[Federal Register Volume 63, Number 245 (Tuesday, December 22, 1998)]
[Rules and Regulations]
[Pages 70952-70969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33300]
[[Page 70952]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 249
[Release No. 34-40761; File No. S7-13-98]
RIN 3235-AH39
Amendment to Rule Filing Requirements for Self-Regulatory
Organizations Regarding New Derivative Securities Products
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission is adopting an
amendment to Rule 19b-4 under the Securities Exchange Act of 1934. The
amendment permits self-regulatory organizations to list and trade new
derivative securities products pursuant to existing self-regulatory
organization trading rules, procedures, surveillance programs and
listing standards without submitting a proposed rule change pursuant to
section 19(b).
EFFECTIVE DATE: February 22, 1999.
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
On April 17, 1998, the Securities and Exchange Commission (``SEC''
or ``Commission'') proposed for comment an amendment to Rule 19b-4
(``Proposed Rule'') \1\ under the Securities Exchange Act of 1934, as
amended (``Exchange Act'' or ``Act''),\2\ to expand the scope of self-
regulatory organization (``SRO'') \3\ matters that do not constitute
proposed rule changes, within the meaning of section 19(b) of the Act
\4\ and Rule 19b-4 \5\ thereunder. In particular, under the amendment,
an SRO rule change would not 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. Today, the Commission adopts the amendment without any
material changes from the proposal. In response to certain commenters,
the Commission also is providing clarification on the amendment.
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\1\ Securities Exchange Act Release No. 39885 (April 17, 1998)
63 FR 23584 (April 29, 1998) (``Proposing Release'').
\2\ 15 U.S.C. 78a et seq.
\3\ 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 clearing 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.
\4\ 15 U.S.C. 78s.
\5\ 17 CFR 240.19b-4.
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B. Description Of Amendment
The Commission previously adopted rules that interpret the terms
``stated policy, practice or interpretation'' and ``proposed rule
change.'' \6\ For example, paragraph (c) of Rule 19b-4 \7\ 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.
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\6\ 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). The
rule adopted today effectively exempts SROs from certain
requirements under Section 19(b) of the Act that otherwise would
apply to the listing and trading of new derivative securities
products.
\7\ 17 CFR 240.19b-4(c).
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Similarly, today the Commission is adopting an amendment to Rule
19b-4, in substantially the same form that it was proposed, so that the
listing and trading of new derivative securities products would not be
proposed rule changes so long as existing SRO trading rules,
procedures, surveillance programs and listing standards apply to the
product class covering a specific new derivative securities product.\8\
Specifically, the Commission is adding a new paragraph (e) to Rule 19b-
4 which states:
\8\ See IV. A. Definition of ``New Derivative Securities
Product'', infra, for a complete discussion of the technical changes
to the definition of new derivative securities product in response
to commenters' requests for clarification.
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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 Final Rule, infra.
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In adopting new paragraph (e), the Commission 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 therefore is deeming
the listing and trading of new derivative securities products to not be
proposed rule changes under rule 19b-4(c)(1) when certain conditions
are met.
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 previously has responded to
the need for flexibility in regulating new derivative securities
products by developing streamlined filing procedures to ease the SROs'
regulatory burden in many circumstances. Today, the Commission is
adopting an amendment to Rule 19b-4 under the Act that expands 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.
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
[[Page 70953]]
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
(excerpt on ``Self-Regulation and SEC Oversight'').
\12\ 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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Currently, SROs obtain Commission approval of proposals submitted
under section 19(b)(2) to adopt listing standards in order to list and
trade various derivative securities products, including, but not
limited to: narrow-based stock index options \14\ and warrants; \15\
portfolio depositary receipts (``PDRs''); \16\ foreign currency
options; \17\ index fund shares; \18\ and equity linked term notes
(``ELNs''). \19\
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\14\ See e.g., Securities Exchange Act Release No. 39453
(December 16, 1997), 62 FR 67101 (December 23, 1997) (order
approving Chicago Board Options Exchange's, Incorporated) (``Amex''
proposal to list and trade options based on the Dow Jones High Yield
Select 10 Index). See also, CBOE Rule 24.2.
\15\ See e.g., Securities Exchange Act Release No. 39079
(September 15, 1997), 62 FR 49543 (September 22, 1997) (order
approving American Stock Exchange's Incorporated (``Amex'') proposal
to list and trade warrants based on the ING Barings, Inc.'s BEMI
Latin America Index (``BEMI Latin America Index Order'')). See also,
Amex Rules 1100-1110 and Section 106 of the Amex Company Guide.
\16\ See e.g., 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 PDRs,
and specifically PDRs based on the Standard and Poors Corporation
(``S&P'') 500 Index known as SPDRs). See also, Amex Rules 1000-1004.
\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). See also, Phlx Rule 1000.
\18\ See e.g., Securities Exchange Act Release No. 36947 (March
8, 1996) 61 FR 10606 (March 14, 1996) (order approving Amex proposal
to list and trade index fund shares that are series of the World
Equity Benchmark Shares issued by Foreign Fund, Inc. and based on 17
Morgan Stanley Capital International indices). See also, Amex Rules
1000A-1003A.
\19\ See e.g., Securities Exchange Act Release No. 32345 (May
20, 1993), 58 FR 30833 (May 27, 1993) (order approving the listing
and trading of ELNs on the Amex). See also, Section 107B of the Amex
Company Guide.
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2. Recent Efforts To Streamline 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
10(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, existing 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). As discussed in V. Technical Changes,
infra, existing Rule 19b-4(e) is being redesignated as Rule 19b-
4(f).
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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 New York Stock
Exchange Incorporated, (``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 (``OCC'').
\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 an SRO that
allow for the listing of specific broad-based \25\ stock index warrant
issuances without further Commission approval pursuant to section 19(b)
of the Act, as long as the index has been previously approved by the
Commission for broad-based index option trading. In addition, the
Commission has approved rules for certain SROs that permit the listing
of specific 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 Narrow-Based Index
Warrant Approval Orders and the Commission has already approved the
underlying stock index for
[[Page 70954]]
warrant or options trading. The Commission also 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\ Moreover, the
Commission 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 thee Commission pursuant to a
section 19(b) rule filing.\28\
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\25\ 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'') proposal
to adopt uniform listing and trading guidelines for broad-based
index warrants on the NASD's Automated Quotation Stock Market).
\26\ 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).
\27\ Supra note 26.
\28\ Supra note 26.
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B. Reasons for Expanding the Scope of SRO Matters That Do Not
Constitute Proposed Rule Change
Despite the streamlined procedures discussed above, the Commission
believes that, consistent with investor protection, more can be done to
speed the introduction of new derivative securities products. Over the
years, the Commission has approved numerous SRO trading rules,
procedures and listing standards for various classes of new derivative
securities products. Based on this experience, the Commission believes
that once 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 are
reasonably and fairly implied by the SRO's existing trading rules,
procedures and listing standards.\29\
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\29\ As the Commission noted in the Proposing Release, as is the
current practice with 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 previously
Commission approved trading rules, procedures and listing standards
of the SRO.
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SRO's are facing increasing competition from overseas and over-the-
counter (``OTC'') derivatives markets.\30\ SROs need to bring new
derivative securities products to market quickly to provide investors
with tailored products that directly meet their evolving investment
needs. Although the existing generic rules have helped to speed the
process of reviewing new derivative securities product proposals, the
Commission now believes that further changes are warranted. 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 amendment
should foster innovation and create a streamlined procedure for SROs to
promptly list new products subject to appropriate trading rules,
procedures, surveillance programs and listing standards.
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\30\ In order to further promote competition, the Commission has
adopted, in a separate release issued today (Securities Exchange Act
Release No. 40760 (December 8, 1998)), Rule 19b-5 under the Act that
permits SROs to operate new pilot 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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Moreover, 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. SROs have 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 are familiar with the
factors discussed in this release that must be considered when listing
and trading such new derivative securities products. The procedures
discussed below will enable the Commission to continue to effectively
protect investors and promote the public interest.
III. Summary of Comments
In the proposing Release, commenters were asked 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.
Commenters were asked whether more or less information was needed on
Form 19b-4(e) for the effective Commission review.\31\ The Commission
received ten comment letters on the Proposing Release.\32\ Commenters
generally supported deeming the listing and trading of certain new
derivative securities products to not be proposed rule changes pursuant
to Rule 19b-4(c)(1). The majority of commenters recommended specific
modifications to the Proposed Rule.
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\31\ Specifically, the Commission asked whether Form 19b-4(e)
should require the SRO to cite its relevant standards under which it
has listed a new derivative securities product. Commenters were also
asked to discuss whether there were any legal or policy reasons why
the Commission should consider a different approach in regulating
new derivative securities products. The Commission did not receive
any comments on these questions.
\32\ The comment letters have been placed in Public File S7-13-
98, which is available for inspection in the Commission's Public
Reference Room. Commenters consisted of six SROs, two futures
markets and one federal agency. See letters from: James E. Buck,
Senior Vice President and Secretary, NYSE, dated May 27, 1998,
(``NYSE Letter''); Jean A. Webb, Secretary, U.S. Commodity Futures
Trading Commission (``CFTC''), dated May 29, 1998 (``CFTC Letter'');
Charles J. Henry, President and Chief Operating Officer, CBOE, dated
May 29, 1998 (``CBOE Letter''); Thomas R. Donovan, President and
Chief Operating Officer, Chicago Board of Trade (``CBOT''), dated
May 29, 1998 (``CBOT Letter''); T. Eric Kilcolin, President and
Chief Operating Officer, Chicago Mercantile Exchange (``CME''),
dated May 29, 1998 (``CME Letter''); James L. Duffy, Executive Vice
President and General Counsel, Amex, dated July 2, 1998 (``Amex
Letter'');' H. Warren Langley, President and Chief Operating
Officer, PCX, dated July 6, 1998 (``Amex Letter''); H. Warren
Langley, President and Chief Operating Officer, PCX, dated July 6,
1998 ``PCX Letter''(); Edity Hallahan, Vice President and Associate
General Counsel, Phlx, dated July 24, 1998 (``Phlx Letter''); Alden
S. Adkins, Senior Vice President and General Counsel, NASD
Regulation, Incorporated ``NASDR''), dated July 29, 1998 (``NASD
Regulation Letter''); and Joan C. Conley, Corporate Secretary, NASD,
dated August 10, 1998 (``NASD Letter''). The NASDR Letter did not
contain substantive comments, but rather merely stated that a
substantive comment letter would be provided in August 1998 by the
NASD. The NASD Letter provided no specific comments except to
express that the NASD ``fully support(s) the (Proposing Release).''
NASD Letter at 2.
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First, the Amex questioned what types of securities are covered by
the definition of new derivative securities product due to other
definitions of ``derivative securities,'' ``warrants'' and ``underlying
instruments'' in other rules under the Act.\33\ The Amex questioned
whether the Commission intended to encompass securities under the
amendment such as issuer call warrants, convertible securities and
continent value rights (``CVRs'').\34\ The same commenter suggested
that ``(d)ue to the broad language of the [definition], SROs and
issuers will be unable to determine whether the phrase `any type of
option' is limited to `standardized options'.'' \35\ The commenter also
sought clarifications as to whether the qualifier ``any type of''
applies only to the word ``option'' or to the entire definition. In
addition, the commenter ``request[ed] that the term `hybrid securities
product' be defined (in a manner) consistent with the CFTC prior
statements and rulemaking.'' \36\ The commenter also asked whether the
words ``based upon''
[[Page 70955]]
are intended to mean ``based in whole'' or ``based in part.''
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\33\ Amex Letter at 3-6. See Text of the Final Rule, infra, for
the complete definition of new derivative securities product.
\34\ See also Amex Letter at 19 (requesting a list of SRO rule
filings from prior years that would have satisfied the conditions of
the amendment).
\35\ Amex Letter at 4. See Section IV. D. Compliance With Other
Federal Securities Laws, infra, for a more detailed discussion of
``standardized options.''
\36\ Amex Letter at 5.
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Second, several commenters asked that the term ``product class'' be
clarified. One commenter was concerned ``that, depending upon how the
crucial term `product class' is interpreted, the scope of the Propos(ed
Rule) could be so restricted that it would have limited impact on the
introduction of new derivative securities products in the listed
markets.'' \37\ The CBOE and PCX requested that the Commission
``clarify in the adopting release for the rule that the term `product
class' is to be construed broadly, perhaps providing examples of
product classes and permissible changes to product class
characteristics that would not require a rule filing under section
19(b) of the Act.'' \38\ The CBOE believed that ``it is important for
the adopting release to make it clear that `product class' is to be
interpreted broadly, so that the Propos(ed Rule) may fulfill its
intended purpose of providing meaningful relief to SROs in connection
with the introduction of new derivative (securities) products.\39\
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\37\ CBOE Letter at 3.
\38\ CBOE Letter at 7 and PCX Letter at 2.
\39\ CBOE Letter at 3.
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Third, several commenters suggested that the Commission broadly
interpret what is meant by the phrase ``existing SRO trading rules,
procedures, surveillance programs and listing standards.'' One
commenter ``urge(d) that the Commission be flexible in the degree of
specificity it will require for the `generic' listing standards and
that, in adopting the proposal, it provide guidance as to what it will
seek in such listing standards.'' The same commenters proposed ``that
the required `generic' standards provide a general description of the
type of security authorized for listing, but not contain detailed
specifications for the product.'' \40\ Another commenter sought
clarification as to whether ``a narrow-based index option must meet the
current generic criteria index option listing standards.'' The
commenter believed that ``more flexible generic listing standards are
necessary to accommodate products that do not currently fit the generic
option listing standards * * * but do not pose significant new legal or
regulatory issues.'' \41\ Another commenter ``assume(d) that * * * the
Commission would not object to the establishment by SROs of broad
ranges or formulas for position limits, margin requirements and other
characteristics of (new) derivative securities products in the rules
initially filed with the Commission for approval under section 19(b)(2)
(of the Act,) thereby allowing SROs to avoid subsequent rule filings
and approvals for changes to such rules or procedures that are within
the previously approved ranges or formulas.'' \42\
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\40\ NYSE Letter at 1 and 2.
\41\ Phlx Letter at 1-2.
\42\ CBOE Letter at 7-8.
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Fourth, two commenters raised concerns regarding the requirement
that SROs ``ensure'' that certain standards are met before listing and
trading a new derivative securities product. One commenters found that
the Proposed Rule ``appear(ed) to set forth high standards for SROs to
satisfy in `ensuring' that various conditions and requirements are
satisfied, even extending to some areas that are beyond the SROs'
control, with the suggestion that if some of these conditions and
requirements are not met, the SRO would not be able to rely on the
proposed amendment, and the listing of products in the absence of
section 19(b)(2) filings and approvals would be in violation of the
Act.'' \43\ To avoid this possibility, the two SROs suggested that the
Commission ``acknowledge in the adopting release that certain elements
described as conditions in the Proposing Release, such as the
requirement to maintain adequate systems capacity, are obligations of
the SROs generally, and are not elevated to special status by virtue of
the (Proposed Rule.'') \44\ Such SROs suggested that the Commission
``indicate that the SROs may rely on the (Proposed R)ule provided they
act in good faith in determining that the requirements of the (Proposed
R)ule have been satisfied with respect to a particular product.'' \45\
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\43\ CBOE Letter at 4.
\44\ CBOE Letter at 10 and PCX Letter at 2.
\45\ PCX Letter at 2.
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Fifth, the Amex had several detailed questions regarding the
standards that new derivative securities products in general, and index
based new derivative securities products in particular, should meet in
order to be consistent with the Act.\46\ The Amex sought guidance
regarding the requirement of SROs to obtain representations from
relevant price reporting authorities regarding the systems capacity for
each new derivative securities product.\47\ The Amex also sought
clarification regarding quotation dissemination for underlying
securities not subject to transaction reporting, foreign securities and
instruments that are not securities.\48\ The Amex also requested more
detailed information regarding the requirement that an index underlying
a new derivative securities product be constructed according to
established criteria for initial inclusion and maintenance of component
securites.\49\ For example, the Amex desired quanitiable standards
regarding the number, weight and liquidity of component securities that
an index should include and maintain.\50\
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\46\ Amex Letter at 10-12.
\47\ Amex Letter at 10.
\48\ Amex Letter at 10.
\49\ Amex Letter at 6-10. The Amex suggests that, for purposes
of classifying an index as broad-based, it is ``reasonable and
appropriate for SROs to employ'' the criteria discussed in the
Interpretation and Statement of General Policy issued by the SEC and
the CFTC. Securities Exchange Act Release No. 20578 (January 18,
1984) 49 FR 2884 (January 24, 1984) (``Joint Policy Statement'').
\50\ Amex Letter at 12. See also, Amex Letter at 18 (requesting
that Commission provide a detailed list of materials that SROs would
need to maintain in order to be in compliance with the amendment)
and Phlx Letter at 2. The Phlx believes that ``the criteria outlined
in the (Proposed Release) require an underlying index.'' Therefore,
the Phlx believes that ``many other (new) derivative (securities)
products, such as foreign currency options or unit investment trusts
(referred to herein as PDRs), do not fall under the standards set
forth in the Proposing Release. In addition, the CBOE believes that
the Proposing Release does not indicate whether current surveillance
procedures are adequate for purposes of Rule 19b-4(e) or whether
there are unique issues presented by new derivative securities
products that will require new surveillance procedures. CBOE Letter
at 4 and 11.
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Sixth the Amex raised several detailed questions regarding
comprehensive information sharing agreements (``ISAs'') with other
markets.\51\ Specifically, the Amex did not believe that the Commission
should require an SRO to obtain the identity of the ultimate purchasers
and sellers of securities pursuant to a comprehensive ISA because the
Amex represents that, under an ISA, SROs ``do not have the authority to
obtain information regarding the ultimate purchasers and sellers of
securities even with respect to their own members trading in their own
markets.'' \52\ In addition, the Amex requested that the Commission
provide a list of the comprehensive ISAs and SEC memoranda of
understanding (``MOU'') with specific countries that SROs may rely upon
when listing and trading new derivative securities products.\53\ In
addition, the Amex believed that ``it would be appropriate to interpret
the Commission's (ISA) coverage standard (for index based new
derivative securities products), if not
[[Page 70956]]
eliminated in its entirety, to call for 50% coverage.'' \54\
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\51\ Amex Letter at 14-16. All comments regarding this issue
were submitted by the Amex. See Section IV. B. Information Sharing
Agreements, 1 infra, for a complete discussion of comprehensive
ISAs.
\52\ Amex Letter at 14.
\53\ Amex Letter at 16.
\54\ Amex Letter at 16.
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Seventh several commenters raised issues regarding the Proposed
Rule's interacdtion with the SEC's review of stock index futures
products. The commenters suggested that the Commission ``develop an
expedited procedure for reviewing applications of futures exchanges to
trade stock index futures contracts.'' \55\ Two comments were also
concerned that a securities exchange could use its authority under the
Proposed Rule to trade a futures contract. These commenters requested
that the Proposed Rule ``be refined to make certain that no securities
exchange could use the proposal to try to trade a futures contract
under the guise of a new derivative securities product.'' \56\
Additionally, several commenters sought clarification regarding the
implications of a securities exchange categorizing an index as broad-
based or narrow-based.\57\ One commenter ``believe(d) that the SEC
should make it clear that the classification decision made by the
securities exchange is in no way binding on a later application from a
futures exchange to trade futures contracts based on the same index.''
\58\
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\55\ CME Letter at 2. See also CBOT Letter at 2 and CFTC Letter
at 2.
\56\ CFTC Letter at 2. See also CME Letter at 2.
\57\ For example, the Amex believes ``that once a determination
is made as to the classification of an index as broad-based or
narrow-based, the classification should remain unchanged given the
important consequences that flow from the classification.'' Amex
letter at 9.
\58\ CME Letter at 3. See also CBOT Letter at 2 noting that the
SEC should ``independently review a futures exchange's application,
not de facto abdicate its statutory responsibility to the securities
exchanges.''
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Eighth, several commenters asked about the public availability of
Form 19b-4(e) filed by an SRO. One commenter noted that ``(w)hile the
(Proposing) Release is silent on the issue, we assume that (any Form
19b-4(e) filed by an SRO) will be (a) public document.'' The same
commenter suggests that ``the Commission could make (any Form 19b-4(e)
filed by an SRO) available on its (w)eb site.'' \59\ The CFTC requested
that the SEC provide the CFTC ``with immediate notice of (new
derivative securities products) listed pursuant to (Rule 19b-4(e) in
order to permit the CFTC to monitor developments and to make a
determination whether any action is necessary.'' \60\
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\59\ NYSE Letter at 2.
\60\ CFTC Letter at 2.
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Ninth, several commenters requested that the Commission take
additional steps to enhance the timeliness of the rule filing process
under section 19(b) of the Act. One commenter requested that ``the
Commission make available a list of SRO rule filings from prior years
that could have employed (the amendment to Rule) 19b-4.'' \61\ One
commenter ``recommend(ed) that the Commission consider exercising its
authority under section 19(b((3)(A) to permit SRO (new) derivative
securities products that do not otherwise qualify under Rule 19b-4(e)
(of the Act) to become effective upon filing, subject to the
Commission's authority to abrogate such rules pursuant to section
19(b)(3)(C) of the Act.'' \62\ In addition, the commenters believed
that ``the rule filing process, in general, could be shortened if SRO
rules that are submitted to the Commission in proper form were
published for notice and comment immediately, or within a set period of
time, such as ten business days.'' \63\ On a related issue, at least
one commenter believed that amendments to existing derivative
securities products, such as splitting an index or changing the
exercise style should not require filing a proposed rule change
pursuant to section 19(b)(2) of the Act. The same commenter
``believe[d] that any modifications to (new) derivative (securities)
products should be effective upon filing [an amendment to Form] 19b-
4(e).'' \64\
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\61\ Amex Letter at 19.
\62\ CBOE Letter at 12-13. See also Phlx Letter at 2 suggesting
that ``combined notice and accelerated approval for new [derivative
securities] products would further streamline the process by
eliminating the time period between notice for comment and
approval.''
\63\ CBOE Letter at 13 and PCX Letter at 2.
\64\ Phlx Letter at 2.
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IV. Discussion
A. Definition of ``New Derivative Securities Product''
In the Proposing Release, the Commission proposed to define ``new
derivative securities product,'' for purposes of section 19(b) of the
Act and Rule 19b-4 thereunder, to be ``any type of option, warrant,
hybrid securities product or any other security, the value of which is
based upon the performance of an underlying instrument.''
As previously noted, at least one commenter requested clarification
regarding specific terms used in the definition.\65\ Use of such terms
in other rules does not govern the terms used in Rule 19b-4(e). The
definition of ``derivative securities'' in Rule 16a-1(c) under the Act
``shall apply solely to section 16 and the rules thereunder.'' \66\
Similarly, Rule 12a-4(a) under the Act states that ``(w)hen used in
this rule, the following terms shall have the meaning indicated.''
``Warrant'' is then defined in Rule 12a-4(a)(1).\67\ Finally, the term
``underlying instrument'' is defined in Rule 15c3-1 for use in
computing a broker-dealer's net capital requirements. The Commission
also notes that it proposed, and is adopting, the defined term ``new
derivative securities product'' in the amendment to Rule 19b-4 solely
for purposes of determining whether an SRO would be required to file a
proposed rule change under Section 19(b) of the Act and Rule 19b-4
thereunder.
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\65\ See Amex Letter at 3-6, notes 33, 35 and 36, supra.
\66\ 17 CFR 240.16a-1 The Commission notes that the definition
of ``derivative securities'' found in Rule 16a-1 is for the purpose
of requiring reports disclosing the beneficial ownership of
directors, officers and principal stockholders of equity securities
registered under 12 of the Act.
\67\ Rule 12a-4(a)(1) defines the term ``warrant'' for purposes
of determining whether a warrant is exempt from registration under
section 12(a) of the Act.
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In response to the Amex's question,\68\ the Commission did not
intend to include traditional issuer warrants \69\ and traditional
convertible securities in the definition of new derivative securities
product under the amendment to Rule 19b-4.\70\ Therefore, SROs that
have listing standards, trading rules and procedures approved by the
Commission for traditional issuer warrants and traditional convertible
securities are not required to submit Form 19b-4(e) when listing
specific traditional issuer warrants and traditional convertible
securities.
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\68\ See Amex Letter at 4, supra note 33.
\69\ The Commission believes that traditional issuer warrants do
not include such things as third party warrants on individual
securities.
\70\ In addition, in response to the Amex's request that the
Commission define the term ``hybrid securities product'' (see Amex
Letter at 5, note 36, supra), the Commission is aware that the CFTC
has issued statements regarding the term ``hybrid securities
product'' for purposes of determining whether a particular product
``combines characteristics of futures contracts or commodity options
with debt, depository or preferred equity interests.'' See
``Statutory Interpretation Concerning Certain Hybrid Instruments''
55 FR 13582 (April 11, 1990). The Commission understands the Amex's
desire to ``avoid possible market disruption or uncertainty'' (see
Amex Letter at 5) when listing new derivative securities products
pursuant to the new amendment. The Commission, however, believes
that an attempt to establish specific criteria for ``hybrid
securities products'' would unduly limit an SRO's ability to develop
new derivative securities products. Rather, the Commission believes
that it would be better able to address an SRO's concern regarding
the status of a particular ``hybrid securities product'' if the SRO
consulted with the Commission regarding a product's specific
characteristics at the time the product is being developed.
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The Commission notes, however, that when CVRs were first developed,
the SROs that sought to list them were required to submit for
Commission approval CVR listing standards, trading
[[Page 70957]]
rules and procedures.\71\ Under the amendment, if an SRO does not have
listing standards, trading rules and procedures for CVRs approved by
the Commission, such SRO must submit a proposed rule change for
Commission approval, under section 19(b), to establish listing
standards, trading rules and procedures for the CVR product class,
prior to listing CVRs.
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\71\ See e.g. Securities Exchange Act Release No. 34759
(September 30, 1994) 59 FR 50939 (October 6, 1994) (order approving
listing and trading of CVRs, among other things, on the CBOE).
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The Commission also seeks to clarify that the term ``any type of
option'' is not limited to any type of ``standardized option.'' \72\
Rather, the term ``any type of option'' includes any type of new
derivative securities product that is an option such as a third party
warrant on an individual security. The Commission also notes that, with
the exceptions discussed above, the qualifier ``any type of'' applies
to the entire definition. In addition, the Commission clarifies that
the term ``based upon'' means ``based in whole or in part.'' \73\
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\72\ See Section IV. D. Compliance With Other Federal Securities
Laws, infra, for a more detailed discussion of ``standardized
options.''
\73\ As previously stated, the Proposing Release stated that
``any other security, the value of which is based upon the
performance of an underlying instrument'' would be defined to be a
``new derivative securities product.'' The Commission believes that
inserting the term ``in whole or in part'' clarifies the scope of
the amendment's coverage.
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The Commission also is revising the proposed definition of new
derivative securities product in order to clarify that if a product's
value is based, in whole or in part, ``upon the interest in'' an
underlying instrument, such product is included within the term ``new
derivative securities product.'' In accordance with these
clarifications, the Commission is adopting paragraph (e) of Rule 19b-4
to define ``new derivative securities product,'' for purposes of
section 19(b) of the Act and Rule 19b-4 thereunder, to be ``any type of
option, warrant, hybrid securities product or any other security, the
value of which is based, in whole or in part, upon the interest in, or
performance of, an underlying instrument.''
1. New Derivative Securities Product Must Be a ``Security'' as Defined
in Section 3(a)(10) of the Act
Several commenters expressed concern that the amendment may be
interpreted to permit SROs to trade futures contracts.\74\ In response,
the Commission reiterates its statement that SROs have the authority to
list and trade ``securities'' as defined in section 3(a)(10) of the
Exchange Act.\75\ The proposed amendment does not provide SROs with any
new authority to list a new derivative product that is not a
``security.'' If an SRO sought to trade a new derivative product that
is not a ``security,'' such as a futures contract, it would be required
to adhere to requirements of the Commodity Exchange Act (``CEA''),\76\
or other applicable laws, and the rules and regulations thereunder.\77\
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\74\ See note 56, supra.
\75\ 15 U.S.C. 78(c)(1)(j). 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'.''
\76\ 7 U.S.C. 1 et seq.
\77\ In response to the CFTC's request that the Commission
provide the CFTC with immediate notice of new derivative products
listed pursuant to the amendment (see CFTC Letter at 2, supra note
60), the Commission notes, as it previously stated in the Proposing
Release, that when an SRO submits trading rules, procedures and
listing standards for a particular product class to the Commission
for approval pursuant to section 19(b) of the Act, the Commission
publishes notice of the proposed rule change and provides an
opportunity for public comment. It is during this period that
interested parties, including the CFTC and futures markets, may
comment upon such issues as the characteristics of the specific
product class, including whether or not they believe the product
class has attributes of a futures contract. In addition, the
Commission reminds commenters that it stated in the Paperwork
Reduction Act section of the Proposing Release and the Instructions
for Completing Form 19b-4(e) that the public has access to the
information contained in Form 19b-4(e). The Commission now clarifies
that upon being filed by an SRO, Form 19b-4(e) will be publicly
available through the Commission's Public Reference Room. In
addition, the Commission will endeavor to make the Forms available
on the Commission's web site (see NYSE Letter at 2, supra note 59
and Proposing Release, supra note 1).
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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 seek to sell their futures contracts to U.S.
persons. Under the amendments to the CEA effected by the Futures
Trading Act of 1982,\78\ section 2(a)(1)(B) of the CEA 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.
In response to commenters' suggestions that the Commission develop an
expedited procedure for reviewing applications of futures exchanges to
trade stock index futures contracts, the Commission will make every
effort to continue to review requests in a timely fashion.\79\ The CEA
requires the CFTC 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. Section 2(a)(1)(B) also sets forth a specific timetable for
review of contract market designation for index futures by the SEC.
These statutory procedures are not affected by the amendment to Rule
19b-4.
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\78\ 7 U.S.C. 2(a)(1)(B).
\79\ See note 55, supra.
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2. Scope of the Amendment
An SRO seeking to list a completely new class of derivative
securities product must 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 promote fair and orderly trading for the
class of securities the SRO seeks to trade and protect investors.\80\
In response to commenters' concerns that the term ``product class'' may
be interpreted so narrowly that it would prevent effective use of the
amendment,\81\ the Commission intends that the term be interpreted
flexibly. Examples of ``product classes'' include, but are not limited
to: Broad-based index options; broad-based index warrants; narrow-based
index options; narrow-based index warrants; foreign currency index
options; foreign currency index warrants; PDRs; index fund shares; and
ELNs.\82\
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\80\ 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).
Accordingly, an SRO could not avoid the requirement of adopting
appropriate listing standards in order to rely on the amendment for
a novel new derivative securities product by simply listing such
product under the ``other security'' category.
\81\ See note 39, supra.
\82\ See notes 14, 15, 16, 17, and 18, supra.
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An SRO is not required to submit Form 19b-4(e) when listing Market
Index Target Term Securities (``MITTS'') or Stock Upside Note
Securities (``SUNS'') overlying an index for which the SRO previously
has listed options or warrants pursuant to Rule 19b-4(e) or for which
the SRO previously has
[[Page 70958]]
received Commission approval under section 19(b) for option or warrant
trading, provided that the SRO has received Commission approval under
section 19(b) to establish listing standards for ``other securities.''
\83\ The listing of MITTS or SUNS on such indices does not raise any
new regulatory issues that the Commission had not previously
considered. If, however, an SRO sought to list MITTS or SUNS overlying
an index for which the SRO had not previously listed options or
warrants pursuant to Rule 19b-4(e) or for which the SRO had not
previously received Commission approval under section 19(b) for option
or warrant trading, such SRO would be required to: Receive Commission
approval for trading rules, procedures and listing standards for MITTS
or SUNS product classes; or consult with the Commission, prior to
listing an individual MITTS or SUNS, in order to determine whether such
new individual MITTS \84\ or SUNS \85\ raised any new regulatory issues
that would preclude the SRO from relying on its ``other securities''
listing standards and therefore require a proposed rule change pursuant
to section 19(b).
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\83\ See Amex Letter at 6.
\84\ See e.g., Securities Exchange Act Release No. 32840
(September 2, 1993) 58 FR 47485 (September 9, 1993) (order approving
NYSE proposal to list and trade global telecommunications MITTS).
See also, Section 703.19 of the NYSE Listed Company Manual.
\85\ See e.g., Securities Exchange Act Release No. 35886 (June
23, 1995) 60 FR 33884 (June 29, 1995) (order approving Amex proposal
to list and trade SUNS on the Lehman Brothers European Stock
Basket). See also, section 107 of the Amex Company Guide.
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Commenters sought guidance regarding the specific criteria that
should be included in trading rules, procedures and listing
standards.\86\ The Commission, however, has determined not to specify
criteria in this release. Rather, the Commission believes that it would
be better able to provide assistance to an SRO in establishing specific
criteria after an SRO has considered what trading rules, procedures and
listing standards best suit its need and has submitted a proposed rule
change under section 19(b) to the Commission for its review.\87\
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\86\ See note 40, supra.
\87\ The Commission does not believe, however, that the SROs
that currently have the authority to list standardized options could
list broad-based index options pursuant to Rule 19b-4(e) without
first receiving Commission approval under section 19(b) for listing
standards for a broad-based index option class. See, Section IV. C.
1. Designation Of Index As Broad-Based Or Narrow-Based, infra.
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In addition, several commenters raised concerns regarding how the
term existing SRO ``trading rules, procedures, surveillance programs
and listing standards'' should be interpreted. Trading rules,
procedures, surveillance programs and listing standards for specific
product classes should be flexible enough to permit innovation within a
product class while maintaining compliance with section 6(b)(5) of the
Act which requires, among other things, that the rules of an exchange
be designed to prevent fraudulent and manipulative acts and practices,
to promote just and equitable principals of trade, and in general, to
protect investors and the public interest. For example, the Commission
has approved trading rules, procedures and listing standards for
generic narrow-based index options.\88\ An SRO can use these trading
rules, procedures and listing standards to list and trade narrow-based
index options or it can submit new trading rules, procedures and
listing standards for narrow-based index options to the Commission for
approval pursuant to section 19(b).\89\ With regard to product classes
that currently do not have trading rules, procedures and listing
standards, as one commenter suggests, the Commission generally would
encourage SROs to establish ranges or formulas for position limits,
margin requirements and other characteristics of new derivative
securities products.\90\
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\88\ See note 23, supra.
\89\ The Commission notes that the Generic Narrow-Based Index
Option Approval Order was drafted to require a filing under section
19(b)(3)(A) of the Act for Commission approval if an SRO sought to
list and trade options that satisfied the criteria of the Generic
Narrow-Based Index Option Approval Order. Therefore, in order to
rely on the amendment adopted today and not submit filings pursuant
to section 19(b)(3)(A) for options that satisfy the criteria of the
Generic Narrow-Based Index Option Approval Order, and SRO could
submit a proposed rule change for Commission approval to eliminate
the section 19(b)(3)(A) rule filing requirement from its existing
rules (see e.g. CBOE Rule 24.2). In the alternative, an SRO could
submit a proposed rule change to the Commission for approval of
completely new listing standards, trading rules and procedures in
order to rely on the amendment to Rule 19b-4 for purposes of listing
and trading narrow-based index options.
\90\ In response to commenters' request that SROs be permitted
to submit proposed rule changes that are effective immediately upon
filing, pursuant to section 19(b)(3)(A), in order to list and trade
new derivative securities that do not satisfy the provisions of Rule
19b-4(e) (see CBOE Letter at 12-13 and Phlx Letter at 2, supra note
62), the Commission must consider investor protection when
determining such a request. In order to utilize Rule 19b-4(e), an
SRO must have in place adequate trading rules, procedures,
surveillance programs and listing standards that pertain to the
class of securities covering the new product. Because a proposed
rule change submitted pursuant to section 19(b)(3)(A) is effective
immediately upon filing and is not subject to Commission review and
approval, the Commission is concerned that the approach suggested by
commenters could be used as an attempt to list and trade new
derivative products without developing adequate listing standards,
trading rules and procedures for such products. As a result, the
Commission believes that it would not be appropriate in the public
interest to permit SROs to submit proposed rule changes that are
effective immediately upon filing, pursuant to section 19(b)(3)(A),
in order to list and trade new derivative securities that do not
satisfy the provisions of Rule 19b-4(e).
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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 for a new class of new derivative securities product, the SRO
would qualify under the 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 amendment does not relieve an SRO from its obligation to
submit a proposed rule change when amending existing listing standards
for particular classes of securities.
B. Standards for All New Derivative Securities Products
The amendment is based 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 criteria it believes new derivative securities product proposals
must meet in order to be consistent with the Act.\91\ Two commenters
were concerned that the standards discussed in the Proposing Release
have always been obligations of the SROs generally, and should not be
elevated to a special status under the amendment.\92\ The Commission
does not intend to revise standards that SROs currently are required to
maintain, such as adequate systems capacity, to be
[[Page 70959]]
raised to a more important level under the amendment.
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\91\ The Commission wishes to clarify, in response to
commenters' concerns, that the criteria discussed in Section IV. B.
Standards For All New Derivative Securities Products applies to all
new derivative securities products including index based new
derivative securities products. The criteria in Section IV. C.
Additional Standards For Index Based New Derivative Securities
Products, infra, applies only to index based new derivative
securities products. See Phlx Letter at 2, supra note 50.
Accordingly, an SRO can utilize the amendment for non-index based
and index-based new derivative securities products provided that the
applicable criteria are satisfied.
\92\ See note 44, supra.
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Additionally, these commenters noted that some requirements
described in the Proposing Release, such as the functional separation
between the trading desk of a broker-dealer and the research persons
responsible for maintaining an index underlying a new derivative
securities product, extend beyond the control of SROs.\93\ As a result,
these commenters believe that SROs should not be held to a higher
standard than what they are currently held to, for the failure of
unaffiliated entities to satisfy certain requirements of the
amendment.\94\ The Commission does not intend to impose new
surveillance requirements on SROs through this amendment. Rather, the
Commission believes that SROs should continue to obtain written
representations, as they currently do, that the broker-dealer has
procedures in place that provide for a functional separation between
the trading desk and research department of the broker-dealer and that
ensure compliance with the functional separation.
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\93\ See note 43, supra. See also Section IV. C. 4. Functional
Separation Letter, infra.
\94\ The Proposing Release proposed that SROs ``ensure'' that
the standards discussed below were satisfied in order to rely on the
amendment.
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Therefore, in order to rely on the amendment, an SRO should
determine, in a manner consistent with the standards that have been
required of SROs in the past,\95\ that each new derivative securities
product meets the criteria for: 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.\96\ Specifically, an SRO should determine that it has adequate
information sharing agreements, clearance and settlement procedures,
systems capacity and transaction reporting procedures for underlying
securities.
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\95\ The Commission notes that an SRO currently must determine
that a new derivative securities product satisfies the SRO's listing
standards, trading rules and procedures, prior to listing such new
derivative securities product. The Commission seeks to clarify that
the standard for listing a new derivative securities product under
new Rule 19b-4(e) is no different.
\96\ As discussed in Section IV. G. Compliance With The Proposed
Amendment, if an SRO has not complied with the standards, the SRO
will not be permitted to rely on the new rule 19b-4(e).
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1. Information Sharing Agreements
In designing a new derivative securities product, the SRO should
determine 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 ISA that covers trading in the new derivative securities
product and its underlying securities in place between the SRO listing
or trading a derivative product and the markets trading the securities
underlying the new derivative securities product.\97\ 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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\97\ In response to the Amex's comments regarding an SRO's
ability to obtain the identity of the ultimate purchasers and
sellers of securities pursuant to a comprehensive ISA, (See Amex
Letter at 14, supra note 52), the Commission believes that a
comprehensive ISA should require that the parties provide each
other, upon request, information about market trading, clearing
activity and customer identity necessary to conduct an
investigation.
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For new derivative securities products based upon domestic
securities, the SRO should determine that the markets upon which all of
the U.S. component securities trade are members of the Intermarket
Surveillance Group (``ISG'').\98\ The ISG was formed to coordinate,
among other things, effective surveillance and investigative
information sharing arrangements in the stock and options markets.\99\
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 determine that 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.\100\ 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 an between the Commission and the foreign
regulator.\101\
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\98\ See ISG Agreement, dated July 14, 1983, amended January 20,
1990. The ISG members are: the Amex; the Boston Stock Exchange,
Incorporated; the CBOE; the Chicago Stock Exchange, Inc.; the
Cincinnati Stock Exchange, Incorporated; the NASD; the NYSE; the
PCX; and the Phlx. The major stock index futures exchanges joined
the ISG as affiliate members in 1990.
\99\ The Commission anticipates that systems that currently are
not national securities exchanges, or systems that have not yet been
developed, may register as national securities exchanges, and
therefore be regulated as an SRO, as a result of the companion
release adopted today (see Securities Exchange Act Release No. 40760
(December 8, 1998), supra note 30). Therefore, if a new SRO trades
component securities underlying a new derivative securities product
and is not a member of the ISG, the SRO seeking to list and trade
such new derivative securities product pursuant to Rule 19b-4(e)
should enter into a comprehensive ISA with the non-ISG SRO.
Conversely, if a new SRO seeks to list and trade a new derivative
securities product pursuant to Rule 19b-4(e) and is not a member of
the ISG, such SRO should enter into a comprehensive ISA with each
SRO that trades securities underlying the new derivative securities
product.
\100\ The Commission believes that in order for an SRO to
determine that a foreign country has no blocking or secrecy laws
that would prevent or interfere with the transfer of information
pursuant to a comprehensive ISA, an SRO can obtain written
verification in the comprehensive ISA or in a separate letter.
\101\ 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. Foreign
countries' securities or ADRs that are not subject to a comprehensive
ISA should not represent a significant percentage of the weight of such
an underlying instrument.\102\ The Commission recognizes that
commenters sought guidance regarding the percentage of comprehensive
ISA coverage standard for index based new derivative securities
products.\103\ The Commission is not specifying thresholds for ISA
coverage. Rather, the Commission will provide assistance to an SRO in
formulating the appropriate percentage of comprehensive ISA coverage
after an SRO has considered what standard best suits the needs of a
specific product class and has submitted a proposed rule change for
Commission approval in order to establish listing
[[Page 70960]]
standards that includes the percentage of comprehensive ISA
coverage.\104\
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\102\ 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.
\103\ See Amex Letter at 16, supra note 54.
\104\ See e.g., Securities Exchange Act Release No. 40157 (July
1, 1998) 63 FR 37426 (July 10, 1998) (order approving the listing
and trading of options on PDRs and index fund shares on the Amex)
for a discussion of an appropriate percentage of comprehensive ISA
coverage for the specific product class of options on PDRs and index
fund shares.
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As previously stated, commenters sought clarification regarding the
validity of comprehensive ISAs and MOUs with specific foreign countries
in order not to contact the Commission prior to listing new derivative
securities products.\105\ The Commission notes that a current
comprehensive ISA or MOU may not be valid in the future due to
political or legal changes in a particular foreign country. Therefore,
while the Commission understands the SROs' desire for certainty, it
does not believe that it is prudent to provide a list of currently
comprehensive ISAs and MOUs that may be invalid at the future time an
SRO seeks to list a new derivative securities product.\106\ An SRO may,
however, contact the Commission, at any time, as it develops new
derivative securities products to clarify that relevant comprehensive
ISAs and MOUs are still valid and to inquire if any new comprehensive
ISAs or MOUs have been determined to be valid. In addition, the
Commission will continue to work with the SROs, as it has in the past,
to develop MOUs with countries in which SROs are unable to sign
comprehensive ISAs.
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\105\ See Amex Letter at 16, supra note 53.
\106\ In addition, the Commission seeks to clarify that if an
SRO lists a new derivative securities product involving a
comprehensive ISA that is valid at the time the SRO relies on Rule
19b-4(e) but subsequently becomes invalid due to political or legal
changes in the foreign country, the SRO should contact the
Commission to determine what actions should be taken.
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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 settled based
on opening prices of the component stocks. If opening price settlement
is not utilized, the settlement value should reflect 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, a
recognized exchange rate should be used to convert the settlement value
into U.S. dollars. In addition, the SRO should determine that adequate
clearance procedures have been established for the new derivative
securities product.
3. Systems Capacity For New Derivative Securities Products
It is essential that the SRO and the applicable authority
responsible for collecting last sale data 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, determine that it has adequate systems
processing capacity to accommodate the new listing and obtain a
representation from the applicable authority responsible for collecting
``last sale data'' that such authority also has adequate systems
processing capacity.\107\
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\107\ The Commission notes that the language in the Proposing
Release required SROs to obtain representations regarding systems
capacity from applicable price reporting authorities. The Commission
has revised the language to require an SRO to obtain a
representation from the applicable authority responsible for
collecting ``last sale data,'' as that term is defined in Rule
11Aa3-1 under the Act. Based on comments received in response to the
Proposing Release (see Amex Letter at 10, supra note 47), the
Commission believes that the previous language could be interpreted
to be limited only to standardized index options. As a result, the
Commission believes that this revision is appropriate in order to
encompass all new derivative securities products that an SRO may
list and under the amendment to Rule 19b-4.
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In addition, in most circumstances, when the new derivative
securities product is index based, an index value should be
disseminated frequently and, if based on U.S. equities only, should
reflect last-sale prices. If an index is composed 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
promptly, and 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).\108\ Certain indices
may use quotes (e.g., a bond index) if last sale prices are unavailable
and the quotes are reliable and spread across multiple dealers.
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\108\ Securities Exchange Act Release No. 39244 (October 15,
1997) 62 FR 55289 (October 23, 1997).
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4. Transaction Reporting of Underlying Instruments
In order to prevent manipulation and ensure liquidity of
instruments 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.\109\ 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.\110\
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\109\ The Commission notes that this section in the Proposing
Release generally referred to underlying securities. Based on
comments received, the Commission has revised this section to
include all underlying instruments, such as foreign currencies
underlying a new derivative securities product (see Amex Letter 10,
supra note 48).
\110\ In the case of securities that are not subject to real-
time transaction reporting (e.g., municipal securities), bids and
offers disseminated by dealers through electronic means, provided
that services are generally used by industry participants and
contain a reasonable number of bids and offers entered with
reasonable frequency, may be used as an objective means of capturing
price information through disseminated quotations (see Amex Letter
at 10, supra note 48). See generally, Securities Exchange Act
Release No. 39495 (December 29, 1997) 63 FR 585 (January 6, 1998).
---------------------------------------------------------------------------
In response to the Amex's request for clarification regarding the
reporting requirements of underlying instruments, the Commission
believes that, in order to prevent fraudulent and manipulative acts and
practices and to protect investors and the public interest, underlying
foreign securities also should be subject to real-time transaction
reporting for an SRO to avail itself of Rule 19b-4(e). For individual
foreign securities underlying a new derivative securities product, an
SRO should determine that such securities satisfy and maintain all
criteria described in this release including the transaction reporting
requirement. In the case of multiple foreign securities underlying a
new derivative securities product, the Commission believes that no more
than a de minimis percentage of the weight of the underlying foreign
securities should be non-real-time reported. In the case of underlying
instruments that are not securities, such as foreign currencies, the
Commission believes that the same investor protection concerns are
applicable and therefore the SROs should endeavor to satisfy the
standards set forth above.\111\
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\111\ See Amex Letter at 10, supra note 48. See also, BEMI Latin
America Index Order, supra note 15.
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[[Page 70961]]
C. Additional Standards for Index Based New Derivative Securities
Products
In addition to the items discussed above, in order to rely on Rule
19b-4(e), SROs should determine 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 an 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
comprising 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).\112\ 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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\112\ Such a classification is necessary 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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For example, SROs need listing standards for broad-based index
option classes even if they have been approved previously for a
specific broad-based index option. Listing standards for specific
broad-based index options have been determined on a case-by-case basis
when such an SRO submits a section 19(b) rule filing and the Commission
approves such filing.\113\ In order for an SRO to avail itself of new
Rule 19b-4(e) to trade broad-based index options, an SRO would need to
propose general criteria for Commission review and approval for
classifying indices as broad-based under Section 19(b) of the Act.\114\
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\113\ The Commission deos not believe, for example, that, absent
a Commission approval order under Section 19(b) establishing
specific criteria for a particular index, CBOE Rule 24.2 regarding
``Designation of an Index'' provides adequate listing standards for
a broad-based index option class. CBOE Rule 24.2 states that ``the
component securities of an index option contract need not meet the
requirements of Rule 5.3 (Criteria for Underlying Securities). The
listing of a class of index options on a new underlying index will
be treated by the (CBOE) as a proposed rule change subject to filing
with and approval by the (SEC) under section 19(b) of the Act.''
Similarly, the Commission does not believe that, absent a Commission
approval order under section 19(b) establishing specific criteria
for a particular index, Amex Rule 901(C) regarding ``Designation of
Stock Index Options'' provides adequate listing standards for a
broad-based index option class.
\114\ The Commission does not believe that it is ``reasonable
and appropriate for SROs to employ'' the criteria discussed in the
Joint Policy Statement (Amex Letter at 6-10, supra note 49) for
purposes of classifying an index as broad-based. Rather, the
Commission believes that an SRO should develop specific listing
standards, trading rules and procedures that the SRO believes
adequately address the needs of a particular class of new derivative
securities and submit such listing standards, trading rules and
procedures as a proposed rule change for Commission review under
section 19(b) of the Act. Supra note 87.
---------------------------------------------------------------------------
As previously stated, commenters have concerns regarding the
implications on the futures markets of a securities exchange
categorizing an index as broad-based or narrow-based.\115\ The
Commission is required, under section 2(a)(1)(B) of the CEA, to analyze
the composition of an index underlying a stock future in order to
determine whether such index is broad-based. By its own terms, the CEA
does not apply to index based derivative securities products that trade
on securities SROs. Accordingly, when an SRO utilizes new Rule 19b-4(e)
to list an index based new derivative securities product, the CEA will
not be applicable. When the Commission reviews proposed listing
standards for index based derivative securities products, it must find
that such standards are consistent with the Exchange Act. The
Commission also notes that, when it reviews a stock index for futures
trading, the Commission is not bound by the determination of an SRO
regarding the classification of an index as broad-based or narrow-
based.
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\115\ See CME Letter at 3, supra note 58 and Amex Letter at 9,
supra note 57.
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2. Initial Inclusion Standards and Maintenance Criteria for Index
Components
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, equal-dollar weighted or modified equal-dollar
weighted).\116\ In addition, SROs must determine that the index
construction standards applied to the underlying securities provide
sufficient liquidity to 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 establish a maximum relative weight for the top
component and the five largest components. Maintenance criteria should
be designed to provide 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).\117\
---------------------------------------------------------------------------
\116\ See Generic Narrow-Based Index Option Approval Order,
supra note 23 and Generic Narrow-Based Index Warrant Approval
Orders, supra note 24.
\117\ Id.
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The Commission recognizes that commenters to the Proposing Release
sought detailed information regarding the initial inclusion and
maintenance of component securities and quantifiable standards
regarding the number, weight, and liquidity of component securities
that an index should maintain.\118\ The Commission, however, has
determined not to impose specific criteria on SROs regarding derivative
securities products discussed in this release. The specific criteria
should be based on the trading rules, procedures and listing standards
that best suit the needs of a particular class of new derivative
securities products and discussed with the Commission when a proposed
rule change is submitted to the Commission for its review.\119\
---------------------------------------------------------------------------
\118\ See Amex Letter at 11, supra note 49 and Amex Letter at
12, supra note 50.
\119\ If an SRO wanted to ensure that amendments to existing and
new derivative securities products, such as splitting an index or
changing the exercise style (see Phlx Letter at 2, supra note 64),
would not be considered to be proposed rule changes, such SRO could,
for example, include such types of amendments as part of its Rule
19b-4 filing for Commission review and approval of the listing
standards, trading rules and procedures for the relevant class of
derivative securities products. In this way, an SRO could notify the
Commission of such changes by submitting Form 19b-4(e).
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3. Component Changes
SRO listing standards should provide that component securities that
fail to meet the index maintenance standards
[[Page 70962]]
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 also should determine that components
are replaced promptly in the event of specified circumstances such as
corporate mergers or spin-offs.
4. Functional Separation Letter
When the index is maintained by a broker-dealer or an affiliate of
a broker-dealer, the SRO's listing standard should include a
requirement that the SRO obtain a letter from the broker dealer
representing that, prior to the listing of a new derivative securities
product, there will be a functional separation, such as a firewall,
between the trading desk of the broker-dealer and the research persons
responsible for maintaining the index. In addition, the broker-dealer
should represent that it has in place procedures to ensure compliance
with the functional separation. 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. 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.\120\
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\120\ Supra notes 43 and 93. See also, Section IV. B. Standards
For All New Derivative Securities Products, supra.
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D. Compliance With Other Federal Securities Laws
The Commission notes that the amendment does not relieve SROs from
any 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 \121\ under the Securities Act of
1933, as amended (``Securities Act''),\122\ and Rule 9b-1 \123\ under
the Exchange Act establish a disclosure framework specifically tailored
to the informational needs of investors in ``standardized options''
\124\ that are traded on an ``options market''.\125\ Under Rule 9b-1,
broker-dealers must provide an updated copy of the options disclosure
document (``ODD'') \126\ to each customer at or prior to the approval
of the customer's account for trading in standardized options.\127\
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 use the ODD.\128\ 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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\121\ 17 CFR 239.20. Form S-20 is used to register classes of
options under the Securities Act.
\122\ 15 U.S.C. 77a et seq.
\123\ 17 CFR 240.9b-1.
\124\ ``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).
\125\ ``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).
\126\ 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
\127\ The ODD may be used as a substitute for the traditional
prospectus.
\128\ 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 notes that the 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 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 19b-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 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 \129\ regulated
under the Investment Company Act of 1940, as amended (``ICA''),\130\
the product must comply with the ICA.
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\129\ See e.g., Investment Company Act Release No. 21979
(December 30, 1997) (exemptive order under the ICA permitting the
trading of a PDR on the Amex based on the Dow Jones Industrial
Average known as DIAMONDS SM Trust).
\130\ 15 U.S.C. 80a et seq.
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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.\131\ The Amex, CBOE, NYSE,\132\ 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.\133\
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 which are intended to ensure 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,
[[Page 70963]]
including trading in the underlying security or securities.\134\
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\131\ The Commission notes that in the companion release adopted
today (supra note 30), SROs are permitted to operate pilot trading
systems, subject to certain conditions, for up to two years, without
submitting a Rule 19b-4 filing to establish, among other things,
trading rules and procedures for the pilot trading system. The
Commission believes that it would not be appropriate in the public
interest to permit an SRO to list and trade new derivative
securities products that either have not been approved under section
19(b) of the Act or do not meet the criteria of Rule 19b-4(e).
\132\ 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. See also note 89, supra.
\133\ See e.g., Amex Rules 900c through 980C; CBOE Rules 24.1
through 24.8; and PCX Rules 7.1 through 7.18.
\134\ In response to comments from the Proposing Release (CBOE
Letter at 11, supra note 50), the Commission believes that current
surveillance programs are appropriate for existing classes of new
derivative securities products. New classes of derivative securities
products, however, may present unique issues that would require
different or additional surveillance programs. The Commission does
not believe that it would be appropriate to establish such standards
before the classes of derivative securities products have been
developed. Rather, the Commission believes that an SRO should
consult with the Commission when new classes of derivative
securities products are developed in order to formulate appropriate
surveillance programs.
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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 of Rule 19b-4(e).\135\ In
response to Proposing Release comments, 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.\136\ 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). This framework would not prevent an
SRO from using the amendment to immediately list a new derivative
securities product under its existing rules, and then, after the
Commission has approved a section 19(b) rule filing proposing new
position limits or margin requirements for the relevant product class,
impose new position limits or margin requirements for the new
derivative securities product.\137\
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\135\ The Commission notes that if an SRO does not have an
appropriate regulatory framework in place for a specific class of
new derivative securities product, the SRO would have to submit a
section 19(b)(2) rule filing. In response to commenters' request for
publication of a rule filing within 10 days of its submission to the
Commission if it is in proper form (see CBOE Letter at 13 and PXC
Letter at 2, supra note 63), the Commission will endeavor to
continue to review rule filings in a timely fashion.
\136\ See CBOE Letter at 7 and PCX Letter at 2, supra note 38.
\137\ 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 its
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).
---------------------------------------------------------------------------
Commenters suggest that amendments to existing derivative
securities products, or amendments to new derivative securities
products that are listed pursuant to the amendment to Rule 19b-4, such
as splitting an index or changing the exercise style, should not
require a proposed rule change pursuant to section 19b(2) of the
Act.\138\ The Commission believes that if the trading rules, procedures
and listing standards for the product class include criteria regarding
splitting an index, changing the exercise style or changing the
composition of the index, such changes would be permitted without being
considered a material change to the derivative securities product and a
proposed rule change pursuant to Section 19(b) would not be required.
---------------------------------------------------------------------------
\138\ Supra note 64.
---------------------------------------------------------------------------
F. Form of Notification to the SEC of New Derivative Securities Product
Listing Pursuant to the Amendment
In order for the Commission to maintain an accurate record of all
new derivative securities products traded on the SROs, it is adopting a
new form, Form 19b-4(e), to be filed by an SRO in order 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.\139\
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\139\ The Commission seeks to clarify that, upon being filed by
an SRO, Form 19b-4(e) will be publicly available through the
Commission's Public Reference Room. In addition, the Commission will
endeavor to make the Forms available on the Commission's web site,
supra note 77. See also, NYSE Letter at 2, supra note 59.
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G. Compliance With the Proposed Amendment
The Commission will review SRO compliance with the proposed
amendment through its routine inspections of the SROs. In order for the
Commission to determine whether an SRO has properly availed itself of
the proposed amendment, the SRO must 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.\140\
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\140\ 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.
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Such records available for Commission review for each new
derivative securities product would include, but are not limited to, a
copy of proposed Form 19b-4(e) under the Act, the information circular
distributed to members and the product description distributed to
investors (if such documents were distributed) and documentation of the
factual and numerical information regarding the new derivative
securities product's characteristics that 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.\141\ In
short, the Commission believes that when an SRO relies on the
amendment, such SRO should determine that its regulatory framework
adequately supports the listing and trading of any new derivative
securities product. Failure to comply with this requirement could mean
that the SRO may be in violation of the Act.\142\ If so, appropriate
measures would be taken, including, but not limited to, ordering
[[Page 70964]]
the SRO to remediate the deficiency or prohibiting opening transactions
in or discontinuing the listing of new derivative securities
products.\143\
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\141\ SROs have had over twenty years of experience undergoing
Commission inspections that have included examination of derivative
securities products. As such, the Commission believes that SROs are
familiar with the types of materials that should be available during
a Commission inspection. See Amex Letter at 18, supra note 50. If an
SRO desired to establish a list of the specific information it would
provide to the Commission upon inspection, the SRO may submit such
list for Commission review as part of its proposed rule change under
section 19(b) of the Act to establish listing standards, trading
rules and procedures for each product class.
\142\ The Commission notes that the amendment should eliminate
approximately 45 SRO rule filings each year. The Commission believes
that the determination as to whether or not a specific previous SRO
rule filing for a derivative securities product would have satisfied
the conditions of the amendment is based upon the listing standards,
trading rules and procedures that an SRO may develop in response to
the adoption of the amendment (see Amex Letter at 19, supra note
34). The Commission reiterates that examples of classes of new
derivative securities products are: Broad-based index options;
broad-based index warrants; narrow-based index options; narrow-based
index warrants; foreign currency index options; foreign currency
index warrants; PDRs; index fund shares; and ELNs. Supra notes 14,
15, 16, 17 and 18. Some classes may not currently satisfy the
requirements of new Rule 19b-4(e). Supra Section IV. C. 1.
Designation Of Index As Broad-Based Or Narrow-Based.
\143\ See section 19(h) of the Act, 15 U.S.C. 78s(h). The
Commission could also use its inspection authority to review whether
an SRO has established appropriate procedures.
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V. Technical Changes
Because the Commission is adopting a new paragraph (e) to Rule 19b-
4 under the Act, Form 19b-4 under the Act \144\ 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 is amended by
revising the first sentence in Exhibit 1, IV 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.''
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\144\ 17 CFR 249.819.
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VI. Conclusion
For the reasons discussed above, the Commission believes that
amending Rule 19b-4 under the Act will reduce signficantly the SROs'
regulatory burden and help SROs maintain their competitive balance with
the overseas and OTC derivatives markets. The amendment to Rule 19b-4
provides guidelines for SROs seeking to rely on it but removes the need
for Commission 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.\145\
Furthermore, the Commission will maintain regulatory oversight over the
SROs' new derivative securities product listing, trading and
surveillance through its routine inspection process. Thus, while the
amendment reduces the recordkeeping and reporting obligations of the
SROs, investor protection is maintained through regular inspection
oversight.
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\145\ As previously stated, the Commission anticipates that the
amendment will eliminate approximately 45 SRO filings each year
pursuant to Rule 19b-4 and Form 19b-4, supra note 142. In addition,
the Commission believes that the amendment reduces the recordkeeping
and reporting requirements, pursuant 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.
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The Commission believes that the amendment offers benefits for
investors. The 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
believes that the amendment will not result in any additional costs for
U.S. investors or others. The amendment should 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 amendment's impact
on efficiency, competition and capital formation and believes that it
would promote these three objectives.\146\ Finally, the Commission
believes that the SROs will spend significantly less time filling out
the form to be used under the 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.\147\
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\146\ 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.
\147\ Because the amendment constitutes a ``major rule'' within
the meaning of the Small Business Regulatory Enforcement Fairness
Act of 1996, 5 U.S.C. 801 et seq., the amendment will take effect 60
days after the date of publication in the Federal Register.
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VII. Costs and Benefits of the Amendment
A. Benefits
To assist the Commission in its evaluation of the costs and
benefits that may result from the amendment, commenters were requested
to provide analysis and data, if possible, relating to costs and
benefits associated with the proposal herein. No comments were received
regarding this request. The Commission believes that the amendment will
reduce SRO compliance burdens under Rule 19b-4. The amendment should
reduce significantly the SROs' regulatory burden and help SROs maintain
their competitive balance with the overseas and OTC derivative markets.
Moreover, the Commission believes that the amendment will foster
innovation and create a streamlined procedure for SROs to list promptly
new derivative securities products subject to appropriate listing
standards.
The Commission believes that the amendment would be considered a
``major'' rule because it is anticipated to result in an annual
beneficial effect on the economy of $100 million or more. The
Commission estimates that because SROs will, on average, list and trade
45 new derivative securities products per year 90 days sooner under the
amendment, broker-dealers and investors will, on average, have 90
additional days per new derivative securities product to derive
significant financial benefits. The Commission has collected data on
the first 90 days of trading activity, including share volume and
dollar volume, from several currently trading SRO new derivative
securities products that could have relied on new Rule 19b-4(e), had
the amendment been in effect when the SRO sought to list and trade such
new derivative securities products.\148\ Based on an analysis of this
data, the Commission believes that increased transaction volumes from
new derivative securities products could exceed $100 million each year.
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\148\ For example, during the fist 90 days of trading,
DIAMONDSSM Trust (supra note 129) (Securities Exchange
Release No. 39525 (January 8, 1998) 63 FR 2438 (January 15, 1998))
traded a total of 52,672,500 shares valued at $4,452,065,077 or an
average of 741,866 shares per day valued at an average of
$62,705,142 per day. During the first 90 days of trading, SPDRs
(supra note 16) traded a total of 12,138,900 shares valued at
$540,575,938 or an average of 183,923 shares per day valued at an
average of $8,190,545 per day. In addition, the Commission analyzed
data on: Market Index Target Term Securities on the S&P 500 Index
trading on the Amex; Lehman Brothers European Stock Basket Stock
Upside Note Securities trading on the Amex (supra note 85); and
options on The Tobacco Index trading on the Amex (Securities
Exchange Act Release No. 38693 (May 29, 1997) 62 FR 30914 (June 5,
1997)).
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B. Costs
The Commission notes that the amendment provides an alternative
approach for SROs to list and trade new derivative securities products.
The Commission is not requiring SROs to incur any additional costs as a
result of the amendment. An SRO may continue to operate under the
current regulatory framework and submit a proposed rule change under
section 19(b) of the Act to list and trade every new derivative
securities products. If an SRO chooses to avail itself of the
amendment, the Commission notes that most SROs already have in place
appropriate listing standards, trading rules, procedures and
surveillance programs for certain product classes such as PDRs and
index fund shares and therefore would not incur any costs by relying on
the
[[Page 70965]]
amendment for these products. The Commission believes that an SRO could
use its past experience with listing and trading new derivative
securities products in order to establish listing standards, trading
rules, procedures and surveillance programs for product classes that
currently would not be covered by the amendment, such as broad-based
index options. Consequently, the Commission believes that an SRO would
incur nominal costs associated with developing and receiving Commission
approval for listing standards, trading rules, procedures and
surveillance programs for product classes that currently would not be
covered by the amendment.
VIII. Effects on Competition, Efficiency and Capital Formation
Section 23(a)(2)\149\ 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. In the Proposing Release, the Commission solicited
comments on the effects on competition, efficiency and capital
formation of the amendment, in general, and the potential competitive
effects across markets, in particular. Specifically, the Commission
requested commenters to address whether the proposed amendment would
generate the anticipated benefits or impose any costs on U.S. investors
or others. The Commission received no comments regarding these issues.
The Commission has considered the amendment in light of the standards
cited in section 23(a)(2) of the Act and believes that it would not
impose any burden on competition not necessary or appropriate in
furtherance of the Exchange Act.
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\149\ See 15 U.S.C. 78w(a)(2).
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Securities SROs potentially compete with futures markets when a
securities SRO seeks to list and trade a broad-based index option and a
futures market seeks contract market designation for a futures contract
overlying the same broad-based index. This constitutes only a small
portion of the new derivative securities products that Rule 19b-4(e)
will cover. While utilizing Rule 19b-4(e) may result in the securities
SROs providing broad-based index options to investors more quickly than
they currently do, it is not certain whether the effect of Rule 19b-
4(e) would result in the securities SROs listing broad-based index
options sooner than the futures markets listing similar broad-based
index futures. Nevertheless, to the extent that it could be argued that
this may be a possible effect of Rule 19b-4(e) in a particular case,
the Commission notes that its jurisdiction over stock index futures is
limited to reviewing such products under the criteria set forth in
section 2(a)(1)(B) of the CEA. Stock index futures must be approved by
the CFTC, not the Commission. To the extent that the Commission does
review such products under the requirements of the CEA, the Commission
must adhere to the 45 day time period set forth in the statute. Despite
the Commission's lack of jurisdiction in actually approving such
products for trading on a futures market, the Commission has committed
to be sensitive to the time involved in its review and has stated in
this release that it will make every effort to continue to review
requests in a timely fashion. As a result, the Commission believes that
the ability of a securities SRO to use the new regulatory framework of
Rule 19b-4(e) will not impose a burden on competition but will instead
promote competition because securities SROs can choose to provide new
derivative securities products to investors more quickly than under the
current regulatory framework. This will allow securities SROs to list
and trade new derivative securities products, on average, 90 days
earlier than under the current regulatory framework.
The Commission also notes that generally OTC derivatives can begin
trading sooner than exchange traded new derivative securities products
because there is no prior Commission approval required for OTC
derivatives as there is for exchange traded new derivative securities
products under section 19(b) of the Act. The Commission believes that
because OTC derivatives are highly customized among individual parties,
exchange traded new derivative securities products do not always
compete with OTC derivatives. Nonetheless, Rule 19b-4(e) may
potentially have a competitive impact in this area because an SRO will
be able to list a new derivative securities product, pursuant to Rule
19b-4(e), more quickly than under the existing regulatory framework.
The Commission believes that the ability of an SRO to use the new
regulatory framework of Rule 19b-4(e) will not impose a burden on
competition but will instead promote competition because SROs could
provide new derivative securities products to investors more quickly
than under the current regulatory framework. This will allow securities
SROs to compete more equally with the OTC market.
Finally, the Commission believes that the amendment will reduce SRO
compliance costs and will enable SROs to compete more effectively with
overseas derivative markets. The Commission believes that SROs should
be able to bring new derivative securities products to market more
quickly to provide investors with tailored products that directly meet
their evolving investment needs.\150\ SROs have had over 20 years of
experience with Commission 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
must be considered when listing and trading such new derivative
securities products. Thus, the Commission believes that there is less
need for its review, notice and approval prior to an SRO listing and
trading a particular new derivative securities product pursuant to
existing SRO trading rules, procedures, surveillance programs and
listing standards. Furthermore, the Commission believes that the
procedures discussed in this release will enable the Commission to
continue effectively protect investors and promote the public interest.
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\150\ The Commission also believes that the amendment will
benefit broker-dealers. See IX. Summary of Final Regulatory
Flexibility Act Analysis, infra.
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IX. Summary of Final Regulatory Flexibility Act Analysis
In the Proposing Release, the Commission prepared an Initial
Regulatory Flexibility Act Analysis (``IRFA'') an accordance with 5
U.S.C. 605(b) regarding the amendment to Rule 19b-4 and Form 19b-4(e)
under the Exchange Act. No comments were received in response to the
IRFA. In addition, the Commission notes that Form 19b-4(e) is being
adopted without any changes and Rule 19b-4(e) is being adopted in
substantially the same format that it was proposed.\151\ As a result,
the Commission has prepared a Final Regulatory Flexibility Analysis
(``FRFA'') in substantially the same form as the IRFA. The following
summarizes the FRFA.
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\151\ See IV.A. Definition of ``New Derivative Securities
Product'', supra, for a complete discussion of the technical changes
to the definition of new derivative securities product in response
to commenters' requests for clarification.
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The FRFA sets forth the statutory authority for the proposed
amendment
[[Page 70966]]
to Rule 19b-4. The FRFA 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.\152\ 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
FRFA.\153\ The FRFA 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.\154\ As a result, broker-dealers will have additional days to
earn income through trading such new derivative securities products. As
of December 31, 1997, the Commission estimated that there were over 870
options market makers and specialists that may be considered small
entities.\155\
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\152\ 17 CFR 240.0-10(c). The Commission notes that SROs and
most issuers listed on a national securities exchange or The Nasdaq
Stock Market would not be considered ``small entities'' under Rule
0-10.
\153\ The Commission recently amended its small business
definition for broker-dealers. See Securities Exchange Act Release
No. 40122 (June 24, 1998) 63 FR 35508 (June 30, 1998) at note 32.
Because the IRFA for this proposal relied on the old definition,
which is broader, the FRFA also relies on the old definition.
\154\ See note 148, supra.
\155\ 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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As previously stated, the Commission estimates that new Rule 19b-
4(e) will eliminate approximately 45 SRO filings each year pursuant to
Rule 19b-4 and Form 19b-4. The Commission has collected data on the
first 90 days of trading activity, including share volume and dollar
volume, from several currently trading SRO new derivative securities
products that could have relied on new Rule 19b-4(e), had the amendment
been in effect when the SROs sought to list and trade such new
derivative securities products.\156\ Based on this data, the Commission
believes that broker-dealer small entities will benefit substantially
from new Rule 19b-4(e).
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\156\ See note 148, supra.
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The FRFA states that the amendment would not impose any new
reporting, recordkeeping or compliance requirements on broker-dealer
small entities. Any new reporting, recordkeeping or compliance burdens
will rest with the SROs, not broker-dealer small entities.
The FRFA discusses the various alternatives considered by the
Commission in connection with the 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
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 amendment for small entities. The Commission also
believes that it would be inconsistent with the purposes of the
Exchange 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 FRFA includes quantifiable information concerning the number of
small entities that would be affected by the proposed rule amendment. A
copy of the FRFA 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.
X. Paperwork Reduction Act
The amendment contains a ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act of 1995 (44 U.S.C.
3501 et seq.). Accordingly, the Commission submitted the collection of
information requirements contained in the amendment to the Office of
Management and Budget (``OMB'') for review and were approved by OMB
which assigned Form 19b-4(e) control number 3235-0504. The collection
of information is in accordance with Section 3507 of the PRA.\157\
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\157\ 44 U.S.C. 3507.
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The collection of information obligations imposed by the amendment
is mandatory. The information filed pursuant to the amendments will not
be kept confidential and therefore will be available to the public. An
agency may not conduct or sponsor, and a person is not required to
comply with, a collection of information unless it displays a currently
valid OMB control number.
The collection of information is necessary for persons to obtain
certain benefits or to comply with certain requirements. The amendment
to which the collection of information relates is necessary as a means
for the Commission to maintain accurate records of new derivative
securities products that are traded. The Commission solicited public
comment on the collection of information requirements contained in the
Proposing Release. The Commission received no comments that addressed
the PRA portion of the release.
The title for the collection of information is: ``Form 19b-4(e)
Under the Securities Exchange Act of 1934.'' The collection of
information requires 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. The 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.
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, however,
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
maintain, on-site, a copy of proposed Form 19b-4(e). The SROs are
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
[[Page 70967]]
recordkeeping requirements set forth in Rule 17a-1 under the Act.\158\
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\158\ 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 140.
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XI. Statutory Basis
The amendment to Rule 19b-4(e) under the Exchange Act is being
adopted 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 Final Rule
List of Subjects 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 amended as follows:
PART 240--GENERAL RULES AND REGULATIONS SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for part 240 continues 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, 781, 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, in whole or in part, upon the
performance of, or interest in, 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:
(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 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
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)).
BILLING CODE 8010-01-M
[[Page 70968]]
[GRAPHIC] [TIFF OMITTED] TR22DE98.020
[[Page 70969]]
[GRAPHIC] [TIFF OMITTED] TR22DE98.021
By the Commission.
Dated: December 8, 1998.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33300 Filed 12-21-98; 8:45 am]
BILLING CODE 8010-01-C