[Federal Register Volume 62, Number 124 (Friday, June 27, 1997)]
[Notices]
[Pages 34733-34735]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-16914]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38750; File No. SR-PHLX-97-04]


Self-Regulatory Organizations; Order Granting Partial Approval to 
a Proposed Rule Change by the Philadelphia Stock Exchange, Inc., 
Modifying the Index Exercise Cut-Off Time

June 20, 1997.

I. Introduction

    On January 8, 1997, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ On January 29, 1997, the Exchange filed Amendment No. 1 
to the rule proposal.\3\ On April 4, 1997, the Exchange filed Amendment 
No. 2 to the proposed rule change.\4\ On April 23, the Exchange filed 
Amendment No. 3 to the proposed rule change.\5\ On May 23, 1997, the 
Commission partially approved the proposed rule change, including 
Amendment Nos. 1 and 2, thereby establishing a 4:02 p.m. close of 
trading for equity options and narrow-based index options, and 
modifying certain option trading rotation procedures.\6\
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Theresa McCloskey, Exchange, to Janice Mitnick, 
Commission, dated January 29, 1997. Amendment No. 1 was a technical 
amendment.
    \4\ Letter from Philip H. Becker, Exchange, to Michael A. 
Walinskas, Commission, dated April 4, 1997. Amendment No. 2 proposed 
a 4:02 p.m. close of trading for narrow-based index options and 
modified option trading rotation procedures. Amendment No. 2 
originally contained a proposal modifying Exchange index option 
exercise cut-off procedures. However, this proposal was resubmitted 
in Amendment No. 3, constituting a withdrawal of such proposal from 
Amendment No. 2.
    \5\ File No. SR-PHLX-97-04, Amendment No. 3, dated April 22, 
1997. Amendment No. 3 proposes to amend rule 1042A and Floor 
Procedure Advice G-1 to change the index option exercise cut-off 
time from 4:30 p.m. (of 15 minutes after the close of trading if 
trading is closed at a time other than the regular close of trading) 
to five minutes after the close of trading. The proposal also 
deletes the current requirement that member organizations must 
accept exercise instructions until 4:15 p.m. each business day.
    \6\ Release No. 34-38554 (May 23, 1997), 62 FR 29756 (June 2, 
1997).
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    Notice of the substance of Amendment No. 3 was provided by issuance 
of a release \7\ and by publication in the Federal Register.\8\ Two 
comment letters were received.\9\ This order approves the Amendment No. 
3, permitting a change to the index option exercise cut-off time from 
4:30 p.m. (or 15 minutes after the close of trading if trading is 
closed at a time other than the regular close of trading) to five 
minutes after the close of trading. As a result of the rule change, the 
exercise cut-off time applicable to narrow-based (industry) index 
options (which close at 4:02 p.m.) will be 4:07 p.m., and the cut-off 
time applicable to broad-based (market) index options (which close at 
4:15 p.m.) will be 4:20 p.m. The order also approves a deletion of the 
current requirement that member organizations must accept exercise 
instructions until 4:15 p.m. each business day.
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    \7\ Securities Exchange Act Release No. 38554 (April 29, 1997).
    \8\ 62 FR 24529 (May 29, 1997).
    \9\ Letter form Michael Schwartz, Committee On Options 
Proposals, to Jonathan Katz, Commission, dated January 10, 1997 
(``CO-OP Letter'') (referencing Chicago Board Options Exchange, Inc. 
(``CBOE''), American Stock Exchange, Inc. (``Amex''), and Pacific 
Exchange, Inc. (``PCX'') proposals to establish a 4:02 p.m. trading 
close for equity and narrow-based index options); letter from Gerald 
D. O'Connell, Susquehanna Investment Group, Michael Walinskas, 
Commission, dated May 28, 1997 (``Susquehanna Letter'').
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II. Description of the Proposal

    The Exchange proposes to amend Rule 1042A and Floor Procedure 
Advice G-1 to change the index option exercise cut-off time from 4:30 
p.m. (or 15 minutes after the close of trading if trading is closed at 
a time other than the regular close of trading) to five minutes after 
the close of trading. The proposal would result in an exercise cut-off 
time applicable to narrow-based index options (which close at 4:02 
p.m.) of 4:07 p.m., and cut-off time applicable to broad-based index 
options (which close at 4:15 p.m.) of 4:20 p.m.
    Currently, Rule 1042A requires that a memorandum to exercise any 
American-style index option must be received or prepared by the 
Exchange member organization no later than 4:30 p.m., or 15 minutes 
after the close of trading if the close occurs at a time other than the 
regular close of trading.\10\ Further, Rule 1042A(a)(ii) currently 
requires the submission of an Exercise Advice Form to the Exchange when 
exercising American-style index option contracts.\11\
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    \10\ Release No. 34-37077 (April 5, 1996), 61 FR 16156 (April 
11, 1996) (Order approving SR-Phlx-95-86).
    \11\ These requirements are currently not in effect on the last 
business day before expiration, pursuant to Rule 1042A(b). Nor are 
they applicable to European-style index options, which by definition 
cannot be exercised prior to expiration.
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    The Exchange states that in the process of reviewing and amending 
its rules to provide for a 4:02 p.m. close for narrow-based index 
options, it re-examined the reference in Rule 1042A to a 4:30 p.m. 
exercise cut-off time. As a result of this re-examination, the Exchange 
has proposed an exercise cut-off time for five minutes after the close 
of trading to establish a cut-off time similar to that of the other 
options exchanges.\12\
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    \12\ See Amex Rule 980C(a)(i); CBOE Rule 11.1, Interpretations 
and Policies .03(b); and PCX Rule 7.15.
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    The proposal also would amend Rule 1042A to delete the requirement 
that member organizations must accept exercise instructions until 4:15 
p.m. each business day. Under the proposal, member organizations could 
establish earlier cut-off times. The Exchange states that the purpose 
of this change is to eliminate a restriction in its rules which the 
CBOE and Amex do not have in their rules. The Exchange also states it 
believes that it is appropriate for member organizations to determine 
how best to comply with the Exchange's exercise cut-off time.
    The Commission received two comment letters regarding the proposal 
to change the index option exercise cut-off.\13\ The CO-OP Letter 
supported a change in the Exchange's exercise cut-off, in order to 
conform its rules with those of the other options exchanges. The 
commenter suggested that such a change to the Exchange's exercise cut-
off would assist in ensuring that the Exchange's rule did not appear to 
give professionals an advantage over public customers.
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    \13\ CO-OP Letter and Susquehanna Letter, supra n.9.
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    The Susquehanna Letter objected to the proposed reduction of the 
exercise cut-off time from 4:30 p.m. to 4:07 p.m. The commenter stated 
that such a change would have a negative impact on market makers' 
ability to facilitate orders received near the close of trading. The 
commenter also argued that the proposal would hinder market makers' 
ability to effect the exercises necessary to control their risk and 
stabilize their positions in preparation for the next day's trading. 
Finally, the commenter argued that the change will provide an unfair 
competitive advantage to broad-based index products.
    The Exchange responded to the comment letter, stating that

[[Page 34734]]

notwithstanding the issues raised in the comment letter, it continues 
to believe that the adoption of the rule proposal is appropriate.\14\ 
The Exchange reiterated its position that the basis of the proposal is 
to conform the Exchanges rules to those of the other options exchanges. 
In addition, the Exchange stated that the rule change has merit for 
reasons other than establishing uniform options exercise deadlines. The 
Exchange believes that the proposal will establish a deadline for 
narrow-based index option exercise that is likely to precede most post-
4:00 p.m. news announcements, thereby assuring a level playing field 
for both long and short investors in narrow-based index options.\15\ 
The Exchange also stated that different exercise cut-off times for 
narrow-based index options and broad-based index options are unlikely 
to confuse market participants or member firms because other options 
exchanges have long operated with different closing times and exercise 
cuts-off for narrow and broad-based index options.\16\
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    \14\ Letter from Philip H. Becker, Exchange, to Michael 
Walinskas, Commission, dated June 5, 1997.
    \15\ The exercise of options after the close of stock trading as 
a result of significant news announcements often can adversely 
impact uncovered short investors in the affected options. For 
instance, if a particular news announcement after the close of stock 
trading has the effect of increasing an index level, uncovered short 
call positions would bear a risk of being assigned without having 
the ability to cover or offset their position until the market 
reopens, potentially at a higher level.
    \16\ The Exchange has notified its membership of this proposal, 
and represents it will issue another notification to its membership 
upon approval of proposal by the Commission.
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    In addition, the Exchange noted that it has examined the impact of 
the reduced exercise cut-off time on the risk assessment of its 
specialists and market makers, and believes that Exchange market 
professionals and market participants will still have adequate time to 
assess their risk in deciding whether to exercise. The Exchange noted 
that trading volume in such index options between 3:50 p.m. and the 
close of trading should not unduly impede the ability of market 
professionals to make these decisions. Finally, the Exchange indicated 
that it will monitor the impact of this rule change on all market 
participants to determine whether its implementation meets the desired 
result.

III. Discussion

    The Commission finds that the 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, 
Section 6(b)(5).\17\ Section 6(b)(5) requires, among other things, that 
the rules of an exchange be designed to promote just and equitable 
principles of trade, perfect the mechanism of a free and open national 
market, and, in general, to further investor protection and the public 
interest.\18\
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    \17\ 15 U.S.C. Sec. 78f(b)(5).
    \18\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. Sec. 78c(f).
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    The Commission believes that it is reasonable for the Exchange to 
amend its rules to change the index option exercise cut-off time to 
five minutes after the close of trading. The Commission notes that the 
Exchange determined to revisit this issue\19\ in connection with its 
earlier approved proposal to establish a 4:02 close of trading for 
narrow-based index (and equity) options. The Exchange consulted 
informally within its membership and other options industry members 
through discussions with compliance, operations and trading 
representatives of its member firms, the Committee on Options Proposals 
(CO-OP), and the Options Clearing Corporation Roundtable in its re-
evaluation. As a result of this re-evaluation of appropriate exercise 
cut-off procedures, the Exchange concluded that achieving uniformity 
with the rules of the other options exchanges is desirable and 
appropriate. As noted above, the Exchange's proposal for index exercise 
cut-off is similar to the current practices of the CBOE, Amex, and the 
PCX. In determining the appropriate exercise cut-off time, the Exchange 
also specifically considered the amount of time market participants 
will have to assess their risk in deciding whether to exercise against 
the benefits of uniformity in rules among the options exchanges.
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    \19\ See Release No. 34-37077 (April 5, 1996), 61 FR 16156 
(April 11, 1996) (order approving SR-Phlx-95-86 extending the 
exercise cut-off for narrow-based (American-style) index options 
from 4:15 p.m. (five minutes after the close of trading) to 4:30 
p.m.).
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    The Commission has considered the issues raised in the proposal, 
the comment letters, and the Exchange's response. The Commission 
believes that the Exchange has adequately responded to the comments 
raised in the comment letters. In addition, the Commission believes 
that the proposal reflects a reasonable balance between the anticipated 
benefits to the Exchange and the options industry as a whole that 
should result from conforming its policy to that of the other options 
exchanges, and the potential adverse impact of the proposal on certain 
market participants. Specifically, the Commission concludes that a 4:07 
p.m. exercise cut-off for narrow-based (American-style) index options 
provides investors and other market participants with adequate time to 
assess their risk in deciding whether to exercise long options 
positions in such options. Moreover, the Commission does not believe 
that different exercise cut-off times for narrow-based index options 
and broad-based index options will create confusion for market 
participants or member firms. Finally, the Commission does not believe 
that the trading volume in narrow-based index options between 3:50 p.m. 
and the close of trading will unduly impede the ability of market 
professionals to make a decision as to whether to exercise.
    The Commission also believes that it is reasonable for the Exchange 
to amend Rule 1042A to delete the requirement that member organizations 
must accept exercise instructions until 4:15 p.m. each business day, 
permitting member organizations to establish earlier cut-off times. The 
Commission notes that the CBOE and Amex rules do not contain such a 
limitation. Further, the Commission believes the change will permit 
member organizations to determine how best to comply with the 
Exchange's exercise cut-off time.\20\
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    \20\ The Commission notes that the Exchange represents it will 
include in its notification to members covering the approval of this 
proposal a provision indicating that members establishing customer 
exercise cut-off limitations should take into account customers' 
desires to maximize the time available to make an options exercise 
determination. This goal should be balanced with the need of members 
to have sufficient time to compile and relay exercise instructions 
to the Exchange. Phone conversation between Edith Hallahan, 
Exchange, and Michael Walinskas, Commission, June 19, 1997.
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    It is contemplated that the Exchange will implement this rule 
change on or about June 23, 1997.\21\
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    \21\ Phone conversation between Edith Hallahan, Exchange and 
Janice Mitnick, Commission, on May 23, 1997.
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IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act, and, in particular, Section 6 of 
the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that Amendment No. 3 to the proposed rule change (SR-PHLX-97-
04) is hereby approved.
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    \22\ 15 U.S.C. Sec. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).

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[[Page 34735]]

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-16914 Filed 6-26-97; 8:45 am]
BILLING CODE 8010-01-M