[Federal Register: December 27, 2002 (Volume 67, Number 249)]
[Notices]
[Page 79174-79179]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27de02-153]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47017; File No. SR-Amex-2002-96]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendment No. 1 Thereto by the American Stock Exchange LLC
To Permit Limited Side-by-Side Trading and Integrated Market Making of
Certain iShares Lehman Treasury Index Exchange-Traded Fund Shares and
Their Related Options
December 18, 2002.
Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and rule 19b-4 thereunder,\2\ notice is hereby given that
on November 20, 2002, the American Stock Exchange LLC (``Amex'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in items I, II,
and III below, which items have been prepared by the Exchange. The
Exchange filed Amendment No. 1 to the proposed rule change on December
3, 2002.\3\ The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Jeffrey P. Burns, Assistant General Counsel,
Amex, to Kelly McCormick Riley, Senior Special Counsel, Division of
Market Regulation, Commission, dated November 27, 2002 (``Amendment
No. 1''). In Amendment No. 1, the Exchange revised the rule text of
the proposal to clarify that the Commission must approved integrated
market making and side-by-side trading in Exchange Traded Fund
(``ETF'') or Trust Issued Receipt (``TIR'') that does not meet the
criteria set forth in Commentary .03(a) or Amex rule 1000 or
Commentary .02(a) to Amex rule 1000A.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend Exchange rules 175, 900 and 958 to
permit the trading of the iShares Lehman 1-3 Year Treasury Bond Fund
(the ``1-3 Year Bond Fund''), the iShares Lehman 7-10 Year Treasury
Bond Fund (the ``7-10 Year Bond Fund''), the iShares Lehman 20+ Year
Treasury Bond Fund (the ``20+Year Bond Fund'') (collectively, the
``iShares Lehman Treasury Index ETFs''),\4\ and any other exchange-
traded fund shares (``ETFs'') approved by the Commission, and their
related options contracts by the same specialist unit and registered
options traders (``ROTs'') and the approved persons of such specialist
unit or ROT without informational or physical barriers. The text of the
proposed rule change appears below. New text is in italics.
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\4\ See Securities Exchange Act Release No. 46252 (July 24,
2002), 67 FR 49715 (July 31, 2002), (``iShares Treasury Index ETF
Approval''). See also Investment Company Act Release Nos. 25622
(June 25, 2002), (approval0; and 25594 (May 29, 2002), 67 FR 38681
(June 5, 2002), (notice) (Trust, Advisor and Distributor of the
funds applied and received a Commission order exemption the funds
from various provisions of the Investment Company Act of 1940
(``1940 Act'')).
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Specialist Prohibitions
Rule 175
(a)-(b) No change.
(c) No specialist or his member organization or any member, limited
partner, officer, or approved person thereof shall act as an options
specialist or function in any capacity involving market making
responsibilities in any option as to which the underlying security is a
stock in which the specialist is registered as such. Notwithstanding
the foregoing:
(1) A specialist member organization or an approved person of a
specialist registered in a stock admitted to dealings on an unlisted
basis may act as a specialist, Registered Options Trader or other
registered market maker in the related option provided that such
persons have established and obtained Exchange approval for procedures
restricting the flow of material, non-public corporate or market
information between them pursuant to Exchange rule 193, and
(2) A specialist, specialist member organization or approved person
of a specialist or specialist member organization registered in an
Exchange Traded Fund Share or Trust Issued Receipt that meets the
criteria set forth in Commentary .03(a) to Amex rule 1000 or Commentary
.02(a) to Amex rule 1000A or approved by the Securities and Exchange
Commission for trading arrangements under this paragraph and rule
958(e) may act as a specialist, Registered Options Trader or other
registered market maker in the related option without implementing
procedures to restrict the flow of information between them and without
any physical separation between the underlying Exchange Traded Fund
Share or Trust Issued Receipt and the related option. In addition,
paragraph (b) of this rule and the Guidelines to this rule are
inapplicable to a specialist or specialist member organization
registered in an Exchange Traded Fund Share or Trust Issued Receipt
that meets the criteria set forth in Commentary .03(a) to Amex rule
1000 or Commentary .02(a) to Amex rule 1000A or approved by the
Securities and Exchange Commission for trading arrangements under this
paragraph and rule 958(e) and the approved persons of such specialist
or specialist member organization.
* * * * *
Applicability, Definitions and References
Rule 900
A. (a) No change.
(b) Definitions--The following terms as used in the Rules of this
Chapter shall, unless the context otherwise indicates, have the
meanings herein specified:
(1) through (37). No change.
(38) Paired Security--The term ``Paired Security'' means a security
which is the subject of securities trading on the Exchange and Exchange
option trading, provided, however, that the term ``Paired Security''
shall not mean an Exchange-Traded Fund Share or Trust Issued Receipt
which is the subject of securities trading on the Exchange and Exchange
option trading if the Exchange-Traded Fund Share or Trust Issued
Receipt meet the criteria
[[Page 79175]]
set forth in Commentary .03(a) to Amex rule 1000 or Commentary .02(a)
to Amex rule 1000A or approved by the Securities and Exchange
Commission for trading arrangements under rule 175(c)(2) and rule
958(e).
(39) through end. No change.
* * * * *
Options Transactions of Registered Traders
Rule 958. No Registered Trader shall initiate an Exchange options
transaction on the Floor for any account in which he has an interest
except in accordance with the following provisions:
(a) through (d). No change.
(e) No equity specialist, odd-lot dealer or NASDAQ market maker may
act as a registered trader in a class of stock options on a stock in
which he is registered in the primary market therefor, provided,
however, that an equity specialist may act as a registered trader in a
class of stock options on an Exchange-Traded Fund Share or a Trust
Issued Receipt in which he is registered in the primary market therefor
if the Exchange-Traded Fund Share or Trust Issued Receipt meets the
criteria set forth in Commentary .03(a) to Amex rule 1000 or Commentary
.02(a) to Amex rule 1000A or approved by the Securities and Exchange
Commission for trading arrangements under this paragraph and rule
175(c)(2).
(f) through end. No change.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, Proposed Rule Change
1. Purpose
The purpose of this proposed rule change is to permit the trading
of the iShares Lehman Treasury Index ETFs and their related options by
the same specialist, specialist firm, and the approved persons of such
specialist or specialist firm without any information or physical
barriers on the floor of the Exchange. Accordingly, this proposal would
permit integrated market making \5\ and side-by-side trading \6\ in
iShares Lehman Treasury Index ETFs and their related options. It would
exempt the underlying ETF specialists and their approved persons from
Amex rule 175(b) and the Guidelines to Amex rule 175.
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\5\ ``Integrated market making'' refers to the trading of
options and their underlying securities by the same specialist and/
or specialist firm.
\6\ ``Side-by-side trading'' refers to the trading of options
and the underlying stocks at the same location, though not
necessarily by the same specialist.
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The Exchange files this rule change in connection with its listing
and trading of options on the iShares Lehman Treasury Index ETFs.\7\
Current Exchange rules impose certain restrictions on the approved
persons \8\ and other persons that are affiliated with a specialist or
specialist unit (collectively ``specialist affiliates''). Among these
rules, Amex rule 175(c) generally prohibits the specialist affiliates
of an Amex equity specialist from acting as an options specialist or
functioning in any capacity involving market making responsibilities in
any option as to which stock the specialist is registered.\9\ A recent
amendment to Amex rule 175(c) added paragraph (c)(2), which permits
integrated market making of certain ``broad-based'' equity ETFs.\10\
Here, the Exchange proposes to amend Amex rules 175, 900 and 958 to
allow integrated market making and side-by-side trading in the iShares
Lehman Treasury Index ETFs and their related options as well as
integrated market making and side-by-side trading of any ETF and its
related option with separate Commission approval.
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\7\ The underlying iShares Treasury Index ETFs commenced trading
on the Amex on July 26, 2002. See iShares Treasury Index ETF
Approval, supra note 4.
\8\ The Exchange defines an ``approved person'' as an individual
or corporation, partnership or other entity which controls a member
or member organization, or which is engaged in the securities
business and is under common control with, or controlled by, a
member or member organization or which is the owner of a membership
held subject to a special transfer agreement. See article I, section
3(g) of the Exchange Constitution. The term ``control'' is defined
in Exchange Definitional rule 13.
\9\ This rule was adopted in connection with the Exchange's
application in the late 1980s to list options on its listed
equities. See Securities Exchange Act Release No. 26147 (October 3,
1988), 53 FR 39556 (October 7, 1988) (File No. SR-Amex-88-16).
\10\ See Securities Exchange Act Release No. 46213 (July 16,
2002), 67 FR 48232 (July 23, 2002) (``ETF Integrated Market Making
Approval'').
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In light of the Commission's recent approval to permit side-by-side
trading and integrated market making on the Amex in certain equity-
based ETFs,\11\ the Exchange believes that iShares Treasury Index ETFs
should be similarly treated. The ETF Integrated Market Making Approval
established a generic criteria for equity-based ETFs that requires such
ETFs to be ``broad-based'' in order be for integrated market making and
side-by-side trading to apply.\12\ For purposes of the instant
proposal, the Exchange requests that the Commission approve certain
fixed-income ETFs, based on various segments or durations of the U.S.
Treasury securities market (arguably, the most liquid and active
securities market in the world), for integrated market making and side-
by-side trading separate from the previously adopted equity-based ETF
generic standards. Accordingly, the Exchange proposes to amend Amex
rule 175(c)(2) to permit the same specialists, their member
organizations, and their approved persons to trade an ETF and its
related options, if approved to do so by the Commission, without
reference to the limitations of Amex rule 175(b) and the Guidelines to
Amex rule 175. The Exchange also proposes to amend the definition of
``Paired Security'' in Amex rule 900 to provide that in addition to
those ETFs that meet the equity-based generic criteria, those ETFs that
are specifically approved for integrated market making and side-by-side
trading by the Commission.
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\11\ See id. The Exchange has filed a proposed rule change that
would allow the trading on a pilot program basis of specified Nasdaq
stocks, ETFs, TIRs and their related options at the same location on
the Trading Floor and by the same specialist units and registered
traders. See SR-Amex-2001-75 (September 6, 2001). The ETF Integrated
Market Making Approval neither amended nor withdrew SR-Amex-2001-75.
\12\ Commentary .03(a) to Amex rule 1000 and Commentary .02(a)
to Amex rule 1000A provide that each component of an index or
portfolio underlying an ETF must meet the following criteria: (1)
Component securities that in the aggregate account for at least 90%
of the weight of the portfolio must have a minimum market value of
at least $75 million; (2) the component securities representing 90%
of the weight of the portfolio each have a minimum monthly trading
volume during each of the last six months of at least 250,000
shares; (3) the most heavily weighted component security cannot
exceed 25% of the weight of the portfolio and the five most heavily
weighted component securities cannot exceed 65% of the weight of the
portfolio; (4) the underlying portfolio must include a minimum of 13
securities; and (5) all securities in the portfolio must be listed
on a national securities exchange or the Nasdaq Stock Market (the
``broad-based criteria'').
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a. The Market for Treasury Securities
The market for U.S. Treasury securities is the largest and most
liquid securities market in the world.\13\
[[Page 79176]]
Through the 3rd quarter of 2002, total daily average transaction volume
for primary dealers \14\ in U.S. Treasury coupon securities was
approximately $316 billion. During this same period, primary dealer
average daily transaction volume in the 1-3 year range was
approximately $132.07 billion; average daily transaction volume in the
3-6 year range was approximately $92.73 billion; average daily
transaction volume in the 6-11 year range was approximately $74.8
billion; and average daily transaction volume in the more than 11 year
range was approximately $18.9 billion.\15\ In the 3rd quarter of 2002,
average daily transaction volumes for the same duration U.S. Treasury
coupon securities were $134.03 billion, $106.97 billion, $83.57 billion
and $20.57 billion, respectively. Most of this trading volume occurs in
the most recently issued security in a particular maturity class.\16\
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\13\ See The Treasury Securities Market: Overview and Recent
Developments, The Federal Reserve Bulletin, December 1999, available
at http://www.federalreserve.gov/pubs/bulletin/1999/1299lead.pdf.
\14\ The Federal Reserve Bank of New York selects Primary
dealers to act as counter parties for its open market operations
(government securities transactions related to the Federal Reserve's
implementation of monetary policy). Primary dealers are required to
participate meaningfully in both open market operations and Treasury
auctions as well as to provide policy relevant market information to
The Federal Reserve Bank of New York.
\15\ Primary dealers in Treasury securities submit statistics on
their transactions in Treasuries to The Federal Reserve Bank of New
York. These statistics are available on their web site at http://www.newyorkfed.org/pihome/statistics/primdeal.html?expand=9
.
\16\ See The Treasury Securities Market: Overview and Recent
Developments, supra note 13.
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The secondary market for Treasury securities is the over-the-
counter (``OTC'') market. Many dealers, and particularly primary
dealers, make markets in Treasury securities. Trading activity takes
place between primary dealers, non-primary dealers, and customers of
these dealers, including financial institutions, non-financial
institutions and individuals. Increasingly, trading in Treasury
securities occurs through automated trading systems.\17\
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\17\ See, e.g., eCommerce in the Fixed-Income Markets: The 2001
Review of Electronic Transaction Systems, November 2001, http://www.bondmarkets.com/research/
ecommerce/ecommercedraft.shtml.
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The primary dealers are among the most active participants in the
secondary market for Treasury securities. The primary dealers and other
large market participants frequently trade with each other, and most of
these transactions occur through an interdealer broker.\18\ The
interdealer brokers provide primary dealers and other large
participants in the Treasury market with electronic screens that
display the bid and offer prices among dealers and allow trades to be
consummated.
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\18\ E.g., BrokerTec Global LLC, Cantor Fitzgerald, Inc.,
Garban-Intercapital, and Liberty Brokerage Investment Corp.
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Quote and trade information regarding Treasury securities is widely
available to market participants from a variety of sources. The
electronic trade and quote systems of the dealers and interdealer
broker are one such source. Groups of dealers also furnish trade and
quote information to vendors such as Bloomberg, Reuters, Bridge,
Moneyline Telerate, and CQG. GovPX,\19\ for example, is a consortium of
government securities interdealer brokers that provides market data
from these government securities interdealer brokers to market data
vendors. TradeWeb, another example, is a consortium of 18 primary
dealers that, in addition to providing a trading platform, also
provides market data direct to subscribers or to other market data
vendors.\20\ In addition, the leading interdealer broker of government
securities (Cantor Fitzgerald) for many years has provided Moneyline
Telerate with market data.
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\19\ www.govpx.com.
\20\ www.tradeweb.com.
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b. iShares Lehman Treasury Index ETFs
The Lehman U.S. Treasury Indexes are each market capitalization
weighted and include all of the securities that meet the particular
Index criteria. Each Index includes all publicly issued, U.S. Treasury
securities that have a remaining maturity of between 1-3 years, 7-10
years or over 20 years (depending on the Index), are non-convertible,
are denominated in U.S. dollars, are rated investment grade (Baa3 or
better) by Moody's Investors Service, are fixed rate, and have more
than $150 million par outstanding. Excluded from each Index are certain
special issues, such as flower bonds,\21\ targeted investor notes
(TINs), state and local government series bonds (SLGs), and coupon
issues that have been stripped from assets that are already included in
the Index. Each Index's constituents are updated on the last calendar
day of each month.
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\21\ A ``flower bond'' is a type of U.S. government bond that,
regardless of its cost price, is acceptable at par value in payment
of estate taxes if the decedent was the legal holder at the time of
death.
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Each Index is valued using end of day bid side prices, as marked by
Lehman. Intra-month cash flows contribute to monthly returns, but they
are not reinvested during the month and do not earn a reinvestment
return. Total returns are calculated based on the sum of price changes,
gain/loss on repayments of principal, and coupon received or accrued,
expressed as a percentage of beginning market value.\22\
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\22\ The Monthly Statement of the Public Debt of the United
States may be obtained at www.publicdebt.treas.gov.
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i. Lehman 1-3 Year Treasury Bond Fund (1-3 Year Bond Fund). The 1-3
Year Bond Fund invests primarily in a portfolio of fixed income
securities with the objective of approximating the total rate of return
of the short term sector of the U.S. Treasury market as defined by the
Lehman Brothers 1-3 Year U.S. Treasury Index. The Lehman 1-3 Year U.S.
Treasury Index represents public obligations of the U.S. Treasury that
have a remaining maturity of between 1 and 3 years. As of September 30,
2002, there were 31`issues included in the Index with the Fund using a
representative sampling strategy to track the Index.\23\
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\23\ As of September 30, 2002, the Index exhibited the following
characteristics: (1) Weighted average maturity of 1.77 years; (2)
weighted average coupon of 4.58%; (3) an effective duration of 1.68
years; (4) yield to maturity of 1.64% and (5) a current yield of
4.37%. In addition, the top holding of the Index constituted 6% of
the Index while the top five (5) holdings represented 30% of the
Index.
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ii. Lehman 7-10 Year Treasury Bond Fund (7-10 Year Bond Fund) The
7-10 Year Bond Fund invests primarily in a portfolio of fixed income
securities with the objective of approximating the total rate of return
of the intermediate term sector of the U.S. Treasury market as defined
by the Lehman Brothers 7-10 Year U.S. Treasury Index. The Lehman 7-10
Year U.S. Treasury Index represents public obligations of the U.S.
Treasury that have a remaining maturity of between 7 and 10 years. As
of September 30, 2002, there were 12 issues included in the Index with
the Fund using a representative sampling strategy to track the
Index.\24\
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\24\ As of September 30, 2002, the Index exhibited the following
characteristics: (1) Weighted average maturity of 8.55 years; (2)
weighted average coupon of 5.98%; (3) an effective duration of 6.65
years; (4) yield to maturity of 3.63% and (5) a current yield of
5.36%. In addition, the top holding of the Index constituted 17% of
the Index while the top five (5) holdings represented 76% of the
Index.
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iii. Lehman 20+ Year Treasury Bond Fund (20+ Year Bond Fund). The
20+ Year Bond Fund invests primarily in a portfolio of fixed income
securities with the objective of approximating the total rate of return
of the long term sector of the U.S. Treasury market as defined by the
Lehman Brothers 20+ Year U.S. Treasury Index. The Lehman 20+ Year U.S.
Treasury Index represents public
[[Page 79177]]
obligations of the U.S. Treasury that have a remaining maturity greater
than 20 years. As of September 30, 2002, there were 18 issues included
in the Index with the Fund using a representative sampling strategy to
track the Index.\25\
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\25\ As of September 30, 2002, the Index exhibited the following
characteristics: (1) Weighted average maturity of 24.18 years; (2)
weighted average coupon of 6.30%; (3) an effective duration of 13.70
years; (4) yield to maturity of 5.14% and (5) a current yield of
5.45%. In addition, the top holding of the Index constituted 11% of
the Index while the top five holdings represented 44% of the Index.
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c. Broad-Based ETF Criteria
As discussed above, the Commission has approved a proposal to
permit integrated market making and side-by-side trading of equity-
based ETFs that meet the broad-based criteria.\26\ For the purpose of
this proposal, the Exchange submits that the iShares Treasury Index
ETFs comply with the broad-based criteria, as applicable, to fixed
income U.S. government securities.
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\26\ See supra, note 12; see also ETF Integrated Market Making
Approval, supra note 10.
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First, the broad-based criteria requires that at least 90% of the
component securities of an Index have a minimum market value of at
least $75 million. The Exchange submits that all three iShares Treasury
Index ETFs meet this criteria based on the requirement that all
Treasury securities of each respective U.S. Treasury Index must have
more than $150 million outstanding in par value. Second, the broad-
based criteria also requires that at least 90% of the component
securities of an Index have a minimum monthly trading volume during
each of the last six months of at least 250,000 shares. Because the
trading of U.S. Treasury securities is based on the underlying
transaction or notional amount rather than ``share'' amounts, the
Exchange submits that this second criteria cannot strictly be applied
to the U.S. Treasury Indexes. However, the Exchange believes that a
comparison can be made if the monthly trading volumes identified in the
broad-based criteria are converted to U.S. dollar amounts. In
connection with the iShares Treasury Index ETFs the average daily
transaction volume through the 3rd quarter of 2002 for primary dealers
in the 1-3 Year Treasury security was approximately $132.07 billion;
for the 3-6 Year Treasury security the average daily transaction volume
for primary dealers was $92.73 billion; for the 6-11 Treasury security
the average daily transaction volume was $74.8 billion; and for
Treasury securities over 11 Years the average daily trading volume was
approximately $18.9 billion. For comparison purposes, Microsoft
Corporation (MSFT) which is a component in several broad-based Indexes
underlying ETFs, would be required to have a minimum monthly trading
dollar value of at least $13.25 million given the current price of MSFT
of $53 per share on October 23, 2002 (250,000 x $53). Clearly, the
monthly trading volumes for the U.S. Treasury securities of the Indexes
underlying the three iShares Treasury Index ETFs far exceeds the
comparative dollar amounts for the largest-capitalized components of
the equity-based indexes under this second requirement of the broad-
based criteria.
Third, under the broad-based criteria, a component security cannot
exceed 25% of the weight of the Index and the five most heavily
weighted component securities cannot exceed 65% of the weight of such
Index. The Lehman 1-3 Year U.S. Treasury Index and the Lehman 20+ Year
U.S. Treasury Index strictly comply with this requirement of the broad-
based criteria applicable to equity-based ETFs. However, the Lehman 7-
10 Year U.S. Treasury Index does not meet the 65% test for the top five
(5) holdings of an Index. The broad-based criteria originally developed
for equity-based ETFs does not correspond well to the U.S. Treasury
securities market. The Exchange believes that the nature of the U.S.
Treasury securities market, renders this third criteria particularly
difficult to apply to certain U.S. Treasury indexes or portfolios
because of the specific duration of the yield curve that the U.S.
Treasury index or portfolio is attempting to track or benchmark.
Furthermore, the Exchange submits that the only differences in these
U.S. Treasury securities held by the corresponding indexes are related
to the rate of interest and maturities. Accordingly, the Exchange
believes that the market for U.S. Treasury securities, which is the
most liquid market in the world, is not particularly susceptible to
manipulation. The Exchange also notes that in connection with the sale
and issue of U.S. Treasury bills, notes and bonds, the Department of
the Treasury limits to 35% the amount that any one bidder may be
awarded in any auction.\27\
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\27\ See 31 CFR 356.22; Department of the Treasury, Final Rules
Relating to the Sale and Issue of Marketable Book-Entry Treasury
Bills, Notes and Bonds, 58 FR 412 (January 5, 1993).
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In contrast, an index or portfolio of equity securities depends on
several corporate issuers rather than the full faith and credit of the
U.S. Government in the case of U.S. Treasury securities. As a result,
the broad-based criteria includes a diversification requirement so that
integrated market making and side-by-side trading would not be
permitted if such Index underlying or ETF was dominated by one (1) or a
few stocks. The Exchange submits that iShares Treasure Index ETFs do
not have similar diversification concerns because the objective of each
such ETF is to approximate the total return of their respective sector
or duration of the U.S. Treasury market.
Fourth, the broad-based criteria requires an index or portfolio
underlying an equity-based ETF to have at least 13 component
securities. The Lehman 7-10 year U.S. Treasury Index currently contains
12 component securities, and therefore, fails this requirement of the
broad-based criteria. The Exchange believes that because the Lehman 7-
10 Year U.S. Treasury Index measures a specific duration of the U.S.
Treasury securities market, the application of this fourth criteria is
unnecessary here. For example, from the time of the launch of the 7-10
Year Bond Fund through September 30, 2002, the Index contained 13
component securities. The Exchange submits that slight modifications to
the Index to better reflect the appropriate market should not determine
whether integrated market making and side-by-side trading are
permissible. Therefore, the Exchange believes that the Lehman 1-3 Year
U.S. Treasury Index and the Lehman 20+ Year U.S. Treasury Index both
strictly comply with this requirement of the broad-based criteria by
containing 31 and 19 U.S. Treasury securities, respectively.
Fifth, the broad-based criteria requires that all securities in the
portfolio be listed on a national securities exchange or the Nasdaq
Stock Market. The Exchange contends that this requirement is
inapplicable on its face to all iShares Treasury Index ETFs because the
component securities of each related Index are not listed on a national
securities exchange or traded through the Nasdaq Stock Market. As
described above, U.S. Treasury securities are traded OTC through a
network of designated primary dealers, non-primary dealers, financial
institutions, non-financial institutions and individuals.
The Exchange further submits that the application of the broad-
based criteria that was developed to ensure that equity-based ETFs are
not susceptible to manipulation is not particularly useful in
connection with this proposal for the integrated market making and
side-by-side trading of ETFs based on U.S. Treasury Indexes. In
particular, the Exchange contends that the nature of the U.S. Treasury
securities market itself
[[Page 79178]]
suggests that it is not susceptible to manipulation due to the
tremendous liquidity and limits on the percentage ownership in any
Treasury auction. As a result, the Exchange believes that the iShares
Treasury Index ETFs are broad-based ETFs that represent a specific
duration of the U.S. Treasury securities market as measured by the
Lehman U.S. Treasury Indexes, and, therefore, such ETFs should be
permitted to be part of an Integrated Market Making environment on the
floor of the Exchange.
d. Integrated Market Making and Side-by-Side Trading
The Amex believes that integrated market making and side-by-side
trading of ETFs and their related options is appropriate. The Exchange
expects that the ability to engage in integrated market making and
side-by-side trading of iShares Treasury Index ETFs would help to
develop deeper, more liquid and efficient markets, as acknowledged by
the Commission Staff's Special Study of the Options Markets.\28\
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\28\ See also Report of the Special Study of the Options Markets
to the Securities and Exchange Commission, H.R. Rep. No. IFC 3, 96th
Cong. 1st sess. (Comm. Print 1978) (``Options Study'') at 878, et.
seq.
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The Exchange believes that the Commission's conclusions and
analysis set forth in the ETF Integrated Market Making Approval equally
apply to the iShares Treasury Index ETFs and their related options. As
the Exchange has previously asserted in connection with equity-based
ETFs, the primary trading market will not enjoy perceived informational
advantages that may be available in the case of individual stock
options, because the pricing of an ETF is not based on the supply and
demand of the ETF itself, but instead, on the prices of and information
on the underlying portfolio of securities and other associated
derivatives.
The Exchange believes that the proposed integrated market making
and side-by-side trading for iShares Treasury Index ETFs will increase
market quality and provide both price and operational efficiencies
while not raising any significant issues of informational
advantage.\29\ In the case of ETFs, the Exchange submits that
informational advantages are minimal because the pricing of ETFs are
based almost entirely on the value of the underlying portfolio of
securities and other associated derivatives with little if any price
impact arising from the supply and demand for the ETF shares.
Accordingly, knowledge of limit orders on the specialist's book for ETF
shares does not provide an informational advantage to the specialist
when pricing or trading ETF shares.
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\29\ See Amex File Nos. 2001-75 and 98-23 (precursor to File No.
2001-75 withdrawn by the Amex on July 17, 2001).
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The Commission has previously stated that ``[t]he integration of
trading in options and their underlying securities on an exchange floor
may create opportunities to engage in manipulative and other improper
trading activities that do not presently exist.''\30\ In order for
integrated market making and side-by-side trading in iShares Treasury
Index ETFs and their related options to potentially create
opportunities for the specialist and registered traders to engage in
improper activity, market making in both the option and the underlying
ETF must yield information that can be used in such an endeavor. With
respect to shares of an iShares Treasury Index ETF and related options,
the Exchange contends that neither the specialist nor the traders are
privy to exclusive market information that is useful in pricing such
shares. Like all market participants, they have access to last sale
information for each of the component securities, the current quotes
for the components and information for any other products that may be
used in pricing the fund shares. Exchange specialists and traders are
unlikely to obtain relevant information from the Exchange floor that is
nor already known by other market participants and already factored
into prices and quotes, especially since the Exchange does not list and
trade the underlying U.S. Treasury securities of the ETFs. Moreover,
showing the specialist's limit order book to the trading crowd
substantially lessens these informational advantage concerns. Given the
enhanced surveillance systems that monitor all trading floor activity
today at the Amex, the Exchange submits that attempts to engage in
improper conduct by a specialist or trader will be readily detected.
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\30\ See Options Study, supra note 28 at 885.
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Among other reasons why limit orders in ETF shares such as the
iShares Treasury Index Fund are not a source of informational advantage
is the number of such shares issued and outstanding may be increased or
decreased at a very low cost in response to changing demand for such
shares. A defining characteristic of all Amex listed unit investment
trusts and management investment companies that hold securities based
on an index or a portfolio of securities is that they are open-
ended.\31\ New ETF shares in these products may be created on any
business day in response to an offer to purchase such shares. As a
result, the Exchange submits that there is substantially less potential
for manipulation of an ETF share's price, because unlike a market in a
thinly traded corporate stock, the market for an ETF share cannot be
successfully squeezed or cornered. The Exchange contends that this is
untrue because the potential supply of ETF shares is, for all practical
purposes, unlimited.
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\31\ ETFs are registered under the 1940 Act either as unit
investment trusts or open-end management investment companies. Each
ETF continuously offers and redeems shares in large aggregation
amounts (50,000 shares), called Creation Units, at a price
established at the end of each business day based on the net asset
value of its portfolio. The individual ETF shares are then listed
and traded in a secondary trading market, such as the Amex.
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The key point of this proposal is that the market for iShares
Treasury Index ETFs is a derivative market of the underlying U.S.
Treasury securities markets and that the options market is also a
derivative of this underlying U.S. Treasury securities market. The
Commission recognized the limitations of the information that
specialists and market makers can obtain from the supply and demand in
derivative products when it noted in the Options Study:
* * * that even while unitary options specialists and competing
options market makers have market information and competitive
advantages of their own, the derivative nature of the options
markets may strictly limit the significance of these advantages.
Stated differently, because stock prices largely determine the
prices of related options, market information concerning the supply
of and demand for a stock may be substantially more valuable than
information concerning supply and demand for options on the
stock.\32\
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\32\ See Options Study, supra note 28 at 916, note 280.
Integrated market making and side-by-side trading in an ETF and its
related options, even for an exchange that was the dominant market for
the underlying ETF or option, is far less likely to yield significant
non-public stock pricing information which would increase any
competitive and market information advantages. Consequently, there is
little likelihood that iShares Treasury Index ETFs and their related
options order flow would provide a meaningful information advantage to
the integrated specialist unit or the market makers in the trading
crowd. Indeed, the Exchange expects that the specialist units and
market makers for such integrated derivative securities markets would
depend primarily upon publicly
[[Page 79179]]
disseminated quotation and transaction information from the U.S.
Treasury securities market when making pricing decisions.\33\
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\33\ See Options Study, supra note 28 at 906.
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Integrated market making in two related derivatives is not
unprecedented. Exchange specialist units and market makers have long
made integrated markets in stock options bearing differing strike
prices and expirations which are separate but closely linked derivative
securities markets. In 1985, the Commission approved an NASD proposal
for fully integrated market making in stock options and their
underlying stock.\34\
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\34\ See Securities Exchange Act Release No. 22026 (May 8,
1985), 50 FR 20310 (May 15, 1985).
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The Exchange contends that integrated market making in derivative
products does not entail a materially increased potential for price
manipulation or other improper trading practices. The Exchange believes
that the primary importance of underlying securities market prices and
the arbitrage opportunities of other traders provides natural
safeguards against this type of activity. Further, such abuses are
unlikely to occur due to the limited influence of derivative markets on
the underlying securities price. To the extent that any risk remains,
the Exchange believes that it is better addressed by surveillance
rather than a restriction that threatens liquidity. The Exchange also
notes that the Commission previously approved integrated market making
and side-by-side trading of related derivative products.\35\ The
Exchange submits that the analysis and rationale set forth by the
Commission in these orders is equally applicable to this Proposal.
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\35\ See Securities Exchange Act Release No. 27383 (October 26,
1989), 54 FR 45846 (October 31, 1989) (Order approving a CBOE
proposal to list and trade market basket contracts based on the S&P
100 and S&P 500 at trading posts adjacent to the related index
options). See also ETF Integrated Market Making Approval, supra note
10.
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Additionally, the Commission has expressed concern that the
integration of trading in options and their underlying securities may
increase the difficulty of detecting improper trading practices on an
exchange floor.\36\ The Exchange notes that it currently has in place
safeguards to detect and prevent potential abuses or manipulative
activities. The Exchange believes that its market surveillance program
will mitigate any regulatory risks that arise from integrated market
making and side-by-side trading of iShare Treasury Index ETFs.
Furthermore, the Commission found that the NASD's surveillance
procedures sufficient to address the regulatory concerns raised by the
NASD's 1985 side-by-side trading program for Nasdaq listed stocks and
options.\37\ The advances in developing comprehensive audit trails for
options will give us the ability to provide considerably enhanced
surveillance oversight compared to the capabilities available in 1985.
Accordingly, the Exchange believes its existing surveillance procedures
are sufficient to detect any improper trading activity, deter potential
manipulative or improper trading activity and minimize the regulatory
risks of integrated market making and side-by-side trading. In sum, the
Exchange conducts regular surveillance to detect any abuses or
attempted manipulations to ensure compliance with its safeguards. The
Exchange believes that the proximity of trading activity in related
options products will increase the effectiveness of these safeguards.
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\36\ See Options Study, supra note 28 at 896.
\37\ See Securities Exchange Act Release Nos. 22439 (September
20, 1985), 50 FR 39191 (September 27, 1985). In the ``Conclusions''
section of the Release, the Commission stated:
For the reasons stated in the OTC Options Release, the
Commission continues to believe that side-by-side market making in
the six pilot stocks should offer substantial market benefits and,
with equity and options audit trails in place, also should reduce to
surveillable levels the regulatory concerns raised by side by side
market making. The Commission also does not believe that the
inclusion of exchange specialists and market makers does not appear
to create any additional or unique regulatory problems and provides
all relevant markets a fair competitive opportunity.
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2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with section 6(b) of the Act,\38\ in general, and furthers the
objectives of section 6(b)(5) of the Act,\39\ in particular, in that it
is designed to prevent fraudulent an manipulative practices, promote
just and equitable principles of trade, foster cooperation and
coordination with persons engaged in facilitating transactions in
securities, to remove impediments and perfect the mechanisms of a free
and open market and the national market system, protect investors and
the public interest and is not designed to permit unfair discrimination
between customers, issuers, brokers or dealers.
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\38\ 15 U.S.C. 78f(b).
\39\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change, as
amended, will impose any burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding, or (ii) as to
which the Exchange consents, the Commission will:
A. By order approve such proposed rule change; or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as amended, is consistent with the Act. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549-0609. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room. Copies of such
filings will also be available for inspection and copying at the
principal office of the Exchange. All submissions should refer to File
No. SR-Amex-2002-96 and should be submitted by January 17, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\40\
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\40\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-32739 Filed 12-26-02; 8:45 am]
BILLING CODE 8010-01-P