[Federal Register Volume 68, Number 195 (Wednesday, October 8, 2003)]
[Notices]
[Pages 58154-58158]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-25513]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48587; File No. SR-ISE-2003-18]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendment No. 
1 Thereto by International Securities Exchange, Inc., Relating to 
Trading Options on the S&P Small Cap 600 Index

October 2, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 29, 2003, the International Securities Exchange, Inc. 
(``Exchange'' or ``ISE'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
On September 26, 2003, the Exchange filed Amendment No. 1 to the 
proposed rule change.\3\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons and is approving the proposed rule change, as 
amended, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated September 25, 
2003 (``Amendment No. 1''). In Amendment No. 1, the ISE represented 
that it would monitor the Standard and Poor's Small Cap 600 Index 
(``S&P Small Cap 600'' or ``Index'') for the Index's adherence to 
certain parameters. The ISE represented that it would notify 
Commission staff if the character of the Index should change from 
the basic description provided in the instant proposed rule change. 
The Exchange also represented that it believed its surveillance 
procedures were adequate to monitor trading in options on the Index. 
The ISE also provided additional information about the membership of 
the Intermarket Surveillance Group (``ISG''). In addition, the ISE 
provided statistics about the median average daily trading volume 
and about the percentage of securities in the Index that would meet 
the listing standards applicable to underlying securities for the 
Exchange's stock options.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend ISE Rules 2001, 2004, 2006 and 
2009, to enable the Exchange to trade options on the S&P Small Cap 600. 
The text of the proposed rule change, as amended, is below. Proposed 
new language is in italics; proposed deletions are in brackets.
* * * * *

Rule 2001. Definitions

    (l) The term ``reporting authority'' with respect to a particular 
index means the institution or reporting service designated by the 
Exchange as the official source for (1) calculating the level of the 
index from the reported prices of the underlying securities that are 
the basis of the index and (2) reporting such level. The reporting 
authority for each index approved for options trading on the Exchange 
[shall be Specified (as provided in Rule 2000)] is specified in 
Supplementary Material .01 to this Rule 2001.
* * * * *

Supplementary Material to Rule 2001

    .01 The reporting authorities designated by the Exchange in respect 
of each index underlying an index options contract traded on the 
Exchange are as provided in the chart below.

------------------------------------------------------------------------
             Underlying index                    Reporting authority
------------------------------------------------------------------------
S&P SmallCap 600 Index....................  Standard & Poor's.
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Rule 2004. Position Limits for Broad-Based Index Options

    (a) Rule 412 generally shall govern position limits for broad-based 
index options, as modified by the Rule 2004. There may be no position 
limits for certain Specified (as provided in Rule 2000) broad-based 
index options contracts. All other Broad-based index options contracts 
shall be subject to a contract limitation fixed by the Exchange, which 
shall not be larger than the limits [Specified (as provided in Rule 
2000) in this paragraph] provided in the chart below.

------------------------------------------------------------------------
                                  Standard limit (on
  Broad-based underlying index     the same side of      Restrictions
                                      the market)
------------------------------------------------------------------------
S&P SmallCap 600 Index..........  100,000 contracts.  No more than
                                                       60,000 near-term.
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* * * * *

Rule 2006. Exemptions from Position Limits

    (a) Broad-based Index Hedge Exemption. The broad-based index hedge 
exemption is in addition to the other exemptions available under 
Exchange Rules, interpretations and policies. The following procedures 
and criteria must be satisfied to qualify for a broad-based index hedge 
exemption:
* * * * *
    (5) Positions in broad-based index options that are traded on the 
Exchange are exempt from the standard limits up to 75,000 contracts (in 
addition to standard limit) unless otherwise [to the extent] Specified 
(as provided in Rule 2000) in this subparagraph (a)(5).
* * * * *

Rule 2009. Terms of Index Options Contracts

    (a) General.
* * * * *
    (4) ``European-Style Exercise.'' [Specified (as provided in Rule 
2000) The following European-style index options, some of which may be 
A.M.-settled as provided in paragraph (a)(5), [may be] are approved for 
trading on the Exchange[.]:
    (i) S&P SmallCap 600 Index.
    (5) A.M.-Settled Index Options. The last day of trading for A.M.-
settled index options shall be the business day preceding the last day 
of trading in the underlying securities prior to expiration. The 
current index value at the expiration of an A.M.-settled index option 
shall be determined, for all purposes under these Rules and the Rules 
of the Clearing Corporation, on the last day of trading in the 
underlying securities prior to expiration, by reference to the reported 
level of such index as derived from first reported sale (opening) 
prices of the underlying securities on such day, except that:
    (i) In the event that the primary market for an underlying security 
does

[[Page 58155]]

not open for trading on that day, the price of that security shall be 
determined, for the purposes of calculating the current index value at 
expiration, as set forth in Rule 2008(g), unless the current index 
value at expiration is fixed in accordance with the Rules and By-Laws 
of the Clearing Corporation; and
    (ii) In the event that the primary market for an underlying 
security is open for trading on that day, but that particular security 
does not open for trading on that day, the price of that security, for 
the purposes of calculating the current index value at expiration, 
shall be the last reported sale price of the security.
    The following A.M.-settled index options [that] are approved for 
trading on the Exchange: [shall be Specified (as provided in Rule 2000) 
in this subparagraph (a)(5).]
    (i) S&P SmallCap 600 Index.
    (b) Long-Term Index Options Series.
* * * * *
    (2) Reduced Value Long Term Options Series.
    (i) Reduced-value long term options series [may be approved for 
trading on Specified (as provided in Rule 2000) indices.] on the 
following stock indices are approved for trading on the Exchange:
    (A) S&P SmallCap 600 Index.
* * * * *
    (c) Procedures for Adding and Deleting Strike Prices. The 
procedures for adding and deleting strike prices for index options are 
provided in Rule 504, as amended by the following:
    (1) The interval between strike prices will be no less than $5.00; 
provided, that in the case of the following [the certain Specified (as 
provided in Rule 2000)] classes of index options, the interval between 
strike prices will be no less than $2.50[.]:
    (i) S&P SmallCap 600 Index, if the strike price is less than 
$200.00.
* * * * *

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

    In its filing with the Commission, the Exchange 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 III below. The Exchange has prepared summaries, set forth in 
Sections A, B and C below, of the most significant aspects of such 
statements.

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

1. Purpose
    The Exchange proposes to amend its rules to provide for the listing 
and trading on the Exchange of cash-settled, European-style index 
options on the S&P SmallCap 600. Options on this index are currently 
trading on the Chicago Board Options Exchange (``CBOE'').\4\ The 
proposed rule changes adopt the same standards that are currently 
applied for Index options traded on the CBOE.
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    \4\ See Securities Exchange Act Release No. 35532 (March 24, 
1995), 60 FR 16518 (March 30, 1995) (SR-CBOE-94-43) (Order approving 
the listing and trading of the S&P 600 on the CBOE).
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    a. Index Design.
    The S&P SmallCap 600 Index is designed to measure the performance 
of small capitalization stocks. The Index is a capitalization-weighted 
index of U.S. stocks with each stock affecting the Index in proportion 
to its market capitalization.
    As of August 21, 2003, the 600 component stocks ranged in 
capitalization from approximately $3 billion to $56 million, and the 
market capitalization of the Index totaled $397 billion. The largest 
stock accounted for 0.74% of the total weighting of the Index, while 
the smallest accounted for 0.01%. The median capitalization of the 
components in the Index was $517 million. A breakdown of the component 
stocks by trading markets shows that Nasdaq is the primary market for 
43% of the weight of the Index (277 issues), the New York Stock 
Exchange (``NYSE'') represents 56% (317 issues), and the American Stock 
Exchange (``AMEX'') represents 1% (6 issues).
    A total of 10 major industry sectors are represented in the Index. 
Those sectors and their weights are as follows: (1) Consumer 
Discretionary (20.2%); (2) Industrials (19.0%); (3) Information 
Technology (16.6%); (4) Financials (13.9%); (5) Health Care (12.9%); 
(6) Energy (5.4%); (7) Materials (4.4%); (8) Utilities (3.8%); (9) 
Consumer Staples (3.6%); and (10) Telecommunications Services (0.2%). 
During the period from March through August 2003, the average daily 
trading volume for the Index component stocks ranged from 8,468 to 4.3 
million shares. As of September 25, 2003, a significant majority of the 
stocks are relatively actively traded, as indicated by an Index 
component median average daily trading volume of 139,002 shares. The 
top 100 stocks account for 34.14% of the Index, while the bottom 100 
stocks account for 4.12% of the Index. The prices for each of the 
components ranged from $2.10 to $410.60. The average price was $23.18. 
The shares outstanding for each of the Index component stocks ranged 
from approximately 4.96 million to 138.64 million with an average of 
29.12 million.
    S&P relies on several criteria to add or delete Index component 
stocks. Among other things, stocks must trade on the NYSE or Amex, or 
be Nasdaq NMS securities; stocks must have adequate liquidity and 
reasonable price evidenced by a 0.3 ratio of annual dollar value traded 
to market capitalization; the companies must have market capitalization 
between $250 million and $900 million; companies must have financial 
viability, measured as four consecutive quarters of positive as-
reported earnings; companies must have public float of at least 40% of 
the stock; and companies must be operating companies, and not closed-
end funds, holding companies, partnerships, investment vehicles or 
royalty trusts.\5\
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    \5\ Should the character of the Index change from the basic 
description contained in the rule filing, ISE will so notify the 
Commission staff. Such a change could require filing a proposed rule 
change pursuant to section 19(b)(1) of the Act and Rule 19b-4 
thereunder. See Amendment No. 1, supra note 3.
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    b. Calculation.
    The value of the Index is determined by Standard and Poor's by 
adding the price of each stock times the number of shares outstanding. 
This sum is then divided by an index divisor (``Index Divisor''), which 
gives the Index a value of 100 on its base date of December 31, 1993. 
The Index Divisor is adjusted by Standard & Poor's for pertinent 
changes in the component stocks. The Index had a closing value of 
215.54 on May 31, 2003.
    c. Maintenance.
    The S&P Small Cap 600 is maintained by Standard and Poor's and ISE 
has represented that it will not influence any S&P decisions concerning 
the maintenance of the Index.\6\ To maintain continuity of the Index, 
Standard and Poor's adjusts the Index Divisor to reflect certain events 
relating to the component stocks. These events include, but are not 
limited to, adjustments for company additions and deletions, share 
changes, stock splits, stock dividends, and stock price adjustments due 
to company restructurings or spinoffs. Some corporate actions, such as 
stock splits and stock dividends, require simple

[[Page 58156]]

changes in the common shares outstanding and the stock prices of the 
companies in the Index. Other corporate actions, such as share 
issuances, change the market value of the Index and require an Index 
Divisor adjustment as well.
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    \6\ Telephone conference between Katherine Simmons, Vice 
President and Associate General Counsel, ISE, and Florence Harmon, 
Senior Special Counsel, Division, Commission, on October 1, 2003.
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    Although ISE is not involved in the maintenance of the Index, it 
represents that it will monitor the Index semi-annually and will notify 
Commission staff in the event that (1) 10% of the capitalization of the 
Index is comprised of securities with a market capitalization of less 
than $100 million; (2) 10% of the capitalization of the Index is made 
up of components with an average daily trading volume of less than 
10,000 shares over the previous six months; or (3) non-U.S. component 
securities (common stock or ADRs) that are not subject to a 
comprehensive surveillance agreement in the aggregate represent more 
than 20% of the weight of the Index's aggregate market capitalization.
    d. Index Options Trading.
    In addition to regular Index options, the Exchange may provide for 
the listing of long-term (up to three years expiration) index options 
series and reduced-value long-term index options on the Index. For 
reduced-value long-term index options, the underlying value would be 
computed at one-tenth of the Index level. The current and closing index 
value of any such reduced-value long-term index option will, after such 
initial computation, be rounded to the nearest one-hundredth.
    The Exchange seeks to have the discretion to list series in 2\1/2\ 
point intervals when the Index level falls below 200. The minimum tick 
size (trading interval) for series trading below $3 will be $.05 
($5.00) and for series trading above $3 will be $.10 ($10.00). The 
trading hours for options on the Index will be from 9:30 a.m. to 4:15 
p.m. Eastern time.\7\
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    \7\ Telephone conference between Katherine Simmons, Vice 
President and Associate General Counsel, ISE, and Florence Harmon, 
Senior Special Counsel, Division, Commission, on October 1, 2003.
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    e. Exercise and Settlement.
    The options on the Index will be European-style index options that 
expire on the Saturday following the third Friday of the expiration 
month. Trading in the expiring contract month will normally cease at 
4:15 p.m. Eastern time on the immediately preceding Thursday.\8\ The 
Index multiplier will be 100. The exercise settlement value of the 
Index at option expiration will be calculated by Standard & Poor's 
based on the opening prices of the component securities on the business 
day prior to expiration (``A.M. Settlement''). If a stock fails to open 
for trading, the last available price on the stock will be used in the 
calculation of the index.
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    \8\ When the last trading day is moved because of Exchange 
holidays (such as when ISE is closed on the Friday before 
expiration), the last trading day for expiring options will be 
Wednesday and the exercise settlement value of Index options at 
expiration will be determined at the opening of regular Thursday 
trading.
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    f. Position Limits.
    The Exchange proposes to establish position limits for options on 
the S&P Small Cap 600 at 100,000 contracts on either side of the 
market, and no more than 60,000 of such contracts may be in the series 
in the nearest expiration month. The hedge exemption for this broad-
based Index will be an additional 75,000 contracts.
    g. Exchange Rules Applicable.
    As modified herein, the Exchange Rules in Chapter 20 will be 
applicable to S&P Small Cap 600 options.
    h. Surveillance.
    The Exchange conducts routine surveillance for trading of equity 
options and has, where appropriate, incorporated all index options into 
its program. In addition, the Exchange has developed surveillance 
procedures specific to index options, which have been provided to the 
Commission. The ISE believes these procedures are adequate to properly 
monitor trading in options on the S&P Small Cap 600.\9\ For 
surveillance purposes, the Exchange will have complete access to 
information regarding trading activity in the underlying securities. In 
addition, the Intermarket Surveillance Group Agreement (``ISG 
Agreement''), dated June 20, 1994, will be applicable to the trading of 
options on the Index.\10\
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    \9\ See Amendment No. 1, supra note 3.
    \10\ The ISE is a member of the Intermarket Surveillance Group 
(``ISG'') under the ISG Agreement, dated June 20, 1994. The members 
of the ISG include all of the U.S. registered stock and options 
markets: the American Stock Exchange LLC (``Amex''), the Boston 
Stock Exchange (``BSE''), the Chicago Board of Options Exchange 
(``CBOE''), the Chicago Stock Exchange (``CHX''), the Cincinnati 
Stock Exchange (``CSE''), the National Association of Securities 
Dealers (``NASD''), the New York Stock Exchange, Inc. (``NYSE'') the 
Pacific Stock Exchange (``PCX'') and the Philadelphia Stock Exchange 
(``Phlx''). The ISE members work together to coordinate surveillance 
and investigative information sharing in the stock and options 
markets. In addition, the major futures exchanges are affiliated 
members of the ISG, which allows for the sharing of surveillance 
information for potential intermarket trading abuses. See Amendment 
No. 1, supra note 3.
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    i. Capacity.
    ISE believes it has the necessary systems capacity to support new 
series that will result from the introduction of S&P Small Cap 600 
index options. ISE has also been informed that the Options Price 
Reporting Authority (``OPRA'') believes that it has the capacity to 
support such new series.\11\
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    \11\ See letter from Joseph P. Corrigan, Executive Director, 
OPRA to Kathy Simmons, Vice President, Legal & Regulatory, ISE, 
dated August 28, 2003.
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2. Statutory Basis
    The Exchange believes that the proposed rule change, as amended, is 
consistent with section 6(b) of the Act \12\ in general, and furthers 
the objectives of section 6(b)(5),\13\ in particular, in that it is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and, in general, 
to protect investors and the public interest.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change, as 
amended, will impose any burden on competition.

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

    The Exchange did not receive any written comments on the proposed 
rule change, as amended.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, 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 Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to the 
File No. SR-ISE-2003-18 and should be submitted by October 29, 2003.

[[Page 58157]]

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder, applicable to a national 
securities exchange,\14\ and, in particular, with the requirements of 
section 6(b) of the Act \15\ and the rules and regulations thereunder. 
The Commission finds that the proposed rule change, as amended, is 
consistent with section 6(b)(5) of the Act,\16\ which requires, among 
other things, that the rules of the Exchange be designed to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanism of a free and open market and, in general, 
protect investors and the public interest consistent with the Act.
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    \14\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
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    The Commission finds that the trading of options on the Index will 
permit investors to participate in the price movements of the 600 
securities on which the Index is based. The Commission also believes 
that the trading of options on the Index will allow investors holding 
positions in some or all of the securities underlying the Index to 
hedge the risks associated with their portfolios. Accordingly, the 
Commission believes S&P Small Cap 600 options will provide investors 
with an important trading and hedging mechanism that should reflect 
accurately the overall movement of stocks in the small-capitalization 
range of U.S. equity securities. By broadening the hedging and 
investment opportunities of investors, the Commission believes that the 
trading of S&P Small Cap 600 options will serve to protect investors, 
promote the public interest, and contribute to remove impediments to a 
free and open market.\17\
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    \17\ Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option or warrant proposal upon a 
finding that the introduction of such new derivative instrument is 
in the public interest. Such a finding would be difficult for a 
derivative instrument that served no hedging or other economic 
function, because any benefits that might be derived by market 
participants likely would be outweighed by the potential for 
manipulation, diminished public confidence in the integrity of the 
markets, and other valid regulatory concerns. In this regard, the 
trading of listed options or warrants on the S&P Small Cap 600 Index 
will provide investors with a hedging vehicle that should reflect 
the overall movement of the small-capitalization stock universe. The 
Commission also believes that these options will provide investors 
with a means by which to make investment decisions in the small-
capitalization equity market, allowing them to establish positions 
or increase existing positions in small-capitalized stocks in a cost 
effective manner.
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    The trading of S&P Small Cap 600 options, however, raises several 
issues, including issues related to index design, customer protection, 
surveillance, and market impact. For the reasons discussed below, the 
Commission believes that the ISE has adequately addressed these issues.

a. Index Design and Structure

    The Commission finds that it is appropriate and consistent with the 
Act to classify the Index as broad-based, and therefore to permit 
Exchange rules applicable to the trading of broad-based index options 
to apply to the Index options. Specifically, the Commission believes 
the Index is broad-based because it reflects a substantial segment of 
the U.S. equities market, in general, and small-capitalization 
securities in particular. First, the Index consists of 600 relatively 
actively traded,\18\ small-capitalization domestic securities. Second, 
the total capitalization of the Index, as of August 21, 2003, was $397 
billion, with the market capitalizations of the individual stocks in 
the Index ranging from a $3 billion to $56 million, with a median value 
of $517 million. Third, the Index includes stocks of companies from a 
broad range of industry sectors, and no industry sector comprises more 
than 20.2% of the Index's total value. Fourth, as of August 21, 2003, 
no single stock comprised more than 0.74% of the Index's total value, 
and the percentage weighting of the 100 largest issues in the Index 
accounted for only 34.14% of the Index. Fifth, the Commission believes 
that the Index selection and maintenance criteria will serve to ensure 
that the Index maintains its broad representative sample of stocks in 
the small-capitalization range of U.S. equity securities. Accordingly, 
the Commission believes it is appropriate to classify the Index as 
broad-based.\19\ Should the character of the Index change from the 
basic description contained in the rule filing, ISE will so notify the 
Commission staff. Such a change could require a filing pursuant to 
section 19(b)(1) of the Act and Rule 19b-4 thereunder.\20\
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    \18\ A significant majority of the stocks are relatively 
actively traded, as indicated by an Index component stock median 
Average Daily Trading Volume of 139,002 shares. See Amendment No. 1, 
supra note 3.
    \19\ The Commission notes that an index purportedly representing 
high capitalization stocks might not be deemed to have actively 
traded stocks if the component stocks' median Average Daily Volume 
was only 139,002 shares. With regard to a small capitalization 
index, where almost by their nature the most active stocks will 
likely not be included, a median average daily trading volume less 
than that for existing broad based indexes could be acceptable, 
depending upon the index's other features. For the S&P Small Cap 
600, the median average daily trading volume is acceptable given the 
large number of component stocks and the inclusion of criteria 
designed to exclude inactively traded stocks from being selected. 
See Amendment No. 1, supra note 3.
    \20\ See Amendment No. 1, supra note 3.
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    The Commission believes that the general broad diversification, 
capitalizations, and relatively liquid markets of the Index's component 
stocks significantly minimize the potential for manipulation of the 
Index. First, as discussed above, the Index represents a broad cross-
section of domestic small capitalization stocks, with no single 
industry group or stock dominating the Index. Second, the majority of 
the stocks that comprise the Index are relatively actively traded.\21\ 
Third, the Commission believes that the Index selection and maintenance 
criteria will serve to ensure that the Index will not be dominated by 
low-priced stocks with small capitalizations, floats, and trading 
volumes.\22\ Fourth, the ISE will monitor the Index semi-annually, and 
will notify staff of the Commission in the event that (1) ten percent 
of the capitalization of the Index is comprised of securities with a 
market capitalization of less than $100 million; (2) ten percent of the 
capitalization of the Index is made up of components with an average 
daily trading volume of less than 10,000 shares over the previous six 
months; or (3) non-U.S. component securities (common stock or ADRs) 
that are not subject to a comprehensive surveillance agreement in the 
aggregate represent more than twenty percent weight of the Index's 
aggregate market

[[Page 58158]]

capitalization.\23\ Fifth, the Exchange has proposed reasonable 
position and exercise limits for the Index options that will serve to 
minimize potential manipulation and other market impact concerns. 
Although a position and exercise limit of 100,000 contracts is high by 
traditional standards, in dollar value it represents $2,155,400,000 
(based on the May 31, 2003 Index closing value of 215.54), which the 
Commission believes is small enough to render it unlikely that 
attempted manipulations of the prices of the Index components would 
affect significantly the Index's value.\24\
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    \21\ See supra note 18.
    \22\ Currently, 61% of the Index is accounted for by stocks 
meeting the ISE's options listing standards. These standards, which 
are uniform among the options exchanges, provide that a security 
underlying an option must, among other things, meet the following 
requirements: (1) The public float must be of at least 7 million 
shares; (2) there must be a minimum of 2,000 stockholders; (3) 
trading volume must have been at least 2.4 million over the 
preceding twelve months; and (4) the market price must have been at 
least $3.00 for the previous five consecutive business days if the 
security is a ``covered security,'' as defined under section 
18(b)(1)(A) of the Securities Act of 1933, or $7.50 for a majority 
of the business days during the preceding three calendar months if 
the security is not a ``covered security.'' See ISE Rule 502.
    As a general matter, for broad-based index options, the 
Commission prefers that at least 50% of an index's components 
continue to be options-eligible. Given the broad diversity of the 
Small Cap 600 Index and the selection and maintenance criteria, 
together with the fact that 61% of the Index's components are 
options eligible, the Commission believes that the Index will not be 
readily susceptible to manipulation.
    \23\ See Amendment No. 1, supra note 3.
    \24\ The Commission would not be inclined to approve such a high 
position limit if the position limit dollar equivalent amount were 
substantially higher than as currently proposed.
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b. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as Index options, can 
commence on a national securities exchange. The Commission notes that 
the trading of standardized exchange-traded options occurs in an 
environment that is designed to ensure, among other things, that: (1) 
The special risks of options are disclosed to public customers; (2) 
only investors capable of evaluating and bearing the risk of options 
trading are engaged in such trading; and (3) special compliance 
procedures are applicable to options accounts. Accordingly, because the 
Index options will be subject to the same regulatory regime as the 
other standardized options traded on the ISE, the Commission believes 
that adequate safeguards are in place to ensure the protection of 
investors in Index options.

c. Surveillance

    The Commission generally believes that a surveillance sharing 
agreement between an exchange proposing to list a stock index 
derivative product and the exchange(s) trading the stocks underlying 
the derivative product is an important measure for surveillance of the 
derivative and underlying securities markets. Such agreements ensure 
the availability of information necessary to detect and deter potential 
manipulations and other trading abuses, thereby making the stock index 
product less readily susceptible to manipulation.\25\ In this regard, 
the NYSE, Amex, and the NASD are all members of ISG.\26\
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    \25\ See Securities Exchange Act Release No. 31243 (September 
28, 1992), 57 FR 45849 (October 5, 1992) (SR-CBOE-91-51).
    \26\ See supra note 10.
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d. Market Impact

    The Commission believes that the listing and trading of S&P Small 
Cap 600 Index Options on the ISE will not adversely affect the 
underlying securities markets.\27\ First, as described above, the Index 
is broad-based and comprised of 600 stocks with no one stock or 
industry group dominating the Index. Second, as noted above, the stocks 
contained in the Index have relatively large capitalizations and are 
relatively actively traded. Third, existing ISE stock index options 
rules and surveillance procedures will apply to S&P Small Cap 600 
options. Fourth, the position limits of 100,000 contracts on either 
side of the market, with no more than 60,000 of such contracts in a 
series in the nearest month expiration month, will serve to minimize 
potential manipulation and market impact concerns. Fifth, the risk to 
investors of contra-party non-performance will be minimized because the 
Index options will be issued and guaranteed by the Options Clearing 
Corporation just like any other standardized option traded in the 
United States.
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    \27\ The ISE has stated that it has the necessary systems 
capacity to support new series that would result from the 
introduction of the S&P Small Cap 600 options. In addition, the OPRA 
has represented that additional traffic generated by options on the 
S&P Small Cap 600 Index is within OPRA's capacity. See supra note 
11.
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    Lastly, the Commission believes that settling expiring S&P Small 
Cap 600 options based on the opening prices of component securities is 
reasonable and consistent with the Act. As noted in other contexts, 
valuing expiring index options for exercise settlement purposes based 
on opening prices rather than closing prices may help reduce adverse 
effects on the securities underlying options on the Index.\28\
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    \28\ See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09).
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    The Commission finds good cause, pursuant to section 19(b)(2) of 
the Act,\29\ for approving the proposed rule change, as amended, prior 
to the thirtieth day after the date of publication of the notice of the 
filing thereof in the Federal Register. The Commission believes that, 
the trading of these options on the Exchange will introduce price 
competition to the benefit of public investors, by providing investors 
with an additional investment choice and that accelerated approval of 
the proposal will allow investors to begin trading the options 
promptly. In addition, the proposed rule change, as amended, reflects 
the listing and trading standards currently applied by the CBOE to 
enable their members to trade the S&P Small Cap 600.\30\ Accordingly, 
the Commission finds that there is good cause, consistent with section 
6(b)(5) and 19(b)(2) of the Act,\31\ to approve the proposed rule 
change, as amended, on an accelerated basis.
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    \29\ 15 U.S.C. 78s(b)(2).
    \30\ See supra note 4.
    \31\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
act,\32\ that the proposed rule change (SR-ISE-2003-18), as amended, is 
hereby approved on an accelerated basis.
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    \32\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-25513 Filed 10-7-03; 8:45 am]
BILLING CODE 8010-01-P