[Federal Register Volume 63, Number 82 (Wednesday, April 29, 1998)]
[Proposed Rules]
[Pages 23584-23597]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10946]



[[Page 23584]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 249

[Release No. 34-39885; File No. S7-13-98]
RIN 3235-AH39


Proposed Amendment to Rule 19b-4, Under the Securities Exchange 
Act of 1934, That Would Deem the Listing and Trading of New Derivative 
Securities Products by Self-Regulatory Organizations To Not Be Proposed 
Rule Changes

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission proposes to amend Rule 
19b-4 under the Securities Exchange Act of 1934. The amendment would 
expand the scope of SRO matters that do not constitute proposed rule 
changes to include the listing and trading of new derivative securities 
products pursuant to existing SRO trading rules, procedures, 
surveillance programs and listing standards.

DATES: Comments should be submitted by May 29, 1998.

ADDRESSES: All comments should be submitted in triplicate and addressed 
to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 
Mail Stop 6-9, 450 Fifth Street, NW., Washington, DC 20549. Comments 
also may be submitted electronically at the following e-mail address: 
[email protected]. All comments should refer to File No. S7-13-98; 
this file number should be included in the subject line if e-mail is 
used. Comment letters will be available for public inspection and 
copying at the Commission's Public Reference Room at the same address. 
Electronically submitted comment letters will be posted on the 
Commission's web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Sharon M. Lawson, Senior Special 
Counsel at (202) 942-0182 or Marianne H. Duffy, Special Counsel at 
(202) 942-4163, Office of Market Supervision, Division of Market 
Regulation, Securities and Exchange Commission, Mail Stop 10-1, 450 
Fifth Street, NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

A. Purpose of Amendment

    The Securities and Exchange Commission (``SEC'' or ``Commission'') 
is proposing to amend Rule 19b-4 under the Securities Exchange Act of 
1934, as amended (``Exchange Act'' or ``Act'') \1\ to expand the scope 
of self-regulatory organization (``SRO'') \2\ matters that do not 
constitute proposed rule changes, pursuant to section 19(b) of the Act 
and Rule 19b-4 \3\ thereunder, to include the listing and trading of 
certain new derivative securities products, as defined below, pursuant 
to existing trading rules, procedures, surveillance programs and 
listing standards.
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    \1\ 15 U.S.C. 78a et seq.
    \2\ Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26), 
defines SRO to mean any national securities exchange, registered 
securities association, registered research agency, and for purposes 
of Section 19(b) of the Act, 15 U.S.C. 78s(b), and other limited 
purposes, the Municipal Securities Rulemaking Board (``MSRB'').
    \3\ 17 CFR 240.19b-4.
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B. Description of Proposed Amendment

    Section 19(b) of the Exchange Act requires every SRO to file with 
the Commission any proposed rule or any proposed change in the rules of 
the SRO. In the past, the Commission has considered the listing and 
trading of new derivative securities products by an SRO to constitute a 
proposed rule change. In order to approve these changes, the Commission 
must find that the listing and trading of the new derivative securities 
product will serve to promote the public interest and help to remove 
impediments to a free and open securities market.\4\ Further, the 
trading of such new derivative securities products must serve to 
protect investors and promote efficiency, competition and capital 
formation.
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    \4\ 15 U.S.C. 78f(b)(5).
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    The Commission has exercised its rulemaking authority \5\ by 
promulgating paragraphs (b),\6\ (c) \7\ and (d) \8\ of Rule 19b-4 under 
the Act, which interpret the terms ``stated policy, practice or 
interpretation'' and ``proposed rule change.'' Paragraph (c) of Rule 
19b-4 provides that certain stated policies, practices and 
interpretations of SROs do not constitute proposed rule changes. 
Specifically, a ``stated policy, practice or interpretation'' of an SRO 
is not a proposed rule change if it is reasonably and fairly implied by 
an existing SRO rule. The Commission now proposes to amend Rule 19b-4 
so that the listing and trading of new derivative securities products 
would not be proposed rule changes so long as there are existing SRO 
trading rules, procedures, surveillance programs and listing standards. 
Specifically, the Commission proposes to add a new paragraph (e) to 
Rule 19b-4 which states:
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    \5\ Sections 3(a)(26), 3(a)(27), 15 U.S.C. 78c(a)(27), 3(a)(28), 
15 U.S.C. 78c(a)(28) and section 3(b), 15 U.S.C. 78c(b), of the Act 
provide that the Commission may promulgate rules regarding, among 
other things, ``stated policies, practices and interpretations'' of 
SROs. Section 19(b) authorizes the Commission to promulgate rules 
regarding ``proposed rule changes'' of SROs. Section 23(a), 15 
U.S.C. 78w(a), of the Act provides that the Commission shall have 
power to make such rules and regulations as may be necessary or 
appropriate to implement the provisions of the Exchange Act for 
which it is responsible or for the execution of the functions vested 
in it by the Exchange Act, and may for such purposes classify 
persons, securities, transactions, statements, applications, reports 
and other matters within its jurisdiction, and prescribe greater, 
lesser or different requirements for different classes thereof. (See 
e.g., Securities Exchange Act Release No. 34140 (June 1, 1994), 59 
FR 29393 (June 7, 1994)). In addition, in 1996, Congress granted the 
Commission the authority, under section 36(a), 15 U.S.C. 78mm(a), to 
exempt any class of person, security or transaction from any 
provision of the Act. Pub. L. 104-290, 110 Stat. 3416 (1996).
    \6\ 17 CFR 240.19b-4(b).
    \7\ 17 CFR 240.19b-4(c).
    \8\ 17 CFR 240.19b-4(d).

the listing and trading of a new derivative securities product by 
(an SRO) shall not be deemed a proposed rule change, pursuant to 
paragraph (c)(1) of (Rule 19b-4), if the Commission has approved, 
pursuant to section 19(b) of the Act ( ), such (SRO's) trading 
rules, procedures and listing standards for the product class that 
would include the new derivative securities product, and the SRO has 
a surveillance program for the product class.\9\
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    \9\See Text of the Proposed Rule, infra.

    In proposing new paragraph (e), the Commission preliminarily 
believes that when the Commission has approved, pursuant to section 
19(b) of the Act, an SRO's trading rules, procedures and listing 
standards for the product class that would include the new derivative 
securities product, the listing and trading of the new derivative 
securities product is reasonably and fairly implied by the SRO's 
existing trading rules, procedures and listing standards. The 
Commission preliminarily believes it is therefore appropriate to deem 
the listing and trading of new derivative securities products to not be 
proposed rule changes pursuant to Rule 19b-4(c)(1) under certain 
conditions.

II. Background

A. Current Procedures for Submission and Approval of SRO New Derivative 
Securities Product Rule Filings

    Over the years, the Commission has sought to revise the rule filing 
requirements to meet the changing needs of the SROs in a competitive 
international marketplace. The Commission has developed streamlined 
filing procedures to ease the regulatory burden in many circumstances. 
Today, the Commission is proposing to expand the scope of SRO matters 
that do not constitute proposed rule changes to include the listing and 
trading of new derivative securities products pursuant to existing SRO 
trading rules,

[[Page 23585]]

procedures, surveillance programs and listing standards.
1. Standard Statutory Procedures
    Section 19(b)(1) \10\ of the Act requires an SRO to file with the 
Commission its proposed rule changes accompanied by a concise general 
statement of the basis and purpose of the proposed rule change. Once a 
proposed rule change has been filed, the Commission is required to 
publish notice of it and provide an opportunity for public comment. The 
proposed rule change may not take effect unless it is approved by the 
Commission or is otherwise permitted to become effective under section 
19(b) of the Act.\11\ Section 19(b)(2) \12\ of the Act sets forth the 
standards and time periods for Commission action either to approve a 
proposed rule change or to institute and conclude a proceeding to 
determine whether a proposed rule change should be disapproved. 
Generally, the Commission must either approve the proposed rule change 
or institute disapproval proceedings within 35 days of the publication 
of notice of the filing or within a longer period as the Commission 
finds appropriate or to which the SRO consents. The Commission must 
approve a proposed rule change if it finds that the rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to the SRO proposing the rule change. 
If the Commission does not make that finding, it must institute 
proceedings to determine whether to disapprove the proposed rule 
change. The Commission also may approve a proposed rule change on an 
accelerated basis prior to 30 days after publication of the notice if 
the Commission finds good cause for so doing and publishes its reasons 
for so finding.\13\
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    \10\ 15 U.S.C. 78s(b)(1).
    \11\ See generally, Senate Comm. on Banking, Housing & Urban 
Affs., Report to accompany S. 249: Securities Acts Amendments of 
1975, S. Rep. No. 94-75, 94th Cong., 1st Sess. 22-38 (Comm. Print 
1975), reprinted in (1975) U.S. Code Cong. & Ad. News 179, 200-15 
(except on ``Self-Regulation and Sec Oversight'').
    \12\ 15 U.S.C. 78s(b)(2).
    \13\ Section 19(b)(2)(B) of the Act, 15 U.S.C. 78s(b)(2)(B).
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    SROs have submitted proposals under section 19(b)(2) to list and 
trade various derivative securities products, including stock options, 
broad-based and narrow-based stock index options\14\ and warrants,\15\ 
unit investment trusts,\16\ foreign currency options,\17\ indexed term 
notes\18\ and other hybrid derivative equity and debt securities.\19\
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    \14\ See e.g., Securities Exchange Act Release No. 39011 
(September 3, 1997), 62 FR 47841 (September 11, 1997) (order 
approving Chicago Board Options Exchange's, Incorporated (``CBOE'') 
proposal to list and trade options based upon the Dow Jones 
Industrial Average) and Securities and Exchange Act Release No. 
38693 (May 29, 1997), 62 FR 30914 (June 5, 1997) (order approving 
American Stock Exchange's, Incorporated (``Amex'') proposal to list 
and trade options based on the the Tobacco Index).
    \15\ See e.g., Securities Exchange Act Release No. 39079 
(September 15, 1997), 62 FR 49543 (September 22, 1997) (order 
approving Amex proposal to list and trade warrants based on the ING 
Barings, Inc.'s BEMI Latin American Index).
    \16\ Securities Exchange Act Release No. 31591 (December 11, 
1992), 57 FR 60253 (December 18, 1992) (order approving Amex rules 
to provide for the listing and trading of portfolio depositary 
receipts (``PDRs''), and specifically PDRs based on the Standard and 
Poors Corporation (``S&P'') 500 Index known as SPDRs). See also, 
Amex Rule 1000(b)(1).
    \17\ See e.g., Securities Exchange Act Release No. 36505 
(November 22, 1995), 60 FR 61277 (November 29, 1995) (order 
approving Philadelphia Stock Exchange's, Incorporated (``Phlx'') 
proposal to list and trade dollar-denominated delivery foreign 
currency options on the Japanese Yen).
    \18\ See e.g., Securities Exchange Act Release No. 37533 (August 
7, 1996), 61 FR 42075 (August 13, 1996) (order approving Amex 
proposal to list and trade indexed term notes based upon a portfolio 
of the top ten dividend yielding stocks in the Dow Jones Industrial 
Average).
    \19\ See e.g., Securities Exchange Act release No. 32950 
(September 23, 1993), 58 FR 50985 (September 29, 1993) (order 
approving New York Stock Exchange's, Incorporated (``NYSE'') 
proposal to list and trade Debt Exchangeable for Common Stock issued 
by the American Express Corporation and linked to the performance of 
First Data Corporation). 
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2. Streamlined Procedures for Certain New Derivative Securities Product 
Rule Filings
    Section 19(b)(3) of the Act \20\ provides that, in certain 
circumstances, a proposed rule change may become effective immediately 
upon filing with the Commission and without the notice and approval 
procedures required by section 19(b)(2). Paragraph (A) of section 
19(b)(3) permits certain types of proposed rule changes to take effect 
in this manner if appropriately designated by the SRO as: (1) 
Constituting a stated policy, practice or interpretation with respect 
to the meaning, administration, or enforcement of an existing rule of 
the SRO; (2) establishing or changing a due, fee, or other charge 
imposed by the SRO; or (3) concerned solely with the administration of 
the SRO. Section 19(b)(3)(A)(iii) \21\ also gives the Commission the 
authority to expand, by rule, the scope of proposed rule changes that 
may become effective under section 19(b)(3)(A) if the Commission 
determines that the expansion is consistent with the public interest 
and the purposes of Section 19(b). Currently, Rule 19b-4(e) under the 
Act \22\ details the scope of proposed rule changes that may be filed 
under section 19(b)(3)(A) of the Act.
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    \20\ 15 U.S.C. 78s(b)(3).
    \21\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \22\ 17 CFR 240.19b-4(e).
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    For the past several years, the Commission has worked with the SROs 
to develop procedures to streamline the review process of new 
derivative securities product rule filings. As a result, SROs can 
submit a proposed rule change in accordance with section 19(b)(3)(A) of 
the Act for certain proposed new derivative securities products. For 
example, on June 3, 1994, the Commission approved proposed rule changes 
submitted by several SROs to establish generic listing standards for 
options on narrow-based stock indices and to adopt streamlined 
procedures for introducing trading in options that satisfy these 
listing standards.\23\ In addition, certain SROs have in place rules 
similar to the streamlined procedures for listing warrants on narrow-
based stock indices.\24\
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    \23\ Securities Exchange Act Release No. 34157 (June 3, 1994) 59 
FR 30062 (June 10, 1994) (order approving generic narrow-based index 
options listing standards for the Amex, the CBOE, the NYSE, the 
Pacific Exchange, Inc., (``PCX''), and the Phlx (``Generic Narrow-
Based Index Option Approval Order'')). Moreover, as of April 28, 
1997, the NYSE transferred its options business to the CBOE. See 
Securities Exchange Act Release Nos. 38541 and 38542 (April 23, 
1997) 62 FR 23516 and 23521 (April 30, 1997) (orders approving 
proposed rule changes by the CBOE and NYSE, respectively, regarding 
the transfer of the NYSE's options business to the CBOE). These SROs 
are the only U.S. exchanges that list standardized options products, 
which are issued, cleared, and settled through the Options Clearing 
Corporation.
    \24\ Securities Exchange Act Release Nos. 37007 (March 21, 1996) 
61 FR 14165 (March 29, 1996) (Amex, CBOE, and Phlx) and 37445 (July 
16, 1996) 61 FR 38494 (July 24, 1996) (NYSE) (orders approving 
uniform listing and trading guidelines for narrow-based stock index 
warrants (``Generic Narrow-Based Index Warrant Approval Orders'')).
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    Furthermore, the Commission has approved rules for certain SROs 
that allow for the listing of specific broad-based \25\ and narrow-
based \26\ stock index warrant issuances without further Commission 
approval pursuant to section 19(b) of the Act, as long as the listing 
complies with the SRO's generic warrant listing standards and the 
Commission has already approved the underlying stock index for warrant 
or

[[Page 23586]]

options trading. In addition, the Commission has approved rules 
allowing for the listing of warrants overlying a single currency 
without a section 19(b) rule filing provided that the underlying 
currency has been approved for options trading.\27\ The Commission also 
has approved rules allowing for the listing of warrants overlying a 
currency index without a section 19(b) rule filing provided the index 
previously has been approved by the Commission pursuant to a section 
19(b) rule filing.
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    \25\ Securities Exchange Act Release Nos. 36165 (August 29, 
1995) 60 FR 46653 (September 7, 1995) (NYSE); 36166 (August 29, 
1995) 60 FR 46660 (September 7, 1995) (PCX); 36167 (August 29, 1995) 
60 FR 46667 (September 7, 1995) (Phlx); 36168 (August 29, 1995) 60 
FR 46637 (September 7, 1995) (Amex); and 36169 (August 29, 1995) 60 
FR 36169 (CBOE) (September 7, 1995) (orders approving uniform 
listing and trading guidelines for index, currency and currency 
index warrants). See also, Securities Exchange Act Release No. 36296 
(September 28, 1995) 60 FR 52234 (October 5, 1995) (order approving 
the National Association of Securities Dealers', Incorporated 
(``NASD'') proposed to adopt uniform listing and trading guidelines 
for broad-based index warrants on the NASD's Automated Quotation 
Stock Market).
    \26\ Supra notes 23 and 24.
    \27\ Supra note 25.
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B. Reasons for Expanding the Scope of SRO Matters That Do Not 
Constitute Proposed Rule Changes

    Over the years, the Commission has approved numerous SRO trading 
rules, procedures and listing standards for various classes of new 
derivative securities products. The Commission preliminarily believes 
that when it has approved, pursuant to section 19(b) of the Act, an 
SRO's trading rules, procedures and listing standards for the product 
class that would include a new derivative securities product, the 
listing and trading of the new derivative securities product should 
therefore be reasonably and fairly implied by the SRO's existing 
trading rules, procedures and listing standards.\28\
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    \28\ The Commission notes that currently with regard to equity 
issues, once an SRO has received approval for its trading rules, 
procedures and listing standards, the listing and trading of a 
specific new equity issue is not deemed a proposed rule change that 
requires a filing under Rule 19b-4 of the Act. Rather, an SRO can 
immediately list and trade a new equity issue so long as that equity 
issue satisfies the Commission approved trading rules, procedures 
and listing standards of the SRO.
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    SROs are facing increasing competition from overseas and over-the-
counter (``OTC'') derivatives markets.\29\ The Commission believes that 
SROs should be able to bring new derivative securities products to 
market quickly to provide investors with tailored products that 
directly meet their evolving investment needs. Although the generic 
rules have helped to speed the process of reviewing new derivative 
securities product proposals, the Commission preliminarily believes 
that further changes are warranted. The Commission preliminarily 
believes that expanding the scope of SRO matters that do not constitute 
a proposed rule change to include the listing and trading of certain 
new derivative securities products will significantly speed the 
introduction of new derivative securities products and enable SROs to 
maintain their competitive balance with the overseas and OTC derivative 
markets. The proposal should foster innovation and create a streamlined 
procedure for SROs to promptly list new products subject to appropriate 
trading rules, procedures, a surveillance program and listing 
standards.
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    \29\ In order to further promote competition, the Commission 
proposes, in a separate release issued today (Securities Exchange 
Act Release No. 39884 (April 17, 1998)), to permit SROs to operate 
new trading systems subject to certain conditions, for a period not 
to exceed two years, without submitting a Rule 19b-4 filing.
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    At the same time, SROs have had over 20 years of experience with 
SEC review of new derivative securities product proposals. SROs that 
have sought approval from the Commission to list and trade such new 
derivative securities products should be familiar with the factors 
discussed in this release that the Commission believes should be 
considered when listing and trading such new derivative securities 
products. Thus, the Commission believes that there is less need for SEC 
review, notice and approval prior to an SRO trading a new derivative 
securities product pursuant to existing trading rules, procedures, a 
surveillance program and listing standards. Nonetheless, the Commission 
preliminarily believes that the proposed procedures discussed in this 
release will enable the Commission to continue to effectively protect 
investors and promote the public interest.

III. Discussion

A. Definition of ``New Derivative Securities Product''

    For the purposes of section 19(b) of the Act and Rule 19b-4 
thereunder, the Commission proposes to define ``new derivative 
securities product'' as any type of option, warrant, hybrid securities 
product or any other security whose value is based upon the performance 
of an underlying instrument.
1. New Derivative Securities Product Must Be a ``Security'' as Defined 
in Section 3(a)(10) of the Act
    The SROs have the authority to list and trade ``securities'' as 
defined in section 3(a)(10) of the Exchange Act.\30\ The term 
``security'' as defined in section 3(a)(10) of the Exchange Act, 
includes, among other instruments, ``any put, call, straddle, option, 
or privilege on any security, certificate of deposit, or group or index 
of securities (including any interest therein or based on the value 
thereof), or any put, call, straddle, option, or privilege entered into 
on a national securities exchange relating to a foreign currency, or in 
general, any instrument commonly known as a `security'.'' \31\ Because 
SROs currently do not have the authority to trade non-securities, the 
proposed amendment does not provide SROs with any new authority to list 
a new derivative product that is not a ``security''.\32\
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    \30\ 15 U.S.C. 78(c)(1)(j).
    \31\ Id.
    \32\ Furthermore, the proposal will only apply to securities 
SROs. It will not apply to entities that seek designation as 
contract markets for futures trading on an index or group of 
securities or to foreign boards of trade that apply to the Commodity 
Futures Trading Commission (``CFTC'') for certification to sell 
their futures contracts to U.S. persons. Under the amendments to the 
CEA effected by the Futures Trading Act of 1982 (Pub. L. 97-444, 96 
Stat. 2294), Section 2(a)(1)(B) of the CEA (7 U.S.C. 2(a)(1)(B)) 
prohibits any person from offering or selling a futures contract 
based on ``any group or index of such securities or any interest 
therein based on the value thereof'' except as permitted under 
Section 2(a)(1)(B)(ii) of the act. The CFTC is required to seek the 
views of the SEC regarding each such application concerning a stock 
index and the SEC may object to the designation on the ground that 
any of the statutory criteria have not been met. The proposal would 
not alter these procedures nor does the Commission believe that it 
is appropriate to do so. The Commission notes that it would have the 
ability to inspect the securities SROs in order to ensure that they 
comply with the terms of the proposed amendment when they do not 
submit proposed rule changes to list and trade new derivative 
securities products. Moreover, the Commission could take appropriate 
measures, including, but not limited to, ordering the SRO to 
remediate the deficiency or prohibiting opening transactions in or 
discontinuing the listing of new derivative securities products if 
the new derivative securities product did not comply with the terms 
of the proposed amendment. In contrast, for stock index futures 
contracts, neither inspection nor enforcement authority is available 
to the Commission. Consequently, the Commission believes that it is 
important for the Commission to continue to review the terms of any 
proposed stock index futures contract before it commences trading.
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2. Scope of Proposal
    As stated above, SROs have sought Commission approval to list and 
trade various new derivative securities products, including, among 
others, stock index options and warrants, unit investment trusts, 
foreign currency options and warrants, and indexed term notes. The 
Commission proposes to make the proposed amendment available to SROs 
seeking to list these classes of new derivative securities products and 
other classes, provided that such classes are subject to existing 
trading rules, procedures, a surveillance program and listing 
standards.
    An SRO seeking to list a completely new class of derivative 
securities product without existing trading rules, procedures, a 
surveillance program and listing standards would still be required to 
submit a proposed rule change pursuant to section 19(b)(2) of the Act 
in order to adopt appropriate trading rules, procedures and listing 
standards for such class. These requirements are intended to ensure 
that there are

[[Page 23587]]

adequate SRO rules to provide for fair and orderly trading for the 
class of securities. Thus, in order to rely on the proposed amendment, 
an SRO must have in place trading rules, procedures and listing 
standards for the specific class of new derivative securities product 
prior to the listing and trading of the class.\33\ Procedures include, 
but are not limited to adequate procedures relating to sales practices 
(including suitability), margin and disclosure requirements. The SRO 
also must have a surveillance program adequate to monitor for abuses in 
the trading of the new derivative securities product, including trading 
in the underlying security or securities. Once an SRO has submitted, 
and the Commission has approved, a section 19(b)(2) proposal to 
establish an appropriate regulatory framework to support trading of a 
new class of new derivative securities product, the SRO would qualify 
under the proposed amendment for further new derivative securities 
products under the same class. For example, if an exchange without any 
options rules sought to trade options, it would first need to file a 
rule change, pursuant to Rule 19b-4, to adopt appropriate trading 
rules, procedures and listing standards that apply to options. In 
addition, the proposed amendment does not relieve an SRO from its 
obligation to submit a proposed rule change to amend its existing 
listing standards for particular classes of securities.
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    \33\ The Commission notes that several exchanges have adopted 
listing standard categories termed ``other securities.'' These 
standards were adopted to allow the listing of securities that 
contain features borrowed from more than one category of currently 
listed securities, such as hybrid new derivative securities products 
that have characteristics of both common stock and debt securities. 
The Commission has clearly stated and reiterates its belief that 
such standards ``are not intended to accommodate the listing of 
securities that raise significant new regulatory issues, and, 
therefore, would require a separate filing with the Commission 
pursuant to Rule 19b-4 under the Act.'' Securities Exchange Act 
Release No. 28217 (July 18, 1990) 55 FR 30056 (July 24, 1990). In 
other words, the ``other securities'' category is not intended to 
permit an SRO to list a new derivative securities product that does 
not fall under another listing category of the SRO. Accordingly, an 
SRO could not avoid the requirement of adopting appropriate listing 
standards in order to rely on the proposed amendment for a novel new 
derivative securities product by simply listing such product under 
the ``other security'' category.
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B. Standards for All New Derivative Securities Products

    The proposal is premised upon the experience that the Commission 
has obtained through its review of new derivative securities product 
proposals by the SROs. Over the years, the Commission has identified 
the factors it believes new derivative securities product proposals 
should meet in order to be consistent with the Act. In order to rely on 
the proposed amendment, an SRO should ensure that the new derivative 
securities product meets the criteria discussed below in the areas of: 
Design and maintenance of the instruments or index underlying the new 
derivative securities product; customer protection rules; surveillance 
of the component securities; and the potential market impact of the new 
derivative securities product.\34\ Specifically, an SRO should have 
adequate information sharing agreements, clearance and settlement 
procedures, systems capacity and transaction reporting procedures for 
underlying securities.
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    \34\ As discussed in Section IV. G. Ensuring Proper Use Of The 
Proposed Amendment, a failure to comply with the standards could 
compromise an SRO's reliance on the proposed amendment.
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1. Information Sharing Agreements
    In designing a new derivative securities product, the SRO should 
ensure that it has adequate information sharing procedures to detect 
and deter potential trading abuses. It is essential that the SRO have 
the ability to obtain the information necessary to detect and deter 
market manipulation, illegal trading and other abuses involving the new 
derivative securities product. Specifically, there should be a 
comprehensive information sharing agreement (``ISA'') in place between 
the SRO listing or trading a derivative product and the markets trading 
the securities underlying the new derivative securities product that 
covers trading in the new derivative securities product and its 
underlying securities.\35\ Such agreements provide a necessary 
deterrent to manipulation because they facilitate the availability of 
information needed to fully investigate a manipulation if it were to 
occur.
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    \35\ The Commission believes that a comprehensive ISA should 
require that the parties provide each other, upon request, 
information about market trading, clearing activity and the identity 
of the ultimate purchasers and sellers of securities. See Securities 
Exchange Act Release No. 31529 (November 27, 1992) 57 FR 57248 
(December 3, 1992).
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    For new derivative securities products based upon domestic 
securities, the SRO should ensure the markets upon which all of the 
U.S. component securities trade are members of the Intermarket 
Surveillance Group (``ISG'').\36\ The ISG was formed to coordinate, 
among other things, effective surveillance and investigative 
information sharing arrangements in the stock and options markets.
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    \36\ See ISG Agreement, dated July 14, 1983, amended January 29, 
1990. The ISG members are: the Amex; the Boston Stock Exchange, 
Incorporated; the CBOE; the Chicago Stock Exchange, Inc.; the NASD; 
the NYSE; the PCX; and the Phlx. The major stock index futures 
exchanges joined the ISG as affiliate members in 1990.
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    For new derivative securities products based on securities from a 
foreign market, the SRO should have a comprehensive ISA with the market 
for the securities underlying the new derivative securities product. 
The SRO should ensure there are no blocking or secrecy laws in the 
foreign country that would prevent or interfere with the transfer of 
information under the comprehensive ISA. If securing a comprehensive 
ISA is not possible, the SRO should contact the Commission prior to 
listing the new derivative securities product. In such instances, the 
Commission may determine that it is appropriate instead to rely on a 
Memorandum of Understanding (``MOU'') between the Commission and the 
foreign regulator.\37\
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    \37\ An MOU provides a framework for mutual assistance in 
investigatory and regulatory matters. Generally, the Commission has 
permitted an SRO to rely on an MOU in the absence of a comprehensive 
ISA only if the SRO receives an assurance from the Commission that 
such an MOU can be relied on for surveillance purposes and includes, 
at a minimum, the transaction, clearing and customer information 
necessary to conduct an investigation. See Securities Exchange Act 
Release No. 35184 (December 30, 1994) 60 FR 2616 (January 10, 1995) 
(order approving the listing and trading of warrants on the CBOE 
overlying the Nikkei Stock Index 300 where there was no 
comprehensive ISA between the CBOE and the underlying market, the 
Tokyo Stock Exchange but there was an MOU between the SEC and the 
Japanese Ministry of Finance). In addition, an SRO should endeavor 
to develop comprehensive ISAs with foreign exchanges that trade the 
underlying securities of an index even if the SRO receives prior 
Commission approval to rely on an MOU in place of a comprehensive 
ISA.
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    For a new derivative securities product overlying an instrument 
with component securities from several countries, the Commission 
recognizes that it may not be practical in all instances to secure 
comprehensive ISAs with all of the relevant foreign markets. Generally, 
foreign countries' securities or American depositary receipts that are 
not subject to a comprehensive ISA should not represent a significant 
percentage of the weight of such an underlying instrument.\38\
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    \38\ If, however, a foreign security had more than 50% of its 
global trading volume in dollar value in U.S. markets, the 
Commission, in the past, has treated such security as a U.S. 
security.
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2. Clearance and Settlement
    The calculation of the settlement value for the new derivative 
securities product should be clear, fixed and objective. In order to 
minimize market impact concerns, a new derivative securities product 
overlying an index of U.S. securities generally should be

[[Page 23588]]

settled based on opening prices of the component stocks. If opening 
price settlement is not utilized, the SRO should ensure that the 
settlement value reflects the last available closing prices prior to 
settlement for the underlying securities or some alternative objective 
settlement measurement. If the new derivative securities product is 
settled in foreign currency, the SRO should ensure that a recognized 
exchange rate is used to convert the settlement value into U.S. 
dollars. In addition, the SRO should ensure that adequate clearance 
procedures have been established for the new derivative securities 
product.
3. Systems Capacity
    It is essential that the SRO and the applicable price reporting 
authority have adequate systems processing capacity to accommodate the 
listing and trading of a new derivative securities product. The SRO 
should, prior to listing a new derivative securities product, ensure 
that it has adequate systems processing capacity to accommodate the new 
listing and obtain a representation from the applicable price reporting 
authority that such price reporting authority also has adequate systems 
processing capacity.
4. Transaction Reporting of Underlying Securities
    In order to prevent manipulation and ensure liquidity of securities 
underlying a new derivative securities product, underlying equity 
securities should be listed on a national securities exchange or traded 
through the facilities of a national securities association or 
otherwise subject to real-time public transaction reporting. For 
securities that are not subject to transaction reporting (e.g., 
municipal securities), there should be an objective means of capturing 
price information through disseminated quotations. For foreign 
securities underlying a new derivative securities product, an SRO 
should ensure that those securities satisfy and maintain all other 
criteria described in this release when relying on the proposed 
amendment.

C. Index Based Products

    In addition to the items discussed above, SROs should ensure that 
if a new derivative securities product is index based: The index is 
classified properly as broad-based or narrow-based; the index is 
constructed according to established criteria for initial inclusion of 
new component securities; the index is maintained so that it measures 
the same segment of the market as originally intended; the index value 
is disseminated frequently; component securities that fail to meet the 
maintenance criteria are replaced according to established policies and 
procedures; and when the index is maintained by a broker-dealer, a 
functional separation exists between the broker-dealer's trading desk 
and research department.
1. Designation of Index as Broad-Based or Narrow-Based
    An SRO should first classify the underlying index as narrow-based 
(i.e., containing securities from a specific industry sector or 
comprised of a small group of securities) or broad-based (i.e., a 
larger group of securities that is representative of the entire market 
or a substantial portion of the entire market).\39\ In order to make a 
determination that an index is broad-based, the SRO should identify how 
the index represents the overall stock market or a substantial portion 
thereof. The SRO should undertake an analysis of the basis for such a 
determination. A mere conclusion by the SRO that an index has been 
designated as broad-based is not determinative of the status of the 
index.
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    \39\ Such a classification is essential because regulatory 
requirements such as position limits and margin levels are different 
for narrow-based and broad-based index options. See e.g., CBOE Rules 
24.4, 24.4A and 24.11.
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2. Index Construction
    The index underlying a new derivative securities product should be 
constructed according to established criteria for initial inclusion of 
new component securities. SROs seeking to rely on the proposed 
amendment should employ objective index construction standards that 
include a minimum number of component securities and a fixed and 
objective weighting methodology (e.g., capitalization weighted, price 
weighted or equal-dollar weighted).\40\ In addition, SROs should use 
index construction standards that ensure that the underlying securities 
have sufficient liquidity so as to help reduce the potential for 
manipulation of the index's component securities. For example, the 
index construction criteria should include, among other things, a 
minimum price, available capitalization, average daily trading volume 
and value of each component security and set a maximum relative weight 
for the top component and the five largest components.
---------------------------------------------------------------------------

    \40\ See Generic Narrow-Based Index Option Approval Order, supra 
note 23 and Generic Narrow-Based Index Warrant Approval Orders, 
supra note 24.
---------------------------------------------------------------------------

3. Maintenance Criteria
    Maintenance criteria should be designed to ensure that an index 
that has derivative products overlying it continues to measure the same 
segment or sector of the market as originally intended, remains 
composed of liquid securities, and does not become dominated by one (or 
a few) component(s). As a result, an SRO seeking to rely on the 
proposed amendment should ensure the index meets reasonable maintenance 
standards.
4. Dissemination of the Index Value
    In most circumstances, the index value should be disseminated 
frequently and, if based on U.S. equities only, should reflect last-
sale prices. If an index is comprised of both U.S. and foreign 
securities, prices for all securities that trade on markets that are 
open during U.S. trading hours should be disseminated, if practicable, 
at least every 15 seconds. Dissemination of an index value based in 
whole or in part on closing prices of component securities should occur 
only for those component securities where the underlying markets are 
closed during U.S. trading hours (the disseminated index value may 
still be adjusted for currency fluctuations) or the underlying 
component value itself is not calculated real-time (e.g., indices of 
open-end mutual funds that report net asset value at the close of 
trading).\41\ Certain indices may use quotes (e.g., a bond index) if 
last sale prices are unavailable and the quotes are reliable and spread 
across several dealers.
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    \41\ Securities Exchange Act Release No. 39244 (October 15, 
1997) 62 FR 55289 (October 23, 1997).
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5. Component Changes
    Component securities that fail to meet the index maintenance 
standards should be replaced within the index according to established 
policies and procedures for reviewing and replacing such component 
securities. Automatic rebalancing of index components also should occur 
according to established policies and procedures (e.g., annually, semi-
annually or quarterly). Notice of component changes should be 
disseminated to news vendors and the public. SROs should ensure that 
components are replaced promptly in the event of specified 
circumstances such as corporate mergers or spin-offs.
6. Functional Separation Letter
    When the index is maintained by a broker-dealer or an affiliate of 
a broker-dealer, the SRO should assure, prior to the listing of a new 
derivative securities product, that there will be a functional

[[Page 23589]]

separation between the trading desk of the broker-dealer and the 
research persons responsible for maintaining the index through a fire 
wall. A fire wall is a mechanism by which employees responsible for 
constructing and maintaining the index are separated from employees 
involved in the sale and trading of securities. In accordance with the 
broker-dealer's fire wall mechanism, the persons responsible for 
maintaining an index should be subject to certain procedures limiting 
the dissemination of index information within the broker-dealer and 
particularly should be prohibited from relaying any information 
concerning a potential change to the components of the index to anyone 
not responsible for maintaining the index, including employees of the 
sales and trading department.

D. Compliance With Other Federal Securities Laws

    The Commission notes that the proposed amendment does not relieve 
SROs from any other obligation under the federal securities laws, or 
rules or regulations thereunder, except the requirement of filing a 
proposed rule change pursuant to section 19(b) of the Act and Rule 19b-
4 thereunder. For example, Form S-20 \42\ under the Securities Act of 
1933, as amended (``Securities Act'') \43\ and Rule 9b-1 \44\ under the 
Exchange Act establish a disclosure framework specifically tailored to 
the informational needs of investors in ``standardized options'' \45\ 
that are traded on an ``options market'' \46\. Under Rule 9b-1, broker-
dealers must provide an updated copy of the options disclosure document 
(``ODD'') \47\ to each customer at or prior to the approval of the 
customer's account for trading in standardized options.\48\ 
Accordingly, when trading a new standardized option, an SRO must 
determine if it should change the ODD to reflect specific 
characteristics and risks associated with the new derivative securities 
product not currently set forth in the ODD and submit such changes to 
the Commission. In addition, a particular new derivative securities 
product may need to be designated as a standardized option under Rule 
9b-1 in order to utilize the ODD.\49\ If the proposing SRO and the 
issuer of the new derivative securities product determine that such 
steps are necessary, they are required to submit proposals to the 
Commission, under Rule 9b-1, prior to listing the new derivative 
securities product.
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    \42\ 17 CFR 239.20. Form S-20 is used to register classes of 
options under the Securities Act.
    \43\ 15 U.S.C. 77a et seq.
    \44\ 17 CFR 240.9b-1.
    \45\ Standardized options'' are options contracts trading on a 
national securities exchange, an automated quotation system of a 
registered securities association or a foreign securities exchange 
which relate to options classes the terms of which are limited to 
specific expiration dates and exercise prices or such other 
securities as the Commission may, by order, designate. 17 CFR 
240.9b-1(a)(4).
    \46\ Options market'' means a national securities exchange, an 
automated quotation system of a registered securities association or 
a foreign securities exchange on which standardized options are 
traded. 17 CFR 240.9b-1(a)(1).
    \47\ The ODD identifies the issuer and describes the uses, 
mechanics and risks of options trading and other matters in language 
that can be easily understood by the general investing public.
    \48\ The ODD may be used as a substitute for the traditional 
prospectus.
    \49\ See Securities Exchange Act Release No. 31920 (February 24, 
1993) 58 FR 12280 (March 3, 1993) (order approving CBOE proposal to 
list and trade FLEX Options based on the S & P's 500 and 100 Stock 
Indices).
---------------------------------------------------------------------------

    The Commission preliminarily notes that the proposed amendment to 
Rule 19b-4 may still be available if an SRO determines that the above 
steps are necessary. So long as all conditions to the proposed 
amendment are met, including the existence of appropriate current 
listing standards for the new product, the SRO may immediately list the 
new derivative securities product without a Section 19(b) rule filing 
after the Commission designates the particular new product as a 
``standardized option'' and approves the Rule 9b-1 filing of amendments 
to the ODD.
    In addition to Form S-20 and Rule 9b-1, the Commission notes that 
other federal securities laws must be complied with even when an SRO 
relies on the proposed amendment to Rule 19b-4. For example, issuers of 
new derivative securities products must continue to comply with, among 
other things, the registration requirements of the Securities Act and 
in addition, if a product is an investment company \50\ regulated under 
the Investment Company Act of 1940, as amended, (``ICA'') \51\ the 
product must comply with the ICA.
---------------------------------------------------------------------------

    \50\ See e.g., Investment Company Act Release No. 21802 (March 
5, 1996) (exemptive order under the ICA permitting the trading of 
Countrybasket Index Funds on the NYSE).
    \51\ 15 U.S.C. 80a et seq.
---------------------------------------------------------------------------

E. Existing Trading Rules, Procedures, Surveillance Programs and 
Listing Standards

    An SRO wishing to list a new derivatives securities product should 
have in place trading rules, procedures, a surveillance program and 
listing standards that pertain to the class of securities covering the 
new product. For example, the Amex, CBOE, NYSE,\52\ PCX, and Phlx are 
the only SROs that currently have in place trading rules, position 
limits, margin requirements and internal surveillance programs that 
pertain to the listing and trading of narrow-based stock index 
options.\53\ Should another exchange desire to trade narrow-based index 
options, it would first have to submit a proposed rule change to the 
Commission adding relevant trading rules, procedures and listing 
standards to its rules. Procedures include, but are not limited to 
adequate procedures relating to sales practices (including 
suitability), margin and disclosure requirements. Otherwise, the SRO 
would be in violation of sections 6(b) and 19(b) of the Act in order to 
assure fair and orderly trading markets. The SRO also must have a 
surveillance program adequate to monitor for abuses in the trading of 
the new derivative securities product, including trading in the 
underlying security or securities.
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    \52\ Although the NYSE transferred its options business to the 
CBOE, supra note 23, the NYSE still has listing standards for 
narrow-based index options in its rules.
    \53\ See e.g., Amex Rules 900c through 980C; CBOE Rules 24.1 
through 24.8; and PCX Rules 7.1 through 7.18.
---------------------------------------------------------------------------

    SROs that have the appropriate regulatory framework in place for a 
specific class of new derivative securities product could immediately 
list such class of new derivative securities product, provided the 
particular SRO satisfies the conditions for the proposed amendment. If 
an SRO sought to alter position limits, margin requirements, or any 
other rules or procedures for a new derivative securities product 
class, however, it would be required to submit a section 19(b)(2) rule 
filing for Commission review. The SRO could apply such proposed rule 
changes to a new product only after the Commission has reviewed and 
approved the proposal pursuant to section 19(b)(2). For example, if an 
options exchange wanted to list immediately a new narrow-based index 
option it could do so under its existing applicable rules. In 
particular, the SRO could immediately list the new narrow-based index 
option and impose its existing position limits and margin requirements.
    If the SRO wanted to impose different position limits or margin 
requirements, or alter other existing trading rules or procedures for 
the new derivative securities product class, it would still be required 
to submit to the Commission a rule filing proposing such changes to its 
existing rules pursuant to section 19(b)(2) of the Act. This framework 
would not prevent an SRO from using

[[Page 23590]]

the proposed amendment to immediately list a new derivative securities 
product under its existing rules, and then impose different position 
limits, margin requirements, or any other trading rule for the new 
product once the Commission has approved the Section 19(b)(2) rule 
filing proposing such rule changes.\54\
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    \54\ The Commission does not anticipate that every proposed 
change in an SRO's existing trading rules to accommodate a new 
derivatives securities product will require a Section 19(b)(2) rule 
filing. An SRO will not be required to submit a rule filing for a 
stated policy, practice or interpretation of the SRO that is 
reasonably or fairly implied by an existing rule of the SRO or is 
concerned solely with the administration of the SRO and is not a 
stated policy, practice or interpretation with respect to the 
meaning, administration or enforcement of an existing rule of the 
SRO. 17 CFR 240.19b-4(c), supra note 7. For example, if an SRO has 
rules that merely delineate each new derivative securities product 
covered by a particular existing trading rule, the SRO need not 
submit a rule filing pursuant to Section 19(b) of the Act and Rule 
19b-4 thereunder merely because it is adding a new derivative 
securities product to the list. See e.g., CBOE Rule 24.9(a)(3) and 
(4).
---------------------------------------------------------------------------

F. Form of Notification to the SEC of New Derivative Securities Product 
Listing Pursuant to the Proposed Amendment

    In order for the Commission to maintain an accurate record of all 
new derivative securities products traded on the SROs, it is proposing 
that an SRO file a new form, proposed Form 19b-4(e), to notify the 
Commission when an SRO begins to trade a new derivative securities 
product that is not required to be submitted as a proposed rule change 
to the Commission for approval. Proposed Form 19b-4(e) should be 
submitted within five business days after an SRO begins trading a new 
derivative securities product that is not the subject of a proposed 
rule change.

G. Ensuring Proper Use of the Proposed Amendment

    The Commission contemplates that its Office of Compliance 
Inspections and Examinations (``OCIE'') will review SRO compliance with 
the proposed amendment through its routine inspection process of the 
SROs. In order for OCIE to determine whether an SRO has properly 
availed itself of the proposed amendment, it is necessary that the SRO 
maintain, on-site, relevant records and information pertaining to each 
new derivative securities product for which the SRO relied on the 
proposed amendment. Such records should be maintained for a period of 
not less than five years, the first two years in an easily accessible 
place, according to the recordkeeping requirements set forth in Rule 
17a-1 under the Act.\55\
---------------------------------------------------------------------------

    \55\ 17 CFR 240.17a-1. SROs may also destroy or otherwise 
dispose of such records at the end of five years according to Rule 
17a-6 under the Act, 17 CFR 240.17a-6.
---------------------------------------------------------------------------

    Such records available for OCIE review would include, among other 
things, a copy of proposed Form 19b-4(e) under the Act and whether the 
factual and numerical information regarding the new derivative 
securities product's characteristics meet the conditions of the 
proposed amendment. The SRO should be able to provide the listing 
standard under which the new derivative securities product falls as 
well as, but not limited to, such other things as the details of its 
surveillance program, records of adequate information sharing 
procedures and index construction and maintenance standards. In short, 
the Commission believes that when an SRO relies on the proposed 
amendment, such SRO should ensure that its regulatory framework 
adequately supports the listing and trading of any new derivative 
securities product. Failure to comply with this requirement would mean 
that the SRO could be in violation of the Act. If so, appropriate 
measures would be taken, including, but not limited to, ordering the 
SRO to remediate the deficiency or prohibiting opening transactions in 
or discontinuing the listing of new derivative securities products.\56\
---------------------------------------------------------------------------

    \56\ See section 19(h) of the Act, 15 U.S.C. 78s(h).
---------------------------------------------------------------------------

IV. Technical Changes

    Because the Commission proposes that a new paragraph (e) be added 
to Rule 19b-4 under the Act, Form 19b-4 under the Act \57\ is amended 
by revising the phrase ``subparagraph (e) of Rule 19b-4'' to read 
``subparagraph (f) of Rule 19b-4'' and the phrase ``subparagraph (e) of 
Securities Exchange Act Rule 19b-4'' to read ``subparagraph (f) of 
Securities Exchange Act Rule 19b-4'' in Exhibit 1, III. (B); and in 
Exhibit 1, IV. revise the first sentence to read ``Interested persons 
are invited to submit written data, views and arguments concerning the 
foregoing, including whether the proposed rule change is consistent 
with the Exchange Act.''
---------------------------------------------------------------------------

    \57\ 17 CFR 249.819.
---------------------------------------------------------------------------

V. Conclusion

    For the reasons discussed above, the Commission preliminarily 
believes that an amendment to Rule 19b-4 under the Act that deems the 
listing and trading of new derivative securities products pursuant to 
existing SRO trading rules, procedures, surveillance programs and 
listing standards, to not be a proposed rule change will reduce 
significantly the SROs' regulatory burden and help SROs maintain their 
competitive balance with the overseas and OTC derivatives markets. The 
proposed amendment to Rule 19b-4 will provide guidelines for SROs 
seeking to rely on it but removes the need for SEC review, notice and 
approval prior to an SRO trading a new derivative securities product 
pursuant to existing SRO trading rules, procedures, surveillance 
programs and listing standards.\58\
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    \58\ The Commission anticipates that the proposed amendment will 
eliminate approximately 45 SRO filings each year pursuant to Rule 
19b-4 and Form 19b-4. In addition, the Commission believes that the 
proposed amendment reduces the recordkeeping and reporting 
requirements, purusant to Rule 19b-4 and Form 19b-4, on the SROs by 
permitting them to submit a one page summary form after they list a 
new derivative securities product instead of filing a complete 
proposed rule change for Commission review prior to listing such new 
derivative securities product.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed amendment 
offers potential benefits for investors. If adopted, the proposed 
amendment will facilitate the listing and trading of new derivative 
securities products by permitting SROs to bring such products to market 
quickly to provide investors with tailored products that directly meet 
their evolving investment needs. The Commission does not anticipate 
that the proposed amendment will result in any costs for U.S. investors 
or others. The Commission preliminarily believes that the proposed 
amendment would reduce the cost of offering new derivative securities 
products to investors because it will foster innovation and create a 
streamlined process for SROs to list and trade such new derivative 
securities products subject to existing trading rules, procedures, 
surveillance programs and listing standards. Thus, the Commission has 
considered the proposed amendment's impact on efficiency, competition 
and capital formation and preliminarily believes that it would promote 
these three objectives.\59\ Finally, the Commission believes that the 
SROs will spend significantly less time filling out the form to be used 
under the proposed amendment than they do now when submitting a 
complete proposed rule change for Commission review, notice and 
approval pursuant to Rule 19b-4 under the Act.
---------------------------------------------------------------------------

    \59\ Section 3(f) of the Act, 15 U.S.C. 78c(f), requires the 
Commission, when it is engaged in rulemaking and is required to 
consider or determine whether an action is necessary or appropriate 
in the public interest, to also consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition and capital formation.

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[[Page 23591]]

VI. Request for Public Comments

    The Commission seeks comments on adopting proposed Rule 19b-4(e) 
and Form 19b-4(e) under the Act. Commentators are asked to consider 
whether the proposed amendment provides appropriate review of the 
listing and trading of new derivative securities products subject to 
existing trading rules, procedures, surveillance programs and listing 
standards. Specifically, comments should address whether more or less 
information is needed on Form 19b-4(e) in order to enable the 
Commission to comply with its statutory obligations to help remove 
impediments to a free and open securities market, protect investors and 
promote the public interest. For example, should Form 19b-4(e) require 
the SRO to cite its relevant standards under which it has listed a new 
derivative securities product? Commentators also may wish to discuss 
whether there are any legal or policy reasons why the Commission should 
consider a different approach in regulating new derivative securities 
products. For purposes of the Small Business Regulatory Enforcement 
Fairness Act of 1996, the Commission is also requesting information 
regarding the potential impact of the proposed amendment on the economy 
on an annual basis. If possible, commentators should provide empirical 
data to support their views. Finally, commentators should consider the 
proposed rule amendment's effect on competition, efficiency and capital 
formation. Comments should be submitted by May 29, 1998.

VII. Costs and Benefits of the Proposed Amendment and its Effects 
on Competition, Efficiency and Capital Formation

    To assist the Commission in its evaluation of the costs and 
benefits that may result from the proposed amendment, commentators are 
requested to provide analysis and data, if possible, relating to costs 
and benefits associated with the proposal herein. The Commission 
preliminarily believes that the proposed amendment will reduce SRO 
compliance burdens under Rule 19b-4.\60\ The proposal would reduce 
significantly the SROs' regulatory burden and help SROs maintain their 
competitive balance with the overseas and OTC derivative markets.\61\ 
Moreover, the Commission believes that the proposed amendment will 
foster innovation and create a streamlined procedure for SROs to 
promptly list new derivative securities products subject to appropriate 
listing standards.
---------------------------------------------------------------------------

    \60\ See supra note 58. As previously stated, the Commission 
believes that the proposed amendment reduces the recordkeeping and 
reporting requirements, pursuant to Rule 19b-4 and Form 19b-4, on 
the SROs by eliminating the requirement of filing a complete 
proposed rule change for Commission review prior to trading a new 
derivate securities product. The Commission estimates that the 
annual aggregate burden and annual aggregate cost for all 
respondents under Form 19b-4 would be reduced by 2,295 hours and 
$152,786, respectively. The cost per hour and per filing is derived 
from information supplied by the SROs. We have valued related 
overhead at 35% of the value of legal and clerical work combined. 
See GSA Guide to Estimating Reporting Costs (1973).
    The annual aggregate burden was derived as follows: 30 routine 
filings at 25 hours legal review time per filing equals 750 hours; 
15 significant filings at 100 hours legal review time per filing 
equals 1,500 hours; and 45 total filings at 1 hour of clerical work 
per filing equals 45 hours. The total of the three sums equals 2,295 
hours.
    The annual aggregate cost was derived as follows: 2,250 hours of 
in-house legal work at $50 per hour equals $112,500; 45 hours of 
clerical work at $15 per hour equals $675; and overhead equals 
$39,611. The total of the three sums equals $152,786.
    A routine filing is one that takes the Commission approximately 
90 days to approve and a significant filing takes more time. See 
infra note 61.
    \61\ The Commission estimates that under current procedures, a 
proposed rule filing for a new derivative securities product takes 
90 days, on average, from the date of the original submission, to be 
approved. In contrast, the proposed amendment permits SROs to 
immediately list and trade a new derivative securities product so 
long as such product is in compliance with proposed Rule 19b-4(e) 
under the Act.
---------------------------------------------------------------------------

    The individual hour burden for each respondent to the collection of 
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e) 
under the Act is estimated to be two hours per proposed Form 19b-4(e). 
The annual aggregate burden for all respondents to the recordkeeping 
collection of information requirements of proposed Rule 19b-4(e) and 
Form 19b-4(e) under the Act is estimated to be 90 hours. This burden is 
computed by estimating that an SRO will utilize 1 hour of in-house 
legal processing time to prepare the substantive information for 
proposed Form 19b-4(e) and 1 hour of clerical time to process proposed 
Form 19b-4(e) for filing. The Commission estimates that an SRO will 
incur a cost of $88 for each proposed Form 19b-4(e) that it 
submits.\62\ Thus, the total cost per year to all SROs to comply with 
proposed Rule 19b-4(e) and Form 19b-4(e) is estimated to be $7,920 (90 
hours at $88 per hour). When the annual aggregate SRO burden of 
preparing proposed Form 19b-4(e) (positive 90 hours) is added to the 
reduction in SRO burden hours under Form 19b-4 (negative 2,295 hours), 
the Commission estimates that the SROs would receive an aggregate net 
savings of 2,205 burden hours per year.
---------------------------------------------------------------------------

    \62\ The Commission estimates that the $88 cost will be broken 
down as follows: 1 hour in-house professional work at $50 per hour; 
1 hour of clerical work at $15 per hour; and overhead (telephone, 
copying and postage) at $23 per Proposed Form 19b-4(e).
    We have valued related overhead at 35% of the value of legal and 
clerical work combined. The cost per hour and per Form 19b-4(e) is 
derived from the information supplied by the SROs used to compute 
the SROs' burden under Form 19b-4, see note 60, supra.
---------------------------------------------------------------------------

    In addition, section 23(a)(2)\63\ of the Act requires that the 
Commission, when promulgating rules under the Exchange Act, to consider 
the impact any rule would have on competition and to not adopt any rule 
that would impose a burden on competition that is not necessary or 
appropriate in the public interest. The Commission has considered the 
proposed amendment in light of the standards cited in section 23(a)(2) 
of the Act and believes that it would not likely impose any significant 
burden on competition not necessary or appropriate in furtherance of 
the Exchange Act. Indeed, the Commission believes that the proposed 
amendment will reduce compliance cost and will enable SROs to compete 
more effectively with overseas and OTC derivatives markets. The 
Commission preliminarily believes that SROs should be able to bring new 
derivative securities products to market quickly to provide investors 
with tailored products that directly meet their evolving investment 
needs.\64\ SROs have had over 20 years of experience with SEC review of 
new derivative securities product proposals. SROs that have sought 
approval from the Commission to list and trade such new derivative 
securities products should be familiar with the factors discussed in 
this release that the Commission believes should be considered when 
listing and trading such new derivative securities products. Thus, the 
Commission preliminarily believes that there is less need for SEC 
review, notice and approval prior to an SRO trading a particular new 
derivative securities product pursuant to existing SRO trading rules, 
procedures, a surveillance program and listing standards. The 
Commission preliminarily believes that the proposed procedures 
discussed in this release will enable the Commission to continue to 
effectively protect investors and promote the public interest. 
Nonetheless, the Commission solicits comments on the costs, benefits 
and competitive effects of the proposed rule amendment, in general, and 
the potential competitive effects across

[[Page 23592]]

markets, in particular. Specifically, the Commission requests 
commentators to address whether the proposed amendment would generate 
the anticipated benefits or impose any costs on U.S. investors or 
others.
---------------------------------------------------------------------------

    \63\ See 15 U.S.C. 78w(a)(2).
    \64\ The Commission also believes that the proposed amendment 
will benefit broker-dealers. See VII. Summary of Regulatory 
Flexibility Act Analysis, infra.
---------------------------------------------------------------------------

VIII. Summary of Regulatory Flexibility Act Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``IRFA'') in accordance with 5 U.S.C. 605(b) regarding the 
proposed amendment to Rule 19b-4 and Form 19b-4(e) under the Exchange 
Act. The following summarizes the IRFA.
    The IRFA sets forth the statutory authority for the proposed 
amendment to Rule 19b-4. The IRFA also discusses the effect of the 
proposed amendment on broker-dealers that are small entities as defined 
in Rule 0-10 under the Exchange Act.\65\ A broker-dealer that has total 
capital of less than $500,000 on the date in the prior fiscal year as 
of which its audited financial statements were prepared, or, if not 
required to prepare such statements, a broker-dealer that had total 
capital of less than $500,000 on the last business day of the preceding 
fiscal year is deemed to be a small entity for purposes of the IRFA. 
The IRFA states that the proposed amendment would enable broker-dealers 
that are small entities (such as certain options market makers and 
options specialists) to trade new derivative securities products 
pursuant to existing trading rules, procedures, surveillance programs 
and listing standards approximately 90 days earlier, on average, 
because the proposed amendment will permit SROs to immediately list 
these new derivative securities product without prior Commission 
approval. As a result, broker-dealers will have additional days to earn 
income through trading such new derivative securities products. As of 
December 31, 1996, the Commission estimated that there were over 900 
options market makers and specialists that may be considered small 
entities.\66\
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    \65\ 17 CFR 240.0-10(c).
    \66\ The Commission bases its estimate on the information 
provided in Form X-17A-5--Financial and Operational Combined Uniform 
Single Reports pursuant to section 17 of the Act and Rule 17a-5 
thereunder.
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    The IRFA states that the proposed amendment would not impose any 
new reporting, recordkeeping or compliance requirements on broker-
dealer small entities. Any new reporting, recordkeeping or compliance 
burdens rest with the SROs, not broker-dealer small entities.
    The IRFA discusses the various alternatives considered by the 
Commission in connection with the proposed amendment that might 
minimize the effect on small entities, including: (a) The establishment 
of differing compliance or reporting requirements or timetables that 
take into account the resources of small entities; (b) the 
clarification, consolidation or simplification of compliance and 
reporting requirements under the rule for small entities; (c) the use 
of performance rather than design standards; and (d) an exemption from 
coverage of the proposed rule amendment, or any part thereof, for small 
entities. The Commission believes that different compliance or 
reporting requirements for small entities are not necessary because the 
proposed rule amendment does not establish any new reporting, 
recordkeeping or compliance requirements for small entities. In 
addition, the Commission has concluded that it is not feasible to 
further clarify, consolidate or simplify the proposed rule amendment 
for small entities. The Commission also believes that it would be 
inconsistent with the purposes of the Act to use performance standards 
to specify different requirements for small entities or to exempt 
broker-dealer small entities from being able to trade new derivative 
securities products that are covered by the proposed rule amendments.
    The IRFA includes information concerning the solicitation of 
comments with respect to the IRFA generally, and in particular, the 
number of small entities that would be affected by the proposed rule 
amendment. A copy of the IRFA may be obtained by contacting Marianne H. 
Duffy, Special Counsel, (202) 942-4163 at Office of Market Supervision, 
Division of Market Regulation, SEC, Mail Stop 10-1, 450 Fifth Street, 
NW., Washington, DC 20549.

IX. Paperwork Reduction Act

    Certain provisions of the proposed amendment to Rule 19b-4 contain 
``collection of information requirements'' within the meaning of the 
Paperwork Reduction Act of 1995 \67\ through the use of proposed Form 
19b-4(e) under the Act. The Commission has submitted the collection to 
the Office of Management and Budget (``OMB'') in accordance with 44 
U.S.C. 3507 and 5 CFR 1320.11. Persons should note that an agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid control 
number. The title for the collection of information is: ``Form 19b-4(e) 
Under the Securities Exchange Act of 1934.''
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    \67\ 44 U.S.C. 3501 et seq.
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A. Summary of Collection of Information Under Proposed Rule 19b-4(e) 
and Form 19b-4(e)

    The collection of information would require SROs to prepare a one-
page summary sheet of nine questions that requests factual information 
regarding the characteristics of the new derivative securities product 
and the underlying securities. Such questions do not require any 
analysis or exhibits.

B. Proposed Use of the Information

    Currently, in order to list and trade a new derivative securities 
product, an SRO must submit a proposed rule change to the Commission 
pursuant to section 19(b) of the Exchange Act and Rule 19b-4 
thereunder. Paragraph (c) of Rule 19b-4 provides that certain stated 
policies, practices and interpretations of SROs do not constitute 
proposed rule changes. Specifically, a ``stated policy, practice or 
interpretation'' of an SRO shall be deemed to be a proposed rule change 
unless it is reasonably and fairly implied by an existing rule of the 
SRO. The Commission proposes to not deem the listing and trading of new 
derivative securities products as proposed rule changes pursuant to 
Rule 19b-4(c)(1) because, if the Commission has approved, pursuant to 
section 19(b) of the Act, such SRO's trading rules and procedures and 
listing standards for the product class that would include the new 
derivative securities product, the listing and trading of the new 
derivative securities product is reasonably and fairly implied by the 
existing trading rules and procedures and listing standards.
    Under current procedures, a proposed rule filing for a new 
derivative securities product takes approximately 90 days from the date 
of the original submission to be ordered.\68\ In contrast, the proposed 
amendment permits SROs to immediately list and trade a new derivative 
securities product so long as such new derivative securities product is 
in compliance with proposed Rule 19b-4(e) under the Act. However, in 
order for the Commission to maintain an accurate record of all new 
derivative securities products traded on the SROs and to determine 
whether an SRO has properly relied on the proposed amendment, it is 
necessary that the SRO file proposed Form 19b-4(e) with the Commission 
when such SRO begins trading a new derivative securities product 
pursuant to the proposed amendment. In addition, an SRO must

[[Page 23593]]

maintain, on-site, a copy of proposed Form 19b-4(e). The Commission 
contemplates that it will ensure SRO compliance with the proposed 
amendment through its routine inspection process of the SROs.
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    \68\ See supra note 61.
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C. Respondents

    The proposed amendment may be used by any SRO. Currently, there are 
ten such SROs for which it is estimated that the proposed amendment 
would be used, in the aggregate, approximately 45 times a year.

D. Total Annual Reporting and Recordkeeping Burden

    The individual burden for each respondent to the collection of 
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e) 
under the Act is estimated to be two hours per proposed Form 19b-4(e). 
The annual aggregate burden for all respondents to the collection of 
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e) 
under the Act is estimated to be 90 hours. This burden is computed by 
estimating that an SRO will utilize 1 hour of in-house legal processing 
time to prepare the substantive information for proposed Form 19b-4(e) 
and 1 hour of clerical time to process proposed Form 19b-4(e) for 
filing. The Commission also estimates that an SRO will incur an 
additional cost of $23 for overhead, including telephone, copying and 
postage, for each proposed Form 19b-4(e) that it submits.\69\ Thus, the 
total operation and maintenance cost per year, in addition to the 
burden hours, to all SROs to comply with proposed Rule 19b-4(e) and 
Form 19b-4(e) is estimated to be $7,920 (90 hours at $88 per hour).
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    \69\ Supra note 62.
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    In addition, as previously stated, because SROs will no longer be 
required to file a lengthier Form 19b-4, the Commission estimates that 
the annual aggregate costs and annual aggregate burden for all 
respondents under Form 19b-4 would be reduced by $152,786 and 2,295 
hours, respectively.\70\ As previously stated, when the annual 
aggregate SRO burden of preparing proposed Form 19b-4(e) is added to 
the reduction in SRO burden hours under Form 19b-4, the Commission 
estimates that the SROs would receive an aggregate net savings of 2,205 
burden hours per year.
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    \70\ Supra note 60.
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E. Retention Period for Recordkeeping Requirements

    The SROs would be required to retain records of the collection of 
information for a period of not less than five years, the first two 
years in an easily accessible place, according to the current 
recordkeeping requirements set forth in Rule 17a-1 under the Act.\71\
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    \71\ SROs may also destroy or otherwise dispose of such records 
at the end of five years according to Rule 17a-6 under the Act, 
supra note 55.
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F. Collection of Information Is Mandatory

    Any collection of information pursuant to proposed Rule 19b-4(e) 
and Form 19b-4(e) under the Act would be mandatory as a means for the 
Commission to maintain accurate records of new derivative securities 
products that are traded.

G. Responses to Collection of Information Will Not Be Kept Confidential

    Any collection of information pursuant to proposed Rule 19b-4(e) 
and Form 19b-4(e) under the Act would not be confidential and would be 
publicly available from the Commission upon request.

H. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to:
    (i) Evaluate whether the proposed collection of information is 
necessary for the performance of the functions of the agency, including 
whether the information shall have practical utility;
    (ii) Evaluate the accuracy of the agency's estimate of the burden 
of the proposed collection of information;
    (iii) Enhance the quality, utility and clarity of the information 
to be collected;
    (iv) and minimize the burden of collection of information on those 
who are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements should direct them to the following persons: (i) Desk 
Officer for the Securities and Exchange Commission, Office of 
Information and Regulatory Affairs, Office of Management and Budget, 
Room 3208, New Executive Office Building, Washington, D.C. 20503; and 
(ii) Jonathan G. Katz, Secretary, Securities and Exchange Commission, 
450 Fifth Street, N.W., Washington, DC 20549 with reference to File No. 
S7-13-98. OMB is required to make a decision concerning the collection 
of information between 30 and 60 days after publication, so a comment 
to OMB is best assured of having its full effect if OMB receives it 
within 30 days of publication.

X. Statory Basis

    The amendment to Rule 19b-4(e) under the Exchange Act is being 
proposed pursuant to 15 U.S.C. 78a et seq., particularly sections 
3(a)(27), 3(b), 19(b), 23(a) and 36(a) of the Act, unless otherwise 
noted.

Text of the Proposed Rule

List of Subjects in 17 CFR Parts 240 and 249

    Reporting and recordkeeping requirements, Securities.

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The general authority citation for part 240 is revised to read, 
in part, as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee, 
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 
80b-11, unless otherwise noted.
* * * * *
    2. Section 240.19b-4 is amended by redesignating paragraphs (e), 
(f), (g), and (h) as paragraphs (f), (g), (h) and (i) and adding new 
paragraph (e) to read as follows:


Sec. 240.19b-4  Filings with respect to proposed rule changes by self-
regulatory organizations.

* * * * *
    (e) For the purposes of this paragraph, new derivative securities 
product means any type of option, warrant, hybrid securities product or 
any other security whose value is based upon the performance of an 
underlying instrument.
    (1) The listing and trading of a new derivative securities product 
by a self-regulatory organization shall not be deemed a proposed rule 
change, pursuant to paragraph (c)(1) of this section, if the Commission 
has approved, pursuant to Section 19(b) of the Act (15 U.S.C. 78s(b)), 
the self-regulatory organization's trading rules, procedures and 
listing standards for the product class that would include the new 
derivative securities product and the self-regulatory organization has 
a surveillance program for the product class.
    (2) Recordkeeping and reporting:

[[Page 23594]]

    (i) Self-regulatory organizations shall retain at their principal 
place of business a file, available to Commission staff for inspection, 
of all relevant records and information pertaining to each new 
derivative securities product traded pursuant to this paragraph (e) for 
a period of not less than five years, the first two years in an easily 
accessible place, as prescribed in Sec. 240.17a-1.
    (ii) When relying on this paragraph (e), a self-regulatory 
organization shall submit Form 19b-4(e) (17 CFR 249.820) to the 
Commission within five business days after commencement of trading a 
new derivative securities product.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    3. The authority citation for part 249 continues to read in part as 
follows:

    Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
    4. Form 19b-4 (referenced in Sec. 249.819) is amended as by 
revising the phrase ``subparagraph (e) of Rule 19b-4'' to read 
``subparagraph (f) of Rule 19b-4'' and the phrase ``subparagraph (e) of 
Securities Exchange Act Rule 19b-4'' to read ``subparagraph (f) of 
Securities Exchange Act Rule 19b-4'' in Exhibit 1, III. (B); and in 
Exhibit 1, IV. revise, the first sentence to read ``Interested persons 
are invited to submit written data, views and arguments concerning the 
foregoing, including whether the proposed rule change is consistent 
with the Exchange Act.''
    5. Section 249.820 and Form 19b-4(e) are added to read as follows:


Sec. 249.820  Form 19b-4(e) for the listing and trading of new 
derivative securities products by self-regulatory organizations that 
are not deemed proposed rule changes pursuant to Rule 19b-4(e) 
(Sec. 240.19b-4(e)).

    This form shall be used by all self-regulatory organizations, as 
defined in Section 3(a)(26) of the Act, to notify the Commission of a 
self-regulatory organization's listing and trading of a new derivative 
securities product that is not deemed a proposed rule change, pursuant 
to Rule 19b-4(e) under the Act (17 CFR 240.19b-4(e)).

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    By the Commission.

    Dated: April 17, 1998.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10946 Filed 4-28-98; 8:45 am]
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