[Federal Register Volume 61, Number 62 (Friday, March 29, 1996)]
[Notices]
[Pages 14172-14177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7705]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37008; Filed No. SR-Amex-95-53]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval of Amendment No. 2 Thereto by the
American Stock Exchange, Inc., Relating to Options on the Morgan
Stanley Healthcare Product Companies Index, the Morgan Stanley
Healthcare Providers Index and the Morgan Stanley Healthcare Payors
Index
March 21, 1996.
I. Introduction
On December 19, 1995, the American Stock Exchange, Inc. (``Amex''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), 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 index
options on three new indexes developed by Morgan Stanley & Co.
Incorporated (``Morgan Stanley'') relating to three different
subsectors within the healthcare sector: the Morgan Stanley Healthcare
Providers Index (``Providers Index''); the Morgan Stanley Healthcare
Payors Index (``Payors Index''); and the Morgan Stanley Healthcare
Product Companies Index (``Product Companies Index'') (collectively the
``Indexes''). On January 2, 1996, the Amex filed Amendment No. 1 to its
proposal.\3\ Notice of the proposed rule change and Amendment No. 1
appeared in the Federal Register on January 23, 1996.\4\ No comment
letters were received on the proposed rule change. On March 20, 1996,
the Exchange filed Amendment No. 2.\5\ This order approves the Amex's
proposal as amended.
\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, the Amex states that for each of the
Indexes, if at any time between annual rebalancings, the top five
stocks in an Index by weight represent in the aggregate more than 60
percent of the Index's value, the Exchange will rebalance the Index
after the close of trading on Expiration Friday in the next month in
the March cycle. See Letter from Claire P. McGrath, Managing
Director and Special Counsel, Derivatives Securities, Amex, to
Michael Walinskas, Branch Chief, Office of Market Supervision
(``OMS''), Division of Market Regulation (``Division''), Commission,
dated January 2, 1996 (``Amendment No. 1'').
\4\ See Securities Exchange Act Release No. 36715 (January 16,
1996), 61 FR 1796 (January 23, 1996).
\5\ In Amendment No. 2 the Exchange clarifies that for each of
the Indexes, both eligibility standards and maintenance criteria
require that upon annual rebalancing, at least 90 percent of each
Index's numerical value and 80 percent of the total number of
component securities must meet the then current criteria for
standardized options trading set forth in either Exchange Rule 915
for component securities not currently the subject of standardized
options trading or Exchange Rule 916 for components currently the
subject to standardized options trading. In addition, stocks on each
quarterly replacement list will be selected and ranked by Morgan
Stanley based on a number of criteria, including conformity to
Exchange Rule 915 for securities not currently the subject of
standardized options trading and conformity to Rule 916 for
securities currently the subject of standardized options trading.
See Letter from Clifford J. Weber, Managing Director, New Products
Development, Amex, to Michael Walinskas, Branch Chief, OMS,
Division, Commission, dated March 20, 1996 (``Amendment No. 2'').
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II. Description of Proposal
A. General
The Amex proposes to trade standardized options on the Indexes,
each of which is comprised of stocks that are traded on the Amex, the
New York Stock Exchange, Inc. (``NYSE''), or are National Market
securities traded through Nasdaq. In addition, the Amex proposes to
amend Amex Rule 902C(d) to include the Amex proposes to amend Amex Rule
902C(d) to include the Indexes in the disclaimer provisions of that
rule.\6\ The Amex also proposes to list long-term options on the
Indexes having up to 36 months to expiration. In lieu of such long-term
options on the full value of the Indexes, the Amex may instead list
long-term options based on one-tenth of the value of each of the
Indexes. These long-term options on either the full or reduced-value of
the Indexes are referred to as ``LEAPS.'' LEAPS on the Indexes will
trade independent of and in addition to regular Index options traded on
the Exchange. However, as discussed below, position and exercise limits
of LEAPS on the Indexes (both full and reduced-value) and regular
options on the Indexes will be aggregated.
\6\ Amex Rule 902C(d) provides, among other things, that Morgan
Stanley does not guarantee the accuracy or completeness of the
Indexes or any data included therein, nor does Morgan Stanley make
any warranty, either express or implied, as to the results to be
obtained by any person or entity from the use of the Indexes or any
data included therein.
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B. Composition of the Indexes
The Indexes have been developed by Morgan Stanley to represent a
portfolio of large, actively traded, healthcare sector stocks. As of
December 1, 1995, the Providers Index was comprised of 15 stocks of
companies engaged in the hospital management and medical/nursing
services industries, with market capitalizations ranging from $494
million to $23 billion, and six month average daily trading volumes
ranging from 95,000 to 995,000 shares. The market capitalization of all
of the stocks in the Providers Index on that date was approximately
$45.2 billion. The total number of shares outstanding for the stocks in
the Providers Index ranged from 19 million shares to 445 million
shares.
The Payor's Index, as of December 1, 1995, was comprised of 12
stocks of companies conducting business in the managed health care and
health industry services industries, with market capitalizations
ranging from $622 million to $10 billion and six month average daily
trading volumes ranging from 170,000 to 1,700,000 shares. The market
capitalization of all of the stocks in the Payor's Index on that date
was approximately $36.3 billion. The total number of shares outstanding
for the stocks in the Payor's Index ranged from 18 million shares to
174 million shares.
Finally, as of this same date, the Product Companies Index was
comprised of 25 equity issues of companies engaged in the major
pharmaceuticals, biotechnology, medical specialities, medical
electronics, and medical/dental distributors industries. The market
capitalizations of these 25 companies range from $1.6 billion to $56.1
billion and the six month average daily trading volumes range from
124,000 to 2,800,000 shares. The market capitalization of all the
stocks in the Product Companies Index on that date was approximately
$475 billion. The total number of shares outstanding for the stocks in
the Product Companies Index ranged from 29 million shares to 1.5
billion shares.
The Exchange will use an ``equal dollar-weighted'' method to
calculate the value of each of the Indexes.\7\ The
[[Page 14173]]
Indexes were each initialized at a level of 200 as of the close of
trading on December 16, 1994. As of the close of trading on February
27, 1996, the Providers Index, the Payors Index, and the Product
Companies Index were valued at 306.66, 260.46, and 357.07,
respectively.\8\
\7\ See infra Section II.D entitled ``Calculation of the
Indexes'' for a description of this calculation method.
\8\ See Letter from Clarie P. McGrath, Managing Director and
Special Counsel, Derivative Securities, to Michael Walinskas, Branch
Chief, OMS, Division, Commission, dated February 28, 1996.
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C. Eligibility Standards for the Inclusion of Component Stocks in the
Indexes
The Amex represents that the Indexes conform with Exchange Rule
901C, which specifies criteria for the inclusion of stocks in an index
on which standardized options will be traded on the Exchange. In
addition, for each of the Indexes, Morgan Stanley has included, and
will include, only those stocks that initially meet the following
standards: (1) a minimum price of $7.50 at the time of announcement of
entry into the Index; (2) a minimum market capitalization of $75
million; (3) average monthly trading volume in the component security
of at least one million shares during the preceding six months; (4)
each component security must be traded on the Amex, NYSE or must be a
National Market security traded through the facility of Nasdaq; and (5)
upon annual rebalancing, at least 90% of the Index numerical value and
at least 80% of the total number of component securities must meet the
then current criteria for standardized option trading set forth in
Exchange Rule 915 for component securities not currently the subject of
standardized options trading and Rule 916 for components which
currently are the subject of standardized options trading.\9\ Also,
because the Indexes are equal-dollar weighted, no component security
will represent more than 25% of the weight of any of the Indexes, nor
will the five highest weighted component securities in any of the
Indexes, in the aggregate, account for more than 60% of the weight of
that Index upon annual rebalancing. The criteria set forth above are
the same as or exceed many of the criteria established for the
expedited listing of options on stock industry indexes pursuant to
Exchange Rule 901C Commentary .02.
\9\ See Amendment No. 2, supra note 5.
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D. Calculation of the Indexes
The Indexes will be calculated using an ``equal dollar-weighted''
methodology designed to ensure that each of the component stocks are
represented in approximately ``equal'' dollar amounts in each Index. In
calculating the initial ``equal dollar-weighting'' of component stocks,
the Amex, using closing prices on December 16, 1994, calculated the
number of shares that would represent an investment of $300,000 in each
of the stocks contained in the Indexes (to the nearest whole share).
The value of each Index equals the current market value (i.e., based on
U.S. primary market prices) of the sum of the assigned number of shares
of each of the stocks in the Index portfolio divided by the current
Index divisor. Each Index divisor was initially calculated to yield a
benchmark value of 200.00 at the close of trading on December 16, 1994.
Annually thereafter, following the close of trading on the third Friday
of December, each Index portfolio will be adjusted by changing the
number of whole shares of each component stock so that each company is
again represented in ``equal'' dollar amounts.\10\ If necessary, a
divisor adjustment is made at the rebalancing to ensure continuity of
an Index's value. The newly adjusted portfolio becomes the basis for
the Index's value on the first trading day following the annual
adjustment.
\10\ In certain circumstances, each Index will be rebalanced
prior to the end of a calendar year. See infra Section II.E.
(Maintenance of the Indexes).
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Subject to the maintenance criteria discussed below, for each Index
the number of shares of each component stock in such Index will remain
fixed between annual reviews except in the event of certain types of
corporate actions, such as the payment of a dividend (other than an
ordinary cash dividend), stock distribution, stock split, reverse stock
split, rights offering, distribution, reorganization, recapitalization,
or similar event with respect to an Index component stock. In a merger
or consolidation of an issuer of a component security, if the security
remains in the Index, the number of shares of that security will be
adjusted, if necessary, to the nearest whole share, to maintain the
component's relative weight in the Index at the level immediately prior
to the corporate action. In the event of a stock replacement, the
dollar value of the security being replaced will be calculated and that
amount invested in the stock of the new component, to the nearest whole
share. In all cases, the divisor will be adjusted, if necessary, to
ensure Index continuity.
Additionally, for each of the Indexes, if at any time between
annual rebalancings, the top five stocks in the Index by weight
represent in the aggregate more than 60% of the Index's value, the
Exchange will rebalance the Index after the close of trading on
expiration Friday in the next month in the March cycle. For example, if
in July it is determined that the top five components in the Morgan
Stanley Healthcare Product Companies Index account for more than 60% of
the Index's weight, then the Index will be rebalanced after the close
of trading on expiration Friday in September.\11\
\11\ See Amendment No. 1, supra note 3.
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Similar to other stock index values published by the Exchange, the
value of each Index will be calculated continuously and disseminated
every 15 seconds over the Consolidated Tape Association's Network B and
to the Options Price Reporting Authority (``OPRA'').
E. Maintenance of the Indexes
The Indexes will be calculated and maintained by the Amex in
consultation with Morgan Stanley which may, from time to time, suggest
changes in the industry categories represented in any or all of the
Indexes or changes in the number of component stocks in an industry
category to properly reflect the changing conditions in the healthcare
sector. In addition, the Amex will replace component securities in each
Index that fail to meet the following maintenance criteria on quarterly
review: (1) a minimum market capitalization of $75 million; (2) average
monthly trading volume in the component security of at least 500,000
shares during the preceding six months; (3) at least 90% of the Index's
numerical value and at least 80% of the total number of component
securities meet the then current criteria for standardized option
trading set forth in Exchange Rule 915 for securities not currently the
subject of standardized options trading and Rule 916 for securities
which are currently the subject of standardized options trading;
12 and (4) a share price of $5.00 or greater for a majority of
business days during the preceding quarter for those limited number of
component securities that do not meet Rule 915 or 916.13
\12\ See Amendment No. 2, supra Note 5.
\13\ Telephone conversation between Clifford J. Weber, Managing
Director, New Products Development, Amex, and James T. McHale,
Attorney, OMS, Division, Commission, on March 19, 1996.
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At the beginning of each calendar quarter, Morgan Stanley will
provide the Amex with a current list of replacement stocks for each
Index from which to draw in the event that a component in an Index must
be replaced due to merger, takeover, failure to satisfy the above
maintenance
[[Page 14174]]
criteria, or other similar event (each a ``Replacement List'').14
The Amex will publicly distribute the Replacement Lists as soon as
practicable following receipt from Morgan Stanley.
\14\ See Letter from Carol Shahmoon, Counsel, Morgan Stanley, to
Michael Walinskas, Branch Chief, OMS, Division, Commission, dated
March 20, 1996 (``Morgan Stanley Letter'').
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Stocks on each Replacement List will be selected and ranked by
Morgan Stanley based on a number of criteria, including conformity to
the eligibility requirements described above 15 and to Exchange
Rule 915 for component securities not currently the subject of
standardized options trading and Rule 916 for components which are
currently the subject of standardized options trading.16 Rules 915
and 916, respectively, set forth the criteria for the initial and
continued listing of standardized options on equity securities. The
replacement stocks will be categorized by Morgan Stanley by industry
within the healthcare sector and ranked within their category based on
the aforementioned criteria. The replacement stock for a security being
removed from an Index will be selected solely by the Amex from the
Replacement List based on industry category and liquidity.17 In
the event no replacement stocks are available that meet the eligibility
criteria and pass Morgan Stanley's selection process, then the security
leaving the Index will be removed without replacement and the divisor
adjusted to ensure Index continuity. It is expected that each Index
will remain at the current number of components; however, if the number
of components in an Index shall increase or decrease by more than one
third, the Exchange must obtain additional approval from the Commission
pursuant to Section 19(b) of the Act.
\15\ See supra Section II.C entitled ``Eligibility Standards for
the Inclusion of Component Stocks in the Indexes.''
\16\ See Amendment No. 2, supra Note 5.
\17\ The Amex will ensure that at the time of selection it will
only select securities that continue to meet the eligibility
requirements discussed above.
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In addition, Morgan Stanley will advise the Exchange regarding the
handling of unusual corporate actions which may arise from time to
time. Routine corporate actions (e.g., stock splits, routine spinoffs,
etc.) which require straightforward index divisor adjustments will be
handled by the Exchange's staff without consultation with Morgan
Stanley. All stock replacements and unusual divisor adjustments caused
by the occurrence of extraordinary events such as dissolution, merger,
bankruptcy, non-routine spinoffs, or extraordinary dividends will be
made by Exchange staff in consultation with Morgan Stanley, although
the Amex ultimately will select the actual replacement stock from the
Replacement List without Morgan Stanley's assistance. All stock
replacements and the handling of non-routine corporate actions will be
announced at least ten business days in advance of such effective
change, whenever practicable. As with all options currently trading on
the Amex, the Exchange will make this information available to the
public through the dissemination of an information circular.
F. Expiration and Settlement
The Index value for purposes of settling outstanding Index options
and Index LEAPS contracts upon expiration will be calculated based upon
the regular way opening sale prices for each of an Index's component
stocks in their primary market on the last trading day prior to
expiration. In the case of National Market securities traded through
Nasdaq, the first reported sale price will be used. Once all of the
component stocks have opened for trading, the value of each Index will
be determined and that value will be used as the final settlement value
for expiring Index options contracts. If any of the component stocks do
not open for trading on the last trading day before expiration, then
the prior trading day's (i.e., Thursday's) last sale price will be used
to calculate each Index. In this regard, before deciding to use
Thursday's closing value of a component stock for purposes of
determining the settlement value of an Index, the Amex will wait until
the end of the trading day on expiration Friday.\18\
\18\ For purposes of the daily dissemination of the Indexes
value, if a stock included in an Index has not opened for trading,
the Amex will use the closing value of that stock in its primary
market on the prior trading day when calculating the value of the
Index, until the stock opens for trading.
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G. Contract Specifications
The proposed options on the Indexes will be cash-settled, European-
style options.\19\ Standard options trading hours for narrow-based
index options (9:30 a.m. to 4:10 p.m. New York time) will apply to the
contracts. The options on the Index will expire on the Saturday
following the third Friday of the expiration month. The last trading
day for an expiring option series will normally be the second to the
last business day before expiration (normally a Thursday). The Exchange
intends to list option series with expirations in the three near-term
calendar months and the two additional calendar months in three month
intervals in the March cycle. The Exchange also intends to list longer
term option series having up to 36 months to expiration. The Exchange
proposes to list near-the-money (i.e. strike prices within ten points
above or below the current index value) option series on any of the
Indexes at 2\1/2\ point strike price intervals when the value of that
Index is below 200 points.
\19\ A European-style option can be exercised only during a
specified period before the option expires.
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H. Listing of Long-Term Options on the Full Value or the Reduced Value
of the Indexes
The proposal provides that the Exchange may list longer term index
options series having up to 36 months to expiration on the full value
of the Indexes. Alternatively, the Exchange may list long-term reduced-
value put and call options based on \1/10\th of the full value of the
Indexes. In either event, the interval between expiration months for
either a full value or reduced value long-term option will not be less
than six months. The reduced-value Index LEAPS will also have a
European-style exercise and will be subject to the same rules that
govern the trading of all the Exchange's index options, including sales
practice rules, margin requirements and floor trading procedures.
I. Position and Exercise Limits, Margin Requirements, and Trading Halts
Because the Indexes are Stock Index Options under Amex Rule 901C(a)
and Stock Index Industry Groups under Rule 900C(b)(1), the proposal
provides that Exchange rules that are applicable to the trading of
narrow-based index options will apply to the trading of options on the
Indexes. Specifically, Exchange rules governing margin
requirements,\20\ position and exercise limits,\21\ and trading halt
procedures \22\ that are
[[Page 14175]]
applicable to the trading of narrow-based index options will apply to
options traded on the Indexes. Position limits on long-term reduced-
value Index options will be equivalent to the position limits for
regular (full value) Index options and would be aggregated with such
options. For aggregation purposes, ten reduced value contracts will
equal one full value contract (for example, if the position limit for
the full value options is 12,000 contracts on the same side of the
market, then the position limit for the reduced value options will be
120,000 contracts on the same aside of the market).
\20\ Pursuant to Amex Rule 462(d)(2)(D)(iv), the margin
requirements for each of the proposed Index options will be: (1) for
each short options position, 100% of the current market value of the
options contract plus 20% of the underlying aggregate Index value,
less any out-of-the-money amount, with a minimum requirement of the
options premium plus 10% of the underlying Index value; and (2) for
long options positions, 100% of the options premium paid.
\21\ Pursuant to Amex Rules 904C and 905C, respectively, the
position and exercise limits for each of the proposed Index options
will be 12,000 contracts, unless the Exchange determines, pursuant
to Rules 904C and 905C, that a lower limit is warranted.
\22\ Pursuant to Amex Rule 918C, the trading of options on each
of the Indexes will be halted or suspended whenever trading in
underlying securities whose weighted value represents more than 20%
of an Index's value are halted or suspended.
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J. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in options on the Indexes. These procedures include complete
access to trading activity in the underlying securities. Further, the
Intermarket Surveillance Group (``ISG'') Agreement, dated July 14,
1983, as amended on January 29, 1990, will be applicable to the trading
of options on the Indexes.\23\
\23\ 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 Amex; the Boston Stock Exchange, Inc.;
the Chicago Board Options Exchange, Inc.; the Chicago Stock
Exchange, Inc.; the National Association of Securities Dealers,
Inc.; the NYSE; the Pacific Stock Exchange, Inc.; and the
Philadelphia Stock Exchange, Inc. Because of potential opportunities
for trading abuses involving stock index futures, stock options, and
the underlying stock, and the need for greater sharing of
surveillance information for these potential intermarket trading
abuses, the major stock index futures exchanges (e.g., the Chicago
Mercantile Exchange and the Chicago Board of Trade) joined the ISG
as affiliate members in 1990.
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Morgan Stanley has also adopted special procedures to prevent the
potential misuse of material, non-public information by the research,
sales, and trading divisions of the firm in connection with the
maintenance of the Indexes.\24\ As discussed above, the Amex will
publicly disseminate each Replacement List by issuing information
circulars so that investors will know in advance which securities will
be considered as replacements for the Index.\25\
\24\ See Morgan Stanley Letter, supra note 14.
\25\ Id.
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In additional, Morgan Stanley will have a limited role in the stock
replacement selection and substitution process. First, when a stock in
an Index no longer meets the published criteria as determined following
a quarterly review of the components by the Exchange, the Amex will
determine, without consultation with Morgan Stanley, which security
from the applicable Replacement List will be selected for addition to
the Index. Second, The Amex will also make adjustments as a result of
stock splits, routine spin-offs, and otherwise, without consultation
with Morgan Stanley. Finally, even in those situations where the Amex
consults with Morgan Stanley, upon the occurrence of certain events,
the actual replacement sock will be selected solely by Amex from the
stocks on the replacement list.
III. Findings and Conclusions
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).\26\ Specifically, the
Commission finds that the trading of options on the Indexes, including
full-value and reduced-value Index LEAPS, will serve to promote the
public interest and help to remove impediments to a free and open
securities market by providing investors with an additional means to
hedge exposure to market risk associated with stocks in the various
healthcare subsectors.\27\
\26\ 15 U.S.C. Sec. 78f(b)(5).
\27\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument is in the public
interest. Such a finding would be difficult for a derivate
instrument that served no hedging or other economic function,
because any benefits that might be derived by market participants
likely would be out weighed by the potential for manipulation,
diminished public confidence in the integrity of the markets, and
other valid regulatory concerns. In this regard, the trading of
listed options on the Index will provide investors with a hedging
vehicle that should reflect the overall movement of the stocks
representing companies in the healthcare sector in the U.S. stock
markets.
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The trading of options on the Indexes and reduced-value Indexes,
however, raises several issues relating to index design, customer
protection, surveillance, and market impact. The Commission believes,
for the reasons discussed below, that the Amex adequately has assessed
these issues.
A. Index Design and Structure
The Commission believes it is appropriate for the Exchange to
designate each of the Indexes as narrow-based for purposes of index
options training. The indexes are each comprised of a limited number of
stocks intended to track discrete subsectors of the healthcare sector
of the stock market. Accordingly, the Commission believes it is
appropriate for the Amex to apply its rules governing narrow-based
index options to trading in the proposed Index options.\28\
\28\ See supra Section II.I (Position and Exercise Limits,
Margin Requirements, and Trading Halts).
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The Commission also believes that the liquid markets, large
capitalizations, and relative weighings of the Indexes' component
stocks significantly minimize the potential for manipulation of the
Index. First, the stocks that comprise each index are actively traded.
Average month trading volume in the component stocks of the Indexes for
the period between June 1, 1995 and December 1, 1995 ranged from 95,000
to 995,000 shares for the Providers Index, 170,000 to 1,700,000 shares
for the Payors Index, and 124,000 to 2,800,000 shares for the Product
Companies Index. Second, the market capitalizations of the stocks in
the Indexes are very large, ranging from $494 million to $23 billion in
the Providers Index, $622 million to $10 billion in the Payors Index,
and $1.6 billion to $56 billion in the Product Companies Index. Third,
because the indexes are equal dollar-weighted, no one particular stock
or group of stocks dominates the index. Specifically, as of December 1,
1995, no one stock accounted for more than 12.13% of the total value of
the Providers Index, 12.47% of the total value of the Payors Index, and
6.38% of the total value of the Product Companies Index. Fourth, the
Indexes will be maintained so that in addition to the other maintenance
criteria discussed above, at each quarterly review and rebalancing
(annual or otherwise), at least 90% of the Indexes numerical value and
at least 80% of the total number of component securities will be
composed of securities eligible for standardized options trading.
Fifth, Morgan Stanley and the Amex will be required to ensure that each
component of each Index is subject to last sale reporting requirements
in the U.S. pursuant to Rule 11aA3-1 of the Act. This will further
reduce the potential for manipulation of the value of the Indexes.
Finally, the Commission believes that the existing mechanisms to
monitor trading activity in the component stocks of the Indexes, or
options on those stocks or the Indexes will help deter as well as
detect any illegal activity.
[[Page 14176]]
In addition, even though the Indexes are only scheduled to be
rebalanced annually, the Commission believes that the Amex and Morgan
Stanley have developed several composition and maintenance criteria for
the Indexes that will minimize the possibility that the Indexes could
be manipulated through trading in less actively traded securities or
securities with smaller prices or floats. First, if at any time during
the year the top five components in an Index, by weight, account for
more than sixty percent of the weight of the Index, the Exchange will
rebalance the Index following the close of trading on Expiration Friday
in the next month in the March cycle. These rebalancing requirements
will serve to ensure that any ``overweight'' stock \29\ will be brought
back into line with the other stocks, thus ensuring that less
capitalized stocks do not become excessively weighted in the Index.
\29\ A stock would be ``overweight'' if its weight in the Index
were greater than the average weight of all of the stocks in the
Index. This would occur, for example, if the price of a component
stock significantly increased relative to the other stocks in the
Index during a particular quarter and prior to the rebalancing.
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Second, after each quarterly review and each rebalancing (annual or
otherwise), at least 90% of an Index's numerical value and at least 80%
of the total number of component securities will be comprised of stocks
that are eligible for standardized options trading. The Commission
believes that this requirement will ensure that the Indexes will be
almost entirely made up of stocks with large public floats that are
actively traded, thus reducing the likelihood that the Indexes could be
easily manipulated by abusive trading in the smaller stocks contained
in the Indexes.
Third, at each quarterly review of the Indexes, a component may
only remain in an Index if it satisfies the remaining maintenance
requirements which include market capitalization and minimum trading
volume requirements.\30\ These requirements are similar to the
continued listing requirements for options on individual equity
securities and should ensure the Indexes are comprised of active and
liquid securities.\31\
\30\ See supra Section II.E (Maintenance of the Indexes).
\31\ See Amex Rule 916.
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Fourth, because the Indexes are narrow-based, the applicable
position and exercise limits (currently 12,000) and margin requirements
will further reduce the susceptibility of the Indexes to manipulation.
Lastly, Morgan Stanley will only add stocks to a Replacement List that
are representative of the healthcare sector and, as discussed
above,\32\ satisfy the inclusion criteria.
\32\ See supra Section II.C (Eligibility Standards for the
Inclusion of Component Stocks in the Indexes).
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The Commission notes that certain concerns are raised when a
broker-dealer, such as Morgan Stanley, is involved in the development
and maintenance of a stock index that underlies an exchange-traded
derivative product. For several reasons, however, the Commission
believes that the Amex has adequately addressed this concern with
respect to options on the Indexes.
First, the values of the Indexes are to be calculated and
disseminated by the Amex so that unless a party independently
calculates the Indexes' values, neither Morgan Stanley nor any other
party will be in receipt of the values prior to the public
dissemination of the Indexes' values. Second, routine corporate actions
(e.g., stock splits, routine spinoffs, etc.) will be handled by the
Amex without consultation with Morgan Stanley. Third, although stock
replacements and unusual divisor adjustments caused by the occurrence
of extraordinary events, such as dissolution, merger, bankruptcy, non-
routine spinoffs, or extraordinary dividends, will be made by Exchange
staff in consultation with Morgan Stanley, Amex alone ultimately will
select the actual replacement stock from the Replacement List without
Morgan Stanley's assistance. Such replacement will be announced
publicly at least 10 business days in advance of the effective change
by the Amex through the dissemination of an information circular,
whenever practicable. Fourth, the Commission believes that the
procedures Morgan Stanley has established to detect and prevent
material non-public information concerning the Indexes from being
improperly used by the person or persons responsible for compiling the
Replacement Lists, as well as other persons within Morgan Stanley, as
discussed above,\33\ adequately serve to minimize the susceptibility to
manipulation of the Indexes, the securities in the Indexes, and
securities added to and deleted from any Replacement List. In summary,
the Commission believes that the procedures outlined above help to
ensure that Morgan Stanley will not have any informational advantages
concerning modifications to the composition of the Indexes due to its
limited role in consulting with Amex on the maintenance of the Indexes
under certain circumstances.
\33\ See Morgan Stanley Letter, supra note 14.
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B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as options on the Indexes
(including full-value and reduced value LEAPS), can commence on a
national securities exchange. The Commission notes that the trading of
standardized exchange-traded options occurs in an environment that is
designed to ensure, among other things that: (1) the special risks of
options are disclosed to public customers; (2) only investors capable
of evaluating and bearing the risks of options trading are engaged in
such trading; and (3) special compliance procedures are applicable to
options accounts. Accordingly, because LEAPS and regular options on the
Indexes will be subject to the same regulatory regime as the other
standardized options currently traded on the Amex, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in options on the Indexes. Finally, the Amex has stated
that it will distribute information circulars to members following
rebalancings and prior to component changes to notify members of
changes in the composition of the Indexes. Additionally, the Amex will
publicly disseminate each Replacement List by means of information
circulars. The Commission believes this should help to protect
investors and avoid investor confusion.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a stock index derivative product
and the exchange(s) trading the stocks underlying the derivative
product is an important measure for surveillance of the derivative and
underlying securities markets. Such agreements ensure the availability
of information necessary to detect and deter potential manipulations
and other trading abuses, thereby making the stock index product less
readily susceptible to manipulation.\34\ In this regard, the Amex,
NYSE, and National Association of Securities Dealers, Inc. are all
members of the ISG, which provides for the exchange of all necessary
surveillance information.\35\
\34\ See Securities Exchange Act Release No. 31243 (September
28, 1992), 57 FR 45849 (October 5, 1992).
\35\See supra note 23.
[[Page 14177]]
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D. Market Impact
The Commission believes that the listing and trading of options on
the Indexes, including full-value and reduced-value Index LEAPS, on the
Amex will not adversely impact the underlying securities markets.\36\
First, as described above, due to the ``equal dollar-weighting''
methodology, no one stock or group of stocks dominates the Indexes.
Second, because at each quarterly review and each rebalancing of the
Indexes, at least 90% of an Index's numerical value and at least 80% of
the total number of component securities must be accounted for by
stocks that are eligible for standardized options trading, the
component stocks generally will be actively-traded, highly-capitalized
stocks. Third, the currently applicable 12,000 contract position and
exercise limits will serve to minimize potential manipulation and
market impact concerns. Fourth, the risk to investors of contra-party
non-performance will be minimized because the options on the Indexes
will be issued and guaranteed by the Options Clearing Corporation just
like any other standardized option traded in the United States.
\36\ In addition, the Amex and the OPRA have represented that
the Amex and the OPRA have the necessary systems capacity to support
those new series of index options that would result from the
introduction of options on the Indexes. See Letter from Charles
Faurot, Managing Director, Market Data Services, Amex, to Michael
Walinskas, Branch Chief, OMS, Division, Commission, dated January
22, 1996; letter from Edward Cook, Jr., Managing Director,
Information Technology, Amex, to Michael Walinskas, Branch Chief,
OMS, Division, Commission, dated February 8, 1996; and letter from
Joe Corrigan, Executive Director, OPRA, to Michael Walinskas, Branch
Chief, OMS, Division, Commission, dated January 22, 1996.
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Lastly, the Commission believes that settling expiring options on
the Indexes (including full-value and reduced-value Index LEAPS) based
on the opening prices of component securities is reasonable and
consistent with the Act. As noted in other contexts, valuing options
for exercise settlement on expiration based on opening prices rather
than closing prices may help reduce adverse effects on markets for
stocks underlying options on the Index.\37\
\37\ Securities Exchange Act Release No. 30944 (July 21, 1992),
57 FR 33376 (July 28, 1992).
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The Commission finds good cause for approving Amendment No. 2 to
the proposal prior to the thirtieth day after the date of publication
of the notice of filing thereof in the Federal Register. Specifically,
Amendment No. 2 merely clarifies that for each of the Indexes, both
eligibility standards and maintenance criteria require that upon annual
rebalancing, at least 90% of each Index's numerical value and 80% of
the total number of component securities must meet the then current
criteria for standardized options trading set forth in either Rule 915
for component securities not currently the subject of standardized
options trading or Rule 916 components which are currently the subject
of standardized options trading. Moreover, Amendment No. 2 provides
that Morgan Stanley will select and rank any stocks to be included in
each Replacement List based on a number of criteria, including
conformity to the same eligibility standards and maintenance criteria
set forth in Rules 915 and 916. The Commission believes that clarifying
the applicable eligibility standards and maintenance criteria for the
Indexes' component securities is consistent with maintaining a fair and
orderly market and reduces the likelihood of investor confusion.
Based on the above, the Commission finds good cause for approving
Amendment No. 2 to the proposed rule change on an accelerated basis and
believes that the proposal, as amended, is consistent with Sections
6(b)(5) and 19(b)(2) of the Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 2. 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 20549. Copies of such filing will also be available
for inspection and copying at the principal office of the Amex. All
submissions should refer to the File No. SR-Amex-95-53 and should be
submitted by April 19, 1996.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\38\ that the proposed rule change (SR-Amex-95-53), as amended, is
approved.
\38\ 15 U.S.C. Sec. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\39\
\39\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 96-7705 Filed 3-28-96; 8:45 am]
BILLING CODE 8010-01-M
