[Federal Register Volume 63, Number 82 (Wednesday, April 29, 1998)]
[Proposed Rules]
[Pages 23584-23597]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10946]
[[Page 23584]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 249
[Release No. 34-39885; File No. S7-13-98]
RIN 3235-AH39
Proposed Amendment to Rule 19b-4, Under the Securities Exchange
Act of 1934, That Would Deem the Listing and Trading of New Derivative
Securities Products by Self-Regulatory Organizations To Not Be Proposed
Rule Changes
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission proposes to amend Rule
19b-4 under the Securities Exchange Act of 1934. The amendment would
expand the scope of SRO matters that do not constitute proposed rule
changes to include the listing and trading of new derivative securities
products pursuant to existing SRO trading rules, procedures,
surveillance programs and listing standards.
DATES: Comments should be submitted by May 29, 1998.
ADDRESSES: All comments should be submitted in triplicate and addressed
to Jonathan G. Katz, Secretary, Securities and Exchange Commission,
Mail Stop 6-9, 450 Fifth Street, NW., Washington, DC 20549. Comments
also may be submitted electronically at the following e-mail address:
rule-comments@sec.gov. All comments should refer to File No. S7-13-98;
this file number should be included in the subject line if e-mail is
used. Comment letters will be available for public inspection and
copying at the Commission's Public Reference Room at the same address.
Electronically submitted comment letters will be posted on the
Commission's web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Sharon M. Lawson, Senior Special
Counsel at (202) 942-0182 or Marianne H. Duffy, Special Counsel at
(202) 942-4163, Office of Market Supervision, Division of Market
Regulation, Securities and Exchange Commission, Mail Stop 10-1, 450
Fifth Street, NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
A. Purpose of Amendment
The Securities and Exchange Commission (``SEC'' or ``Commission'')
is proposing to amend Rule 19b-4 under the Securities Exchange Act of
1934, as amended (``Exchange Act'' or ``Act'') \1\ to expand the scope
of self-regulatory organization (``SRO'') \2\ matters that do not
constitute proposed rule changes, pursuant to section 19(b) of the Act
and Rule 19b-4 \3\ thereunder, to include the listing and trading of
certain new derivative securities products, as defined below, pursuant
to existing trading rules, procedures, surveillance programs and
listing standards.
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\1\ 15 U.S.C. 78a et seq.
\2\ Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26),
defines SRO to mean any national securities exchange, registered
securities association, registered research agency, and for purposes
of Section 19(b) of the Act, 15 U.S.C. 78s(b), and other limited
purposes, the Municipal Securities Rulemaking Board (``MSRB'').
\3\ 17 CFR 240.19b-4.
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B. Description of Proposed Amendment
Section 19(b) of the Exchange Act requires every SRO to file with
the Commission any proposed rule or any proposed change in the rules of
the SRO. In the past, the Commission has considered the listing and
trading of new derivative securities products by an SRO to constitute a
proposed rule change. In order to approve these changes, the Commission
must find that the listing and trading of the new derivative securities
product will serve to promote the public interest and help to remove
impediments to a free and open securities market.\4\ Further, the
trading of such new derivative securities products must serve to
protect investors and promote efficiency, competition and capital
formation.
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\4\ 15 U.S.C. 78f(b)(5).
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The Commission has exercised its rulemaking authority \5\ by
promulgating paragraphs (b),\6\ (c) \7\ and (d) \8\ of Rule 19b-4 under
the Act, which interpret the terms ``stated policy, practice or
interpretation'' and ``proposed rule change.'' Paragraph (c) of Rule
19b-4 provides that certain stated policies, practices and
interpretations of SROs do not constitute proposed rule changes.
Specifically, a ``stated policy, practice or interpretation'' of an SRO
is not a proposed rule change if it is reasonably and fairly implied by
an existing SRO rule. The Commission now proposes to amend Rule 19b-4
so that the listing and trading of new derivative securities products
would not be proposed rule changes so long as there are existing SRO
trading rules, procedures, surveillance programs and listing standards.
Specifically, the Commission proposes to add a new paragraph (e) to
Rule 19b-4 which states:
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\5\ Sections 3(a)(26), 3(a)(27), 15 U.S.C. 78c(a)(27), 3(a)(28),
15 U.S.C. 78c(a)(28) and section 3(b), 15 U.S.C. 78c(b), of the Act
provide that the Commission may promulgate rules regarding, among
other things, ``stated policies, practices and interpretations'' of
SROs. Section 19(b) authorizes the Commission to promulgate rules
regarding ``proposed rule changes'' of SROs. Section 23(a), 15
U.S.C. 78w(a), of the Act provides that the Commission shall have
power to make such rules and regulations as may be necessary or
appropriate to implement the provisions of the Exchange Act for
which it is responsible or for the execution of the functions vested
in it by the Exchange Act, and may for such purposes classify
persons, securities, transactions, statements, applications, reports
and other matters within its jurisdiction, and prescribe greater,
lesser or different requirements for different classes thereof. (See
e.g., Securities Exchange Act Release No. 34140 (June 1, 1994), 59
FR 29393 (June 7, 1994)). In addition, in 1996, Congress granted the
Commission the authority, under section 36(a), 15 U.S.C. 78mm(a), to
exempt any class of person, security or transaction from any
provision of the Act. Pub. L. 104-290, 110 Stat. 3416 (1996).
\6\ 17 CFR 240.19b-4(b).
\7\ 17 CFR 240.19b-4(c).
\8\ 17 CFR 240.19b-4(d).
the listing and trading of a new derivative securities product by
(an SRO) shall not be deemed a proposed rule change, pursuant to
paragraph (c)(1) of (Rule 19b-4), if the Commission has approved,
pursuant to section 19(b) of the Act ( ), such (SRO's) trading
rules, procedures and listing standards for the product class that
would include the new derivative securities product, and the SRO has
a surveillance program for the product class.\9\
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\9\See Text of the Proposed Rule, infra.
In proposing new paragraph (e), the Commission preliminarily
believes that when the Commission has approved, pursuant to section
19(b) of the Act, an SRO's trading rules, procedures and listing
standards for the product class that would include the new derivative
securities product, the listing and trading of the new derivative
securities product is reasonably and fairly implied by the SRO's
existing trading rules, procedures and listing standards. The
Commission preliminarily believes it is therefore appropriate to deem
the listing and trading of new derivative securities products to not be
proposed rule changes pursuant to Rule 19b-4(c)(1) under certain
conditions.
II. Background
A. Current Procedures for Submission and Approval of SRO New Derivative
Securities Product Rule Filings
Over the years, the Commission has sought to revise the rule filing
requirements to meet the changing needs of the SROs in a competitive
international marketplace. The Commission has developed streamlined
filing procedures to ease the regulatory burden in many circumstances.
Today, the Commission is proposing to expand the scope of SRO matters
that do not constitute proposed rule changes to include the listing and
trading of new derivative securities products pursuant to existing SRO
trading rules,
[[Page 23585]]
procedures, surveillance programs and listing standards.
1. Standard Statutory Procedures
Section 19(b)(1) \10\ of the Act requires an SRO to file with the
Commission its proposed rule changes accompanied by a concise general
statement of the basis and purpose of the proposed rule change. Once a
proposed rule change has been filed, the Commission is required to
publish notice of it and provide an opportunity for public comment. The
proposed rule change may not take effect unless it is approved by the
Commission or is otherwise permitted to become effective under section
19(b) of the Act.\11\ Section 19(b)(2) \12\ of the Act sets forth the
standards and time periods for Commission action either to approve a
proposed rule change or to institute and conclude a proceeding to
determine whether a proposed rule change should be disapproved.
Generally, the Commission must either approve the proposed rule change
or institute disapproval proceedings within 35 days of the publication
of notice of the filing or within a longer period as the Commission
finds appropriate or to which the SRO consents. The Commission must
approve a proposed rule change if it finds that the rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to the SRO proposing the rule change.
If the Commission does not make that finding, it must institute
proceedings to determine whether to disapprove the proposed rule
change. The Commission also may approve a proposed rule change on an
accelerated basis prior to 30 days after publication of the notice if
the Commission finds good cause for so doing and publishes its reasons
for so finding.\13\
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\10\ 15 U.S.C. 78s(b)(1).
\11\ See generally, Senate Comm. on Banking, Housing & Urban
Affs., Report to accompany S. 249: Securities Acts Amendments of
1975, S. Rep. No. 94-75, 94th Cong., 1st Sess. 22-38 (Comm. Print
1975), reprinted in (1975) U.S. Code Cong. & Ad. News 179, 200-15
(except on ``Self-Regulation and Sec Oversight'').
\12\ 15 U.S.C. 78s(b)(2).
\13\ Section 19(b)(2)(B) of the Act, 15 U.S.C. 78s(b)(2)(B).
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SROs have submitted proposals under section 19(b)(2) to list and
trade various derivative securities products, including stock options,
broad-based and narrow-based stock index options\14\ and warrants,\15\
unit investment trusts,\16\ foreign currency options,\17\ indexed term
notes\18\ and other hybrid derivative equity and debt securities.\19\
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\14\ See e.g., Securities Exchange Act Release No. 39011
(September 3, 1997), 62 FR 47841 (September 11, 1997) (order
approving Chicago Board Options Exchange's, Incorporated (``CBOE'')
proposal to list and trade options based upon the Dow Jones
Industrial Average) and Securities and Exchange Act Release No.
38693 (May 29, 1997), 62 FR 30914 (June 5, 1997) (order approving
American Stock Exchange's, Incorporated (``Amex'') proposal to list
and trade options based on the the Tobacco Index).
\15\ See e.g., Securities Exchange Act Release No. 39079
(September 15, 1997), 62 FR 49543 (September 22, 1997) (order
approving Amex proposal to list and trade warrants based on the ING
Barings, Inc.'s BEMI Latin American Index).
\16\ Securities Exchange Act Release No. 31591 (December 11,
1992), 57 FR 60253 (December 18, 1992) (order approving Amex rules
to provide for the listing and trading of portfolio depositary
receipts (``PDRs''), and specifically PDRs based on the Standard and
Poors Corporation (``S&P'') 500 Index known as SPDRs). See also,
Amex Rule 1000(b)(1).
\17\ See e.g., Securities Exchange Act Release No. 36505
(November 22, 1995), 60 FR 61277 (November 29, 1995) (order
approving Philadelphia Stock Exchange's, Incorporated (``Phlx'')
proposal to list and trade dollar-denominated delivery foreign
currency options on the Japanese Yen).
\18\ See e.g., Securities Exchange Act Release No. 37533 (August
7, 1996), 61 FR 42075 (August 13, 1996) (order approving Amex
proposal to list and trade indexed term notes based upon a portfolio
of the top ten dividend yielding stocks in the Dow Jones Industrial
Average).
\19\ See e.g., Securities Exchange Act release No. 32950
(September 23, 1993), 58 FR 50985 (September 29, 1993) (order
approving New York Stock Exchange's, Incorporated (``NYSE'')
proposal to list and trade Debt Exchangeable for Common Stock issued
by the American Express Corporation and linked to the performance of
First Data Corporation).
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2. Streamlined Procedures for Certain New Derivative Securities Product
Rule Filings
Section 19(b)(3) of the Act \20\ provides that, in certain
circumstances, a proposed rule change may become effective immediately
upon filing with the Commission and without the notice and approval
procedures required by section 19(b)(2). Paragraph (A) of section
19(b)(3) permits certain types of proposed rule changes to take effect
in this manner if appropriately designated by the SRO as: (1)
Constituting a stated policy, practice or interpretation with respect
to the meaning, administration, or enforcement of an existing rule of
the SRO; (2) establishing or changing a due, fee, or other charge
imposed by the SRO; or (3) concerned solely with the administration of
the SRO. Section 19(b)(3)(A)(iii) \21\ also gives the Commission the
authority to expand, by rule, the scope of proposed rule changes that
may become effective under section 19(b)(3)(A) if the Commission
determines that the expansion is consistent with the public interest
and the purposes of Section 19(b). Currently, Rule 19b-4(e) under the
Act \22\ details the scope of proposed rule changes that may be filed
under section 19(b)(3)(A) of the Act.
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\20\ 15 U.S.C. 78s(b)(3).
\21\ 15 U.S.C. 78s(b)(3)(A)(iii).
\22\ 17 CFR 240.19b-4(e).
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For the past several years, the Commission has worked with the SROs
to develop procedures to streamline the review process of new
derivative securities product rule filings. As a result, SROs can
submit a proposed rule change in accordance with section 19(b)(3)(A) of
the Act for certain proposed new derivative securities products. For
example, on June 3, 1994, the Commission approved proposed rule changes
submitted by several SROs to establish generic listing standards for
options on narrow-based stock indices and to adopt streamlined
procedures for introducing trading in options that satisfy these
listing standards.\23\ In addition, certain SROs have in place rules
similar to the streamlined procedures for listing warrants on narrow-
based stock indices.\24\
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\23\ Securities Exchange Act Release No. 34157 (June 3, 1994) 59
FR 30062 (June 10, 1994) (order approving generic narrow-based index
options listing standards for the Amex, the CBOE, the NYSE, the
Pacific Exchange, Inc., (``PCX''), and the Phlx (``Generic Narrow-
Based Index Option Approval Order'')). Moreover, as of April 28,
1997, the NYSE transferred its options business to the CBOE. See
Securities Exchange Act Release Nos. 38541 and 38542 (April 23,
1997) 62 FR 23516 and 23521 (April 30, 1997) (orders approving
proposed rule changes by the CBOE and NYSE, respectively, regarding
the transfer of the NYSE's options business to the CBOE). These SROs
are the only U.S. exchanges that list standardized options products,
which are issued, cleared, and settled through the Options Clearing
Corporation.
\24\ Securities Exchange Act Release Nos. 37007 (March 21, 1996)
61 FR 14165 (March 29, 1996) (Amex, CBOE, and Phlx) and 37445 (July
16, 1996) 61 FR 38494 (July 24, 1996) (NYSE) (orders approving
uniform listing and trading guidelines for narrow-based stock index
warrants (``Generic Narrow-Based Index Warrant Approval Orders'')).
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Furthermore, the Commission has approved rules for certain SROs
that allow for the listing of specific broad-based \25\ and narrow-
based \26\ stock index warrant issuances without further Commission
approval pursuant to section 19(b) of the Act, as long as the listing
complies with the SRO's generic warrant listing standards and the
Commission has already approved the underlying stock index for warrant
or
[[Page 23586]]
options trading. In addition, the Commission has approved rules
allowing for the listing of warrants overlying a single currency
without a section 19(b) rule filing provided that the underlying
currency has been approved for options trading.\27\ The Commission also
has approved rules allowing for the listing of warrants overlying a
currency index without a section 19(b) rule filing provided the index
previously has been approved by the Commission pursuant to a section
19(b) rule filing.
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\25\ Securities Exchange Act Release Nos. 36165 (August 29,
1995) 60 FR 46653 (September 7, 1995) (NYSE); 36166 (August 29,
1995) 60 FR 46660 (September 7, 1995) (PCX); 36167 (August 29, 1995)
60 FR 46667 (September 7, 1995) (Phlx); 36168 (August 29, 1995) 60
FR 46637 (September 7, 1995) (Amex); and 36169 (August 29, 1995) 60
FR 36169 (CBOE) (September 7, 1995) (orders approving uniform
listing and trading guidelines for index, currency and currency
index warrants). See also, Securities Exchange Act Release No. 36296
(September 28, 1995) 60 FR 52234 (October 5, 1995) (order approving
the National Association of Securities Dealers', Incorporated
(``NASD'') proposed to adopt uniform listing and trading guidelines
for broad-based index warrants on the NASD's Automated Quotation
Stock Market).
\26\ Supra notes 23 and 24.
\27\ Supra note 25.
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B. Reasons for Expanding the Scope of SRO Matters That Do Not
Constitute Proposed Rule Changes
Over the years, the Commission has approved numerous SRO trading
rules, procedures and listing standards for various classes of new
derivative securities products. The Commission preliminarily believes
that when it has approved, pursuant to section 19(b) of the Act, an
SRO's trading rules, procedures and listing standards for the product
class that would include a new derivative securities product, the
listing and trading of the new derivative securities product should
therefore be reasonably and fairly implied by the SRO's existing
trading rules, procedures and listing standards.\28\
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\28\ The Commission notes that currently with regard to equity
issues, once an SRO has received approval for its trading rules,
procedures and listing standards, the listing and trading of a
specific new equity issue is not deemed a proposed rule change that
requires a filing under Rule 19b-4 of the Act. Rather, an SRO can
immediately list and trade a new equity issue so long as that equity
issue satisfies the Commission approved trading rules, procedures
and listing standards of the SRO.
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SROs are facing increasing competition from overseas and over-the-
counter (``OTC'') derivatives markets.\29\ The Commission believes that
SROs should be able to bring new derivative securities products to
market quickly to provide investors with tailored products that
directly meet their evolving investment needs. Although the generic
rules have helped to speed the process of reviewing new derivative
securities product proposals, the Commission preliminarily believes
that further changes are warranted. The Commission preliminarily
believes that expanding the scope of SRO matters that do not constitute
a proposed rule change to include the listing and trading of certain
new derivative securities products will significantly speed the
introduction of new derivative securities products and enable SROs to
maintain their competitive balance with the overseas and OTC derivative
markets. The proposal should foster innovation and create a streamlined
procedure for SROs to promptly list new products subject to appropriate
trading rules, procedures, a surveillance program and listing
standards.
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\29\ In order to further promote competition, the Commission
proposes, in a separate release issued today (Securities Exchange
Act Release No. 39884 (April 17, 1998)), to permit SROs to operate
new trading systems subject to certain conditions, for a period not
to exceed two years, without submitting a Rule 19b-4 filing.
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At the same time, SROs have had over 20 years of experience with
SEC review of new derivative securities product proposals. SROs that
have sought approval from the Commission to list and trade such new
derivative securities products should be familiar with the factors
discussed in this release that the Commission believes should be
considered when listing and trading such new derivative securities
products. Thus, the Commission believes that there is less need for SEC
review, notice and approval prior to an SRO trading a new derivative
securities product pursuant to existing trading rules, procedures, a
surveillance program and listing standards. Nonetheless, the Commission
preliminarily believes that the proposed procedures discussed in this
release will enable the Commission to continue to effectively protect
investors and promote the public interest.
III. Discussion
A. Definition of ``New Derivative Securities Product''
For the purposes of section 19(b) of the Act and Rule 19b-4
thereunder, the Commission proposes to define ``new derivative
securities product'' as any type of option, warrant, hybrid securities
product or any other security whose value is based upon the performance
of an underlying instrument.
1. New Derivative Securities Product Must Be a ``Security'' as Defined
in Section 3(a)(10) of the Act
The SROs have the authority to list and trade ``securities'' as
defined in section 3(a)(10) of the Exchange Act.\30\ The term
``security'' as defined in section 3(a)(10) of the Exchange Act,
includes, among other instruments, ``any put, call, straddle, option,
or privilege on any security, certificate of deposit, or group or index
of securities (including any interest therein or based on the value
thereof), or any put, call, straddle, option, or privilege entered into
on a national securities exchange relating to a foreign currency, or in
general, any instrument commonly known as a `security'.'' \31\ Because
SROs currently do not have the authority to trade non-securities, the
proposed amendment does not provide SROs with any new authority to list
a new derivative product that is not a ``security''.\32\
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\30\ 15 U.S.C. 78(c)(1)(j).
\31\ Id.
\32\ Furthermore, the proposal will only apply to securities
SROs. It will not apply to entities that seek designation as
contract markets for futures trading on an index or group of
securities or to foreign boards of trade that apply to the Commodity
Futures Trading Commission (``CFTC'') for certification to sell
their futures contracts to U.S. persons. Under the amendments to the
CEA effected by the Futures Trading Act of 1982 (Pub. L. 97-444, 96
Stat. 2294), Section 2(a)(1)(B) of the CEA (7 U.S.C. 2(a)(1)(B))
prohibits any person from offering or selling a futures contract
based on ``any group or index of such securities or any interest
therein based on the value thereof'' except as permitted under
Section 2(a)(1)(B)(ii) of the act. The CFTC is required to seek the
views of the SEC regarding each such application concerning a stock
index and the SEC may object to the designation on the ground that
any of the statutory criteria have not been met. The proposal would
not alter these procedures nor does the Commission believe that it
is appropriate to do so. The Commission notes that it would have the
ability to inspect the securities SROs in order to ensure that they
comply with the terms of the proposed amendment when they do not
submit proposed rule changes to list and trade new derivative
securities products. Moreover, the Commission could take appropriate
measures, including, but not limited to, ordering the SRO to
remediate the deficiency or prohibiting opening transactions in or
discontinuing the listing of new derivative securities products if
the new derivative securities product did not comply with the terms
of the proposed amendment. In contrast, for stock index futures
contracts, neither inspection nor enforcement authority is available
to the Commission. Consequently, the Commission believes that it is
important for the Commission to continue to review the terms of any
proposed stock index futures contract before it commences trading.
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2. Scope of Proposal
As stated above, SROs have sought Commission approval to list and
trade various new derivative securities products, including, among
others, stock index options and warrants, unit investment trusts,
foreign currency options and warrants, and indexed term notes. The
Commission proposes to make the proposed amendment available to SROs
seeking to list these classes of new derivative securities products and
other classes, provided that such classes are subject to existing
trading rules, procedures, a surveillance program and listing
standards.
An SRO seeking to list a completely new class of derivative
securities product without existing trading rules, procedures, a
surveillance program and listing standards would still be required to
submit a proposed rule change pursuant to section 19(b)(2) of the Act
in order to adopt appropriate trading rules, procedures and listing
standards for such class. These requirements are intended to ensure
that there are
[[Page 23587]]
adequate SRO rules to provide for fair and orderly trading for the
class of securities. Thus, in order to rely on the proposed amendment,
an SRO must have in place trading rules, procedures and listing
standards for the specific class of new derivative securities product
prior to the listing and trading of the class.\33\ Procedures include,
but are not limited to adequate procedures relating to sales practices
(including suitability), margin and disclosure requirements. The SRO
also must have a surveillance program adequate to monitor for abuses in
the trading of the new derivative securities product, including trading
in the underlying security or securities. Once an SRO has submitted,
and the Commission has approved, a section 19(b)(2) proposal to
establish an appropriate regulatory framework to support trading of a
new class of new derivative securities product, the SRO would qualify
under the proposed amendment for further new derivative securities
products under the same class. For example, if an exchange without any
options rules sought to trade options, it would first need to file a
rule change, pursuant to Rule 19b-4, to adopt appropriate trading
rules, procedures and listing standards that apply to options. In
addition, the proposed amendment does not relieve an SRO from its
obligation to submit a proposed rule change to amend its existing
listing standards for particular classes of securities.
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\33\ The Commission notes that several exchanges have adopted
listing standard categories termed ``other securities.'' These
standards were adopted to allow the listing of securities that
contain features borrowed from more than one category of currently
listed securities, such as hybrid new derivative securities products
that have characteristics of both common stock and debt securities.
The Commission has clearly stated and reiterates its belief that
such standards ``are not intended to accommodate the listing of
securities that raise significant new regulatory issues, and,
therefore, would require a separate filing with the Commission
pursuant to Rule 19b-4 under the Act.'' Securities Exchange Act
Release No. 28217 (July 18, 1990) 55 FR 30056 (July 24, 1990). In
other words, the ``other securities'' category is not intended to
permit an SRO to list a new derivative securities product that does
not fall under another listing category of the SRO. Accordingly, an
SRO could not avoid the requirement of adopting appropriate listing
standards in order to rely on the proposed amendment for a novel new
derivative securities product by simply listing such product under
the ``other security'' category.
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B. Standards for All New Derivative Securities Products
The proposal is premised upon the experience that the Commission
has obtained through its review of new derivative securities product
proposals by the SROs. Over the years, the Commission has identified
the factors it believes new derivative securities product proposals
should meet in order to be consistent with the Act. In order to rely on
the proposed amendment, an SRO should ensure that the new derivative
securities product meets the criteria discussed below in the areas of:
Design and maintenance of the instruments or index underlying the new
derivative securities product; customer protection rules; surveillance
of the component securities; and the potential market impact of the new
derivative securities product.\34\ Specifically, an SRO should have
adequate information sharing agreements, clearance and settlement
procedures, systems capacity and transaction reporting procedures for
underlying securities.
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\34\ As discussed in Section IV. G. Ensuring Proper Use Of The
Proposed Amendment, a failure to comply with the standards could
compromise an SRO's reliance on the proposed amendment.
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1. Information Sharing Agreements
In designing a new derivative securities product, the SRO should
ensure that it has adequate information sharing procedures to detect
and deter potential trading abuses. It is essential that the SRO have
the ability to obtain the information necessary to detect and deter
market manipulation, illegal trading and other abuses involving the new
derivative securities product. Specifically, there should be a
comprehensive information sharing agreement (``ISA'') in place between
the SRO listing or trading a derivative product and the markets trading
the securities underlying the new derivative securities product that
covers trading in the new derivative securities product and its
underlying securities.\35\ Such agreements provide a necessary
deterrent to manipulation because they facilitate the availability of
information needed to fully investigate a manipulation if it were to
occur.
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\35\ The Commission believes that a comprehensive ISA should
require that the parties provide each other, upon request,
information about market trading, clearing activity and the identity
of the ultimate purchasers and sellers of securities. See Securities
Exchange Act Release No. 31529 (November 27, 1992) 57 FR 57248
(December 3, 1992).
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For new derivative securities products based upon domestic
securities, the SRO should ensure the markets upon which all of the
U.S. component securities trade are members of the Intermarket
Surveillance Group (``ISG'').\36\ The ISG was formed to coordinate,
among other things, effective surveillance and investigative
information sharing arrangements in the stock and options markets.
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\36\ See ISG Agreement, dated July 14, 1983, amended January 29,
1990. The ISG members are: the Amex; the Boston Stock Exchange,
Incorporated; the CBOE; the Chicago Stock Exchange, Inc.; the NASD;
the NYSE; the PCX; and the Phlx. The major stock index futures
exchanges joined the ISG as affiliate members in 1990.
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For new derivative securities products based on securities from a
foreign market, the SRO should have a comprehensive ISA with the market
for the securities underlying the new derivative securities product.
The SRO should ensure there are no blocking or secrecy laws in the
foreign country that would prevent or interfere with the transfer of
information under the comprehensive ISA. If securing a comprehensive
ISA is not possible, the SRO should contact the Commission prior to
listing the new derivative securities product. In such instances, the
Commission may determine that it is appropriate instead to rely on a
Memorandum of Understanding (``MOU'') between the Commission and the
foreign regulator.\37\
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\37\ An MOU provides a framework for mutual assistance in
investigatory and regulatory matters. Generally, the Commission has
permitted an SRO to rely on an MOU in the absence of a comprehensive
ISA only if the SRO receives an assurance from the Commission that
such an MOU can be relied on for surveillance purposes and includes,
at a minimum, the transaction, clearing and customer information
necessary to conduct an investigation. See Securities Exchange Act
Release No. 35184 (December 30, 1994) 60 FR 2616 (January 10, 1995)
(order approving the listing and trading of warrants on the CBOE
overlying the Nikkei Stock Index 300 where there was no
comprehensive ISA between the CBOE and the underlying market, the
Tokyo Stock Exchange but there was an MOU between the SEC and the
Japanese Ministry of Finance). In addition, an SRO should endeavor
to develop comprehensive ISAs with foreign exchanges that trade the
underlying securities of an index even if the SRO receives prior
Commission approval to rely on an MOU in place of a comprehensive
ISA.
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For a new derivative securities product overlying an instrument
with component securities from several countries, the Commission
recognizes that it may not be practical in all instances to secure
comprehensive ISAs with all of the relevant foreign markets. Generally,
foreign countries' securities or American depositary receipts that are
not subject to a comprehensive ISA should not represent a significant
percentage of the weight of such an underlying instrument.\38\
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\38\ If, however, a foreign security had more than 50% of its
global trading volume in dollar value in U.S. markets, the
Commission, in the past, has treated such security as a U.S.
security.
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2. Clearance and Settlement
The calculation of the settlement value for the new derivative
securities product should be clear, fixed and objective. In order to
minimize market impact concerns, a new derivative securities product
overlying an index of U.S. securities generally should be
[[Page 23588]]
settled based on opening prices of the component stocks. If opening
price settlement is not utilized, the SRO should ensure that the
settlement value reflects the last available closing prices prior to
settlement for the underlying securities or some alternative objective
settlement measurement. If the new derivative securities product is
settled in foreign currency, the SRO should ensure that a recognized
exchange rate is used to convert the settlement value into U.S.
dollars. In addition, the SRO should ensure that adequate clearance
procedures have been established for the new derivative securities
product.
3. Systems Capacity
It is essential that the SRO and the applicable price reporting
authority have adequate systems processing capacity to accommodate the
listing and trading of a new derivative securities product. The SRO
should, prior to listing a new derivative securities product, ensure
that it has adequate systems processing capacity to accommodate the new
listing and obtain a representation from the applicable price reporting
authority that such price reporting authority also has adequate systems
processing capacity.
4. Transaction Reporting of Underlying Securities
In order to prevent manipulation and ensure liquidity of securities
underlying a new derivative securities product, underlying equity
securities should be listed on a national securities exchange or traded
through the facilities of a national securities association or
otherwise subject to real-time public transaction reporting. For
securities that are not subject to transaction reporting (e.g.,
municipal securities), there should be an objective means of capturing
price information through disseminated quotations. For foreign
securities underlying a new derivative securities product, an SRO
should ensure that those securities satisfy and maintain all other
criteria described in this release when relying on the proposed
amendment.
C. Index Based Products
In addition to the items discussed above, SROs should ensure that
if a new derivative securities product is index based: The index is
classified properly as broad-based or narrow-based; the index is
constructed according to established criteria for initial inclusion of
new component securities; the index is maintained so that it measures
the same segment of the market as originally intended; the index value
is disseminated frequently; component securities that fail to meet the
maintenance criteria are replaced according to established policies and
procedures; and when the index is maintained by a broker-dealer, a
functional separation exists between the broker-dealer's trading desk
and research department.
1. Designation of Index as Broad-Based or Narrow-Based
An SRO should first classify the underlying index as narrow-based
(i.e., containing securities from a specific industry sector or
comprised of a small group of securities) or broad-based (i.e., a
larger group of securities that is representative of the entire market
or a substantial portion of the entire market).\39\ In order to make a
determination that an index is broad-based, the SRO should identify how
the index represents the overall stock market or a substantial portion
thereof. The SRO should undertake an analysis of the basis for such a
determination. A mere conclusion by the SRO that an index has been
designated as broad-based is not determinative of the status of the
index.
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\39\ Such a classification is essential because regulatory
requirements such as position limits and margin levels are different
for narrow-based and broad-based index options. See e.g., CBOE Rules
24.4, 24.4A and 24.11.
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2. Index Construction
The index underlying a new derivative securities product should be
constructed according to established criteria for initial inclusion of
new component securities. SROs seeking to rely on the proposed
amendment should employ objective index construction standards that
include a minimum number of component securities and a fixed and
objective weighting methodology (e.g., capitalization weighted, price
weighted or equal-dollar weighted).\40\ In addition, SROs should use
index construction standards that ensure that the underlying securities
have sufficient liquidity so as to help reduce the potential for
manipulation of the index's component securities. For example, the
index construction criteria should include, among other things, a
minimum price, available capitalization, average daily trading volume
and value of each component security and set a maximum relative weight
for the top component and the five largest components.
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\40\ See Generic Narrow-Based Index Option Approval Order, supra
note 23 and Generic Narrow-Based Index Warrant Approval Orders,
supra note 24.
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3. Maintenance Criteria
Maintenance criteria should be designed to ensure that an index
that has derivative products overlying it continues to measure the same
segment or sector of the market as originally intended, remains
composed of liquid securities, and does not become dominated by one (or
a few) component(s). As a result, an SRO seeking to rely on the
proposed amendment should ensure the index meets reasonable maintenance
standards.
4. Dissemination of the Index Value
In most circumstances, the index value should be disseminated
frequently and, if based on U.S. equities only, should reflect last-
sale prices. If an index is comprised of both U.S. and foreign
securities, prices for all securities that trade on markets that are
open during U.S. trading hours should be disseminated, if practicable,
at least every 15 seconds. Dissemination of an index value based in
whole or in part on closing prices of component securities should occur
only for those component securities where the underlying markets are
closed during U.S. trading hours (the disseminated index value may
still be adjusted for currency fluctuations) or the underlying
component value itself is not calculated real-time (e.g., indices of
open-end mutual funds that report net asset value at the close of
trading).\41\ Certain indices may use quotes (e.g., a bond index) if
last sale prices are unavailable and the quotes are reliable and spread
across several dealers.
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\41\ Securities Exchange Act Release No. 39244 (October 15,
1997) 62 FR 55289 (October 23, 1997).
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5. Component Changes
Component securities that fail to meet the index maintenance
standards should be replaced within the index according to established
policies and procedures for reviewing and replacing such component
securities. Automatic rebalancing of index components also should occur
according to established policies and procedures (e.g., annually, semi-
annually or quarterly). Notice of component changes should be
disseminated to news vendors and the public. SROs should ensure that
components are replaced promptly in the event of specified
circumstances such as corporate mergers or spin-offs.
6. Functional Separation Letter
When the index is maintained by a broker-dealer or an affiliate of
a broker-dealer, the SRO should assure, prior to the listing of a new
derivative securities product, that there will be a functional
[[Page 23589]]
separation between the trading desk of the broker-dealer and the
research persons responsible for maintaining the index through a fire
wall. A fire wall is a mechanism by which employees responsible for
constructing and maintaining the index are separated from employees
involved in the sale and trading of securities. In accordance with the
broker-dealer's fire wall mechanism, the persons responsible for
maintaining an index should be subject to certain procedures limiting
the dissemination of index information within the broker-dealer and
particularly should be prohibited from relaying any information
concerning a potential change to the components of the index to anyone
not responsible for maintaining the index, including employees of the
sales and trading department.
D. Compliance With Other Federal Securities Laws
The Commission notes that the proposed amendment does not relieve
SROs from any other obligation under the federal securities laws, or
rules or regulations thereunder, except the requirement of filing a
proposed rule change pursuant to section 19(b) of the Act and Rule 19b-
4 thereunder. For example, Form S-20 \42\ under the Securities Act of
1933, as amended (``Securities Act'') \43\ and Rule 9b-1 \44\ under the
Exchange Act establish a disclosure framework specifically tailored to
the informational needs of investors in ``standardized options'' \45\
that are traded on an ``options market'' \46\. Under Rule 9b-1, broker-
dealers must provide an updated copy of the options disclosure document
(``ODD'') \47\ to each customer at or prior to the approval of the
customer's account for trading in standardized options.\48\
Accordingly, when trading a new standardized option, an SRO must
determine if it should change the ODD to reflect specific
characteristics and risks associated with the new derivative securities
product not currently set forth in the ODD and submit such changes to
the Commission. In addition, a particular new derivative securities
product may need to be designated as a standardized option under Rule
9b-1 in order to utilize the ODD.\49\ If the proposing SRO and the
issuer of the new derivative securities product determine that such
steps are necessary, they are required to submit proposals to the
Commission, under Rule 9b-1, prior to listing the new derivative
securities product.
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\42\ 17 CFR 239.20. Form S-20 is used to register classes of
options under the Securities Act.
\43\ 15 U.S.C. 77a et seq.
\44\ 17 CFR 240.9b-1.
\45\ Standardized options'' are options contracts trading on a
national securities exchange, an automated quotation system of a
registered securities association or a foreign securities exchange
which relate to options classes the terms of which are limited to
specific expiration dates and exercise prices or such other
securities as the Commission may, by order, designate. 17 CFR
240.9b-1(a)(4).
\46\ Options market'' means a national securities exchange, an
automated quotation system of a registered securities association or
a foreign securities exchange on which standardized options are
traded. 17 CFR 240.9b-1(a)(1).
\47\ The ODD identifies the issuer and describes the uses,
mechanics and risks of options trading and other matters in language
that can be easily understood by the general investing public.
\48\ The ODD may be used as a substitute for the traditional
prospectus.
\49\ See Securities Exchange Act Release No. 31920 (February 24,
1993) 58 FR 12280 (March 3, 1993) (order approving CBOE proposal to
list and trade FLEX Options based on the S & P's 500 and 100 Stock
Indices).
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The Commission preliminarily notes that the proposed amendment to
Rule 19b-4 may still be available if an SRO determines that the above
steps are necessary. So long as all conditions to the proposed
amendment are met, including the existence of appropriate current
listing standards for the new product, the SRO may immediately list the
new derivative securities product without a Section 19(b) rule filing
after the Commission designates the particular new product as a
``standardized option'' and approves the Rule 9b-1 filing of amendments
to the ODD.
In addition to Form S-20 and Rule 9b-1, the Commission notes that
other federal securities laws must be complied with even when an SRO
relies on the proposed amendment to Rule 19b-4. For example, issuers of
new derivative securities products must continue to comply with, among
other things, the registration requirements of the Securities Act and
in addition, if a product is an investment company \50\ regulated under
the Investment Company Act of 1940, as amended, (``ICA'') \51\ the
product must comply with the ICA.
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\50\ See e.g., Investment Company Act Release No. 21802 (March
5, 1996) (exemptive order under the ICA permitting the trading of
Countrybasket Index Funds on the NYSE).
\51\ 15 U.S.C. 80a et seq.
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E. Existing Trading Rules, Procedures, Surveillance Programs and
Listing Standards
An SRO wishing to list a new derivatives securities product should
have in place trading rules, procedures, a surveillance program and
listing standards that pertain to the class of securities covering the
new product. For example, the Amex, CBOE, NYSE,\52\ PCX, and Phlx are
the only SROs that currently have in place trading rules, position
limits, margin requirements and internal surveillance programs that
pertain to the listing and trading of narrow-based stock index
options.\53\ Should another exchange desire to trade narrow-based index
options, it would first have to submit a proposed rule change to the
Commission adding relevant trading rules, procedures and listing
standards to its rules. Procedures include, but are not limited to
adequate procedures relating to sales practices (including
suitability), margin and disclosure requirements. Otherwise, the SRO
would be in violation of sections 6(b) and 19(b) of the Act in order to
assure fair and orderly trading markets. The SRO also must have a
surveillance program adequate to monitor for abuses in the trading of
the new derivative securities product, including trading in the
underlying security or securities.
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\52\ Although the NYSE transferred its options business to the
CBOE, supra note 23, the NYSE still has listing standards for
narrow-based index options in its rules.
\53\ See e.g., Amex Rules 900c through 980C; CBOE Rules 24.1
through 24.8; and PCX Rules 7.1 through 7.18.
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SROs that have the appropriate regulatory framework in place for a
specific class of new derivative securities product could immediately
list such class of new derivative securities product, provided the
particular SRO satisfies the conditions for the proposed amendment. If
an SRO sought to alter position limits, margin requirements, or any
other rules or procedures for a new derivative securities product
class, however, it would be required to submit a section 19(b)(2) rule
filing for Commission review. The SRO could apply such proposed rule
changes to a new product only after the Commission has reviewed and
approved the proposal pursuant to section 19(b)(2). For example, if an
options exchange wanted to list immediately a new narrow-based index
option it could do so under its existing applicable rules. In
particular, the SRO could immediately list the new narrow-based index
option and impose its existing position limits and margin requirements.
If the SRO wanted to impose different position limits or margin
requirements, or alter other existing trading rules or procedures for
the new derivative securities product class, it would still be required
to submit to the Commission a rule filing proposing such changes to its
existing rules pursuant to section 19(b)(2) of the Act. This framework
would not prevent an SRO from using
[[Page 23590]]
the proposed amendment to immediately list a new derivative securities
product under its existing rules, and then impose different position
limits, margin requirements, or any other trading rule for the new
product once the Commission has approved the Section 19(b)(2) rule
filing proposing such rule changes.\54\
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\54\ The Commission does not anticipate that every proposed
change in an SRO's existing trading rules to accommodate a new
derivatives securities product will require a Section 19(b)(2) rule
filing. An SRO will not be required to submit a rule filing for a
stated policy, practice or interpretation of the SRO that is
reasonably or fairly implied by an existing rule of the SRO or is
concerned solely with the administration of the SRO and is not a
stated policy, practice or interpretation with respect to the
meaning, administration or enforcement of an existing rule of the
SRO. 17 CFR 240.19b-4(c), supra note 7. For example, if an SRO has
rules that merely delineate each new derivative securities product
covered by a particular existing trading rule, the SRO need not
submit a rule filing pursuant to Section 19(b) of the Act and Rule
19b-4 thereunder merely because it is adding a new derivative
securities product to the list. See e.g., CBOE Rule 24.9(a)(3) and
(4).
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F. Form of Notification to the SEC of New Derivative Securities Product
Listing Pursuant to the Proposed Amendment
In order for the Commission to maintain an accurate record of all
new derivative securities products traded on the SROs, it is proposing
that an SRO file a new form, proposed Form 19b-4(e), to notify the
Commission when an SRO begins to trade a new derivative securities
product that is not required to be submitted as a proposed rule change
to the Commission for approval. Proposed Form 19b-4(e) should be
submitted within five business days after an SRO begins trading a new
derivative securities product that is not the subject of a proposed
rule change.
G. Ensuring Proper Use of the Proposed Amendment
The Commission contemplates that its Office of Compliance
Inspections and Examinations (``OCIE'') will review SRO compliance with
the proposed amendment through its routine inspection process of the
SROs. In order for OCIE to determine whether an SRO has properly
availed itself of the proposed amendment, it is necessary that the SRO
maintain, on-site, relevant records and information pertaining to each
new derivative securities product for which the SRO relied on the
proposed amendment. Such records should be maintained for a period of
not less than five years, the first two years in an easily accessible
place, according to the recordkeeping requirements set forth in Rule
17a-1 under the Act.\55\
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\55\ 17 CFR 240.17a-1. SROs may also destroy or otherwise
dispose of such records at the end of five years according to Rule
17a-6 under the Act, 17 CFR 240.17a-6.
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Such records available for OCIE review would include, among other
things, a copy of proposed Form 19b-4(e) under the Act and whether the
factual and numerical information regarding the new derivative
securities product's characteristics meet the conditions of the
proposed amendment. The SRO should be able to provide the listing
standard under which the new derivative securities product falls as
well as, but not limited to, such other things as the details of its
surveillance program, records of adequate information sharing
procedures and index construction and maintenance standards. In short,
the Commission believes that when an SRO relies on the proposed
amendment, such SRO should ensure that its regulatory framework
adequately supports the listing and trading of any new derivative
securities product. Failure to comply with this requirement would mean
that the SRO could be in violation of the Act. If so, appropriate
measures would be taken, including, but not limited to, ordering the
SRO to remediate the deficiency or prohibiting opening transactions in
or discontinuing the listing of new derivative securities products.\56\
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\56\ See section 19(h) of the Act, 15 U.S.C. 78s(h).
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IV. Technical Changes
Because the Commission proposes that a new paragraph (e) be added
to Rule 19b-4 under the Act, Form 19b-4 under the Act \57\ is amended
by revising the phrase ``subparagraph (e) of Rule 19b-4'' to read
``subparagraph (f) of Rule 19b-4'' and the phrase ``subparagraph (e) of
Securities Exchange Act Rule 19b-4'' to read ``subparagraph (f) of
Securities Exchange Act Rule 19b-4'' in Exhibit 1, III. (B); and in
Exhibit 1, IV. revise the first sentence to read ``Interested persons
are invited to submit written data, views and arguments concerning the
foregoing, including whether the proposed rule change is consistent
with the Exchange Act.''
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\57\ 17 CFR 249.819.
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V. Conclusion
For the reasons discussed above, the Commission preliminarily
believes that an amendment to Rule 19b-4 under the Act that deems the
listing and trading of new derivative securities products pursuant to
existing SRO trading rules, procedures, surveillance programs and
listing standards, to not be a proposed rule change will reduce
significantly the SROs' regulatory burden and help SROs maintain their
competitive balance with the overseas and OTC derivatives markets. The
proposed amendment to Rule 19b-4 will provide guidelines for SROs
seeking to rely on it but removes the need for SEC review, notice and
approval prior to an SRO trading a new derivative securities product
pursuant to existing SRO trading rules, procedures, surveillance
programs and listing standards.\58\
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\58\ The Commission anticipates that the proposed amendment will
eliminate approximately 45 SRO filings each year pursuant to Rule
19b-4 and Form 19b-4. In addition, the Commission believes that the
proposed amendment reduces the recordkeeping and reporting
requirements, purusant to Rule 19b-4 and Form 19b-4, on the SROs by
permitting them to submit a one page summary form after they list a
new derivative securities product instead of filing a complete
proposed rule change for Commission review prior to listing such new
derivative securities product.
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The Commission preliminarily believes that the proposed amendment
offers potential benefits for investors. If adopted, the proposed
amendment will facilitate the listing and trading of new derivative
securities products by permitting SROs to bring such products to market
quickly to provide investors with tailored products that directly meet
their evolving investment needs. The Commission does not anticipate
that the proposed amendment will result in any costs for U.S. investors
or others. The Commission preliminarily believes that the proposed
amendment would reduce the cost of offering new derivative securities
products to investors because it will foster innovation and create a
streamlined process for SROs to list and trade such new derivative
securities products subject to existing trading rules, procedures,
surveillance programs and listing standards. Thus, the Commission has
considered the proposed amendment's impact on efficiency, competition
and capital formation and preliminarily believes that it would promote
these three objectives.\59\ Finally, the Commission believes that the
SROs will spend significantly less time filling out the form to be used
under the proposed amendment than they do now when submitting a
complete proposed rule change for Commission review, notice and
approval pursuant to Rule 19b-4 under the Act.
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\59\ Section 3(f) of the Act, 15 U.S.C. 78c(f), requires the
Commission, when it is engaged in rulemaking and is required to
consider or determine whether an action is necessary or appropriate
in the public interest, to also consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition and capital formation.
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[[Page 23591]]
VI. Request for Public Comments
The Commission seeks comments on adopting proposed Rule 19b-4(e)
and Form 19b-4(e) under the Act. Commentators are asked to consider
whether the proposed amendment provides appropriate review of the
listing and trading of new derivative securities products subject to
existing trading rules, procedures, surveillance programs and listing
standards. Specifically, comments should address whether more or less
information is needed on Form 19b-4(e) in order to enable the
Commission to comply with its statutory obligations to help remove
impediments to a free and open securities market, protect investors and
promote the public interest. For example, should Form 19b-4(e) require
the SRO to cite its relevant standards under which it has listed a new
derivative securities product? Commentators also may wish to discuss
whether there are any legal or policy reasons why the Commission should
consider a different approach in regulating new derivative securities
products. For purposes of the Small Business Regulatory Enforcement
Fairness Act of 1996, the Commission is also requesting information
regarding the potential impact of the proposed amendment on the economy
on an annual basis. If possible, commentators should provide empirical
data to support their views. Finally, commentators should consider the
proposed rule amendment's effect on competition, efficiency and capital
formation. Comments should be submitted by May 29, 1998.
VII. Costs and Benefits of the Proposed Amendment and its Effects
on Competition, Efficiency and Capital Formation
To assist the Commission in its evaluation of the costs and
benefits that may result from the proposed amendment, commentators are
requested to provide analysis and data, if possible, relating to costs
and benefits associated with the proposal herein. The Commission
preliminarily believes that the proposed amendment will reduce SRO
compliance burdens under Rule 19b-4.\60\ The proposal would reduce
significantly the SROs' regulatory burden and help SROs maintain their
competitive balance with the overseas and OTC derivative markets.\61\
Moreover, the Commission believes that the proposed amendment will
foster innovation and create a streamlined procedure for SROs to
promptly list new derivative securities products subject to appropriate
listing standards.
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\60\ See supra note 58. As previously stated, the Commission
believes that the proposed amendment reduces the recordkeeping and
reporting requirements, pursuant to Rule 19b-4 and Form 19b-4, on
the SROs by eliminating the requirement of filing a complete
proposed rule change for Commission review prior to trading a new
derivate securities product. The Commission estimates that the
annual aggregate burden and annual aggregate cost for all
respondents under Form 19b-4 would be reduced by 2,295 hours and
$152,786, respectively. The cost per hour and per filing is derived
from information supplied by the SROs. We have valued related
overhead at 35% of the value of legal and clerical work combined.
See GSA Guide to Estimating Reporting Costs (1973).
The annual aggregate burden was derived as follows: 30 routine
filings at 25 hours legal review time per filing equals 750 hours;
15 significant filings at 100 hours legal review time per filing
equals 1,500 hours; and 45 total filings at 1 hour of clerical work
per filing equals 45 hours. The total of the three sums equals 2,295
hours.
The annual aggregate cost was derived as follows: 2,250 hours of
in-house legal work at $50 per hour equals $112,500; 45 hours of
clerical work at $15 per hour equals $675; and overhead equals
$39,611. The total of the three sums equals $152,786.
A routine filing is one that takes the Commission approximately
90 days to approve and a significant filing takes more time. See
infra note 61.
\61\ The Commission estimates that under current procedures, a
proposed rule filing for a new derivative securities product takes
90 days, on average, from the date of the original submission, to be
approved. In contrast, the proposed amendment permits SROs to
immediately list and trade a new derivative securities product so
long as such product is in compliance with proposed Rule 19b-4(e)
under the Act.
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The individual hour burden for each respondent to the collection of
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e)
under the Act is estimated to be two hours per proposed Form 19b-4(e).
The annual aggregate burden for all respondents to the recordkeeping
collection of information requirements of proposed Rule 19b-4(e) and
Form 19b-4(e) under the Act is estimated to be 90 hours. This burden is
computed by estimating that an SRO will utilize 1 hour of in-house
legal processing time to prepare the substantive information for
proposed Form 19b-4(e) and 1 hour of clerical time to process proposed
Form 19b-4(e) for filing. The Commission estimates that an SRO will
incur a cost of $88 for each proposed Form 19b-4(e) that it
submits.\62\ Thus, the total cost per year to all SROs to comply with
proposed Rule 19b-4(e) and Form 19b-4(e) is estimated to be $7,920 (90
hours at $88 per hour). When the annual aggregate SRO burden of
preparing proposed Form 19b-4(e) (positive 90 hours) is added to the
reduction in SRO burden hours under Form 19b-4 (negative 2,295 hours),
the Commission estimates that the SROs would receive an aggregate net
savings of 2,205 burden hours per year.
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\62\ The Commission estimates that the $88 cost will be broken
down as follows: 1 hour in-house professional work at $50 per hour;
1 hour of clerical work at $15 per hour; and overhead (telephone,
copying and postage) at $23 per Proposed Form 19b-4(e).
We have valued related overhead at 35% of the value of legal and
clerical work combined. The cost per hour and per Form 19b-4(e) is
derived from the information supplied by the SROs used to compute
the SROs' burden under Form 19b-4, see note 60, supra.
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In addition, section 23(a)(2)\63\ of the Act requires that the
Commission, when promulgating rules under the Exchange Act, to consider
the impact any rule would have on competition and to not adopt any rule
that would impose a burden on competition that is not necessary or
appropriate in the public interest. The Commission has considered the
proposed amendment in light of the standards cited in section 23(a)(2)
of the Act and believes that it would not likely impose any significant
burden on competition not necessary or appropriate in furtherance of
the Exchange Act. Indeed, the Commission believes that the proposed
amendment will reduce compliance cost and will enable SROs to compete
more effectively with overseas and OTC derivatives markets. The
Commission preliminarily believes that SROs should be able to bring new
derivative securities products to market quickly to provide investors
with tailored products that directly meet their evolving investment
needs.\64\ SROs have had over 20 years of experience with SEC review of
new derivative securities product proposals. SROs that have sought
approval from the Commission to list and trade such new derivative
securities products should be familiar with the factors discussed in
this release that the Commission believes should be considered when
listing and trading such new derivative securities products. Thus, the
Commission preliminarily believes that there is less need for SEC
review, notice and approval prior to an SRO trading a particular new
derivative securities product pursuant to existing SRO trading rules,
procedures, a surveillance program and listing standards. The
Commission preliminarily believes that the proposed procedures
discussed in this release will enable the Commission to continue to
effectively protect investors and promote the public interest.
Nonetheless, the Commission solicits comments on the costs, benefits
and competitive effects of the proposed rule amendment, in general, and
the potential competitive effects across
[[Page 23592]]
markets, in particular. Specifically, the Commission requests
commentators to address whether the proposed amendment would generate
the anticipated benefits or impose any costs on U.S. investors or
others.
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\63\ See 15 U.S.C. 78w(a)(2).
\64\ The Commission also believes that the proposed amendment
will benefit broker-dealers. See VII. Summary of Regulatory
Flexibility Act Analysis, infra.
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VIII. Summary of Regulatory Flexibility Act Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``IRFA'') in accordance with 5 U.S.C. 605(b) regarding the
proposed amendment to Rule 19b-4 and Form 19b-4(e) under the Exchange
Act. The following summarizes the IRFA.
The IRFA sets forth the statutory authority for the proposed
amendment to Rule 19b-4. The IRFA also discusses the effect of the
proposed amendment on broker-dealers that are small entities as defined
in Rule 0-10 under the Exchange Act.\65\ A broker-dealer that has total
capital of less than $500,000 on the date in the prior fiscal year as
of which its audited financial statements were prepared, or, if not
required to prepare such statements, a broker-dealer that had total
capital of less than $500,000 on the last business day of the preceding
fiscal year is deemed to be a small entity for purposes of the IRFA.
The IRFA states that the proposed amendment would enable broker-dealers
that are small entities (such as certain options market makers and
options specialists) to trade new derivative securities products
pursuant to existing trading rules, procedures, surveillance programs
and listing standards approximately 90 days earlier, on average,
because the proposed amendment will permit SROs to immediately list
these new derivative securities product without prior Commission
approval. As a result, broker-dealers will have additional days to earn
income through trading such new derivative securities products. As of
December 31, 1996, the Commission estimated that there were over 900
options market makers and specialists that may be considered small
entities.\66\
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\65\ 17 CFR 240.0-10(c).
\66\ The Commission bases its estimate on the information
provided in Form X-17A-5--Financial and Operational Combined Uniform
Single Reports pursuant to section 17 of the Act and Rule 17a-5
thereunder.
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The IRFA states that the proposed amendment would not impose any
new reporting, recordkeeping or compliance requirements on broker-
dealer small entities. Any new reporting, recordkeeping or compliance
burdens rest with the SROs, not broker-dealer small entities.
The IRFA discusses the various alternatives considered by the
Commission in connection with the proposed amendment that might
minimize the effect on small entities, including: (a) The establishment
of differing compliance or reporting requirements or timetables that
take into account the resources of small entities; (b) the
clarification, consolidation or simplification of compliance and
reporting requirements under the rule for small entities; (c) the use
of performance rather than design standards; and (d) an exemption from
coverage of the proposed rule amendment, or any part thereof, for small
entities. The Commission believes that different compliance or
reporting requirements for small entities are not necessary because the
proposed rule amendment does not establish any new reporting,
recordkeeping or compliance requirements for small entities. In
addition, the Commission has concluded that it is not feasible to
further clarify, consolidate or simplify the proposed rule amendment
for small entities. The Commission also believes that it would be
inconsistent with the purposes of the Act to use performance standards
to specify different requirements for small entities or to exempt
broker-dealer small entities from being able to trade new derivative
securities products that are covered by the proposed rule amendments.
The IRFA includes information concerning the solicitation of
comments with respect to the IRFA generally, and in particular, the
number of small entities that would be affected by the proposed rule
amendment. A copy of the IRFA may be obtained by contacting Marianne H.
Duffy, Special Counsel, (202) 942-4163 at Office of Market Supervision,
Division of Market Regulation, SEC, Mail Stop 10-1, 450 Fifth Street,
NW., Washington, DC 20549.
IX. Paperwork Reduction Act
Certain provisions of the proposed amendment to Rule 19b-4 contain
``collection of information requirements'' within the meaning of the
Paperwork Reduction Act of 1995 \67\ through the use of proposed Form
19b-4(e) under the Act. The Commission has submitted the collection to
the Office of Management and Budget (``OMB'') in accordance with 44
U.S.C. 3507 and 5 CFR 1320.11. Persons should note that an agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number. The title for the collection of information is: ``Form 19b-4(e)
Under the Securities Exchange Act of 1934.''
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\67\ 44 U.S.C. 3501 et seq.
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A. Summary of Collection of Information Under Proposed Rule 19b-4(e)
and Form 19b-4(e)
The collection of information would require SROs to prepare a one-
page summary sheet of nine questions that requests factual information
regarding the characteristics of the new derivative securities product
and the underlying securities. Such questions do not require any
analysis or exhibits.
B. Proposed Use of the Information
Currently, in order to list and trade a new derivative securities
product, an SRO must submit a proposed rule change to the Commission
pursuant to section 19(b) of the Exchange Act and Rule 19b-4
thereunder. Paragraph (c) of Rule 19b-4 provides that certain stated
policies, practices and interpretations of SROs do not constitute
proposed rule changes. Specifically, a ``stated policy, practice or
interpretation'' of an SRO shall be deemed to be a proposed rule change
unless it is reasonably and fairly implied by an existing rule of the
SRO. The Commission proposes to not deem the listing and trading of new
derivative securities products as proposed rule changes pursuant to
Rule 19b-4(c)(1) because, if the Commission has approved, pursuant to
section 19(b) of the Act, such SRO's trading rules and procedures and
listing standards for the product class that would include the new
derivative securities product, the listing and trading of the new
derivative securities product is reasonably and fairly implied by the
existing trading rules and procedures and listing standards.
Under current procedures, a proposed rule filing for a new
derivative securities product takes approximately 90 days from the date
of the original submission to be ordered.\68\ In contrast, the proposed
amendment permits SROs to immediately list and trade a new derivative
securities product so long as such new derivative securities product is
in compliance with proposed Rule 19b-4(e) under the Act. However, in
order for the Commission to maintain an accurate record of all new
derivative securities products traded on the SROs and to determine
whether an SRO has properly relied on the proposed amendment, it is
necessary that the SRO file proposed Form 19b-4(e) with the Commission
when such SRO begins trading a new derivative securities product
pursuant to the proposed amendment. In addition, an SRO must
[[Page 23593]]
maintain, on-site, a copy of proposed Form 19b-4(e). The Commission
contemplates that it will ensure SRO compliance with the proposed
amendment through its routine inspection process of the SROs.
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\68\ See supra note 61.
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C. Respondents
The proposed amendment may be used by any SRO. Currently, there are
ten such SROs for which it is estimated that the proposed amendment
would be used, in the aggregate, approximately 45 times a year.
D. Total Annual Reporting and Recordkeeping Burden
The individual burden for each respondent to the collection of
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e)
under the Act is estimated to be two hours per proposed Form 19b-4(e).
The annual aggregate burden for all respondents to the collection of
information requirements of proposed Rule 19b-4(e) and Form 19b-4(e)
under the Act is estimated to be 90 hours. This burden is computed by
estimating that an SRO will utilize 1 hour of in-house legal processing
time to prepare the substantive information for proposed Form 19b-4(e)
and 1 hour of clerical time to process proposed Form 19b-4(e) for
filing. The Commission also estimates that an SRO will incur an
additional cost of $23 for overhead, including telephone, copying and
postage, for each proposed Form 19b-4(e) that it submits.\69\ Thus, the
total operation and maintenance cost per year, in addition to the
burden hours, to all SROs to comply with proposed Rule 19b-4(e) and
Form 19b-4(e) is estimated to be $7,920 (90 hours at $88 per hour).
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\69\ Supra note 62.
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In addition, as previously stated, because SROs will no longer be
required to file a lengthier Form 19b-4, the Commission estimates that
the annual aggregate costs and annual aggregate burden for all
respondents under Form 19b-4 would be reduced by $152,786 and 2,295
hours, respectively.\70\ As previously stated, when the annual
aggregate SRO burden of preparing proposed Form 19b-4(e) is added to
the reduction in SRO burden hours under Form 19b-4, the Commission
estimates that the SROs would receive an aggregate net savings of 2,205
burden hours per year.
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\70\ Supra note 60.
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E. Retention Period for Recordkeeping Requirements
The SROs would be required to retain records of the collection of
information for a period of not less than five years, the first two
years in an easily accessible place, according to the current
recordkeeping requirements set forth in Rule 17a-1 under the Act.\71\
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\71\ SROs may also destroy or otherwise dispose of such records
at the end of five years according to Rule 17a-6 under the Act,
supra note 55.
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F. Collection of Information Is Mandatory
Any collection of information pursuant to proposed Rule 19b-4(e)
and Form 19b-4(e) under the Act would be mandatory as a means for the
Commission to maintain accurate records of new derivative securities
products that are traded.
G. Responses to Collection of Information Will Not Be Kept Confidential
Any collection of information pursuant to proposed Rule 19b-4(e)
and Form 19b-4(e) under the Act would not be confidential and would be
publicly available from the Commission upon request.
H. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
(i) Evaluate whether the proposed collection of information is
necessary for the performance of the functions of the agency, including
whether the information shall have practical utility;
(ii) Evaluate the accuracy of the agency's estimate of the burden
of the proposed collection of information;
(iii) Enhance the quality, utility and clarity of the information
to be collected;
(iv) and minimize the burden of collection of information on those
who are to respond, including through the use of automated collection
techniques or other forms of information technology.
Persons wishing to submit comments on the collection of information
requirements should direct them to the following persons: (i) Desk
Officer for the Securities and Exchange Commission, Office of
Information and Regulatory Affairs, Office of Management and Budget,
Room 3208, New Executive Office Building, Washington, D.C. 20503; and
(ii) Jonathan G. Katz, Secretary, Securities and Exchange Commission,
450 Fifth Street, N.W., Washington, DC 20549 with reference to File No.
S7-13-98. OMB is required to make a decision concerning the collection
of information between 30 and 60 days after publication, so a comment
to OMB is best assured of having its full effect if OMB receives it
within 30 days of publication.
X. Statory Basis
The amendment to Rule 19b-4(e) under the Exchange Act is being
proposed pursuant to 15 U.S.C. 78a et seq., particularly sections
3(a)(27), 3(b), 19(b), 23(a) and 36(a) of the Act, unless otherwise
noted.
Text of the Proposed Rule
List of Subjects in 17 CFR Parts 240 and 249
Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The general authority citation for part 240 is revised to read,
in part, as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k,
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d),
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and
80b-11, unless otherwise noted.
* * * * *
2. Section 240.19b-4 is amended by redesignating paragraphs (e),
(f), (g), and (h) as paragraphs (f), (g), (h) and (i) and adding new
paragraph (e) to read as follows:
Sec. 240.19b-4 Filings with respect to proposed rule changes by self-
regulatory organizations.
* * * * *
(e) For the purposes of this paragraph, new derivative securities
product means any type of option, warrant, hybrid securities product or
any other security whose value is based upon the performance of an
underlying instrument.
(1) The listing and trading of a new derivative securities product
by a self-regulatory organization shall not be deemed a proposed rule
change, pursuant to paragraph (c)(1) of this section, if the Commission
has approved, pursuant to Section 19(b) of the Act (15 U.S.C. 78s(b)),
the self-regulatory organization's trading rules, procedures and
listing standards for the product class that would include the new
derivative securities product and the self-regulatory organization has
a surveillance program for the product class.
(2) Recordkeeping and reporting:
[[Page 23594]]
(i) Self-regulatory organizations shall retain at their principal
place of business a file, available to Commission staff for inspection,
of all relevant records and information pertaining to each new
derivative securities product traded pursuant to this paragraph (e) for
a period of not less than five years, the first two years in an easily
accessible place, as prescribed in Sec. 240.17a-1.
(ii) When relying on this paragraph (e), a self-regulatory
organization shall submit Form 19b-4(e) (17 CFR 249.820) to the
Commission within five business days after commencement of trading a
new derivative securities product.
* * * * *
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
3. The authority citation for part 249 continues to read in part as
follows:
Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
4. Form 19b-4 (referenced in Sec. 249.819) is amended as by
revising the phrase ``subparagraph (e) of Rule 19b-4'' to read
``subparagraph (f) of Rule 19b-4'' and the phrase ``subparagraph (e) of
Securities Exchange Act Rule 19b-4'' to read ``subparagraph (f) of
Securities Exchange Act Rule 19b-4'' in Exhibit 1, III. (B); and in
Exhibit 1, IV. revise, the first sentence to read ``Interested persons
are invited to submit written data, views and arguments concerning the
foregoing, including whether the proposed rule change is consistent
with the Exchange Act.''
5. Section 249.820 and Form 19b-4(e) are added to read as follows:
Sec. 249.820 Form 19b-4(e) for the listing and trading of new
derivative securities products by self-regulatory organizations that
are not deemed proposed rule changes pursuant to Rule 19b-4(e)
(Sec. 240.19b-4(e)).
This form shall be used by all self-regulatory organizations, as
defined in Section 3(a)(26) of the Act, to notify the Commission of a
self-regulatory organization's listing and trading of a new derivative
securities product that is not deemed a proposed rule change, pursuant
to Rule 19b-4(e) under the Act (17 CFR 240.19b-4(e)).
BILLING CODE 8010-01-P
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By the Commission.
Dated: April 17, 1998.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10946 Filed 4-28-98; 8:45 am]
BILLING CODE 8010-01-C
