[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: 94-2717]
[[Page Unknown]]
[Federal Register: February 7, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33551; International Series Release No. 630; File No.
SR-PSE-93-33]
Self-Regulatory Organizations; Filing and Order Granting
Accelerated Approval of Proposed Rule Change and Amendment No. 1 to the
Proposed Rule Change by the Pacific Stock Exchange, Inc. Relating to
the Listing of Options on American Depositary Receipts
January 31, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December
2, 1993, the Pacific Stock Exchange, Inc., (``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 self-regulatory organization. The Commission
is publishing this notice to solicit comments on the proposed rule
change from interested persons.\1\
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\1\The proposal was amended on December 28, 1993 to clarify the
procedure the PSE 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 Michael D. Pierson, Senior
Attorney, Market Regulation, PSE, to Richard Zack, Branch Chief,
Office of Derivatives Regulation, Division of Market Regulation
(``Division''), Commission, dated December 28, 1993 (``Amendment No.
1'').
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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 Rules 3.6 and 3.7 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. The text of
the proposal is available at the Office of the Secretary, PSE and at
the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in Sections (A), (B) and (C) below,
of the most significant aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
On November 27, 1992, the Commission approved a PSE 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.\2\ First, the ADR Approval Order provides
that for ADR options to be eligible for listing and continued trading,
the PSE 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 PSE'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 PSE 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 PSE 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.
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\2\Securities Exchange Act Release No. 31530 (November 27,
1992), 57 FR 57262 (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.
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Furthermore, the PSE 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 PSE 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 PSE and the primary exchange on which the
foreign securities underlying the ADRs trade.\3\
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\3\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.
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The proposal provides that to determine whether 50% or more of the
world-wide trading volume in the underlying foreign securities occurs
in the U.S. ADR market, the PSE 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.\4\ Under
the proposal, the PSE will determine that 50% or more 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.\5\
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.\6\
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\4\Under the proposal, such related securities include all
classes of common stock issued by the foreign issuer and ADRs that
overly any one of these classes of common stock. See Regulation,
PSE, to Richard Zack, Branch Chief, Office of Derivatives
Regulation, Division, Commission, dated December 28, 1993 (``ADR
Letter'').
\5\See ADR Letter, supra note 4, and telephone conversation
between Michael D. Pierson, Senior Attorney, Market Regulation, PSE,
and Brad Ritter, Attorney, Office of Derivatives Regulation,
Division, Commission, on January 27, 1994.
\6\See ADR Letter, supra note 4. 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 PSE 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.
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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'')\7\ and whose markets are linked together
by the Intermarket Trading System (``ITS'').\8\ 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.\9\
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\7\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 PSE, and the Philadelphia
Stock Exchange, Inc. (``Phlx'').
\8\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.
\9\See ADR Letter, supra note 4.
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The Exchange believes that the proposed rule change is consistent
with Section 6(b) of the Act,\10\ in general, and furthers the
objectives of Section 6(b)(5), in particular, in that it is designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and to remove impediments to and
perfect the mechanism of a free and open market and a national market
system.
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\10\15 U.S.C. 78f(b) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition
The PSE believes that the proposed rule change will not impose a
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 Exchange has requested that the proposed rule change be given
accelerated effectiveness pursuant to Section 19(b)(2) of the Act.\11\
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\11\15 U.S.C. 78f(b)(2) (1988).
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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\
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\12\15 U.S.C. 78f(b)(5) (1988).
\13\For example, if an investor wants to invest in 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.
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The Commission also believes that it is appropriate to permit the
PSE to list and trade options on ADRs given that these options will be
subject to specific requirements related to the protection of
investors. First, PSE rules require that the ADRs underlying these
options meet the PSE'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 PSE 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 PSE standard. The Commission believes however, that requiring
the PSE 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\
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\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.
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Third, the PSE 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 PSE 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 PSE to
detect or deter manipulation because the proposal requires that 50% or
more of the trading activity in the underlying foreign securities occur
in the U.S. ADR market. The Commission notes the 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\
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\17\See ADR Letter, supra note 4.
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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 provide 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.
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\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.
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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 50% or more 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 PSE 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\
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\19\See supra note 4, and accompanying text.
\20\Id.
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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 PSE, 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.
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\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.
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The Commission finds good cause for approving the proposed rule
change, including 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.
The PSE proposal to list and trade ADR options where 50% or more of
the world-wide trading volume of the underlying foreign security occurs
in the U.S. ADR market is identical to proposals by the Amex, CBOE, and
Phlx to provide for the listing of ADR options that meet this uniform
standard.\22\ The Amex, CBOE, and Phlx proposals were subject to a full
notice and comment period and no comments were received.\23\
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\22\Securities Exchange Act Release Nos. 33102 (October 25,
1993), 58 FR 58356 (November 1, 1993) (SR-CBOE-93-38), 33103
(October 25, 1993), 58 FR 58357 (November 1, 1993) (SR-Amex-93-28),
and 33252 (November 26, 1993), 58 FR 63604 (December 2, 1993) (SR-
Phlx-93-54).
\23\Although Amendment No. 1 to the proposal was not part of the
Amex, CBOE, and Phlx proposals when they were noticed for comment,
the Commission notes that Amendment No. 1 merely clarifies how the
PSE 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 does not
make a substantive change to the proposal and, thus, raises no new
issues. Further, the Commission believes that the Amendment
strengthens the proposal by ensuring that the standard will be
applied consistently by all the markets seeking to list ADR options.
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The Commission further notes that approving the current proposal,
including Amendment No. 1, on an accelerated basis will permit the PSE
to compete on an equal basis with the other options exchanges for
orders in ADR options. Accordingly, since the Commission finds that the
current proposal involves the exact same issues as the above-noted
proposals, the Commission believes it is consistent with Sections
19(b)(2) and 6(b)(5) of the Act\24\ to approve the PSE's proposal on an
accelerated basis.
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\24\ 15 U.S.C. 78s(b)(2) and 78F(b)(5)(1988).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the proposed rule change, including 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,\25\ that the proposed rule change (SR-PSE-93-33) 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.
\25\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2717 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M
