[Federal Register Volume 59, Number 58 (Friday, March 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-7077]
[[Page Unknown]]
[Federal Register: March 25, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33783; File No. SR-NASD-94-07]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc., Relating to an Extension and
Expansion of a Position Limit Hedge Exemption Pilot Program
March 18, 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 February
9, 1994, the National Association of Securities Dealers, Inc.
(``NASD''), filed with the Securities and Exchange Commission
(``Commission'') a proposed rule change as described in Items I and II
below, which items have been prepared by the NASD. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing to amend Section 3 of Appendix E (``Section
3'') to the NASD's Rules of Fair Practice (``Rules'') to extend, until
December 31, 1995, the NASD's pilot program for exemptions from equity
option position limits for certain hedged positions (``hedge exemption
pilot program''). The NASD also proposes to amend section 3 of the
Rules to expand the hedge exemption pilot program to provide that the
underlying hedged equity position may be comprised of securities
readily convertible into or economically equivalent to the stock
underlying the corresponding hedging options position. In addition, the
NASD proposes to add a new example to the list of examples contained at
the end of section 3(a) of the Rules to illustrate the operation of the
position limit hedge exemption. The text of the proposed rule change is
available at the Office of the Secretary, NASD, 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 NASD included statements
concerning the purpose of and basis for the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in section
(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 February 9, 1990, the Commission approved an NASD proposal to
implement a two-year pilot program during which certain fully hedged
equity option positions would be automatically exempt from established
position and exercise limits.\1\ Specifically, the hedge exemption
pilot program provides for an automatic exemption from equity option
position limits for accounts that have established one of the four most
commonly used hedged positions on a limited one-for-one basis (i.e.,
the number of shares represented by one options contract). The exempted
positions are: (1) Long stock and short calls; (2) long stock and long
puts; (3) short stock and long calls; and (4) short stock and short
puts. Under the hedge exemption pilot program, the largest options
position (combining hedged and unhedged positions) that may be
established may not exceed twice the basic position limit.\2\ In
addition, the hedge exemption pilot program does not change the
exercise limits contained in the Rules.\3\ Therefore, market
participants are allowed to exercise, during any five consecutive
business days, the same number of options contracts set forth as the
position limit for that option, including those options positions that
are hedged.
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\1\See Securities Exchange Act Release No. 27697 (February 9,
1990), 55 FR 5535 (February 15, 1990). Position limits impose a
ceiling on the number of equity option contracts in each class on
the same side of the market (i.e., aggregating long calls and short
puts, and long puts and short calls) that can be held or written by
an investor or group of investors acting in concert. Exercise limits
restrict the number of options contracts which an investor or group
of investors acting in concern can exercise within five consecutive
business days.
\2\See Section 3 of the NASD Rules.
\3\See Section 4 of Appendix E of the Rules.
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The NASD is proposing three amendments to the hedge exemption pilot
program. First, because the hedge exemption pilot program expired on
February 9, 1992, the NASD is proposing to re-implement the pilot
program until December 31, 1995. In addition, in order to avoid future
lapses in the hedge exemption pilot program, the NASD proposes to
incorporate this expiration date into its Rules in a new subsection (c)
to section 3.
Second, the NASD proposes to amend Section 3 of the Rules to expand
the hedge exemption pilot program to provide that in addition to stock,
the underlying hedged security position may be comprised of securities
readily convertible into or economically equivalent to the security
underlying the corresponding hedging options position. The NASD
believes that expanding the hedge exemption pilot program in this
manner is appropriate and consistent with the Act because it would
allow investors to hedge instruments that are economically equivalent
to stocks more efficiently and effectively. Specifically, because the
NASD believes that the value of such a security likely will fluctuate
in tandem with the value of the security into which it is convertible
or economically equivalent, the NASD believes investors with positions
in these securities should be able to hedge their positions with equity
options to the same extent that investors with long or short positions
in the underlying security can.\4\ In addition, because the hedge
exemption pilot program requires the positions in the convertible or
economically equivalent securities and the corresponding options to be
fully hedged, the NASD believes that the expansion of the pilot program
will not significantly increase concerns regarding intermarket
manipulations or disruptions of either the options markets or the
underlying stock market.
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\4\In this connection, the NASD will determine on a case-by-case
basis whether an instrument that is being used as the basis for the
underlying hedged position is readily convertible into or
economically equivalent to the security underlying the corresponding
options position. Further, the NASD will find that an instrument
that is not presently convertible into a security, but which will be
at a future date, is not a ``convertible'' security for purposes of
the hedge exemption pilot program. In addition, the NASD notes that
if a convertible security used to hedge an options position is
called for redemption by the issuer, the security would have to be
converted into the underlying security immediately or the
corresponding option position reduced accordingly.
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Third, the NASD proposes to add a new example to the list of
examples contained at the end of Section 3 of the Rules to illustrate
the operation of the position limit hedge exemption. The NASD believes
that this example will serve to avoid investor confusion concerning the
hedge exemption pilot program.
The NASD believes that the proposed rule change is consistent with
section 15A(b)(6) of the Act\5\ in that it is designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest. Specifically,
the NASD believes that the proposed extension and expansion of the
hedge exemption pilot program may increase the depth and liquidity of
the options markets by permitting investors to hedge greater amounts of
stock than would otherwise be the case without the hedge exemption. At
the same time, the NASD represents that the higher position limits
available by virtue of the hedge exemption pilot program have not
resulted in disruptions of the underlying stock markets due to
restrictions in those markets and the NASD's surveillance program. In
this connection, the NASD will continue to monitor the use of the
position limit hedge exemption to ensure that NASD members are
complying with the requirements of the exemption. The NASD also will
continue to monitor the market effects, if any, from the position limit
hedge exemptions.
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\5\15 U.S.C. 78o-3(b)(6) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will impose
any burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
No written comments were solicited or received by the NASD with
respect to the proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
The NASD has requested that the proposed rule change be given
accelerated effectiveness pursuant to Section 19(b)(2) of the Act.
The Commission finds that the proposed rule change to extend the
hedge exemption pilot program 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 15A(b)(6) thereunder.\6\ Specifically, the Commission
concludes, as it did when originally approving the hedge exemption
pilot program that providing for increased position and exercise limits
for equity options in circumstances where those excess positions are
fully hedged with offsetting stock positions will provide greater depth
and liquidity to the market and allow investors to hedge their stock
portfolios more effectively, without significantly increasing concerns
regarding intermarket manipulations or disruptions of either the
options market or the underlying stock market.
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\6\Id.
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In addition, with respect to the NASD's proposal to expand the
types of securities eligible to serve as the basis for the underlying
hedge position to include convertible securities and securities
economically equivalent to the stock underlying the corresponding
hedging options position, the Commission continues to believes, as it
did in approving similar proposals by the options exchanges,\7\ that
such expansion is consistent with the Act because it will allow
investors to use instruments that are economically equivalent to stocks
more efficiently and effectively for purposes of hedging their equity
options positions.\8\ Specifically, the Commission concurs with the
NASD's belief that because the value of a convertible security or a
security economically equivalent to the stock underlying a
corresponding hedging options position likely will fluctuate in tandem
with the value of the security that it is convertible into or
economically equivalent to, investors with positions in such securities
should be able to hedge their positions in equity options with those
securities to the same extent that investors with long or short
positions in the underlying securities can. Moreover, as with the
original hedge exemption pilot program,\9\ the Commission believes the
expansion of the pilot program in this manner likely will enhance the
depth and liquidity in the options markets. In addition, because the
hedge exemption pilot program still requires the positions in the
securities and the corresponding options to be fully hedged, the
Commission believes the expansion will not significantly increase
concerns regarding intermarket manipulation or disruption of either the
options markets or the underlying stock market.
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\7\See, e.g., Securities Exchange Act Release No. 32904
(September 14, 1993), 58 FR 49339.
\8\See supra note 4.
\9\See supra note 1.
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With respect to the proposed example to be added to section 3 of
the Rules, the Commission believes the example may serve to avoid
investor confusion concerning the hedge exemption pilot program.
The Commission also notes that before the hedge exemption pilot
program can be approved on a permanent basis, the NASD Must provide the
Commission with a report on the operation of the pilot program.
Specifically, the NASD must provide the Commission with details on (1)
the frequency with which the exemptions have been used; (2) the types
of investors using the exemptions; (3) the size of the positions
established pursuant to the hedge exemption pilot program; (4) what
types of convertible or economically equivalent securities are being
used to hedge positions and how frequently such securities have been
used to hedge; (5) whether the NASD has received any complaints on the
operation of the hedge exemption pilot program; (6) whether the NASD
has taken any disciplinary action against, or commenced any
investigations, examinations, or inquiries concerning, any of its
members for any violation of any term or condition of the hedge
exemption pilot program; (7) the market impact, if any, of the hedge
exemption pilot program; and (8) how the NASD has implemented
surveillance procedures to ensure compliance with the terms and
conditions of the hedge exemption pilot program. In addition, the
Commission expects the NASD to inform the Commission of the results of
any surveillance investigations undertaken for apparent violations of
the provisions of the hedge exemption pilot program.
The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register so that the hedge
exemption pilot program can be re-implemented without further delay and
to help avoid any potential investor confusion concerning the
availability of the hedge exemption as a result of the lapse of the
pilot program. The Commission notes that the NASD has not experienced
any significant problems with the hedge exemption pilot program since
its inception and that the NASD will continue to monitor the pilot
program to ensure that no problems arise. Moreover, no adverse comments
have been received by the NASD concerning the hedge exemption pilot
program since its implementation. Additionally, the proposal to expand
the hedge exemption pilot program to include convertible securities and
securities economically equivalent to the stock underlying the
corresponding hedging options position is substantively similar to
proposals previously approved by the Commission for the options
exchanges.\10\ Finally, the proposed example to be added to section 3
of the Rules merely serves to clarify the operation of the hedge
exemption pilot program and is not a substantive rule change. As a
result, because of the importance of maintaining the quality and
efficiency of the securities markets, the Commission believes good
cause exists for approving the extension and expansion of the NASD's
hedge exemption pilot program on an accelerated basis.
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\10\See supra note 7.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. 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 at the
Commission's Public Reference Section, 450 Fifth Street, NW.,
Washington, DC 20549. Copies of such filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to File No. SR-NASD-94-07 and should be
submitted by April 15, 1994.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\11\ that the proposed rule change (File Nos. SR-NASD-94-07), is
approved and, accordingly, the hedge exemption pilot program as
expanded herein, is extended until December 31, 1995.
\11\15 U.S.C. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\17 CFR 200.30-3(a)(12) (1992).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-7077 Filed 3-24-94; 8:45 am]
BILLING CODE 8010-01-M
