[Federal Register Volume 61, Number 197 (Wednesday, October 9, 1996)]
[Notices]
[Pages 52982-52985]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-25925]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37773; File No. SR-Amex-96-05]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval of Amendments Thereto Relating to
Assurances of Delivery for Short Sales of Derivative Securities into an
Underwriting Syndicate's Stabilizing Bid
October 1, 1996.
On January 31, 1996, the American Stock Exchange, Inc. (``Amex'' 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 require that members
trading derivative securities as Registered Options Traders
[[Page 52983]]
(``ROTs'') pursuant to Amex Rule 958 make prior arrangements either to
borrow the necessary securities or to obtain other affirmative
assurances that delivery can be made on settlement date prior to
effecting a short sale into an underwriting syndicate's stabilizing
bid.
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\1 \15 U.S.C. 78s(b)(1) (1988 & Supp. V 1993).
\2 \17 CFR Sec. 240.19b-4 (1994).
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Notice of the proposed rule change was published for comment and
appeared in the Federal Register on March 20, 1996.3 No comments
were received on the proposal. On June 12 and July 17, 1996,
respectively, Amex submitted Amendments No. 1 and 2 to the
proposal.4 This order approves the proposal, as amended, and
solicits comments on the Amendments.
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\3 \Securities Exchange Act Release No. 36956 (March 11, 1996),
61 FR 11451.
\4 \Letters from William Floyd Jones, Amex, to Stephen M. Youhn,
SEC dated June 10, 1996 (``Amendment No. 1'') and to Ivette Lopez,
SEC, dated July 17, 1996 (``Amendment No. 2,'' together with
Amendment No. 1, ``Amendments'').
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I. Description of the Proposal
Since 1989, the Exchange has required members and member
organizations effecting short sales for both customer and proprietary
accounts either to make prior arrangements to borrow the securities
sold short or to obtain other acceptable assurances that delivery can
be made on settlement date.5 Such assurances include knowledge
that the security is available for borrowing, conversion privileges,
rights exercises or other similar situations so long as the security
needed for delivery can be timely obtained. Short sales by specialists,
market makers and odd-lot dealers in fulfilling their market making
responsibilities are excepted from this requirement. Arbitrageurs and
other traders may not rely upon this ``market maker'' exception.
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\5 \See Securities Exchange Act Release No. 27542 (Dec. 15,
1989) (``Release No. 27542'').
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In 1992, the Exchange amended its rules to permit Registered Equity
Market Makers (``REMMs'') to register as ROTs in order to trade index
warrants for their own account subject to Amex Rule 958.6 The
Exchange deemed it desirable to enable members to trade these equity
derivative securities 7 subject to Rule 958 (which affords
specialist ``good faith'' margin treatment and an exemption from
stabilization requirements) instead of the more restrictive provisions
of Rules 111 and 114 applicable to REMMs because the Exchange believed
that application of Rules 111 and 114 to index warrants would make it
unlikely that members would trade such securities. The 1992 rule change
also exempted members trading as ROTs from the short sale policy given
their market making activities in index warrants.
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\6 \See Securities Exchange Act Release No. 24277 (June 8, 1992)
(``Release No. 24277''). The SEC has recently approved an Amex
proposal to allow regular members to trade currency warrants for
their own account subject to the provisions of Amex Rule 958. See
Securities Exchange Act Release No. 36852 (Feb. 15, 1996).
\7 \The term ``equity derivative security'' refers to an
underwritten security the value of which is determined by reference
to another security, or to a currency, commodity, interest rate or
index of the foregoing. Such securities are commonly listed pursuant
to Exchange Company Guide Sections 106, 107, 118 or Amex Rule 1102.
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According to the Exchange, the purpose of exempting Floor based
market makers from ``pre-borrowing'' is that such a requirement would
unacceptably interfere with market making activities, thereby degrading
liquidity. The exemptions from the ``pre-borrowing'' policy may,
however, create situations in the ordinary course of secondary market
trading where a market maker or ROT may be unable to borrow a security
it has sold short in connection with its market making obligations and,
therefore, fails to deliver the security within the normal settlement
cycle.
To prevent this result in one particular instance, the Exchange
proposes to modify its short sale policy to require ROTs who trade
equity derivatives pursuant to Rule 958 to make prior arrangements to
borrow these securities or obtain other acceptable assurances that
delivery can be made on settlement date in the limited situation where
they are selling short into the stabilizing bid of an underwriting
syndicate. Amex believes that implementation of this modified short
sale policy will provide increased stability to the market for listed
Amex equity derivative securities during a stabilized distribution. The
result will be a reduction in the number of ``fails'' (i.e., failure to
effect delivery of the security to the purchaser), and resulting ``buy-
ins'' (i.e., the purchase of the security of the account of the short
seller after it fails to deliver in accordance with the procedures of
the clearing corporation).
The Amex asserts that this filing addresses only short selling in a
distribution of equity derivatives that is being stabilized by the
underwriter. The Exchange believes that there is little or no need for
supplemental market making during a stabilized distribution since buy
side investor interest, in all likelihood, has been accurately gauged
and met by the underwriting syndicate either through the initial
distribution or an overallotment option. Likewise, sell side investor
interest will be met by the underwriting syndicate through the
stabilizing bid. As is the case with any equity or equity derivative
security, the Exchange notes that the specialist also is available to
supply liquidity to investors.
The Exchange notes that it does not seek to impose a pre-borrowing
requirement on ROTs who sell short on the offer in connection with
satisfying investor buying interest. The Exchange, moreover, does not
seek to prohibit short selling by ROTs. It only seeks to require ROTs
to obtain adequate assurances that an equity derivative such as an
index or currency warrant is available for borrowing. This ensures the
ROT's ability to settle the trade in accordance with their contractual
obligations.
According to the Exchange, selling into a stabilizing bid adds no
liquidity to the market since it involves selling to a bidder who may
prefer not to buy. The Exchange believes that to permit ROTs to sell
short without pre-borrowing where the sale by definition does not
provide liquidity and may result in a fail, is inconsistent with
allowing stabilization by underwriters to facilitate a distribution.
The Exchange believes that, while it is sound policy to permit market
to sell short without pre-borrowing in circumstances where the short
sale may add liquidity to the market, a short sale into a syndicate bid
is not such a circumstance.
Amex represents that a specialist, unlike a ROT, needs Floor
Official approval if it wishes to across the market to hit a bid to
establish or increase a short position. In such a circumstance, the
specialist must satisfy the Floor Official that the short sale is
appropriate relative to the condition of the general market, the market
in the particular stock and the adequacy of the specialist's position
to the immediate and reasonably anticipated needs of the full lot and
the odd lot market.\8\ Amex expects that a Floor Official would not
approve a specialist's short selling into an underwriting syndicate's
stabilizing bid because it would be difficult to imagine a circumstance
under which such a course of dealings would be necessary in relation to
the needs of the market for the security. As such, Amex does not
believe that a ROT would have any justification for selling short into
a stabilizing bid. Therefore, rather than make his actions subject to
Floor Official approval as could be required by the Exchange to address
the problem identified in the instant proposal, Amex
[[Page 52984]]
believes it is more beneficial to impose a pre-borrowing
requirement.\9\
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\8\ See Amex Rule 170, Commentary .01.
\9\ According to Amex, in one recent situation, a ROT sold short
into an underwriter's stabilizing bid more than five percent of the
total issuance of a currency warrant. When questioned by the
Exchange's staff as to how he intended to settle these trades, the
ROT responded that he did not know where he was going to obtain the
security and, in fact, expected to fail on settlement date. Amex
asserts that it frequently is difficult to borrow index or currency
warrants for short sale purposes as these securities may not be
marginable. As anticipated, the ROT failed to deliver the security
sold short and ultimately was ``bought-in.''
In the situation described above, the Exchange does not believe
the ROT in question was providing liquidity to investors. Instead,
the Exchange believes the ROT knowingly was taking advantage of the
existence of a stabilizing bid of an underwriting syndicate in order
to engage in a short sale speculation based on his opinion as to the
appropriate price of the security. While short selling can be a
perfectly proper strategy and can itself bring supply and demand
into balance, Amex believes that it is appropriate to constrain
potential excesses by rule.
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Amex represents that the New York Stock Exchange (``NYSE'') also
list equity derivative securities and that market makers on the NYSE
are subject to rules analogous to those applicable to REMMs on the
Amex, including rules relating to short selling (i.e., pre-borrowing
requirement). As a result, Amex believes that potential underwriters
may view this distinction between the rules of the NYSE and Amex as an
incentive to list equity derivatives on the NYSE.
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).\10\ In particular, the
Commission believes the proposal is consistent with the Section 6(b)(5)
requirement that the rules of an exchange be designated to promote just
and equitable principles of trade and not to permit unfair
discrimination between customers, issuers, brokers, and dealers.
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\10\ 15 U.S.C. 78f(b)(5) (1982).
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In approving the Amex's current short sale policy in 1982, the
Commission noted that the imposition of a formal affirmative borrowing
requirement on members effecting short sales for both customer and
proprietary accounts was appropriate for the protection of investors
and the maintenance of fair and orderly markets.\11\ By restricting
naked short selling,\12\ the Commission noted that the affirmative
borrowing requirement should curtail downward speculative selling
pressures in stocks traded on the Amex. The Commission noted, however,
that it was appropriate for the Exchange to exempt specialists, market
makers and odd-lot dealers from the general borrowing requirement in
fulfilling their market-making responsibilities, because their short
selling often was undertaken passively pursuant to their market-making
operations. In this connection, the Commission noted it was reasonable
for the Exchange not to exempt arbitrageurs and other traders from the
borrowing requirement because their short selling activities were not
passive in nature.\13\
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\11\ See Release No. 27542, supra note 5.
\12\ A naked security position may be defined as an unhedged or
uncovered security position that exposes the holder to the entire
market risk associated with the position. A short sale becomes a
naked short sale when the short seller or the short seller's broker
fails to borrow and deliver stock to the broker's clearing agent.
Brokers may fail to deliver stock to the clearing agent in long
sales as well, but such fails are normally for short periods or for
relatively small quantities of stock.
\13\ See Release No. 27542, supra note 5.
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When the Commission approved the Amex's 1992 proposal allowing
REMMs to trade equity derivatives as ROTs pursuant to Amex Rule 958,
these market makers assumed continuous affirmative market making
obligations in their assigned securities and were treated as
specialists.\14\ As a result, these ROTs were entitled to good faith
margin treatment and also were exempted from the affirmative
determination pre-borrowing requirement when engaging in short sales of
their assigned securities. The Commission stated that the purpose of
that rule change was to enhance supplemental market making activitiy in
equity derivatives, thereby increasing the depth and liquidity of the
market.\15\
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\14\ See Release No. 24277, supra note 6.
\15\ Id.
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Consistent with that finding, the Commission believes it is
reasonable for the Exchange to adopt this limited exception to its
short sale policy in order to require ROTs to make an affirmative
determination that an equity derivative security is available for
borrowing prior to selling short into the stabilizing bid of an
underwriting syndicate. The Commission believes that the imposition of
a pre-borrowing requirement should help to reduce the number of times
market makers sell short underwritten securities in distribution and
are unable to deliver on settlement date. By improving the settlement
mechanism of equity derivative securities which are sold short during
stabilized distributions, the Commission believes the depth and
liquidity of the equity derivative market will be enhanced.
As was stated in Release No. 27542, the Commission believes that
short selling by market makers in furtherance of bona-fide market
making obligations should not be restricted by imposing a pre-borrowing
requirement. The Commission does not believe, however, that market
makers who sell short for reasons other than in furtherance of their
market making responsibilities (e.g., speculation), should be relieved
from the pre-borrowing requirement. As such, the Commission believes
that the Amex proposal is a reasonable attempt to limit the
availability of the exemption from the affirmative determination
requirement to situations where a ROT is engaging in bona-fide market
making transactions.
In approving this proposal, the Commission notes that this policy
is strictly limited to instances where a ROT sells short into the
stabilizing bid of an underwriting syndicate. This policy does not
apply to a ROT's short sales outside of an underwritten distribution.
The Commission notes that a ROT may sell short in an ordinary secondary
market transaction without being required to make an affirmative
determination as to the security's availability for pare-borrowing. Nor
does this Ampex policy impose an affirmative borrowing requirement upon
every short sale undertaken by a ROT during an underwritten
distribution. A ROT may sell short into the offer side of the market
without a pre-borrowing requirement. Finally, the Commission notes that
this Amex policy will not operate as an outright prohibition of short
selling by a ROT. While ROTs may still engage in short sale
transactions, the availability of the exemption from the pre-borrowing
requirement will be limited strictly to short sales undertaken in the
course of bona fide market making activities. Accordingly, ROTs will be
required to comply with the affirmative pre-borrowing requirement prior
to selling short into the stabilizing bid of an underwriting syndicate.
The Commission finds good cause to approve the Amendments to the
filing prior to the thirtieth date after the date of publication of
notice thereof in the Federal Register. Although the Amendments clarify
the original proposal and provide more detailed justification for
adopting the instant policy, the Commission notes that they do not
change the substance of the Amex proposal as originally filed. Although
the filing results in an expansion of the applicability of the Amex
short sale policy, the Commission notes that the underlying short sale
policy is not changed by the Amendments. Accordingly, the
[[Page 52985]]
Commission believes that Amendments raise no new or unique issues that
were not already presented in the original filing. The Commission notes
also that the original proposal was subject to the full notice and
comment period and no comment letters were received. Accordingly,
consistent with Section 6(b)(5) of the Act, the Commission believes
that good exists to approve the Amendments to the filing on an
accelerated basis.
III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the Amendments. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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. Sec. 552, will be available for inspection and copying at
the Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing will also be available
for inspection and copying at the principal office of the Amex. All
submission should refer to File No. SR-Amex-96-05 and should be
submitted by October 30, 1996.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\16\ that the proposal rule change (File No. SR-Amex-96-05) is
approved, as amended.
\16\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\17\
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\17\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-25925 Filed 10-8-96; 8:45 am]
BILLING CODE 8010-01-M
