[Federal Register Volume 65, Number 16 (Tuesday, January 25, 2000)]
[Notices]
[Pages 4010-4012]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1737]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42346; File No. SR-Phlx-99-57]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the 
Philadelphia Stock Exchange, Inc. Relating to the Permanent Approval of 
the Elimination of Position and Exercise Limits for FLEX Equity Options

January 18, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on January 4, 2000, the Philadelphia Stock 
Exchange, Inc. (``Phlx'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I and II below, which Items have been 
prepared by the Phlx. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Phlx requests permanent approval for the elimination of position 
and exercise limits \3\ on Flexible Exchange Options on equity 
securities (``FLEX equity options'').
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    \3\ Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market (i.e.,  
aggregating long calls and short puts or long puts and short calls) 
that can be held or written by an investor or group of investors 
acting in concert. Exercise limits prohibit an investor or group of 
investors acting in concert from exercising more than a specified 
number of puts or calls in a particular class within five 
consecutive business days.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item III below. The self-regulatory 
organization has prepared summaries, set forth in Sections A, B, and C 
below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Phlx requests permanent approval of the pilot program 
eliminating position and exercise limits on FLEX equity options. FLEX 
equity options at the Phlx have been trading since January 1998.\4\ The 
Commission approved the elimination of position and exercise limits on 
FLEX equity options, on a two-year pilot basis, concurrently with the 
approval of the trading of FLEX equity options.\5\
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    \4\ Securities Exchange Act Release No. 39549 (January 14, 
1998), 63 FR 3601 (January 23, 1998) (approving SR-Phlx-96-38).
    \5\ The Commission notes that it recently approved identical 
proposed rule changes from the American Stock Exchange, Chicago 
Board Options Exchange and the Pacific Exchange. See Securities 
Exchange Act Release No. 42223 (December 10, 1999), 64 FR 71158 
(December 30, 1999) (approving SR-Amex-99-40, SR-PCX-99-41, and SR-
CBOE-99-59).
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    In addition to eliminating position and exercise limits, the pilot 
program required that a member or member organization (other than a 
Specialist or Registered Options Trader) report to the Exchange 
information for each account that maintains a position on the same side 
of the market in excess of the position limit established pursuant to 
the applicable exchange rule for Non-FLEX Equity options of the same 
class. The report included information regarding the FLEX Equity option 
position, positions in any related instrument, the purpose or strategy 
for the position, and the collateral used by the account.\6\
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    \6\ The Exchange also required that an updated report be filed 
when a change in the options position occurred or when a significant 
change in the hedge of that position occurred.
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    Furthermore, the Commission, in its order approving the pilot 
program, required the Exchange to submit a report containing a 
description of: (i) the types of strategies used by FLEX Equity options 
market participants and whether FLEX Equity options are being used in 
lieu of existing standardized equity options; (ii) the type of market 
participants using FLEX Equity option both before and during the pilot 
program, including how the utilization of FLEX Equity options has 
changed; (iii) the average size of FLEX Equity option contracts both 
before and during the pilot program, the size of the largest FLEX 
Equity option contract on any given day both before and during the 
pilot program, and the size of the largest FLEX Equity option held by 
any single customer/member both before and during the pilot program; 
and (iv) any impact on the prices of underlying stocks during the 
establishment or unwinding of FLEX positions that are greater than 
three times the standard position limit. Phlx filed its report, which 
will be discussed below, on July 15, 1999.
2. Statutory Basis
    The basis under the Act for the proposed rule change is the 
requirement under Section 6(b)(5) \7\ that an Exchange have rules that 
are designed to promote just and equitable principles of trade, to 
remove impediments to, and perfect the mechanism of a free and open 
market and, in general, to protect investors and the public interest.
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    \7\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change will impose no burden on competition.

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

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

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Room, located at the above address. 
Copies of such filing will also be available for inspection and copying 
at

[[Page 4011]]

the principal office of the Exchange. All submissions should refer to 
File No. SR-Phlx-99-57 and should be submitted by February 15, 2000.

IV. Commission's Findings and Order Granting Accelerated Approval 
of Proposed Rule Change

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Sections 6 and 11A of the Act.\8\ 
Specifically, the Commission believes that the rule proposal is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and is not designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers.
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    \8\ See 15 U.S.C. 78f(b) and 78k-1. In approving this rule 
change, the Commission notes that it has considered the proposal's 
impact on efficiency, competition, and capital formation, consistent 
with Section 3 of the Act. Id. at 78c(f).
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    The Commission also believes that the proposed rule change is 
consistent with Section 11A of the Act in that the permanent 
elimination of position and exercise limits for FLEX Equity options 
allows the Exchange to better compete with the growing over-the-counter 
(``OTC'') market in customized equity options, thereby encouraging fair 
competition among brokers and dealers and exchange markets. The 
attributes of the Exchange's options markets versus a OTC market 
include, but are not limited to, a centralized market center, an 
auction market with posted transparent market quotations and 
transaction reporting, parameters and procedures for clearance and 
settlement, and the guarantee of The Options Clearing Corporation 
(``OCC'') for all contracts traded on the Exchange.
    The Commission has generally taken a gradual, evolutionary approach 
toward expansion of position and exercise limits. Given that the 
current pilot program has run for the past two years without incident, 
the Commission believes that it is appropriate to approve the pilot on 
a permanent basis, First, the FLEX Equity options market is 
characterized by large, sophisticated institutional investors (or 
extremely high net worth individuals), who have both the experience and 
ability to engage in negotiated, customized transactions. For example, 
with a required minimum size of 250 contracts (or the number of 
contracts having $1 million of underlying equivalent value) to open a 
transaction in a new series,\9\ FLEX Equity options are designed to 
appeal to institutional investors, and it is unlikely that many retail 
investors would be able to engage in options transactions at that size. 
Second, all of the Exchange's other current rules and provisions 
governing FLEX Equity options remain applicable.\10\ Third, the OCC 
will serve as the counter-party guarantor in every exchange-traded 
transaction. Fourth, the proposed elimination of position and exercise 
limits for FLEX Equity options could potentially expand the depth and 
liquidity of the FLEX equity market without significantly increasing 
concerns regarding intermarket manipulations or disruptions of the 
options or the underlying securities. Fifth, the enhanced reporting 
requirements should help the Exchange to monitor accounts under risk 
and to take any appropriate action. Finally, the Exchange's 
surveillance program will be applicable to the trading of FLEX Equity 
options and should detect and deter trading abuses arising from the 
elimination of position and exercise limits.
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    \9\ See Phlx Rule 1079(a)(8)(A)(ii).
    \10\ See Phlx Rule 1079.
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    As described above, the Exchange has adopted important safeguards 
that will allow it to monitor large positions in order to identify 
instances of potential risk and to assess additional margin and/or 
capital charges, if necessary. The Exchange requires each member or 
member organization (other than a Specialist, a Registered Options 
Trader, a Market Maker, or a Designated Primary Market Maker) that 
maintains a position on the same-side of the market in excess of the 
position limit level established pursuant to the applicable Exchange 
rule \11\ for Non-FLEX Equity options of the same class to report 
information to the exchange regarding the FLEX Equity option position, 
positions in any related instrument, the purpose or strategy for the 
position, and the collateral used by the account. By monitoring 
accounts in excess of the Non-FLEX Equity option position limit in this 
manner, the Exchange should be provided with the information necessary 
to determine whether to impose additional margin and/or whether to 
assess capital charges upon a member organization carrying the account. 
In addition, this information should allow the Exchange to determine 
whether a large position could have an undue effect on the underlying 
market and to take the appropriate action.
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    \11\ See Phlx Rule 1001.
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    The Commission believes that it is reasonable to treat FLEX Equity 
options differently than regular standardized options. FLEX options 
compete directly with OTC options. The Commission believes that it 
would be beneficial to attract OTC activity back to a more transparent 
market with a clearinghouse guarantee. Hence, a liberalization of 
position limits for FLEX Equity options is a measured deregulatory 
means to enable the Exchange to compete with the OTC market while 
preserving important oversight safeguards.
    As noted above, the Exchange was required to submit a report 
assessing the effects of the pilot program. This information was 
required to allow the Commission to valuate the consequences of the 
program and to determine whether permanent approval was appropriate. 
The Commission has reviewed Phlx's report. Although the Commission 
cannot entirely rule out the potential for future adverse effects on 
the securities markets for the FLEX Equity options or component 
securities underlying FLEX Equity options, the report supports 
permanent approval of the pilot because such effects and abuses have 
not occurred over the two year pilot period.
    In the report, the Exchange indicates that there were no instances 
of any unusual market effects developing out of FLEX trades. Through 
1998, there were a total of 189 trades, 47 transacted by institutions 
and 142 undertaken by retail customers. The average institutional trade 
size was 772 contracts with the largest trade involving 8,000 
contracts. Retail investor trades averaged 120 contracts with the 
largest trade involving 1,760 contracts.\12\ During 1998, four firms 
executed trades on behalf of a total of 15 retail customers. Based on 
the above, the Exchange concludes that that elimination of position and 
exercise limits for FLEX Equity options did not have any impact on the 
prices of the underlying stocks during the establishment or unwinding 
of FLEX Equity positions.
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    \12\ The Commission notes that the minimum value size for an 
opening transaction (other than FLEX quotes responsive to a FLEX 
request for quotes) in any FLEX series in which there is no open 
interest at the time the request for quotes is submitted is the 
lesser of 250 contracts or the number of contracts overlying $1 
million in the underlying securities. However, the minimum value 
size for a transaction in any currently-opened FLEX series is 100 
contracts in the case of opening transactions for FLEX Equity 
options and 25 contracts in the case of closing transactions in FLEX 
Equity options. See Phlx Rule 1079(a)(8)(A)(ii) and (a)(8)(B)(i).
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    Finally, given the size and sophisticated nature of the FLEX Equity 
options market, the reporting and margin requirements, and the fact 
that the pilot program has run the past two years without incident, the 
Commission

[[Page 4012]]

believes that eliminating position and exercise limits for FLEX Equity 
options on a permanent basis does not substantially increase 
manipulative concerns. The Commission continues to believe that the 
enhanced market surveillance of large positions should help the 
Exchange to take the appropriate action in order to avoid any 
manipulation or market risk concerns. The Commission expects the 
Exchange to take prompt action, including timely communication with the 
Commission and other marketplace self-regulatory organizations 
responsible for oversight of trading in FLEX options and the underlying 
stocks, should any unanticipated adverse market effects develop. In 
summary, because of the special nature of the FLEX Equity markets, the 
Commission believes that the Exchange's proposals should be approved on 
a permanent basis. In permanently approving the proposals, the 
Commission believes that the distinctions between the FLEX Equity 
options market and the standardized equity options market, as described 
above, warrant the different regulatory applications of position and 
exercise limits under the Act.
    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. Specifically, the Commission 
believes that because permanent approval of the proposal will allow the 
pilot program to continue uninterrupted based on the same terms and 
conditions of the original pilot, it is consistent with the protection 
of investors and the public interest to approve the proposed rule 
changes on an accelerated basis. Furthermore, as noted above, the 
Commission recently approved identical proposed rule changes from the 
American Stock Exchange, Chicago Board Options Exchange and the Pacific 
Exchange.\13\ A full 21-day comment period was provided for those 
proposals and no comments were received. Accordingly, the Commission 
believes it is consistent with Section 6(b)(5) and Section 19(b)(2) of 
the Act to grant accelerated approval to the proposed rule change.\14\
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    \13\ See supra note 5.
    \14\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-Phlx-99-57) is approved.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-1737 Filed 1-24-00; 8:45 am]
BILLING CODE 8010-01-M