[Federal Register Volume 64, Number 127 (Friday, July 2, 1999)]
[Notices]
[Pages 36055-36057]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-16866]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41557; File No. SR-Amex-99-09]


Self-Regulatory Organizations; American Stock Exchange LLC; Order 
Granting Approval to Proposed Rule Change and Amendment No. 1 to the 
Proposed Rule Change Amending Amex Rule 901C To Allow Modified Equal-
Dollar and Modified Capitalization Weighting Calculation Methodologies 
for Narrow-Based Index Options

June 24, 1999.
    On March 1, 1999, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
19b-4 thereunder.\2\ The filing was amended on March 12, 1999 to 
provide additional information on modified weighting methodologies.\3\ 
The proposed rule change would amend Commentary .02 to Amex Rule 901C 
to add modified equal-dollar weighting and modified capitalization 
weighting as acceptable weighting calculation methodologies for the 
construction of narrow-based index options.\4\ Notice of the proposed 
rule change, as amended, was published in the Federal Register on April 
20, 1999.\5\ The Commission did not receive any comment letters on the 
filing. This Order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Scott G. Van Hatten, Legal Counsel, Amex, to 
Nancy Sanow, Senior Special Counsel, Commission, dated March 11, 
1999.
    \4\ The Exchange refers to narrow-based index options as options 
on a ``stock index industry group.'' A stock index industry group is 
defined in the Amex Rules as a group of stocks representing a 
particular industry or related industries. See Amex Rule 900C(b)(1).
    \5\ Securities Exchange Act Release No. 41276 (April 12, 1999) 
64 FR 19393.
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I. Introduction and Background

    The Exchange proposes to amend Amex Rule 901C to add modified 
equal-dollar weighting and modified capitalization weighting as 
acceptable weighting calculation methodologies for the construction of 
narrow-based index options. Commentary .02 to Amex Rule 901C permits 
the Exchange to list options on stock industry index groups if the 
index meets certain criteria. Presently, the criteria require the index 
to be calculated using the capitalization, price, or equal-dollar 
weighting methodologies. Several other indexes which use a modified 
capitalization weighting methodology, however, including the 
Inter@ctive Week Internet Index, the Nasdaq-100 Index, and the Amex 
Eurotop 100 Index, were individually approved by the Commission as 
indexes that may underlie index options.\6\ The Amex Mexico Index and 
the Amex Networking Index, which use a modified equal-dollar weighting 
index calculation methodology, were also approved by the Commission as 
indexes that may underlie index options.\7\
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    \6\ Securities Exchange Act Release No. 41124 (March 1, 1999) 64 
FR 11520 (March 9, 1999) (File No. SR-Amex-99-04) (Inter@ctive 
Internet Index); Securities Exchange Act Release No. 40642 (November 
5, 1998) 63 FR 63759 (November 16, 1998) (File No. SR-CBOE-98-43) 
(Nasdaq-100 Index); Securities Exchange Act Release No. 30463 (March 
11, 1992) 57 FR 9284 (March 17, 1992) (File Nos. SR-Amex-90-25 and 
SR-Amex-91-01) (Amex Eurotop 100 Index).
    \7\ Securities Exchange Act Release No. 34500 (August 8, 1994) 
59 FR 41534 (August 12, 1994) (File No. SR-Amex-94-20) (Amex Mexico 
Index); Securities Exchange Act Release No. 37017 (March 22, 1996) 
61 FR 14168 (March 29, 1996) (File No. SR-Amex-96-03) (Amex 
Networking Index).
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II. Description of the Proposal

    The Exchange proposes to include modified capitalization and 
modified equal-dollar weighting calculation methodologies in Commentary 
.02 to Amex Rule 901C. Increasingly, the Exchange receives requests to 
construct new indexes using the modified capitalization or modified 
equal-dollar weighting methodologies to enable the proposed indexes to 
meet the generic criteria for narrow-based indexes, to provide for the 
timely trading of options on newly proposed indexes, or similar 
reasons. The Exchange wishes to accommodate these requests, and 
proposes to add these methodologies to the existing narrow-based 
criteria set forth in Commentary .02 of Amex Rule 901C that permits the 
listing of options on stock index groups pursuant to Rule 19b-4(e) 
under the Act.\8\ Use of these methodologies should allow the Exchange 
greater flexibility in developing indexes and facilitate the listing of 
options on stock industry index groups that more accurately reflect the 
industry represented by the index.
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    \8\ 17 CFR 240.19b-4(e)
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Modified Capitalization Weighting

    To determine an index value using the capitalization weighting 
calculation methodology, the following calculation applies: Multiplying 
the primary exchange regular way last sale price of each component 
security by the number of shares outstanding; adding the products; and 
dividing the result by the current index divisor. The index value for a 
modified capitalization weighted index is calculated in a similar 
manner. However, instead of using the actual number of shares 
outstanding, an adjusted number of shares outstanding is used in the 
calculation (i.e., multiplying the primary exchange regular way last 
sale price of each component security by the adjusted number of shares 
outstanding; adding the products; and then dividing the result by the 
current index divisor). The modified capitalization weighting 
methodology uses an adjusted number of shares outstanding to prevent 
components with relatively large market capitalizations from 
representing an inordinately large portion of an index's value. For 
example, inclusion of a large

[[Page 36056]]

capitalization company in an index along with a number of smaller 
capitalization companies may result in the larger capitalization 
company's representation in the index exceeding 25% of the index's 
value. Thus, options on these indexes could not be listed on the Amex. 
However, since use of the modified capitalization methodology permits a 
reduction in the large capitalization company's representation in the 
index to an amount less than 25% of the index's value, the listing 
criteria of Amex rule 901C, Commentary .02(a)(7) are satisfied.

Modified Equal-Dollar Weighting

    Use of the equal-dollar weighting calculation methodology to 
determine an index value is accomplished by establishing an initial 
dollar representation (e.g., $100,000); determining the number of 
shares of each component representing this amount; and then multiplying 
the primary exchange regular way last sale price of each component 
security by its predetermined fixed number of shares. The equal-dollar 
weighted methodology can be used to provide more equitable 
representation of each component in a particular index. Modified equal-
dollar weighting methodology is useful when the capitalization of 
companies within an index varies widely, by permitting larger 
capitalized companies to represent a larger portion of an index's 
value.
    In effect, the modified equal-dollar weighting methodology is the 
mirror image of the modified capitalization weighting methodology. 
While the modified capitalization weighting methodology prevents large 
capitalization companies from skewing an index, the modified equal-
dollar weighting methodology guards against small capitalized companies 
from doing so. Determining an initial index value for modified equal-
dollar weighted indexes uses two or more fixed dollar values for 
different groups of the index components instead of using the same 
fixed dollar value for each component. In this way, the modified equal-
dollar weighted method allows for similar component stocks to be 
weighted similarly, while differentiating among dissimilar groups 
(e.g., large capitalization stocks versus small capitalization stocks). 
For example, a ten stock index, calculated under this method, that has 
five components with capitalizations of approximately $1 billion (or $5 
billion in aggregate) and five components with capitalizations of 
approximately $500 million (or $2.5 billion in aggregate), allows the 
larger capitalization components to account for twice the amount of the 
smaller capitalized components, rather than having each component 
account for 10% of the index (as would be the case in a pure equal-
dollar weighted index). Thus, the modified structure can be used to 
provide a more accurate representation of the market capitalization 
composition of the underlying industry for which the index is designed 
to measure.

III. Discussion

    Under the Act, self-regulatory organizations (``SROs'') like the 
Amex are assigned rulemaking and enforcement responsibilities to 
perform their role in regulating the securities industry for the 
protection of investors and other related purposes. This role has 
particular importance in the context of the listing of narrow-based 
stock index options under Rule 19b-4(e), since the Exchange is the only 
regulatory authority reviewing such securities before their trading 
begins. The Commission recently adopted new Rule 19b-4(e),\9\ 
eliminating the requirement that an SRO file a proposal under Section 
19(b)(3)(A) \10\ to list and trade options on narrow-based indexes, 
provided that the SRO relying on Rule 19b-4(e) has generic listing 
criteria approved by the Commission and meets certain other 
requirements. With the approval of the proposed rule change, Amex will 
be permitted under Rule 19b-4(e) to introduce new options that are 
based on narrow-based stock indexes using modified capitalization or 
equal-dollar weightings, but without the Exchange having to file a 
proposal under Section 19(c)(3)(A) of the Act.
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    \9\ See Securities Exchange Act Release No. 40761 (December 8, 
1998) 63 FR 70952 (December 22, 1998) (amending Rule 19b-4 with 
respect to rule filing requirements for SROs listing and trading a 
new derivative securities product).
    \10\ 15. U.S.C. 78s(b)(3)(A).
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    Pursuant to Section 19(b)(2) of the Act,\11\ the Commission is 
required to approve an SRO's proposed rule change if the Commission 
determines that the proposal is consistent with the applicable 
statutory standards. The Commission finds that the proposal is 
consistent with the requirements of Section 6(b) of the Act \12\ in 
general, and particularly furthers the objectives of Section 6(b)(5) of 
the Act,\13\ in that it is designed to promote just and equitable 
principles of trade and further the protection of investors and the 
public interest by increasing flexibility in developing an index by 
allowing an index to more accurately reflect an underlying industry 
sector. This enhanced flexibility and accuracy should also foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities, and remove impediments to, and perfect the 
mechanisms of, a free and open market and a national market system. As 
represented by the Exchange, modifying the capitalization amounts or 
dollar values of the securities underlying an index can prevent an 
individual stock from inappropriately skewing the performance of an 
entire index. The Commission therefore believes that market accuracy 
and transparency should be correspondingly enhanced by use of the 
modified capitalization and modified equal-dollar weighting methods, 
and approves them for use in the context of Commentary .02 to Amex Rule 
901C concerning eligibility criteria for index components of a narrow-
based stock index.
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    \11\ 15 U.S.C. 78s(b)(2).
    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that the Exchange has represented that it will 
review the component weighings of indexes employing the modified 
capitalization weighting methodology quarterly, and if necessary, 
adjust them to ensure that the index continues to meet the weighting 
guidelines. In addition, the Exchange has further represented that 
adjustments will be made on an intra-quarterly basis, as necessary, to 
reflect corporate actions, share issuances and repurchases, and other 
events of significance.
    With regard to the use of the modified equal-dollar weighting 
methodology, the Commission notes that the Exchange has represented 
that the number of shares of each component security will be examined 
and, if necessary, adjusted quarterly, so that the members of each 
weighting group are set to the appropriate index weight to ensure 
compliance with the criteria. The number of shares of each component 
stock in the index portfolio will remain fixed between quarterly 
reviews, except in the event of corporate actions such as the payment 
of a dividend other than an ordinary cash dividend, stock distribution, 
reorganization, recapitalization, or similar event with respect to the 
component stocks. In the event of a merger or consolidation of an 
issuer of a component stock, if the stock remains in the index, the 
number of shares of that security in the portfolio may be adjusted to 
the nearest whole share, to maintain the component's relative weight in 
the index at the level immediately prior to the corporate action. In 
the event of a stock addition or replacement, the average dollar value 
of the remaining components in the same weighting group will be

[[Page 36057]]

calculated, and that amount invested in the stock of the new component 
to the nearest whole share. In all cases, the divisor will be adjusted, 
if necessary, to ensure index continuity.
    The Commission further notes that the Exchange has represented that 
the terms of any modified capitalization or modified equal-dollar 
weighting calculation methodology will be clearly defined, and will 
consist of objective standards that permits any newly developed narrow-
based index initially to meet, and subsequently, to continue to be 
maintained, in accordance with the generic criteria set forth in 
Commentary .02 to Amex Rule 901C. In addition, the Exchange has 
represented that these terms will be discussed in marketing materials 
describing the index and in the Information Circulars the Exchange will 
distribute to members upon the launch of new index options.

IV. Conclusion

    The Commission finds that the proposed rule change is consistent 
with the Act, and in particular, with Section 6(b)(5).
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposal, SR-Amex 99-09, be and hereby is 
approved.\15\

    \14\ 15 U.S.C. 78s(b)(2).
    \15\ In approving the proposal, the Commission has considered 
the rule's impact on efficiency, competition, and capital formation. 
15 U.S.C. 78c(f).
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    For the Commission, by the Division of Market Regulations, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-16866 Filed 7-1-99; 8:45 am]
BILLING CODE 8010-01-M