[Federal Register Volume 65, Number 33 (Thursday, February 17, 2000)]
[Notices]
[Pages 8224-8226]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3749]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42389; File Nos. SR-PCX-00-01; SR-Amex-00-02]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Changes by the Pacific 
Exchange, Inc. and the American Stock Exchange LLC Relating to Exercise 
Price Intervals and Exercise Prices for FLEX Equity Options

February 7, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on January 11, and January 27, 2000, the Pacific Exchange, Inc. 
(``PCX'') and the American Stock Exchange LLC (``Amex'') (collectively 
the ``Exchanges''), respectively, filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule changes as 
described in Items I and II below, which Items have been prepared by 
the Exchanges. The Commission is publishing this notice and order to 
solicit comments on the proposed rule changes from interested persons 
and to approve the proposals on an accelerated basis.
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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 Organizations' Statements of the Terms of 
Substance of the Proposed Rule Changes

    The Amex proposes to remove paragraph (c)(3) from Exchange Rule 
903G. Paragraph (c)(3) limits exercise

[[Page 8225]]

price intervals and exercise prices for FLEX Equity call options to 
those that apply to Non-FLEX Equity call options. In addition, PCX 
proposes to delete Commentary .01 to PCX Rule 8.102, which is similar 
to the paragraph Amex proposes to remove.\3\
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    \3\ The Commission approved these rule changes in a single 
approval order in 1996. See Release No. 34-37726 (September 25, 
1996), 61 FR 51474 (October 2, 1996).
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II. Self-Regulatory Organizations' Statements of the Purpose of, 
and Statutory Basis for, the Proposed Rule Changes

    In their filings with the Commission, the Exchange included 
statements concerning the purpose of and basis for the proposed rule 
changes and discussed any comments they received on the proposed rule 
changes. The text of these statements may be examined at the places 
specified in Item III below. The Exchanges have prepared summaries, set 
forth in Sections A, B, and C below, of the most significant aspects of 
such statements.

A. Self-Regulatory Organizations' Statements of the Purpose of, and 
Statutory Basis for, the Proposed Rule Changes

1. Purpose
    The Exchanges propose to eliminate their rules that limit the 
exercise price intervals and exercise prices available for FLEX Equity 
call options to those intervals and prices that are available for Non-
FLEX Equity call options. This policy was intended to eliminate 
uncertainty concerning what constitutes a ``qualified'' covered call 
for certain purposes under the Internal Revenue Code pending 
clarification of this tax issue.
    Currently, under Section 1092(c)(4)(B) of the Internal Revenue 
Code, certain covered short positions in call options qualify for 
advantageous tax treatment if the options are not in the money by more 
than a specified amount at the time they are written. One measure used 
to determine whether a call option is qualified is whether its exercise 
or ``strike'' price is not lower than the ``lowest qualified benchmark 
price,'' which is generally the highest strike price available for 
trading that is less than the current price of the underlying stock. 
Since the exercise prices of FLEX Equity Options are not subject to the 
same intervals that apply to Non-FLEX Equity Options, this has raised 
the question whether the existence of a series of FLEX Equity Options 
with a strike price of, for example, 58 when the price of the 
underlying stock is 59 would disqualify a Non-FLEX call option with a 
strike price of 55, which would otherwise be the highest strike price 
available that is less than the price of the stock.
    The Internal Revenue Service (``IRS'') reviewed this issue and 
proposed regulations that would not require that strike prices 
established by equity options with flexible terms be taken into account 
in determining whether standard term equity options are too deep in the 
money to receive qualified covered call treatment. \4\ These 
regulations became effective on January 25, 2000. \5\ The effect of the 
IRS regulations and the Exchanges' proposed withdrawal of the 
limitations on the exercise price of Equity FLEX call options is that 
certain taxpayers, particularly institutional and other large 
investors, can engage in transactions in Equity FLEX call options with 
a wider range of exercise prices (as was originally intended) without 
affecting the applicability of Section 1092 of the Internal Revenue 
Code for qualified covered call options involving equity options with 
standard terms.
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    \4\ Department of the Treasury, IRS REG-104641-97, 63 FR 34616 
(June 25, 1998).
    \5\ Department of the Treasury, IRS REG-104641-97, 65 FR 3812 
(January 2000).
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    The Exchanges believe that the proposed rule changes, by 
eliminating a restriction on Equity FLEX call options which has 
restricted their usefulness as a risk managing mechanism, will remove 
impediments to and perfect the mechanisms of a free and open market in 
FLEX Equity Options, and thus are consistent with the objectives of 
Section 6(b)(5) \6\ of the Act.
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    \6\ 15 U.S.C. 78f(b)(5).
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2. Statutory Basis
    The Exchanges believe that the proposed rule changes are consistent 
with and further the objectives of Section 6(b)(5) \7\ of the Act in 
that the changes are designed to remove impediments to a free and open 
market and to protect investors and the public interest.
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    \7\ Id.
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B. Self-Regulatory Organizations' Statements on Burden on Competition

    The Exchanges do not believe that the proposed rule changes will 
impose any burden on competition.

C. Self-Regulatory Organizations' Statements on Comments on the 
Proposed Rule Changes Received From Members, Participants, or Others

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

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed 
rules are consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule changes that are filed 
with the Commission, and all written communications relating to the 
proposed rule changes between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filings will also be available for inspection and copying at the 
principal offices of the PCX and Amex. All submissions should refer to 
File Nos. SR-PCX-00-01 and SR-Amex-00-02 and should be submitted by 
March 9, 2000.

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

    After careful review, the Commission finds that the proposals are 
consistent with the requirements of the Act.\8\ In particular, the 
Commission finds that the proposals are consistent with Section 6(b)(5) 
\9\ of the Act. Section 6(b)(5) requires, among other things, that the 
rules of an exchange be designed to remove impediments to a free and 
open market and to protect investors and the public interest.
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    \8\ In addition, pursuant to Section 3(f) of the Act, the 
Commission has considered the proposed rules' impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposals allow sophisticated, 
high net-worth investors to take full advantage of FLEX options. In 
part, FLEX options were created to allow these investors to manage 
their risks by having the ability to negotiate strike prices, contract 
terms for exercise style (i.e., American, European, or capped), and 
expiration dates. However, because of the potential adverse tax effect 
on qualified covered calls, the Exchanges limited FLEX call strike 
prices and exercise intervals to those available for standardized 
equity calls. Now that the tax issue has been clarified, this 
limitation is being removed. With the removal of this

[[Page 8226]]

limitation, the Commission believes that sophisticated, high net-worth 
investors will have a better opportunity to take advantage of the risk-
management mechanisms provided by FLEX options.\10\
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    \10\ The Commission expects that the Options Disclosure Document 
(``ODD'') will promptly be amended to reflect the removal of the 
strike price limitation for FLEX equity call options. See October 
1996 Supplement to the ODD.
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    The Commission finds good cause for approving the proposed rule 
changes prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. The Commission recently 
approved a virtually identical Chicago Board Options Exchange, Inc., 
proposal SR-CBOE-99-63,\11\ which had been published as SR-CBOE-98-
39.\12\ The Commission received no comment letters on this filing. 
Additionally, Amex filed a very similar proposal, SR-Amex-98-43, which 
it later withdrew because the IRS had not yet acted on its proposed 
rulemaking.\13\ The current proposals mirror the changes that were 
approved in SR-CBOE-99-63. In addition, the proposals allow FLEX 
options to be used as they were originally intended to be used. The 
Commission believes, therefore, that granting accelerated approval to 
the proposed rule changes is appropriate and consistent with Section 6 
of the Act.\14\
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    \11\ See Release No. 34-42371 (January 31, 2000) (order 
approving SR-CBOE-99-63.)
    \12\ See Release No. 34-40584 (October 21, 1998), 63 FR 58080 
(October 29, 1998) (notice of filing of SR-CBOE-98-39.)
    \13\ See Release No. 34-40795 (December 15, 1998), 63 FR 71321 
(December 24, 1998) (notice of filing SR-Amex-98-43.)
    \14\ 15 U.S.C. 78f.
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    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-PCX-00-01 and SR-Amex-00-02) 
are hereby approved on an accelerated basis.

    \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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-3749 Filed 2-16-00; 8:45 am]
BILLING CODE 8010-01-M