[Federal Register Volume 68, Number 28 (Tuesday, February 11, 2003)]
[Notices]
[Pages 6977-6979]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-3319]


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Securities and Exchange Commission

[Release No. 34-47307; File No. SR-NASD-2002-134]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval to Proposed Rule Change and 
Notice of Filing and Order Granting Accelerated Approval to Amendment 
No. 1 to the Proposed Rule Change Relating to Exemptions from Options 
Position and Exercise Limits

February 3, 2003.

I. Introduction

    On October 1, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exhange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and rule 19b-4 thereunder,\2\ a 
proposed rule change to amend NASD rule 2860(b)(3)(A) by eliminating 
options position and exercise limits for positions entered into under 
certain enumerated hedge strategies and establishing position and 
exercise limits of five times the standard limit for certain of those 
strategies when they include an over-the-counter (OTC) option contract. 
On December 23, 2002, the NASD filed Amendment No. 1 to the proposed 
rule change.\3\ The proposed

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rule change was published for comment in the Federal Register on 
December 30, 2002.\4\ The Commission received no comments on the 
proposal. This order approves the proposed rule change, and notices and 
grants accelerated approval to Amendment No. 1 to the proposed rule 
change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Gary L. Goldsholle, Associate General 
Counsel, Office of General Counsel, NASD, to Katherine A. England, 
Assistant Director, Division of Market Regulation (``Division''), 
Commission, dated December 20, 2003 (``Amendment No. 1''). In 
Amendment No. 1, the NASD corrected grammatical errors in the rule 
language text of the proposed rule change.
    \4\ See Securities Exchange Act Release No. 47080 (December 23, 
2002), 67 FR 79676 (December 30, 2002).
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II. Description of the Proposal

    The proposed rule change amends NASD's options position and 
exercise limits. The proposed rule change establishes six qualified 
hedge strategies:
    1. Where each option contract is ``hedged'' or ``covered'' by 100 
shares of the underlying \5\ security or securities convertible into 
the underlying security, or, in the case of an adjusted option, the 
same number of shares represented by the adjusted contract: (a) Long 
call and short stock; (b) short call and long stock; (c) long put and 
long stock; or (d) short put and short stock.
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    \5\ NASD represents that the phrase ``securities convertible 
into the underlying security'' does not include single stock futures 
products. Telephone Conversation between Gary L. Goldsholle, 
Associate General Counsel, Office of General Counsel, NASD and Tim 
Fox, Law Clerk, Division, Commission on December 6, 2002.
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    2. Reverse Conversions--A long call position accompanied by a short 
put position, where the long call expires with the short put, and the 
strike price of the long call and short put is equal, and where each 
long call and short put position is hedged with 100 shares (or other 
adjusted number of shares) of the underlying security or securities 
convertible into such underlying security.
    3. Conversions--A short call position accompanied by a long put 
position where the short call expires with the long put, and the strike 
price of the short call and long put is equal, and where each short 
call and long put position is hedged with 100 shares (or other adjusted 
number of shares) of the underlying security or securities convertible 
into such underlying security.
    4. Collars--A short call position accompanied by a long put 
position, where the short call expires with the long put and the strike 
price of the short call equals or exceeds the strike price of the long 
put position and where each short call and long put position is hedged 
with 100 shares (or other adjusted number of shares) of such the 
underlying security or securities convertible into such underlying 
security. Neither side of the short call/long put position can be in-
the-money at the time the position is established.
    5. Box Spreads--A long call position accompanied by a short put 
position with the same strike price and a short call position 
accompanied by a long put position with a different strike price.
    6. Back-to-Back Options--A listed option position hedged on a one-
for-one basis with an OTC option position on the same underlying 
security. The strike price of the listed option position and 
corresponding OTC option position must be within one strike price 
interval of each other and no more than one expiration month apart.
    Under the proposed rule change, there would be no position and 
exercise limits when such qualified hedge strategies are effected 
solely with standardized equity options. In addition, the proposed rule 
change establishes standardized equity option position and exercise 
limits of five times the standard limit when one component of such 
strategies is an OTC option contract. Further, within the list of 
proposed hedge strategies, NASD proposes that the option component of a 
reversal, a conversion or a collar position can be treated as one 
contract rather than as two contracts.
    The proposed rule change also modifies the conventional equity 
options position and exercise limits. First, the proposed rule change 
expands the hedge exemption for conventional options to include all of 
the qualified hedge strategies. Second, the proposed rule change 
increases the conventional equity options position and exercise limits 
for such qualified hedge strategies to five times the standard limits. 
Third, the proposed rule change provides that conventional equity 
options positions under the hedge strategies not be aggregated with 
other options positions similar to the way that positions under the 
current equity option hedge exemption and OTC collar aggregation 
exemption are not aggregated with other options positions.
    Under the proposed rule change, the standard position and exercise 
limits will remain in place for unhedged equity options positions. Once 
an account reaches the standard limit, positions identified as a 
qualified hedge strategy would be subject to the increased position 
limits, or exempted from position limit calculations, as appropriate. 
The exemption would be automatic (i.e., it will not require pre-
approval from NASD) to the extent that a member identifies that a pre-
existing qualified strategy is in place or is employed from the point 
that an account's position reaches the standard limit and provides the 
required supporting documentation to NASD.\6\ The exemption would 
remain in effect to the extent that the exempted position remains 
intact and NASD is provided with any required supporting documentation.
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    \6\ Under the proposed rule change, the existing reporting 
procedures that serve to identify and document hedged positions 
above a certain threshold continue to apply. Paragraph (b)(5) of 
NASD rule 2860 requires reporting to NASD of aggregate positions of 
200 more contracts of the put class and the call class on the same 
side of the market covering the same underlying security.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities associations \7\ and, in 
particular, the requirements of section 15A of the Act \8\ and the 
rules and regulations thereunder. The Division finds specifically that 
the proposed rule change is consistent with section 15A(b)(6) of the 
Act \9\ because it is designed to promote just and equitable principles 
of trade, and to protect investors and public interest.
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    \7\ In approving this proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \8\ 15 U.S.C. 78o-3.
    \9\ 15 U.S.C. 78o-3(b)(6).
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    Position and exercise limits serve as a regulatory tool designed to 
address potential manipulative schemes and adverse market impact 
surrounding the use of options. The NASD proposes to expand the hedge 
exemption from position and exercise limits. The NASD also proposes to 
modify the conventional equity options position and exercise limits. 
The Commission believes it is permissible to expand the current equity 
hedge exemption without risk of disruption to the options or underlying 
cash markets. The Commission believes that existing position and 
exercise limits, procedures for maintaining the exemption, and the 
reporting requirements imposed by the NASD will help protect against 
potential manipulation. The Commission notes that the existing standard 
position and exercise limits will remain in place for unhedged equity 
option positions. To further ensure against market disruption, the NASD 
will establish a position and exercise limit equal to no greater than 
five times the standard limit for those hedge strategies that include 
an OTC option component.
    In addition, according to the NASD, once an account reaches the 
standard

[[Page 6979]]

limit, positions identified as a qualified hedge strategy would be 
subject to the increased position limits, or exempted from position 
limit calculations, as appropriate. The exemption would be automatic 
(i.e., it will not require pre-approval from NASD) to the extent that a 
member identifies that a pre-existing qualified strategy is in place or 
is employed from the point that an account's position reaches the 
standard limit and provides the required supporting documentation to 
NASD.\10\ The exemption would remain in effect to the extent that the 
exempted position remains intact and NASD is provided with any required 
supporting documentation.
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    \10\ Under the proposed rule change, the existing reporting 
procedures that serve to identify and document hedged positions 
above a certain threshold continue to apply. Paragraph (b)(5) of 
NASD rule 2860 requires reporting to NASD of aggregate positions of 
200 more contracts of the put class and the call class on the same 
side of the market covering the same underlying security.
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    The Commission notes that it has previously approved changes to 
similar rules of the options exchanges that eliminated standardized 
equity option position and exercise limits for certain qualified hedge 
strategies and established position and exercise limits of five times 
the standard limit for certain of those strategies when they include an 
over-the-counter (OTC) option contract.\11\ The Commission does not 
believe that the proposed rule changes raises novel regulatory issues 
that were not already addressed and should benefit NASD members by 
permitting them greater flexibility in using hedge strategies 
advantageously, while providing an adequate level of protection against 
the opportunity for manipulation of these securities and disruption in 
the underlying market.
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    \11\ See Securities Exchange Act Release No. 45603 (March 20, 
2002), 67 FR 14751 (March 27, 2002) (CBOE-2000-12); Securities 
Exchange Act Release No. 45650 (March 26, 2002), 67 FR 15638 (Apr. 
2, 2002) (AMEX-2001-71); Securities Exchange Act Release No. 45737 
(April 11, 2002), 67 FR 18975 (Apr. 17, 2002) (PCX-2000-45); 
Securities Exchange Act Release No. 45899 (May 9, 2002), 67 FR 34980 
(May 16, 2002) (PHLX-2002-33); and Securities Exchange Act Release 
No. 46228 (July 18, 2002), 67 FR 48689 (July 25, 2002) (ISE-2002-
15).
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    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Amendment No. 1 
merely provides technical corrections and clarification to the proposed 
rule text. The Commission, therefore, believes that granting 
accelerated approval of Amendment No. 1 is appropriate and consistent 
with section 15A(b)(6) \12\ and section 19(b) \13\ of the Act.
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    \12\ 15 U.S.C. 78o-3(b)(6).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether it 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 at the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-2002-134 and should be 
submitted by March 4, 2003.
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    \13\ 15 U.S.C. 78s(b).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\14\ that the proposed rule change (File No. SR-NASD-2002-134), as 
amended, be and hereby is, approved.
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    \14\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-3319 Filed 2-10-03; 8:45 am]
BILLING CODE 8010-01-P