[Federal Register Volume 67, Number 197 (Thursday, October 10, 2002)]
[Notices]
[Pages 63183-63184]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-25747]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46595; File No. SR-OCC-2002-06]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to 
Adjustment Procedures for Stock Futures

October 3, 2002.

I. Introduction

    On April 12, 2002, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange

[[Page 63184]]

Commission (``Commission'') proposed rule change File No. SR-OCC-2002-
06 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on August 9, 2002.\2\ No comment letters were received. For 
the reasons discussed below, the Commission is approving the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 46312 (August 5, 2002), 
67 FR 51919.
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II. Description

    The proposed rule change amends OCC's adjustment procedures for 
stock futures to provide for adjusting stock futures contracts to 
compensate for special cash dividends and for rights distributions that 
expire in the money during the life of the futures contract. Security 
futures markets and certain firms interested in trading stock futures 
have expressed to OCC their belief that in order for stock futures to 
be successful they must replicate a position in the underlying stock as 
closely as possible. This means that, among other things, if an 
unanticipated corporate event (i.e., an event that cannot be discounted 
in futures prices) materially affects the value of an underlying stock, 
the terms of futures contracts on that stock should be adjusted to 
compensate for the event. There are two types of corporate events that 
cause particular concern from this perspective: (1) Special (i.e., non-
recurrent) cash dividends and (2) rights distributions.
    OCC does not, as a general rule, adjust options for cash dividends 
unless the amount of the dividend exceeds 10 per cent of the value of 
the underlying stock. If the holder of a call option wants to capture a 
dividend below that threshold, he can do so by exercising his option. 
Because stock futures, like other futures products, are not 
exercisable, the holder of a long stock future would not have that 
ability. Recurrent cash dividends are not regarded as a problem because 
they can be anticipated and discounted in futures settlement prices. 
But there is no economical way for holders of long stock futures 
positions to ensure themselves the benefit of unscheduled dividends.
    Similarly, if the issuer of an underlying stock declares a rights 
distribution and the rights will expire before the options do, the 
holder of a call option can capture the value of the rights by 
exercising the option before the rights expire. In contrast, the holder 
of a long stock future would have no way of obtaining the benefit of a 
rights distribution if the rights expire before the future does.
    OCC's by-laws currently specify adjustment procedures for stock 
futures that generally parallel the adjustment rules for options. These 
procedures do not take into account the economic differences between 
options and futures discussed above. The security futures markets and 
firms interested in trading stock futures strongly believe that OCC's 
adjustment provisions should accommodate these differences.\3\
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    \3\ Although this would cause the adjustment procedures for 
stock futures to diverge from those applicable to equity options, 
the consensus among prospective markets and market participants 
appears to be that it is more important to avoid discontinuity 
between stock futures and the underlying stocks than between futures 
and options.
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    This rule change addresses that concern. OCC's by-laws presently 
provide that, as a general rule, outstanding stock futures contracts 
will not be adjusted to compensate for ``ordinary'' cash dividends. A 
cash dividend is deemed ``ordinary'' if the amount does not exceed 10 
per cent of the value of the underlying stock on the declaration date. 
This rule change amends Article XII, Section 3, of the by-laws to 
provide that in the case of stock futures, a cash dividend would be 
deemed ``ordinary'' if OCC determined that it was declared pursuant to 
a policy or practice of paying such dividends on a quarterly or other 
regular basis regardless of the size of the cash dividend.\4\ This 
change recognizes that market pricing mechanisms can compensate for 
anticipated cash dividends, but because the market cannot anticipate 
and cannot price for special dividends, the rule change provides for 
adjustments to outstanding stock futures when a company pays a special 
(i.e., non-recurring) cash dividend without regard to size. This will 
be done through a one-time adjustment in the futures settlement price 
that has the effect of causing the short holder to pass the value of 
the dividend to the long holder.
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    \4\ Quarterly stock dividends will be deemed ``ordinary'' 
regardless of size. Stock futures contracts will ordinarily be 
adjusted for other stock distributions, even if recurrent (e.g., 
annual), to avoid creating an unnecessary discontinuity with equity 
options.
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    Article XII, Section 3, of OCC's By-Laws currently provides that 
outstanding stock futures will not be adjusted to compensate for rights 
distributions where the rights expire before the maturity date of the 
future. Under the rule change, if rights will expire before they are to 
be delivered under a stock futures contract, the futures contract will 
be adjusted through a one-time adjustment in the futures settlement 
price in an amount equal to the value of the rights as determined by 
OCC. OCC's good-faith determination of value will be conclusive and 
binding on investors.
    Because Interpretation and Policy .11 to Article XIII applies only 
to certain types of adjustments, it is being deleted because OCC has 
concluded that it is likely to be more confusing than useful.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to promote the protect investors and the 
public interest.\5\ Because OCC's current procedures do not allow for 
price adjustments to stock futures, which include securities futures, 
in the event of special cash dividends and rights distributions, there 
can be a disconnect between the value of stock futures and the value of 
the underlying stock. This proposed rule change, which allows OCC to 
make adjustments to stock futures contracts in these circumstances, 
will address this possible disconnect and will allow the price of stock 
futures to more accurately reflect the price of the underlying stock.
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    \5\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular with the requirements of Section 17A(b)(3)(F) of the Act 
and the rules and regulations thereunder applicable.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2002-06) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-25747 Filed 10-9-02; 8:45 am]
BILLING CODE 8010-01-P