[Federal Register Volume 67, Number 24 (Tuesday, February 5, 2002)]
[Rules and Regulations]
[Pages 5199-5202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-2764]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-45371]


Exemption of Transactions in Certain Options and Futures on 
Security Indexes From Section 31 of the Exchange Act

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is, by 
rule, exempting two classes of securities from the fee and assessment 
requirements of Section 31 of the Securities Exchange Act of 1934 
(``Exchange Act''): options on narrow-based security indexes and 
futures on narrow-based security indexes. In light of the very low 
amount of Section 31 fees currently collected on options on narrow-
based security indexes, the Commission is granting the exemption for 
options on such indexes to relieve certain national securities 
exchanges of the burden of having to calculate whether an index is 
narrow-based or broad-based. The Commission is granting the exemption 
for futures on narrow-based security indexes to promote a level playing 
field between options and futures.

EFFECTIVE DATE: February 1, 2002.

FOR FURTHER INFORMATION CONTACT: Michael Gaw, Special Counsel, 202-942-
0158, Division of Market Regulation, Securities and Exchange 
Commission, 450 5th Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION:

I. Background and Summary

    Section 31 of the Exchange Act \1\ requires national securities 
exchanges and national securities associations to pay fees and 
assessments to the Commission based on sales of or transactions in 
certain securities. Specifically, a national securities exchange is 
required to pay to the Commission fees based on the aggregate dollar 
amount of sales of certain securities transacted on that exchange,\2\ 
and a national securities association is required to pay to the 
Commission fees based on the aggregate dollar amount of sales of 
certain securities transacted by or through any member of the 
association otherwise than on a national securities exchange.\3\ In 
addition, an exchange or association is required to pay to the 
Commission an assessment for each round turn transaction on a security 
future.\4\ Section 31(f) of the Exchange Act \5\ provides that ``[t]he 
Commission, by rule, may exempt any sale of securities or any class of 
sales of securities from any fee or assessment imposed by [Section 31], 
if the Commission finds that such exemption is consistent with the 
public interest, the equal regulation of markets and brokers and 
dealers, and the development of a national market system.''
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    \1\ 15 U.S.C. 78ee.
    \2\ See 15 U.S.C. 78ee(b).
    \3\ See 15 U.S.C. 78ee(c).
    \4\ See 15 U.S.C. 78ee(d).
    \5\ 15 U.S.C. 78ee(f).
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    On January 16, 2002, President Bush signed into law the Investor 
and Capital Markets Fee Relief Act (``Fee Relief Act'') \6\ which, 
among other things, amends Section 31 to provide that ``options on 
securities indexes (excluding a narrow-based security index)'' are 
exempt from the fee requirements of Section 31. Thus, as provided by 
statute, national securities exchanges and national securities 
associations are not required to pay to the Commission fees on sales of 
options on security indexes that are not narrow-based security indexes 
\7\ (i.e., are ``broad-based security indexes''). The exclusion of 
sales of options on broad-based indexes from Section 31 fees is 
consistent with the treatment of futures on broad-based indexes, which 
compete with options on broad-based indexes and are not subject to 
assessments under Section 31.
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    \6\ Pub. L. No. 107-123, 115 Stat. 2390 (2002).
    \7\ The term ``narrow-based security index'' is defined in 
Section 3(a)(55)(B) of the Exchange Act, 15 U.S.C. 78c(a)(55)(B).
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    The Commission today is amending Rule 31-1 under the Exchange Act 
\8\ by adding new paragraphs (f) and (g) to exempt options and futures, 
respectively, on narrow-based security indexes from Section 31. The 
Commission also is adopting conforming amendments to the preliminary 
note in Rule 31-1.
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    \8\ 17 CFR 240.31-1.
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II. Discussion

A. Exemption for Options on Narrow-Based Security Indexes

    The Exchange Act defines a narrow-based security index to be an 
index that has any one of the following four characteristics: (1) It 
has nine or fewer component securities; (2) any one of its component 
securities comprises more than 30 percent of its weighting; (3) any 
group of five of its component securities together comprise more than 
60 percent of its weighting; or (4) the lowest weighted component 
securities

[[Page 5200]]

comprising, in the aggregate, 25 percent of the index's weighting have 
an aggregate dollar value of average daily trading volume of less than 
$50 million (or in the case of an index with 15 or more component 
securities, $30 million).\9\ This definition was added to the Exchange 
Act by the Commodity Futures Modernization Act of 2000 which, among 
other things, authorized the trading of futures on single securities 
and on narrow-based security indexes.
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    \9\ See 15 U.S.C. 78c(a)(55)(B)(i)--(iv).
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    Trading of futures on narrow-based security indexes is subject to 
joint regulation by the Commission and the Commodity Futures Trading 
Commission (``CFTC''), whereas trading of futures on broad-based 
security indexes is subject to the sole jurisdiction of the CFTC. To 
ensure that trading of an index future is not subject to one regulatory 
framework one instant and another regulatory framework the next 
instant, an index is excluded from the definition of ``narrow-based 
security index'' if: (1) a future on such index traded on a CFTC-
regulated market for at least 30 days as a future on a broad-based 
security index; and (2) such index has not had the above 
characteristics of a narrow-based security index for more than 45 
business days over three calendar months.\10\ This exclusion, in 
effect, creates a tolerance period that permits trading in futures on 
broad-based security indexes to continue to be regulated exclusively by 
the CFTC if the index becomes narrow-based for 45 or fewer business 
days in a three-month period.\11\
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    \10\ See 15 U.S.C. 78c(a)(55)(C)(iii).
    \11\ If the index becomes narrow-based for more than 45 days 
over three consecutive calendar months, the Exchange Act then 
provides an additional grace period of three months during which the 
index is excluded from the definition of narrow-based security 
index. See 15 U.S.C. 78c(a)(55)(E).
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    This statutory tolerance period applies only when a future is 
trading on an index. When a future is not trading on an index, the 
index can switch continuously between a broad-based security index and 
a narrow-based security index. Thus, when a future is not trading on an 
index, an option on that index could be an option on a narrow-based 
security index one instant--and thus be subject to Section 31 fees--and 
be an option on a broad-based security index--and thus be exempt from 
Section 31 fees--just an instant later. Exchanges and associations 
must, therefore, continuously monitor the status of an index underlying 
an option and pay Section 31 fees to the Commission only for sales 
executed when the underlying index was narrow-based.
    Currently, the trading volume of options on narrow-based security 
indexes, and thus the amount of Section 31 fees levied on such trading, 
is insignificant. The fees paid by the exchanges to the Commission in 
2001 for all sales of options on indexes that were, or in the near 
future might become, narrow-based security indexes was below 
$35,000.\12\ In light of the currently low dollar volume of sales of 
options on narrow-based security indexes and the resources that 
exchanges and associations must devote to monitoring the narrow-based 
status of the underlying indexes, the Commission believes that it is 
consistent with the public interest, the equal regulation of markets 
and brokers and dealers, and the development of a national market 
system to exempt options on narrow-based security indexes from the fee 
requirements of Section 31.
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    \12\ By contrast, the Commission collected a total of 
approximately $1.1 billion in Section 31 fees in the twelve months 
from September 2000 to August 2001.
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    To the extent that the dollar volume of sales of options on narrow-
based security indexes increases, the Commission may reevaluate its 
decision today to exempt such products from Section 31 fees.\13\
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    \13\ The Commission could consider, for example, adopting rules 
that establish a tolerance period for security indexes underlying 
options that is similar to the statutory tolerance period for 
futures on security indexes. See supra notes 10-11 and accompanying 
text.
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B. Exemption for Futures on Narrow-Based Security Indexes

    In addition, the Commission is exempting futures on narrow-based 
security indexes from the fee assessment requirements of Section 31. 
The Commission believes that such an exemption is necessary and 
appropriate to maintain a level competitive playing field between 
futures on narrow-based security indexes and options on narrow-based 
security indexes that compete with one another. The Commission notes 
that one of the reasons that Congress relieved exchanges and 
associations from the requirement to pay Section 31 fees on options on 
security indexes (excluding narrow-based security indexes) is that 
futures on such indexes are not subject to Section 31 assessments. 
Similarly, the Commission believes that an exemption for futures on 
narrow-based security indexes is consistent with the public interest, 
the equal regulation of markets and brokers and dealers, and the 
development of a national market system. As with the exemption for 
options on narrow-based security indexes, the Commission may reevaluate 
its decision today to exempt futures on narrow-based security indexes 
from Section 31 assessments after trading commences in these products.

III. Consideration of the Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation

    Section 3(f) of the Exchange Act \14\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition, and capital formation. In addition, Section 23(a)(2) of 
the Exchange Act \15\ requires the Commission, when promulgating rules 
under the Exchange Act, to consider the impact any such rules would 
have on competition. Section 23(a)(2) further provides that the 
Commission may not adopt a rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
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    \14\ 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78w(a)(2).
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    The Commission has considered the effect of the amendments to Rule 
31-1 on efficiency, competition, and capital formation. The Commission 
does not believe that these amendments will impose any burden on 
competition. To the contrary, the Commission believes that the 
amendments will promote a level playing field between options and 
futures on narrow-based security indexes.
    The Commission also has considered whether exempting options and 
futures on narrow-based security indexes from Section 31 might divert 
trading activity from securities that are not exempt from Section 31 to 
these options and futures that are exempt. However, the Commission 
views this prospect as highly unlikely. Options and futures on single 
stocks and options and futures on narrow-based security indexes are, in 
practice, very imperfect substitutes for each other.\16\ Given this 
imperfection, the very small per-transaction Section 31 fee on 
transactions in the single-stock options and futures would not likely 
be the controlling factor in a market participant's decision to 
purchase index

[[Page 5201]]

options or futures rather than options or futures on the index's 
component securities.
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    \16\ A market participant would view an option or future on a 
narrow-based security index as a close substitute for individual 
options or futures on the component securities only if the market 
participant desired to have an interest in all of the index's 
component securities, and in the proportion that such securities 
were weighted in the index.
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IV. Administrative Procedure Act and Other Considerations

    Section 553(b) of the Administrative Procedure Act (``APA'') \17\ 
generally requires an agency to publish notice of a proposed rule 
making in the Federal Register. This requirement does not apply, 
however, if the agency ``for good cause finds (and incorporates the 
finding and a brief statement of reasons therefor in the rules issued) 
that notice and public procedure thereon are impracticable, 
unnecessary, or contrary to the public interest.'' \18\
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    \17\ 5 U.S.C. 553(b).
    \18\ 5 U.S.C. 553(b)(B).
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    Although President Bush signed the Fee Relief Act into law on 
January 16, 2002, it became effective retroactively to December 28, 
2001.\19\ Thus, in complying with the requirements of Section 31, 
national securities exchanges and national securities associations 
currently must continuously monitor whether an index underlying an 
index option is narrow-based or broad-based. The Commission finds that 
it is unnecessary and contrary to the public interest to continue to 
require exchanges and associations to incur this burden and assess the 
required fees during a notice and comment period when the amount of 
such fees would be an infinitesimal portion of the total fees collected 
and paid to the Commission under Section 31. Therefore, the Commission 
finds good cause to waive the APA's notice and comment provisions with 
respect to the amendments to Rule 31-1.
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    \19\ See Section 11 of the Fee Relief Act.
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    The APA also generally requires that an agency publish an adopted 
rule in the Federal Register 30 days before it becomes effective.\20\ 
However, this requirement does not apply if the rule grants or 
recognizes an exemption or relieves a restriction \21\ or if the agency 
finds good cause not to delay the effective date.\22\ The Commission 
finds that the amendments to Rule 31-1 meet both criteria. The 
amendments exempt two classes of securities--options on narrow-based 
security indexes and futures on narrow-based security indexes--from the 
fee assessments of Section 31. Moreover, as discussed above, making the 
rule amendments effective immediately will spare exchanges and 
associations the burden and expense of monitoring indexes and assessing 
the required fees for the period during which the amendments are not 
effective. Therefore, the Commission finds good cause to issue the rule 
amendments without a delayed effective date.
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    \20\ See 5 U.S.C. 553(d).
    \21\ See 5 U.S.C. 553(d)(1).
    \22\ See 5 U.S.C. 553(d)(3).
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    The Regulatory Flexibility Act \23\ is not applicable to the 
promulgation of the rule amendments. The flexibility analysis 
requirement of the Regulatory Flexibility Act applies only if the 
Commission would be required by the APA to publish general notice of 
the proposed rulemaking.\24\ As discussed above, the Commission has 
determined that the APA does not require it to solicit public comment 
in this case.
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    \23\ 5 U.S.C. 601-612.
    \24\ See 5 U.S.C. 603(a).
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    The Paperwork Reduction Act \25\ is not applicable to the 
promulgation of the amendments because they do not impose any 
collection of information requirements that would require the approval 
of the Office of Management and Budget.
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    \25\ 44 U.S.C. 3501 et seq.
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V. Consideration of Costs and Benefits

A. Costs

    Eliminating Section 31 fees for transactions in options or futures 
on narrow-based indexes theoretically could result in slightly higher 
fees on transactions in other securities that do not benefit from a 
Section 31 exemption. The Exchange Act, as amended by the Fee Relief 
Act, requires the Commission to set rates for Section 31 fees so that 
such rates are reasonably likely to produce aggregate fee collections 
that equal amounts prescribed by the Fee Relief Act.\26\ Thus, although 
the Commission may exempt certain securities from Section 31, it cannot 
reduce the total amount of fees that it is required to collect under 
Section 31. An exemption granted to certain securities could, 
therefore, result in a higher rate paid on transactions in the 
remaining, non-exempted securities. However, because the fees collected 
on trades in options on narrow-based security indexes are very small 
relative to the overall fees collected on non-exempt securities 
transactions in the United States,\27\ the Commission concludes that 
the amendments to Rule 31-1 adopted today will have a negligible 
effect, if any, on the fees paid on these other securities 
transactions.\28\ Furthermore, the Commission believes that, although 
futures on narrow-based security indexes have not yet begun trading, 
the dollar volume of trading in these products will be very small for 
the foreseeable future. Therefore, the Commission also believes that an 
exemption for futures on narrow-based security indexes will have a 
negligible effect, if any, on the fees paid on other securities 
transactions.
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    \26\ See 15 U.S.C. 78ee(j).
    \27\ See supra note 12 and accompanying text.
    \28\ Assuming, for the sake of argument, that the Commission 
would collect $35,000 in fees on trades in options on narrow-based 
security indexes in the absence of this exemption in fiscal year 
2003, this amount would have represented only 0.0041% of the $849 
million in Section 31 fees targeted for collection in fiscal year 
2003 under Section 31, as amended by the Fee Relief Act. This amount 
is so small that it would not affect the fee rate that the 
Commission is required to publish for fiscal year 2003 pursuant to 
Section 31. See 15 U.S.C. 78ee.
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B. Benefits

    The benefits of the amendments to Rule 31-1 adopted today will 
equal the costs saved: (1) By certain national securities exchanges 
from not having to monitor the indexes underlying options for purposes 
of Section 31; (2) by certain national securities exchanges from no 
longer having to collect Section 31 fees from market participants for 
transactions in options on narrow-based security indexes; and (3) by 
market participants who effect transactions in options on narrow-based 
security indexes and who will no longer have to pay Section 31 fees on 
such transactions.
1. Benefits From Relieving Monitoring Burdens
    With the adoption of the amendments to Rule 31-1, all index options 
and index futures--whether based on narrow-based or broad-based 
indexes--are now exempt from Section 31 fees. The Commission believes 
that three national securities exchanges will derive certain benefits 
from not having to monitor whether an index that underlies an option is 
narrow-based or broad-based for purposes of Section 31.
    In August 2001, the Commission adopted a rule that established a 
methodology for calculating the market value of a narrow-based security 
index (``Index Calculation Rule'').\29\ In adopting the Index 
Calculation Rule, the Commission estimated the costs that would be 
imposed on national securities exchanges, designated contract markets, 
derivatives transaction execution facilities, and foreign boards of 
trade to calculate the market value of security indexes in accordance 
with the rule. As noted above, the Fee Relief Act excluded from Section 
31 options on broad-based security indexes but not options on narrow-
based security indexes. Thus, when the Fee Relief Act

[[Page 5202]]

became effective retroactively to December 28, 2001, three additional 
national securities exchanges \30\ were required adhere to the Index 
Calculation Rule to ascertain whether the indexes underlying their 
option products were narrow-based or broad-based, for purposes of 
paying Section 31 fees only on the correct index options. The 
Commission believes that one of the benefits of the rule amendments 
adopted today will be the elimination of the monitoring costs for these 
three exchanges.
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    \29\ See Securities Exchange Act Release No. 44724 (August 20, 
2001), 66 FR 44490 (August 23, 2001) (adopting Rules 3a55-1 to 3a55-
3).
    \30\ Currently, there are five registered national securities 
exchanges that trade options. Only three of them--the American Stock 
Exchange, the Chicago Board Options Exchange, and the Philadelphia 
Stock Exchange--trade options on security indexes, some of which are 
narrow-based. Thus, a Section 31 exemption for options on narrow-
based security indexes will affect only these three exchanges.
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    In the adopting release for the Index Calculation Rule, the 
Commission--upon a suggestion made by one of the commenters--assumed 
that two full-time staff persons, one supervisory and the other 
clerical, would be required to apply the new rule. The Commission 
estimated the total annual cost of employing one clerical staff person 
would be approximately $57,600, and that the total annual cost of 
employing a supervisory staff person would be approximately $180,000. 
The Commission concluded, therefore, that the total cost to each 
affected exchange to engage the staff necessary to comply with the 
Index Calculation Rule would be $237,600 annually.\31\ Further, the 
Commission anticipated that there would be systems implementation costs 
associated with the Index Calculation Rule. The Commission estimated 
that each affected exchange would incur a one-time system installation 
fee of $300 and additional systems costs of $25,800 annually.\32\
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    \31\ See 66 FR at 44510.
    \32\ See id.
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    The Commission believes that a Section 31 exemption for 
transactions in options on narrow-based security indexes will relieve 
three national securities exchanges of the compliance costs associated 
with the Index Calculation Rule. These exchanges will no longer incur 
the costs of monitoring indexes in a manner consistent with that rule 
for purposes of paying Section 31 fees, which costs were estimated by 
the Commission in the adopting release. Thus, the Commission believes 
that each of the three exchanges will avoid a one-time system 
installation fee of $300; additional systems costs of $25,800 annually; 
and staffing costs of $237,600 annually.
    A futures market would derive no corresponding benefit from a 
Section 31 exemption for futures on narrow-based security indexes 
because the futures market will still be required to monitor the 
indexes underlying its futures products, in a manner prescribed by the 
Index Calculation Rule, to ensure compliance with the appropriate 
regulatory framework.
2. Benefits of Relieving Collection Burdens
    Furthermore, the Commission believes that three national securities 
exchanges will derive a small benefit from not having to collect and 
pay to the Commission Section 31 fees on options on narrow-based 
security indexes. However, the Commission believes that the collection 
and payment of Section 31 fees for options on narrow-based security 
indexes required only minor configurations to the existing systems of 
the exchanges, and that discontinuing such collection and payment will 
yield only very small cost savings to these exchanges.
    The Commission does not believe that the futures markets will 
derive any corresponding benefit from a Section 31 exemption on 
transactions in futures on narrow-based security indexes. Currently, 
futures on narrow-based security indexes are not traded on any U.S. 
futures market. Furthermore, the Commission does not believe that these 
markets have current plans to trade such products in the near future. 
Therefore, because the futures markets would not in any case have had 
to devote resources to the collection and payment of Section 31 fees on 
transactions in futures on narrow-based security indexes, the 
Commission does not believe that the exemption granted today for such 
futures would create any benefits for the futures markets. The 
Commission believes, nevertheless, that such an exemption is necessary 
to establish a level playing field between options and futures on 
narrow-based security indexes at such time as these futures may be 
traded.
3. Benefits of Eliminating Section 31 Fees Payable By Market 
Participants Who Effect Transactions in Options or Futures on Narrow-
based Security Indexes
    One benefit of the amendments to Section 31 adopted today is that 
market participants who effect transactions in options or futures on 
narrow-based security indexes will not have to pay Section 31 fees on 
such transactions. However, as noted above, the Commission acknowledges 
that this benefit is offset by the increase in the rate of Section 31 
fees that must be paid by market participants on transactions in other, 
non-exempted securities.

VI. Statutory Authority

    The amendments to Rule 31-1 under the Exchange Act are being 
adopted pursuant to 15 U.S.C. 78a et seq., particularly Sections 23(a) 
and 31 of the Exchange Act.

List of Subjects in 17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

Text of Rule Amendment

    For the reasons set forth above, the Commission amends Part 240 of 
Chapter II, Title 17 of the Code of Federal Regulations 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, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, and 80b-11, unless otherwise noted.
* * * * *

    2. Section 240.31-1 is amended by:
    a. Removing the phrase ``other than narrow-based security indexes'' 
in the first sentence of the Preliminary Note;
    b. Removing the period at the end of paragraph (a) and adding in 
its place a ``;'';
    c. Removing the ``and'' at the end of paragraph (d);
    d. Removing the period at the end of paragraph (e) and adding in 
its place a ``;''; and
    e. Adding paragraphs (f) and (g) to read as follows:


Sec. 240.31-1  Securities transactions exempt from transaction fees.

* * * * *
    (f) Sales of options on narrow-based security indexes; and
    (g) Round turn transactions in futures on narrow-based security 
indexes.

    Dated: January 31, 2002.
    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-2764 Filed 2-1-02; 10:26 am]
BILLING CODE 8010-01-P