[Federal Register Volume 69, Number 10 (Thursday, January 15, 2004)]
[Notices]
[Pages 2377-2379]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-855]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49045; File No. SR-OCC-2003-01]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
Relating to Exercise-by-Exception Policies

January 8, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 23, 2003, 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

    OCC is proposing to modify certain of its practices and policies 
with respect to exercise by exception processing of expiring equity 
options. Specifically, OCC is (1) modifying its methodology for 
extracting closing prices for underlying securities and (2) making 
explicit certain circumstances under which OCC will remove options on 
an underlying security from exercise by exception processing.

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), 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 proposed rule change would modify OCC's practices and policies 
with respect to exercise by exception processing of expiring equity 
options.
Exercise by Exception Processing
    Rule 805 sets forth OCC's procedures for processing expiring equity 
and index options. It provides for the use of ``exercise by exception'' 
processing \3\ to expedite the exercise of such expiring options by 
clearing members. Under that procedure, expiring options that are in-
the-money by a specified amount are exercised unless a clearing member 
instructs otherwise. Equity options are determined to be in-the-money 
based on the difference between the exercise price and the closing 
price of the underlying security on the last trading

[[Page 2378]]

day before expiration.\4\ To be exercised under the exercise by 
exception procedure, equity options must be in the money by at least 
\3/4\ of a point per share if carried in a customers' account and at 
least \1/4\ of a point per share if carried in a firm or market maker 
account.
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    \3\ ``Exercise by exception'' processing is a procedural 
convenience extended to clearing members to relieve them of the 
operational burden of entering individual exercise instructions for 
every option contract to be exercised. It is not intended to obviate 
the need for customers to communicate exercise instructions to their 
brokers. OCC Rule 805, Interpretation & Policy .02.
    \4\ Rule 805(i) defines the term closing price to mean the last 
reported sale price for the underlying security during regular 
trading hours as determined by OCC on the trading day immediately 
preceding the expiration date on a national securities exchange or 
other domestic securities market as determined by OCC.
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Closing Price Selection Methodology
    Until recently, OCC obtained closing prices for underlying 
securities in the following sequence: first from the New York Stock 
Exchange, then from the American Stock Exchange, and finally from the 
Nasdaq Stock Market. This method presumed that underlying equity 
securities were traded on only one of these markets. However, 
underlying equity securities are now being cross-listed on certain of 
these markets.
    This caused OCC to reassess its methodology for selecting closing 
prices. OCC's Board of Directors considered the matter at its November 
2002 meeting and approved an interim modification to OCC's selection 
methodology pending further study. Under the modified methodology, OCC 
selects a closing price for a multiply traded underlying security from 
the exchange that originally listed that security. (OCC determines a 
security's original listing market based on the trading symbol.) This 
interim approach was announced via an information memorandum.\5\
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    \5\ That information memorandum is available on OCC's Web site 
at http://www.optionsclearing.com/market/infomemos/ nov--02/
18537.htm.
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    To determine a long-term solution, OCC consulted with a broad 
cross-section of its membership. The consensus of the membership was 
that OCC should use a composite closing price, which is a price readily 
available to all market participants.\6\ An OCC staff analysis also 
concluded that a composite closing price addressed almost all known 
expiration pricing issues. At its March 2003 regular meeting, the Board 
of Directors approved the use of composite closing prices for exercise 
by exception processing. After completing a clearing member awareness 
program, composite closing prices will be used in exercise by exception 
processing beginning with the June 2003 expiration.
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    \6\ A composite closing price for an underlying security is 
defined by OCC's price vendors to mean the last reported sale price 
from any eligible trade source (i.e., primary listing market or 
participating regional market). It is not an average price.
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Determination Not To Apply Exercise by Exception Processing
    Rule 805 currently provides that if an underlying security is not 
traded on the last trading day before expiration, OCC may either:
    (i) Fix a closing price on such basis as it deems appropriate in 
the circumstances (including using the last sales price from the most 
recent trading day for which a last sales price is available); or
    (ii) Determine not to fix a closing price for that security, in 
which case clearing members may exercise only by giving OCC affirmative 
instructions.
    Clearing members have strongly preferred that OCC set a closing 
price for an underlying security so that it would be subject to 
exercise by exception processing. (Many clearing members have 
provisions in their agreements with options customers providing that 
unless the customer instructs otherwise, the clearing member is 
authorized to exercise options that are in the money by OCC's threshold 
amount and not to exercise options that are not.) OCC's practice has 
been to honor clearing members' preferences and to fix a closing price 
based on the last reported trade even if a stock has not traded for an 
extended period. In those cases, OCC publishes an information 
memorandum shortly before each expiration informing market participants 
of the price it intends to use for exercise by exception processing, 
including the date on which the price was obtained. Such memoranda 
remind readers that OCC's exercise thresholds are an operational 
convenience, do not dictate which options should or should not be 
exercised, and strongly urge firms to contact customers with expiring 
long positions.
    Despite these precautions, there is a risk that using stale closing 
prices for exercise by exception processing can contribute to 
unintended exercises or non-exercises. OCC has therefore reassessed its 
policy on fixing closing prices for underlying securities in which 
trading has been halted. After consulting with its clearing members, 
OCC has determined to establish the following policy:
    [sbull] If OCC becomes aware at any time on or before the Monday 
before expiration that trading in an underlying security has been 
halted and if trading does not resume before expiration, OCC will 
suspend the exercise by exception procedure with respect to options on 
that security.\7\
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    \7\ Under OCC's previous clearing system, exercise by exception 
was suspended with respect to an underlying security by not fixing a 
closing price for that security. Rule 805(j) reflects that 
procedure. OCC's current system uses a different process to suspend 
exercise by exception and generates closing prices for all 
underlying securities, including those for which exercise by 
exception has been suspended. A technical modification is being made 
to Rule 805(j) to reflect this change.
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    [sbull] If OCC does not become aware until the Tuesday before 
expiration or thereafter that trading in an underlying security has 
been halted and if trading does not resume before expiration, the 
exercise by exception procedure will apply, and OCC will fix a closing 
price on such basis as it deems appropriate in the circumstances 
(including, without limitation, using the last sale price during 
regular trading hours on the most recent trading day for which a last 
sale price is available).
    [sbull] If OCC becomes aware before the close of trading on 
expiration Friday that trading in a previously halted underlying 
security has resumed, the exercise by exception procedure will apply, 
and OCC will fix a closing price for that security in the normal 
manner.
    If trading in an underlying stock is halted on or before Monday of 
expiration week, firms should have sufficient time to contact most 
customers for exercise instructions. If trading is not halted until 
after expiration Monday, firms may not have enough time to obtain such 
instructions. Continuing to apply the exercise by exception procedure 
in this limited situation will preserve for firms that have no specific 
exercise instructions from a customer the option of relying on the 
provisions in their customer agreements authorizing them to base 
exercise decisions on OCC's exercise thresholds. Firms would, of 
course, remain free to solicit specific exercise instructions as they 
deem necessary or appropriate. This policy change also is scheduled to 
go in effect with the June 2003 expiration.
    OCC believes that the proposed rule change is consistent with the 
requirements of Section 17A of the Act and the rules and regulations 
thereunder because it removes impediments to and perfects the mechanism 
of a national system for the clearance and settlement of securities 
transactions and 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.

[[Page 2379]]

(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

    The foregoing rule change has become effective pursuant to Section 
19(b)(3)(A)(iii) of the Act \8\ and Rule 19b-4(f)(4)\9\ promulgated 
thereunder because the proposal effects a change in an existing service 
of OCC that (A) does not adversely affect the safeguarding of 
securities or funds in the custody or control of OCC or for which it is 
responsible and (B) does not significantly affect the respective rights 
or obligations of OCC or persons using the service. At any time within 
sixty days of the filing of the proposed rule change, the Commission 
may summarily abrogate such rule change if it appears to the Commission 
that such action is necessary or appropriate in the public interest, 
for the protection of investors, or otherwise in furtherance of the 
purposes of the Act.
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    \8\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \9\ 17 CFR 240.19b-4(f)(4).
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IV. 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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-OCC-2003-01. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review your comments more efficiently, comments should be sent in 
hardcopy or by e-mail but not by both methods. 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 and OCC's Web site at http://www.theocc.com. All submissions should refer to the File No. SR-OCC-
2003-01 and should be submitted by January 30, 2004.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-855 Filed 1-14-04; 8:45 am]
BILLING CODE 8010-01-P