[Federal Register Volume 60, Number 133 (Wednesday, July 12, 1995)]
[Notices]
[Pages 35971-35976]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16996]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35930; International Series Release No. 824, File No.
SR-CBOE-95-20]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 1 and 2 to the Proposed Rule Change by the Chicago Board
Options Exchange, Inc., Relating to the Listing of Options and Long-
Term Options on the CBOE Latin 15 Index and Long-Term Options on a
Reduced-Value CBOE Latin 15 Index
June 30, 1995.
I. Introduction
On March 20, 1995, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for the listing and
trading of index options on the CBOE Latin 15 Index (``Latin 15'' or
``Index''). Notice of the proposal appeared in the Federal Register on
April 13, 1995.\3\ No comment letters were received on the proposed
rule change. The Exchange subsequently filed Amendment No. 1 to the
proposed rule change on June 6, 1995,\4\ and Amendment No. 2 on June
13, 1995.\5\ This order approves the Exchange's proposal, as amended.
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
\3\ See Securities Exchange Act Release No. 35573 (April 6,
1995), 60 FR 18862.
\4\ In Amendment No. 1, as discussed more fully herein, the
Exchange proposed certain maintenance standards for the Latin 15
Index. See Letter from Eileen Smith, Director, Product Development,
Research Department, CBOE, to Brad Ritter, Senior Counsel, Office of
Market Supervision (``OMS''), Division of Market Regulation
(``Division''), Commission, dated June 7, 1995 (``Amendment No.
1'').
\5\ In Amendment No. 2, the Exchange extends the proposed
trading hours for options on the Index from 3:10 p.m., Chicago time,
to 3:15 p.m., Chicago time. See Letter from Eileen Smith, Director,
Product Development, Research Department, CBOE, to Brad Ritter,
Senior Counsel, OMS, Division, Commission, dated June 13, 1995
(``Amendment No. 2'').
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II. Description of Proposal
A. General
The CBOE proposes to list for trading options on the Latin 15
Index, a new securities index developed by the CBOE. The Latin 15 Index
consists of fifteen components, including American Depositary Receipts
(``ADRs''), American Depositary Shares (``ADSs''), and closed-end
country funds from four Latin American countries: Argentina, Brazil,
Chile, and Mexico.\6\ The CBOE also proposes to list either long-term
options on the full-value Index or long-term options on a reduced-value
Index that will be computed at one-tenth of the value of the Latin 15
Index (``Latin 15 LEAPS'' or ``Index LEAPS'').\7\ Latin 15 leaps will
trade independent of and in addition to regular Index options traded on
the Exchange,\8\ however, as discussed below, for purposes of position
and exercise limits, positions in Index LEAPS and regular Index options
will be aggregated.
\6\ The components of the Index are: Argentina Fund Inc.;
Telefonica de Argentina S.A.; YPF Sociedad Anonima S.A.; Aracruz
Celulose S.A.; Brazil Fund, Inc.; Brazilian Equity Fund, Inc.; Banco
Osorno Y La Union; Compania de Telefonos de Chile; Empresa Nacional
Electricidad S.A.; Empresas La Moderna S.A. de C.V.; Grupo Tribasa
S.A. de C.V.; Coca Cola Femsa S.A.; Telefonos de Mexico S.A.; Grupo
Televisa S.A.; and Vitro Sociedad Anonima.
\7\ LEAPS is an acronym for Long-Term Equity Anticipation
Securities. LEAPS are long-term index option series that expire from
12 to 60 months from their date of issuance. See CBOE Rule
24.9(b)(1).
\8\ According to the CBOE, the Latin 15 Index represents a
segment of the U.S. equity market that is not currently represented
in the derivative markets and as such, the CBOE concludes, should
offer investors a low-cost means of achieving diversification of
their portfolios toward or away from Latin American market
securities.
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B. Composition of the Index
The Index was designed by the Exchange and is based on a
combination of 12 ADRs and ADSs overlying Latin American securities,
and the shares of three closed-end country funds that invest in Latin
American securities. The shares of each of the components contained in
the Index currently traded in the U.S. on the New York Stock Exchange
(``NYSE'').
[[Page 35972]]
As of the close of trading on June 1, 1995, the Index was valued at
131.92. As of the close of trading on March 14, 1995, the market
capitalizations of the components comprising the Index ranged in
capitalization from a low of $77.17 million to a high of $10.58
billion. The total capitalization on that date was $38.77 billion; the
mean capitalization was $2.58 billion; and the median capitalization
was $812.50 million. The largest component accounted for 11.67% of the
total weight of the Index, and the five largest components accounted
for 46.67% of the total weight of the Index. On that same date, the
smallest component accounted for 5.00% of the total weight of the
Index. The average trading volume of the components of the Index, for
the period from September 1, 1994, through February 28, 1995, ranged
from a high of 5.78 million shares per day to a low of 52,579 shares
per day.
C. Maintenance
The Index will be maintained by the CBOE. The CBOE may change the
composition of the Index at any time, subject to compliance with the
maintenance criteria discussed below, to reflect the conditions in the
Latin American securities markets. If it becomes necessary to replace a
component of the Index, the Exchange represents that every effort will
be made to add only replacement securities (i.e., ADRs, ADSs, and
closed-end country funds) that preserve the character of the Index.
Moreover, replacement securities must be listed on either the American
Stock Exchange (``Amex'') or the NYSE, or must be Nasdaq National
Market (``Nasdaq/NM'') securities.\9\ In considering securities to be
added to the Index, the CBOE will take into account the capitalization,
liquidity, volatility, and the name recognition of the particular
securities. Further, a component of the Index may be replaced in the
event of certain events, such as a merger, consolidation, dissolution,
or liquidation, or a change in the investment objectives of a country
fund component.
\9\ The Commission notes that the CBOE will be required to
ensure that each component in the Index is a ``reported security''
as defined in Rule 11Aa3-1 of the Act.
The Exchange will most likely maintain 15 components in the
Index.\10\ In addition, in choosing securities as replacements for or
additions to the Index, the CBOE will not make a composition change
that would result in less than 85% of the weight of the Index or 80% of
the number of components in the Index satisfying the listing criteria
for standardized options trading set forth in CBOE Rule 5.3 \11\ (for
securities that are not then the subject of standardized options
trading) and CBOE Rule 5.4 \12\ (for securities that are then the
subject of standardized options trading).\13\ Additionally, at least
twice each year, the CBOE will review the Index and apply these same
standards to ensure that not less than 85% of the weight of the Index
and 80% of the number of securities represented in the Index continue
to satisfy the criteria for standardized options trading set forth in
CBOE Rule 5.3 (for securities that are not then the subject of
standardized options trading) and CBOE Rule 5.4 (for securities that
are then the subject of standardized options trading).\14\
\10\ In no event will the CBOE decrease the number of components
in the Index to less than 10. The Commission notes that if the CBOE
determines to increase the number of components to greater than 20,
the Exchange will be required to submit a rule filing pursuant to
Section 19(b) of the Act.
\11\ See Amendment No. 1, supra note 4. The CBOE's options
listing standards, which are uniform among the options exchanges,
provide that a security underlying an option must, among other
things, meet the following requirements: (1) the public float must
be at least 7,000,000 shares; (2) there must be a minimum of 2,000
stockholders; (3) trading volume in the U.S. must have been at least
2.4 million over the preceding twelve months; and (4) the U.S.
market price must have been at least $7.50 for a majority of the
business days during the preceding three calendar months. See CBOE
Rule 5.3, Interpretation and Policy .01.
\12\ See Amendment No. 1, supra note 4. The CBOE's options
maintenance standards, which are uniform among the options
exchanges, provide that a security underlying an option must, among
other things, meet the following requirements: (1) the public float
must be at least 6,300,000 shares; (2) there must be a minimum of
1,600 stockholders; (3) trading volume in the U.S. must have been at
least 1.8 million over the preceding twelve months; and (4) the U.S.
market price must have been at least $5.00 for a majority of the
business days during the preceding six calendar months. See CBOE
Rule 5.3, Interpretation and Policy .01.
\13\ For these purposes, the closed-end fund components of the
Index will be deemed to satisfy the listing criteria for
standardized options trading if they satisfy the numerical
requirements in CBOE Rule 5.3, Interpretation and Policy .01 (for
closed-end country fund shares that are not then the subject of
standardized options trading) and CBOE Rule 5.4, Interpretation and
Policy .01 (for securities that are then the subject of standardized
options trading). It is currently the case, therefore, that closed-
end fund components of the Index that are not eligible for
standardized options trading pursuant to the Commission's Country
Fund Approval Order (see infra note 36) are counted as being options
eligible for purposes of this 85%/80% requirement.
\14\ Id.
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Moreover, at least twice each year, based on the most recent
Commission filings by the closed-end funds represented in the Index,
the CBOE will review the holdings of each of the closed-end funds to
determine whether: (1) Any security that is not eligible for
standardized options trading and that is held by one or more closed-end
funds represented in the Index accounts, in aggregate, for more than 5%
of the weight of the Index; or (2) securities from any one country that
are not eligible for standardized options trading and that are held by
one or more closed-end funds represented in the Index account, in
aggregate, for more than 25% of the weight of the Index.
The CBOE will promptly notify the Commission staff at any time that
the CBOE determines that the Index fails to satisfy any of the above
maintenance criteria. Further, in such an event, the Exchange will not
open for trading any additional series of Index options or Index LEAPS
unless the Exchange determines that such failure is not significant,
and the Commission staff affirmatively concurs in that determination,
or unless the Commission specifically approves the continued listing of
the class of Index options or Index LEAPS pursuant to a proposal filed
in accordance with Section 19(b)(2) of the Act.\15\
\15\ See Amendment No. 1, supra note 4.
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D. Applicability of CBOE Rules Regarding Index Options
Except as modified by this order, the rules in Chapter XXIV of the
CBOE Rules will be applicable to Index options and full-value and
reduced-value Index LEAPS. In accordance with Chapter XXIV of CBOE's
rules, the Index will be treated as a narrow-based index for purposes
of applicable position and exercise limits, policies regarding trading
halts and suspensions, and margin treatment.\16\
\16\ See infra Section II.H.
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E. Calculation of the Index
The value of the CBOE Latin 15 Index is calculated using a
``modified equal-dollar-weighted'' formula, meaning that each of the
components (fund shares or individual stocks) from each of the four
countries is represented in approximately equal dollar amounts in
relation to the other shares from that country. The countries in the
index are then weighted, at the beginning of each quarter, as follows:
Argentina--17.5%, Brazil--35%, Chile--17.5%, and Mexico--30%. The
Exchange believes this methodology will present a fairer representation
of the respective economies. The ``modified'' description refers to the
fact that the dollar-weighting is performed on a country by country
basis and not between shares of different countries.
The number of shares of each component security in the Index will
remain fixed between quarterly reviews except in the event of certain
types of corporate actions, such as the payment
[[Page 35973]]
of a dividend (other than an ordinary cash dividend), stock
distributions, stock splits, reverse stock splits, rights offerings, or
a distribution, reorganization, recapitalization, or some such similar
event with respect to an Index component. When the Index is adjusted
between quarterly reviews, the number of shares of the relevant
component in the portfolio will be adjusted, 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
replacement, the average dollar value of the remaining portfolio
components will be calculated and that amount invested in the new
component stock, to the nearest whole share. In both cases, the divisor
will be adjusted, if necessary, to ensure continuity in the value of
the Index.\17\
\17\ Telephone conversation between Eileen Smith, Director,
Product Development, Research Department, CBOE, and Brad Ritter,
Senior Counsel, OMS, Division, Commission, on June 12, 1995.
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The value of the Index will be calculated continuously and will be
disseminated to the Options Price Reporting Authority (``OPRA'') every
fifteen seconds by the CBOE, based on the last-sale prices of the
securities comprising the Index.\18\ OPRA, in turn, will disseminate
the Index value to other financial vendors such as Reuters, Telerate,
and Quotron.
\18\ For purposes of dissemination of the Index value, if the
shares of an ADR, ADS, or closed-end country fund included in the
Index have not opened for trading, the CBOE will use the closing
value of those shares on the prior trading day when calculating the
value of the Index, until those shares open for trading.
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The Index value for purposes of settling outstanding regular Index
options and full-value and reduced-value Index LEAPS contracts upon
expiration will be calculated based upon the regular way opening sale
prices for each of the securities comprising the Index in their primary
market on the last trading day prior to expiration.\19\ In the event
that a security traded as a Nasdaq/NM security is added to the Index,
the first reported sale price for those shares will be used for
determining a settlement value. Once the shares of all of the component
securities represented in the Index have opened for trading, the value
of the Index will be determined and that value will be used as the
final settlement value for expiring Index options contracts, including
full-value and reduced-value Index LEAPS. If any of the components of
the Index do not open for trading on the last trading day before
expiration, then the prior trading day's (i.e., normally Thursday's)
last sale price will be used in the Index value calculation. In this
regard, before deciding to use Thursday's closing value for a security
contained in the Index for purposes of determining the settlement value
of the Index, the CBOE will wait until the end of the trading day on
Expiration Friday (as defined herein).
\19\ As noted above, each of the component securities currently
trade on the NYSE. Moreover, the NYSE is the primary market for an
overwhelming majority of the securities contained in the Index.
F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\20\ Standard options trading hours (8:30 a.m. to 3:15
p.m., Chicago time) \21\ will apply to the contracts. The Index
multiplier will be $100. The strike price interval will be $5.00 for
full-value Index options with a duration of one year or less to
expiration.\22\ In addition, pursuant to CBOE Rule 24.9, there may be
up to six expiration months outstanding at any given time.
Specifically, there may be up to three expiration months from the
March, June, September, and December cycle plus up to three additional
near-term months so that the two nearest term months will always be
available. As described in more detail below, the Exchange also intends
to list several Index LEAPS series that expire from 12 to 60 months
from the date of issuance.
\20\ A European-style option can be exercised only during a
specified period before the option expires.
\21\ See Amendment No. 2, supra note 5.
\22\ For a description of the strike price intervals for
reduced-value Index options and long-term Index options, See infra,
Section II.G.
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Lastly, the options on the Index will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). Accordingly, because options on the Index will settle based
upon opening prices of the securities comprising the Index on the last
trading day before expiration (normally Expiration Friday), the last
trading day for an expiring Index option series will normally be the
second to the last business day before expiration (normally a
Thursday).
G. Listing of Long-Term Options on the Full-Value or Reduced-Value
Latin 15 Index
The proposal provides that the Exchange may list long-term Index
options that expire from 12 to 60 months from listing based on the
full-value Index or a reduced-value Index that will be computed at one-
tenth of the full-value Latin 15 Index. Existing Exchange requirements
applicable to full-value Index options will apply to full-value and
reduced-value Index LEAPS.\23\ The current and closing Index value for
reduced-value Latin 15 LEAPS will be computed by dividing the value of
the full-value Index by 10 and rounding the resulting figure to the
nearest one-hundredth. For example, an Index value of 125.46 would be
12.55 for the reduced-value Index LEAPS and an Index value of 125.44
would be 12.54 for the reduced-value Index LEAPS. The reduced-valued
Index LEAPS will also be European-style and will be subject to the same
rules that govern the trading of Index options, including sales
practice rules, margin requirements and floor trading procedures.
Pursuant to CBOE Rule 24.9, the strike price interval for the reduced-
value Index LEAPS will be no less than $2.50 instead of $5.00.
\23\ See CBOE Rule 24.9(b).
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H. Position and Exercise Limits, Margin Requirements, and Trading Halts
Exchange rules governing margin requirements,\24\ position and
exercise limits,\25\ and trading halt procedures \26\ that are
applicable to the trading of narrow-based index options will apply to
options traded on the Index. The proposal further provides that, for
purposes of determining whether given positions in full-value and
reduced-value Index LEAPS comply with applicable position and exercise
limits, positions in full-value and reduced-value Index LEAPS will be
aggregated with positions in the regular Index options. For these
purposes, ten reduced-value contracts will equal one full-value
contract.
\24\ Pursuant to CBOE Rule 24.11, the margin requirements for
the Index options will be: (1) for short options positions, 100% of
the current market value of the options contract plus 20% of the
underlying aggregate Index value, less any out-of-the-money amount,
with a minimum requirement of the options premium plus 10% of the
underlying Index value; and (2) for long options positions, 100% of
the options premium paid.
\25\ Pursuant to CBOE Rules 24.4A and 24.5, respectively, the
position and exercise limits for the Index options will be 10,500
contracts, unless the Exchange determines, pursuant to such rules,
that a lower limit is warranted.
\26\ Pursuant to CBOE Rule 24.7, the trading on the CBOE of
index options and Index LEAPS may be halted or suspended whenever
trading in component securities whose weighted value represents more
than 20% of the Index value are halted or suspended.
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I. 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 regular Index options and in full-value and reduced-value
Index LEAPS. These procedures include complete access to trading
activity in the shares of the securities comprising the Index.
[[Page 35974]]
Further, the Intermarket Surveillance Group Agreement will be
applicable to the trading of options on the Index.\27\
\27\ The Intermarket Surveillance Group (``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 CBOE; the Chicago Stock
Exchange, Inc.; the National Association of Securities Dealers, Inc.
(``NASD''); 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.
III. Findings and Conclusions
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange and, in
particular, the requirements of Section 6(b)(5).\28\ Specifically, the
Commission finds that the trading of Latin 15 Index options, including
full-value and reduced-value Index LEAPS, will serve to promote the
public interest and help to remove impediments to a free and open
securities market by providing investors with a means of hedging
exposure to market risk associated with emerging Latin American market
securities.\29\
\28\ 15 U.S.C. Sec. 78f(b)(5) (1988).
\29\ 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 Index
options and full-value and reduced-value Index LEAPS will provide
investors with a hedging vehicle that should reflect the overall
movement of Latin American market securities.
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The trading of options on the Latin 15 Index, including full-value
and reduced-value Index LEAPS, however, raises several issues related
to index design, customer protection, surveillance, and market impact.
The Commission believes, for the reasons discussed below, that the CBOE
has adequately addressed these issues.
A. Index Design and Structure
In light of the number of component stocks and overall
capitalization of the Latin 15 Index, the Commission finds that it is
appropriate to treat the Latin 15 Index as a narrow-based index under
CBOE rules for purposes of applicable position and exercise limits,
trading halt and suspension procedures, and margin treatment.\30\
\30\ The reduced-value Latin 15 Index, which consists of the
same component mutual fund components as the Index and is calculated
by dividing the Index value by ten, is identical to the Latin 15
Index.
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The commission also finds that the large capitalizations, liquid
markets, and relative weightings of the individual securities
comprising the Index minimize the potential for manipulation of the
Index. First, the securities comprising the Index are actively traded,
with an average daily trading volume for all components for the period
from September 1, 1994 through February 28, 1995, of approximately
629,412 shares per day. Second, the market capitalizations of the
components of the Index are large, ranging from a high of $10.58
billion to a low of $77.17 million as of March 14, 1995, with the mean
and median being $2.58 billion and $812.50 million, respectively.
Third, although the Index is composed of only 15 securities, no
particular component security or group of securities dominates the
Index. Specifically, as of March 14, 1995, no component security
contained in the Index accounted for more than 11.67% of the Index's
total value and the five highest weighted securities in the Index
accounted for 46.67% of the Index's value.
Fourth, the proposed maintenance criteria will serve to ensure
that: (1) the Index remains composed substantially of liquid, highly
capitalized securities; and (2) the Index is not dominated by any one
security that does not satisfy the Exchange's options listing criteria,
any non-options eligible security held by one or more of the country
funds represented in the Index, or non-options eligible securities from
any one country held by one or more of the country funds represented in
the Index. Specifically, in considering changes to the composition of
the Index, 85% of the weight of the Index and 80% of the number of
components in the Index must comply with the listing criteria for
standardized options trading set forth in CBOE Rule 5.3 (for securities
that are not then the subject of standardized options trading) and CBOE
Rule 5.4 (for securities that are then the subject of standardized
options trading).\31\ Additionally, the CBOE is required to review the
composition of the Index at least semiannually to ensure that the Index
continues to meet this 85%/80% criterion.
\31\ See supra note 13. Additionally, the securities contained
in the Index must be ``reported'' securities and must be traded on
the Amex or the NYSE or must be Nasdaq/NM securities. The CBOE is
also limited in its ability to change the number of components in
the Index without having to obtain Commission approval. See supra
notes 9 and 10.
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Moreover, at least twice each year, based on the most recent
Commission filings by the closed-end funds represented in the Index,
the CBOE will review the holdings of each of the closed-end funds to
determine whether: (1) Any security that is not eligible for
standardized options trading and that is held by one or more country
funds represented in the Index accounts, in aggregate, for more than 5%
of the weight of the Index; or (2) securities from any one country that
are not eligible for standardized options trading and that are held by
one or more country funds represented in the Index account, in
aggregate, for more than 25% of the weight of the Index. These
maintenance standards will ensure that a non-options eligible security
or group of such securities from a foreign country where the CBOE does
not have a comprehensive surveillance sharing agreement will not
account for a significant percentage of the weight of the Index.
The CBOE will promptly notify the Commission staff at any time that
the CBOE determines that the Index fails to satisfy any of the above
maintenance criteria. Further, in such an event, the Exchange will not
open for trading any additional series of Index options or Index LEAPS
unless the Exchange determines that such failure is not significant,
and the Commission staff affirmatively concurs in that determination,
or unless the Commission specifically approves the continued listing of
that class of Index options or Index LEAPS pursuant to a proposal filed
in accordance with Section 19(b) of the Act.\32\
\32\ See Amendment No. 1, supra note 4.
For the above reasons, the Commission believes that these criteria
minimize the potential for manipulation of the Index and eliminate
domination concerns.
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated
[[Page 35975]]
financial instruments, such as Latin 15 Index options, including full-
value and reduced-value Latin 15 LEAPS, can commence on a national
securities exchange. The Commission notes that the trading of
standardized exchange-traded options occurs in an environment that is
designed to ensure, among other things, that: (1) the special risks of
options are disclosed to public customers; (2) only investors capable
of evaluating and bearing the risks of options trading are engaged in
such trading; and (3) special compliance procedures are applicable to
options accounts. Accordingly, because the Index options and Index
LEAPS will be subject to the same regulatory regime as the other
standardized index options currently traded on the CBOE, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in Latin 15 Index options and full-value and reduced-value
Latin 15 Index LEAPS.
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.\33\ In this regard, the Commission
notes that the NYSE, which currently is the primary market for the vast
majority of the Index's component securities, is a member of the
ISG.\34\ The Commission believes that this arrangement ensures the
availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the Index
options and full-value and reduced-value Index LEAPS less readily
susceptible to manipulation.\35\
\33\ See Securities Exchange Act Release No. 31243 (September
28, 1992), 57 FR 45849 (October 5, 1992).
\34\ See supra note 27.
\34\ See, e.q., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (October 5, 1992) (order approving
the listing of index options and index LEAPS on the CBOE Biotech
Index).
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The Commission notes that the shares of the three closed-end
country funds contained in the Index are not eligible for standardized
options trading predominantly as a result of the lack of relevant
market information sharing agreements between the CBOE and the home
markets of the securities held by the funds.\36\ For several reasons,
however, the Commission believes that including these closed-end
country funds in the Index is appropriate. First, the NYSE is the
primary market for each of the closed-end fund components in the Index.
As a result, as noted above, the CBOE can obtain information regarding
the trading of the closed-end fund securities through the ISG.\37\
Second, the maintenance criteria discussed above ensure, among other
things, (1) that the Index will not become a surrogate for trading
options on either the closed-end country funds represented in the Index
or individual Latin American market securities held by those component
country funds for which standardized options could not otherwise be
traded, and (2) minimize the potential for manipulation of the value of
the Index.\38\ The Commission also notes that these maintenance
criteria ensure that if additional closed-end funds are added to the
Index, the Index will be subject to the same standards that the
Commission approved for the Exchange's Emerging Markets Index and the
Emerging Asian Markets Index, both of which are composed solely of
closed-end funds.\39\
\36\ Options on the securities issued by international funds are
eligible for standardized options trading where those securities
meet or exceed the Exchange's established uniform options listing
standards (see supra notes 10 and 11) and (1) the Exchange has a
market information sharing agreement with the primary home exchange
on which each of the foreign securities comprising the fund's
portfolio trade, (2) the fund is classified as a diversified fund,
as that term is defined by Section 5(b) of the Investment Company
Act, 15 U.S.C. Sec. 80a-5(b), and the fund's portfolio is composed
of securities from five or more countries, or (3) the listing of a
particular international fund option is specifically approved by the
Commission. See Securities Exchange Act Release No. 33068 (October
19, 1993), 58 FR 55093 (October 25, 1993) (``Country Fund Approval
Order'').
\37\ See supra note 27.
\38\ See supra Section III.A.
\39\ See Securities Exchange Act Release Nos. 35303 (January 31,
1995), 60 FR 7607, (February 8, 1995) (approval of CBOE Emerging
Markets Index), and 35304 (January 31, 1995), 60 FR 7601, (February
8, 1995) (approval of CBOE Emerging Asian Markets Index).
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Finally, in contrast to other foreign securities products,
international closed-end country funds hold portfolios of securities
chosen by portfolio managers.\40\ Although the composition of the
portfolio of each country fund represented in the Index is published on
a semiannual basis, the securities held by each country fund
represented in the Index can be changed at any time at the discretion
of the portfolio managers, as long as their investment decisions are
consistent with the stated investment objectives and policies of the
particular closed-end fund. For these reasons, the Commission believes
that it generally would be difficult for someone to use options on the
Index to attempt a manipulation of the market for any particular
closed-end country fund represented in the Index or to attempt a
manipulation of the Index through a manipulation of the shares of one
or more of the closed-end country funds contained in the Index.
\40\ See Country Fund Approval Order, supra note 36.
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The Commission notes that generally the only people who could
attempt such a manipulation would be people who have access to
``inside'' information about the composition of the portfolio of a
closed-end fund and the trading activities of the country fund's
portfolio manager.\41\ The Investment Advisers Act of 1940 (``Advisers
Act''),\42\ and the rules promulgated thereunder, contain provisions
designed to detect and deter certain advisory employees and affiliates
from trading in any securities based on ``inside'' information about
the investment decisions of a closed-end fund. Rule 204-2(a)(12) under
the Advisers Act requires an investment adviser to make and keep
accurate records of every transaction in a security in which the
investment advisor or any advisory representative has a beneficial
interest. Accordingly, the Commission believes that the Advisers Act
gives it the authority to review the trading activities of anyone who
is likely to have access to the information necessary to use options on
the Index to attempt a manipulation of the relevant markets.
\41\ Id.
\42\ 15 U.S.C. 80b-1 et. seq. (1988).
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D. Market Impact
The Commission believes that the listing and trading on the CBOE of
Latin 15 Index options, including full-value and reduced-value Index
LEAPS, will not adversely impact the markets for the securities
contained in the Index.\43\ First, because of the ``modified equal-
dollar-weighting'' formula described above, no one security or group of
securities represented in the Index will dominate the weight of the
Index immediately following a quarterly rebalancing. Second, the
maintenance criteria for the Index ensure that: (1) The Index will be
substantially comprised of securities that satisfy the Exchange's
[[Page 35976]]
listing standards for standardized options trading; and (2) individual
securities that are not options eligible that are held by one or more
of the country funds represented in the Index and non-options eligible
securities from individual countries represented by those holdings will
not dominate the Index.\44\ Third, because the securities comprising
the Index must be ``reported securities'' as defined in Rule 11Aa3-1 of
the Act, the components of the Index generally will be actively-traded
and highly-capitalized. Fourth, the 10,500 contract position and
exercise limits applicable to Index options and Index LEAPS will serve
to minimize potential manipulation and market impact concerns.
\43\ In addition, the CBOE has represented that the CBOE and the
OPRA have the necessary systems capacity to support those new series
of index options that would result from the introduction of Index
options and Index LEAPS. See Memorandum from Joe Corrigan, Executive
Director, OPRA, to Eileen Smith, Director, Product Development,
Research Department, CBOE, dated March 17, 1995.
\44\ See supra Section III.A.
Lastly, the Commission believes that settling expiring Latin 15
Index options, including full-value and reduced-value Index LEAPS,
based on the opening prices of the component securities is 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 the closed-end
fund securities underlying options on the Index.\45\
\45\ See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992). The Commission notes that prior
to listing Index options or Index LEAPS (or any other product based
on the Index), the CBOE will be required to review the Index and its
components based on the then most recent semiannual reports filed
with the Commission by each of the closed-end funds represented in
the Index to ensure that the listing criteria discussed above are
satisfied.
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The Commission finds good cause for approving Amendment Nos. 1 and
2 to the proposal prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Specifically, Amendment No. 1 provides objective maintenance criteria
which, for the reasons stated above, minimize the potential for
manipulation of the Index and the securities comprising the Index.
Further, as discussed above, the Commission believes that these
maintenance criteria significantly strengthen the customer protection
and surveillance aspects of the proposal, as originally proposed.\46\
\46\ See supra note III.A.
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Amendment No. 2 merely extends the proposed trading hours for
options on the Index by five minutes (i.e., until 3:15 p.m., Chicago
time). The Commission notes that this is consistent with CBOE Rule 24.6
whereby trading until 3:10 p.m. is the exception to the general rule
that index options traded at the CBOE trade until 3:15 p.m., Chicago
time.
Based on the above, the Commission finds good cause for approving
Amendment Nos. 1 and 2 to the proposed rule change on an accelerated
basis and believes that the proposal, as amended, is consistent with
Sections 6(b)(5) and 19(b)(2) of the Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1 and 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying at the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the CBOE. All
submissions should refer to the File Number SR-CBOE-95-20 and should be
submitted by August 2, 1995.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\47\ that the proposed rule change (SR-CBOE-95-20), as amended, is
approved.
\47\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\48\
\48\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 95-16996 Filed 7-11-95; 8:45 am]
BILLING CODE 8010-01-M
