94-2711. Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Order Approving, and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to, a Proposed Rule Change Relating to the Listing of Options on American ...  

  • [Federal Register Volume 59, Number 25 (Monday, February 7, 1994)]
    [Unknown Section]
    [Page 0]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 94-2711]
    
    
    [[Page Unknown]]
    
    [Federal Register: February 7, 1994]
    
    
    -----------------------------------------------------------------------
    
    SECURITIES AND EXCHANGE COMMISSION
    [Release No. 34-33553; International Series Release No. 632; File No. 
    SR-Phlx-93-54]
    
     
    
    Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
    Order Approving, and Notice of Filing and Order Granting Accelerated 
    Approval of Amendment No. 1 to, a Proposed Rule Change Relating to the 
    Listing of Options on American Depositary Receipts
    
    January 31, 1994.
    
    I. Introduction
    
        On November 15, 1993, the Philadelphia Stock Exchange, Inc. 
    (``Phlx'' or ``Exchange'') submitted to the Securities and Exchange 
    Commission (``Commission'' or SEC''), 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 provide for the listing and 
    trading of options on American Depositary Receipts (``ADRs'') where 50% 
    or more of the world-wide trading volume of the underlying foreign 
    security occurs in the U.S. ADR market.
    ---------------------------------------------------------------------------
    
        \1\15 U.S.C. 78s(b)(1) (1988).
        \2\17 CFR 240.19b-4 (1993).
    ---------------------------------------------------------------------------
    
        The proposed rule change was published for comment in Securities 
    Exchange Act Release No. 33252 (November 26, 1993), 58 FR 63604 
    (December 2, 1993). No comments were received on the proposed rule 
    change.\3\
    ---------------------------------------------------------------------------
    
        \3\The proposal was amended on January 5, 1994 to clarify the 
    procedure the Phlx would use to determine whether 50% or more of the 
    world-wide trading volume of the underlying foreign security occurs 
    in the U.S. ADR market. Letter from Michele R. Weisbaum, Associate 
    General Counsel, Phlx, to Monica C. Michelizzi, Staff Attorney, 
    Office of Derivatives Regulation, Division of Market Regulation 
    (``Division''), Commission, dated January 5, 1994 (``Amendment No. 
    1``).
    ---------------------------------------------------------------------------
    
    II. Description
    
        On November 27, 1992, the Commission approved a Phlx proposal to 
    list and trade ADR options where the underlying foreign security is 
    subject to a comprehensive surveillance sharing agreement and the 
    underlying ADR meets or exceeds the Exchange's established uniform 
    options listing standards.\4\ First, the ADR Approval Order provides 
    that for ADR options to be eligible for listing and continued trading, 
    the Phlx must have comprehensive surveillance sharing agreements in 
    place with the foreign exchanges that serve as the primary markets for 
    the foreign securities underlying the ADRs, unless the Commission 
    otherwise approves the options' listing without an agreement. Second, 
    the Phlx's initial listing standards require that the ADRs underlying 
    the Exchange-listed options have a ``float'' of 7,000,000 ADRs 
    outstanding, 2,000 shareholders, trading volume of at least 2,400,000 
    over the prior twelve month period, and a minimum price of $7\1/2\ for 
    a majority of the business days during the preceding three month 
    period. Moreover, options on ADRs must meet or exceed the maintenance 
    criteria for continued listing under the Phlx rules. Those criteria 
    require that the ADRs underlying Exchange-listed options maintain a 
    ``float'' of 6,300,000 ADRs, 1,600 shareholders, trading volume of at 
    least 1,800,000 over the prior twelve month period, and a minimum price 
    of $5 on a majority of the business days during the preceding six month 
    period. Additionally, the ADR Approval Order requires the Phlx to make 
    reasonable inquiry to evaluate the securities underlying the ADRs to 
    ensure that these securities are generally consistent with the above-
    noted listing requirements.
    ---------------------------------------------------------------------------
    
        \4\Securities Exchange Act Release No. 31532 (November 27, 
    1992), 57 FR 57264 (December 3, 1992) (``ADR Approval Order''). A 
    comprehensive surveillance sharing agreement provides, among other 
    things, for the exchange of market trading activity, clearing 
    activity, and the identity of the ultimate purchaser or seller of 
    the securities traded.
    ---------------------------------------------------------------------------
    
        Furthermore, the Phlx options initial listing standards require 
    that the ADR underlying an ADR option be registered and listed on a 
    national securities exchange or traded through the facilities of a 
    national securities association and be reported as a national market 
    system security. The issuers of the ADRs also must be in compliance 
    with any other applicable requirements of the Act.
        The current proposal would authorize the Phlx to list and trade 
    options on ADRs where 50% or more of the world-wide trading volume in 
    the underlying foreign security occurs in the U.S. ADR market. The 
    proposal also provides that the percentage of the world-wide trading 
    volume that occurs in the U.S. ADR market meet a maintenance standard 
    of 30% for the ADR options to continue to be trading on the Exchange. 
    Under the proposal, if the ADR options meet the above-noted criteria, 
    the options may be listed without the existence of a surveillance 
    sharing agreement between the Phlx and the primary exchange on which 
    the foreign securities underlying the ADRs trade.\5\
    ---------------------------------------------------------------------------
    
        \5\Under the proposal, should the ADR option not meet this 
    numerical standard, the Exchange could not list the ADR option 
    unless there is a surveillance sharing agreement between the 
    Exchange and the primary exchange on which the foreign securities 
    underlying the ADRs trade or the Commission specifically authorized 
    the listing. The Commission would give such authorization in the 
    context of approving a rule filing submitted under section 19 of the 
    Act and Rule 19b-4, thereunder.
    ---------------------------------------------------------------------------
    
        The proposal provides that to determine whether 50% or more of the 
    world-wide trading volume in the underlying foreign security occurs in 
    the U.S. ADR market, the Phlx will calculate the trading volume for the 
    previous three months in the related securities which can affect the 
    pricing of the foreign security underlying the ADR option.\6\ Under the 
    proposal, the Phlx will determine that at least 50% of the world-wide 
    trading volume in a particular foreign security occurs in the U.S. ADR 
    market if the combined trading volume for ADRs overlying any class of 
    the foreign issuer's common stock, occurring in the U.S. ADR market, is 
    not less than 50% of the sum of (1) the combined trading volume for all 
    classes of the foreign issuer's common stock, and (2) the combined 
    trading volume for all ADRs overlying any of these classes of stock.\7\ 
    The above-noted calculation also will be used to determine if the 
    trading volume in the U.S. ADR market falls below 30% of the world-wide 
    trading volume for the underlying foreign security.\8\
    ---------------------------------------------------------------------------
    
        \6\Under the proposal, such related securities include all 
    classes of common stock issued by the foreign issuer and ADRs that 
    overlie any one of these classes of common stock. See Amendment No. 
    1, supra note 3.
        \7\See Amendment No. 1, supra note 3, and telephone conversation 
    between Michele R. Weisbaum, Associate General Counsel, Phlx, and 
    Brad Ritter, Attorney, Office of Derivatives Regulation, Division, 
    Commission, on January 27, 1994.
        \8\See Amendment No. 1, supra note 3. Under this calculation, 
    the trading volume for any U.S. ADR trading on an exchange that is 
    not part of the U.S. ADR market will be included in the 
    determination of world-wide trading volume , but not in the 
    determination of U.S. ADR market trading volume. The Phlx also 
    represents that it will use its best efforts to discover all markets 
    (foreign and U.S.) on which the foreign security (and any related 
    securities) underlying the ADR options trades.
    ---------------------------------------------------------------------------
    
        The proposal also defines the U.S. ADR market as the U.S. self-
    regulatory organizations that are members of the Intermarket 
    Surveillance Group (``ISG'')\9\ and whose markets are linked together 
    by the Intermarket Trading System (``ITS'').\10\ The U.S. self-
    regulatory organizations that currently make up the U.S. ADR market are 
    the Amex, the BSE, the CBOE, the CHX, the CSE, the NASD, the NYSE, the 
    PSE, and the Phlx.\11\
    ---------------------------------------------------------------------------
    
        \9\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. 
    (``Amex''), the Boston Stock Exchange, Inc. (``BSE''), the Chicago 
    Board Options Exchange, Inc. (``CBOE''), the Chicago Stock Exchange, 
    Inc. (``CHX''), the Cincinnati Stock Exchange, Inc. (``CSE''), the 
    National Association of Securities Dealers, Inc. (``NASD''), the New 
    York Stock Exchange, Inc. (``NYSE''), the Pacific Stock Exchange, 
    Inc. (``PSE''), and the Phlx.
        \10\ITS is a communications system designed to facilitate 
    trading among competing markets by providing each market with order 
    routing capabilities based on current quotation information. The 
    system links the participant markets and provides facilities and 
    procedures for: (1) The display of composite quotation information 
    at each participant market, so that brokers are able to determine 
    readily the best bid and offer available from any participant for 
    multiply trading securities; (2) efficient routing of orders and 
    sending administrative messages (on the functioning of the system) 
    to all participating markets; (3) participation, under certain 
    conditions, by members of all participating markets in opening 
    transactions in those markets; and (4) routing orders from a 
    participating market to a participating market with a better price. 
    The exchanges on which Empresas ADRs trade are ITS participant 
    markets. The NASD's Computer Assisted Execution System links NASD 
    market makers, for order routing and execution purposes, to ITS for 
    ADRs.
        \11\See Amendment No. 1, supra note 3.
    ---------------------------------------------------------------------------
    
    III. Discussion
    
        The Commission finds 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).\12\ Specifically, the Commission finds 
    that allowing options to trade on ADRs, among other things, gives 
    investors a better means to hedge their positions in the ADRs, as well 
    as enhanced market timing opportunities.\13\ Further, the pricing of 
    the ADRs underlying ADR options may become more efficient and market 
    makers in these ADRs, by virtue of enhanced hedging opportunities, may 
    be able to provide deeper and more liquid markets.\14\ In sum, options 
    on ADRs likely engender the same benefits to investors and the market 
    place that exist with respect to options on common stock.\15\
    ---------------------------------------------------------------------------
    
        \12\15 U.S.C. 78f(b)(5) (1988).
        \13\For example, if an investor wants to invest the ADRs but 
    does not have sufficient cash available until a future date, he can 
    purchase an ADR option now for less money and exercise the option to 
    purchase the ADRs at a later date.
        \14\See e.g. Report of the Special Study of the Options Markets 
    to the Securities and Exchange Commission, 96th Cong., 1st Sess. 
    (Comm. Print No. 96-IFC3, December 22, 1978).
        \15\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 new product is in the public interest. Such 
    a finding would be difficult for a derivative instrument 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.
    ---------------------------------------------------------------------------
    
        The Commission also believes that it is appropriate to permit the 
    Phlx to list and trade options on ADRs given that these options will be 
    subject to specific requirements related to the protection of 
    investors. First, Phlx rules require that the ADRs underlying these 
    options meet the Phlx's uniform options listing standards in all 
    respects. As described above, this would include the initial and 
    maintenance criteria. These criteria ensure, among other things, that 
    the underlying ADRs will maintain adequate price and float to prevent 
    the ADR options from being readily susceptible to manipulation.
        Second, the ADR Approval Order requires that the Phlx make a 
    reasonable inquiry to evaluate foreign securities underlying the ADR 
    options to ensure that these securities are generally consistent with 
    the requirements set forth in the Exchange's options listing standards. 
    In the ADR Approval Order, the Commission recognized that in some 
    cases, an ADR underlying an option could meet the options listing 
    standards while the foreign security on which the ADR is based may not 
    meet these standards in every respect. For example, in the case of ADRs 
    overlying certain foreign securities, one ADR could represent several 
    shares of a specific stock. For this reason, it is possible that the 
    price of the ADR will meet exchange listing standards even though the 
    market price of the foreign security underlying the ADR may be less 
    than the Phlx standard. The Commission believes, however, that 
    requiring the Phlx to review the foreign securities underlying the ADR 
    options to ensure that they are generally consistent with the 
    Exchange's options listing standards, along with other market 
    safeguards, will adequately protect investors from the possibility that 
    these ADR options can be potentially manipulated.\16\
    ---------------------------------------------------------------------------
    
        \16\For example, we would expect the Exchange to consider 
    delisting an option on an ADR if the price and public float of the 
    underlying security did not meet trading or size maintenance 
    standards, or if the security underlying the ADR failed to meet 
    other standards that raised manipulative concerns.
    ---------------------------------------------------------------------------
    
        Third, the Phlx has in place an adequate mechanism for providing 
    for the exchange of the surveillance information necessary to 
    adequately detect and deter market manipulation or trading abuses 
    involving ADR options. Although the proposal does not require the Phlx 
    to have a comprehensive surveillance sharing agreement in place with 
    the foreign exchange on which the security underlying the ADR options 
    trade, the Commission believes that this does not impair the ability of 
    the Phlx to detect or deter manipulation because the proposal requires 
    that the 50% or more of the trading activity in the underlying foreign 
    securities occur in the U.S. ADR market. The Commission notes that 
    proposal requires the U.S. self-regulatory organizations that 
    constitute the U.S. ADR market to be members of the ISG, which will 
    provide for the exchange of necessary surveillance information 
    concerning trading activity in the ADR options, and the respective 
    underlying ADR market.\17\
    ---------------------------------------------------------------------------
    
        \17\See Amendment No. 1, supra note 3.
    ---------------------------------------------------------------------------
    
        As a general matter, the Commission believes that the existence of 
    a surveillance sharing agreement that effectively permits the sharing 
    of information between an exchange proposing to list an equity option 
    and the exchange trading the stock underlying the equity option is 
    necessary to detect and deter market manipulation and other trading 
    abuses. In particular, the Commission notes that surveillance sharing 
    agreements providing an important deterrent to manipulation because 
    they facilitate the availability of information needed to fully 
    investigate a potential manipulation if it were to occur. These 
    agreements are especially important in the context of derivative 
    products based on foreign securities because they facilitate the 
    collection of necessary regulatory, surveillance and other information 
    from foreign jurisdictions.
        In the context of ADRs, the Commission believes that, in most 
    cases, the relevant underlying equity market is the primary market on 
    which the security underlying the ADR trades. This is because, in most 
    cases, the market for the security underlying the ADR generally is 
    larger in comparison to the ADR market, both in terms of share volume 
    and the value of trading. Because of the additional leverage provided 
    by an option on an ADR, the Commission generally believes that having a 
    comprehensive surveillance sharing agreement in place, between the 
    exchange where the ADR option trades and the exchange where the foreign 
    security underlying the ADR primarily trades, will ensure the integrity 
    of the marketplace.\18\ The Commission further believes that the 
    ability to obtain relevant surveillance information, including, among 
    other things, the identity of the ultimate purchasers and sellers of 
    securities, is an essential and necessary component of a comprehensive 
    surveillance sharing agreement.
    ---------------------------------------------------------------------------
    
        \18\See also Securities Exchange Act Release No. 26653 (March 
    21, 1989), 54 FR 12705 (order approving the trading of options on 
    the International Market Index (``IMI''), an index comprised of ADRs 
    traded in the United States based on foreign securities). In this 
    approval order, the Commission specifically required that there be 
    comprehensive surveillance sharing agreements in place between the 
    Amex and the foreign exchanges on which the securities underlying 
    the ADRs trade so that a substantial percentage of the Index was 
    covered by comprehensive surveillance sharing agreements.
    ---------------------------------------------------------------------------
    
        Under the current proposal, however, the Commission believes that 
    it is appropriate to permit the listing of options on an ADR without 
    the existence of a comprehensive surveillance sharing agreement with 
    the foreign market where the underlying security trades, as long as the 
    U.S. market for the underlying ADRs is at least as large as the market 
    for the underlying foreign security. Specifically, the proposed listing 
    standards require that a least 50% of the world-wide trading volume in 
    the underlying foreign security occur in the U.S. ADR market, which 
    consists of the Amex, the BSE, the CBOE, the CHX, the CSE, the NASD, 
    the NYSE, the PSE, and the Phlx. The proposal further requires that for 
    the continued trading of the ADR options the percentage of the world-
    wide trading volume occurring in the U.S. ADR market must not fall 
    below 30%. The Commission believes these standards will ensure that the 
    relevant pricing market for the options on ADRs is the U.S. ADR market 
    rather than the foreign market where the security underlying the ADR 
    trades.
        Moreover, the Commission believes that the proposed method for 
    determining whether the trading volume in the U.S. ADR market meets the 
    required percentages is adequate to ensure that the U.S. ADR market is 
    and continues to be the price discovery market for the foreign security 
    underlying the ADR option. Specifically, the Phlx has represented that 
    it will calculate the trading volume for the previous three months in 
    the underlying ADR, the underlying foreign security, and other related 
    securities which can affect the pricing of the underlying foreign 
    security.\19\ To list an ADR option without the existence of a 
    comprehensive surveillance sharing agreement, the proposal requires the 
    combined trading volume for ADRs overlying any class of the foreign 
    issuer's stock, occurring in the U.S. ADR market, to be not less than 
    50% of the combined world-wide trading volume for all classes of the 
    issuer's stock and all ADRs that overlie any of these classes.\20\
    ---------------------------------------------------------------------------
    
        \19\See supra note 6, and accompanying text.
        \20\Id.
    ---------------------------------------------------------------------------
    
        In summary, the Commission believes that in cases where a 
    substantial percentage of the world-wide trading volume for the 
    underlying ADR, the underlying foreign security, and other securities 
    relevant to the pricing of these securities occurs in the U.S. ADR 
    market,\21\ the U.S. ADR market operates as the price discovery market 
    for the foreign securities (i.e., stocks and ADRs) underlying the ADR 
    options. In these cases, the Commission believes that the U.S. ADR 
    market is the instrumental market for purposes of deterring and 
    detecting potential manipulation or other abusive trading strategies in 
    conjunction with transactions in the overlying ADR options market. 
    Therefore, because the Phlx, and all the other U.S. self-regulatory 
    agencies which make up the U.S. ADR market are members of the ISG, the 
    Commission believes that there is an effective surveillance sharing 
    arrangement to permit the exchanges and the NASD to adequately 
    investigate any potential manipulations of the ADR options or their 
    underlying securities.
    ---------------------------------------------------------------------------
    
        \21\We note that it is appropriate to view the U.S. ADR market 
    as a single market even though it is made up of several national 
    securities exchanges and the NASD. The Commission notes that all of 
    the markets on which or through which these ADRs could trade are 
    linked together by ITS. The Commission further notes that, one 
    market, the NYSE, typically operates as the primary exchange on 
    which trades in U.S. ADRs are executed.
    ---------------------------------------------------------------------------
    
        The Commission finds good cause for approving Amendment No. 1 to 
    the proposed rule change prior to the thirtieth day after the date of 
    publication of notice of filing thereof in the Federal Register. 
    Amendment No. 1 merely clarifies how the Phlx will determine whether 
    not less than 50% (or less than 30%, in the case of the maintenance 
    standard) of the world-wide trading volume in the underlying foreign 
    security (as represented by ADRs, common stock and any other related 
    securities) occurs in the U.S. ADR market. The Commission believes that 
    this amendment strengthens the proposal by ensuring that the standard 
    will be applied consistently by all the markets seeking to list ADR 
    options and raises no new issues.
        Accordingly, because the Commission believes that the amendment 
    makes clarifying, non-substantive changes to the proposal, the 
    Commission finds that it is consistent with sections 19(b)(2) and 
    6(b)(5) of the Act\22\ to approve Amendment No. 1 to the Amex's 
    proposal on an accelerated basis.
    ---------------------------------------------------------------------------
    
        \22\15 U.S.C. 78s(b)(2) and 78f(b)(5) (1988).
    ---------------------------------------------------------------------------
    
    IV. Solicitation of Comments
    
        Interested persons are invited to submit written data, views and 
    arguments concerning Amendment No. 1 to the proposed rule change. 
    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 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 in the Commission's Public 
    Reference Section, 450 Fifth Street, NW., Washington, DC. Copies of 
    such filing will also be available for inspection and copying at the 
    principal office of the above-mentioned self-regulatory organization. 
    All submissions should refer to the file number in the caption above 
    and should be submitted by February 28, 1994.
        It is therefore ordered, Pursuant to section 19(b)(2) of the 
    Act,\23\ that the proposed rule change (File No. SR-Phlx-93-54) is 
    approved, effective February 7, 1994. Accordingly, the Exchange may 
    submit listing certificates for ADR options as specified herein on 
    February 7, 1994 pursuant to Rule 12d1-3 under the Act and commence 
    trading in the options according to the time parameters established in 
    the Joint Options Listing Procedures Plan.
    
        \23\15 U.S.C. 78s(b)(2) (1988).
    ---------------------------------------------------------------------------
    
        For the Commission, by the Division of Market Regulation, 
    pursuant to delegated authority.\24\
    ---------------------------------------------------------------------------
    
        \24\17 CFR 200.30-3(a)(12) (1993).
    ---------------------------------------------------------------------------
    
    Margaret H. McFarland,
    Deputy Secretary.
    [FR Doc. 94-2711 Filed 2-4-94; 8:45 am]
    BILLING CODE 8010-01-M
    
    
    

Document Information

Published:
02/07/1994
Department:
Securities and Exchange Commission
Entry Type:
Uncategorized Document
Document Number:
94-2711
Pages:
0-0 (1 pages)
Docket Numbers:
Federal Register: February 7, 1994, Release No. 34-33553, International Series Release No. 632, File No. SR-Phlx-93-54