[Federal Register Volume 60, Number 204 (Monday, October 23, 1995)]
[Notices]
[Pages 54395-54398]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26182]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36381; File No. SR-CBOE-95-38]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving Proposed Rule Change Relating to the Listing and
Trading of Warrants on the CBOE Technology 50 Index
October 17, 1995.
On August 1, 1995, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b) of
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to list and trade warrants based
on the CBOE Technology 50 Index (``Tech 50 Index'' or ``Index''). The
Exchange subsequently filed Amendment No. 1 to the proposal on August
2, 1995,\3\ Amendment No. 2 on August 3, 1995,\4\ and Amendment No. 3
on August 29, 1995.\5\
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988 & Supp. V 1993).
\2\ 17 CFR 240.19b-4 (1994).
\3\ As a result of the Commission's approval of the Exchange's
Generic Warrant Listing Standards (as defined herein), Amendment No.
1 has been rendered moot.
\4\ In Amendment No. 2, as discussed herein, the CBOE amended
certain of the objective standards set forth in the section of its
proposal entitled ``Classification of the Index as Broad-Based.''
See Letter from Timothy Thompson, CBOE, to Michael Walinskas, SEC,
dated August 3, 1995 (``Amendment No. 2'').
\5\ In Amendment No. 3, as discussed herein, the Exchange
amended the composition of the Index to, in the Exchange's opinion,
provide better balance between the technology industry subsectors
represented in the Index. See Letter from William Speth, Jr., Senior
Research Analyst, Research Department, CBOE, to Brad Ritter, Senior
Counsel, SEC, dated August 29, 1995 (``Amendment No. 3'').
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Notice of the proposed rule change and Amendment Nos. 1, 2, and 3
thereto were published for comment and appeared in the Federal Register
on
[[Page 54396]]
September 15, 1995.\6\ No comments were received on the proposal. This
order approves the proposal, as amended.
\6\ See Securities Exchange Act Release No. 36207 (Sept. 8,
1995), 60 FR 47970.
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I. Description of the Proposal
The purpose of the proposed rule change is to permit the Exchange
to list and trade cash-settled index warrants based on the Tech 50
Index (``Index Warrants''). On August 29, 1995, the Commission approved
an Exchange proposal that established uniform listing and trading
guidelines for stock index, currency and currency index warrants
(``Generic Warrant Listing Standards Approval Order'').\7\ The Exchange
states that the listing and trading of warrants based on the Tech 50
Index will comply in all respects with the Generic Warrant Listing
Standards Approval Order.
\7\ See Securities Exchange Act Release No. 36169 (August 29,
1995).
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Index Design
The Exchange represents that the Tech 50 Index is a broad-based
index comprised of stocks of 50 of the largest domestic technology
companies, representing various industry groups. The Index was designed
by and will be maintained by the CBOE. The Index is price-weighted and
reflects changes in the prices of the component stocks relative to the
Index base date, January 3, 1995, when the Index was set to an initial
level of 200.00.
On August 15, 1995, the 50 stocks in the Index ranged in market
capitalization from a low of approximately $829.28 million to a high of
approximately $82.47 billion. Total market capitalization for the Index
on August 15, 1995, was approximately $578.53 billion. The highest
weighted stock in the Index on that date accounted for 5.62% of the
weight of the Index and the lowest weighted security in the Index
accounted for 0.68% of the weight of the Index. In aggregate, the five
highest weighted components on that date accounted for 21.45% of the
weight of the Index. Currently, the Exchange represents that all of the
component stocks are eligible for the listing of standardized options
on the Exchange pursuant to CBOE Rule 5.3.
As of August 15, 1995, the Exchange represents that the industry
breakdown for the Index, by weight, was as follows: (1) Computer
hardware--8.20%; (2) computer software--14.63%; (3) computers systems
and services--11.12%; (4) integrated circuit components--10.43%; (5)
semiconductors--12.66%; (6) precision instrumentation--3.15%; (7)
medical technology--8.74%; (8) network and server systems--10.14%; (9)
telecommunication components--12.62%; and (10) telecommunications--
8.31%.\8\
\8\ Id.
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Warrant Terms
Index Warrants will be direct obligations of their issuer, subject
to cash-settlement in U.S. dollars and either exercisable throughout
their life (i.e., American-style) or exercisable only immediately prior
to their expiration date (i.e., European-style). Upon exercise (or at
the warrant expiration date in the case of warrants with European-style
exercise), the holder of an Index Warrant structured as a ``put'' will
receive payment in U.S. dollars to the extent that the value of the
Index has declined below a pre-stated cash settlement value.
Conversely, upon exercise (or at the warrant expiration date in the
case of warrants with European-style exercise), the holder of an Index
Warrant structured as a ``call'' will receive payment in U.S. dollars
to the extent that the Index value has increased above a pre-stated
cash settlement value. Index Warrants that are out-of-the-money at the
time of expiration will expire worthless.
Maintenance of the Index
The Index will be maintained by the Exchange and will be reviewed
monthly.\9\ The CBOE may change the composition of the Index at any
time to reflect changes affecting the components of the Index or the
various technology industry subsectors represented in the Index. If it
becomes necessary to remove a stock from the Index (e.g., because of a
takeover or merger), the CBOE will take into account the
capitalization, liquidity, volatility, and name recognition of any
proposed replacement security.\10\
\9\ These reviews are mainly for the purpose of determining
whether to make composition changes to the Index and generally are
not for the purpose of applying the proposed objective standards for
ensuring that the Index remains broad-based (see ``Classification of
the Index as Broad-Based,'' infra). Telephone conversation among
Timothy Thompson, CBOE, Eileen Smith, CBOE, and Brad Ritter, SEC, on
August 3, 1995.
\10\ Whenever a new component is added to the Index, the CBOE
will apply those objective standards proposed for ensuring that the
Index remains broad-based (see ``Classification of the Index as
Broad-Based,'' infra) that could be affected by the addition of a
new component security to the Index. Telephone conversation between
Timothy Thompson, CBOE, and Brad Ritter, SEC, on August 4, 1995.
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The Exchange intends to maintain the Index with 50 components,
however, the Exchange may increase the number of components in the
Index by up to 33%, i.e., 66 stocks.\11\
\11\ The Commission notes that the Exchange will be required to
distribute a circular to members notifying them of any change in the
components of the Index. Further, if the Exchange determines to
maintain the Index with some number of components other than 50, the
Exchange will be required to change the name of the Index. In such
an event, the Exchange should immediately notify the Commission to
determine whether a rule filing pursuant to Section 19(b) of the Act
will be required.
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Calculation and Dissemination of the Value of the Index
The Index value will be calculated by the CBOE or its designee on a
real-time base using last-sale prices, and will be publicly
disseminated every 15 seconds. If a component stock is not currently
being traded, the most recent price at which the stock traded will be
used in the Index value calculation. The value of the Index as of the
close of trading on September 29, 1995, was 335.22.
The Index is price-weighted and reflects changes in the prices of
the component stocks relative to the base date of January 3, 1995, when
the Index was set to an initial value of 200.00. Specifically, the
Index value is calculated by adding the prices of the component stocks
and then dividing this sum by the Index divisor.\12\ The Index divisor
is adjusted to reflect non-market changes in the prices of the
component securities as well as changes in the composition of the
Index. Changes that may result in divisor changes include, but are not
limited to, stock splits and dividends (other than ordinary cash
dividends), spin-offs, certain issuances, and mergers and acquisitions.
\12\ As of August 15, 1995, the share prices of the Index
components ranged from a high of $158.13 to a low of $19.00. See
Amendment No. 3.
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Classification of the Index as Broad-Based
The CBOE has designed the Index to meet certain objective criteria
which it believes are appropriate to classify the Index as broad-based
for warrant trading.\13\ To ensure that the Index remains
representative of a broad spectrum of the various high technology
industries and is comprised of relatively actively-traded stocks, the
Exchange will maintain the Index according to the following guidelines:
(1) Each underlying security selected for inclusion in the Index must
have an average daily trading volume of at least 75,000 shares during
the preceding six months; (2) each underlying security included in the
Index must thereafter maintain an average daily trading volume of at
least 50,000 shares during
[[Page 54397]]
the preceding six months; (3) no underlying security will represent
more than 15% of the total weight of the Index; (4) the five most
heavily weighted securities in the Index will not represent more than
40% of the total weight of the Index; (5) the Index will be comprised
of at least ten technology industry subsectors (i.e., Standard Industry
Classification (``SIC'') codes) representing a total of no less than 50
underlying securities; and (6) at least 75% of the total weight of the
Index will be represented by underlying securities that are eligible
for the listing of standardized options pursuant to CBOE Rule 5.3. The
Exchange will conduct semi-annual reviews of the underlying securities
included in the Index to assure that the Index continues to meet the
standards set forth above. The Exchange represents that the above
guidelines are similar to the requirements set forth in Interpretation
.01 to Rule 7.3 of the Pacific Stock Exchange (``PSE'') regarding the
designation of the PSE's High Technology Index as a broad-based index
for purposes of the trading of standardized options.\14\
\13\ See Amendment No. 2.
\14\ Securities Exchange Act Release No. 29994, 56 FR 63536
(Dec. 4, 1991).
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Warrant Listing Standards and Customer Safeguards
As discussed earlier, the Exchange has established Generic Warrant
Listing Standards.\15\ The Exchange represents that the Generic Warrant
Listing Standards will be applicable to the listing and trading of
index warrants generally, including Tech 50 Index warrants. These
standards will govern all aspects of the listing and trading of index
warrants, including, issuer eligibility,\16\ position and exercise
limits,\17\ reportable positions,\18\ automatic exercise,\19\
settlement,\20\ margin,\21\ and trading halts and suspensions.\22\
\15\ See supra note 7 and accompanying text.
\16\ See CBOE Rule 31.5E (1) and (4). Issuers are required to
have a minimum tangible net worth in excess of $250 million or, in
the alternative, have a minimum tangible net worth in excess of $150
million, provided that the issuer does not have (including as a
result of the proposed issuance) issued and outstanding warrants
where the aggregate original issue price of all such warrant
offerings (combined with offerings by its affiliates) listed on a
national securities exchange or securities association exceeds 25%
of the issuer's net worth.
\17\ See CBOE Rule 30.35. In particular, under CBOE Rule 30.35,
no member can control an aggregate position in a stock index warrant
issue, or in all warrants issued on the same stock index, on the
same side of the market, in excess of 15,000,000 warrants
(12,500,000 warrants with respect to warrants on the Russell 2000
Index) with an original issue price of ten dollars or less. Stock
index warrants with an original issue price greater than ten dollars
will be weighted more heavily in calculating position limits.
CBOE Rule 30.35 also establishes exercise limits on stock index
warrants which are analogous to those found in stock index options.
The rule prohibits holders from exercising, within any five
consecutive business days, long positions in warrants in excess of
the base position limit set forth above.
\18\ See CBOE Rules 30.50(d) and 4.13.
\19\ See CBOE Rule 31.5E(6).
\20\ See CBOE Rule 31.5E(5).
\21\ See CBOE Rule 30.53. In general, the margin requirements
for long and short positions in stock index warrants are the same as
margin requirements for long and short positions in stock index
options. Accordingly, all purchases of warrants will require payment
in full, an short sales of stock index warrants will require initial
margin of: (i) 100 percent of the current value of the warrant plus
(ii) 15 percent of the current value of the underlying broad stock
index less the amount by which the warrant is out of the money, but
with a minimum of ten percent of the index value.
\22\ See CBOE Rules 30.36 and 24.7.
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Additionally, these warrants will be sold only to accounts approved
for the trading of standardized options\23\ and, the Exchange's options
suitability standards will apply to recommendations in Index
warrants.\24\ The Exchange's rules regarding discretionary orders will
also apply to transactions in Index warrants.\25\ Finally, prior to the
commencement of trading, the Exchange will distribute a circular to its
membership calling attention to certain compliance responsibilities
when handling transactions in Tech 50 Index warrants.
\23\ See CBOE Rules 30.52(c) and 9.7.
\24\ See CBOE Rules 30.52(d) and 9.9.
\25\ See CBOE Rule 30.50, Interpretation .03 (requiring that the
standards of Rule 9.10 be applied to index warrant transactions).
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II. Discussion
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, the requirements of Section 6(b)(5) of the Act.\26\
Specifically, the Commission finds that the trading of warrants based
on the Tech 50 Index will serve to protect investors, promote the
public interest, and help to remove impediments to a free and open
securities market by providing investors holding positions in some or
all of the securities underlying the Index with a means to hedge
exposure to market risk associated with their portfolios.\27\ The
trading of warrants based on the Tech 50 Index should provide investors
with a valuable hedging vehicle that should reflect accurately the
overall movement of technology industry securities.
\26\ 15 U.S.C. 78f(b) (5).
\27\ Pursuant to Section 6(b) (5) of the Act, the Commission
must predicate approval of any new securities product upon a finding
that the introduction of such product is in the public interest.
Such a finding would be difficult with respect to a warrant 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.
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Nevertheless, the trading of warrants on the Tech 50 Index raises
several concerns related to index design, customer protection,
surveillance, and market impact. The Commission believes, however, for
the reasons discussed below, that the CBOE has adequately addressed
these concerns.
A. Index Design and Structure
The Commission finds that it is appropriate and consistent with the
Act for the CBOE to designate the Index as a broad-based index for
warrant trading. First, the high-technology sector is a substantial
segment of the U.S. equities market, and the Index reflects that
segment. Second, the Index includes multiple industries within the
high-tech sector, such as medical technology, telecommunications and
telecommunication components, and does not rely solely on computer-
related companies. Third, the Index consists of 50 actively traded
stock (all options eligible), of which 25 trade on Nasdaq and 25 trade
on the NYSE. Fourth, the market capitalization of the stocks comprising
the Index are very large. Specifically, the total capitalization of the
Index, as of August 15, 1995, was approximately $578.5 billion, with
the market capitalization of the individual stocks in the Index ranging
from a high of $82.47 billion to a low of $829.28 million, with a mean
value of $11.57 billion. Fifth, no one particular stock or group of
stocks dominates the weight of the Index. Specifically, as of August
15, 1995, no single stock accounted for more than 5.62% of the Index's
total value, and the percentage weighting of the five largest issues in
the Index accounted for 21.45% of the Index's value. Additionally, the
lowest weighted stock in the Index accounted for 0.68% of the Index's
value. Accordingly, the Commission believes it is appropriate to
classify the Index as broad-based so that the CBOE may list
[[Page 54398]]
warrants for trading pursuant to the Generic Warrant Listing
Standards.\28\
\28\ See supra note 7 and accompanying text.
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B. Customer Protection
Special customer protection concerns are presented by Tech 50 Index
warrants because they are leveraged derivative securities. The CBOE has
addressed these concerns, however, by applying the special suitability,
account approval, disclosure, and compliance requirements adopted in
the Generic Warrant Listing Standards Approval Order. Moreover, the
CBOE plans to distribute a circular to its membership identifying the
specific risks associated with Tech 50 Index warrants. Finally,
pursuant to the Exchange's listing guidelines, only substantial
companies capable of meeting CBOE index warrant issuer standards will
be eligible to issue Index warrants.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a security index derivative
product and the exchange(s) trading the securities 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 security
index product less readily susceptible to manipulation.\29\ In this
regard, the CBOE, NYSE, and NASD are all members of the Intermarket
Surveillance Group, which provides for the exchange of all necessary
surveillance information.\30\
\29\ Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\30\ The Intermarket Surveillance Group (``ISG'') was formed on
July 14, 1983 to, among other things, coordinate more effectively
surveillance and investigative information sharing arrangements in
the stock and options markets. See Intermarket Surveillance Group
Agreement, July 14, 1983. The most recent amendment to the ISG
Agreement, which incorporates the original agreement and all
amendments made thereafter, was signed by ISG members on January 29,
1990. See Second Amendment to the Intermarket Surveillance Group
Agreement, January 29, 1990. The members of the ISG are: the
American Stock Exchange, Inc.; the Boston Stock Exchange, Inc.;
CBOE; the Chicago Stock Exchange Inc.; the National Association of
Securities Dealers, Inc. (``NASD''); the NYSE; the Pacific Stock
Exchange, Inc.; and the Philadelphia Stock Exchange, Inc. Because of
potential opportunities for trading abuses involving stock index
futures, stock options, and the underlying stock and the need for
greater sharing of surveillance information for these potential
intermarket trading abuses, the major stock index futures exchanges
(e.g., the Chicago Mercantile Exchange and the Chicago Board of
Trade) joined the ISG as affiliate members in 1990.
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D. Market Impact
The Commission believes that the listing and trading of Tech 50
Index warrants on the CBOE will not adversely impact the underlying
securities. First, the existing index warrants surveillance procedures
of the CBOE will apply to warrants on the Index. In addition, the
Commission notes that the Index is broad-based and diversified and
includes highly capitalized securities that are actively traded.
Additionally, the CBOE has established reasonable position and exercise
limits for stock index warrants, which will serve to minimize potential
manipulation and other market impact concerns.
It Therefore is Ordered, pursuant to Section 19(b) (2) of the
Act,\31\ that the proposed rule change (SR-CBOE-95-38) is approved, as
amended.
\31\ 15 U.S.C. Sec. 78s(b) (2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\32\
\32\ 17 CFR 200.30-3(a) (12) (1994)
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[FR Doc. 95-26182 Filed 10-20-95; 8:45 am]
BILLING CODE 8010-01-M
