[Federal Register Volume 67, Number 148 (Thursday, August 1, 2002)]
[Notices]
[Pages 49973-49975]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-19392]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46265; File No. SR-OCC-2002-09]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating to Fixing 
Settlement Prices in the Event of Market Disruptions

July 25, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 17, 2002, The Options 
Clearing Corporation (``OCC'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which items have been prepared primarily by 
OCC. The Commission is publishing this notice to solicit comments on 
the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The proposed rule change would amend Article XII, Section 5 
(relating to futures which include security futures) and Article XVII, 
Section 4 of OCC's by-laws (relating to index options) to provide OCC 
with the ability in the event of market disruptions to conform 
settlement prices for OCC-cleared security futures and index options to 
settlement prices that are used for related products (e.g., futures on 
the same index) not cleared by OCC.

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

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B),

[[Page 49974]]

and (C) below, of the most significant aspects of such statements.\2\
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    \2\ The Commission has modified parts of these statements.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The primary purpose of the proposed rule change is to ensure that 
OCC will have the ability in case of market disruptions to conform 
settlement prices for OCC-cleared security futures and index options, 
where appropriate, to settlement prices that are used for related 
products such as other futures on the same security or index traded in 
other markets and not cleared by OCC. The proposed rule change would 
primarily affect the fixing of exercise settlement amounts for expiring 
options as well as final settlement prices for maturing futures 
contracts.\3\ OCC does not anticipate any substantive change in its 
present policy with respect to fixing settlement prices for index 
options that are exercised prior to expiration.\4\
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    \3\ These would include single stock futures and narrow-based 
index futures as well as broad-based index futures subject to the 
exclusive jurisdiction of the Commodity Futures Trading Commission.
    \4\ That general policy would be restated in proposed 
Interpretation .02 to Section 4 of Article XVII of OCC's by-laws.
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    In the event of an interruption in the markets for an underlying 
security or one or more component securities in an underlying index, 
OCC needs to have discretion to act to set final settlement values in a 
manner that avoids inconsistencies between the futures and options 
markets and among futures markets.\5\ Investors may employ hedging and 
other trading strategies that involve holding positions on the same 
underlying security or index in different contracts. These strategies 
are based on the expectation that the values of different derivative 
contracts on the same underlying interest will have a predictable 
relationship to one another. This expectation may not be met when 
trading halts or other disruptions in markets for the underlying 
interests require the derivatives markets to fix settlement prices 
using prices or values other than those that would normally be used. In 
such cases, discrepancies in settlement prices can occur unless prices 
for derivative products traded in different markets are fixed using a 
common method. Unless such coordination occurs, investors with 
positions in options and futures that were intended to hedge one 
another may find that the positions do not produce the anticipated 
offset.
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    \5\ This rule change would affect the fixing of final settlement 
prices for futures contracts and exercise settlement amounts for 
options. However, in the case of options exercised other than at 
expiration, coordination with other markets is ordinarily not a 
significant factor because either there is no concurrent final 
settlement in related futures markets or in any case an investor 
need not exercise the option.
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    In the spring of 2000, OCC attempted to solve the problem of a 
potential disconnect between the options and futures markets in setting 
final index contract settlement prices by conforming its rules more 
closely to the rules of the Chicago Mercantile Exchange (``CME'') as 
then in effect.\6\ OCC's rule change, SR-OCC-00-01, broadened the 
circumstances under which OCC could fix a settlement price for expiring 
index options to include situations where market disruptions affected 
one or more securities in an index (as opposed to ``securities 
representing a substantial portion of the value of an index'') and 
added a paragraph relating solely to expiring options specifically 
permitting OCC to fix settlement prices based on the next opening 
prices for one or more component stocks.\7\
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    \6\ For example, CME Rule 2003. A, which governs the method for 
determining the final settlement price for Standard & Poor's 500 
Stock Index Futures, provided (at that time) as follows:
    If the primary market for a component stock in the index does 
not open on the day scheduled for determination of the Final 
Settlement Price, then the price of that stock shall be determined, 
for the purposes of calculating the Final Settlement Price, based on 
the opening price of that stock on the next day that its primary 
market is open for trading.
    If a component stock in the index does not trade on the day 
scheduled for determination of the Final Settlement Price while the 
primary market for that stock is open for trading, the price of that 
stock shall be determined, for the purposes of calculating the Final 
Settlement Price, based on the last sale price of that stock.
    \7\ Securities Exchzange Act Release No. 42769 (May 9, 2000), 65 
FR 31036 (May 15, 2000) [SR-OCC-00-01]
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    Effective December 1, 2001, CME changed its rules governing its 
method of fixing final settlement prices for each of its index futures 
products under certain circumstances. CME's newly amended rules provide 
that if the primary market for a component stock opens for trading on 
the day scheduled for determination of a final settlement price but the 
component stock does not trade while the market is open, the price of 
the component stock for purposes of calculating the final settlement 
price will be based on the last sale price of the stock unless CME's 
president or his delegate determines that there is a reasonable 
likelihood that trading in the component stock will occur shortly. In 
that case, for purposes of determining the final settlement price, the 
price of the component stock may be based on the opening price of the 
component stock on the next day the component stock is traded on its 
primary market.\8\
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    \8\ CME added the following underlined language to CME Rule 
2003.A:
    If a component stock in the index does not trade on the day 
scheduled for determination of the Final Settlement Price while the 
primary market for that stock is open for trading, the price of that 
stock shall be determined, for the purposes of calculating the Final 
Settlement Price, based on the last sale price of that stock. 
However, if the President of the Exchange or his delegate determines 
that there is a reasonable likelihood that trading in the stock 
shall occur shortly, the President or his delegate may instruct that 
the price of stock shall be based, for the purposes of calculating 
the Final Settlement Price, on the opening price of the stock on the 
next day that it is traded on its primary market. Factors to be 
considered in determining whether trading in the stock is likely to 
occur shortly shall include the nature of the event and recent 
liquidity levels in the affected stock.
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    OCC's rules do not authorize OCC to fix a settlement price based on 
a stock's next opening price in situations where the stock's primary 
market is open but the stock does not open or remain open for trading. 
SR-OCC-00-01 authorized the use of opening values only in cases where a 
stock's primary market did not open or remain open for trading at or 
before the time when the exercise settlement amount would ordinarily be 
determined. As a result, OCC is again faced with a potential disconnect 
between its rules and CME's rules.
    The most fundamental aspect of SR-OCC-00-01 is that for the first 
time OCC was allowed to fix a settlement value based on prices that 
occurred after an expiration and to treat options that were in the 
money based upon that subsequently determined price as having been 
exercised on the expiration date. The proposed rule change would make 
more explicit the scope of OCC's ability to invoke that authority and 
the discretion that the extent to which OCC or an adjustment panel (in 
the case of options) can fix final settlement prices and exercise 
settlement amounts.\9\ The proposed rule change would make clear that 
OCC may follow CME's current rule and may use either the latest closing 
prices for individual stocks that fail to trade or use opening prices 
for the next day on which the stock trades.
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    \9\ A supplement to the Options Disclosure Document that 
describes the substance of the by-law changes proposed herein has 
been prepared. It will be filed with the Commission once the options 
exchanges have reviewed it.
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    The authority to fix final settlement prices for futures and 
exercise settlement amounts for options in unusual market conditions 
should be sufficiently broad to ensure that the authority will exist to 
conform such settlement values to the settlement values established for 
related products traded in other markets whenever that result is deemed 
on balance to be in the

[[Page 49975]]

best interests of investors. Experience has shown that this authority 
must be stated somewhat broadly so that if in the future CME or other 
related markets amend the circumstances in which they can fix 
settlement values or the means by which they use to fix those values, 
OCC would not need to amend its rules further to conform. Because CME 
and other markets often do not coordinate with OCC when they change 
their rules governing the fixing of settlement values, OCC may not be 
able to conform its rules to amendments made by other markets quickly 
enough to avoid a disconnect between the futures and options markets. 
The proposed change would provide OCC with discretion both as to the 
circumstances in which authority would exist to fix a settlement value 
and the method by which the settlement value would be fixed.\10\
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    \10\ If OCC decides to fix the exercise settlement amount for an 
expiring index option, the settlement amount shall be fixed by a 
panel consisting of two designated representatives of each exchange 
on which the affected option is open for trading and the Chairman of 
OCC. The panel shall fix the exercise settlement amount based on its 
judgment as to what is appropriate for the protection of investors 
and the public interest, taking into account such factors as 
fairness to holders and writers of options of the affected options, 
the maintenance of a fair and orderly market in such options, 
consistency of interpretation and practice, and consistency with 
actions taken in related futures or other markets. OCC notes that 
the coordination of final settlement values is not the only factor 
that OCC or an adjustment panel could consider in deciding whether 
and how to fix settlement values. Accordingly, there could be 
circumstances where settlement values for OCC-cleared products would 
not be conformed to prices used in other markets, even though the 
authority would exist to do so.
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    OCC believes that the proposed rule change is consistent with the 
purposes and requirements of Section 17A of the Act because it fosters 
cooperation and coordination with persons engaged in the clearance and 
settlement of securities transactions, removes impediments to and 
perfects the mechanism of a national system for the prompt and accurate 
clearance and settlement of securities transactions, and, in general, 
protects investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.

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

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none have been received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within thirty five-days of the date of publication of this notice 
in the Federal Register or within such longer period (i) as the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (a) By order approve the proposed rule change; or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW, Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street NW, Washington, 
DC 20549. Copies of such filing will also be available for inspection 
and copying at the principal office of OCC. All submissions should 
refer to the File No. SR-OCC-2002-09 and should be submitted by August 
22, 2002.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-19392 Filed 7-31-02; 8:45 am]
BILLING CODE 8010-01-P