[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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.''
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \59\ NYSE Letter at 2.
    \60\ CFTC Letter at 2.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \78\ 7 U.S.C. 2(a)(1)(B).
    \79\ See note 55, supra.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \115\ See CME Letter at 3, supra note 58 and Amex Letter at 9, 
supra note 57.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \120\ Supra notes 43 and 93. See also, Section IV. B. Standards 
For All New Derivative Securities Products, supra.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.''
---------------------------------------------------------------------------

    \144\ 17 CFR 249.819.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \149\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \150\ The Commission also believes that the amendment will 
benefit broker-dealers. See IX. Summary of Final Regulatory 
Flexibility Act Analysis, infra.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \156\ See note 148, supra.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \157\ 44 U.S.C. 3507.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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