[Federal Register Volume 63, Number 180 (Thursday, September 17, 1998)]
[Notices]
[Pages 49720-49722]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-24885]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40428; File No. SR-AMEX-98-23]


Self-Regulatory Organizations; Proposed Rule Change by the 
American Stock Exchange, Inc. Relating to Integrated Market Making for 
Fund Shares

September 10, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934,\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that on 
June 30, 1998, the American Stock Exchange, Inc. (the ``Amex'' or the 
``Exchange'') filed with the Securities and Exchange Commission (the 
``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Amex proposes to amend Exchange Rules 175 and 958 to allow the 
trading of Fund Shares, options on Fund Shares and related index 
options at the same location on the Exchange's trading floor and by the 
same specialists and registered traders.

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 Amex included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed

[[Page 49721]]

rule change. The text of these statements may be examined at the places 
specified in Item IV below. The Amex 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
    Since 1992, the Exchange has listed and traded, pursuant to its 
equity trading rules, a number of products that derive their value from 
indexes or portfolios of other equity securities. These products 
include Exchange-listed securities representing interests in open-end 
unit investment trusts or open-end management investment companies that 
hold securities based on an index or a portfolio of securities (These 
products are collectively referred to hereinafter as ``Fund 
Shares'').\3\
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    \3\ Currently, the Exchange trades unit investment trust 
securities known as Portfolio Depository Receipts SM 
(``PDRs'') based on the Standard & Poor's 500 Composite 
Stock Price Index, the Standard & Poor's MidCap 400 Index 
TM and the Dow Jones Industrial Average. In addition, the 
Exchange trades fund shares which are issued by an open-end 
management investment company consisting of seventeen separate 
series known as World Equity Benchmark Shares SM 
(``WEBs'') based on seventeen foreign equity indexes. PDRs and WEBs 
are listed on the Amex pursuant to Rule 1000, et seq. and rule 1000A 
et seq., respectively, and trade like shares of common stock. The 
Exchange is developing other fund shares for listing and trading 
which will have structures similar to PDRs and WEBs and proposes to 
trade options on many such securities. (See, Securities Exchange Act 
Release No. 36947 (March 8, 1996), 61 FR 10606 (March 14, 1996) for 
Fund Shares and Securities Exchange Act Release No. 31591 (December 
11, 1992), 57 FR 60253 (December 18, 1992) for PDRs).
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    The Exchange proposes to amend Exchange Rules 175 and 958 to allow 
the trading of Fund Shares, options on Fund Shares and related index 
options at the same location or adjacent locations on the Exchange's 
trading floor and by the same specialist units and registered traders 
(hereinafter referred to as ``Exchange-wide fund share market 
making''). Amex believes that Exchange-wide fund share market making 
will provide a climate in which reduced customer trading costs will 
result from narrower spreads, cross product arbitrage, integrated risk 
management, increased liquidity and depth, higher trading volume and 
more effective and efficient servicing of customer order flow while 
assuring that there will be no undue advantage or preference among 
participants in the marketplace. Recent and expected future growth in 
the listing and trading of Fund Shares and the anticipated approval of 
the Exchange's proposed filing concerning the trading of options on 
Fund Shares will permit customers and market makers to manage risks and 
coordinate related positions with lower trading costs and more 
effective and efficient execution of their investment strategies.\4\
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    \4\ On July 1, 1998, the Commission approved a proposed rule 
change which permits the trading of options on Exchange-Traded Fund 
Shares. Securities Exchange Act Release No. 40157 (July 1, 1998), 63 
FR 37426 (July 10, 1998).
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    The Exchange believes the proposed rule change will promote market 
efficiency by allowing the same specialist unit and registered traders 
to trade a number of related products, realizing the cost reducing 
advantages of cross product arbitrage and integrated risk management. 
Such advantages will result in narrower spreads, increased liquidity 
and depth, and higher trading volume in the markets for risk-related 
Fund Shares, options on Fund Shares and index options. Most 
importantly, the Exchange believes the proposed rule change will result 
in more effective and efficient servicing of customers' orders at lower 
expected transaction costs to the customers.
    The Exchange believes that the proposed integration of market 
making in Fund Shares, options on Fund Shares and their related index 
options can increase market quality and will provide both price and 
operational efficiencies while raising minimal issues of informational 
advantage due to the derivative nature of all of these products.\5\ 
Such informational advantages are minimal because pricing of the Fund 
Shares is not based on supply of and demand for the Fund Shares, but on 
the value of the underlying index or portfolio of securities. For 
example, unlike stocks, prices of which are based in part on 
information regarding the performance of the issuer and the supply of 
and demand for the stock in the secondary market, Fund Shares are 
priced according to the current market prices of the underlying 
components held in the Fund Shares' portfolio trust. The specialist for 
the Fund Shares is privy to information that indicates the supply of 
and demand for the Fund Shares themselves, but the specialist cannot 
rely upon such information when pricing Fund Shares since the index or 
basket of securities upon which the Fund Shares are based may not move 
in the same manner that the supply of and demand for the Fund Shares 
indicates. Accordingly, the Exchange does not believes that knowledge 
of limit orders on the specialist's book for the Fund Shares themselves 
provides an informational advantage to the specialist when pricing or 
trading the Fund Shares. The fund share market is a derivative market 
of underlying stocks and the markets for index options and fund share 
options is, correspondingly, a further derivative of this underlying 
market.
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    \5\ At the Commission staff's request, the Exchange researched 
the issues of integrated market making and side-by-side trading. A 
letter setting forth the results of that research and an analysis of 
such activities with respect to Fund Shares and the overlying 
options was forwarded to the Commission staff. The letter reviews 
and analyzes Commission precedent for (and against) integrated 
market making as well as statements made by the Commission in the 
Report of the Special Study of the Options Markets, H.R. Rep. No 
IFC3, 96th Cong. 1st sess. (Committee Print 1978) (referred to 
hereinafter as the ``Options Study''). See, Letter from Claire P. 
McGrath, Vice President and Special Counsel, Derivative Securities 
Division, Amex, to Howard Kramer, Senior Associate Director, 
Division of Market Regulation, Commission, dated June 2, 1998.
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    The Commission has stated that ``[t]he integration of trading in 
options and their underlying securities on an exchange floor may create 
opportunities to engage in manipulative and other improper trading 
activities that do not presently exist.''\6\ In order for the 
integration of market making in fund shares and their overlying options 
to create opportunities for the specialist and registered options 
traders to engage in manipulative activity, market making in both 
products must yield information that can be used in such an endeavor. 
As discussed in the previous section, the Exchange believes that 
neither the specialist nor the traders in any or all of these products 
are privy to exclusive market information that is useful in pricing the 
fund shares. Like all market participants, they have access to last 
sale information for each of the component securities, the current 
quotes for the components and price information for any other products 
such as a futures contract that may be used in pricing the fund shares. 
What little market information the specialist and traders are able to 
glean on the Exchange floor is more than likely known by other market 
participants and already factored into prices and quotes. In addition, 
given the enhanced surveillance systems that monitor all trading floor 
activity today, attempts to manipulate the market by a specialist or 
trader will be readily detected.
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    \6\ Options Study at 885.
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    Among other reasons why limit orders in Fund Shares are not a 
source of informational advantage is the number of Fund Shares issued 
and outstanding may be increased or decreased at a very low cost in 
response to changing demand for the Fund Shares. A defining 
characteristic of all Amex-listed unit

[[Page 49722]]

investment trust and management investment companies that hold 
securities based on an index or a portfolio of securities is that they 
are open-ended. New Fund Shares in these products may be created on any 
business day in response to an offer to purchase such shares. 
Accordingly, the ability of the seller of a call option on any such 
Fund Share to deliver upon exercise is a function of the availability 
of all the shares of the components represented in the trust, not just 
the share held by the fund itself. As a result, there is substantially 
less potential for manipulation of a Fund Share's price, since. unlike 
the market in a thinly traded corporate stock, the market for Fund 
Share's cannot be successfully squeezed or cornered because the 
potential supply to Fund Shares is, for all practical purposes, 
unlimited.
    Lastly, although the Exchange believes that the proposed rule 
change will not increase the potential for trading abuse or 
manipulation, the Exchange currently has in place safeguards to detect 
and prevent any such abuse or manipulative activities. The Exchange 
believes its existing surveillance pro endures are more than sufficient 
to detect any improper trading activity, deter any potential 
manipulative or improper trading activity and minimize the regulatory 
risks of integrated market making. The concentration of related product 
trading activity helps in the surveillance that assures that a customer 
receives a price appropriate to the state of the market when his order 
arrives on the trading floor. The Exchange conducts regular 
surveillance to detect any abuse or attempted manipulations and to 
insure compliance with its safeguards. The Exchange believes that the 
proximity of trading activity in related products will increase the 
effectiveness of these safeguards.\7\
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    \7\ In addition to the foregoing, in recent months the 
Commission has approved rule changes by other options exchanges 
which will permit these exchanges to list and trade, under unlisted 
trading privileges, some or all Fund Shares now listed on the Amex 
or which might be listed on the Amex or some other exchange in the 
future. In contrast to Amex rules which currently place limitations 
on option and equity trading locations and specialists' 
affiliations, the Amex believes that the rules of some of the other 
U.S. options exchanges impose no such limitations on trading 
locations, specialists' affiliations or market maker participation 
on these or related products. The proposed rule change will permit 
the Amex to conduct its business without unnecessary fetters not 
imposed on competitive markets. The changes will permit Amex 
specialists and market makers to use other related products traded 
on the Amex in the same way that specialists and market makers on 
other exchanges will be able to use related products traded on their 
exchanges in their market making and risk management activities in 
Fund Shares and related options products.
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(2) Statutory Basis
    The proposed rule change is consistent with Section 6(b) of the Act 
\8\ in general and furthers the objectives of Section 6(b)(5) \9\ in 
particular in that is 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 
facilitating transactions in securities, and to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system.
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    \8\ 15 U.S.C. 78f.
    \9\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, 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, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW., Washington, 
DC 20549. Copies of such filing will also be available for inspection 
and copying at the principal office of the Amex. All submissions should 
refer to File No. SR-Amex-98-23 and should be submitted by October 8, 
1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-24885 Filed 9-16-98; 8:45 am]
BILLING CODE 8010-01-M