[Federal Register Volume 59, Number 197 (Thursday, October 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25278]
[[Page Unknown]]
[Federal Register: October 13, 1994]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34793; File No. SR-Amex-94-31]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change American Stock
Exchange, Inc. Relating to Market Index Option Escrow Receipts
October 5, 1994.
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 26, 1994, the American Stock Exchange, Inc. (``Amex'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') the proposed rule change as described in
Items I and II below, which Items have been prepared by the self-
regulatory organization. On October 3, 1994, the Exchange submitted
Amendment No. 1 to the proposed rule change to codify certain aspects
of the market index option escrow receipt (``MIOER'') program in the
text of its rules.\3\ The Amex has requested accelerated approval of
the proposal. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1991).
\3\See letter from Claire McGrath, Managing Director & Special
Counsel, Derivative Securities, Amex, to Beth Stekler, Attorney,
Division of Market Regulation, SEC, dated October 3, 1994
(``Amendment No. 1''). Specifically, Amendment No. 1 codifies
certain provisions regarding (1) Options Clearing Corporation
(``OCC'') review of the issuing bank or trust company and (2)
minimum collateral levels.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Amex proposes to amend Exchange Rule 462 to provide for an
index option escrow receipt program. The text of the proposed rule
change is available at the Office of the Secretary, Amex, and at the
Commission.
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 self-regulatory organization
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 self-regulatory
organization 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
In October 1984, the Exchange filed a proposal to amend Rule 462 to
provide for the use of cash, cash equivalents, one or more qualified
securities, or a combination of the foregoing, as collateral for escrow
receipts issued to cover short call positions in broad-based stock
index options.\4\ The proposal was approved as a pilot program at each
of the options exchanges and was successfully extended over the years.
The Amex now seeks to join the other exchanges and make the pilot
program permanent. The Amex also seeks to make conforming changes to
Rule 462, so that the rule will correspond to rule language adopted by
OCC\5\ and the other options exchanges.\6\
---------------------------------------------------------------------------
\4\See Securities Exchange Act Release No. 22323 (August 13,
1985), 50 FR 33439. (August 19, 1985) (File Nos. SR-Amex-84-33; SR-
CBOE-84-28, SR-NYSE-84-35; SR-PSE-85-19; SR-Phlx-85-18) (``pilot
approval order''). For further discussion of the MIOER pilot
program, particularly the acceptable types of collateral, the value
thereof and the rights and responsibilities of the customer, the
issuing bank or trust company, the broker-dealer and OCC, see infra,
notes 13-17 and accompanying text.
\5\See Securities Exchange Act Release No. 33549 (January 31,
1994), 59 FR 5629 (February 7, 1994) (File No. SR-OCC-89-04) (``OCC
approval order'').
\6\See Securities Exchange Act Release No. 34405 (July 19,
1994), 59 FR 37795 (July 25, 1994) (File Nos. SR-CBOE-87-03, SR-PSE-
87-21, SR-Phlx-87-05) (``permanent approval order'') (approving
proposals by the Chicago Board Options Exchange (``CBOE'') the
Pacific Stock Exchange (``PSE'') and the Philadelphia Stock Exchange
(``Phlx'') to implement their MIOER programs on a permanent basis
and to make certain minor refinements to the type of property
acceptable as an escrow deposit). For further discussion of the
comparable amendments to Amex Rule 462, see infra notes 18-19 and
accompanying text.
---------------------------------------------------------------------------
2. Statutory Basis
The proposed rule change is consistent with Section 6(b) of the Act
in general and furthers the objectives of Section 6(b)(5) in particular
in that it is designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in facilitating
transactions in securities, and to remove impediments to and perfect
the mechanism of a free and open market and a national market system.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change 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
No written comments were solicited or received with respect to the
proposed rule change.
III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth St., NW., Washington, DC 20549. 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 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 the Amex. All
submissions should refer to File No. SR-Amex-94-31 and should be
submitted by November 3, 1994.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
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 exchange, and, in
particular, with the requirements of Section 6(b).\7\ In particular,
the Commission believes the proposal is consistent with the Section
6(b)(5) requirements that the rules of an exchange be designed to
promote just and equitable principles of trade, prevent fraudulent and
manipulative acts, and, in general, protect investors and the public
interest.
---------------------------------------------------------------------------
\7\15 U.S.C. 78f(b) (1988).
---------------------------------------------------------------------------
For various reasons, such as state and federal regulations, many
institutions may write call options only on a covered basis in a cash
account.\8\ Many of these institutions, however, are legally restrained
from having deposits of cash or securities at a brokerage firm.
Accordingly, in lieu of such a deposit, a bank may issue to the broker
an escrow receipt on behalf of their mutual customer, in order to meet
the margin requirements for any short options the customer may have
written.\9\
---------------------------------------------------------------------------
\8\In the context of a short call position, an options writer is
covered if he owns the securities underlying the options he has
written.
\9\Pursuant to Regulation T of the Board of Governors of the
Federal Reserve System (``Federal Reserve Board''), in a cash
account, an escrow agreement may be used in lieu of margin for a
short call option position if a bank holds the underlying security
for the customer writing the option. See 12 CFR 220.8(a)(4)(i)
(1990).
---------------------------------------------------------------------------
Because it is difficult to apply the traditional concept of
``cover'' to broad-based, cash-settled index options,\10\ the
Commission approved in 1984 an Amex proposal to allow index options
writers to enter into escrow agreements without requiring them to
collateralize the agreements with all the securities underlying the
index.\11\ The original MIOER program permitted the use of escrow
receipts for short call positions if, among other things, a bank or
trust company held for the customer a ``basket'' of at least ten
qualified equity securities. Due to inadequate recordkeeping
procedures, settlement delays and financial disincentives, many market
participants found this program to be impracticable and uneconomic,
particularly in comparison to similar products traded on commodities
exchanges.\12\
---------------------------------------------------------------------------
\10\Existing options on broad-based stock indexes overlie from
20 to over 2,000 securities. As a result, it can be impracticable
for an index options writer to be ``covered'' by having appropriate
positions in each component security. In addition, because index
options are cash-settled, the securities underlying an index option
are never delivered upon assignment.
\11\See Securities Exchange Act Release No. 20732 (March 7,
1984), 49 FR 9665 (March 14, 1994) (File No. SR-Amex-84-05). At that
time, the staff of the Federal Reserve Board indicated that it
believed a MIOER could be used as cover in a cash account. See
letter from Laura Homer, Securities Credit Officer, Federal Reserve
Board, to Richard G. Ketchum, Associate Director, SEC, Division of
Market Regulation, dated January 27, 1984.
\12\In addition, OCC, at that time, did not accept escrow
receipts for index options margin For further discussion of the
original MIOER program and the problems encountered thereunder, see
pilot approval order, supra, note 4.
---------------------------------------------------------------------------
Accordingly, in 1985, the Commission approved, on a pilot basis, an
Amex proposal to change the type of property acceptable as an escrow
deposit.\13\ This pilot program subsequently has been extended seven
times,\14\ in order to provide the Amex and OCC with the opportunity to
resolve certain matters concerning the format of the receipt and
administration of the program.
---------------------------------------------------------------------------
\13\See pilot approval order, supra note 4. The Commission
simultaneously approved the use by the clearing member of an escrow
receipt form, in lieu of margin payments to OCC. See Securities
Exchange Act Release No. 22324 (August 13, 1985), 50 FR 33443
(August 18, 1985) (File No. SR-OCC-85-07).
\14\See, e.g., Securities Exchange Act Release Nos. 23741
(October 22, 1986), 51 FR 39724 (October 30, 1986) (File No. SR-
Amex-86-26); 24121 (February 20, 1987), 52 FR 6258 (March 2, 1987)
(File No. SR-Amex-87-09); 24708 (July 15, 1987), 52 FR 27604 (July
22, 1987) (File No. SR-Amex-87-09, Amendment No. 1); 25242 (January
5, 1988), 53 FR 648 (January 11, 1988) (File No. SR-Amex-87-09,
Amendment No. 2); 25888 (July 6, 1988), 53 FR 26547 (July 13, 1988)
(File No. SR-Amex-87-09, Amendment No. 3); 26274 (November 10,
1988), 53 FR 46522 (November 17, 1988) (File No. SR-Amex-87-09,
Amendment No. 4); 27657 (January 30, 1990), 55 FR 4295 (February 7,
1990) (File No. SR-Amex-87-09; Amendment No. 5)
---------------------------------------------------------------------------
Currently, a MIOER may be collateralized by cash, cash equivalents,
one or more qualified equity securities, or a combination thereof.
Pursuant to Regulation T, the term ``cash equivalents'' is defined to
mean the market value of any of the following instruments with one year
or less to maturity: (1) Securities issued or guaranteed by the United
States or its agencies; (2) negotiable bank certificates of deposit; or
(3) bankers acceptances issued by banking institutions in the United
States and payable in the United States.\15\ An equity security (other
than warrants, rights or options) is qualified to be used as collateral
for MIOERs issued to cover short call positions if it is traded on a
national securities exchange and substantially meets the listing
requirements of the New York Stock Exchange (``NYSE'') or Amex or if it
is enumerated on the current list of over-the-counter margin stocks
published by the Federal Reserve Board.
---------------------------------------------------------------------------
\15\See 12 CFR 220.8(a)(3)(ii) (1990).
---------------------------------------------------------------------------
The current escrow receipt program requires that, at the time the
option is written, the total value of the collateral underlying the
MIOER must be at least equal to the aggregate initial position value
(i.e., the index value at trade date times the applicable index
multiplier times the number of options contracts covered by the
collateral). Although the escrow deposit may include only one or even
no securities, the customer must affirm that he is writing index
options against a diversified portfolio. In addition, the issuing bank
or trust company must be approved by OCC if the receipt is to be
forwarded to OCC to meet the clearing member's margin obligations.\16\
---------------------------------------------------------------------------
\16\There are also certain financial, regulatory and depository
standards for MIOER issuers. For further discussion of OCC's
monitoring obligations, see OCC approval order, supra, note 5.
---------------------------------------------------------------------------
Thereafter, the terms of the MIOER\17\ specify that, if the value
of the collateral falls below 55% of the current position value, the
issuing bank or trust company promptly must notify the customer and
request that the escrow deposit be supplemented. If the value of the
collateral falls below 50% of the current position value, the bank or
trust company promptly must notify OCC and the broker who, in turn,
will disregard the MIOER and request that margin be deposited for the
previously covered short position.
---------------------------------------------------------------------------
\17\Under the Amex rules, escrow receipts must be in a form
satisfactory to the Exchange. Because the Commission has only
reviewed the escrow receipt submitted by OCC, the Commission
previously has indicated and now reiterates that approval of these
proposals is limited to the use of escrow receipts containing terms
and conditions substantively identical to those in the OCC escrow
receipt.
---------------------------------------------------------------------------
The Amex proposes to convert its MIOER program from pilot to
permanent status and to conform Rule 462 with recently approved
amendments to the rules of OCC\18\ and the other options exchanges.\19\
Despite certain refinements, as discussed in more detail below, the
current rules will, for the most part, continue to apply.
---------------------------------------------------------------------------
\18\See OCC approval order supra, note 5.
\19\See permenent approval order, supra, note 6.
---------------------------------------------------------------------------
First, the Amex proposal will limit acceptable ``cash equivalents''
to securities issued or guaranteed by the United States and having one
year or less to maturity (``short-term United States government
securities''). As a result, securities issued or guaranteed by agencies
of the United States, certificates of deposit and bankers acceptances
will no longer be eligible as collateral for MIOERs issued to cover
short call positions.
In addition, the definition of ``qualified equity securities'' will
be amended to incorporate all exchange-traded securities, whether or
not they meet NSE or Amex listing standards. The proposals also will
make certain editorial changes to the Exchange's rules regarding the
use of over-the-counter securities to collateralize an escrow receipt,
in order to conform that language with the phrasing used in OCC's
rules.
After careful review of the operation of the pilot program, the
Commission has concluded that the revised MIOER should help provide a
safe and efficient mechanism by which index call options can be written
in a cash account. As set forth in more detail in its order approving
the pilot procedures,\20\ the Commission believes that the range of
collateral permitted thereunder should provide market participants with
greater flexibility, prevent settlement delays and eliminate many of
the problems encountered under the original MIOER program. To the
extent that the revised escrow receipt is a cost-effective means for
institutions restricted to cash account transactions to manage
portfolio risk, its implementation on a permanent basis should
encourage broader participation in the index options market, thereby
adding depth and liquidity to that market.
---------------------------------------------------------------------------
\20\See pilot approval order, supra, note 4.
---------------------------------------------------------------------------
Based on its experience with the pilot program, however, the Amex,
along with OCC, has proposed certain minor refinements to the types of
property acceptable as collateral for MIOERs issued to cover short call
positions. As the Commission noted in regard to the recently approval
proposal by OCC,\21\ these new standards will ensure that only liquid
assets are eligible to underlie escrow receipts. Specifically, the
Commission believes that the proposed rule change is a reasonable
response to OCC's finding that certificates of deposit and bankers
acceptances present an undue risk to OCC because it has no means of
ensuring that issuers of such instruments are financially sound.\22\
Thus, the Commission agrees that limiting ``cash equivalents'' to
short-term United States government securities will enhance the
integrity of escrowed collateral. Moreover, the changes to the
definition of ``qualified equity security'' are consistent with the
Federal Reserve Board's definition of ``margin security'' or existing
OCC rules.
---------------------------------------------------------------------------
\21\See OCC approval order, supra, note 5.
\22\In contrast to its monitoring of MIOER issuers, OCC receives
no financial information on banks issuing certificates of deposit or
bankers' acceptances. Because of the potential exposure if the
issuer fails and the instruments become worthless, OCC proposed
eliminating them as eligible types of collateral. See Securities
Exchange Act Release No. 26951 (June 21, 1989), 54 FR 26870 (June
26, 1989) (File No. SR-OCC-89-04). OCC also found that few customers
utilize such instruments. Id.
---------------------------------------------------------------------------
Finally, the Commission has determined that the escrow receipt
contains safeguards (e.g., minimum collateral levels; the requirement
that issuing banks or trust companies notify customers and OCC of
reductions in collateral)\23\ that should help ensure the adequacy of
the collateral posted and diminish the risks associated with MIOERs. To
date, the Amex's experience with the pilot program supports the
Commission's earlier conclusion that, absent extremely unusual
circumstances, the value of the collateral should be greater than the
cash difference between the current index value and the exercise price
of the option (i.e, the amount the must be delivered upon
assignment.\24\ The Commission therefore believes that implementation
on a permanent basis is now appropriate.
---------------------------------------------------------------------------
\23\For further discussion of value requirements and incentives
for the industry to police itself, see supra, notes 16-17 and
accompanying text.
\24\See pilot approval order, supra, note 4.
---------------------------------------------------------------------------
The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. This will permit the
portfolio management benefits of the proposed rule change to be
realized as soon as possible. In addition, the Amex's proposal is
identical to proposals by the CBOE, PSE and Phlx that were published in
the Federal Register for the full comment period and were approved by
the Commission.\25\
---------------------------------------------------------------------------
\25\No comments were received in connection with the proposed
rule changes by the other options exchanges. See permanent approval
order, supra, note 6.
---------------------------------------------------------------------------
It is therefore ordered, pursuant to Section 19(b)(2)\26\ that the
proposed rule change (SR-Amex-94-31) is hereby approved.
---------------------------------------------------------------------------
\26\15 U.S.C. 78s(b)(2) (1988).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation, pursuant
to delegated authority.\27\
---------------------------------------------------------------------------
\27\17 CFR 200.30-3(a)(12) (1991).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-25278 Filed 10-12-94; 8:45 am]
BILLING CODE 8010-01-M
