[Federal Register Volume 70, Number 8 (Wednesday, January 12, 2005)]
[Notices]
[Pages 2194-2196]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-90]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50972; File No. SR-Amex-2004-25]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Amendments No. 1 and No. 2 Thereto by the American Stock 
Exchange LLC Relating to Revisions to Amex Rule 111

January 6, 2005.

I. Introduction

    On April 28, 2004, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 Amex Rule 111. On May 
10, 2004, the Exchange submitted Amendment No. 1 to the proposed rule 
change.\3\ On June 8, 2004, the Exchange submitted Amendment No. 2 to 
the proposed rule change.\4\ The proposed rule change and Amendments 
Nos. 1 and 2 were published for comment in the Federal Register on 
October 25, 2004.\5\ No comments were received on the amended proposal. 
This order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Bill Floyd-Jones, Counsel, Exchange, to 
Nancy Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated May 7, 2004 (``Amendment No. 1''). 
In Amendment No. 1, the Exchange clarified the proposed rule 
language, and provided additional explanation in the purpose section 
of the proposed rule change.
    \4\ See Letter from Bill Floyd-Jones, Counsel, Exchange, to 
Nancy Sanow, Assistant Director, Division, Commission, dated June 7, 
2004 (``Amendment No. 2''). In Amendment No. 2, the Exchange added a 
definition of ``bona fide hedge'' to the text of the proposed rule 
change. In Amendment No. 2, the Exchange also reprinted pages 33--35 
of Securities Exchange Act Release No. 15533 (January 29, 1979) as 
proposed Commentary .13 to the text of the proposed rule change.
    \5\ See Securities Exchange Act Release No. 50552 (October 15, 
2004), 69 FR 62308.
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II. Description

A. Background

    The original Act gave the Commission the authority to regulate 
``floor trading'' \6\ by members of national securities exchanges.\7\ 
In 1964, the Commission exercised this authority by adopting SEC Rule 
11a-1--``Regulation of Floor Trading.'' \8\ Rule 11a-1 provided, with 
certain exceptions, that no member of a national securities exchange, 
while on the floor of such exchange, could initiate any transaction in 
any security admitted to trading on the exchange, for an account in 
which such member had an interest. One of the exceptions permitted 
member transactions for their own account if such transactions were 
executed in conformity with a Commission-approved exchange plan 
designed to eliminate floor trading activities that were not beneficial 
to the market.
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    \6\ The Commission has defined ``floor trading'' as trading by 
members of national securities exchanges for their own account while 
personally present on the trading floor of an exchange. See 
Securities Exchange Act Release No. 7290 (April 9, 1964), 29 FR 5168 
(April 15, 1964).
    \7\ As originally adopted, section 11(a) of the Act provided:
    The Commission shall prescribe such rules and regulations as it 
deems necessary or appropriate in the public interest or for the 
protection of investors, (1) to regulate or prevent floor trading by 
members of national securities exchanges, directly or indirectly for 
their own account or for discretionary accounts, and (2) to prevent 
such excessive trading on the exchange but off the floor by members, 
directly or indirectly for their own account, as the Commission may 
deem detrimental to the maintenance of a fair and orderly market. It 
shall be unlawful for a member to effect any transaction in a 
security in contravention of such rules and regulations, but such 
rules and regulations may make such exemptions for arbitrage 
transactions, for transactions in exempted securities, and within 
the limitations of subsection (b) of this section, for transactions 
by odd-lot dealers and specialists, as the Commission may deem 
necessary or appropriate in the public interest or for the 
protection of investors.
    \8\ See Securities Exchange Act Release No. 7330 (June 2, 1964), 
29 FR 7380 (June 6, 1964).
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    Shortly after the adoption of SEC Rule 11a-1, the Exchange 
submitted a floor trading plan (``Plan'').\9\ As part of the Plan, the 
Exchange proposed Amex Rules 110, 111, and 112, which (1) created a 
registered equity trader program, and (2) incorporated the trading 
exemptions found in SEC Rule 11a-1(b)(1) through (b)(6). On July 23, 
1964, the Commission approved the Exchange's Plan,\10\ together with 
revisions to the Plan that exempted from the prohibitions contained in 
SEC Rule 11a-1 and the Plan: (1) Transactions in bonds, (2) hedging 
transactions by rights specialists in the underlying security, and (3) 
certain block transactions.\11\
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    \9\ Securities Exchange Act Release No. 7359 (June 30, 1964), 29 
FR 9344 (July 8, 1964).
    \10\ Securities Exchange Act Release No. 7374, 29 FR 10632 (July 
30, 1964).
    \11\ Securities Exchange Act Release No. 7375 (July 23, 1964), 
29 FR 10632 (July 30, 1964).
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    Generally, Amex Rule 110 prohibits any member from initiating 
transactions while on the floor for an account in which such member has 
an interest unless such member is registered as a ``Registered 
Trader.'' Registered Traders are limited in the transactions they may 
initiate on the floor under Amex Rule 111. For example, Registered 
Traders must meet stabilization tests, may not act as a broker for off-
floor orders in stocks in which such Registered Trader has initiated 
transactions for his own account, and may not retain priority over off-
floor orders when establishing or increasing positions in his own 
account. Amex Rule 111(f)(1) through (6) exempts certain member 
transactions from the Registered Trader requirements set forth in Amex 
Rules 110 and 111 and reflects the exemptions from Rule 11a-1(b)(1) 
through (6). For example, transactions by registered specialists in 
their specialty stock, transactions by odd-lot dealers, and bona fide 
arbitrage transactions of members are not subject to the restrictions 
set forth in Amex Rules 110 and 111.
    In 1975, Congress substantially amended Section 11(a) of the Act 
\12\ by extending the general prohibition on member floor trading 
embodied in SEC Rule 11a-1 \13\ to off-floor member trading. 
Specifically, section 11(a) of the Act prohibits, subject to certain

[[Page 2195]]

exceptions, any member of an exchange from effecting any transaction on 
such exchange for its own account, the account of an associated person 
or an account with respect to which it or an associated person thereof 
exercises investment discretion. The statutory exemptions to the 
general prohibition found in section 11(a)(1) of the Act include, among 
other things, bona fide arbitrage and bona fide hedge transactions. 
These exceptions reflect Congress' belief that these types of trading 
activities either contributed to the maintenance of fair and orderly 
markets, or at least had not given rise to serious abuse.\14\
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    \12\ See 15 U.S.C. 78k(a).
    \13\ 17 CFR 240.11a-1.
    \14\ See Securities Act Amendments of 1975, Report of the Senate 
Comm. on Banking, Housing and Urban Affairs to Accompany S. 249, S. 
Rep. No. 94-75, 94th Cong., 1st Sess. 99 (1975).
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B. Proposed Rule Change

    The Exchange proposes to amend Amex Rule 111 to conform it to the 
1975 amendments to section 11(a) of the Act by allowing members 
registered as options specialists and registered options traders 
(``ROTs'') to initiate, while on the Amex floor, bona fide hedging 
transactions for their accounts in Amex listed securities and to allow 
members registered as equity specialists to initiate, while on the Amex 
floor, bona fide hedging transactions for their accounts in options 
traded on Amex. Currently, as noted above, Amex members can execute 
transactions on the floor for accounts in which they have an interest 
only if they are Registered Traders. The proposed rule change would 
permit equity specialists, options specialists, and ROTs to initiate 
bona fide hedge transactions without having to register as Registered 
Traders and without being subject to the limitations set forth in Amex 
Rules 110 and 111.\15\
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    \15\ Amex Rules 110 and 111 apply to options transactions 
pursuant to Amex Rules 950(a) and 958.
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    Under the Exchange's proposed rule change, options specialists and 
ROTs could give an order for their account directly to an Amex broker 
on the floor for a security underlying an option in which they are 
registered for the purpose of acquiring or liquidating a bona fide 
hedge position through a trade on the Exchange. Similarly, Amex 
proposes to permit equity specialists (subject to Amex Rule 175, which 
regulates option transactions by equity specialists) to give an order 
for their account directly to an Amex broker on the floor for a 
security overlying an equity in which they are registered for the 
purpose of acquiring or liquidating a bona fide hedge position through 
a trade on the Exchange.
    The proposed rule would exempt bona fide hedge transactions in 
securities underlying options by option specialists and ROTs from the 
requirements of Amex Rule 110, and paragraphs (a) through (e) of Amex 
Rule 111. Likewise, the proposed rule would exempt bona fide hedge 
transactions in options overlying securities by equity specialists from 
the requirements of Amex Rules 110, 111, and 958 (which regulates the 
transactions of ROTs).
    The Exchange also proposes under Amex Rule 111(i) to add a 
definition of ``bona fide hedge'' which shall have the meaning found in 
SEC Rule 11a1-3(T) and in pages 33-35 of the release adopting that 
rule.\16\ The Exchange further proposes to provide a reprint of pages 
33-35 of the 1979 Release in proposed Commentary 13 of Amex Rule 111.
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    \16\ See Securities Exchange Act Release No. 15533 (January 29, 
1979), 44 FR 6084, 6090-6091 (January 31, 1979) (``1979 Release'').
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    Brokers who receive orders from equity specialists, options 
specialists or ROTs would be required to prepare a record of any bona 
fide hedge order given to them,\17\ and specialists and ROTs who give 
bona fide hedge orders to brokers would have to prepare and submit to 
the Exchange a record of all such orders and transactions effected for 
an account in which they have an interest.\18\
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    \17\ See Amex Rule 153.
    \18\ See Amex Rules 957 and 175, Guidelines for Specialists' 
Specialty Option Transactions Pursuant to Rule 175, paragraph (j).
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III. Discussion

    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,\19\ and, in particular, the requirements of 
section 6(b)(5) of the Act,\20\ which requires that the rules of a 
national securities exchange be designed to, among other things, 
prevent fraudulent and manipulative acts and practices, and promote 
just and equitable principles of trade. In addition, the Commission 
believes that the Amex's proposal is consistent with section 11(a) of 
the Act.
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    \19\ In approving the proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \20\ 15 U.S.C. 78f(b)(5).
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    Specifically, Amex proposes to allow its members to effect a 
certain type of proprietary transaction on the Amex floor that is 
currently permitted under the Act. Section 11(a)(1)(D) of the Act 
allows members of a national securities exchange to engage in ``any 
bona fide hedge transaction involving a long or short position in an 
equity security and a long or short position in a security entitling 
the holder to acquire or sell such equity security.'' \21\ The 
Commission has defined bona fide hedge transactions for the purposes of 
section 11(a)(1)(D) of the Act.\22\ In the 1979 Release, the Commission 
stated that, while the application of the term is largely a matter of 
custom and practice, the term bona fide hedge implied ``an appreciable 
offset of risk, for all or part of the position being hedged.'' \23\ 
The Commission continued, in the 1979 Release, to describe whether 
particular combinations of stock and options positions would result in 
risk reduction, the timing of hedging transactions, and the liquidation 
of hedge positions.\24\
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    \21\ 15 U.S.C. 78k(a)(1)(D). The Commission also has extended 
the bona fide hedge definition to options to options hedging. See 17 
CFR 240.11a1-3(T).
    \22\ See 1979 Release, supra note 16, at 6090-6091.
    \23\ See id. at 6090.
    \24\ See id. at 6090-6091.
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    Amex has proposed to adopt the Commission's definition of bona fide 
hedge set forth in the 1979 Release and in Rule 11a1-3(T). Accordingly, 
the Commission believes that Amex's proposed definition is consistent 
with the requirements of the Act. As noted above, the Commission's 
definition is specific as to the types and sizes of transactions that 
can be considered bona fide hedges, the timing of executing hedge 
transactions and liquidating hedge positions. Amex must ensure that the 
bona fide hedge transactions executed by specialists and ROTs comply 
with these requirements for Section 11(a) exemption purposes.\25\ Amex 
must also ensure that equity specialists continue to comply with Amex 
Rule 175, which regulates option transactions by equity specialists.
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    \25\ For example, in the 1979 Release, the Commission noted that 
to the extent that a position more than offsets the risk of the 
position to be hedged, the excess position would not be part of a 
bona fide hedge for the purposes of Section 11(a)(1)(D) of the Act. 
See id. at 6091.
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    The Commission notes that the Exchange's proposed rule change does 
not alter the general prohibition on side-by-side trading \26\ and 
integrated market

[[Page 2196]]

making \27\ on the Exchange.\28\ Accordingly, equity specialists may 
not act as specialists or ROTs in options overlying the stocks in which 
they are registered, and options specialists and ROTs may not act as 
specialists in the securities underlying the options in which they are 
registered. Furthermore, Amex may not move the location of stock and 
options trading posts such that related stocks and options are traded 
at the same or adjacent locations on the floor.\29\
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    \26\ ``Side-by-side trading'' refers to the trading of 
securities and related derivative products at the same location, 
though not necessarily by the same specialist. See Securities 
Exchange Act Release No. 46213 (July 16, 2002), 67 FR 48232, 48233, 
note 9 (July 23, 2002).
    \27\ ``Integrated market making'' refers to the trading of 
securities and related derivative products by the same specialist or 
specialist firm. See id. at 48233, note 10.
    \28\ The Commission notes that, currently, specified exchange-
traded funds and trust issued receipts and their related options may 
be traded on the Amex by the same Exchange specialist or specialist 
firm without informational or physical barriers or other 
restrictions. See id. at 48236.
    \29\ See Securities Exchange Act Release No. 26147 (October 3, 
1988), 53 FR 39956 (October 7, 1988).
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IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-Amex-2004-25), as amended, 
is approved.
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    \30\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-90 Filed 1-11-05; 8:45 am]
BILLING CODE 8010-01-P