exchange is proposing changes to its margin rules at this time
because of recent amendments to the Federal Reserve Board's Regulation
T, the regulation that covers extensions of credit by and to brokers
and dealers.\3\ Among other things, the amendments to Regulation T will
modify or delete certain Board rules regarding options transactions in
favor of rules that must be adopted by the options exchanges and
approved by the Commission. The new options provisions in Regulation T
will not become effective until June 1, 1997. In the course of amending
its rules to accommodate the changes necessary because of the
Regulation T amendments, the Exchange has found it necessary for the
sake of clarity to propose changes to the margin rules that would
conform certain CBOE rules to the rules of the NYSE and to make
clarifying changes to its existing provisions. The Exchange is also
submitting concurrently separate changes to its margin rules in another
rule filing, See SR-CBOE-97-18. That second filing will be referred to
herein as the ``Second Margin Filing.'' This present filing will be
referred to as the ``First Margin Filing.''
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\3\ See 61 FR 20386 (May 6, 1996).
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Definition Section
The Exchange is proposing the addition of a definition section in
new paragraph (a) of Rule 12.3. The first definition that is being
added is a definition of the term ``current market value,'' which is
used throughout the Rule. The proposed definition is consistent with
the NYSE rules \4\ and the current definition of the term contained in
CBOE Rule 24.11, which governs margin for index options. However, the
Exchange is also proposing to add an interpretation to Rule 12.3
covering situations where there is no closing price or where trading
was halted and not reopened before the normal end of the trading day or
where the closing price was outside the last bid and offer that was
established after the closing price. In such situations, a member
organization may use a reasonable estimate of the market value of the
security based upon the then current bids and offers in determining the
``current market value'' of a security, including an option. The
Exchange believes that this interpretation will allow member
organizations to arrive at a more reasonable estimate of the current
market value in general, and particularly where the underlying
securities may be trading or quoted in other markets or in cases where
the underlying security re-opens for trading and the options remain
closed.
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\4\ See NYSE Rule 431(a)(1).
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The term ``escrow agreement'' is also defined in new paragraph (a)
of Rule 12.3. The proposed definition is nearly identical to the
definition in Regulation T except that the CBOE definition is more
restrictive as to the entities that may issue approved escrow receipts.
The CBOE definition requires the issuer to be a U.S. bank or trust
company supervised and examined by state or federal authority. The
Regulation T definition allows the issuer to be a bank or any person
designated as a control location under paragraph (c) of Rule 15c3-3
under the Act. The CBOE is concerned that certain control locations,
such as transfer agents, are not appropriate issuers of escrow receipts
and that Exchange rules should continue to limit issuers of receipts to
entities such as banks, as currently set forth in Rule 24.11(d). The
Exchange will, however, continue to study this issue.
Finally, the Exchange is revising its definition of ``exempted
security'' by adopting the Regulation T definition.\5\
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\5\ The Commission notes that the text of the CBOE's rule filing
refers to the definition contained in Section 3(a)(12) of the Act
rather than the definition contained in Regulation T.
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Customer Margin Accounts
The Exchange is also proposing to reorganize Rule 12.3 so that all
provisions concerning customer margin accounts are in the same sections
of the Rule. Currently, customer margin provisions appear throughout
the Rule. Paragraph (b) will set forth the default margin requirements
on long and short positions in customer margin accounts. Paragraph (c)
will set forth the specific margin treatment for particular types of
securities and positions held in customer margin accounts.
The margin treatment of ``exempted securities'' is proposed to be
moved from current paragraph (b)(3) of the Rule to new paragraph
(c)(3), and amended so that it is consistent with the NYSE's margin
rule, Rule 431.\6\ Specifically, the treatment for exempted securities
is being revised so that obligations of the United States (as specified
in the rule) will be subject to a margin requirement of from 1% to 6%,
depending on the years to maturity for the obligation. Zero coupon
bonds will be subject to a margin requirement of 3% for bonds with five
years or more to maturity. All other exempted securities will be
subject to an initial and maintenance margin requirement of 15% of the
current market value or 7% of the principal amount, whichever amount is
greater. Currently, the rule requires margin of 5% on obligations of
the United States and margin of 15% of the principal amount or 25% of
the current market value of other exempted securities, whichever amount
is lower.
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\6\ See NYSE Rule 431(e).
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The Exchange is also adopting a margin treatment for nonconvertible
debt securities which is consistent with the margin treatment in NYSE
Rule 431,\7\ except that the Exchange is not adopting the special
exemptions relating to mortgage related securities at this time because
this provision is currently
[[Page 19366]]
the subject of discussion by an industry committee and may be changed.
The rule will require margin to be maintained equal to 20% of the
current market value or 7% of the principal amount of the non-
convertible debt, whichever amount is greater.
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\7\ Id.
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The next section, labeled ``Security Offsets,'' combines two
current provisions from Rule 12.3 that deal with the margin treatment
of short securities offset against: (i) Long positions in a security
exchangeable or convertible into the security held in a short position
and (ii) long positions in the same security as the short position. The
convertible or exchangeable provision is the same as in the current
rule (12.3(b)(1)(A)) except that an incorrect parenthetical referring
to options is being deleted because options cannot be and never have
been considered convertible securities. The Exchange notes that the
rules of the other self-regulatory-organizations (``SROs'') and
Regulation T do not refer to options as convertible securities. The
provision dealing with offsets between long and short positions in the
same security is being moved from 12.3(b)(2)(D) of the current Rule,
and the margin requirement is being revised from 10% to 5% of the
current market value of the ``long'' securities to conform the CBOE
rule to a similar provision in NYSE Rule 431.\8\
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\8\ Id.
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The next provision under new paragraph (c) of Rule 12.3, which
deals with exceptions to the default margin treatment for positions in
a customer margin account, is the treatment for a short equity call
option position offset by a warrant to purchase the underlying
security. The proposed treatment is new to Rule 12.3 and is consistent
with a provision of Regulation T.\9\ The provision requires no margin
for this position if the warrant to purchase the underlying security
does not expire on or before the expiration date of the short call, and
if the amount (if any) by which the exercise price of the warrant
exceeds the exercise price of the short call is deposited in the
account.
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\9\ See Regulation T, Section 220.4(b).
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The next provision, which requires margin to be deposited and
maintained equal to 100% of the current market value of long positions
in listed equity options, is consistent with current Rule 12.5 and
Regulation T and is being added to Rule 12.3 for the sake of clarity.
The provision detailing the margin requirements for short listed
equity options is the same as that found in paragraph (a)(5) of the
current Rule 12.3 with three exceptions. First, the provision has been
moved. Second, the treatment of over-the-counter (``OTC'') options has
been deleted from the provision because the Exchange is adopting the
more extensive OTC margin provisions of the NYSE. Third, the Exchange
is proposing the addition of a provision that would cap the margin on
short puts that are out-of-the-money at a percentage of the exercise
price of the short put. The reason for this cap is that, under the
general rule, margin is required equal to the options market value plus
10% of the current market value of equivalent units of the underlying
security for an option dealt in on the exchange. However, as the market
value of the underlying security increases above the strike price, at
some point the put becomes farther out-of-the-money and the risk of the
position decreases. Without the cap, the margin requirement would also
continue to increase at the same time that the risk of the position is
decreasing.
The Exchange is also clarifying the margin treatment of interest
rate put options under Rule 23.23 \10\ and the margin treatment of put
warrants under Rule 30.53. The treatment is the same as that for short
uncovered put options as described above.
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\10\ The Commission notes that the CBOE's margin rule for
interest rate option contracts is 23.13 and not 23.12 as indicated
in the CBOE's filing.
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The provisions governing margin treatment for various related
securities positions involving listed options carried in a customer
margin account have been revised and rearranged. This became necessary
after various changes that were made over time rendered the provisions
difficult to follow. The Exchange believes that the changes being
proposed will simplify the provisions and make them easier for members
to follow.\11\ The treatment for a covered call writing position where
the underlying security is a convertible security is similar to that
currently describe in 12.3(b)(1)(C) but has been revised to be
consistent with Rule 431.\12\ The treatment for covered puts is similar
to the treatment under current Rule 12.3; however, the language has
been revised to conform the CBOE rule to the language in Regulation T.
The language regarding covered calls has been reworded from what
currently appears in paragraph (b)(1)(C)(1).
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\11\ Telephone conversation between Diane Malley, Supervisor,
Department of Financial Compliance, CBOE, Timothy Thompson, Senior
Attorney, Legal Department, CBOE, and Chester McPherson, Staff
Attorney, Division of Market Regulation, Commission, April 10, 1997.
\12\ See NYSE Rule 431(f)(2)(H)(i).
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In the case of both short calls and short puts, the amount of
margin is reduced when a short option contract is hedged with a long
option contract of the same type. The treatment of short option
contracts offset by long option contracts where the long option expires
with or after the short option is the same as that required currently
under Rule 24.11 for index options. In the case where the long call
option (or short put option) strike price is less than or equal to the
exercise price of the offsetting short call option (or long put
option), no margin is required; however, the long position must be paid
for in full. When the exercise price of the long call option (or short
put option) is greater than the exercise price of the offsetting short
call option (or long put option) the amount of margin required is the
lesser of: (1) The margin required under the general short listed
equity option rule or (2) the difference in aggregate exercise prices.
The treatment for a straddle (a short call option and a short put
option the same underlying interest) requires margin on the put or
call, whichever amount is greater, plus the current market value of the
other option. The margin treatment for straddles is merely being moved
from current paragraph (a)(5) of Rule 12.3.
The rules governing the margin requirements for OTC options have
been adopted from NYSE Rule 431 \13\ except that the Exchange has made
a slight change to cap the minimum margin on OTC short puts. A chart
submitted with the filing sets forth the initial and/or maintenance
margin required for options on various types of underlying securities.
The amount of margin required is the percentage of the current market
value of the underlying component times the multiplier, if any, (set
forth in the chart) plus any ``in-the-money-amount.'' The amount of the
margin required to be maintained may be reduced for a short put or call
by any ``out-of-the-money.'' The amount to which the margin required
may be reduced is set forth in a separate column.
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\13\ See NYSE Rule 431(f)(2)(D)(iii).
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The Exchange is proposing to add margin treatment for related
securities positions involving OTC options held in a customer margin
account. The Exchange is proposing to add special margin treatment for
covered write convertibles, covered calls/puts, spreads, and straddles
involving OTC options. The proposed margin treatment is the same
treatment that is set forth in NYSE Rule 431 except for the change to
cap the minimum margin on short puts.
[[Page 19367]]
Customer Cash Account
The Exchange is proposing to add a provision to Rule 12.3 detailing
the circumstances under which a customer may carry short equity options
in a cash account, i.e., an account in which no credit is extended.
This provision is consistent with a provision in Regulation T and is
being added so that the CBOE rule is more complete, thus enabling its
members to rely on such rules for all aspects of margin regulation. The
proposed rule would permit either a call option contract or a put
option contract held in a short position to be carried in a cash
account if the option contract is covered, i.e., if the account
contains one of the specified offsets.
In the case of a short call, allowable offsets include: (i) The
underlying security, in an amount equal to or greater than that
underlying the option, provided the option premium is held in the
account until full cash payment for the underlying security is
received; (ii) a security immediately convertible without the payment
of money into an equal or greater quantity of the security underlying
the option, if such security is held or purchased in the account, on
the same day provided that the option premium is held in the account
until full cash payment for the convertible security is received and
the ability to convert does not expire before the expiration of the
short call option; or (iii) an escrow agreement issued by a bank and
either held in the account at the time the call is written or received
in the account promptly thereafter.
In the case of a short put option, allowable offsets include (i)
Cash or cash equivalents as defined in Regulation T of not less than
the aggregate put exercise amount; or (ii) an escrow agreement issued
by a bank which is obligated to deliver the required cash in the event
of assignment of the short put.
CBOE Rule 24.11A currently permits certain debit put spreads to be
carried in a cash account.\14\ The Exchange is proposing to move
certain provisions from Rule 24.11A into Rule 12.3. In addition, the
Exchange will propose the expansion of the types of strategies that may
be carried in a cash account in the Second Margin Filing.
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\14\ The Commission notes that CBOE Rule 24.11A relates to debit
put spread cash account transactions, and not Rule 24.11 as
indicated in the rule filing.
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Market Maker and Specialist Accounts
The CBOE rules and the rules of the other regulatory bodies have
always distinguished the margin treatment for market-makers and
specialists from that applicable to customers and other broker-dealers
because of the unique position of market-makers and specialists in
maintaining liquid markets. The rules recognize that options market-
makers and specialists must engage in various hedging transactions to
manage the risk involved in fulfilling their role. Specific provisions
governing permitted offset treatment for market-makers and specialists
are being deleted from Regulation T, which as a result will defer to
the rules of the SROs.
The proposed rule sets forth various permitted offset positions
which may be cleared and carried by a member organization on behalf of
one or more registered specialists, registered market-makers, or
Designated Primary Market-Makers (hereinafter referred to generically
as ``market-makers'') upon a margin basis satisfactory to the concerned
parties. A permitted offset position will be defined to mean, in the
case of an option in which a market-maker makes a market, a position in
the underlying instrument or other related instrument, and in the case
of other securities in which a market-maker makes a market, a position
in options overlying the securities in which a market-maker makes a
market, if the account holds the following positions: (i) A long
position in the underlying instrument offset by a short option position
which is ``in- or at-the-money''; (ii) a short position in the
underlying instrument offset by a long option position which is ``in-
or at-the-money''; (iii) a stock position resulting from the assignment
of a market-maker short option position; (iv) a stock position
resulting from the exercise of a market-maker long position; (v) a net
long position in a security (other than an option) in which a market-
maker makes a market; (vi) a net short position in a security (other
than an option) in which the market-maker makes a market; or (vii) an
offset position as defined in SEC Rule 15c3-1.
For purposes of the rule, ``in- or at-the-money'' means the current
market price of the underlying security is not more than two standard
exercise price intervals below (with respect to a call option) or above
(with respect to a put option) the exercise price of the option. In
determining the types of instruments which are entitled to be carried
in a permitted offset position, reference can be made to the definition
of ``related instrument'' which is set forth in the rule. ``Related
instrument'' within an option class or product group is any related
derivative product that meets the offset level requirements for product
groups under Rule 15c3-1, including its appendices (the net capital
rule) of the Act, or any applicable SEC staff interpretations or no-
action positions (hereinafter referred to collectively as ``SEC Rule
15c3-1''). The term ``product group'' means two or more option classes,
related instruments, and qualified stock baskets for which it has been
determined that a percentage of offsetting profits may be applied to
losses in the determination of net capital as set forth in SEC Rule
15c3-1.
The Exchange is also proposing to add a provision regarding trading
in an account in a deficit. The addition generally states that nothing
shall prohibit the carrying firm from effecting hedging transactions in
the deficit account with the prior written approval of the carrying
firm's SEC designated examining authority.
The Exchange is also proposing in the Second Margin Filing to
permit a market-maker to receive market-maker margin treatment on
transactions in options or other derivative securities effected on an
exchange of which that market-maker is not a member and on which that
market-maker is not registered as a market-maker if the options or
other derivative securities are dually listed on the exchange on which
that market-maker is a registered market-maker, or if the transactions
are recognized offsets as defined by Rule 15c3-1 under certain
conditions specified in the proposed rule.
Broker-Dealer Account
The Exchange is also proposing to add a provision that would
provide margin relief to accounts held by non-market-maker broker-
dealers. Under the new provision, a member organization may carry the
proprietary account of another registered broker-dealer upon a margin
basis which is satisfactory to both parties, provided the requirements
of Regulation T are adhered to and the account is not carried in a
deficit equity condition. The amount of any deficiency between the
equity maintained in the account and the margin required by the other
provisions of this Rule shall be deducted in computing the net capital
of the member organization under Rule 15c3-1 of the Act. This new
provision is similar to the provision of NYSE Rule 431(e)(6), and would
permit the proprietary accounts of all registered broker-dealers to be
carried on a ``good faith'' margin basis for purposes of maintenance
margin. Broker-dealers would still be subject to initial margin
requirements under Exchange rules and Regulation T.
[[Page 19368]]
Interpretations to Rule 12.3
The Exchange is proposing to add four interpretations to Rule 12.3.
Also, current Interpretation .01 to Rule 12.3 is proposed to be deleted
because the interpretation concerns SuperShares, which the Exchange no
longer trades. The Exchange is also proposing to delete interpretation
.07 of Rule 24.11 because it also concerns SuperShares. New
Interpretation .01 would set forth in a chart form the margin
requirements applicable to short positions in listed options and in
index and foreign currency warrants. The general requirement is that
margin is required equal to the current market value of the option/
warrant plus the applicable percentage of the underlying instrument
(set forth in the chart). The margin required may be reduced by any
``out-of-the money'' amount, as defined in the rule. However, the
margin may not be reduced below the option market value plus a
different specified percentage of the current market value of the
underlying instrument as set forth in the chart. The determination of
the ``out-of-the-money amount'' is also set forth in a separate chart.
As described above, Interpretation .02 describes how a member
organization may determine ``current market value'' in the event there
is no closing price or trading has been halted.
Interpretation .03 specifies that for purposes of the CBOE margin
rules, index warrants should be treated as if they were index options
unless the rules specify otherwise. The Exchange states that this
interpretation is consistent with the position of the Commission and
recognizes that the two types of products are essentially equivalent
from a market risk standpoint.
Changes to Rule 12.11
The Exchange is proposing a minor change to Rule 12.11. Rule 12.11
allows a member organization that is a member of the NYSE to elect to
be bound by the rules of the NYSE instead of the requirements set forth
in Rules 12.3 to 12.10. The Exchange is changing Rule 12.11 to allow
the member organization to exempt themselves from Rules 12.3 to 12.9,
but not from 12.10. Rule 12.10 establishes that the margin requirements
set forth in the rule are minimum requirements and authorizes the
Exchange to impose higher margin requirements when it deems such higher
requirements to be advisable. The Exchange has determined that it is
necessary to clarify that the Exchange may still impose higher margin
requirements on its members when the Exchange believes such higher
requirements are warranted, even when those members have elected to
generally be subject to the margin rules of the NYSE. The Exchange
believes that because it will be in the best position to determine when
higher margin requirements may be required for positions in Exchange-
traded products it should not allow a member to exempt itself from this
provision. The change to Rule 12.11 also makes it clear that if a
member organization chooses to be bound by NYSE margin rules it will be
exempt not only from CBOE margin rules in Chapter 12, but also from
those margin rules in other chapters of the Exchange's rules.
Changes to Rule 24.11
The Exchange is proposing to add to Rule 24.11 (which covers margin
requirements for index options) a provision setting forth the margin
requirements for covered calls and covered puts that is essentially
identical to the provision applicable to equity options.\15\ In
addition, the Exchange is proposing to add a definition of ``qualified
stock basket'' to Rule 24.11. This definition is used to describe
allowable offsets in customer accounts for covered calls and covered
puts. In addition, the Exchange makes a cross-reference to the
provision of Rule 12.3 that governs the cash account treatment of short
index options offset by long index options. Finally, the Exchange is
proposing to change Interpretation .04 that defines ``cash
equivalent.'' Instead of specifically defining cash equivalent as it is
currently defined in the rule, the Exchange has decided to defer to the
definition in Regulation T because the Exchange expects that the
definition in Regulation T may change from time to time.
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\15\ See, e.g., NYSE Rule 431(f)(2)(H)(i).
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2. Statutory Basis
The basis under the Act for this proposed rule change is the
requirement under Section 6(b)(5) that an exchange have rules that are
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in securities, to remove impediments to protect and
perfect the mechanism of a free and open market and a national market
system, and in general, to protect investors and the public interest.
The proposed rule change: (i) Establishes CBOE rules to govern
areas of margin regulation that will no longer be addressed by
Regulation T of the Board of Governors of the Federal Reserve System,
(ii) conforms certain CBOE margin rules to those of the NYSE, and (iii)
corrects or clarifies current provisions of the CBOE margin rules. The
Exchange believes that the proposed rule change, is consistent with,
and furthers, the objectives of Section 6(b)(5) of the Act.
B. Self-Regulatory Organization's Statement on Burden on Competition
The CBOE 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
No written comments were solicited or received with respect to the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 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 90 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 the self-regulatory organization 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.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. 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 Room. Copies of all such filing will also
be available for inspection and copying at the principal office of the
CBOE. All
[[Page 19369]]
submissions should refer to the file number SR-CBOE-97-17 and should be
submitted by May 12, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-10161 Filed 4-18-97; 8:45 am]
BILLING CODE 8010-01-M