[Federal Register Volume 67, Number 101 (Friday, May 24, 2002)]
[Rules and Regulations]
[Pages 36740-36763]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12979]



[[Page 36739]]

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Part IV





Commodity Futures Trading Commission

Securities and Exchange Commission





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17 CFR Parts 41 and 240



Cash Settlement and Regulatory Halt Requirements for Security Futures 
Products; Final Rule

  Federal Register / Vol. 67, No. 101 / Friday, May 24, 2002 / Rules 
and Regulations  

[[Page 36740]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 41

RIN 3038-AB86

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-45956; File No. S7-15-01]
RIN 3235-AI24


Cash Settlement and Regulatory Halt Requirements for Security 
Futures Products

AGENCIES: Commodity Futures Trading Commission and Securities and 
Exchange Commission.

ACTION: Joint final rule.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the 
Securities and Exchange Commission (``SEC'') (collectively 
``Commissions'') are adopting a new rule generally to require that the 
final settlement price for each cash-settled security futures product 
fairly reflect the opening price of the underlying security or 
securities, and that trading in any security futures product halt when 
a regulatory halt is instituted with respect to a security or 
securities underlying the security futures product by the national 
securities exchange or national securities association listing the 
security. The rule adopted today would set forth more specifically how 
the exchange's or association's rules can satisfy provisions added to 
the Commodity Exchange Act (``CEA'') and the Securities Exchange Act of 
1934 (``Exchange Act'') by the Commodity Futures Modernization Act of 
2000 (``CFMA''). The Commissions are also issuing an interpretation of 
the statutory requirement under the CEA and the Exchange Act that 
procedures be put in place for coordinated surveillance among the 
markets trading security futures products and any market trading any 
security underlying the security futures products or any related 
security.

EFFECTIVE DATE: The rules are effective June 24, 2002.

FOR FURTHER INFORMATION CONTACT:
CFTC
    Richard A. Shilts, Acting Director, Division of Economic Analysis, 
at (202) 418-5275; Thomas M. Leahy, Jr., Financial Instruments Unit 
Chief, Division of Economic Analysis, at (202) 418-5278; or Gabrielle 
A. Sudik, Attorney, Office of General Counsel, at (202) 418-5120, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW, Washington, DC 20581. E-mail: ([email protected]), 
([email protected]), or ([email protected]).
SEC
    Jerry Carpenter, Assistant Director, at (202) 942-4187; Terri 
Evans, Assistant Director, at (202) 942-4162; Alton Harvey, Office 
Head, at (202) 942-4167; Michael Gaw, Special Counsel, at (202) 942-
0158; Cyndi Nguyen, Attorney, at (202) 942-4163; and Michael Rae, 
Attorney, at (202) 942-0785, Division of Market Regulation, Securities 
and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-
1001.

SUPPLEMENTARY INFORMATION: The CFTC is adopting Rule 41.1(j) through 
(l), 41.25(a)(2), 41.25(b), and 41.25(d) under the CEA.\1\ The SEC is 
adopting Rule 6h-1 under the Exchange Act.\2\
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    \1\ Rule 41.1(j)-(l), 17 CFR 41.1, hereinafter referred to as 
CFTC Rule 41.1; 41.25(a)(2), 17 CFR 41.25(a)(2), hereinafter 
referred to as CFTC Rule 41.25(a)(2); 41.25(b), 17 CFR 41.25(b), 
hereinafter referred to as CFTC Rule 41.25(b); and 41.25(d), 17 CFR 
41.25(d), hereinafter referred to as CFTC Rule 41.25(d).
    \2\ Rule 6h-1, 17 CFR 240.6h-1, hereinafter referred to as SEC 
Rule 6h-1.
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Table of Contents

I. Introduction
II. Discussion
    A. Settlement Prices for Cash-Settled Security Futures Products
    1. Background
    2. Proposed Rule for Settlement Prices
    3. Final Rule
    a. Final Settlement Price for Cash-Settled Security Futures 
Products Must Fairly Reflect the Opening Price
    i. CFTC Technical Amendment
    b. Definitions of ``Opening Price'' and ``Regular Trading 
Session''
    c. Determining a Final Settlement Price When Opening Price Not 
Readily Available
    d. New Provision to Resolve Conflict Between Market Rules and 
Clearing Agency Rules
    e. Exemptions
    B. Regulatory Halts
    1. Background
    2. Proposed Rule for Regulatory Halts
    3. Final Rule
    a. Trading Halt Coordination in Single-Stock Futures
    b. Trading Halt Coordination in Narrow-Based Security Index 
Futures
    c. Definition of a Regulatory Halt
    d. Exemptions
    C. Commissions' Interpretation of Statutory Requirements for 
Coordinated Surveillance
    1. Markets Trading Security Futures
    2. Exchanges Trading Securities Other Than Security Futures
III. Paperwork Reduction Act
    CFTC:
    SEC:
    A. Summary of Collection of Information
    B. Proposed Use of Information
    C. Respondents
    D. Total Annual Reporting and Recordkeeping Burden
    E. Record Retention Period
    F. Collection of Information Is Mandatory
    G. Confidentiality
IV. Costs and Benefits of the Final Rule
    CFTC:
    SEC:
    A. Comments
    B. Benefits of SEC Rule 6h-1 under the Exchange Act
    C. Costs of SEC Rule 6h-1 under the Exchange Act
V. Consideration of the Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    SEC:
    A. Effects on Competition
    1. Settlement Procedures for Cash-Settled Security Futures 
Products
    2. Trading Halt Provisions
    3. Conclusion
    B. Effects on Efficiency and Capital Formation
    1. Settlement Procedures for Cash-Settled Security Futures 
Products
    2. Trading Halt Provisions
VI. Final Regulatory Flexibility Act
    CFTC:
    SEC:
VII. Statutory Basis and Text of Rule
Appendix A

I. Introduction

    The CFMA \3\ authorizes the trading of futures on individual stocks 
and narrow-based security indexes (collectively, ``security futures 
'').\4\ The CFMA defines security futures products as ``securities'' 
under the Exchange Act,\5\ the Securities Act of 1933,\6\ the 
Investment Company Act of 1940,\7\ and the Investment Advisers Act of 
1940,\8\ and as contracts of sale for future delivery of a single 
security or of a narrow-based security index or options thereon under 
the CEA.\9\ Accordingly, the regulatory framework established by the 
CFMA for the markets and intermediaries trading security futures

[[Page 36741]]

products provides the SEC and the CFTC with joint jurisdiction.
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    \3\ Pub. L. No. 106-554, Appendix E, 114 Stat. 2763.
    \4\ After December 21, 2003, the Commissions may jointly 
determine to permit trading of puts, calls, straddles, options, or 
privileges on security futures (along with security futures, 
collectively referred to as ``security futures products''). See 
Section 2(a)(1)(D)(iii) of the CEA, 7 U.S.C. 2(a)(1)(D)(iii); 
Section 6(h)(6) of the Exchange Act, 15 U.S.C. 78f(h)(6).
    \5\ See Section 3(a)(10) of the Exchange Act, 15 U.S.C. 
78c(a)(10).
    \6\ See Section 2(a)(1) of the Securities Act of 1933, 15 U.S.C. 
77b(a)(1).
    \7\ See Section 2(a)(36) of the Investment Company Act of 1940, 
15 U.S.C. 80a-2(a)(36).
    \8\ See Section 202(a)(18) of the Investment Advisers Act of 
1940, 15 U.S.C. 80b-2(a)(18).
    \9\ See Section 1a(31) of the CEA, 7 U.S.C. 1a(31).
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    Under the Exchange Act, it is unlawful for any person to effect 
transactions in security futures products that are not listed on a 
national securities exchange \10\ or on a national securities 
association registered pursuant to Section 15A(a) of the Exchange 
Act.\11\ In addition, Section 6(h)(2) of the Exchange Act \12\ provides 
that such an exchange or association may trade only those security 
futures products that conform with listing standards filed by the 
exchange or association with the SEC under Section 19(b) of the 
Exchange Act \13\ and that meet certain criteria specified in Section 
2(a)(1)(D)(i) of the CEA \14\ and the standards and conditions 
enumerated in Section 6(h)(3) of the Exchange Act.\15\
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    \10\ Section 6(g) of the Exchange Act, 15 U.S.C. 78f(g), allows 
a designated contract market under Section 5 of the CEA, 7 U.S.C. 7, 
or a registered derivatives transaction execution facility under 
Section 5a of the CEA, 7 U.S.C. 7a, to register as a national 
securities exchange solely for the purpose of trading security 
futures products (``Security Futures Product Exchange''). See 
Securities Exchange Act Release No. 44692 (August 13, 2001), 66 FR 
43721 (August 20, 2001) (adopting, in part, requirements for 
designated contract markets and registered derivatives transaction 
execution facilities to register as national securities exchanges). 
By definition, the phrase ``national securities exchange'' 
encompasses Security Futures Product Exchanges. For simplicity, the 
text of this release refers to national securities exchanges and 
national securities associations. The CFTC's rules in Section VII of 
this release, however, by their terms, apply to designated contract 
markets and registered derivatives transaction execution facilities.
    \11\ 15 U.S.C. 78o-3(a).
    \12\ 15 U.S.C. 78f(h)(2).
    \13\ 15 U.S.C. 78s(b).
    \14\ 7 U.S.C. 2(a)(1)(D)(i).
    \15\ 15 U.S.C. 78f(h)(3).
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    In particular, the CEA and the Exchange Act stipulate that the 
listing standards of an exchange or association trading security 
futures products shall, among other things, require that trading in the 
security futures product not be readily susceptible to manipulation of 
the price of such security futures products, nor to causing or being 
used in the manipulation of the price of any underlying security or 
option thereon.\16\ In addition, listing standards must require that 
the market on which the security futures product trades has in place 
procedures to coordinate trading halts between such market and any 
market on which any security underlying the security futures product is 
traded and other markets on which any related security is traded.\17\
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    \16\ See Section 2(a)(1)(D)(i)(VII) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(VII); Section 6(h)(3)(H) of the Exchange Act, 15 
U.S.C. 78f(h)(3)(H).
    \17\ See Section 2(a)(1)(D)(i)(X) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(X); Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C. 
78f(h)(3)(K). Before a national securities exchange or national 
securities association lists or trades security futures products, it 
is required to file, pursuant to Section 19(b) of the Exchange Act, 
15 U.S.C. 78s(b), a proposed rule change with the SEC establishing 
listing standards that comply with Section 6(h)(3) of the Exchange 
Act, 15 U.S.C. 78f(h)(3). Generally, a national securities exchange 
registered under Section 6(a) of the Exchange Act, 15 U.S.C. 78f(a), 
or a national securities association registered under Section 15A(a) 
of the Exchange Act, 15 U.S.C. 78o-3(a), must file proposed rule 
changes with the SEC pursuant to Section 19(b)(1) of the Exchange 
Act, 15 U.S.C. 78s(b)(1), for notice, comment, and SEC approval, 
prior to implementation, unless the rule is otherwise permitted to 
become effective pursuant to Section 19(b)(3) of the Exchange Act, 
15 U.S.C. 78s(b)(3). A Security Futures Product Exchange or a 
national securities association registered under Section 15A(k) of 
the Exchange Act, 15 U.S.C. 78o-3(k), must generally submit, 
pursuant to Section 19(b)(7) of the Exchange Act, 15 U.S.C. 
78s(b)(7), proposed rule changes relating to certain enumerated 
matters, including listing standards. See 17 CFR 240.19b-7.
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    Accordingly, the Commissions proposed amendments to Rule 41.1 and 
Rule 41.25 under the CEA, and new Rule 6h-1 under the Exchange Act to 
generally provide that (i) the final settlement price for each cash-
settled security futures product fairly reflect the opening price of 
the underlying security or securities, and (ii) the listing standards 
of national securities exchanges and national securities associations 
trading security futures products establish a halt in trading in any 
security futures product when the national securities exchange or 
national securities association listing the security institutes a 
regulatory halt with respect to a security or securities underlying the 
security futures product.\18\ In response to the Proposing Release, the 
Commissions received eight comment letters.\19\ As discussed further 
below, the Commissions are adopting the rule substantially as proposed, 
with slight modifications in response to recommendations by commenters.
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    \18\ See Securities Exchange Act Release No. 44743 (August 24, 
2001), 66 FR 45904 (August 30, 2001) (``Proposing Release'').
    \19\ See letters to Jean A. Webb, Secretary, CFTC, and Jonathan 
G. Katz, Secretary, SEC, from, or on behalf of: Joanne Moffic-
Silver, General Counsel, Chicago Board Options Exchange, dated 
October 1, 2001 (``CBOE Letter''); David J. Vitale, President and 
Chief Executive Officer, Chicago Board of Trade, dated October 1, 
2001 (``CBOT Letter''); James J. McNulty, President and Chief 
Executive Officer, Chicago Mercantile Exchange, Inc., dated October 
1, 2001 (``CME Letter''); Jonathon Barton, Chairman, Futures 
Industry Association/Securities Industry Association Steering 
Committee on Security Futures, dated April 4, 2002 (``FIA/SIA 
Steering Committee Letter''); James E. Buck, Senior Vice President 
and Secretary, New York Stock Exchange, Inc., dated October 19, 2001 
(``NYSE Letter''); William H. Navin, Executive Vice President and 
General Counsel, the Options Clearing Corporation, dated October 3, 
2001 (``OCC Letter''); Joel Greenberg, Managing Director, 
Susquehanna International Group, LLP, dated October 17, 2001 (``SIG 
Letter''); and Larry Coury, Silvia Madrid, Laura Murias, Mike 
Periera, Vivek Sahota, Benjamin Sparks, Adrian Spirollari, and 
Wallace Truesdale, Students at Fordham University School of Law, 
dated October 1, 2001 (``Students Letter''). In addition to the 
comment letters received on the Proposing Release, the Commissions 
reviewed three comment letters received by the CFTC on its separate 
proposal regarding full membership in the Intermarket Surveillance 
Group. See infra discussion at Section II.C., Commissions' 
Interpretation of Statutory Requirements for Coordinated 
Surveillance.
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II. Discussion

A. Settlement Prices for Cash-Settled Security Futures Products

1. Background
    All currently traded index futures and options are cash-settled. 
When stock index futures and options began trading in the mid-1980s, 
virtually all of these products used closing-price settlement 
procedures. Closing-price settlement procedures in index futures and 
options generally base the index settlement price on the execution 
prices from the last regular session trades in the underlying 
securities. The cash settlement provisions of stock index futures and 
options contracts facilitated the growth of sizeable index arbitrage 
activities by firms and professional traders and made it relatively 
easy for arbitrageurs to buy or sell the underlying stocks at or near 
the market close on expiration Fridays \20\ in order to ``unwind'' 
arbitrage-related positions. These types of unwinding programs at the 
close on expiration Fridays often severely strained the liquidity of 
the securities markets.
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    \20\ The term ``expiration Fridays'' refers to the third Friday 
of each month that marks the expiration date for that month's 
individual stock options, stock index options, and stock index 
futures contracts. On the expiration date, options and futures 
contracts cease to exist. Some stock index futures and options 
expire on a quarterly basis, with their expiration Friday occurring 
on the third Friday of the last month of the quarter (March, June, 
September, and December).
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    Regulators and self-regulators were concerned that the liquidity 
constraints faced by the securities markets to accommodate expiration-
related buy or sell programs at the market close on expiration Fridays 
could exacerbate ongoing market swings during an expiration and could 
provide opportunities for entities to anticipate these pressures and 
enter orders as part of manipulative or abusive trading practices 
designed to artificially drive up or down share prices. To reduce such 
expiration-related strains on market liquidity, markets trading the 
most actively-traded futures contracts and many stock index option 
contracts moved to opening-price settlement procedures. As discussed in 
the Proposing Release, opening-price settlement procedures offered 
several features that enabled the securities

[[Page 36742]]

markets to better handle expiration-related unwinding programs.
2. Proposed Rule for Settlement Prices
    In view of the experience gained with settlements in cash-settled 
stock index futures and options in the 1980s and in light of the 
potential for manipulation of the underlying securities markets, the 
Commissions proposed that security futures products that specify cash 
settlement in lieu of physical delivery use a final settlement price 
that fairly reflected the opening price of the underlying security or 
securities as the basis for cash settling positions at contract 
expiration.\21\
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    \21\ See Proposing Release, supra note 18.
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    The Commissions' proposal also required that, if an opening price 
for an underlying security or securities was not readily available, the 
final settlement price of the overlying cash-settled security futures 
product had to fairly reflect the price of the underlying security or 
securities during its most recent regular trading session. The 
Commissions' proposal provided exchanges and associations with some 
discretion to implement this general rule. Finally, the proposal 
explicitly permitted the Commissions to grant a national securities 
exchange or national securities association an exemption from the above 
requirements.
3. Final Rule
a. Final Settlement Price for Cash-Settled Security Futures Products 
Must Fairly Reflect the Opening Price
    The Commissions are adopting the requirement as proposed that the 
final settlement price of a cash-settled security futures product 
fairly reflect the opening price of the underlying security or 
securities, if the opening price is readily available.\22\
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    \22\ CFTC Rule 41.25(b)(1) and SEC Rule 6h-1(b)(1). The CFTC is 
adopting one technical change to CFTC Rule 41.25(b). See discussion 
infra at II.A.3.a.i., CFTC Technical Amendment.
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    Several commenters generally supported this aspect of the 
proposal.\23\ One commenter stated that cash-settled security futures 
products should be settled based on opening prices of the underlying 
securities because cash-settled index options already are required to 
settle in the same manner.\24\ A second commenter advocated opening 
price settlement because closing-price settlement procedures for 
futures and options products in the 1980s ``strained the liquidity of 
the securities markets and raised concerns about opportunities for 
manipulative or abusive trading practices.'' \25\ This commenter 
believed that, with the increased use of opening-price settlement, 
specialists are better able to handle expiration-related unwinding 
programs because there are well-developed opening procedures to 
disseminate price indications in an orderly manner and because 
specialists have the remainder of the session to trade out of any 
position imbalances acquired at the opening.
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    \23\ See CBOE Letter, CBOT Letter, and NYSE Letter.
    \24\ See CBOE Letter.
    \25\ See NYSE Letter.
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    A third commenter noted that the migration in 1987 from closing 
price to opening price settlement on its S&P 500 and other futures 
contracts ``was largely in response to the fact that Friday afternoon 
settlements--which corresponded to existing practices for listed 
options expirations--exposed NYSE specialists to large information-less 
market-on-close orders without an adequate mechanism to cope.''\26\ 
Nevertheless, this commenter pointed out potential problems with the 
proposed approach. It stated, for example, that the openings of all 
securities do not occur simultaneously and, therefore, calculation of 
an index must be based on non-synchronous transaction prices. This 
commenter also noted that a volume-weighted average transaction price 
over a short time interval has evolved into an industry standard for 
determining final settlement prices for futures based on securities 
trading on decentralized markets, such as Nasdaq. In response to the 
foregoing, the Commissions note that the rule being adopted today does 
not mandate that a particular methodology be used to derive an opening 
price. A national securities exchange or national securities 
association is, therefore, free to develop its own methodology for 
determining final settlement prices, provided that the result ``fairly 
reflects'' the opening price.\27\
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    \26\ See CME Letter.
    \27\ Any rule change proposed by a national securities exchange 
or national securities association to establish listing standards 
for security futures products, including methodologies for 
determining final settlement prices, would have to be filed with the 
SEC pursuant to Section 19 of the Exchange Act, 15 U.S.C. 78s, and 
the rules thereunder. See supra note 10 and accompanying text. Rule 
changes should also be submitted to the CFTC in accordance with CFTC 
Rule 41.24, 17 CFR 41.24.
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    The same commenter also stated that the Commissions' proposal could 
create a discrepancy between security futures products based on narrow-
based security indexes and other derivative products based on the same 
indexes: while the former would be required to settle using opening 
prices, the latter are subject to no such requirement.\28\ Another 
commenter noted that the option on the S&P 100 index (the ``OEX'' 
option) still employs closing-price settlement and called upon the 
Commissions to bring OEX into line with the opening-price settlement 
procedures now being adopted.\29\
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    \28\ See CME Letter.
    \29\ See NYSE Letter.
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    The Commissions do not believe it is necessary or appropriate at 
this time to mandate opening settlement procedures for all options and 
futures. As the Commissions noted in the Proposing Release, CBOE 
believed that the closing price settlement procedures were appropriate 
for OEX because these options were used primarily by retail investors 
and were not actively used in the types of index arbitrage unwinding 
programs that had strained the liquidity of the securities markets at 
the close on expiration.\30\ Further, the Commissions note that the 
vast majority of options do use opening-price settlement procedures; 
\31\ therefore, the rule being adopted today is consistent with that 
general practice.\32\
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    \30\ For example, the OCC indicated that for the month of 
November 2001, the dollar amount of premiums settled in SPX options 
was over 12 times larger than that for OEX options. Both indexes are 
capitalization-based indexes from Standard & Poor's.
    \31\ See Proposing Release, supra note .
    \32\ If the circumstances so warrant, the SEC may in the future 
consider requiring all cash-settled options to use opening-price 
settlement procedures.
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    One commenter also did not believe that the decision to employ 
opening-rather than closing-price procedures should be based on a 
perceived threat of increased manipulative activity, arguing that 
improvements in audit trails, record-keeping practices, and inter-
exchange cooperation have greatly increased the ability to detect and 
punish manipulative activity.\33\ The Commissions agree that these 
enhancements have increased the ability of regulators to detect and 
punish manipulative trading activity. Nevertheless, the Commissions 
believe that it is appropriate to take steps that reduce not merely the 
incentive, but also the ability to manipulate the market. For example, 
one commenter described its implementation of special closing 
procedures to reduce the scope for end-of-day manipulation, while 
stating that the use of opening prices would obviate the need for these 
special closing procedures.\34\ This commenter also noted that opening-
price settlement decreases the likelihood of price distortions not 
brought about by manipulative intent, such as human

[[Page 36743]]

error, that can significantly affect the closing prices of securities 
and their overlying indexes, because the markets have no time before 
the closing to correct such errors. The Commissions believe that market 
distortions--whether caused by manipulation, human error, or 
difficulties in balancing buy- and sell-side interest--are more likely 
to occur in an environment in which closing-price settlement of 
derivative products is used, and that the potential for these 
distortions exists to a far lesser degree at the opening.\35\
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    \33\ See CME Letter.
    \34\ See NYSE Letter.
    \35\ See supra discussion at Section II.A.1., Background.
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i. CFTC Technical Amendment
    The CFTC notes one technical change to the text of CFTC Rule 
41.25(b). In an earlier rulemaking, the CFTC adopted an introductory 
paragraph that required that the cash settlement price of security 
futures products must be ``reliable and acceptable, be reflective of 
prices in the underlying securities market and be not readily 
susceptible to manipulation.'' \36\ The CFTC included this language in 
the earlier rulemaking to reflect the CFTC's longstanding policy 
regarding the standards for cash-settlement of futures contracts, which 
are set forth in the CFTC's Guideline No. 1.\37\ The CFTC also included 
this language in the Proposing Release for the present rulemaking.\38\ 
In the final rules published today, the CFTC has decided to eliminate 
this introductory paragraph because the requirements of the paragraph 
are embodied in the remainder of the Rule 41.25(b) and in other rules 
in Part 41.
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    \36\ See 66 FR 55078 (November 1, 2001).
    \37\ See 17 CFR Part 40, Appendix A(a)(2)(iii).
    \38\ See 66 FR at 45918.
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    The requirements that the cash settlement price must be reliable, 
acceptable and reflect the prices in the underlying securities markets 
are embodied in CFTC Rules 41.25(b)(1) and (2). These rules require 
that cash settlement prices be based on the opening price of a security 
futures product's underlying security or securities, or, if the opening 
price for one or more securities is not readily available, the final 
settlement price of the security futures products must fairly reflect 
the price of the underlying security or securities during the most 
recent regular trading session for such securities or the next 
available opening price. Based on prior analyses and for reasons 
discussed in the proposing release, the CFTC previously has determined 
that opening prices represent reliable indicators of the values of 
securities and thus are acceptable for hedging of securities' 
positions. In addition, opening prices are established under procedures 
designed to ensure that the prices are reflective of prices in the 
underlying securities market. Finally, the requirement that the cash 
settlement price not be readily susceptible to manipulation is embodied 
in CFTC Rule 41.22(f), which states, ``Trading in the security futures 
products is not readily susceptible to manipulation of the price of 
such security futures product, nor to causing or being used in the 
manipulation of the price of any underlying security, option on such 
security, or option on a group or index including such securities, 
consistent with the conditions for trading of [sect] 41.25[.]'' \39\
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    \39\ See 17 CFR 41.22(f); 66 FR at 55084. See also Core 
Principle for Contract Markets 3 of the CEA requiring designated 
contract markets to list contracts that are not readily susceptible 
to manipulation; Core Principle for Contract Markets 4 of the CEA 
requiring designated contract markets to monitor trading to prevent 
manipulation, price distortion, and disruptions of the delivery or 
cash-settlement process; and Core Principle for DTEFs 3 of the CEA 
requiring DTEFs to monitor trading to ensure orderly trading. 
Sections 5(d)(3), 5(d)(4) and 5a(d)(3) of the CEA; 7 U.S.C. 7(d)(3), 
7(d)(4) and 7a(d)(3).
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b. Definitions of ``Opening Price'' and ``Regular Trading Session''
    The Commissions are adopting the definition of ``regular trading 
session'' as proposed.\40\ However, in response to comments, the 
Commissions have modified the definition of ``opening price'' by 
clarifying that, if a security is not listed on a national securities 
exchange or a national securities association, the opening price shall 
be the price at which a security opened for trading, or a price that 
fairly reflects the price at which a security opened for trading, on 
the primary market for the security.
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    \40\ A ``regular trading session'' of a security means the 
normal hours for business of a national securities exchange or 
national securities association that lists the security. See CFTC 
Rule 41.1(k) and SEC Rule 6h-1(a)(2).
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    The Commissions proposed to define ``opening price'' as ``the price 
at which a security opened for trading, or a price that fairly reflects 
the price at which a security opened for trading, during the regular 
trading session of the national securities exchange or national 
securities association that lists the security.'' \41\ One commenter, 
however, observed that security futures products may be based on 
securities the primary markets of which are foreign, and that using the 
opening price from a U.S. market--if there is one--might not be a 
meaningful or practical solution for optimal contract design.\42\
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    \41\ See proposed CFTC Rule 41.1(j) and proposed SEC Rule 6h-
1(a)(1).
    \42\ See CME Letter.
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    The Commissions acknowledge that the proposed definition of 
``opening price'' failed to contemplate that the market trading a 
security that underlies a security futures product could be a market 
other than a national securities exchange or national securities 
association, such as a foreign stock exchange. Therefore, the 
Commissions have revised the definition to provide that, if the 
underlying security is not listed on a national securities exchange or 
a national securities association, the opening price is the price at 
which the security opened for trading, or a price that fairly reflects 
the price at which a security opened for trading, on the primary market 
for the security. To the extent that the underlying security is listed 
on a national securities exchange or national securities association, 
however, as explained further below, the Commissions continue to 
believe that it is appropriate to use the opening price from the 
listing market.\43\
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    \43\ If a security futures product were based on an American 
Depository Receipt (``ADR'') traded on a national securities 
exchange or national securities association, the opening price for 
the ADR would necessarily, under the rule adopted today, be derived 
from the national securities exchange or national securities 
association that trades it. However, if a security futures product 
were based on the foreign security itself, the market listing the 
security futures product must exercise its discretion to identify 
the primary market of the foreign security for purposes of deriving 
its opening price. See Securities Exchange Act Release No. 44725 
(August 20, 2001).
---------------------------------------------------------------------------

    One commenter stated that it may soon become the case that the 
listing market is not the primary trading venue for a security and, 
thus, not the most liquid market.\44\ The Commissions agree that this 
possibility exists, but nevertheless believe that national securities 
exchanges and national securities associations are, at the present 
time, a significant source of liquidity for those securities that are 
permitted to underlie security futures products and, therefore, that 
opening prices derived from these listing markets are appropriate to 
use as final settlement prices. Moreover, the Commissions believe, at 
this time, that a rule requiring, for example, the calculation of 
trading volumes to determine the appropriate primary market from which 
to derive an opening price for a security listed in the U.S. would 
impose unnecessary burdens without furthering the anti-manipulation 
goals enshrined in Section 2(a)(1)(D)(i)(VII) of the CEA \45\

[[Page 36744]]

and Section 6(h)(3)(H) of the Exchange Act.\46\
---------------------------------------------------------------------------

    \44\ See CME Letter.
    \45\ 7 U.S.C. 2(a)(1)(D)(i)(VII).
    \46\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------

c. Determining a Final Settlement Price When Opening Price Not Readily 
Available
    The Commissions proposed that, if the opening price of an 
underlying security were not readily available, the final settlement 
price of a cash-settled security futures product overlying that 
security must reflect a price of the underlying security taken from its 
most recent regular trading session. The proposed rule provided, 
however, that national securities exchanges and national securities 
associations could request exemptions from the Commissions on a case-
by-case basis.
    Although one commenter supported this aspect of the proposal,\47\ 
four commenters generally opposed the Commissions' exclusive use of a 
``look back'' settlement procedure for security futures products when 
the opening prices for the underlying securities are unavailable and, 
instead, recommended using the next day's opening prices.\48\ These 
commenters noted that the existing cash settlement procedures for stock 
index options and stock index futures allow ``next opening'' 
prices.\49\ Further, one commenter, a clearing agency, urged the 
Commissions not to require national securities exchanges and national 
securities associations to adopt rules addressing the determination of 
security futures final settlement prices when opening prices are not 
readily available, because of potential conflicts with clearing agency 
rules.\50\ Another commenter believed that the establishment of 
consistent and commercially appropriate alternative pricing conventions 
should be resolved by a collaboration among the exchanges that design 
the product and the clearinghouse, with appropriate consultation with 
their members and participants.\51\
---------------------------------------------------------------------------

    \47\ See CBOT Letter.
    \48\ See CBOE Letter, CME Letter, and SIG Letter. See also OCC 
Letter (urging the Commissions to withdraw this aspect of the 
proposal, or at a minimum, modify it to allow the final settlement 
value to be based on the next opening).
    \49\ See CBOE Letter, CME Letter, and SIG Letter. Two of these 
commenters--the CBOE and the CME--stated that, until May 2000, the 
futures and options markets derived alternate settlement prices from 
a previous trading session, but changed their procedures after 
Hurricane Floyd threatened to close the NYSE on the expiration 
Friday of September 17, 1999. See, e.g., Securities Exchange Act 
Release No. 42857 (May 30, 2000), 65 FR 36185 (June 7, 2000) 
(approving SR-CBOE-00-02, which replaced look-back pricing with next 
opening pricing procedures on CBOE in certain situations). See also 
FIA/SIA Steering Committee Letter (stating that the Commissions' 
proposed requirement is inconsistent with existing market practice 
and rules governing a broad range of listed stock index products) 
and OCC By-Laws, Article XII, Section 5 (allowing OCC to fix the 
final settlement price for security futures products using next 
opening prices of the underlying securities, as well as look-back 
pricing).
    \50\ See OCC Letter.
    \51\ See FIA/SIA Steering Committee Letter.
---------------------------------------------------------------------------

    In addition, several commenters contended that under the 
Commissions' proposed rule hedges could be significantly disrupted.\52\ 
One commenter specifically noted that market participants holding 
hedged or arbitraged positions expect to unwind the positions 
simultaneously at stock prices that have equal value in relation to 
derivative settlement prices.\53\ According to the commenter, this 
equal value is achieved when the prices used to calculate the index 
settlement are the same prices that the market participant receives 
when unwinding the stock side of the position; when one or more 
component stocks cannot be unwound at that price, the settlements 
become disjointed and financial exposure occurs. Two commenters 
described how such a scenario would have unfolded had September 14, 
2001, been an expiration Friday: A security futures product--under the 
Commissions'' proposal--would have settled based on the prices of 
underlying securities traded on September 10, although prices at the 
next opening on September 17 were generally significantly lower.\54\
---------------------------------------------------------------------------

    \52\ See CBOE Letter, CME Letter, FIA/SIA Steering Committee 
Letter, OCC Letter, and SIG Letter.
    \53\ See SIG Letter.
    \54\ See OCC Letter and SIG Letter.
---------------------------------------------------------------------------

    In response to the comment letters, the final rule adopted by the 
Commissions allows for either look-back or next opening prices to be 
used as alternate final settlement prices when an opening price is not 
readily available.\55\ The Commissions agree with the commenters that 
the original proposal could result in an unwanted and unwarranted de-
linking of hedging positions if they mandated look-back pricing 
procedures for security futures products. The Commissions also agree 
that it would be inadvisable for the Commissions' rule to result in 
proposed rule changes by national securities associations and national 
securities exchanges that could conflict with the rules of their 
registered clearing agency or derivatives clearing organization.\56\
---------------------------------------------------------------------------

    \55\ CFTC Rule 41.25(b)(2) and SEC Rule 6h-1(b)(2). The 
Commissions' rules do not specify the circumstances in which an 
opening price would not be ``readily available.'' National 
securities exchanges and national securities associations, however, 
would have to establish, as part of their listing standards, 
specific rules that apply this term. In addition, national 
securities exchanges and national securities associations would have 
to file proposed rule changes to delineate which method would be 
used in determining final settlement prices and when it would be 
applied.
    \56\ For a further discussion on this issue, see discussion 
infra at II.A.3.d., New Provision to Resolve Conflict Between Market 
Rules and Clearing Agency Rules.
---------------------------------------------------------------------------

    The Commissions will not, however, prohibit a national securities 
exchange or national securities association from employing look-back 
pricing if it believed that such course were appropriate. One commenter 
stated that situations may arise in which a very small percentage of 
the securities of an index fail to trade on an expiration Friday.\57\ 
In such situations, the commenter believed, it would be reasonable to 
allow the overlying derivative on the index to settle by using look-
back prices for those few underlying securities that did not open, 
rather than waiting to obtain the next opening price for those few 
securities before settlement. The commenter recommended that there be 
flexibility to employ look-back pricing if two percent or less of the 
weighting of an index did not open for trading on an expiration Friday. 
While the Commissions do not believe it is appropriate to set a de 
minimis standard for use of look-back pricing, the Commissions agree 
with the commenter's general point that situations may arise where the 
ability to use look-back pricing will facilitate the fair settlement of 
an overlying security futures product. The Commissions further note 
that the final rule being adopted today is consistent with OCC rules 
that allow for look-back pricing in certain circumstances.\58\
---------------------------------------------------------------------------

    \57\ See SIG Letter.
    \58\ See OCC By Laws, Article XII, Section 5 (allowing OCC to 
fix the final settlement price for security futures products using 
next opening prices of the underlying securities, as well as look-
back pricing).
---------------------------------------------------------------------------

d. New Provision To Resolve Conflict Between Market Rules and Clearing 
Agency Rules
    The rule adopted by the Commissions today allows a national 
securities exchange or national securities association to choose 
between look-back and next opening pricing procedures for security 
futures products; however, it also provides the registered clearing 
agency or derivatives clearing organization that is used to clear such 
products with the authority to determine the final settlement prices in 
certain circumstances.\59\ The Commissions believe that the rule 
adopted today is consistent with the current conditions under which OCC 
provides clearing services to national securities exchanges and 
national

[[Page 36745]]

securities associations. Any national securities exchange or national 
securities association wishing to use OCC clearing services for 
security futures must enter into a clearing agreement with OCC in which 
both parties agree that security futures will be cleared by OCC in 
accordance with OCC's by-laws and rules, which currently give OCC the 
final authority to determine final settlement prices in certain 
circumstances.\60\ The Commissions believe that the rule adopted today 
takes into account such arrangements, as well as allows for similar 
arrangements between other clearing agencies or derivatives clearing 
organizations and national securities exchanges or national securities 
associations. The Commissions also believe that the rule adopted today 
addresses concerns raised by commenters.
---------------------------------------------------------------------------

    \59\ See CFTC Rule 41.25(b)(3) and SEC Rule 6h-1(b)(3).
    \60\ See Securities Exchange Act Release No. 44727 (August 20, 
2001), 66 FR 45351 (August 28, 2001).
---------------------------------------------------------------------------

    Under proposed CFTC Rule 41.25 and SEC Rule 6h-1, a clearing agency 
or derivatives clearing organization would not have been entitled to 
determine a final settlement price. One clearing agency commenter 
pointed out that its rules relating to security futures products 
specifically provide that, in the case of a conflict between OCC's 
rules and the rules of a national securities exchange or national 
securities association, OCC rules control.\61\ OCC expressed the view 
that ``the Commissions' rules should not force the exchanges to adopt 
rules in this area at all, but rather should permit that function to be 
left to the rules of the clearing organization.'' \62\ OCC further 
stated that, ``[w]hether or not the exchanges have rules on this 
subject, it should remain clear that the rules of the clearing 
organization will control in the event of any inconsistency, thus 
assuring uniformity of treatment of fungible products that might be 
traded on more than one exchange.'' Another commenter endorsed the view 
that the clearing agency's rules should control in the event of a 
conflict.\63\
---------------------------------------------------------------------------

    \61\ See OCC Letter and OCC By-Laws, Article XII, Section 6.
    \62\ See also FIA/SIA Steering Committee Letter (urging the 
Commissions not to require exchanges and associations to adopt rules 
addressing the determination of fallback security futures final 
settlement prices when opening prices are not readily available).
    \63\ See CBOE Letter.
---------------------------------------------------------------------------

    The Commissions disagree with the view that markets trading 
security futures products should not address settlement procedures. To 
the extent that a clearing agency or derivatives clearing organization 
does not have rules in place to address all situations for determining 
the settlement price of a cash-settled security futures product, the 
national securities exchange or national securities association that 
trades such product should have rules in place. However, the 
Commissions believe that it is appropriate to expressly provide that, 
in the event of a conflict between the rules of a registered clearing 
agency or derivatives clearing organization and a market that trades a 
security futures product, the clearing agency or derivatives clearing 
organization may establish a new final settlement price for a security 
futures product if it determines, pursuant to its rules, that the final 
settlement price determined by the exchange or association is not 
consistent with the protection of investors or customers, as 
applicable, and the public interest, taking into account such factors 
as fairness to buyers and sellers of the affected security futures 
product, the maintenance of a fair and orderly market in such security 
futures product, and consistency of interpretation and practice. In the 
absence of such a provision, confusion could arise if securities 
underlying a security futures product failed to trade on an expiration 
Friday and the market trading the security futures product and its 
clearing agency or derivatives clearing organization had different 
rules for determining a final settlement price. Moreover, this 
provision will make security futures products that trade on different 
markets more fungible, because a single clearing agency or derivatives 
clearing organization will be able in certain circumstances to 
harmonize procedures across different markets for determining alternate 
settlement prices.
e. Exemptions
    In the final rule adopted by the Commissions, the Commissions' 
ability to grant exemptions to the rule's requirements has been 
expanded slightly from that proposed. The proposal explicitly provided 
that any national securities exchange or national securities 
association may receive an exemption from the requirements that final 
settlement prices of security futures products reflect the opening 
prices of the underlying securities or, if opening prices are not 
available, look-back pricing procedures. The final rule explicitly 
provides that the CFTC may grant an exemption with respect to any 
provision of paragraphs (a)(2) and (b) of CFTC Rule 41.25, provided 
that the CFTC finds that the exemption is consistent with the public 
interest and the protection of customers.\64\ Similarly, the rule 
explicitly provides that the SEC may grant an exemption with respect to 
any provision of SEC Rule 6h-1, provided that the exemption is 
necessary or appropriate in the public interest and consistent with the 
protection of investors.\65\ The Commissions are expanding the scope of 
the exemption to make it more consistent with the SEC's exemptive 
authority under Section 36 of the Exchange Act, which allows the SEC, 
by rule, regulation, or order to conditionally or unconditionally 
exempt any person, security, or transaction, or any classes thereof, 
from any rule or regulation under the Exchange Act, to the extent that 
such exemption is necessary or appropriate in the public interest, and 
is consistent with the protection of investors.\66\ Because exchanges 
and associations are subject to the requirements of both CFTC Rule 
41.25(a)(2) and (b) and SEC Rule 6h-1, to be exempt from such 
requirements an exchange or association would have to obtain an 
exemption from both the CFTC and the SEC.
---------------------------------------------------------------------------

    \64\ See CFTC Rule 41.25(d). In the Proposing Release, the CFTC 
referred to ``investors'' when discussing the exemptive provision. 
The final rule will more closely adhere to the CEA, and refer 
instead to ``customers.''
    \65\ See SEC Rule 6h-1(d).
    \66\ See Section 36 of the Exchange Act, 15 U.S.C. 78mm. See 
also Section 8a(5) of the CEA allows the CFTC to make and promulgate 
such rules and regulations as, in the judgment of the CFTC, are 
reasonably necessary to effectuate any of the provisions or to 
accomplish any of the purposes of the CEA. 7 U.S.C. 12a(5). The CFTC 
believes that granting an exemption to the use of opening prices for 
cash settlement would be consistent with Section 8a(5) of the CEA, 
so long as the exemption is consistent with the public interest, the 
protection of customers, and otherwise furthers the provisions of 
the CEA.
---------------------------------------------------------------------------

B. Regulatory Halts

1. Background
    Generally, there are two types of regulatory halts used in the 
equity and options markets: News pending halts and circuit breaker 
halts. News pending halts are designed to protect the interests of 
current and potential shareholders by facilitating the orderly 
dissemination of potentially market moving information and the 
discovery of fair and reasonable prices for securities based on new 
information.\67\ A news pending halt benefits current

[[Page 36746]]

and potential shareholders by halting all trading in the securities 
until there has been an opportunity for the information to be 
disseminated to the public. It also helps to promote public confidence 
in the market and the integrity of the marketplace by giving the public 
an opportunity to evaluate information in making investment decisions.
---------------------------------------------------------------------------

    \67\ See, e.g., the American Stock Exchange LLC (``Amex''), 
Listing Standards, Policies and Requirements, Section 402(b); Boston 
Stock Exchange (``BSE'') Rules of the Board of Governors, Supplement 
to Chapter XXVII, Section 4; National Association of Securities 
Dealers (``NASD'') Rule 4120; and the New York Stock Exchange, Inc. 
(``NYSE'') Listed Company Manual, Sections 202.06 and 202.07.
---------------------------------------------------------------------------

    Circuit breakers are brief, coordinated cross-market trading halts 
used by the stock, options, and index futures markets to mitigate 
systemic stress when a severe one-day market drop of historic 
proportions prevents the financial markets from operating in an orderly 
manner.\68\ The Commissions approved various exchanges' circuit breaker 
proposals in response to the October 1987 market break to permit these 
brief, coordinated cross-market halts to provide opportunities during a 
severe market decline to reestablish an equilibrium between buying and 
selling interests in an orderly fashion, and to help to provide market 
participants with a reasonable opportunity to become aware of, and 
respond to, significant price movements.\69\ The coordinated cross-
market trading halts provided by circuit breaker procedures are 
designed to operate only during significant market declines and to 
substitute orderly, pre-planned halts for the ad hoc and destabilizing 
halts which can occur when market liquidity is exhausted.\70\ 
Currently, all stock exchanges and the NASD have rules or policies to 
implement coordinated circuit breaker halts.\71\ The options markets 
also have rules applying circuit breakers.\72\ Finally, the index 
futures exchanges have adopted circuit breaker halt procedures in 
conjunction with their price limit rules \73\ for index products.\74\ 
The options markets also have in place rules regarding trading halts on 
index options.\75\ Several of the options markets will halt trading 
when, for example, a certain fixed percentage of the index halts 
trading or when it is appropriate in the interests of a fair and 
orderly market and to protect investors.\76\
---------------------------------------------------------------------------

    \68\ See Circuit Breaker Report by the Staff of the President's 
Working Group on Financial Markets dated August 18, 1998 (``Circuit 
Breaker Report'').
    \69\ See Securities Exchange Act Release No. 26198 (October 19, 
1988), 53 FR 41637 (October 24, 1988) (order approving circuit 
breaker rules for the Amex, CBOE, NASD, NYSE). The CFTC approved 
circuit breaker price limit and trading halt rule changes after the 
publication in the Federal Register of the proposed rule changes and 
request for public comment, 53 FR 35539 (September 14, 1988) (CBOT, 
CME, Kansas City Board of Trade, New York Futures Exchange).
    \70\ See Circuit Breaker Report, supra note 68.
    \71\ See Securities Exchange Act Release No. 39846 (April 9, 
1998), 63 FR 18477 (April 15, 1998) (order approving proposals by 
Amex, BSE, Chicago Stock Exchange (``CHX''), NASD, NYSE, and the 
Philadelphia Stock Exchange, Inc. (``Phlx'')). See also Amex Rule 
117; BSE, Rules of the Board of Governors, Section 34A; CHX Rule 
10A; Cincinnati Stock Exchange (``CSE'') Rule 12.11; NYSE Rule 80B; 
the Pacific Exchange, Inc. (``PCX'') Rule 4.22 (a), (b), and (c); 
and Phlx Rule 133. CSE Rule 12.11 gives the chairman or the 
president of the CSE the power to suspend trading whenever he or she 
believes that such suspension would be in the public interest, which 
has been interpreted as requiring the CSE, as a matter of policy, to 
halt trading in all equities traded on the CSE in conjunction with 
halted trading at all other U.S. equity and equity-related markets. 
See Securities Exchange Act Release No. 26440 (January 10, 1989), 54 
FR 1830 (January 17, 1989). The NASD also recognizes the risks 
imposed on any single market that remains open while all other U.S. 
markets have halted trading in response to extraordinary price 
movements, and maintains a market closing policy to halt, upon SEC 
request, all domestic trading in both securities listed on the 
Nasdaq Stock Market and all equity and equity-related securities 
trading in the over-the-counter market should other major securities 
markets initiate market-wide trading halts in response to 
extraordinary market conditions. See NASD Rule 4120; NASD IM-4120-4. 
The SEC notes that it has a standing request with the NASD to halt 
trading as quickly as practicable whenever the NYSE and other equity 
markets have suspended trading. See Securities Exchange Act Release 
No. 39582 (January 26, 1998), 63 FR 5408 (February 2, 1998).
    \72\ See Amex Rule 950 (applying Amex Rule 117, Trading Halts 
Due to Extraordinary Market Volatility, to options transactions); 
CBOE Rule 6.3B; the International Securities Exchange, LLC (``ISE'') 
Rule 703; PCX Rule 4.22 (which applies to options contracts through 
Rules 6.1(a) and (e)); and Phlx Rule 133.
    \73\ A price limit, in itself, does not halt trading in the 
futures, but prohibits trading at prices below the pre-set limit 
during a price decline. Intraday price limits are removed at pre-set 
times during the trading session, such as ten minutes after the 
thresholds are reached or at 3:30 p.m., whichever is earlier. Daily 
price limits remain in effect for the entire trading session. 
Specific price limits are set for each stock index futures contract. 
There are no price limits for U.S. stock index options, equity 
options, or stocks.
    \74\ See, e.g., CME Rule 4002.I. The CME will implement a 
circuit breaker trading halt in SPX Futures if the 10 percent 
circuit breaker halt has been imposed in the securities markets and 
the futures are ``locked'' at their 10 percent price limit. Trading 
will not reopen in SPX Futures until the circuit breaker halt has 
been lifted in the securities markets and trading has resumed in 
stocks comprising at least 50 percent of the index capitalization. 
The CME will implement another circuit breaker trading halt in SPX 
Futures if the 20 percent circuit breaker halt has been imposed in 
the securities markets and the futures are locked at their 20 
percent price limit. Once again, trading will not reopen in SPX 
Futures until the circuit breaker halt has been lifted in the 
securities markets and trading has resumed in stocks comprising at 
least 50 percent of the index capitalization.
    \75\ See Amex Rule 918C(b)(3); CBOE Rule 24.7; PCX Rule 7.11; 
and Phlx Rule 1047A(c).
    \76\ For example, trading on the PCX in any index option is 
halted whenever trading in underlying securities whose weighted 
value represents more than 20 percent of the value of a broad-based 
index or 10 percent of the value of other indices is halted. See PCX 
Rule 7.11. Similarly, under Phlx Rule 1047A(c), trading in any index 
option may be halted whenever trading on the primary market in 
underlying securities representing more than 10 percent of the 
current index value is halted or suspended, and there is approval 
from two floor officials and the concurrence of a market regulation 
officer. See Phlx Rule 1047A(c).
---------------------------------------------------------------------------

2. Proposed Rule for Regulatory Halts
    As discussed above, Section 2(a)(1)(D)(i)(X) of the CEA \77\ and 
Section 6(h)(3)(K) of the Exchange Act \78\ provide that listing 
standards for security futures products must include procedures to 
coordinate trading halts between the market that trades the security 
futures product, any market that trades any underlying security, and 
other markets on which any related security is traded. To assure such 
coordination of trading halts, the Commissions proposed CFTC Rule 
41.25(a)(2) and SEC Rule 6h-1. More specifically, the Commissions 
proposed that trading in a future on a single security be halted at all 
times that such a news pending regulatory halt or a circuit breaker 
regulatory halt has been instituted by the listing market for the 
underlying security. The Commissions also proposed that trading be 
halted in a future on a narrow-based security index when a news pending 
or circuit breaker regulatory halt was instituted for one or more 
underlying securities that constitute 30 percent or more of the market 
capitalization of the narrow-based security index.\79\
---------------------------------------------------------------------------

    \77\ 7 U.S.C. 2(a)(1)(D)(i)(X).
    \78\ 15 U.S.C. 78f(h)(3)(K).
    \79\ It should be noted that the Commissions have jointly 
adopted rules to establish the method of determining the market 
capitalization of a narrow-based security index for the limited 
purpose of determining whether a security is one of the 750 
securities with the largest market capitalization under one of the 
exclusions from the definition of narrow-based security index. See 
Securities Exchange Act Release No. 44724 (August 20, 2001), 66 FR 
44490 (August 23, 2001).
---------------------------------------------------------------------------

3. Final Rule
a. Trading Halt Coordination in Single-Stock Futures
    The Commissions are adopting, as proposed, a requirement that the 
rules of a national securities exchange or national securities 
association that lists or trades security futures products provide that 
trading of a future on a single security be halted at all times that a 
regulatory halt has been instituted for the underlying security.
    Two commenters agreed that trading in a future on a single security 
should be halted when trading in the underlying security is subject to 
a regulatory halt.\80\ Another commenter, while generally supporting 
the proposed trading halt requirements for single-stock futures, 
believed that it may be appropriate to trade a single stock futures 
product when the listing market has imposed a trading halt, if the 
listing

[[Page 36747]]

market is not the principal trading venue for the underlying security 
because the prices on that market may not be reflective of current 
market conditions.\81\
---------------------------------------------------------------------------

    \80\ See CBOT Letter and NYSE Letter.
    \81\ See CME Letter. See infra notes 103-104 and accompanying 
text.
---------------------------------------------------------------------------

    In addition, one commenter believed that the requirement to halt 
trading in single-stock futures when trading in the underlying security 
is halted was overly broad to satisfy the requirement that procedures 
be put in place to coordinate trading halts.\82\ This commenter 
believed that this was overly broad and burdensome in its application 
to retail investors for whom single-stock futures might serve as the 
only available means for managing risk. This commenter recommended 
allowing trading halt sessions during which investors with risk 
exposure to an underlying equity, which has been halted, might have the 
opportunity to enter into single stock futures transactions with 
dealers.
---------------------------------------------------------------------------

    \82\ See Students Letter.
---------------------------------------------------------------------------

    The Commissions understand the concern raised by one commenter 
regarding continued trading of a security futures product when the 
underlying security has halted trading if the listing market is not the 
primary market. However, the Commissions believe that designating the 
listing market as the venue for the purpose of applying the rule 
provides for ease of use and application, because it does not require 
national securities exchanges or national securities associations to 
determine the primary market for each underlying security. Further, due 
to the contractual relationship between the issuer and the listing 
market, the listing market has a direct and ongoing relationship with 
the issuer. The Commissions believe, therefore, that the listing market 
is in the best position to be informed promptly by the issuer that 
pending news would require the imposition of a trading halt. Finally, 
the Commissions believe that the listing market represents sufficient 
liquidity that imposing a trading halt on a security futures product 
when the listing market for the underlying security imposes a trading 
halt furthers the purposes of Section 2(a)(1)(D)(i)(X) of the CEA\83\ 
and Section 6(h)(3)(K) of the Exchange Act.\84\
---------------------------------------------------------------------------

    \83\ 7 U.S.C. 2(a)(1)(D)(i)(X).
    \84\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

    With respect to the commenter's concern regarding the potential 
impact of such a rule on retail investors, the Commissions note that 
one of the purposes of trading halts is to provide for an adequate 
opportunity for information about a security to be disseminated to the 
public. The Commissions do not believe that it would be consistent with 
the protection of investors to permit investors, including retail 
investors, to trade a surrogate for a security--i.e., a future on the 
security--without the benefit of material information about such 
security or the benefit of such other information that was the basis 
for the regulatory halt.
    Finally, with respect to news pending halts, two commenters 
questioned the absolute requirement that trading in a security futures 
product must be halted during a news pending halt in the underlying 
security.\85\ These commenters recommended providing exchanges with 
discretion to impose a trading halt when there is a news pending 
trading halt in the underlying security. Specifically, one commenter 
believed that this discretion is important because there may be 
circumstances when it is necessary to allow trading in a security 
futures product when the underlying stock is halted, such as when there 
is a need to adjust positions before an expiration.\86\
---------------------------------------------------------------------------

    \85\ See CBOE Letter and FIA/SIA Steering Committee Letter.
    \86\ See CBOE Letter.
---------------------------------------------------------------------------

    Given the rarity of an occurrence when a national securities 
exchange or national securities association would feel compelled to 
continue trading a security futures product while the trading of 
underlying stock is halted, the Commissions do not agree that there 
ought to be discretion in imposing regulatory halts for security 
futures products. The Commissions note that the underpinning for 
imposing news pending regulatory halts is promoting investor protection 
and fair and orderly markets. To the extent that there is pending news 
that could impact an investor's decision and to the extent that single-
stock futures are surrogates for the underlying security, the 
Commissions continue to believe in the need for a provision requiring 
that trading in a security futures product be halted at all times that 
a regulatory halt has been instituted for the underlying security or 
securities, with certain limits for narrow-based security index 
futures. Furthermore, in the event that discretion is needed, the 
Commissions note that the exemptive authority in CFTC Rule 41.25(d) and 
SEC Rule 6h-1(d) allows the Commissions to exempt national securities 
exchanges or national securities associations from the regulatory halt 
provisions if the CFTC determines that such an exemption is consistent 
with the public interest and the protection of customers and the SEC 
determines that such exemption is necessary or appropriate in the 
public interest and consistent with the protection of investors.
    By adopting this rule, the Commissions aim to maintain and preserve 
the integrity of this mechanism so that the trading of security futures 
products will not be used as a tool to circumvent the institution of 
regulatory halts. Moreover, the Commissions believe that the purpose of 
halting trading in the underlying security would be frustrated if 
market participants could circumvent this halt by trading during the 
halt in the related security futures product.\87\
---------------------------------------------------------------------------

    \87\ The Commissions' rules do not preclude a market trading 
security futures products from halting trading for other appropriate 
reasons, such as operational difficulties being experienced by the 
market or its automated systems or concerns over clearance and 
settlement operations.
---------------------------------------------------------------------------

b. Trading Halt Coordination in Narrow-Based Security Index Futures
    The Commissions proposed that national securities exchanges and 
national securities associations halt trading in a future on a narrow-
based security index when component securities representing 30 percent 
or more of the market capitalization of such index are subject to a 
regulatory halt. In response to comments, the final rules modify the 
proposal by increasing to 50 percent the market capitalization 
represented by the component security or securities in a narrow-based 
security index that must be halted before a national securities 
exchange or national securities association must halt trading in a 
future on such index.
    In addition to the comments supporting the Commissions' proposed 
trading halt rule,\88\ the Commissions received three comments 
specifically addressing the application of regulatory halts to futures 
based on narrow-based security indexes.\89\ One commenter neither 
specifically supported nor opposed the Commissions' proposed 30 percent 
capitalization test, although it suggested a possible alternative such 
as allowing narrow-based security index futures based principally on 
U.S. listed securities to continue trading until they have become limit 
offered at a price limit corresponding to a particular coordinated 
circuit breaker level.\90\ Another commenter believed that the 
Commissions' proposal to require a trading halt in a narrow-based 
security index future when a component security or securities that 
constitute 30 percent or more of the market capitalization of

[[Page 36748]]

the index are subject to a trading halt was too low a threshold to 
justify the disruption that it would inflict upon the futures 
market.\91\ Instead, this commenter recommended that the threshold be 
no lower than 50 percent of an index's capitalization to be consistent 
with the threshold required for re-opening futures trading on broad-
based indexes following a market-wide halt. This commenter noted that 
when trading in futures on a broad-based index is halted as a result of 
an exchange-wide halt in the relevant securities market, such futures 
trading resumes only when at least 50 percent of the securities 
underlying an index, by market capitalization, have reopened for 
trading.\92\
---------------------------------------------------------------------------

    \88\ See supra notes 80 and 81.
    \89\ See CBOE Letter, CBOT Letter, and CME Letter.
    \90\ See CME Letter.
    \91\ See CBOT Letter.
    \92\ See, e.g., CBOT Rule 1008.01 and CME Rule 4002.I., supra 
note 74.
---------------------------------------------------------------------------

    Another commenter recommended providing exchanges with greater 
discretion to decide whether to impose or maintain a trading halt.\93\ 
This commenter stated that by specifying a specific percentage level, 
the proposed rule implied that it would be improper for an exchange to 
consider trading interruptions in underlying stocks that collectively 
represent less than 30 percent of an index. This commenter also 
believed that because not all indexes underlying security futures 
products may be capitalization weighted, it may be difficult for 
exchanges to determine on a real-time basis when securities comprising 
30 percent of the market capitalization of a price-weighted or equal 
dollar weighted index are halted. Similarly, one of the commenters 
expressed a concern that, with respect to corporate news events, it may 
be operationally difficult to determine on a real-time basis whether 
the threshold of market capitalization has been crossed.\94\ This 
commenter hoped the Commissions would recognize the potential 
difficulty and accept good faith attempts to comply.
---------------------------------------------------------------------------

    \93\ See CBOE Letter.
    \94\ See CME Letter.
---------------------------------------------------------------------------

    The Commissions do not believe that trading in a narrow-based 
security index future should necessarily be halted because a trading 
halt has been instituted for only one or several low-weighted component 
securities. An inappropriately low threshold could lead to needless and 
potentially disruptive trading halts in the narrow-based index future. 
However, as noted in the Proposing Release, regulatory halts of narrow-
based-index component securities could affect a sufficiently large 
portion of the index to make continued trading of a security futures 
product based on that index a means of improperly circumventing 
regulatory halts in the underlying component securities. Under these 
circumstances, trading halt procedures would not be coordinated, as 
required by Section 2(a)(1)(D)(i)(X) of the CEA\95\ and Section 
6(h)(3)(K) of the Exchange Act,\96\ since the security futures product 
would continue to trade while investors would be precluded from trading 
the underlying securities. Moreover, the SEC believes that continued 
trading in the security futures product under these circumstances could 
undercut key provisions in the securities laws designed to protect 
investors and promote the fair and orderly operation of the markets.
---------------------------------------------------------------------------

    \95\ 7 U.S.C. 2(a)(1)(D)(i)(X).
    \96\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

    However, in response to the commenter's statement that the 30 
percent market capitalization test was too low, and therefore, 
potentially too disruptive to the market, and after consideration of 
the potential effects of the proposed 30 percent trading halt 
threshold, the Commissions are requiring that trading be halted in a 
narrow-based security index futures product when component securities 
representing 50 percent or more of the market capitalization of that 
narrow-based security index are subject to a regulatory halt. The 
Commissions believe that one of the major economic benefits that market 
participants derive from the trading of futures on narrow-based 
security indexes is the ability to hedge positions containing the 
securities underlying the indexes, thereby reducing the risk of holding 
positions in those securities. For traders using a narrow-based 
security index future to hedge a position containing the component 
index securities, trading halts in certain of those component 
securities necessarily will introduce basis risk because the one-to-one 
relationship between the cash portfolio of securities and the narrow-
based index future is disrupted.
    The Commissions believe that the proposed 30 percent threshold is 
too low because it could unnecessarily disrupt hedge positions 
involving futures on narrow-based security indexes that may still be 
substantially performing their intended risk-shifting function when 
trading is halted in a limited number of the index's component 
securities. The Commissions believe that a 50 percent threshold would 
better serve the requirement's intended purpose. In adopting a 50 
percent threshold, the Commissions sought to balance the utility of 
maintaining effective hedge positions with concerns about circumventing 
the coordination requirement by allowing trading in narrow-based index 
futures to continue when trading in a limited number of the underlying 
securities is halted.
    The Commissions believe that while it is not possible to eliminate 
completely the risk involved in hedging securities with a future on a 
narrow-based security index when trading halts are instituted for 
certain of those underlying securities, the 50 percent threshold 
reduces such risk. Therefore, the Commissions are adopting a 50 percent 
threshold because it appears to appropriately balance the goals of 
hedging utility with the prevention of improper circumvention of 
regulatory halts in the underlying securities. The Commissions also 
note that the 50 percent threshold is consistent with existing 
thresholds for re-opening trading in broad-based security index futures 
following a market-wide trading halt in the trading of the underlying 
securities.\97\
---------------------------------------------------------------------------

    \97\ See CBOT Rule 1008.01 and CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------

    The Commissions reiterate, however, that their rule is not designed 
to preclude a market trading futures on narrow-based security indexes 
from halting trading when securities representing less than 50 percent 
of the market capitalization of the index are halted or for other 
appropriate reasons, such as operational difficulties being experienced 
by the market or its automated systems or concerns over clearance and 
settlement operations. The Commissions also note that the threshold at 
50 percent provides further discretion to national securities exchanges 
and national securities associations to establish their thresholds at 
lower levels, or to change the thresholds as market conditions or 
experience warrant. This provides flexibility to the markets to modify 
trading halt thresholds, which would not be possible if the Commissions 
set the threshold at a lower level.
    With respect to the commenters' concern regarding the potential 
difficulty in calculating the market capitalization of an index, 
especially for price-weighted or equal dollar weighted indexes, for 
purposes of instituting the regulatory halt, the Commissions note that 
selecting market capitalization as the method for calculating the 
weight of the index is similar to an existing standard used to 
calculate trigger points for circuit breaker operations.\98\ The 
Commissions chose to apply a similar

[[Page 36749]]

method in implementing regulatory halts to narrow-based security index 
futures products. In addition, in specifying market capitalization as 
the method for weighing an index, the rule provides clarity and 
uniformity for all national securities exchanges and national 
securities associations to utilize in implementing regulatory halts in 
security futures products based on narrow-based security indexes and 
helps prevent the trading of security futures products from becoming a 
means of circumventing regulatory halts in the underlying securities.
---------------------------------------------------------------------------

    \98\ See, e.g., CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------

c. Definition of a Regulatory Halt
    The Commissions are adopting the definition of regulatory halt as 
proposed.\99\ Specifically, a regulatory halt is defined as a delay, 
halt, or suspension in the trading of a security by the national 
securities exchange or national securities association that lists the 
security as a result of a news pending regulatory halt or the operation 
of circuit breakers. The definition of regulatory halt does not include 
the listing market's halting of trading because of an imbalance of buy 
and sell orders in a particular security or when trading is disrupted 
due to a problem in its systems or on its trading floor. The definition 
of regulatory halt in the rule adopted today incorporates the 
definition of news pending regulatory halt contained in the 
Consolidated Tape Association Plan (``CTA Plan'').\100\ Under the CTA 
Plan, a regulatory halt occurs whenever the primary market for any 
eligible security, in the exercise of its regulatory functions, halts 
or suspends trading in the security because the primary market has 
determined (i) that there are matters relating to the security or 
issuer that have not been adequately disclosed to the public, or (ii) 
that there are regulatory problems relating to the security which 
should be clarified before trading is permitted to continue.\101\ When 
a regulatory trading halt is initiated by the primary market for a 
security, the regional exchanges and Nasdaq also halt trading in the 
security, and the options exchanges halt trading in related options. 
The options exchanges also halt trading in an equity option when the 
underlying security has ceased trading.\102\
---------------------------------------------------------------------------

    \99\ See CFTC Rule 41.1(l) and SEC Rule 6h-1(a)(3).
    \100\ See Securities Exchange Act Release No. 41315 (April 20, 
1999), 64 FR 23142 (April 29, 1999) (noting that the NYSE follows 
the CTA Plan when instituting a regulatory halt); and Securities 
Exchange Act Release No. 41877 (September 14, 1999), 64 FR 51566 
(September 23, 1999) (noting that Amex follows the CTA Plan when 
instituting a regulatory halt); see also CTA Plan (Second 
Restatement), Section XI (a). The CTA Plan is a joint industry plan 
that governs the consolidated transaction reporting system, and each 
of the participants agrees to comply with the provisions of the 
plan. Recognizing the importance of disseminating information with 
respect to trading halts in certain securities, the CTA Plan imposes 
notification obligations upon the primary market whenever a 
regulatory halt occurs.
    \101\ See CTA Plan (Second Restatement), Section XI (a). For 
example, an event that may qualify under this standard and call for 
a regulatory halt is when it is unclear whether a security continues 
to meet the listing standards of the market on which the security is 
listed.
    \102\ The rules of the options exchanges generally provide for 
halts in options whenever it is appropriate in the interests of a 
fair and orderly market and to protect investors. See Amex Rule 
918(b); CBOE Rule 6.3(a) and .04 of the Interpretations and Policies 
of CBOE Rule 6.3; ISE Rule 702; PCX Rule 6.65(a); and Phlx Rule 
1047(b).
---------------------------------------------------------------------------

    Although generally supporting the requirement to halt trading in 
single-stock futures when trading in the underlying security has been 
halted due to a corporate news event, one commenter stated that the 
definition of regulatory halt could be refined to address situations 
not contemplated by the CFMA, such as where the listing market is not 
the primary trading venue for the underlying security or where the 
listing market is in a foreign country.\103\
---------------------------------------------------------------------------

    \103\ See CME Letter.
---------------------------------------------------------------------------

    In response to this comment, the Commissions note that the rule 
being adopted today does not preclude national securities exchanges and 
national securities associations trading security futures products from 
halting trading if they believe it is necessary to the orderly 
operation of the market. The rules of a national securities exchange or 
national securities association may permit it to halt trading in 
situations not covered by the rule being adopted today.\104\ To the 
extent that the security or securities underlying a security futures 
product is listed on a foreign market, under the rule adopted today, 
national securities exchanges and national securities associations have 
the flexibility to impose trading halt requirements where the 
underlying security is listed solely on a foreign market. Further, the 
Commissions believe that it would be unduly burdensome and 
administratively difficult to require national securities exchanges and 
associations to calculate the primary market for each security 
underlying a security futures product. Again, under their rules, 
national securities exchanges and associations may also halt trading in 
a security futures product if the primary market, but not the listing 
market, halted trading in the underlying security or securities, but it 
is not mandated by the Commissions' rules.
---------------------------------------------------------------------------

    \104\ One commenter believed that the Commissions should expand 
on the examples of the reasons why national securities exchanges and 
associations could impose additional trading halts to include order 
imbalances. See NYSE Letter. As noted above, the rule being adopted 
today does not preclude a market trading security futures products 
from establishing rules that permit or require it to halt trading 
for other appropriate reasons.
---------------------------------------------------------------------------

    With respect to the Commissions' proposal to include within the 
definition of ``regulatory halt'' trading halts due to circuit breaker 
procedures, three commenters generally supported the extension of 
market-wide circuit breaker procedures to security futures products in 
order to ensure coordinated and consistent circuit breaker procedures 
across equity products.\105\ One of the commenters, however, noted a 
potential competitive issue over security futures product ``look-
alikes'' that can trade in the unregulated upstairs market and do 
currently trade in foreign jurisdictions that may not adhere to the 
coordinated circuit breaker procedures.\106\ This commenter recommended 
that the Commissions provide exchanges with latitude in implementing 
coordinated circuit breaker procedures and flexibility in imposing this 
requirement on security futures products where the principal trading 
venues for the underlying securities (or for a subset in the case of 
narrow-based indexes) are in foreign markets.
---------------------------------------------------------------------------

    \105\ See CBOE Letter and FIA/SIA Steering Committee Letter; see 
also CME Letter.
    \106\ See CME Letter.
---------------------------------------------------------------------------

    The Commissions note that the coordinated cross-market trading 
halts provided by circuit breaker procedures are designed to operate 
only during significant market declines and to substitute orderly, pre-
planned halts for the ad hoc and destabilizing halts that can occur 
when market liquidity is exhausted. The circuit breakers also protect 
investors and the market by providing opportunities for market and 
market participants to assess market conditions and potential systemic 
stress during a historic market decline. In approving the original 
circuit breakers proposed by the securities market, the SEC noted that 
the circuit breakers were an effort by the securities and futures 
markets to arrive at a coordinated means to address potentially 
destabilizing market volatility of the severity of the October 1987 
market break.\107\ Therefore, in the interest of having coordinated 
trading halts across the U.S. equity markets, the Commissions do not 
agree that the exchanges should have latitude in implementing 
coordinated circuit breaker procedures on security futures products 
where the underlying

[[Page 36750]]

security is not solely listed in a foreign market. To the extent that 
additional latitude is needed, the Commissions have the discretion to 
grant separate exemptions in those circumstances if the CFTC determines 
that such an exemption is consistent with the public interest and the 
protection of customers and the SEC determines that such exemption is 
necessary or appropriate in the public interest and consistent with the 
protection of investors.
---------------------------------------------------------------------------

    \107\ See Securities Exchange Act Release No. 26198 (October 19, 
1988), 53 FR 41637 (October 24, 1988).
---------------------------------------------------------------------------

    For these reasons, the Commissions believe that it is important to 
include within the definition of regulatory halt cross-market circuit 
breakers and, therefore, to require the application of cross-market 
circuit breaker regulatory halt procedures to security futures 
products. Moreover, the Commissions believe that such requirement is 
necessary to satisfy the requirements of Section 2(a)(1)(D)(i)(X) of 
the CEA\108\ and Section 6(h)(3)(K) of the Exchange Act.\109\ If cross-
market circuit breaker regulatory halt procedures were not applied to 
the security futures products, such a failure would undermine the use 
of trading halts in the underlying securities markets.
---------------------------------------------------------------------------

    \108\ 7 U.S.C. 2(a)(1)(D)(i)(X).
    \109\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

d. Exemptions
    As discussed previously,\110\ the Commissions are expanding the 
exemption provisions in CFTC Rule 41.25(d) and SEC Rule 6h-1(d), which 
were originally proposed to apply only to the final settlement prices 
for security futures products. Under the final rule, the CFTC has the 
authority to grant an exemption with respect to any provision of 
paragraphs (a)(2) and (b) of CFTC Rule 41.25, provided that the CFTC 
finds that the exemption is consistent with the public interest and the 
protection of customers.\111\ The SEC has the authority to grant an 
exemption with respect to any provision of SEC Rule 6h-1, provided that 
the exemption is necessary or appropriate in the public interest and 
consistent with the protection of investors.\112\ Because exchanges and 
associations are subject to the requirements of both CFTC Rule 
41.25(a)(2) and (b) and SEC Rule 6h-1, to be exempt from such 
requirements an exchange or association would have to obtain an 
exemption from both the CFTC and the SEC.
---------------------------------------------------------------------------

    \110\ See supra discussion at II.A.3.e., Exemptions, which 
discusses the expansion of the exemption to make it more consistent 
with the SEC's exemptive authority under Section 36 of the Exchange 
Act.
    \111\ See CFTC Rule 41.25(d).
    \112\ See SEC Rule 6h-1(d).
---------------------------------------------------------------------------

C. Commissions' Interpretation of Statutory Requirements for 
Coordinated Surveillance

1. Markets Trading Security Futures
    In amending the CEA and Exchange Act to permit the trading of 
futures on single stocks and narrow-based security indexes, Congress 
specifically required that exchanges and associations trading these new 
products have procedures in place for coordinated surveillance with 
other markets on which security futures products trade, any market on 
which any security underlying the security futures product is traded, 
and other markets on which any related security trades.\113\ Because 
security futures products are surrogates for the securities on which 
their values are based, such coordinated surveillance is essential to 
detection of manipulation and insider trading. As discussed in detail 
below, the Commissions interpret the statutory requirement for 
coordinated surveillance to mean that if an exchange or association is 
a Full Member of the Intermarket Surveillance Group (``ISG'') \114\ or 
has the ability to obtain all information that a Full Member of the ISG 
is currently able to obtain from both current and former members, 
including, among other things, the ability to obtain market 
surveillance reports or information, and information relating to 
investigations, then that market would meet the statutory requirement 
for coordinated surveillance.
---------------------------------------------------------------------------

    \113\ Section 2(a)(1)(D)(i)(VIII) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(VIII); Section 6(h)(3)(I) of the Exchange Act, 15 
U.S.C. 78f(h)(3)(I).
    \114\ ISG Full Members are Amex, BSE, CBOE, CHX, CSE, ISE, NASD, 
NYSE, PCX and Phlx.
---------------------------------------------------------------------------

    For an exchange or association to satisfy the statutory requirement 
that ``procedures be in place for coordinated surveillance,'' the 
Commissions stated in the Proposing Release that they believed it was 
``essential that all such exchanges and associations be Full Members of 
the ISG.'' \115\ In view of the role that the ISG plays, the 
Commissions stated their belief that the ISG should grant full 
memberships to all national securities exchanges and national 
securities associations registered pursuant to Section 15A(a) of the 
Exchange Act \116\ trading securities futures products, including 
Security Futures Product Exchanges, upon a good-faith showing that the 
entities meet the criteria for full membership.
---------------------------------------------------------------------------

    \115\ See Proposing Release, supra note 18.
    \116\ 15 U.S.C. 78o-3(a).
---------------------------------------------------------------------------

    The CFTC in a separate proposing release also proposed, in part, to 
require boards of trade trading security futures products to be Full 
Members of ISG.\117\ The CFTC received three comment letters regarding 
this aspect of the CFTC Proposal.\118\ All of the commenters raised 
concerns regarding mandatory memberships in ISG. As a result, the CFTC 
deferred making a decision on requiring membership in ISG to allow the 
Commissions together to consider the appropriate means of ensuring that 
the coordinated surveillance requirement under the CEA and the Exchange 
Act is satisfied.\119\
---------------------------------------------------------------------------

    \117\ See 66 FR 37932 (July 20, 2001) (``CFTC Proposal'').
    \118\ The CFTC received comment letters from CME, Amex, and ISG.
    \119\ See 66 FR 55078 (November 1, 2001).
---------------------------------------------------------------------------

    As noted in the Proposing Release, ISG was created under the 
auspices of the SEC as a forum to ensure that national securities 
exchanges and national securities associations adequately share 
surveillance information and coordinate inquiries and investigations 
designed to address potential intermarket manipulations and trading 
abuses. Full Members routinely share a great deal of surveillance and 
investigatory information, and the SEC continues to believe that this 
framework has proven to be an effective mechanism to ensure that there 
is adequate information sharing and investigatory coordination for 
potential intermarket manipulations and trading abuses.
    The Commissions continue to believe that any national securities 
exchange--including an exchange registered under Section 6(g) of the 
Exchange Act--that satisfies the requirements to be a Full Member of 
ISG should be admitted as a Full Member of ISG. Nevertheless, in light 
of comment letters received on the CFTC Proposal, we do not believe 
that an exchange trading security futures products must be a Full 
Member of ISG to satisfy the requirement that ``procedures be in place 
for coordinated surveillance among the market on which the security 
futures product is traded, any market on which any security underlying 
the security futures product is traded, and other markets on which any 
related security is traded to detect manipulation and insider 
trading.'' \120\
---------------------------------------------------------------------------

    \120\ Section 2(a)(1)(D)(i)(VIII) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(VIII); Section 6(h)(3)(I) of the Exchange Act, 15 
U.S.C. 78f(h)(3)(I).
---------------------------------------------------------------------------

    In particular, the Commissions believe that exchanges and 
associations trading security futures products may also satisfy the 
CEA's and Exchange Act's coordinated surveillance requirement through 
Affiliate Membership in ISG, if the Affiliate Members trading security 
futures products also enter into supplemental

[[Page 36751]]

agreements with other Affiliate Members trading security futures 
products and with Full Members to share the same information as Full 
Members of ISG currently share with each other.\121\ The Commissions, 
however, believe that the current information sharing agreement among 
Affiliate Members and the agreement between Affiliate and Full Members 
(referred to in Appendix A as ``Affiliate Agreement'') is insufficient 
to satisfy the obligation of a market trading security futures products 
to coordinate surveillance with other markets trading security futures 
and with markets trading related products because of certain 
limitations on the information that must be shared.\122\ The 
Commissions believe, however, that these limitations, discussed below, 
can be overcome if Affiliate Members trading security futures products 
and Full Members agree to share information beyond what is currently 
required by the ISG for Affiliate Members.
---------------------------------------------------------------------------

    \121\ An ISG Affiliate Member is a contract market or foreign 
self-regulatory organization that has become affiliated with ISG. 
See Appendix A for the relevant provisions of the agreement among 
Full Members of ISG.
    \122\ Futures exchanges and non-U.S. exchanges and associations 
are Affiliate Members of ISG. The limitations in an Affiliate 
Member's obligations to share information is of less concern when an 
Affiliate Member is not trading securities.
---------------------------------------------------------------------------

    For example, ISG provides to Full Members market surveillance 
reports. It is unclear whether Full Members have access to market 
surveillance reports of Affiliate Members or whether Affiliate Members 
have access to such information from each other. The Commissions 
understand that this information is, as a practical matter, made 
available to all ISG members upon request, but believe that the 
obligation to provide such information upon request should be explicit. 
In addition, Full Members are required to share information and 
documents, upon request, about current and former members.\123\ 
Affiliate Members, however, are only required to share with each other 
and with Full Members information and documents relating to current 
members.\124\ Similarly, Full Members are only required to share with 
Affiliate Members information about current members, not about their 
former members.\125\ The Commissions believe that information about 
former members is necessary under some circumstances to facilitate 
investigations by Full and Affiliate Members.
---------------------------------------------------------------------------

    \123\ See Appendix A, Section 2(b).
    \124\ See, e.g., Appendix A, Section 2(c).
    \125\ See, e.g., Appendix A, Section 2(d).
---------------------------------------------------------------------------

    Moreover, the agreement among Full Members allows Full Members to 
request information and documents from each other relating to ongoing 
investigations.\126\ This information can be very useful in assisting 
an exchange performing its own, related investigation. However, the 
agreement between Full Members and Affiliate Members (and among 
Affiliate Members) does not provide for the sharing of this type of 
information. It is the Commissions' understanding that these agreements 
did not provide for the sharing of investigatory information due to a 
perceived prohibition in the CEA that restricted the sharing of such 
information.\127\ The CFTC, however, believes the CEA allows the 
sharing of investigatory documents and information, provided that the 
futures market providing such information adopts a rule allowing for 
the sharing of information pursuant to an information sharing 
arrangement.\128\ Therefore, because there is no legal prohibition on 
sharing investigatory information, the Commissions believe that such 
information may be shared between Affiliate and Full Members and among 
Affiliate Members trading security futures products. Without the 
sharing of such investigatory information, investigations by an 
Affiliate Member into manipulation or trading abuses related to the 
trading of security futures could be hindered unnecessarily. In 
addition, a Full Member's inability to obtain such information or 
documents from an Affiliate Member could hinder the Full Member's 
investigation of manipulation or trading abuses in other securities 
that were related to manipulation or trading abuses in the trading of 
security futures on an Affiliate Member's market.
---------------------------------------------------------------------------

    \126\ See Appendix A, Section 2(b).
    \127\ See 8c(a)(2) of the CEA, 7 U.S.C. 12c(a)(2).
    \128\ See 8a(6) of the CEA, 7 U.S.C. 12a(6).
---------------------------------------------------------------------------

    Finally, once information is requested, Affiliate Members are 
generally only required to use ``best efforts'' in accordance with 
their rules to obtain the information.\129\ In addition, Affiliate 
Members only need to provide the information to Full Members to the 
extent that it is not inconsistent with its rules or with applicable 
law.\130\ Similarly, Full Members are only required to use best efforts 
in accordance with their rules to obtain the requested information for 
Affiliate Members and to provide such information to the extent that it 
is not inconsistent with its rule or applicable law.\131\ Such 
limitations are not included as part of the agreement among Full 
Members. The Commissions believe that any restrictions on the ability 
of Affiliate or Full Members to share information could hinder the 
ability of these members to coordinate surveillance.
---------------------------------------------------------------------------

    \129\ See, e.g., Appendix A, Section 2(c).
    \130\ Id.
    \131\ See, e.g., Appendix A, Section 2(d).
---------------------------------------------------------------------------

    As discussed above, the Commissions believe that the limitations on 
an Affiliate Member's obligations to share information could be easily 
addressed through means other than becoming Full Members of ISG. For 
example, Affiliate Members trading security futures products and Full 
Members could enter into a supplementary agreement to share the 
information described above among each other despite the limitations in 
the current agreements.\132\ If Full and Affiliate Members enter into 
this type of agreement, the Commissions believe that the markets would 
meet the statutory requirement for coordinated surveillance.
---------------------------------------------------------------------------

    \132\ The Commissions note that this may require exchanges and 
associations trading security futures products to implement rules 
allowing for the sharing of information. See supra notes 126-128.
---------------------------------------------------------------------------

    The Commissions also believe that exchanges trading security 
futures products could satisfy the requirement to coordinate 
surveillance by entering into bilateral surveillance agreements with 
each exchange, association, or market on which any security underlying 
the security futures product or related security is traded to detect 
manipulation and insider trading. The Commissions, however, believe 
that such bilateral agreements would have to contain essentially the 
same information sharing obligations that Full Members of ISG currently 
have with respect to each other.\133\
---------------------------------------------------------------------------

    \133\ See Appendix A, Section 2.
---------------------------------------------------------------------------

    Accordingly, if a market trading security futures products becomes 
a Full Member of the ISG, becomes an Affiliate Member of the ISG and 
enters into a supplemental agreement to share the additional 
information described above with Full Members and other Affiliate 
Members trading security futures products, or enters into appropriate 
bilateral surveillance agreements to detect manipulation and insider 
trading with each exchange, association or market on which security 
futures products trade, and any market on which any security underlying 
the security futures product or related security is traded, the 
Commissions believe that the market would satisfy the requirements of 
Section 2(a)(1)(D)(i)(VIII) of the CEA and Section 6(h)(3)(I) of the 
Exchange Act.\134\
---------------------------------------------------------------------------

    \134\ 7 U.S.C. 2(a)(1)(D)(i)(VIII); 15 U.S.C. 78f(h)(3)(I).

---------------------------------------------------------------------------

[[Page 36752]]

2. Exchanges Trading Securities Other Than Security Futures

    Sections 6(b)(1) and 15A(b)(2) of the Exchange Act require all 
national securities exchanges and national securities associations to 
enforce compliance by their members and persons associated with their 
members, with the provisions of the Exchange Act and the rules and 
regulations thereunder.\135\ Securities exchanges' and associations' 
memberships in ISG currently enable them to satisfy this requirement 
with respect to enforcement of the proscriptions against insider 
trading and the anti-manipulation provisions of the federal securities 
laws.\136\ Security futures products are surrogates for their 
underlying securities and, therefore, there is the potential that 
trading in this new product could be used to manipulate trading in the 
underlying security or in other related securities, such as options. 
Accordingly, the SEC believes that the introduction of security futures 
products means that, to satisfy their obligations under Sections 6 and 
15A of the Exchange Act,\137\ exchanges and associations that trade 
securities that are related to security futures must have the same 
ability to share information and to coordinate surveillance with 
markets trading such security futures products as they currently have 
through ISG with exchanges and associations trading other securities. 
For this reason, the SEC believes that the limitations described above 
in the current obligations of Affiliate Members to share information 
with Full Members would also unnecessarily hinder or constrain the 
ability of national securities exchanges and national securities 
associations to enforce compliance with the federal securities laws.
---------------------------------------------------------------------------

    \135\ In addition, Sections 6(b)(1) and 15A(b)(2) of the 
Exchange Act require all national securities exchanges and national 
securities associations to enforce compliance by their members and 
persons associated with their members, with the provisions of the 
exchanges' or associations' own rules. Section 6(b)(1) of the 
Exchange Act, 15 U.S.C. 78f(b)(1); Section 15A(b)(2) of the Exchange 
Act, 15 U.S.C. 78o-3(b)(2).
    \136\ Sections 9 and 10(b) of the Exchange Act, 15 U.S.C. 78i 
and 78j(b).
    \137\ 15 U.S.C. 78f and 15 U.S.C. 78o-3.
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    The SEC believes that exchanges and associations could address 
these limitations on the obligations of Affiliate Members to share 
information by, for example, entering into a supplementary agreement to 
share such information among Full and Affiliate Members despite the 
limitations in the current agreements. Alternatively, the SEC believes 
that exchanges or associations trading securities that are related to 
security futures traded by an exchange or association that is not a 
Full Member of ISG could satisfy the requirement to coordinate 
surveillance by entering into bilateral surveillance agreements with 
such exchange or association that is adequate to detect manipulation 
and insider trading. The Commissions, however, believe that such 
bilateral agreements would have to contain essentially the same 
information sharing obligations that Full Members of ISG currently have 
with respect to each other.

III. Paperwork Reduction Act

    CFTC: This rulemaking contains information collection requirements. 
As required by the Paperwork Reduction Act of 1995, 44 U.S.C. 3507(d), 
the CFTC submitted a copy of the proposed amendments to its rules to 
the Office of Management and Budget (OMB) for its review.
    Collection of Information: Part 41, Relating to Security Futures 
Products, OMB Control Number 3038-0059.
    No comments were received in response to the CFTC's invitation in 
the proposed rules to comment on any paperwork burden associated with 
these regulations.\138\
---------------------------------------------------------------------------

    \138\ See Proposing Release, 66 FR at 45912.
---------------------------------------------------------------------------

    SEC: Certain provisions of the new rule contain ``collection of 
information requirements'' within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\139\ Accordingly, the Commission 
submitted the proposed rule to the Office of Management and Budget 
(``OMB'') in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB 
approved the new collection and assigned it OMB Control No. 3235-0555. 
An agency may not conduct or sponsor, and a person is not required to 
respond to, a collection of information unless it displays a currently 
valid control number.
---------------------------------------------------------------------------

    \139\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    In the Proposing Release, the Commissions solicited comments on 
these collection of information requirements. The Commissions received 
no comments that specifically addressed the PRA portion of the 
Proposing Release. Because the new rule is substantially similar to the 
proposed rule, the SEC continues to believe that the estimates 
published in the Proposing Release regarding the proposed collection of 
information burdens associated with the new rule are appropriate.

A. Summary of Collection of Information

    As discussed above, the Exchange Act, as amended by the CFMA, 
provides that a national securities exchange or national securities 
association may trade security futures products only if the listing 
standards for such products conform with the requirements set forth in 
Section 6(h)(3) of the Exchange Act.\140\ These listing standards must, 
among other things, require that: (1) Trading in the security futures 
product not be readily susceptible to manipulation of the price of such 
security futures product, nor to causing or being used in the 
manipulation of the price of any underlying security, option on such 
security, or option on a group or index including such securities,\141\ 
and (2) the market on which the security futures product is traded has 
in place procedures to coordinate trading halts between such market and 
any market on which any security underlying the security futures 
product is traded and other markets on which any related security is 
traded.\142\ To further these statutory mandates, the SEC is adopting 
SEC Rule 6h-1 to generally provide that: (1) the final settlement price 
for each cash-settled security futures product fairly reflect the 
opening price of the underlying security or securities; and (2) the 
trading in any security futures product halt when a regulatory halt is 
instituted with respect to a security or securities underlying the 
security futures product by the national securities exchange or 
national securities association listing the security. The SEC 
anticipates that national securities exchanges and national securities 
associations that wish to trade security futures products will file 
with the SEC proposed rule changes, pursuant to Section 19(b) of the 
Exchange Act,\143\ to establish listing standards that are consistent 
with the requirements set forth in Section 6(h)(3) of the Exchange 
Act.\144\
---------------------------------------------------------------------------

    \140\ 15 U.S.C. 78f(h)(3).
    \141\ See 15 U.S.C. 78f(h)(3)(H).
    \142\ See 15 U.S.C. 78f(h)(3)(K).
    \143\ 15 U.S.C. 78s(b).
    \144\ 15 U.S.C. 78f(h)(3).
---------------------------------------------------------------------------

B. Proposed Use of Information

    The SEC will review these proposed rule changes in the manner 
prescribed by Section 19(b) of the Exchange Act. In addition, the SEC 
will publish these proposed rule changes to afford the public an 
opportunity to comment on the listing standards adopted by national 
securities exchanges and national securities associations with respect 
to security futures products.

[[Page 36753]]

C. Respondents

    The SEC estimates that there will be 17 respondents to the proposed 
rule: 9 currently registered national securities exchanges, 1 national 
securities association (the NASD) that operates a securities market 
(Nasdaq), and an estimated 7 futures markets that are expected to 
register as Security Futures Product Exchanges.

D. Total Annual Reporting and Recordkeeping Burden

    The SEC received no comments on its proposed estimates and has not 
revised them. The SEC estimates the paperwork burden for each 
respondent to comply with proposed SEC Rule 6h-1 will be 10 hours of 
legal work at $128/hour,\145\ for a total cost of $1,280 per 
respondent. The SEC estimates that the total burden on all respondents 
will be 170 hours (10 hours/response x 17 respondents x 1 response/
respondent), for a total cost of $21,760 ($1,280/response x 17 
respondents x 1 response/respondent). The SEC believes that these 
burdens will be incurred on a one-time basis and will not recur.
---------------------------------------------------------------------------

    \145\ The estimated rate of $128 per hour is derived from the 
SIA Management and Professional Earnings, Table 107 (Attorney, New 
York), and includes a 35 percent differential for bonus, overhead, 
and other expenses.
---------------------------------------------------------------------------

E. Record Retention Period

    As set forth in SEC Rule 17a-1,\146\ a national securities exchange 
or national securities association must retain records of the 
collection of information for at least five years, the first two years 
in an easily accessible place. However, SEC Rule 17a-1 requires a 
national securities exchange registered under Section 6(g) of the 
Exchange Act to retain only those records relating to persons, 
accounts, agreements, contracts, and transactions involving security 
futures products.\147\
---------------------------------------------------------------------------

    \146\ 17 CFR 240.17a-1.
    \147\ See 15 U.S.C. 78q(b)(4)(B).
---------------------------------------------------------------------------

F. Collection of Information Is Mandatory

    This collection of information is mandatory for any national 
securities exchange or national securities association that elects to 
list and trade security futures products.

G. Confidentiality

    Any information filed with the Commission will be made publicly 
available. Information in the files of national securities exchanges or 
national securities associations that elect to list and trade security 
futures products will be subject to Commission enforcement inquiries or 
investigations and trading reconstructions, as well as for inspections 
and examinations.

IV. Costs and Benefits of the Final Rule

    CFTC: Section 15 of the CEA requires the CFTC to consider the costs 
and benefits of its action before issuing a new regulation.\148\ The 
CFTC understands that, by its terms, Section 15 does not require the 
CFTC to quantify the costs and benefits of a new regulation or to 
determine whether the benefits of the proposed regulation outweigh its 
costs. Nor does Section 15 require that each proposed rule be analyzed 
in isolation when that rule is a component of a larger package of rules 
or rule revisions. Rather, Section 15 simply requires the CFTC to 
``consider the costs and benefits'' of its action.
---------------------------------------------------------------------------

    \148\ 7 U.S.C. 19.
---------------------------------------------------------------------------

    Section 15 further specifies that costs and benefits shall be 
evaluated in light of five broad areas of market and public concern: 
protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the CFTC could in its discretion give 
greater weight to any one of the five enumerated areas of concern and 
could in its discretion determine that, notwithstanding its costs, a 
particular rule was necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the Act.
    The CFTC considered the costs and benefits of these rules in light 
of the specific areas of concern identified in Section 15,\149\ and 
concluded that the rules should have no effect, from the standpoint of 
imposing costs or creating benefits, on the financial integrity or 
price discovery function of the futures and options markets or on the 
risk management practices of trading facilities or others. The rules 
also should have no material effect on the protection of market 
participants and the public and should not impact the efficiency and 
competition of the markets.
---------------------------------------------------------------------------

    \149\ See Proposing Release, 66 FR at 45914.
---------------------------------------------------------------------------

    The CFTC invited public comment on the costs and benefits of the 
proposed rules.\150\ The CFTC received no comments. Accordingly, the 
CFTC has determined to adopt the rules discussed above.
---------------------------------------------------------------------------

    \150\ See Proposing Release, 66 FR at 45914.
---------------------------------------------------------------------------

    SEC: The CFMA \151\ authorizes the trading of futures on individual 
stocks and narrow-based security indexes (``security futures'').\152\ 
The CFMA provides, among other things, that the listing standards for 
security futures products must require that trading in security futures 
products not be readily susceptible to manipulation of the price of 
such security futures product, nor to causing or being used in the 
manipulation of the price of any underlying security, option on such 
security, or option on a group or index including such securities.\153\ 
In addition, listing standards must require that the market on which 
the security futures product trades has in place procedures to 
coordinate trading halts between such market and any market on which 
any security underlying the security futures product is traded and 
other markets on which any related security is traded.\154\
---------------------------------------------------------------------------

    \151\ Pub. L. No. 106-554, Appendix E, 114 Stat. 2763.
    \152\ After December 21, 2003, the SEC and the CFTC may jointly 
determine to permit trading of puts, calls, straddles, options, or 
privileges on security futures (along with security futures, 
collectively referred to as ``security futures products''). See 
Section 2(a)(1)(D)(iii) of the CEA, 7 U.S.C. 2(a)(1)(D)(iii); 
Section 6(h)(6) of the Exchange Act, 15 U.S.C. 78f(h)(6).
    \153\ See Section 2(a)(1)(D)(i)(VII) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(VII); Section 6(h)(3)(H) of the Exchange Act, 15 
U.S.C. 78f(h)(3)(H).
    \154\ See Section 2(a)(1)(D)(i)(X) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(X); Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C. 
78f(h)(3)(K).
---------------------------------------------------------------------------

    Accordingly, the SEC is adopting new SEC Rule 6h-1 under the 
Exchange Act generally to require that the final settlement price for 
each cash-settled security futures product fairly reflect the opening 
price of the underlying security or securities, and that trading in any 
security futures product halt when a regulatory halt is instituted with 
respect to a security or securities underlying the security futures 
product by the national securities exchange or national securities 
association listing the security.
    Specifically, SEC Rule 6h-1(a) defines the terms ``opening price,'' 
``regular trading session,'' and ``regulatory halt'' generally as 
proposed.\155\ However, the SEC has incorporated a provision into the 
definition of ``opening price'' to clarify that if a security is not 
listed on a national securities exchange or a national securities 
association, the opening price shall be the price at which a security 
opened for trading, or a price that fairly reflects the price at which 
a security opened for trading, on the primary market for the security.
---------------------------------------------------------------------------

    \155\ SEC Rule 6h-1(a).
---------------------------------------------------------------------------

    Also like the proposed rule, adopted SEC Rule 6h-1(b)(1) requires 
that the final settlement price of a cash-settled security futures 
product must fairly reflect the opening price of the

[[Page 36754]]

underlying security or securities.\156\ However, if the opening price 
for one or more securities underlying a security futures product is not 
readily available,\157\ SEC Rule 6h-1(b)(2) provides that the final 
settlement price of the security futures product shall fairly reflect 
the price of the underlying security or securities during its most 
recent regular trading session or the next available opening price of 
the underlying security or securities.\158\ Furthermore, 
notwithstanding SEC Rule 6h-1(b)(1) or (b)(2), the SEC amended the 
proposed rule to add SEC Rule 6h-1(b)(3), which states that if a 
clearing agency to which a final settlement price of a security futures 
product is or would be reported determines, pursuant to its rules, that 
such final settlement price is not consistent with the protection of 
investors and the public interest, the clearing agency has the 
authority to determine, under its rules, a final settlement price for 
such security futures product. Under SEC Rule 6h-1(b)(3), the clearing 
agency must take into account such factors as fairness to buyers and 
sellers of the affected security futures product, the maintenance of a 
fair and orderly market in such security futures product, and 
consistency of interpretation and practice.
---------------------------------------------------------------------------

    \156\ SEC Rule 6h-1(b).
    \157\ Although SEC Rule 6h-1(b)(2) does not define when an 
opening price would not be ``readily available,'' national 
securities exchanges and national securities associations would have 
to establish, as part of their listing standards, rules that 
interpret this term.
    \158\ The SEC amended the proposed rule to allow look forward 
pricing in response to recommendations by commenters.
---------------------------------------------------------------------------

    With respect to regulatory halts for security futures products, the 
SEC is generally adopting the provision as proposed requiring that 
trading of a security futures product based on a single security be 
halted at all times that a regulatory halt has been instituted for the 
underlying security.\159\ The trading of security futures product based 
on a narrow-based security index must be halted at all times that a 
regulatory halt has been instituted for one or more of the underlying 
securities that constitute 50 percent or more of the market 
capitalization of the narrow-based security index.\160\
---------------------------------------------------------------------------

    \159\ SEC Rule 6h-1(c)(1).
    \160\ In the Proposing Release, the SEC originally proposed 
halting trading in a security futures product when 30 percent of the 
market capitalization of a narrow-based security index halted 
trading in the underlying markets. As discussed further below, this 
change was made in response to commenters. See SEC Rule 6h-1(c)(2). 
The rule being adopted today does not preclude a market trading 
security futures products based on narrow-based security indexes 
from halting trading at a threshold of less than 50 percent of the 
market capitalization of the index or for other appropriate reasons, 
such as operational difficulties being experienced by the market or 
its automated systems or concerns over clearance and settlement 
operations.
---------------------------------------------------------------------------

    Finally, the SEC has expanded the exemption in SEC Rule 6h-1(d) to 
permit the SEC to grant a national securities exchange or national 
securities association an exemption from any provision of SEC Rule 6h-1 
if the SEC determines that such an exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors. The SEC has expanded the scope of the exemption to make 
it more consistent with its exemptive authority under Section 36 of the 
Exchange Act, which allows the SEC, by rule, regulation, or order to 
conditionally or unconditionally exempt any person, security, or 
transaction, or any classes thereof, from any rule or regulation under 
the Exchange Act, to the extent that such exemption is necessary or 
appropriate in the public interest, and is consistent with the 
protection of investors.\161\
---------------------------------------------------------------------------

    \161\ See supra note 66 and accompanying text.
---------------------------------------------------------------------------

A. Comments

    In the Proposing Release,\162\ the SEC requested comments on all 
aspects of the costs and benefits of the adopted rule, including 
identification of additional costs and benefits of the changes. In 
addition, the SEC encouraged commenters to identify, discuss, analyze, 
and supply relevant data regarding the proposed rule. Specifically, the 
SEC requested data to quantify the costs and benefits of the proposed 
rule. The SEC requested estimates of these costs and benefits, as well 
as any costs and benefits not already described, which may result from 
the adoption of the proposed rule. Furthermore, the SEC requested 
comment on the estimate of the number of respondents that would be 
affected by proposed SEC Rule 6h-1 and the costs and benefits 
associated with complying with the proposed rule. The SEC specifically 
requested comments on the operational and maintenance costs associated 
with the proposal and whether these costs would be significant. 
Commenters were asked to provide analysis and empirical data to support 
their views on the costs and benefits associated with the proposal.
---------------------------------------------------------------------------

    \162\ See Proposing Release, supra note 18.
---------------------------------------------------------------------------

    Although no comments specifically addressed the Costs and Benefits 
analysis in the Proposing Release,\163\ there were comments that may 
apply generally to the costs and benefits of the adopted rule. The SEC 
anticipates that the rule adopted today will generate the costs and 
benefits described below and has incorporated the general comments into 
the applicable discussion.
---------------------------------------------------------------------------

    \163\ See Proposing Release, supra note 18.
---------------------------------------------------------------------------

B. Benefits of SEC Rule 6h-1 Under the Exchange Act

    Adopted SEC Rule 6h-1(a) defines the terms ``opening price,'' 
``regular trading session,'' and ``regulatory halt.'' As a definitional 
provision, subparagraph (a) imposes no costs on the respondents. 
However, by defining the terms, the SEC believes that adopted SEC Rule 
6h-1(a) should benefit respondents by providing legal certainty to 
respondents when complying with the rule.
    One commenter stated that the definition of ``opening price'' 
failed to anticipate instances where the market trading a security 
underlying a security futures product may be a market other than a 
national securities exchange or national securities association, such 
as a foreign stock exchange.\164\ Therefore, the SEC has revised the 
definition to provide that, if the underlying security is not listed on 
a national securities exchange or a national securities association, 
the opening price is the price at which the security opened for 
trading, or a price that fairly reflects the price at which a security 
opened for trading, on the primary market for the security. The SEC 
believes that the additional language should provide clear guidance and 
clarification of the term ``opening price'' in those instances where 
the security futures products may be based on securities that are not 
listed in the United States. To the extent that the underlying security 
is listed on a national securities exchange or national securities 
association, the SEC believes that it is appropriate to use the opening 
price from the listing market. Despite the commenter's view that the 
listing market may not be the primary trading venue for a security and, 
thus, not the most liquid market,\165\ the SEC believes that the 
listing market is a significant source of liquidity for a security that 
underlies a security futures product and that a rule requiring, for 
example, the calculation of trading volumes to determine the 
appropriate primary market from which to derive an opening price for a 
security listed in the U.S. would impose unnecessary burdens without 
significantly furthering anti-manipulation goals.
---------------------------------------------------------------------------

    \164\ See CME Letter.
    \165\ See CME Letter.
---------------------------------------------------------------------------

    Further, this commenter stated that the proposed definition of the 
term ``regulatory halt,'' which is being

[[Page 36755]]

adopted as proposed, also does not address situations where the listing 
market is not the primary trading venue for the underlying security or 
where the listing market is in a foreign country.\166\ The SEC notes 
that the rule adopted today is not intended to limit the ability of 
national securities exchanges and national securities associations to 
impose a trading halt in other circumstances, such as when the 
underlying security is listed on a foreign market that has halted 
trading. The rule provides national securities exchanges and national 
securities associations with the flexibility to submit proposed rule 
changes that address situations not covered by the rule being adopted 
today.\167\ However, in those instances where the underlying security 
is listed in the United States, the SEC believes that by specifically 
designating the listing market as the appropriate venue, the rule 
allows for ease of application and clear guidance for respondents to 
administer and implement the rule. For example, the SEC believes that, 
due to the contractual relationship between the issuer and the listing 
market, the listing market has a direct and ongoing relationship with 
the issuer and, therefore, is in the best position to be informed 
promptly by the issuer that pending news would require the imposition 
of a trading halt.
---------------------------------------------------------------------------

    \166\ See CME Letter.
    \167\ One commenter believed that the SEC and the CFTC should 
expand on the examples of the types of reasons why national 
securities exchanges and associations could impose additional 
trading halts provided in the footnotes of the Proposing Release to 
include order imbalances. See NYSE Letter. As noted above, the rule 
being adopted today is not designed to preclude a market trading 
security futures products from halting trading for other appropriate 
reasons. Therefore, a national securities exchange or national 
securities association would be free to impose additional 
restrictions on trading that are not required by this rule.
---------------------------------------------------------------------------

    Adopted SEC Rule 6h-1(b)(1) requires that the final settlement 
price of a cash-settled security futures product must fairly reflect 
the opening price of the underlying security or securities. Several 
commenters generally supported this aspect of the proposal.\168\ The 
SEC believes that the provision for cash-settled security futures 
products under adopted SEC Rule 6h-1(b)(1) is necessary to minimize 
opportunities for intermarket manipulations and to promote the fair and 
orderly operation of the securities markets. In particular, opening-
price settlement procedures appear to be necessary to satisfy Section 
6(h)(3)(H) of the Exchange Act \169\ that listing standards for 
security futures products must require that trading in a security 
futures product not be readily susceptible to manipulation of the price 
of such product, nor to causing or being used in the manipulation of 
the price of any underlying security, option on such security, or 
option on a group or index including such securities.
---------------------------------------------------------------------------

    \168\ See CBOE Letter, CBOT Letter, and NYSE Letter.
    \169\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------

    The SEC believes that SEC Rule 6h-1(b)(1) should facilitate the 
ability of the securities markets to handle expiration-related 
unwinding programs and mitigate the liquidity strains that had 
previously been experienced in the securities markets on expirations 
for stock index futures and options. The SEC further believes that the 
liquidity constraints associated with expiration-related buy or sell 
programs at the close on expiration Fridays aggravated ongoing market 
swings during an expiration and provided opportunities for entities to 
anticipate these pressures and enter orders as part of manipulative or 
abusive trading practices designed to artificially drive up or down 
share prices.\170\
---------------------------------------------------------------------------

    \170\ The liquidity constraints faced by the securities markets 
due to unwinding programs used in closing-price settlement 
procedures were discussed by the SEC staff in its report on the 
market decline on November 15, 1991. See SEC Division of Market 
Regulation, Trading Analysis of November 15, 1991 (October 1992).
---------------------------------------------------------------------------

    The SEC notes that the rule adopted today provides national 
securities exchanges and national securities associations with 
flexibility to implement the requirements of the Exchange Act. The SEC 
notes that the rule adopted today does not mandate that a particular 
methodology be used to derive an opening price. A national securities 
exchange or national securities association would retain the 
flexibility to establish the procedures to determine the opening price, 
which will be used to determine the settlement price of security 
futures products. The SEC believes that this flexibility should provide 
respondents with the ability to meet the needs of the market place, 
while satisfying their obligations under the Exchange Act.
    In those instances where the opening price was not readily 
available, the SEC proposed that the final settlement price of a cash-
settled security futures product overlying that security must reflect a 
price of the underlying security taken from its most recent regular 
trading session. The proposed rule also provided that national 
securities exchanges and national securities associations could request 
exemptions from the settlement price provisions from the SEC on a case-
by-case basis.
    Although one commenter supported this aspect of the proposal,\171\ 
four commenters generally opposed the SEC's exclusive use of a ``look 
back'' settlement procedure for security futures products when the 
opening prices for the underlying securities are unavailable and, 
instead, recommended using the next day's opening prices.\172\ These 
commenters noted that the existing cash settlement procedures for stock 
index options and stock index futures allow ``next opening'' 
prices.\173\ Further, one commenter, a clearing agency, urged the SEC 
not to require national securities exchanges and national securities 
associations to adopt rules addressing the determination of security 
futures final settlement prices when opening prices are not readily 
available because of potential conflicts with clearing agency 
rules.\174\ Another commenter believed that the establishment of 
consistent and commercially appropriate alternative pricing conventions 
should be resolved by a collaboration among the exchanges that design 
the product and the clearinghouse, with appropriate consultation with 
their members and participants.\175\ Furthermore, several commenters 
argued that under the SEC's proposed rule hedges could be significantly 
disrupted.\176\
---------------------------------------------------------------------------

    \171\ See CBOT Letter.
    \172\ See CBOE Letter, CME Letter, and SIG Letter. See also OCC 
Letter (urging the Commissions to withdraw this aspect of the 
proposal, or at a minimum, modify it to allow the final settlement 
value to be based on the next opening).
    \173\ See CBOE Letter, CME Letter, and SIG Letter. See also FIA/
SIA Steering Committee Letter (stating that the Commissions' 
proposed requirement is inconsistent with existing market practice 
and rules governing a broad range of listed stock index products) 
and OCC By-Laws, Article XII, Section 5 (allowing OCC to fix the 
final settlement price for security futures products using next 
opening prices of the underlying securities, as well as look-back 
pricing).
    \174\ See OCC Letter.
    \175\ See FIA/SIA Steering Committee Letter.
    \176\ See CBOE Letter, CME Letter, FIA/SIA Steering Committee 
Letter, OCC Letter, and SIG Letter.
---------------------------------------------------------------------------

    In response to the commenters, the final rule adopted by the SEC 
allows either look-back or look forward opening prices to be used as 
alternate final settlement prices when an opening price is not readily 
available. Specifically, adopted SEC Rule 6h-1(b)(2) requires that, if 
an opening price for one or more securities underlying a security 
futures product is not readily available, the final settlement price of 
the security futures product shall fairly reflect (i) the price of the 
underlying security or securities during the most recent regular 
trading session for such security or securities, or (ii) the next 
available opening price of the underlying security or securities.

[[Page 36756]]

    As discussed earlier, the SEC agrees with the commenters' view that 
the proposed rule could have resulted in an unwanted and unwarranted 
de-linking of hedging positions if it mandated look-back pricing 
procedures for security futures products. The SEC believes that the 
adopted rule will provide national securities exchanges and national 
securities associations with some discretion to implement this general 
rule without dictating how the settlement price is derived for a 
security futures product. The SEC further notes that the final rule 
adopted today is consistent with OCC rules that allow for look-back 
pricing in certain circumstances.
    In addition, one commenter indicated that problems could arise if 
an exchange or association that trades a security futures product and 
the registered clearing agency through which it clears such product had 
different rules for the determination of an alternate settlement 
price.\177\ For example, a national securities exchange or national 
securities association wishing to use OCC clearing services for 
security futures must enter into a clearing agreement with OCC in which 
both parties agree that security futures will be cleared by OCC in 
accordance with OCC's by-laws and rules, which currently give OCC the 
final authority to determine final settlement prices in certain 
circumstances.\178\ This commenter recommended that the clearing agency 
be permitted, under its rules, to determine the final settlement price 
of the security futures product.\179\ In light of the comments, the 
final rule has been amended. Pursuant to adopted SEC Rule 6h-1(b)(3), 
if a clearing agency determines, pursuant to its rules, that such final 
settlement price is not consistent with the protection of investors and 
the public interest, taking into account such factors as fairness to 
buyers and sellers of the affected security futures product, the 
maintenance of a fair and orderly market in such security futures 
product, and consistency of interpretation and practice, the clearing 
agency has the authority to determine, under its rules, a final 
settlement price for such security futures product.
---------------------------------------------------------------------------

    \177\ See OCC Letter.
    \178\ See supra note 60 and accompanying text.
    \179\ See OCC Letter; see also CBOE Letter (recommending that 
security futures products have the proviso that the clearing 
corporation rules have precedence for determining the index value at 
expiration during a trading halt in the underlying security); FIA/
SIA Steering Committee Letter (urging the Commissions not to require 
exchanges and associations to adopt rules addressing the 
determination of fallback security futures final settlement prices 
when opening prices are not readily available).
---------------------------------------------------------------------------

    The SEC believes that in the absence of such a provision, confusion 
could arise if securities underlying a security futures product failed 
to trade on an expiration Friday and the market trading the security 
futures product and its clearing agency had different rules determining 
a final settlement price. Moreover, this provision should make security 
futures products that trade on different markets more fungible, because 
a single clearing agency will be able to harmonize procedures across 
different markets for determining alternate settlement prices.
    In addition, adopted SEC Rule 6h-1(c)(1) and (c)(2) requires the 
trading on security futures products based on a single security to be 
halted at all times that a regulatory halt has been instituted for the 
underlying security or, if based on a narrow-based security index, to 
be halted at all times that a regulatory halt has been instituted for 
one or more underlying securities that constitute 50 percent or more of 
the market capitalization of the narrow-based security index. The SEC 
believes that the adopted rule should help preserve the investor 
protection and market integrity goals of regulatory halt procedures in 
the securities markets. The SEC believes that the close relationship 
between the underlying security or securities and the pricing of the 
overlying security futures product generally justifies a regulatory 
halt of the security futures product at all times that a regulatory 
halt has been instituted for the underlying security or 
securities.\180\
---------------------------------------------------------------------------

    \180\ The trading halt provision of adopted SEC Rule 6h-1(c) 
would not be exclusive. The adopted rule is not designed to preclude 
a market trading security futures products from halting trading for 
other appropriate reasons, such as operational difficulties being 
experienced by the market or its automated systems or concerns over 
clearance and settlement operations.
---------------------------------------------------------------------------

    With respect to regulatory halts due to pending news, the SEC does 
not agree with two commenters who questioned the absolute requirement 
that trading in a security futures product must be halted during a news 
pending halt in the underlying security.\181\ These commenters 
recommended providing exchanges with discretion to impose a trading 
halt when there is a news pending trading halt in the underlying 
security.\182\ Specifically, one commenter believed that this 
discretion is necessary to allow trading in a security futures product 
when the underlying stock is halted in certain circumstances, such as 
when there is a need to adjust positions before an expiration.\183\ 
Given the rarity of such situations and that the significant 
underpinning for imposing news pending regulatory halts is to promote 
investor protection and fair and orderly markets, the SEC believes 
that, to the extent that there is pending news that could impact an 
investor's decision and to the extent that single-stock futures are 
surrogates for the underlying security, there is a need for a provision 
requiring that trading in a security futures product be halted at all 
times that a regulatory halt has been instituted for the underlying 
security or securities, with certain limits for narrow-based security 
index futures. SEC Rule 6h-1(c)(1) and (2), which concern regulatory 
halts, will benefit current and potential shareholders by providing an 
opportunity for material information about the underlying security or 
securities to be disseminated to the public. Since pending news may 
have a significant effect on trading, the SEC believes that all 
investors should have an opportunity to learn of and react to material 
information in order to make informed investment judgments.\184\ 
Accordingly, news pending regulatory halts should foster public 
confidence in the market and promote the integrity of the market place. 
Furthermore, the SEC believes that requiring an exchange or association 
to halt trading on a security futures product at all times that a 
regulatory halt has been instituted for the underlying security or 
securities should contribute to the maintenance of an efficient market.
---------------------------------------------------------------------------

    \181\ See CBOE Letter and FIA/SIA Steering Committee Letter.
    \182\ Id.
    \183\ See CBOE Letter.
    \184\ See Securities Exchange Act Release No. 32890 (September 
14, 1993), 58 FR 48916 (September 20, 1993).
---------------------------------------------------------------------------

    In addition, the SEC believes that regulatory halts in the trading 
of security futures products due to the operation of circuit breakers 
should further protect investors and the markets by mitigating 
potential systemic stress during a historic market decline and allow 
for the reestablishment of an equilibrium between buying and selling 
interests in an orderly fashion. The SEC generally believes that pre-
determined, coordinated, cross-market operations of circuit breakers 
would effectively address market declines that threaten to result in ad 
hoc and potentially destabilizing market closings.
    The SEC does not agree with one commenter's recommendation that the 
SEC should provide exchanges with latitude in implementing coordinated 
circuit breaker procedures and flexibility in imposing this requirement 
on security futures products where the

[[Page 36757]]

principal trading venues for the underlying securities (or for a subset 
of securities in the case of narrow-based indexes) are in foreign 
markets.\185\ The SEC believes that it is important to require the 
application of cross-market circuit breaker regulatory halt procedures 
to security futures products and that such a requirement is necessary 
to satisfy the requirements of Section 6(h)(3)(K) of the Exchange 
Act.\186\ If cross-market circuit breaker regulatory halt procedures 
were not applied to the security futures products, the lack of such 
procedures would undermine the use of trading halts in the underlying 
securities. Furthermore, national securities exchanges and national 
securities associations do have the flexibility under the rule to 
impose trading halt requirements where the underlying security is 
listed solely on a foreign market.
---------------------------------------------------------------------------

    \185\ See CME Letter.
    \186\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

    In addition, to be effective, circuit breakers have to be 
coordinated across stock, stock index futures, and options markets in 
order to prevent intermarket problems of the kind experienced in 
October 1987.\187\ Since the markets currently coordinate regulatory 
halts between the listing market for the underlying security and other 
markets that trade the underlying security or any related security in 
order to promote investor protection and fair and orderly markets, SEC 
Rule 6h-1(c)(1) and (2) should help ensure such coordination and 
effectiveness through the use of regulatory halts in the markets 
trading security futures products.
---------------------------------------------------------------------------

    \187\ In response to the events of October 19, 1987, when the 
Dow Jones Industrial Average (``DJIA'') sustained a one-day decline 
of 508 points (22.6%), the nation's securities and futures markets 
in 1988 adopted rules that provide for coordinated, cross-market 
trading halts in all equity and equity-derivative markets following 
specified declines in the DJIA. See Circuit Breaker Report, supra 
note 68. See also Securities Exchange Act Release No. 38080 
(December 23, 1996), 61 FR 69126 (December 31, 1996) (citing the 
SEC's desire to have coordinated mechanisms across these markets to 
deal with potential volatility that may develop during periods of 
extreme downward volatility).
---------------------------------------------------------------------------

    Although the SEC understands the concern raised by one commenter 
regarding continued trading of a security futures product when the 
underlying security has halted trading if the listing market is not the 
primary market,\188\ the SEC believes that, due to the contractual 
relationship between the issuer and the listing market, the listing 
market has a direct and ongoing relationship with the issuer and is, 
consequently, in the best position to be informed promptly by the 
issuer that pending news would require the imposition of a trading 
halt. The SEC also believes that designating the listing market as the 
venue for the purpose of applying the rule provides for ease of use and 
application and prevents national securities exchanges or national 
securities associations from having to determine the primary market for 
each underlying security. Further, the SEC believes that the listing 
market should represent sufficient liquidity that imposing a trading 
halt on a security futures product when the listing market for the 
underlying security imposes a trading halt furthers the purposes of 
Section 6(h)(3)(K) of the Exchange Act.\189\
---------------------------------------------------------------------------

    \188\ See CME Letter.
    \189\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

    With respect to narrow-based security indexes, the SEC believes 
that trading should be halted when a trading halt has been instituted 
for a sufficiently large portion of an index in order to prevent 
continued trading of the security futures product from becoming a means 
to improperly circumvent regulatory trading halts in the underlying 
securities. If trading in only one component security is halted, 
continued trading in a security future based on an index in which such 
a security represents a substantial portion of the index value could 
also undermine the trading halt in the underlying security. The SEC 
believes that trading halt procedures also would not be coordinated, as 
contemplated by Section 6(h)(3)(K) of the Exchange Act,\190\ if the 
security futures product based on an index continued to trade while 
investors were precluded from trading some or all of the underlying 
securities. Moreover, the SEC believes that continued trading in the 
security futures product under these circumstances could undercut key 
provisions in the securities laws designed to protect investors and 
promote the fair and orderly operation of the markets.
---------------------------------------------------------------------------

    \190\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

    Accordingly, the SEC believes that a general practice whereby 
trading is halted for the security futures product when investors lack 
access to current pricing information in the primary market for the 
underlying security should contribute to the maintenance of fair and 
orderly markets. Moreover, the SEC believes that this coordination of 
trading halts by SEC Rule 6h-1(c)(1) and (2) would generally benefit 
investors and the market by providing fewer opportunities for abuse and 
manipulation. SEC Rule 6h-1(c)(1) and (2) also would further increase 
investor confidence in the stability of the markets by assuring 
investors and the public that the national securities exchanges and 
national securities associations trading security futures product are 
reasonably equipped to handle market demand and pending material news.
    Furthermore, in the final rule adopted by the SEC, the rule permits 
the SEC to grant an exemption with respect to any provision of SEC Rule 
6h-1 based on its existing exemptive authority pursuant to Section 36 
of the Exchange Act. Any exemption would require a finding that the 
action is necessary or appropriate in the public interest and 
consistent with the protection of investors. The SEC believes that the 
exemption provided for in SEC Rule 6h-1(d)\191\ would benefit national 
securities exchanges and national securities associations by providing 
them with flexibility in responding to changing market conditions, as 
well as provide the SEC with continued oversight over the respondents 
by granting an exemption when it is necessary or appropriate in the 
public interest and is consistent with the protection of investors.
---------------------------------------------------------------------------

    \191\ The SEC may grant an exemption from the rule, either 
unconditionally or on specified terms and conditions, if it finds 
that such exemption is necessary or appropriate in the public 
interest and consistent with the protection of investors. See 
Section 36 of the Exchange Act, 15 U.S.C. 78mm.
---------------------------------------------------------------------------

B.Costs of SEC Rule 6h-1 under the Exchange Act

    The SEC estimates that there would be 17 respondents to the rule: 9 
currently registered national securities exchanges, 1 national 
securities association (the NASD) that operates a securities market 
(Nasdaq), and an estimated 7 futures markets that are expected to 
register as Security Futures Product Exchanges.
    National securities exchanges and national securities associations 
may file proposed rule changes pursuant to Section 19(b) of the 
Exchange Act \192\ to implement SEC Rule 6h-1.\193\ However, the SEC 
notes that even in the absence of SEC Rule 6h-1 each of the respondents 
would have to file one or more proposed rule changes to adopt listing 
standards for security futures products to trade security futures 
products pursuant to the Exchange Act, as amended by the CFMA.
---------------------------------------------------------------------------

    \192\ 15 U.S.C. 78s(b).
    \193\ The SEC has adopted Rule 19b-7, which would direct 
Security Futures Product Exchanges to file proposed rule changes on 
Form 19b-7. See Securities Exchange Act Release No. 44692, supra 
note.
---------------------------------------------------------------------------

    Further, under Rule 17a-1 of the Exchange Act,\194\ a national 
securities exchange or national securities association is required to 
retain records of the collection of information for at

[[Page 36758]]

least 5 years, with the first 2 years in an easily accessible place. 
However, Rule 17a-1 requires a Security Futures Product Exchange to 
retain only those records relating to persons, accounts, agreements, 
contracts, and transactions involving security futures products.\195\ 
The SEC believes that respondents would not incur any additional 
capital or start-up costs beyond the paperwork costs, nor any 
additional operational or maintenance costs, to comply with the 
collection of information requirements under SEC Rule 6h-1.\196\ As 
discussed above, the paperwork burden for each respondent to comply 
with the new rule will be $1,280, resulting in a total cost for the 17 
respondents of $21,760.
---------------------------------------------------------------------------

    \194\ 17 CFR 240.17a-1.
    \195\ See 15 U.S.C. 78q(b)(4)(B).
    \196\ See Paperwork Reduction Act discussion at Section III.
---------------------------------------------------------------------------

    As mentioned earlier, adopted SEC Rule 6h-1(a) defines the terms 
``opening price,'' ``regular trading session,'' and ``regulatory 
halt.'' The definitions of the relevant terms impose no costs on the 
respondents.
    SEC Rule 6h-1 also requires respondents that choose to trade 
security futures products to develop a system for determining the 
settlement price of a cash-settled security futures product to fairly 
reflect the opening price of the underlying security. However, because 
respondents to the adopted rule currently have systems in place to 
determine opening prices, the SEC believes that respondents complying 
with the settlement provisions of SEC Rule 6h-1 would only incur 
minimal operational or maintenance costs to reconfigure their current 
settlement procedures to fairly reflect the opening price of the 
underlying security.
    In addition, in order to comply with SEC Rule 6h-1(c)(1) and (2), 
the SEC believes that national securities exchanges and national 
securities associations may incur costs in developing or adapting 
existing systems to monitor when listing markets have instituted a 
regulatory halt for an underlying security of the security futures 
product. Similarly, costs may be incurred for system changes needed to 
calculate the market capitalization of an underlying narrow-based 
security index and when one or more of the underlying securities that 
constitute 50 percent or more of the market capitalization of a narrow-
based security index are subject to a regulatory halt. The commenters 
did not provide the SEC with actual estimates of the costs they would 
incur to institute such a system. To the extent that systems need to be 
developed to determine the market capitalization of narrow-based 
security indexes to trigger a regulatory trading halt, the SEC does not 
believe that the additional costs that may be incurred will be 
substantial. Similarly, with respect to the costs in developing or 
adapting existing systems to monitor when listing markets institute 
regulatory halts for the security or securities, as applicable, 
underlying the security futures product, the SEC believes that these 
costs should not be substantial in light of the fact that the majority 
of affected markets already have systems in place to monitor regulatory 
halts. For instance, the SEC notes that 9 of the estimated 17 
respondents are already required to provide notification of regulatory 
halts since they are participants of the Consolidated Tape Association 
Plan (``CTA Plan'')\197\ and thus, should already have systems in place 
to monitor each other of regulatory halts being instituted. The SEC 
also believes that each of the remaining respondents will have to 
develop a similar system to monitor when regulatory halts have been 
instituted for the underlying security. However, any costs that will be 
incurred to establish such a system arise from the requirements of the 
Exchange Act, as amended by the CFMA, to coordinate trading halts.\198\ 
The rule adopted today merely clarifies the requirement imposed by the 
Exchange Act, as amended by the CFMA.
---------------------------------------------------------------------------

    \197\ The CTA Plan is a joint industry plan that governs the 
consolidated transaction reporting system. Parties to the CTA Plan 
are as follows: the American Stock Exchange LLC, Boston Stock 
Exchange, Inc., Chicago Board Options Exchange, Inc., Chicago Stock 
Exchange, Inc., Cincinnati Stock Exchange, Inc., National 
Association of Securities Dealers, Inc., New York Stock Exchange, 
Inc., Pacific Exchange, Inc., and Philadelphia Stock Exchange, Inc. 
See CTA Plan (Second Restatement), Section III (a).
    \198\ Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C. 
78f(h)(3)(K).
---------------------------------------------------------------------------

    One commenter believed that the requirement to halt trading in 
single-stock futures when trading in the underlying security is halted 
was overly broad to satisfy the requirement that procedures be put in 
place to coordinate trading halts.\199\ This commenter believed that 
this was overly broad and burdensome in its application to retail 
investors for whom single-stock futures might serve as the only 
available means for managing risk and that the SEC should allow trading 
halt sessions during which investors with risk exposure to an 
underlying equity, which has been halted, might have the opportunity to 
enter into single-stock futures transactions with dealers.
---------------------------------------------------------------------------

    \199\ See Students Letter.
---------------------------------------------------------------------------

    In response, the SEC notes that the purpose of trading halts is to 
ensure that there is an adequate opportunity for information about a 
security to be disseminated to the public. The SEC does not believe 
that it would be consistent with the protection of investors to permit 
investors, including retail investors, to trade a surrogate for a 
security when trading is halted in that security. By adopting this 
rule, the SEC seeks to maintain and preserve the integrity of this 
mechanism so that the trading of security futures products will not be 
used as a tool to circumvent the institution of regulatory halts. 
Moreover, the SEC believes that the purpose of halting trading in the 
underlying security would be frustrated if market participants could 
circumvent this halt by trading during the halt in the related security 
futures product.\200\
---------------------------------------------------------------------------

    \200\ The SEC's rule does not preclude a market trading security 
futures products from halting trading for other appropriate reasons, 
such as operational difficulties being experienced by the market or 
its automated systems or concerns over clearance and settlement 
operations.
---------------------------------------------------------------------------

    Another commenter believed that the SEC's proposal to require a 
trading halt in a narrow-based security index future when a security or 
securities that constitute 30 percent or more of the market 
capitalization of the index are subject to a trading halt was too low a 
threshold to justify the disruption that it would inflict upon the 
futures market.\201\ Another commenter recommended providing exchanges 
with greater discretion to decide whether to impose or maintain a 
trading halt.\202\ This commenter also believed that because not all 
indexes underlying security futures products may be capitalization 
weighted, it may be difficult for exchanges to determine on a real-time 
basis when securities comprising 30 percent of the market 
capitalization of a price-weighted or equal dollar weighted index are 
halted. Similarly, one of the commenters expressed a concern that, with 
respect to corporate news events, it may be operationally difficult to 
determine on a real-time basis whether the threshold of market 
capitalization has been crossed.\203\
---------------------------------------------------------------------------

    \201\ See CBOT Letter.
    \202\ See CBOE Letter.
    \203\ See CME Letter.
---------------------------------------------------------------------------

    In response to the commenter's statement that the 30 percent market 
capitalization test was too low and after consideration of the 
potential effects of the proposed 30 percent trading halt threshold, 
the adopted rule requires trading to be halted in a narrow-based 
security index futures product when component securities representing 
50 percent or more of the market capitalization of that narrow-based

[[Page 36759]]

security index are subject to a regulatory halt.\204\ The SEC believes 
that one of the major economic benefits that market participants derive 
from the trading of futures on narrow-based security indexes is the 
ability to hedge positions containing the securities underlying the 
indexes, thereby reducing the risk of holding positions in those 
securities. For traders using a narrow-based security index future to 
hedge a position containing the component index securities, trading 
halts in certain of those component securities necessarily will 
introduce basis risk because the one-to-one relationship between the 
cash portfolio of securities and the narrow-based index future is 
disrupted.
---------------------------------------------------------------------------

    \204\ As with adopted SEC Rule 6h-1(c)(1), the trading halt 
provision of adopted SEC Rule 6h-1(c)(2) is not intended to be 
exclusive. The adopted rule is not designed to preclude a market 
trading security futures products based on narrow-based security 
indexes from halting trading at a threshold of less than 50 percent 
of the market capitalization of the index or for other appropriate 
reasons, such as operational difficulties being experienced by the 
market or its automated systems or concerns over clearance and 
settlement operations.
---------------------------------------------------------------------------

    The SEC believes that the proposed 30 percent threshold is too low 
because it could unnecessarily disrupt hedge positions involving 
futures on narrow-based security indexes that may still be 
substantially performing their intended risk-shifting function when 
trading is halted in a limited number of the index's component 
securities. The SEC believes that a 50 percent threshold would better 
serve the requirement's intended purpose. In adopting a 50 percent 
threshold, the SEC sought to balance the utility of maintaining 
effective hedge positions with concerns about circumventing the 
coordination requirement by allowing trading in narrow-based index 
futures to continue when trading in a limited number of the underlying 
securities is halted. The SEC believes that while it is not possible to 
eliminate completely the risk involved in hedging securities with a 
future on a narrow-based security index when trading halts are 
instituted for certain of those underlying securities, the 50 percent 
threshold reduces such risk. Therefore, the SEC is adopting a 50 
percent threshold because it appears to appropriately balance the goals 
of hedging utility with prevention of improperly circumventing 
regulatory halts in the underlying securities. With respect to the 
commenters' concern regarding the potential difficulty in calculating 
the market capitalization of an index, especially for price-weighted or 
equal dollar weighted indexes, for purposes of instituting the 
regulatory halt, the SEC notes that selecting market capitalization as 
the method for calculating the weight of the index is similar to an 
existing standard used to calculate trigger points for circuit breaker 
operations.\205\ Consequently, the SEC chose to apply a similar method 
in implementing regulatory halts to narrow-based security index futures 
product. Furthermore, in specifying market capitalization as the method 
for weighing an index, the rule provides clarity and uniformity for all 
respondents to utilize in implementing regulatory halts in security 
futures products based on narrow-based security indexes. If the rule 
allowed for different methods of weighing an index for purposes of 
imposing a regulatory halt in the trading of a security futures 
product, the SEC believes that the trading of security futures products 
may be more susceptible to becoming a means of circumventing regulatory 
halts in the underlying securities.
---------------------------------------------------------------------------

    \205\ See, e.g., CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------

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

    SEC: Section 3(f) of the Exchange Act \206\ requires the SEC, 
whenever it is engaged 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 \207\ requires the SEC, 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 SEC 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. In the 
Proposing Release, the SEC requested comment on these issues.\208\
---------------------------------------------------------------------------

    \206\ 15 U.S.C. 78c(f).
    \207\ 15 U.S.C. 78w(a)(2).
    \208\ The CFTC is not required to consider its proposed rules 
under these standards.
---------------------------------------------------------------------------

A. Effects on Competition

1. Settlement Procedures for Cash-Settled Security Futures Products
    SEC Rule 6h-1 provides that the final settlement price for each 
cash-settled security futures product fairly reflect the opening price 
of the underlying security or securities. In the event that the opening 
price of an underlying security is not readily available, SEC Rule 6h-1 
permits a national securities exchange or national securities 
association that lists and trades an overlying cash-settled security 
futures product to use look-back or next opening pricing procedures to 
derive a final settlement price for the security futures product. 
However, if a clearing agency determines, pursuant to its rules, that 
such final settlement price is not consistent with the protection of 
investors and the public interest, taking into account such factors as 
fairness to buyers and sellers of the affected security futures 
product, the maintenance of a fair and orderly market in such security 
futures product, and consistency of interpretation and practice, the 
clearing agency has the authority to determine, under its rules, a 
final settlement price for such security futures product.
    The SEC does not believe that these provisions will impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. The rule adopted today codifies what 
is general industry practice for other cash-settled derivative 
products. Thus, even in the absence of the rule, it is likely that the 
markets would have opted for opening-price rather than closing-price 
procedures for security futures products. In addition, under the final 
rule, the market listing the security futures product may use look-back 
or next opening prices in instances where the opening price of an 
underlying security is not readily available. The SEC believes that 
this flexibility will assist national securities exchanges and national 
securities associations in responding to market conditions when 
creating security futures products. Finally, the provision that allows 
a clearing agency to determine a final settlement price in certain 
instances will remove an obstacle to the fungibility of security 
futures products, which may in time lead to the same security futures 
product being multiply traded on more than one national securities 
exchange or national securities association. The SEC believes that the 
trading of security futures products on multiple markets promote 
competition.
    The Commissions received one comment on the proposed settlement 
procedures that briefly addressed competitive issues. This commenter 
stated that exchange-listed security futures products ``will be subject 
to intense competition'' and urged the Commissions to avoid rulemaking 
that would lead to the sub-optimal design of security futures products 
and thereby ``unfairly tilt the competitive landscape.'' \209\ In light 
of the revisions

[[Page 36760]]

made to the rule at the suggestion of the various commenters, the SEC 
believes that the rule will further the anti-manipulation principles of 
Section 6(h)(3)(H) of the Exchange Act \210\ while giving the markets 
flexibility to determine the characteristics of the products that they 
wish to trade. In addition, the SEC believes that the final rule 
promotes competition by providing national securities exchanges and 
national securities associations with the ability to structure their 
security futures products so as to respond to competitive forces in the 
marketplace.
---------------------------------------------------------------------------

    \209\ See CME Letter.
    \210\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------

2. Trading Halt Provisions
    The Commissions received two comments that address the competitive 
aspects of the trading halt provisions of the proposed rule. One 
commenter stated that security futures product ``lookalikes'' can trade 
in the unregulated upstairs market and in foreign jurisdictions; to the 
extent that these other trading venues do not coordinate their trading 
halts, ``there is a potential competitive issue.'' \211\ Likewise, the 
second commenter stated that sophisticated investors could create a 
synthetic future in a halted stock.\212\
---------------------------------------------------------------------------

    \211\ See CME Letter.
    \212\ See Students Letter.
---------------------------------------------------------------------------

    The SEC does not believe that the trading halt provisions will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. These provisions do 
restrict competition, in the sense that they restrict the freedom and 
ability to trade a security futures product whenever trading is halted 
in the underlying security or securities. The SEC believes, however, 
that such a requirement is necessary and appropriate to further the 
purposes of the Exchange Act, which require that listing standards for 
security futures products must include procedures to coordinate trading 
halts between the market that trades the security futures product, any 
market that trades any underlying security, and other markets on which 
any related security is traded. Specifically, in the absence of these 
mandatory halts for the security futures product, the purpose of 
declaring the halt in the underlying security or securities would be 
frustrated, because the market for the overlying security futures 
product could serve as a proxy for the underlying market.
    Further, the SEC believes that trading halts promote fair 
competition by providing an adequate opportunity for information about 
a security to be disseminated to the public. The SEC does not believe 
that it would be consistent with the protection of investors, 
particularly retail investors, to permit trading in a surrogate for a 
security when trading is halted in that security. Thus, the SEC 
believes it is essential, to ensure fair and orderly markets, to 
prevent a national securities exchange or national securities 
association from becoming a proxy market by trading an overlying 
security futures product when trading is halted in an underlying 
security. Furthermore, any potential restraint on competition caused by 
the rule's trading halt provisions must be weighed against the 
requirement that listing standards, pursuant to Section 6(h)(3)(K) of 
the Exchange Act,\213\ include procedures to coordinate trading halts 
with the market that trades the underlying security.
---------------------------------------------------------------------------

    \213\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------

3. Conclusion
    The SEC finds that SEC Rule 6h-1 will promote competition and will 
not impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.

B. Effects on Efficiency and Capital Formation

1. Settlement Procedures for Cash-Settled Security Futures Products
    The SEC believes that the settlement provisions of SEC Rule 6h-1 
will improve efficiency and capital formation. Although no commenters 
addressed the efficiency and capital formation aspects of the proposed 
rule directly, some of the commenters \214\ noted that the proposed 
rule could have significant adverse monetary consequences and, by 
implication, impact efficiency and capital formation. Under the 
proposed rule, a security futures product would have been required to 
use look back prices in the event that the opening price of the 
underlying security or securities were not readily available. These 
commenters noted that situations could arise where, due to some 
disruption to the markets, a hedge consisting of a security futures 
product and another security was ``mismatched.'' This unhedged exposure 
could result in significant market losses. The final rule reduces the 
possibility of such losses--and, thus, improves efficiency and capital 
formation--by allowing security futures products to settle based on 
next opening prices if an opening price for one or more security 
futures products is not readily available and by allowing a registered 
clearing agency, in certain circumstances, to harmonize inconsistent 
settlement practices.
---------------------------------------------------------------------------

    \214\ See supra note 52.
---------------------------------------------------------------------------

2. Trading Halt Provisions
    The Commissions received no comments directly addressing efficiency 
and capital formation aspects of the trading halt provisions of SEC 
Rule 6h-1.
    Regulatory trading halts provide an opportunity for investors to 
learn of, and react to, material information to make informed 
investment judgments. In addition, they mitigate potential systematic 
stress during severe market declines and allow for the reestablishment 
of an equilibrium between buying and selling interests in an orderly 
fashion. Accordingly, the SEC believes that the trading halt provisions 
of SEC Rule 6h-1, by requiring national securities exchanges and 
national securities associations to halt trading in security futures 
products when trading is halted in the underlying security or 
securities, will ultimately improve efficiency and capital formation by 
creating a more fair and orderly marketplace.

VI. Final Regulatory Flexibility Act

    CFTC: The Regulatory Flexibility Act (``RFA'') requires federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities.\215\ The rules adopted herein would affect 
designated contract markets, registered derivatives transaction 
execution facilities and derivatives clearing organizations. The CFTC 
has previously established certain definitions of ``small entities'' to 
be used in evaluating the impact of its rules on small entities in 
accordance with the RFA. In its previous determinations, the CFTC 
concluded that contract markets are not small entities for the purpose 
of the RFA.\216\ The CFTC recently determined that registered 
derivatives transaction execution facilities and derivatives clearing 
organizations are not small entities for purposes of the RFA.\217\ The 
CFTC invited the public to comment on the Chairman's certification that 
these rules would not have a significant economic impact on a 
substantial number of small entities.\218\ The CFTC received no 
comments on the certification.
---------------------------------------------------------------------------

    \215\ 5 U.S.C. 601 et seq.
    \216\ See 47 FR 18618, 18619 (April 30, 1982) (discussing 
contract markets).
    \217\ See 66 FR 14262, 14268 (March 9, 2001) (discussing 
registered derivatives transaction execution facilities); 66 FR 
45604, 45609 (August 29, 2001) (discussing derivatives clearing 
organizations).
    \218\ See Proposing Release, 66 FR at 45918.

---------------------------------------------------------------------------

[[Page 36761]]

    SEC: Pursuant to Section 605(b) of the Regulatory Flexibility 
Act,\219\ the SEC certified that the adopted rule would not have a 
significant economic impact on a substantial number of small entities. 
This certification, including the reasons therefore, was attached to 
the Proposing Release No. 34-44743 (August 24, 2001) as Appendix A. The 
SEC solicited comments concerning the impact on small entities and the 
Regulatory Flexibility Act certification, but received no comments.
---------------------------------------------------------------------------

    \219\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

VII. Statutory Basis and Text of Rule

List of Subjects

17 CFR Part 41

    Security futures products, Trading halts and Settlement provisions.

17 CFR Part 240

    Securities.

Commodity Futures Trading Commission

17 CFR Chapter I

    The CFTC has the authority to adopt these rules pursuant to 
sections 2(a)(1)(D)(i)(VII), 2(a)(1)(D)(i)(X), and 8a(5) of the CEA, 7 
U.S.C. 2(a)(1)(D)(i)(VII), 2(a)(1)(D)(i)(X), and 12(a)(5).

    For the reasons set out in the joint preamble, Title 17, Chapter I 
of the Code of Federal Regulations is amended as follows.

PART 41--SECURITY FUTURES PRODUCTS

    1. The authority citation for Part 41 is revised to read as 
follows:

    Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114 Stat. 
2763; 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78(g)(2).


    2. Section 41.1 is amended by adding paragraphs (j), (k) and (l) to 
read as follows:


[sect] 41.1  Definitions.

    For purposes of this part:
* * * * *
    (j) Opening price means the price at which a security opened for 
trading, or a price that fairly reflects the price at which a security 
opened for trading, during the regular trading session of the national 
securities exchange or national securities association that lists the 
security. If the security is not listed on a national securities 
exchange or a national securities association, then opening price shall 
mean the price at which a security opened for trading, or a price that 
fairly reflects the price at which a security opened for trading, on 
the primary market for the security.
    (k) Regular trading session of a security means the normal hours 
for business of a national securities exchange or national securities 
association that lists the security.
    (l) Regulatory halt means a delay, halt, or suspension in the 
trading of a security, that is instituted by the national securities 
exchange or national securities association that lists the security, as 
a result of:
    (1) A determination that there are matters relating to the security 
or issuer that have not been adequately disclosed to the public, or 
that there are regulatory problems relating to the security which 
should be clarified before trading is permitted to continue; or
    (2) The operation of circuit breaker procedures to halt or suspend 
trading in all equity securities trading on that national securities 
exchange or national securities association.

    3. Section 41.25 is amended by adding the text of paragraph (a)(2) 
and adding paragraph (d) and by revising paragraph (b) to read as 
follows:


[sect] 41.25  Additional conditions for trading for security futures 
products.

    (a) Common provisions. * * *
    (2) Regulatory trading halts. The rules of a designated contract 
market or registered derivatives transaction execution facility that 
lists or trades one or more security futures products must include the 
following provisions:
    (i) Trading of a security futures product based on a single 
security shall be halted at all times that a regulatory halt has been 
instituted for the underlying security; and
    (ii) Trading of a security futures product based on a narrow-based 
security index shall be halted at all times that a regulatory halt has 
been instituted for one or more underlying securities that constitute 
50 percent or more of the market capitalization of the narrow-based 
security index.
* * * * *
    (b) Final settlement prices for security futures products.
    (1) The final settlement price of a cash-settled security futures 
product must fairly reflect the opening price of the underlying 
security or securities;
    (2) Notwithstanding paragraph (b)(1) of this section, if an opening 
price for one or more securities underlying a security futures product 
is not readily available, the final settlement price of the security 
futures product shall fairly reflect:
    (i) The price of the underlying security or securities during the 
most recent regular trading session for such security or securities; or
    (ii) The next available opening price of the underlying security or 
securities.
    (3) Notwithstanding paragraphs (b)(1) or (b)(2) of this section, if 
a derivatives clearing organization registered under Section 5b of the 
Act or a clearing agency exempt from registration pursuant to Section 
5b(a)(2) of the Act, to which the final settlement price of a security 
futures product is or would be reported determines, pursuant to its 
rules, that such final settlement price is not consistent with the 
protection of customers and the public interest, taking into account 
such factors as fairness to buyers and sellers of the affected security 
futures product, the maintenance of a fair and orderly market in such 
security futures product, and consistency of interpretation and 
practice, the clearing organization shall have the authority to 
determine, under its rules, a final settlement price for such security 
futures product.
* * * * *
    (d) The Commission may exempt from the provisions of paragraphs 
(a)(2) and (b) of this section, either unconditionally or on specified 
terms and conditions, any designated contract market or registered 
derivatives transaction execution facility, if the Commission 
determines that such exemption is consistent with the public interest 
and the protection of customers. An exemption granted pursuant to this 
paragraph shall not operate as an exemption from any Securities and 
Exchange Commission rules. Any exemption that may be required from such 
rules must be obtained separately from the Securities and Exchange 
Commission.

    Issued in Washington, DC on May 17, 2002 by the Commodity 
Futures Trading Commission.
Jean A. Webb,
Secretary.

Securities and Exchange Commission

17 CFR Chapter II

    The SEC is adopting the rules pursuant to its authority under 
Exchange Act Sections 6, 9, 15A, 19, 23(a), and 36, 15 U.S.C. 78f, 78i, 
78o-3, 78s, 78w(a), and 78mm.

    For the reasons set out in the joint preamble, Title 17, Chapter 
II, part 240 of the Code of Federal Regulations is amended as follows.

[[Page 36762]]

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 240.6h-1 is added to read as follows:


[sect] 240.6h-1  Settlement and regulatory halt requirements for 
security futures products.

    (a) For the purposes of this section:
    (1) Opening price means the price at which a security opened for 
trading, or a price that fairly reflects the price at which a security 
opened for trading, during the regular trading session of the national 
securities exchange or national securities association that lists the 
security. If the security is not listed on a national securities 
exchange or a national securities association, then opening price shall 
mean the price at which a security opened for trading, or a price that 
fairly reflects the price at which a security opened for trading, on 
the primary market for the security.
    (2) Regular trading session of a security means the normal hours 
for business of a national securities exchange or national securities 
association that lists the security.
    (3) Regulatory halt means a delay, halt, or suspension in the 
trading of a security, that is instituted by the national securities 
exchange or national securities association that lists the security, as 
a result of:
    (i) A determination that there are matters relating to the security 
or issuer that have not been adequately disclosed to the public, or 
that there are regulatory problems relating to the security which 
should be clarified before trading is permitted to continue; or
    (ii) The operation of circuit breaker procedures to halt or suspend 
trading in all equity securities trading on that national securities 
exchange or national securities association.
    (b) Final settlement prices for security futures products.
    (1) The final settlement price of a cash-settled security futures 
product must fairly reflect the opening price of the underlying 
security or securities.
    (2) Notwithstanding paragraph (b)(1) of this section, if an opening 
price for one or more securities underlying a security futures product 
is not readily available, the final settlement price of the security 
futures product shall fairly reflect:
    (i) The price of the underlying security or securities during the 
most recent regular trading session for such security or securities; or
    (ii) The next available opening price of the underlying security or 
securities.
    (3) Notwithstanding paragraph (b)(1) or (b)(2) of this section, if 
a clearing agency registered under Section 17A of the Act (15 U.S.C. 
78q-1), or exempt from registration pursuant to Section 17A(b)(7) of 
the Act (15 U.S.C. 78q-1(b)(7)), to which the final settlement price of 
a security futures product is or would be reported determines, pursuant 
to its rules, that such final settlement price is not consistent with 
the protection of investors and the public interest, taking into 
account such factors as fairness to buyers and sellers of the affected 
security futures product, the maintenance of a fair and orderly market 
in such security futures product, and consistency of interpretation and 
practice, the clearing agency shall have the authority to determine, 
under its rules, a final settlement price for such security futures 
product.
    (c) Regulatory trading halts. The rules of a national securities 
exchange or national securities association registered pursuant to 
Section 15A(a) of the Act (15 U.S.C. 78o-3(a)) that lists or trades one 
or more security futures products must include the following 
provisions:
    (1) Trading of a security futures product based on a single 
security shall be halted at all times that a regulatory halt has been 
instituted for the underlying security; and
    (2) Trading of a security futures product based on a narrow-based 
security index shall be halted at all times that a regulatory halt has 
been instituted for one or more underlying securities that constitute 
50 percent or more of the market capitalization of the narrow-based 
security index.
     (d) The Commission may exempt from the requirements of this 
section, either unconditionally or on specified terms and conditions, 
any national securities exchange or national securities association, if 
the Commission determines that such exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors. An exemption granted pursuant to this paragraph shall not 
operate as an exemption from any Commodity Futures Trading Commission 
rules. Any exemption that may be required from such rules must be 
obtained separately from the Commodity Futures Trading Commission.

    By the Securities and Exchange Commission.

    Dated: May 17, 2002.
Margaret H. McFarland,
Deputy Secretary.

    Note: Appendix A to the preamble will not appear in the Code of 
Federal Regulations.

Appendix A

Relevant Provisions of the Agreement Among

    American Stock Exchange LLC, Boston Stock Exchange, 
Incorporated, Chicago Board Options Exchange, Incorporated, Chicago 
Stock Exchange, Incorporated, Cincinnati Stock Exchange, 
Incorporated, International Securities Exchange LLC, National 
Association of Securities Dealers, Inc., New York Stock Exchange, 
Inc., Pacific Exchange, Inc., Philadelphia Stock Exchange, Inc. 
(collectively, ``ISG/SROs'') as of [the date of Release].
* * * * *

Section 1. Intermarket Surveillance Group (``ISG'')

    (a)(i) The Intermarket Surveillance Group (``ISG'') shall have 
as its purposes: (a) the coordination and development of programs 
and procedures designed to assist in identifying possible fraudulent 
and manipulative acts and practices across markets, particularly, 
between markets which trade the same or related securities and 
between markets which trade equity securities and options on an 
index in which such securities are included, (b) the routine 
exchange of Market Surveillance Reports, as that term is defined in 
Section 2(e), among ISG/SROs which is appropriate to the performance 
of adequate market surveillance, and (c) the exchange of 
information, upon request, among ISG/SROs which is appropriate to 
the requesting ISG/SRO in the discharge of its regulatory 
responsibilities under the Act to enforce compliance by its members 
and persons associated with its members with its rules. Each of the 
nine ISG/SROs will appoint form time to time one of its executive 
officers responsible for market surveillance to serve as its 
Principal Representative on the ISG. Each Principal Representative 
at any time appointed by an ISG/SRO shall serve as a member of ISG 
until such appointing ISG/SRO shall appoint a successor, such 
successor appointment to be evidenced by a written notice delivered 
by the appointing ISG/SRO to each of the other ISG/SROs.
    (a)(ii) An ``ISG affiliate'' is a contract market or foreign 
self-regulatory organization which shall have such privileges and 
obligations as are set forth herein. A contract market or foreign 
self-regulatory organization shall become an ISG Affiliate if: (a) 
it is so approved by the unanimous vote of all ISG/SROs in 
attendance at a meeting of the ISG, and (b) the principal executive 
officer of the contract market or foreign self-regulatory 
organization so approved agrees in writing in a form approved by the 
ISG/SROs that the organization accepts the privileges and 
obligations of an ISG Affiliate. (Such a

[[Page 36763]]

writing is hereinafter referred to as an ``Affiliate Agreement.'')
    An ISG Affiliate shall appoint an Affiliate Representative to 
the ISG who shall be one of the executive officers of the ISG 
Affiliate responsible for market surveillance. The Affiliate 
Representative shall select one member form the ISG Affiliate staff 
to serve as an alternate for, and under the direction of, the 
Affiliate Representative. The alternate shall be generally familiar 
with market surveillance techniques and procedures.
* * * * *

Section 2. Sharing of Information and Confidentiality

    (a) Attached hereto as Exhibit A is an executed copy of the 
Agreement between SIAC (``Information Processor'') and the ISG 
Participants, including the Letter Agreement amending the Agreement 
(the ``Service Agreement''), providing for the development and 
operation of a Central Collection and Reporting System. As provided 
in the Service Agreement, each of the ISG/SROs will routinely 
receive Market Surveillance Reports relating to securities (as that 
term is defined in Section 3(a)(10) of the Act):
    (i) Which are traded on such receiving ISG/SRO, and
    (ii) That are derived from (e.g., options) or underlie (e.g., 
stocks) securities which are traded on such receiving ISG/SRO.
    (b) From time to time, an ISG/SRO (``requesting SRO'') may ask 
another ISG/SRO (``requested SRO'') to provide it with information 
or documents: (i) relating to a security traded through the 
facilities of either ISG/SRO or (ii) relating to a member or a 
former member of either ISG/SRO (including, but not limited to 
information or documents concerning the identity, trading activity 
and positions of the requested ISG/SRO's members, former members or 
customers of the requested ISG/SRO's members or former members) for 
the purpose of enforcing compliance with the provisions of the Act, 
or for other regulatory purposes. Upon receipt of such a request, 
the requested ISG/SRO shall obtain such information from its own 
records or from its members and former members, and shall provide 
any information or documents so gathered to the requesting ISG/SRO. 
In addition, an ISG/SRO may ask another ISG/SRO to provide it with 
information or documents relating to an investigation or a 
disciplinary action by the requested ISG/SRO against any of its 
members, member organizations or persons associated with its members 
or member organizations. Upon receipt of such a request, the 
requested ISG/SRO shall obtain such information or documents 
concerning disciplinary actions from its own records and shall 
provide such information or documents to the requesting ISG/SRO.
    (c) From time to time, an ISG/SRO may ask an ISG Affiliate to 
provide it with information or documents: (1) Relating to a 
security, an option on a security, a currency option, a futures 
contract, an option on a futures contract or any other derivative or 
underlying instrument traded through the facilities of the ISG 
Affiliate, or (2) relating to a member of an ISG/SRO or the ISG 
Affiliate (including, but not limited to, information or documents 
concerning the identity, trading activity and positions of the ISG 
Affiliate's members or customers of the ISG Affiliate's members). An 
ISG Affiliate shall agree in an Affiliate Agreement that, upon 
receipt of such a request, it shall use its best efforts in 
accordance with its rules to obtain such information from its own 
records or from its members, and, to the extent not inconsistent 
with its rules or with applicable law, provide any information or 
documents so gathered to the requesting ISG/SRO. In addition, an 
ISG/SRO may ask an ISG Affiliate to provide it with information or 
documents relating to the disposition of a disciplinary action taken 
by the ISG Affiliate against any of its members, member 
organizations or persons associated with its members or member 
organizations. An ISG Affiliate shall agree in an Affiliate 
Agreement that, upon receipt of such a request, it shall obtain such 
information or documents concerning disciplinary actions from its 
own records and, to the extend not inconsistent with its rules or 
with applicable law, provide such information or documents to the 
requesting ISG/SRO.
    (d) From time to time, an ISG Affiliate may ask an ISG/SRO to 
provide it with information or documents: (1) Relating to a 
security, an option on a security, a currency option or any other 
derivative or underlying instrument traded through the facilities of 
the ISG/SRO, or (2) relating to a member of an ISG Affiliate or the 
ISG/SRO (including, but not limited to, information or documents 
concerning the identity, trading activity and positions of the ISG/
SRO's members or customers of the ISG/SRO's members). Upon receipt 
of such a request, the ISG/SRO shall use its best efforts in 
accordance with its rules to obtain such information from its own 
records or from its members, and, to the extent not inconsistent 
with its rules or with applicable law, provide any information or 
documents so gathered to the requesting ISG Affiliate. In addition, 
an ISG Affiliate may ask ISG/SRO to provide it with information or 
documents relating to the disposition of a disciplinary action taken 
by the ISG/SRO against any of its members, member organizations or 
persons associated with its members or member organizations. Upon 
receipt of such a request, the ISG/SRO shall obtain such information 
or documents concerning disciplinary actions from its own records 
and, to the extent not inconsistent with its rules or with 
applicable law, provide such information or documents to the 
requesting ISG Affiliate.
    (e) Market Surveillance Reports as used in this Agreement shall 
include:
    (i) with respect to securities subject to last sale reporting 
pursuant to CTA, CQ, OPRA or NASDAQ Plans: quotations, last sale, 
clearing and other trading information available pursuant to, or 
collected under, such Plans; and post trade information generated 
pursuant to the ITS Plan.
    (ii) reports routinely collected by an ISG/SRO relating to 
program trading, i.e., the purchase or sale of stocks that are part 
of a coordinated trading strategy, or relating to trades by its 
members and member organizations which are not reported to the 
Consolidated Tape.
    (iii) reports relating to positions or exercises of securities.
* * * * *
[FR Doc. 02-12979 Filed 5-23-02; 8:45 am]
BILLING CODE 8010-01-P; 6391-01-P