[Federal Register Volume 62, Number 108 (Thursday, June 5, 1997)]
[Notices]
[Pages 30914-30918]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-14687]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38693; File No. SR-Amex-97-15]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to Options on
the NatWest Energy Index
May 29, 1997.
I. Introduction
On March 20, 1997, the American Stock Exchange, Inc. (``Amex'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``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 authorize Options on the
NatWest Energy Index.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on April 24, 1997.\3\ No comments were received on the
proposal. This order approves the proposal.
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\3\ Securities Exchange Act Release No. 38526 (Apr. 18, 1997),
62 FR 20043 (Apr. 24, 1997).
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II. Description of the Proposal
A. General
Amex proposes to trade options on The NatWest Energy Index
(``Index''), a cash-settled narrow based index developed by the Amex
and NatWest Securities Corporation (``NatWest'') based on 30 stocks (or
ADRs thereon) of companies whose business is in various segments of the
energy industry. In addition, the Amex proposes to amend (1) Rule 901C,
Commentary .01 to reflect that 90% of the Index's numerical index value
will be accounted for by stocks that meet the current criteria and
guidelines set forth in Rule 915; and (2) Rule 902C to include the
NatWest Energy Index in the disclaimer provisions of that rule.\4\
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\4\ Amex Rule 902 will be amended to add subsection (g) which
will provide, among other things, that NatWest does not guarantee
the accuracy or completeness of the Index or any data included
therein, nor does NatWest make any warranty, either express or
implied, as to the results to be obtained by any person or entity
from the use of the Index or any data included therein.
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B. Composition of the Index
The Amex and NatWest have developed the Index based entirely on
shares of widely held companies involved in producing and providing
different types of energy products. The industries represented by these
companies are domestic and international oil producers, refiners and
transmitters, oil equipment manufacturers and drillers, and natural gas
producers.
The Exchange will use an ``equal dollar-weighted'' method to
calculate the value of the Index.\5\ The Index was initialized at a
level of 250.00 as of the close of trading on December 20, 1996.
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\5\ See infra section II.D entitled ``Calculation of the Index''
for a description of this calculation method.
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C. Eligibility Standards for the Inclusion of Component Stocks in the
Index
The Exchange represents that the Index conforms with Exchange Rule
901C, which specifies criteria for inclusion of stocks in an index on
which standardized options will be traded. In addition, the Index has
met the following standards: (1) Each of the component securities is
traded on the Amex, the New York Stock Exchange (``NYSE'') or through
Nasdaq and are reported national market system securities; (2) each of
the component securities has a minimum market
[[Page 30915]]
capitalization of at least $75 million;\6\ (3) each of the components
has had a monthly trading volume of at least one million shares during
each of the previous six months; (4) each of the component securities
in the Index has met the initial eligibility criteria for standardized
options trading set forth in Rule 915;\7\ (5) foreign country
securities or ADRs thereon that are not subject to comprehensive
surveillance sharing agreements do not in the aggregate represent more
than 20% of the weight of the Index; and (6) no individual component
stock in the Index represents more than 25% of the weight of the Index,
and the top five highest weighted stocks do not constitute more than
50% of the weight of the Index. The criteria set forth above are
identical to the criteria established for the expedited listing of
options on stock industry indexes pursuant to Exchange Rule 901C,
Commentary .02.
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\6\ In the case of ADRs, this represents market value as
measured by total world-wide shares outstanding.
\7\ Initial eligibility criteria include: (1) the security must
have a minimum of 7,000,000 shares held by persons other than those
required to report their security holdings under Section 16(a) of
the Act; (2) there must be at least 2,000 holders of the security;
(3) the security must have a trading volume of at least 2,400,000
shares over the preceding twelve months; (4) the security must have
had a share price of at least 7\1/2\ for the majority of business
days for the last three calendar months preceding the date of
selection; and (5) the issuer is in compliance with any applicable
requirements of the Act.
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D. Calculation of the Index
The Index shall be calculated by the Amex using an ``equal-dollar
weighting'' methodology designed to ensure that each of the component
securities is represented in an approximately ``equal'' dollar amount
in the Index. The following is a description of how the equal-dollar
weighting calculation method works. As of the market close on December
20, 1996, a portfolio of stocks was established representing an
investment of $100,000 in the stock (rounded to the nearest whole
share) of each of the companies in the Index. The value of the 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 Index divisor. The Index
divisor was initially determined to yield a benchmark value of 250.00
at the close of trading on December 20, 1996. Annually thereafter,
following the close of trading on the third Friday of December, the
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. If necessary, a divisor adjustment is made at
the rebalancing to ensure continuity of the Index's value. The newly
adjusted portfolio becomes the basis for the Index's value on the first
trading day following the annual adjustment.\8\
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\8\ In certain circumstances, the Index will be rebalanced prior
to the end of a calendar year. See infra Section II.E entitled
``Maintenance of the Index.''
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Subject to the maintenance criteria discussed below, for the Index
the number of shares of each component stock in the Index portfolio
remains 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 the component
stocks. In a merger or consolidation of an issuer of a component stock,
if the stock remains in the Index, the number of shares of that
security in the portfolio 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, if at any time between annual rebalancings the top
five stocks in the Index by weight represent in the aggregate more than
one-third of the Index's value, the Exchange will rebalance the Index
after the close of trading on Expiration Friday in the next month on
the March cycle.\9\ For example, if in July it is determined that the
top five components in the Index account for more than one-third of the
Index's weight, then the Index will be rebalanced after the close of
trading on expiration Friday in September.
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\9\ The options on The NatWest Energy Index will expire on the
Saturday following the third Friday of the expiration month
(``Expiration Friday'').
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Similar to other stock index values published by the Exchange, the
value of the 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 Index
The Index will be calculated and maintained by the Amex in
consultation with NatWest which may, from time to time, suggest changes
in the Index's components, in the industry categories represented or in
the number of component stocks in an industry category to properly
reflect the changing conditions in the energy sector. The Index will be
maintained in accordance with Rule 901C, Commentary .02 which provides
that the Index continues to meet the eligibility standards set forth
above, except that, (1) the total number of component securities will
not increase or decrease by more than 33\1/3\% from the number of
components in the Index at the time of its initial listing and in no
event will the Index have less than nine components; (2) the monthly
trading volume of each component security shall be at least 500,000
shares, or for each of the lowest weighted components in the Index that
in the aggregate account for no more than 10% of the weight of the
Index, the monthly trading volume shall be at least 400,000 shares; and
(3) no single component will represent more than 25% of the weight of
the Index and the five highest weighted components will represent no
more than 50% of the Index as of the first day of January and July in
each year.
At the beginning of each calendar year, NatWest will provide the
Amex with a current list of replacement stocks on which to draw in the
event that a component in the Index is to be replaced (``Replacement
List'').\10\ The Amex will publicly distribute the Replacement List as
soon as practicable following receipt from NatWest.
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\10\ See letter from Jeffrey T. Letzler, General Counsel,
NatWest to Sharon Lawson, Assistant Director, SEC, dated May 16,
1997 (``NatWest Letter'').
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The stocks in the Replacement List will be selected and ranked by
NatWest based on a number of criteria, including conformity to the
initial eligibility standards set forth above,\11\ trading liquidity,
market capitalization, the ability to borrow shares and share price.
The replacement stocks will be categorized by industry within the
energy sector and ranked within their category based on the
aforementioned criteria. The replacement stock for a security leaving
the Index will be selected by the Amex from the Replacement List based
on industry category and liquidity.\12\
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\11\ See supra Section II. C entitled ``Eligibility Standards
for the Inclusion of Component Stocks in the Index.''
\12\ 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, NatWest will advise the Exchange regarding the
handling of
[[Page 30916]]
unusual corporate actions which may arise from time to time. Routine
corporate actions (e.g., stock splits, routine spin-offs, etc.) which
require straightforward index divisor adjustments will be handled by
Exchange staff without consultation with NatWest. All stock
replacements and unusual divisor adjustments caused by the occurrence
of extraordinary events such as dissolution, merger, bankruptcy, non-
routine spin-offs or extraordinary dividends will be made by Exchange
staff in consultation with NatWest. 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
dissemination of an information circular.
F. Expiration and Settlement
The exercise settlement value for all of the Index's expiring
options will be calculated based upon the primary exchange regular way
opening sale prices for the component stocks. In the case of securities
traded through the Nasdaq system, the first reported regular way sale
price will be used. If any component stock does not open for trading on
its primary market on the last trading day before expiration, then the
prior day's last sale price will be used in the calculation.\13\
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\13\ The Commission notes that pursuant to Article XVII, Section
4 of the Options Clearing Corporation's (``OCC'') by-laws, OCC is
empowered to fix an exercise settlement amount in the event it
determines a current index value is unreported or otherwise
unavailable. Further, OCC has the authority to fix an exercise
settlement amount whenever the primary market for the securities
representing a substantial part of the value of an underlying index
is not open for trading at the time when the current index value
(i.e., the value used for exercise settlement purposes) ordinarily
would be determined. See Securities Exchange Act Release No. 37315
(June 17, 1996), 61 FR 42671 (order approving SR-OCC-95-19).
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G. Contract Specifications
The proposed options on the Index will be European-style,\14\ and
cash settled. Standard option trading hours (9:30 a.m. to 4:10 p.m. New
York time) will apply. The last trading day in an expiring option
series will normally be the second to last business day preceding the
Saturday following the third Friday of the expiration month (normally a
Thursday). The Exchange Plans to list option series with expirations in
the three near-term calendar months and in the two additional calendar
months in the March cycle. The Exchange also intends to list longer
term option series having up to thirty-six months to expiration.
Trading in expiring options will cease at the close of trading on the
last trading day. The Exchange proposes to list near-the-money (i.e.,
within ten points above or below the current index value) option series
on the Index at 2-\1/2\ point strike (exercise) price intervals when
the value of the Index is below 200 points.
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\14\ A European-style option can be exercise 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 Index
The proposal provides that the Exchange may list longer term option
series having up to thirty-six months to expiration on the full value
of the Index. In lieu of such long-term options on a full value Index
level, the Exchange may instead list long-term, reduced value put and
call options based on one-tenth (\1/10\th) the Index's full value. 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 trading of any long term options would be subject to the
same rules which govern the trading of all the Exchange's index
options, including sales practice rules, margin requirements and floor
trading procedures and all options will have European-style exercise.
I. Position and Exercise Limits, Margin Requirements and Trading Halts
Because the Index is a Stock Index Option under Amex Rule 901C(a)
and Stock Index Industry Group 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
Index. Specifically, Exchange rules governing margin requirements,
position and exercise limits,\15\ and trading halt procedures \16\ that
are applicable to trading of narrow-based index options will apply to
options traded on the Index. Position limits on reduced value long-term
NatWest Energy Index options will be equivalent to the position limits
for regular (full value) Index options and would be aggregated with
such options (for example, if the position limit for the full value
options is 15,000 contracts on the same side of the market, then the
position limit for the reduced value options will be 150,000 contracts
on the same side of the market).
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\15\ Pursuant to Amex Rules 904C and 905C, respectively, the
position and exercise limits for the proposed Index options will be
15,000 contracts, unless the Exchange determines, pursuant to Rules
904C and 905C, that a lower limit is warranted.
\16\ Pursuant to Amex Rule 918C, the trading of options on the
Index will be halted or suspended whenever trading in underlying
securities whose weighted value represents more than 20% of the
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 Index. 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 Index.\17\
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\17\ 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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NatWest 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 Index.\18\ 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.\19\
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\18\ See NatWest Letter, supra note 10.
\19\ Id.
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In addition, NatWest will have a limited role in the stock
replacement selection and substitution process. First, when a stock in
the 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 NatWest, 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
[[Page 30917]]
NatWest. Even in those situations where the Amex consults with NatWest,
upon the occurrence of certain events, the actual replacement stock
will be selected solely by Amex from the stocks on the Replacement
List. Finally, the special procedures developed by NatWest to prevent
the misuse of material, non-public information concerning the Index
will also be used in connection with the addition or removal of an
industry group from the Index.
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,\20\ and, in
particular, with the requirements of Section 6(b)(5).\21\ Specifically,
the Commission finds that the trading of options on the Index,
including full-value and reduced value index options, 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
energy sectors.\22\
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\20\ In approving this rule, the Commission has considered the
proposed rules' impact on efficiency, competition, and capital
formation. 15 U.S.C. Sec. 78c(f).
\21\ 15 U.S.C. 78f(b)(5).
\22\ 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 derivative
instrument that served no hedging or other economic function,
because any benefits that might be derived by market participants
likely would be outweighed by the potential for manipulation,
diminished public confidence in the integrity of the markets, and
other valid regulatory concerns. 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 energy sector in the U.S. stock
markets.
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The trading of options on the Index and reduced-value Index,
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 addressed
these issues.
A. Index Design and Structure
The Commission believes it is appropriate for the Exchange to
designate the Index as narrow-based for purposes of index options
trading. The Index is comprised of a limited number of stocks intended
to track discrete industry groups of the energy 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.\23\
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\23\ See supra Section II.I entitled ``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 Index's component stocks
significantly minimize the potential for manipulation of the Index.
First, the stocks that comprise the Index are actively traded. Minimum
monthly trading volume in the component stocks of the Index for the
period between June 1, 1996 and December 1, 1996 ranged from 2.52
million to 27.52 million shares. Second, the market capitalizations of
the stocks in the Index are very large, ranging from $1.86 billion to
$126 billion. Third, because the index is equal dollar-weighted, no one
particular stock or group of stocks dominates the Index.
Fourth, the Index will be maintained so that in addition to the
other maintenance criteria discussed above in Section II. E, at each
rebalancing, at least 90% of the Index's numerical value and at least
80% of the total number of component securities will be composed of
securities eligible for standardized options trading. Fifth, NatWest
and Amex will be required to ensure that each component of the 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 Index. Finally, the Commission
believes that Amex's existing mechanisms to monitor trading activity in
the component stocks of the Index, or options on those stocks or the
Index, will help deter as well as detect any illegal activity.
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 Index, 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
options on the Index 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 Index. 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 Index. 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.\24\ In this regard, markets on
which the components of the Index currently trade, the markets on which
all component stocks trade are members of the ISG, which provides for
the exchange of all necessary surveillance information.\25\
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\24\ See Securities Exchange Act Release No. 31243 (September
28, 1992), 57 FR 45849 (October 5, 1992).
\25\ See supra note 17.
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The Commission notes that certain concerns are raised when a
broker-dealer, such as NatWest, 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 Index.
First, the value of the Index is to be calculated and disseminated
by the Amex independent of NatWest. Accordingly, neither NatWest nor
any other party will be in receipt of the value prior to its public
dissemination. Second, routine corporate actions (e.g., stock splits,
routine spinoffs, etc.) will be handled by the Amex without
consultation with NatWest. Third, although stock replacements and
unusual divisor adjustments caused by the occurrence of extraordinary
events,
[[Page 30918]]
such as dissolution, merger, bankruptcy, non-routine spinoffs, or
extraordinary dividends, will be made by Exchange staff in consultation
with NatWest, Amex alone ultimately will select the actual replacement
stock from the Replacement List without NatWest's assistance. Such
replacements 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 NatWest has established to
detect and prevent material non-public information concerning the Index
from being improperly used by the person or persons responsible for
compiling the Replacement List, as well as other persons within NatWest
responsible for coordinating with Amex on the Index, as discussed
above,\26\ adequately serve to minimize the likelihood of manipulation
of options on the Index, the securities in the Index, and securities
added to and deleted from any Replacement List. In summary, the
Commission believes that the procedures outlined above help to ensure
that NatWest will not have any informational advantages concerning
modifications to the composition of the Index due to its limited role
in consulting with Amex on the maintenance of the Index under certain
circumstances.
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\26\ See NatWest Letter, supra note 10.
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D. Market Impact
The Commission believes that the listing and trading of options on
the Index, including long-term full-value and reduced-value Index
options, on the Amex will not adversely impact the underlying
securities markets.\27\ First, as described above, due to the ``equal
dollar-weighting'' methodology, no one stock or group of stocks
dominates the Index. Second, as noted above, the stocks contained in
the Index have relatively large capitalizations and are relatively
actively traded. Third, the currently applicable 15,000 contract
position and exercise limits will serve to minimize potential
manipulation and market impact concerns. Fourth, the risk to investors
of contraparty non-performance will be minimized because the options on
the Index will be issued and guaranteed by the Options Clearing
Corporation just like any other standardized option traded in the
United States.
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\27\ 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 Index. See Letter from Edward Cook,
Jr., Managing Director, Trading Floor Systems & Technology, Amex, to
Ivette Lopez, Assistant Director, Division of Market Regulation,
SEC, dated April 7, 1997; and letter from Joe Corrigan, Executive
Director, OPRA, to Ivette Lopez, Assistant Director, Division of
Market Regulation, SEC, dated April 15, 1997.
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Lastly, the Commission believes that settling expiring options on
the Index (including long-term full-value and reduced-value Index
options) 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.\28\
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\28\ Securities Exchange Act Release No. 30944 (July 21, 1992),
57 FR 33376 (July 28, 1992).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\29\ that the proposed rule change (SR-AMEX-97-15) is approved.
\29\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\30\
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\30\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-14687 Filed 6-4-97; 8:45 am]
BILLING CODE 8010-01-M
