[Federal Register Volume 63, Number 77 (Wednesday, April 22, 1998)]
[Notices]
[Pages 19992-19994]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10600]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39865; File No. SR-NASD-98-02]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to an Extension of the 
Option Position Limit Hedge Exemption Pilot Program

April 14, 1998.
    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 January 21, 1998, NASD Regulation, Inc. (``NASD Regulation'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by the self-regulatory organization. NASD Regulation 
filed an amendment to the proposed rule change on March 23, 1998.\3\ 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons. For the reasons discussed 
below, the Commission is granting accelerated approval of the proposed 
rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 200.19b-4.
    \3\ See Letter from Alden S. Adkins, Senior Vice President and 
General Counsel, NASD Regulation, to Katherine A. England, Assistant 
Director, Commission, dated March 17, 1998 (``Amendment No. 1''). 
Amendment No. 1 shortens the requested extension by providing for an 
extension of the pilot until December 31, 1998, instead of December 
31, 1999.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend Rule 2860(b)(3)(A)(vii)(c) of 
the National Association of Securities Dealers, Inc. (``NASD'' or 
``Association''), to extend, until December 31, 1998, the Association's 
pilot program for exemptions from equity option position limits for 
certain hedged positions (``hedge exemption pilot program''). Below is 
the text of the proposed rule change. Proposed new language is in 
italics; proposed deletions are in brackets.

Rule 2860. Options

* * * * *
(b)(3)(A)(vii) Equity Option Hedge Exemption
    a. The following positions, where each option contract is 
``hedged'' by 100

[[Page 19993]]

shares of stock or securities readily convertible into or economically 
equivalent to such stock, or, in the case of an adjusted option 
contract, the same number of shares represented by the adjusted 
contract, shall be exempted from established limits contained in (i) 
through (vi) above:
    1. long call and short stock;
    2. short call and long stock;
    3. long put and long stock;
    4. short put and short stock.
    b. Except as provided under the OTC Collar Exemption contained in 
paragraph (b)(3)(A)(viii), in no event may the maximum allowable 
position, inclusive of options contracts hedged pursuant to the equity 
option position limit hedge exemption in subparagraph a. above, exceed 
three times the applicable position limit established in paragraph 
(b)(3)(A)(i)-(v).
    c. The Equity Option Hedge Exemption is a pilot program authorized 
by the Commission through December 31, 1998[7].

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 self-regulatory organization 
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 
places specified in Item IV below. The self-regulatory organization 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, the Proposed Rule Change

1. Purpose
    On February 9, 1990, the Commission approved the NASD's proposal to 
implement a pilot program pursuant to which certain fully hedged equity 
option positions would be automatically exempt from established 
position \4\ and exercise \5\ limits. On March 18, 1994, the Commission 
extended the NASD's hedge exemption pilot program through December 31, 
1995.\6\ On December 29, 1995, the Commission again extended the NASD's 
hedge exemption pilot program through December 31, 1997.\7\ The 
proposed rule change herein would extend the hedge exemption pilot 
program for an additional one year, or through December 31, 1998.
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    \4\ Position limits impose a ceiling on the number of options 
contracts in each class on the same side of the market, i.e., 
aggregating long calls and short puts and long puts and short calls, 
that can be held or written by an investor or group of investors 
acting in concert. Rule 2860(b)(3)(A) currently provides that equity 
option position limits are 4,500, 7,500, 10,500, 20,000, and 25,000 
contracts, depending on the trading volume and number of outstanding 
shares of the underlying stock.
    \5\ Exercise limits restrict the number of options contracts 
that an investor or group of investors acting in concert can 
exercise within five consecutive business days. Under NASD Rules, 
exercise limits correspond to position limits, such that investors 
in options classes on the same side of the market are allowed to 
exercise, during any five consecutive business days, only the number 
of options contracts set forth as the applicable position limit for 
those options classes. See NASD rule 2860(b)(3).
    \6\ Exchange Act Release No. 33783 (March 18, 1994), 59 FR 14229 
(March 25, 1994).
    \7\ Exchange Act Release No. 36657 (December 29, 1995), 61 FR 
434 (January 5, 1996).
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    The NASD's hedge exemption provides for an automatic exemption from 
equity option position limits for accounts that have established one of 
the four most commonly used hedged positions \8\ and where each option 
contract is either (i) hedged by 100 shares of stock, (ii) hedged by 
securities that are readily convertible into, or economically 
equivalent to, such stock,\9\ or (iii) in the case of an adjusted 
options contract, hedged by the number of shares represented by the 
adjusted contract.
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    \8\ The four exempted hedge positions are: (1) long stock and 
short calls; (2) long stock and long puts; (3) short stock and long 
calls; and (4) short stock and short puts.
    \9\ The Commission notes that NASD Regulation determines on a 
case-by-case basis whether an instrument that is being used as the 
basis for the underlying hedged positions is readily convertible 
into, or economically equivalent to, the security underlying the 
corresponding option position. In this regard, NASD Regulation 
generally finds that an instrument that is not presently convertible 
into a security, but which will be at a future date, is not a 
``convertible'' security for purposes of the hedge exemption. In 
addition, NASD Regulation notes that if a convertible security used 
to hedge an option position is called for redemption by the issuer, 
the security would have to be converted into the underlying security 
immediately or the corresponding option position would have to be 
reduced accordingly.
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    Under the NASD's hedge exemption, the largest options position 
(combining hedged and unhedged positions) that may be established may 
not exceed three times the basic position limits, i.e., 13,500, 22,500, 
31,500, 60,000, or 75,000 contracts, depending on the basic position 
limit of the underlying security. The exercise limit for options 
positions established pursuant to the hedge exemption are commensurate 
with the position limits that may be established pursuant to the hedge 
exemption. Thus, for example, if the position limit for an option is 
25,000 contracts and an investor has established a position of 75,000 
contracts pursuant to the hedge exemption, the investor may exercise 
all 75,000 contracts during five consecutive business days.
    The proposed rule change to extend the effective date of the pilot 
program is necessary to enable market participants to continue to avail 
themselves of the hedge exemption and to create parity and consistency 
with the other self-regulatory organizations which have in effect an 
equity hedge exemption.\10\ The proposed rule change extends the 
effective date until December 31, 1998.
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    \10\ See, e.g., American Stock Exchange Rule 904; Chicago Board 
Options Exchange Rule 4.11; Philadelphia Stock Exchange Rule 1001; 
Pacific Stock Exchange Rule 6.8.
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2. Statutory Basis
    NASD Regulation believes the proposed rule change is consistent 
with Section 15A(b)(6) of the Act.\11\ Section 15A(b)(6) requires that 
the rules of a national securities association be 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 transaction in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national system and, in general, to protect 
investors and the public interest. Specifically, the NASD believes that 
extending the effectiveness of the hedge exemption pilot program may 
increase the depth and liquidity of the options markets by permitting 
investors to hedge greater amounts of stock than would otherwise be 
permitted under NASD rules. Extending the effectiveness also will 
promote consistency among the rules of the NASD and the other options 
self-regulatory organizations. The NASD notes that the higher position 
limits currently available by virtue of the hedge exemption have not 
resulted in the disruptions of the underlying stock market. However, 
the NASD will continue to monitor the market effects, if any, from the 
hedge exemption to ensure that members are complying with all 
applicable requirements.
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    \11\ 15 U.S.C. Sec. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change will impose no burden on competition that 
is not necessary or appropriate in furtherance of the purposes of the 
Act.

[[Page 19994]]

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. Commission's Findings and Order Granting Accelerated Approval 
of the Proposed Rule Change

    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 association and, in 
particular, with the requirements of Section 15A(b)(6). Specifically, 
the Commission believes that the proposed extension of the NASD's 
equity option position limit hedge exemption pilot program will 
accommodate the needs of investors and market participants while at the 
same time furthering investor protection and the public interest.\12\
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    \12\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    The Commission finds good cause to approve the proposed rule 
change, as amended prior to the 30th day after the date of publication 
of notice of filing thereof in the Federal Register. Specifically, by 
accelerating the approval of the NASD's rule proposal, the operation of 
the hedge exemption pilot program, which as been in place since 1990, 
will continue on an uninterrupted basis until December 31, 1998. The 
Commission previously extend the effectiveness of the equity option 
hedge exemption pilot program on an accelerated basis on two prior 
occasions.\13\ The Commission believes that Amendment No. 1 improves 
the proposed rule change by shortening the extension of the pilot 
program only until December 31, 1998, instead of December 31, 1999. An 
extension until December 31, 1998 will give NASD Regulation sufficient 
time to consider the operation of the equity option hedge exemption 
program without allowing the program to drag on for another two years 
on a pilot basis.\14\ The Commission believes that good cause exists to 
accelerate approval of the proposed rule change, as amended, because 
expressly continuing the hedge exemption pilot program by rule will 
reduce the potential for confusion about the status of such exemption, 
which expired on December 31, 1997, and will promote consistency among 
the options markets all of which are a similar exemption. Accordingly, 
the Commission believes that it is consistent with Section 15A(b)(6) of 
the Act to approve the proposed rule change on an accelerated basis.
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    \13\ See Exchange Act Release Nos. 36657 (December 29, 1995), 61 
FR 434 (January 5, 1996) (accelerated approval extending 
effectiveness of hedge exemption pilot program through December 31, 
1997); 33783 (March 18, 1994), 59 FR 14229 (March 25, 1994) 
(accelerated approval extending effectiveness of hedge exemption 
pilot program through December 31, 1995).
    \14\ The Commission notes that NASD Regulation initially 
requested that the equity option hedge exemption pilot program be 
extended until December 31, 1999. At the Commission's request, the 
proposed rule change was amended to shorten the requested extension 
only until December 31, 1998. Given that the equity option hedge 
exemption program has been running on a pilot basis for eight years, 
the Commission recommends that NASD Regulation either take steps to 
adopt the program on a permanent basis in the near future or 
eliminate it.
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IV. Solicitation of Comments

    Interested person are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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. 552, will be available for inspection and copying at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-NASD-98-02 and 
should be submitted by May 13, 1998.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-NASD-98-02) is approved on a 
pilot basis until December 31, 1998.

    \15\ 15 U.S.C. 78s(b)(2).
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    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. 98-10600 Filed 4-21-98; 8:45 am]
BILLING CODE 8010-01-M