[Federal Register Volume 66, Number 28 (Friday, February 9, 2001)]
[Notices]
[Pages 9739-9742]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-3341]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43921; File No. SR-Phlx-00-107]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the 
Philadelphia Stock Exchange, Inc., Relating to Listing and Trading of 
Options on Exchange-Traded Fund Shares

February 2, 2001.
    Pursuant to section 19(b)91) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 21, 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 changes from interested persons and to approve the 
proposal 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 Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx proposes to amend its rules to create listing criteria and 
amend trading rules to allow the Exchange to list options on Exchange-
Traded Fund Shares. The text of the proposed rule change is available 
at the Phlx or the Commission.

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 Phlx included statements 
concerning the purpose of and basis for the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III below. The Phlx 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 purpose of the proposed rule change is to provide for the 
trading of options and FLEX options on Exchange-Traded Fund Shares.\3\ 
As noted above, Exchange-Traded Fund Shares are exchange-listed 
securities representing interests in open-end unit investment trusts or 
open-end management investment companies (``Funds'') that hold 
securities based on an index or a portfolio of securities.\4\ Exchange-
Traded Fund Shares are issued in exchange for an ``in kind'' deposit of 
a specified portfolio of securities, together with a cash payment, in 
minimum size aggregations or multiples thereof (``Creation Units''). 
The size of the applicable Creation Unit size aggregation is set forth 
in the Fund's prospectus, and varies from one series

[[Page 9740]]

of Exchange-Traded Fund Shares to another, but generally is of 
substantial size (e.g., value in excess of $450,000 per Creation Unit). 
A Fund, generally, will issue and sell Exchange-Traded Fund Shares in 
Creation Unit size through a principal underwriter on a continuous 
basis at the net asset value per share next determined after an order 
to purchase Exchange-Traded Fund Shares and the appropriate securities 
are received. Following issuance, Exchange-Traded Fund Shares are 
traded on an exchange like other equity securities, and equity trading 
rules apply. Likewise, redemption of Exchange-Traded Fund Shares is 
made in Creation Unit size and ``in kind,'' with a portfolio of 
securities and cash exchange for the Exchange-Traded Fund Shares that 
have been tendered for redemption
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    \3\ In general, FLEX options provide investors with the ability 
to customize basic option features including size, expiration date, 
exercise style, and certain exercise prices. See Phlx Rule 1079.
    \4\ Currently, the Exchange trades unit investment trust 
securities known as Trust Shares. The Exchange has also just 
received approval to trade Index Fund Shares which are issued by an 
open-end management investment company. Trust Shares and Index Fund 
Shares are listed on the Phlx pursuant to Role 803(i) and 803(l), 
respectively, and trade like shares of common stock. The Commission 
notes that not all Trust Shares or Index fund shares trading on the 
Phlx may meet the standards for options trading approved by this 
order.
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    Generally, options on Exchange-Traded Fund Shares are proposed to 
be traded on the Exchange pursuant to the same rules and procedures 
that apply to trading in options on equity securities. However, the 
Exchange is also proposing to list FLEX options on Exchange-Traded Fund 
Shares and some options will have a unit of trading of 1000 Exchange-
Traded Fund Shares. The Exchange will list option contracts covering 
either 100 or 1000 Exchange-Traded Fund Shares, or both, depending on 
the price and volatility of the underlying Exchange-Traded Fund Shares 
and the popularity of the options.\5\
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    \5\ This 1000 share feature was proposed and approved by the 
American Stock Exchange and The Options Clearing Corporation. 
Securities Exchange Act Release Nos. 40157 (July 1, 1998), 63 FR 
37426 (July 10, 1998) (SR-Amex-96-44) and 40132 (June 25, 1998), 63 
FR 36467 (June 25, 1998) (SR-OCC-97-02). In the event the Exchange 
lists options covering both 100 and 1000 of the same underlying 
Exchange-Traded Fund Shares, the Exchange will assign separate 
trading symbols to the options and will issue an Information 
Circular to all its members advising of the trading symbols. 
Telephone conservation between John Dayton, Assistant Secretary and 
Counsel, Phlx, and Heather Traeger, Special Counsel, Division of 
Market Regulation, Commission, on January 31, 2001.
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    The proposed position, exercise and reporting limits for options on 
Exchange-Traded Fund Shares would be the same as those established for 
stock options as set forth in Phlx Rules 1001, 1002 and 1003. The Phlx 
anticipates that most options on Exchange-Traded Fund Shares initially 
will qualify for only the lowest position limit. As with other equity 
options, the position limits will be increased for options if the 
volume of trading in the Exchange-Traded Fund Shares increases to meet 
the requirements of a higher limit. As is currently the case for all 
FLEX options, no position or exercise limits will be applicable to FLEX 
options overlying Exchange-Traded Fund Shares.
    The listing and maintenance standards proposed for options on 
Exchange-Traded Fund Shares are set forth in proposed Commentary .06 
under Phlx Rule 1009 and in proposed Commentary .08 under Phlx Rule 
1010, respectively. Pursuant to the proposed initial listing standards, 
Phlx will only list options on Exchange-Traded Fund Shares that are 
principally traded on a national securities exchange or through the 
facilities of a national securities association and reported as 
national market securities. in addition, the initial listing standards 
require that either: (1) The Exchange-Traded Fund Shares meet the 
uniform options listing standards in Commentary .01 to Rule 1009, which 
include minimum public float, trading volume, and share price of the 
underlying security in order to list the option,\6\ or (2) the 
Exchange-Traded Fund Shares must be available for creation or 
redemption each business day in cash or in kind from the Fund at a 
price related to the net asset value, and the Exchange will require 
that the investment company shall provide that Exchange-Traded Fund 
Shares may be created even through some or all of the securities needed 
to be deposited have not been received by the Fund.\7\
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    \6\ Specifically, Commentary .01 to Rule 1009 requires the 
underlying security to have a public float of 7,000,000 shares, 
2,000 holders, trading volume of 2,400,000 shares in the preceding 
12 months, a share price of $7.50 for the majority of the business 
days during the three calendar months preceding the date of the 
selection, and that the issuer of the underlying security is in 
compliance with the Act.
    \7\ This assumes that the authorized creation participant has 
undertaken to deliver the shares as soon as possible and such 
undertaking has been secured by the delivery and maintenance of 
collateral consisting of cash or cash equivalents satisfactory to 
the Fund which underlies the option, as described in the Fund 
prospectus.
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    In addition, the initial listing standards require that: (1) Any 
Exchange-Traded Fund Share with non-U.S. stocks in the underlying index 
or portfolio that are not subject to comprehensive surveillance 
agreements do not in the aggregate represent more than 50% of the 
weight of the index or portfolio; (2) stocks for which the primary 
market is in any one country that is not subject to a comprehensive 
surveillance agreement do not represent 20% or more of the weight of 
the index or portfolio; and (3) stocks for which the primary market is 
in any two countries that are not subject to comprehensive surveillance 
agreements do not represent 33% or more of the weight of the index or 
portfolio.
    The Exchange's proposed maintenance standards provide that if a 
particular series of Exchange-Traded Fund Shares should cease to trade 
on an exchange or as national market securities traded through the 
facilities of a national securities association, there will be no 
opening transactions in the options on the Exchange-Traded Fund Shares, 
and all such options will trade on a liquidation-only basis. In 
addition, the Phlx will consider the suspension of opening transactions 
in any series of options of the class covering Exchange-Traded Fund 
Shares if: (1) The options fail to meet the uniform equity option 
maintenance standards in Commentary.01 to Rule 1010,\8\ when the 
options were listed pursuant to the equity option listing standards of 
Commentary .01 to Rule 1009; (2) following the initial twelve-month 
period beginning upon the commencement of trading of the Exchange-
Traded Fund Shares on a national securities exchange or as national 
market securities through the facilities of a national securities 
association there are fewer than 50 record and/or beneficial holders of 
Exchange-Traded Fund Shares for 30 or more consecutive trading days; 
(3) the value of the index or portfolio of securities on which the 
Exchange-Traded Fund Shares are based is no longer calculated or 
available; or (4) such other event shall occur or condition exist that 
in the opinion of the Exchange makes further dealing in such options on 
the Exchange inadvisable.
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    \8\ Specifically, Commentary .01 to Rule 1010 provides that an 
underlying security will not meet the Exchange's requirements for 
continued listing when, among other things; (1) There are fewer than 
6,300,000 publicly-held shares; (2) there are fewer than 1,600 
holders; (3) trading volume was less than 1,800,000 shares in the 
preceding twelve months; or (4) the share price of the underlying 
security closed below $5 on a majority of the business days during 
the preceding 6 months.
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    Options on Exchange-Traded Fund Shares will be physically-settled 
and will have the American-style exercise feature used on all 
standardized equity options. The Exchange, however, also proposes to 
trade FLEX options, which will be available with both the American-
style and European-style exercise feature, as well as other FLEX option 
features.\9\
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    \9\ An American-style option may be exercised at any time prior 
to its expiration. A European-style option, however, may be 
exercised only on its expiration date.
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    The proposed margin requirements for options on Exchange-Traded 
Fund Shares are at the same levels that apply to options generally 
under Exchange Rule 722, except, with respect to Exchange-Traded Fund 
Shares based on a broad-based index or portfolio, minimum margin must 
be deposited

[[Page 9741]]

and maintained equal to 100% of the current market value of the option 
plus 15% of the market value of equivalent units of the underlying 
security value. Exchange-Traded Fund Shares that hold securities based 
upon a narrow-based index or portfolio must have options margin that 
equals at least 100% of the current market value of the contract plus 
20% of the market value of equivalent units of the underlying security 
value. In this respect, the margin requirements proposed for options on 
Exchange-Traded Fund Shares are comparable to margin requirements that 
currently apply to broad-based and narrow-based index options.
    The Exchange believes it has the necessary systems capacity to 
support the additional series of options that would result from the 
introduction of options on Exchange-Traded Fund Shares, and it has been 
advised that the Options Price Reporting Authority (``OPRA'') also will 
have the capacity to support these additional series due to recent 
enhancements.
2. Statutory Basis
    The Phlx believes that the listing and trading of options on 
Exchange-Traded Fund Shares should provide investors with another 
choice of venue to conduct trading in these products. Thus, the 
Exchange believes that the proposed rule change is consistent with 
section 6(b)(5) of the Act \10\ in that it is designed to promote just 
and equitable principles of trade, to remove impediments to and perfect 
the mechanism of a free and open market and a national market system 
and, in general, to protect investors and the public interest.
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    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

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

    The Phlx has neither solicited nor received written comments on 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, as amended, is 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, 
DC 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 in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Phlx. All submissions should refer to File No. 
SR-Phlx-00-107 and should be submitted by March 2, 2001.

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

    The Commission finds that the proposed rule change, as amended, 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 section 6(b)(5).\11\ 
Specifically, the Commission believes that providing for the listing 
and trading of options and FLEX Equity options \12\ on Exchange-Traded 
Fund Shares should give investors a better means to hedge their 
positions in the underlying Fund Shares. Further, the Commission 
believes that pricing of the underlying Fund Shares may become more 
efficient and market makers in these shares, by virtue of enhanced 
hedging opportunities, may be able to provide deeper and more liquid 
markets. In sum, the Commission believes that options on Fund Shares 
likely will engender the same benefits to investors and the market 
place that exist with respect to options on common stock, thereby 
serving to promote the public interest and remove impediments to a free 
and open securities market.\13\
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    \11\ 15 U.S.C. 78f(b)(5).
    \12\ The Commission hereby incorporates by reference its 
findings and conclusions with respect to the appropriateness of FLEX 
Equity options generally. See Securities Exchange Act Release No. 
37336 (June 19, 1996), 61 FR 33558 (June 27, 1996).
    \13\ In approving this rule, the Commission notes that it has 
also considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
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    As a general matter, the Commission believes that a regulatory 
system designed to protect public customers must be in place before the 
trading of sophisticated financial instruments, such as options on Fund 
Shares, can commence trading on a national securities exchange. The 
Commission notes that the trading of standardized exchange-traded 
options occurs in an environment that is designed to ensure, among 
other things, that: (1) The special risks of options are disclosed to 
public customers; (2) only investors capable of evaluating and bearing 
the risks of options trading are engaged in such trading; and (3) 
special compliance procedures are applicable to options accounts. With 
regard to position and exercise limits, the Commission finds that it is 
appropriate to adopt the tiered approach used in setting position and 
exercise limits for standardized stock options. This approach should 
serve to minimize potential manipulation and market impact concerns. In 
addition, the Commission believes that the rationale for allowing FLEX 
Equity options generally to trade without position and exercise limits 
is equally applicable in the context of FLEX Equity options on Fund 
Shares.
    Accordingly, because options and FLEX Equity options on Fund Shares 
will be subject to the same regulatory regime as the other options and 
FLEX Equity options currently traded on the Phlx, the Commission 
believes that adequate safeguards are in place to ensure the protection 
of investors in options and FLEX Equity options on Fund Shares.
    The Commission also believes that it is appropriate to permit the 
Phlx to list and trade options, including FLEX Equity options, on 
Exchange-Traded Fund Shares given that these options must meet specific 
requirements related to the protection of investors.\14\ First, the 
Exchange's listing and delisting criteria for options on Fund Shares 
are adequate. With regard to initial listing, the proposal requires 
that either: (1) The underlying Fund Shares meet the Phlx's uniform 
options listing standards; or (2) the Exchange-Traded Fund Shares must 
be available for creation or redemption each business day in cash or in 
kind from the Fund at a price related to the net asset value, and the 
Exchange will require that the underlying Fund Shares may be created 
even though some or all

[[Page 9742]]

of the securities needed to be deposited have not been received by the 
Fund.\15\ This listing requirement should ensure that there exists 
sufficient supply of the underlying Fund Shares so that a short call 
writer, for example, will have the ability to secure delivery of the 
Fund Shares upon exercise of the option.
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    \14\ The Commission notes, and Phlx has verified, that holders 
of options on Fund Shares who exercise and receive the underlying 
Fund Shares must receive, like any purchaser of Fund Shares, a 
product description or prospectus, as appropriate. Telephone 
conversation between John Dayton, Assistant Secretary and Counsel, 
Phlx, and Geoffrey Pemble, Attorney, Division of Market Regulation, 
Commission, on February 2, 2001.
    \15\ This assumes that the authorized creation participant has 
undertaken to deliver the shares as soon as possible and such 
undertaking has been secured by the delivery and maintenance of 
collateral consisting of cash or cash equivalents satisfactory to 
the Fund which underlies the option, as described in the Fund 
prospectus.
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    The Commission believes the Phlx has adequately addressed potential 
concerns about the ability to produce Fund Shares upon exercise of the 
option through the adoption of the listing standards set forth above. 
In particular, options listed pursuant to the uniform options listing 
standards will have to meet the options maintenance listing standards 
that require, among other things, that a minimum number of Fund Shares 
be outstanding to continue trading the options.\16\ The alternative 
listing criteria, noted above, should also help to ensure that the 
underlying Fund Shares will be available upon exercise by requiring the 
Fund to allow market participants to create Fund Shares even though 
some or all of the necessary securities needed to be deposited are not 
available.\17\ Although there is no absolute assurance that market 
participants will go ahead and create Fund Shares in the event a short 
call writer needs to purchase Fund Shares to meet an exercise notice, 
it is likely that arbitrage opportunities will create an incentive to 
do so. Further, in the event there are not enough Fund Shares to meet 
exercise requirements, as with other physically-settled equity options, 
the Options Clearing Corporation has rules that would apply to such 
situations.
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    \16\ See supra note 6.
    \17\ See supra note 16.
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    Second, the Commission believes that the surveillance standard 
developed by the Phlx for options on Fund Shares is adequate to address 
the concerns associated with the listing and trading of such 
securities. Specifically, the Phlx has proposed that: (1) Any Fund 
Share with non-US stocks in the underlying index or portfolio that are 
not subject to comprehensive surveillance agreements do not in the 
aggregate represent more than 50% of the weight of the index or 
portfolio; (2) stocks for which the primary market is in any one 
country that is not subject to a comprehensive surveillance agreement 
do not represent 20% or more of the weight of the index or portfolio; 
and (3) stocks for which the primary market is in any two countries 
that are not subject to comprehensive surveillance agreements do not 
represent 33% or more of the weight of the index or portfolio.
    As a general matter, the Commission believes that comprehensive 
surveillance agreements provide an important deterrent to manipulation 
because they facilitate the availability of information needed to fully 
investigate a potential manipulation if it were to occur. These 
agreements are especially important in the content of derivative 
products based on foreign securities because they facilitate the 
collection of necessary regulatory, surveillance and other information 
from foreign jurisdictions. In evaluating the current proposal, the 
Commission believes that requiring comprehensive surveillance 
agreements to be in place between the Phlx and the primary markets for 
foreign securities that comprise 50% or more of the weight of the 
underlying index or portfolio upon which Fund Shares are based, as well 
as the other conditions discussed above, provides an adequate mechanism 
for the exchange of surveillance sharing information necessary to 
detect and deter possible market manipulations. Although the Commission 
recognizes that up to 50% of the Portfolio's value may not be covered 
by comprehensive surveillance agreements, the other requirements will 
ensure that a significant percentage of the portfolio is not made up of 
securities from uncovered countries. Further, as to the domestically-
traded Fund Shares themselves and the domestic stocks in the underlying 
index or portfolio upon which Fund Shares are based, the Intermarket 
Surveillance Group Agreement will be applicable to the trading of 
options on Fund Shares.
    Finally, the Commission believes that it is appropriate to require 
minimum margin of 100% of the current market value of the option plus 
15% of the market value of the underlying security value (``broad-based 
margin'') for options on Fund Shares based on a broad-based index or 
portfolio and for options on Fund Shares which have been approved to 
date. Moreover, the Commission believes that requiring minimum margin 
of 100% of the current market value of the option plus 20% of the 
market value of the underlying security value (``narrow-based margin'') 
for options on Fund Shares based on a narrow-based index or portfolio 
is appropriate. The Commission notes that these margin requirements for 
options on Exchange-Traded Fund Shares are comparable to margin 
requirements that currently apply to broad-based and narrow-based index 
options.
    The Commission finds good cause for approving the proposed rule 
change (SR-Phlx-00-107), as amended, prior to the thirtieth day after 
the date of publication of notice thereof in the Federal Register. The 
Commission notes that the proposed rule change is based on Amex Rules 
915 and 916, which the Commission approved previously.\18\ The 
Commission also observes that the proposed rule change concerns issues 
that previously have been the subject of a full comment period pursuant 
to section 19(b) of the Act.\19\ The Commission does not believe that 
the proposed rule change raises novel regulatory issues that were not 
addressed in the previous filings. Accordingly, the Commission finds 
that there is good cause, consistent with section 6(b)(5) of the Act, 
to approve the amended proposal on an accelerated basis.
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    \18\ See Securities Exchange Act Release No. 40157 (July 1, 
1998), 63 FR 37426 (July 10, 1998) (SR-Amex-96-44).
    \19\ 15 U.S.C. 78s(b).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-Phlx-00-107), as amended, is 
hereby approved on an accelerated basis.
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    \20\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-3341 Filed 2-8-01; 8:45 am]
BILLING CODE 8010-01-M