[Federal Register Volume 64, Number 127 (Friday, July 2, 1999)]
[Notices]
[Pages 36055-36057]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-16866]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41557; File No. SR-Amex-99-09]
Self-Regulatory Organizations; American Stock Exchange LLC; Order
Granting Approval to Proposed Rule Change and Amendment No. 1 to the
Proposed Rule Change Amending Amex Rule 901C To Allow Modified Equal-
Dollar and Modified Capitalization Weighting Calculation Methodologies
for Narrow-Based Index Options
June 24, 1999.
On March 1, 1999, the American Stock Exchange LLC (``Amex'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') a proposed rule change pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule
19b-4 thereunder.\2\ The filing was amended on March 12, 1999 to
provide additional information on modified weighting methodologies.\3\
The proposed rule change would amend Commentary .02 to Amex Rule 901C
to add modified equal-dollar weighting and modified capitalization
weighting as acceptable weighting calculation methodologies for the
construction of narrow-based index options.\4\ Notice of the proposed
rule change, as amended, was published in the Federal Register on April
20, 1999.\5\ The Commission did not receive any comment letters on the
filing. This Order approves the proposed rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from Scott G. Van Hatten, Legal Counsel, Amex, to
Nancy Sanow, Senior Special Counsel, Commission, dated March 11,
1999.
\4\ The Exchange refers to narrow-based index options as options
on a ``stock index industry group.'' A stock index industry group is
defined in the Amex Rules as a group of stocks representing a
particular industry or related industries. See Amex Rule 900C(b)(1).
\5\ Securities Exchange Act Release No. 41276 (April 12, 1999)
64 FR 19393.
---------------------------------------------------------------------------
I. Introduction and Background
The Exchange proposes to amend Amex Rule 901C to add modified
equal-dollar weighting and modified capitalization weighting as
acceptable weighting calculation methodologies for the construction of
narrow-based index options. Commentary .02 to Amex Rule 901C permits
the Exchange to list options on stock industry index groups if the
index meets certain criteria. Presently, the criteria require the index
to be calculated using the capitalization, price, or equal-dollar
weighting methodologies. Several other indexes which use a modified
capitalization weighting methodology, however, including the
[email protected] Week Internet Index, the Nasdaq-100 Index, and the Amex
Eurotop 100 Index, were individually approved by the Commission as
indexes that may underlie index options.\6\ The Amex Mexico Index and
the Amex Networking Index, which use a modified equal-dollar weighting
index calculation methodology, were also approved by the Commission as
indexes that may underlie index options.\7\
---------------------------------------------------------------------------
\6\ Securities Exchange Act Release No. 41124 (March 1, 1999) 64
FR 11520 (March 9, 1999) (File No. SR-Amex-99-04) ([email protected]
Internet Index); Securities Exchange Act Release No. 40642 (November
5, 1998) 63 FR 63759 (November 16, 1998) (File No. SR-CBOE-98-43)
(Nasdaq-100 Index); Securities Exchange Act Release No. 30463 (March
11, 1992) 57 FR 9284 (March 17, 1992) (File Nos. SR-Amex-90-25 and
SR-Amex-91-01) (Amex Eurotop 100 Index).
\7\ Securities Exchange Act Release No. 34500 (August 8, 1994)
59 FR 41534 (August 12, 1994) (File No. SR-Amex-94-20) (Amex Mexico
Index); Securities Exchange Act Release No. 37017 (March 22, 1996)
61 FR 14168 (March 29, 1996) (File No. SR-Amex-96-03) (Amex
Networking Index).
---------------------------------------------------------------------------
II. Description of the Proposal
The Exchange proposes to include modified capitalization and
modified equal-dollar weighting calculation methodologies in Commentary
.02 to Amex Rule 901C. Increasingly, the Exchange receives requests to
construct new indexes using the modified capitalization or modified
equal-dollar weighting methodologies to enable the proposed indexes to
meet the generic criteria for narrow-based indexes, to provide for the
timely trading of options on newly proposed indexes, or similar
reasons. The Exchange wishes to accommodate these requests, and
proposes to add these methodologies to the existing narrow-based
criteria set forth in Commentary .02 of Amex Rule 901C that permits the
listing of options on stock index groups pursuant to Rule 19b-4(e)
under the Act.\8\ Use of these methodologies should allow the Exchange
greater flexibility in developing indexes and facilitate the listing of
options on stock industry index groups that more accurately reflect the
industry represented by the index.
---------------------------------------------------------------------------
\8\ 17 CFR 240.19b-4(e)
---------------------------------------------------------------------------
Modified Capitalization Weighting
To determine an index value using the capitalization weighting
calculation methodology, the following calculation applies: Multiplying
the primary exchange regular way last sale price of each component
security by the number of shares outstanding; adding the products; and
dividing the result by the current index divisor. The index value for a
modified capitalization weighted index is calculated in a similar
manner. However, instead of using the actual number of shares
outstanding, an adjusted number of shares outstanding is used in the
calculation (i.e., multiplying the primary exchange regular way last
sale price of each component security by the adjusted number of shares
outstanding; adding the products; and then dividing the result by the
current index divisor). The modified capitalization weighting
methodology uses an adjusted number of shares outstanding to prevent
components with relatively large market capitalizations from
representing an inordinately large portion of an index's value. For
example, inclusion of a large
[[Page 36056]]
capitalization company in an index along with a number of smaller
capitalization companies may result in the larger capitalization
company's representation in the index exceeding 25% of the index's
value. Thus, options on these indexes could not be listed on the Amex.
However, since use of the modified capitalization methodology permits a
reduction in the large capitalization company's representation in the
index to an amount less than 25% of the index's value, the listing
criteria of Amex rule 901C, Commentary .02(a)(7) are satisfied.
Modified Equal-Dollar Weighting
Use of the equal-dollar weighting calculation methodology to
determine an index value is accomplished by establishing an initial
dollar representation (e.g., $100,000); determining the number of
shares of each component representing this amount; and then multiplying
the primary exchange regular way last sale price of each component
security by its predetermined fixed number of shares. The equal-dollar
weighted methodology can be used to provide more equitable
representation of each component in a particular index. Modified equal-
dollar weighting methodology is useful when the capitalization of
companies within an index varies widely, by permitting larger
capitalized companies to represent a larger portion of an index's
value.
In effect, the modified equal-dollar weighting methodology is the
mirror image of the modified capitalization weighting methodology.
While the modified capitalization weighting methodology prevents large
capitalization companies from skewing an index, the modified equal-
dollar weighting methodology guards against small capitalized companies
from doing so. Determining an initial index value for modified equal-
dollar weighted indexes uses two or more fixed dollar values for
different groups of the index components instead of using the same
fixed dollar value for each component. In this way, the modified equal-
dollar weighted method allows for similar component stocks to be
weighted similarly, while differentiating among dissimilar groups
(e.g., large capitalization stocks versus small capitalization stocks).
For example, a ten stock index, calculated under this method, that has
five components with capitalizations of approximately $1 billion (or $5
billion in aggregate) and five components with capitalizations of
approximately $500 million (or $2.5 billion in aggregate), allows the
larger capitalization components to account for twice the amount of the
smaller capitalized components, rather than having each component
account for 10% of the index (as would be the case in a pure equal-
dollar weighted index). Thus, the modified structure can be used to
provide a more accurate representation of the market capitalization
composition of the underlying industry for which the index is designed
to measure.
III. Discussion
Under the Act, self-regulatory organizations (``SROs'') like the
Amex are assigned rulemaking and enforcement responsibilities to
perform their role in regulating the securities industry for the
protection of investors and other related purposes. This role has
particular importance in the context of the listing of narrow-based
stock index options under Rule 19b-4(e), since the Exchange is the only
regulatory authority reviewing such securities before their trading
begins. The Commission recently adopted new Rule 19b-4(e),\9\
eliminating the requirement that an SRO file a proposal under Section
19(b)(3)(A) \10\ to list and trade options on narrow-based indexes,
provided that the SRO relying on Rule 19b-4(e) has generic listing
criteria approved by the Commission and meets certain other
requirements. With the approval of the proposed rule change, Amex will
be permitted under Rule 19b-4(e) to introduce new options that are
based on narrow-based stock indexes using modified capitalization or
equal-dollar weightings, but without the Exchange having to file a
proposal under Section 19(c)(3)(A) of the Act.
---------------------------------------------------------------------------
\9\ See Securities Exchange Act Release No. 40761 (December 8,
1998) 63 FR 70952 (December 22, 1998) (amending Rule 19b-4 with
respect to rule filing requirements for SROs listing and trading a
new derivative securities product).
\10\ 15. U.S.C. 78s(b)(3)(A).
---------------------------------------------------------------------------
Pursuant to Section 19(b)(2) of the Act,\11\ the Commission is
required to approve an SRO's proposed rule change if the Commission
determines that the proposal is consistent with the applicable
statutory standards. The Commission finds that the proposal is
consistent with the requirements of Section 6(b) of the Act \12\ in
general, and particularly furthers the objectives of Section 6(b)(5) of
the Act,\13\ in that it is designed to promote just and equitable
principles of trade and further the protection of investors and the
public interest by increasing flexibility in developing an index by
allowing an index to more accurately reflect an underlying industry
sector. This enhanced flexibility and accuracy should also foster
cooperation and coordination with persons engaged in facilitating
transactions in securities, and remove impediments to, and perfect the
mechanisms of, a free and open market and a national market system. As
represented by the Exchange, modifying the capitalization amounts or
dollar values of the securities underlying an index can prevent an
individual stock from inappropriately skewing the performance of an
entire index. The Commission therefore believes that market accuracy
and transparency should be correspondingly enhanced by use of the
modified capitalization and modified equal-dollar weighting methods,
and approves them for use in the context of Commentary .02 to Amex Rule
901C concerning eligibility criteria for index components of a narrow-
based stock index.
---------------------------------------------------------------------------
\11\ 15 U.S.C. 78s(b)(2).
\12\ 15 U.S.C. 78f(b).
\13\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
The Commission notes that the Exchange has represented that it will
review the component weighings of indexes employing the modified
capitalization weighting methodology quarterly, and if necessary,
adjust them to ensure that the index continues to meet the weighting
guidelines. In addition, the Exchange has further represented that
adjustments will be made on an intra-quarterly basis, as necessary, to
reflect corporate actions, share issuances and repurchases, and other
events of significance.
With regard to the use of the modified equal-dollar weighting
methodology, the Commission notes that the Exchange has represented
that the number of shares of each component security will be examined
and, if necessary, adjusted quarterly, so that the members of each
weighting group are set to the appropriate index weight to ensure
compliance with the criteria. The number of shares of each component
stock in the index portfolio will remain fixed between quarterly
reviews, except in the event of corporate actions such as the payment
of a dividend other than an ordinary cash dividend, stock distribution,
reorganization, recapitalization, or similar event with respect to the
component stocks. In the event of 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 may 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 stock addition or replacement, the average dollar value
of the remaining components in the same weighting group will be
[[Page 36057]]
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.
The Commission further notes that the Exchange has represented that
the terms of any modified capitalization or modified equal-dollar
weighting calculation methodology will be clearly defined, and will
consist of objective standards that permits any newly developed narrow-
based index initially to meet, and subsequently, to continue to be
maintained, in accordance with the generic criteria set forth in
Commentary .02 to Amex Rule 901C. In addition, the Exchange has
represented that these terms will be discussed in marketing materials
describing the index and in the Information Circulars the Exchange will
distribute to members upon the launch of new index options.
IV. Conclusion
The Commission finds that the proposed rule change is consistent
with the Act, and in particular, with Section 6(b)(5).
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposal, SR-Amex 99-09, be and hereby is
approved.\15\
\14\ 15 U.S.C. 78s(b)(2).
\15\ In approving the proposal, the Commission has considered
the rule's impact on efficiency, competition, and capital formation.
15 U.S.C. 78c(f).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulations,
pursuant to delegated authority.\16\
---------------------------------------------------------------------------
\16\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-16866 Filed 7-1-99; 8:45 am]
BILLING CODE 8010-01-M
