[Federal Register Volume 59, Number 199 (Monday, October 17, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25554]
[[Page Unknown]]
[Federal Register: October 17, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34810; File No. SR-PSE-94-12]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of a Proposed Rule Change and Amendment
Nos. 1, 2, and 3 to the Proposed Rule Change by the Pacific Stock
Exchange, Inc. Relating to Exercise Cut-Off Procedures for Expiring
Equity Options
October 7, 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 May 25, 1994, the Pacific Stock Exchange (``PSE'' or ``Exchange'')
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. The PSE filed Amendment No. 1 to
the proposed rule change on June 17, 1994, Amendment No. 2 on September
19, 1994, and Amendment No. 3 on September 30, 1994.\3\ The Commission
is publishing this notice to solicit comments on the proposed rule
change, as amended, from interested persons. This order also approves
the proposed rule change, as amended, on an accelerated basis.\4\
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\In Amendment Nos. 1, 2, and 3 the PSE proposes to make
certain clarifying amendments to Rule 6.24, as discussed herein. In
addition, Amendment No. 3 requests accelerated effectiveness of the
proposed rule change. See Letters from Michael Pierson, Senior
Attorney, Market Regulation, PSE, to Francois Mazur, Attorney,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated June 17, 1994; from
David Semak, Vice President, Regulation, PSE, to Brad Ritter, Senior
Counsel, OMS, Division, Commission, dated September 19, 1994
(``Amendment No. 2''); and from Michael Pierson, Senior Counsel,
OMS, Division, Commission, dated September 30, 1994 (``Amendment No.
3'').
\4\See infra Section III.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The PSE proposes to amend its rules on procedures relating to the
exercise of expiring equity option contracts.\5\ The text of the
proposed rule change is available at the Office of the Secretary, PSE,
and at the Commission.
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\5\The Commission notes that substantively similar proposals by
the other options exchanges are being approved concurrently with the
PSE's proposed rule change. See File Nos. SR-Amex-94-01; SR-CBOE-94-
06; and SR-Phlx-93-37.
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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 IV below. The PSE 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
The Exchange is proposing to amend its Rule 6.24 in several
respects. First, the Exchange is proposing to add a new Commentary .04
to Rule 6.24 in order to incorporate a new exercise cut-off procedure
for expiring equity options. Second, the Exchange is proposing to add
new commentary .05 to Rule 6.24 to address the responsibility for the
submission of final exercise decisions to the Exchange and to provide
that member firms may establish internal processing cut-off times prior
to the Exercise Cut-Off Time (as defined herein).\6\ Third, the
Exchange is proposing to add a new Commentary .06 to Rule 6.24 in order
to address situations in which a member submits or prepares an exercise
instruction after the 5:30 p.m. Eastern Standard Time (``E.S.T.'')
exercise cut-off time (``Exercise Cut-Off Time'') in an expiring equity
option on the basis of material information that is released after the
Exercise Cut-Off Time.\7\ Finally, the Exchange proposes to modify
subsection (b) of Rule 6.24 to clarify that the provisions of Rule 6.24
only apply to non-cash settled equity option contracts.
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\6\See Amendment No. 2, supra note 3.
\7\Id.
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More specifically, proposed Commentary .04 would provide that
clearing members must follow the procedures of The Options Clearing
Corporation (``OCC'') when exercising expiring non-cash settled equity
option contracts. It also provides that members must follow certain
procedures with respect to the exercising of non-cash settled equity
option contracts which would otherwise not be exercised, or the non-
exercising of option contracts which otherwise would be exercised, by
operation of OCC Rule 805.\8\
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\8\OCC Rule 805 provides for automatic exercise of in-the-money
options at expiration without the submission of an exercise notice
to the OCC if the price of the security underlying the option is at
or above a certain price (for calls) or at or below a certain price
(for puts); and the non-exercise of an option at expiration if the
price of the security underlying the option does not satisfy such
price levels. See OCC Rule 805.
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Pursuant to the proposal, there will be two means of exercising an
expiring equity option: (1) Take no action and allow exercise
determinations to be made in accordance with OCC Rule 805; or (2) the
market maker, floor broker, or clearing member, as applicable, must
submit a contrary exercise advice (i.e., a notice committing an option
holder either to exercise an option that would not otherwise be
exercised automatically pursuant to OCC Rule 805, or not exercise an
option that otherwise would be exercised automatically pursuant to OCC
Rule 805) (``Contrary Exercise Advice''). Contrary Exercise Advices
would be submitted by a market maker, floor broker, or clearing member
either: (1) In such form or manner prescribed by the Exchange to a
place designated by the Exchange; or (2) to the Exchange via the OCC in
a format prescribed by the OCC. The proposal also provides that
subsequent to the delivery of a Contrary Exercise Advice, should the
market maker, floor broker, customer, or firm determine to act other
than as reflected on the original contrary Exercise Advice, an ``advice
cancel'' must also be delivered in such form or manner prescribed by
the Exchange to a place designated by the Exchange no later than the
Exercise Cut-Off Time.
Subsection (c) to Commentary .04 would also be amended to provide
that all of the procedures of Commentary .04 are in full force and
effect whether or not the OCC waives the exercise-by-exception
provisions of OCC Rule 805.\9\ In the event of such waiver, the
procedures of Commentary .04 shall be followed as if such provisions of
OCC Rule 805 were in full force and effect.\10\
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\9\The Commission notes that this could occur where an
underlying security is not traded on its primary market on the
trading day immediately preceding an expiration date and, as a
result, the OCC determines not to fix a closing price for that
security. See OCC Rule 805(l).
\10\When the OCC waives the exercise-by-exception procedure, the
OCC's rules require submission of an affirmative exercise notice for
all exercises even in circumstances where a Contrary Exercise Advice
is not required to be submitted to the Exchange. See Amendment No.
3, supra note 3.
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Subsection (e) to Commentary .04 provides that the failure of any
member to follow the procedures set forth in Commentary .04 may be
referred to the Ethics and Business Conduct Committee and result in the
assessment of a fine, which may include, but is not limited to,
disgorgement of potential economic gain obtained or loss avoided by the
subject exercise, as determined by the Ethics and Business Conduct
Committee.\11\
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\11\If any member relies on one of the exceptions to Rule
6.24(b) as the basis for the failure of the member to comply with
the procedures set forth in new Commentary .04, the burden shall be
on the member to establish the grounds for the exception. Telephone
conversation between Michael Pierson, Senior Attorney, Market
Regulation, PSE, and Brad Ritter, Senior Counsel, OMS, Division,
Commission, on October 6, 1994. The only exceptions to Rule 6.24
are: (1) To remedy mistakes or errors made in good faith; (2) to
take appropriate action as the result of a failure to reconcile
unmatched Exchange transactions; and (3) where exceptional
circumstances relating to a customer's or member's ability to
communicate exercise instructions to a member organization (or a
member organization's ability to receive such exercise instructions)
prior to the Exercise Cut-Off Time warrant such action.
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Proposed Commentary .05 provides that members and member
organizations shall properly communicate, in accordance with Rule 6.24,
final exercise decisions to the Exchange in respect of options
positions for which they are responsible.\12\ Additionally, Commentary
.05 also will provide that member organizations may establish an
internal processing cut-off time prior to the Exercise Cut-Off Time at
which time final exercise decisions from their customers will no longer
be accepted by them for expiring options.\13\
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\12\See Amendment No. 2, supra note 3.
\13\Id.
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Finally, proposed Commentary .06 provides that if a member submits
or prepares an exercise instruction after the Exercise Cut-Off Time in
any expiring option on the basis of material information that is
released after the Exercise Cut-Off Time, then such activity is
inconsistent with just and equitable principles of trade.\14\
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\14\Id.
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The Exchange believes that the proposed rule change is consistent
with Section 6 of the Act, in general, and furthers the objectives of
Section 6(b)(5) of the Act, in particular, in that it is designed to
prevent fraudulent and manipulative acts and practices and to promote
just and equitable principles of trade.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any inappropriate burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
Written comments on the proposed rule change were neither solicited
nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
The PSE has requested that the proposed rule change be given
accelerated effectiveness pursuant to Section 19(b)(2) of the Act.\15\
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\15\See Amendment No. 3, supra note 3.
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The Commission believes that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to national securities exchanges, particularly,
Section 6(b)(5) of the Act.\16\ Specifically, the Commission believes
the Exchange's proposal 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
protect investors and the public interest.
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\16\15 U.S.C. 78f(b)(5) (1988).
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Although all options exchanges currently have a uniform 5:30 p.m.
(e.s.t.) Exercise Cut-Off Time for expiring equity options,\17\ the
OCC's rules permit the OCC to accept exercise notices for expiring
equity options from clearing firms until 12 a.m. (e.s.t.) on the
expiration date (i.e., the Saturday after an Expiration Friday). This
additional time within which to receive exercise notices from clearing
members was provided to accommodate corrections of mistakes made in
good faith, trade reconciliations, and certain exceptional
circumstances that affected a customer's ability to inform its
brokerage firm or affected a firm's ability to receive final exercise
decisions before the Exercise Cut-Off Time. Because exercise
instructions presently are submitted to clearing members and then to
the OCC by the clearing members, without having the audit trail pass
directly through the Exchange, it is difficult for the Exchange to
surveil for violations of Rule 6.24.\18\ As a result, there have been
situations where member organizations have either delayed making
exercise decisions until after 5:30 p.m. (e.s.t.) on Expiration Friday
in anticipation of the release of material news concerning a particular
underlying company, or having made decisions prior to 5:30 p.m.
(e.s.t.), changed these decisions based upon such material news.\19\
The Commission, therefore, believes that it is appropriate for the
Exchange to make it clear in its rules that the submission of a
Contrary Exercise Advice on the basis of material information released
after the Exercise Cut-Off Time will be actively deemed inconsistent
with just and equitable principles of trade.\20\
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\17\Generally, equity options may be traded until the close of
business on the last business day before expiration, which is
generally the third Friday of the expiration month (``Expiration
Friday'').
\18\The Commission believes that the Executive Cut-Off Time
serves an important investor protection function. Specifically, the
Exercise Cut-Off Time protects holders of short positions in equity
options from unanticipated events occurring after the close of the
market. As the Commission has previously stated, if expiring equity
options were allowed to be exercised after the Exercise Cut-Off Time
for reasons other than the exceptions set forth above, the
Commission believes that options writers could be unfairly
disadvantaged with respect to options holders by not having the same
opportunity to react to such unanticipated events. See Securities
Exchange Act Release No. 19589 (March 10, 1983), 48 FR 11196 (March
16, 1983).
\19\See e.g., In re Farmers Group Stock Options Litigation,
Master File No. 88-4994 (E.D.Pa 1989).
\20\See supra note 18.
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The Commission believes that the proposed exercise procedures
should enhance the Exchange's ability to surveil for violations of Rule
6.24 by providing an enhanced audit trail for identifying late
exercises. Specifically, every time an exercise decision is made
contrary to OCC Rule 805, a Contrary Exercise Advice must be filed with
the Exchange,\21\ in addition to submitting an exercise instruction to
a clearing member as is currently required.\22\ Similarly, the proposal
requires that documentation must be prepared and submitted to the
proper options exchange whenever a late exercise decision is made in
reliance on one of the exceptions to Rule 6.24, with the burden of
establishing the existence of the exception on the party submitting the
Contrary Exercise Advice. The proposed rule change, therefore, should
facilitate the Exchange's ability to monitor and enforce compliance
with Rule 6.24.\23\ Accordingly, because the proposed rule change
significantly bolsters the Exchange's existing procedures regarding the
exercise of expiring equity options and helps to ensure compliance with
their rules, the Commission believes that the proposal is consistent
with the Act.\24\
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\21\Even though this may be accomplished by submitting exercise
decisions directly to the Exchange, the more likely manner of
accomplishing this will be to submit the exercise decisions to the
Exchange electronically through the Clearing Management and Control
System (``C/MACS''). Due to the burden that would be placed on
members of having to manually process every exercise decision for
delivery directly to the Exchange, the procedures and rules being
approved herein will not be implemented by the PSE until the OCC
submits a written representation to the Commission that C/MACS have
been modified as necessary, fully tested, and ready to go on-line,
to allow members to submit exercise decisions to the Exchange
through C/MACS. This process is expected to be completed in time for
the November 1994 expirations.
\22\For customers, an exercise instruction is a notice delivered
to a member organization to exercise an option. For a clearing
member, market maker, or floor broker, an exercise instruction is a
notice to the OCC to exercise an option that would not be
automatically exercised pursuant to OCC Rule 805, or not to exercise
an option that otherwise would automatically be exercised pursuant
to OCC Rule 805. The OCC has separate rules regarding the cut-off
time by which exercise notices must be delivered to the OCC by the
clearing members. The proposed rule change does not in any way
affect the rules of the OCC in this regard. Because the OCC's rules
are not changing, the reporting of final exercise decisions as
contemplated by the revised rule does not serve to substitute as the
effective exercise notice to OCC for the exercise or non-exercise of
expiring options. The Commission also notes that the proposed
procedures discussed herein are in addition to the Exchange's
existing procedures regarding the submission of exercise
instructions to clearing members, which for the most part, are not
being amended by this proposal. See PSE Rule 6.24.
\23\PSE Rule 6.24 does not apply to expiring series of index
options on the business day immediately prior to expiration. See PSE
Rules 7 (Introduction) and 7.15(f). An additional purpose of the
proposed rule change is to specifically state within Rule 6.24 that
the Exercise Cut-Off Time does not apply to expiring index options.
\24\The Commission notes that the PSE has represented that it
will prepare (in cooperation with the other options exchanges) and
distribute a notice to member organizations describing the new
procedures set forth above, and notifying member organizations as to
when the new procedures will be fully in effect. See supra notes 5
and 21.
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Even though the proposed rule change significantly improves the
Exchange's audit trail with respect to late exercises, the Commission
believes that the Exchange should continue to examine ways of ensuring
compliance with the Exercise Cut-Off Time and the other requirements of
Rule 6.24. In this regard, the Commission encourages the Exchange to
review the permitted exceptions to Rule 6.24 and consider ways of
establishing parameters as to the extent of the exceptions.\25\
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\25\For example, the Exchange may want to define expressly in
the rule the circumstances that qualify for a good faith exception.
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The Commission finds good cause for approving the proposed rule
change, as amended, prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Specifically, the Commission notes that the amended proposal is
substantively similar to proposals submitted by the other options
exchanges, which are being approved concurrently with the PSE's
proposed rule change.\26\ Additionally, each of the proposals submitted
by the other exchanges was noticed for the full comment period without
any comments being received by the Commission. Finally, Amendment Nos.
1, 2, and 3 to the PSE proposal, as was the case with the amendments to
the proposals submitted by the other options exchanges, merely clarify
the application of the rules and may serve to minimize confusion and
disputes between and among members and customers as to the application
of Rule 6.24, as amended. Accordingly, the Commission believes that it
is consistent with section 6(b)(5) of the Act to approve the proposed
rule change, as amended, on an accelerated basis.
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\26\See supra note 5.
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Interested persons are invited to submit written data, views and
arguments concerning the proposed rule change, as amended. Persons
making written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street NW.,
Washington, DC 20549. Copies of the submissions, 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 filings will also be available for inspection and copying at
the principal office of the PSE. All submissions should refer to File
No. SR-PSE-94-12 and should be submitted by November 7, 1994.
It Is Therefore Ordered, Pursuant to section 19(b)(2) of the
Act,\27\ that the proposed rule change (File No. SR-PSE-94-12), as
amended, is hereby approved.\28\
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\27\15 U.S.C. 78s(b)(2) (1982).
\28\The Commission notes, however, that the proposed rule change
will not be implemented until the Commission receives certain
written representations from the OCC regarding the operational
status of C/MACS. See supra note 21.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-25554 Filed 10-14-94; 8:45 am]
BILLING CODE 8010-01-M
