[Federal Register: September 2, 2003 (Volume 68, Number 169)]
[Notices]
[Page 52257-52259]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02se03-148]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48405; File No. SR-ISE-2003-05]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Amendment No. 1 by the International Securities Exchange,
Inc. Relating to the Establishment of Trading Rules for Index Options
and Generic Listing and Maintenance Standards for Narrow-Based Index
Options
August 25, 2003.
I. Introduction
On February 24, 2003, the International Securities Exchange, Inc.
(``ISE'' 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 enable the ISE to trade index
options on the Exchange. The ISE filed Amendment No. 1 to the proposed
rule change on April 17, 2003.\3\ The proposed rule change, as amended,
was published for comment in the Federal Register on May 2, 2003.\4\
The Commission received no comments on the proposal. This order
approves the proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Katherine Simmons, Vice President and
Associate General Counsel, ISE to Florence Harmon, Senior Special
Counsel, Division of Market Regulation, Commission, dated April 16,
2003. In Amendment No. 1, the ISE submitted a new Form 19b-4, which
replaced the original filing in its entirety.
\4\ See Securities Exchange Act Release No. 47749 (April 25,
2003), 68 FR 13348.
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II. Description of the Proposal
A. Introduction
The ISE proposes to establish trading rules to enable Members to
trade index options on the Exchange. In addition, the ISE proposes to
establish generic listing standards and maintenance standards for
``narrow-based'' index options pursuant to Rule 19b-4(e) under the
Act.\5\ The ISE represents that all of the proposed new Exchange Rules
and changes to existing Exchange Rules are based on the existing rules
of the other four options exchanges.\6\ Many of the new trading rules
and generic listing standards will comprise the new Chapter 20 in the
ISE Rules.
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\5\ 17 CFR 240.19b-4(e). The term ``narrow-based index'' is
defined as an index designed to be representative of a particular
industry or a group of related industries. See Proposed ISE Rule
2001(i). Narrow-based indices listed and traded on the ISE pursuant
to generic listing and maintenance standards, among other
characteristics, must consist of ten or more component securities.
See Proposed ISE Rule 2002(b)(2).
\6\ See, e.g., CBOE Rules 4.11, 4.16, 6.2, 6.7, 8.7, 11.1,
15.10, and 24.1 through 24.20, PCX Rules 7.11 and 13.2, Amex Rule
905C, and Phlx Rule 1033A.
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B. Index Options Trading Rules
The proposed rules, among other things, establish general rules
that will govern the trading sessions for index options, including the
days and hours of business, the rules governing trading rotations at
the opening, and the rules related to the trading halts or
suspensions.\7\ The proposed rules further provide for the procedures
Members must follow with respect to the exercise of American-style,
cash settled index options.\8\ The proposed rules also provide for
position limit and
[[Page 52258]]
exercise limits for index options.\9\ In addition, the proposed rules
provide for exemption standards from position limits and procedures for
requesting exemptions from those proposed rules.\10\ The proposed
position limits and exercise limits, as well as the proposed
exemptions, are different for broad-based index options and narrow-
based index options.\11\ The proposed rules establish standards for
when a member seeking to sell short a Nasdaq NMS security included in
an index underlying an index option listed and traded on the Exchange
is exempt from the NASD short sale rule.\12\
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\7\ See Proposed ISE Rule 2008.
\8\ See Proposed ISE Rule 418(a)(3) and 1100(h).
\9\ See Proposed ISE Rules 2004, 2005, and 2007.
\10\ See Proposed ISE Rule 2006.
\11\ See Proposed ISE Rules 2004 to 2007.
\12\ See Proposed ISE Rule 1407(d)(1)(ii).
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C. Generic Listing Standards and Maintenance Standards for Narrow-Based
Index Options
The ISE further proposes to establish generic listing and
maintenance standards in Proposed ISE Rule 2002 to enable the Exchange
to list and trade new narrow-based index options pursuant to Rule 19b-
4(e) under the Act.\13\ Proposed ISE Rule 2002 addresses both initial
listing and maintenance standards for narrow-based index options.\14\
The generic listing and maintenance standards are modeled after
standards that the Commission originally approved for streamlined
listing and trading pursuant to Section 19(b)(3)(A) of the Act.\15\ The
options exchange subsequently filed proposed rule changes with the
Commission to eliminate the Section 19(b)(3)(A) rule filing requirement
from their existing SRO rules, after the Commission indicated that
products meeting the listing criteria approved by the Commission in its
1994 Generic Narrow-Based Index Options Approval Order qualified for
filing pursuant to Rule 19b-4(e) under the Act.\16\
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\13\ 17 CFR 240.19b-4(e). Rule 19b-4(e) provides that the
listing and trading of a new derivative securities product by a
self-regulatory organization (``SRO'') shall not be deemed a
proposed rule change, pursuant to paragraph (c)(1) of Rule 19b-4, if
the Commission has approved, pursuant to Section 19(b) of the Act,
the SRO's trading rules, procedures, and listing standards for the
product class that includes the new derivative securities product
and the SRO has a surveillance program for the product class. When
relying on Rule 19b-4(e), the SRO must submit Form 19b-4(e) to the
Commission within five business days after the exchange begins
trading the new derivative securities products. See Securities
Exchange Act Release No. 40761 (December 8, 1998), 63 FR 70952
(December 22, 1998) (File No. S7-13-98).
\14\ The proposed generic listing standards approved herein do
not apply to the listing of options on broad-based indices.
\15\ In 1994, the Commission approved a proposed rule change
submitted by the American Stock Exchange, Inc. (``Amex''), the
Chicago Board Options Exchange, Inc. (``CBOE''), the New York Stock
Exchange, Inc. (``NYSE''), the Pacific Stock Exchange, Inc.
(``PSE''), and the Philadelphia Stock Exchange, Inc. (``Phlx'')
(collectively the ``options exchanges''), which permitted the
options exchanges to list and trade options on narrow-based indexes
thirty days after submitting a filing pursuant to Section
19(b)(3)(A) of the Act. The Commission found that such filings would
constitute a stated policy, practice, or interpretation with respect
to the administration of an existing Exchange rule, pursuant to
Section 19(b)(3)(A) of the Act, relieving the Exchange of the former
requirement of obtaining specific Commission approval of such
narrow-based index options pursuant to Section 19(b)(2) of the Act.
See Securities Exchange Act Release No. 34157 (June 3, 1994), 59 FR
30622 (June 10, 1994) (SR-Amex-92-35) (SR-CBOE-93-59) (SR-NYSE-94-
17) (SR-PSE-94-07) and (SR-Phlx-94-10) (the ``1994 Generic Narrow-
Based Index Options Approval Order'').
\16\ See Securities Exchange Act Release No. 40761 (December 8,
1998), 63 FR 70952 (December 22, 1998) (File No. S7-13-98).
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Notwithstanding the generic listing standards for options on
narrow-based indexes, the Exchange will need to file additional
proposed rule changes with the Commission when the Exchange identifies
specific products because the rules related to trading options on
indices are product specific in many areas. For purposes of this
proposed rule change, certain rules indicate that they apply to
``specified'' indices. ISE Rules 2001(l), 2004(a), 2006(a), 2007(a),
2009, and 2011 all contain provisions that are dependant upon the
Exchange identifying specific index products in the rule. Accordingly,
proposed ISE Rule 2000 states that where the rules in Chapter 20
indicate that particular indices or requirements with respect to
particular indices will be ``Specified,'' the ISE shall file a proposed
rule change with the Commission pursuant to section 19(b)(1) of the Act
\17\ and Rule 19b-4 thereunder \18\ to specify such indices or
requirements.
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\17\ See note 1 supra.
\18\ See note 2 supra.
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III. Commission Findings and Order Granting Approval of the Proposed
Rule Change
After careful review, the Commission finds that the proposed rule
change, as amended, is consistent with the requirements of section
6(b)(5) of the Act \19\ and the rules and regulations thereunder
applicable to a national securities exchange.\20\ The Commission
believes that the ISE's proposal to establish trading rules and
procedures applicable to index options and establish generic listing
and maintenance standards for narrow-based index options strikes a
reasonable balance between the Commission's mandates under section
6(b)(5) of the Act \21\ to remove impediments to and perfect the
mechanisms of a free and open market and a national market system while
protecting investors and the public interest.
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\19\ 15 U.S.C. 78f(b)(5).
\20\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\21\ See note 19 supra.
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A. Index Options Trading Rules
The Commission believes that trading options on an index of
securities (including a narrow-based index) permits investors to
participate in the price movements of the index's underlying securities
and allows investors holding positions in some or all of such
securities to hedge the risks associated with their portfolios. The
Commission further believes that trading options on an index provides
investors with an important trading and hedging mechanism that is
designed to reflect accurately the overall movement of the component
stocks. In making this finding the Commission notes that all of the
proposed new Exchange Rules and changes to existing Exchange Rules are
based on the existing rules of the other four options exchanges.\22\
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\22\ See, e.g., CBOE Rules 4.11, 4.16, 6.2, 6.7, 8.7, 11.1,
15.10, and 24.1 through 24.20, PCX Rules 7.11 and 13.2, Amex Rule
905C, and Phlx Rule 1033A.
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B. Generic Listing and Maintenance Standards for Narrow-Based Index
Options
In approving the generic listing and maintenance standards for
narrow-based index options, the Commission considered the structure of
these securities, their usefulness to investors and to the markets and
the ISE rules that govern their trading. The proposal to establish
generic standards for narrow-based index options should reduce the
ISE's regulatory burden, as well as benefit the public interest, by
enabling the ISE to bring qualifying products to the market more
quickly. Furthermore, the Commission notes that it has previously
approved similar proposals by the Amex, CBOE, NYSE, PSE, and the Phlx
to establish generic listing and maintenance standards for narrow-based
index options.\23\
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\23\ See note 15 supra.
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The Commission finds that adopting generic listing and maintenance
standards for these securities and applying Rule 19b-4(e) should
fulfill the intended objective of that rule by allowing those index
option products that satisfy the generic standards to start trading,
without the need for notice and comment and Commission approval. The
Exchange's ability to rely on Rule 19b-4(e) for these products
potentially reduces the time frame for listing and
[[Page 52259]]
trading these securities, and thus enhances investors' opportunities.
The Exchange, however, must maintain regulatory oversight over any
products listed under the generic listing standards through adequate
surveillance. ISE represents that its surveillance procedures are
sufficient to detect fraudulent trading among members in the trading of
narrow-based index options pursuant to the generic listing and
maintenance standards. The Commission believes that these surveillance
procedures are adequate to address concerns associated with listing and
trading of the narrow-based index options.
The Commission believes that the listing and maintenance standards
set forth herein are consistent with the listing and maintenance
standards for narrow-based index options that the Amex, CBOE, PCX and
the Phlx have developed and are reasonably designed to ensure the
protection of investors and the public interest. Specifically, the
Commission finds that the generic standards covering minimum
capitalization, monthly trading volume, and relative weightings of
component stocks are designed to ensure that the trading markets for
component stocks are adequately capitalized and sufficiently liquid,
and that no one stock or stock group dominates the index. Thus, the
Commission believes that the satisfaction of these requirements
significantly minimizes the potential for manipulation of the index.
Two other important requirements included in the proposal are that
at least 90 percent of the component securities, by weight, and 80
percent of the total number of component securities, must be eligible
individually for options trading, and that no more than 20 percent of
the weight of the index may be comprised of ADRs that are not subject
to a comprehensive surveillance sharing agreement. The Commission
believes that these standards are necessary to ensure that index
options are not used as surrogate instruments to trade options on
stocks and/or ADRs that otherwise are not eligible for options trading.
The Commission also believes that the number of securities required
to constitute the narrow-based index is large enough to ensure that an
index is not created for the purpose of obtaining more favorable
regulatory treatment, e.g., with respect to position and exercise
limits, as compared with the trading of options in the underlying
stocks.
The Commission also finds the requirements that all securities
comprising the index be ``reported securities,'' as defined in Rule
11Aa3-1 under the Act,\24\ and that the index value be disseminated at
least once every 15 seconds during trading hours of the index, will
contribute significantly to the transparency of the market for such
index options. The Commission further believes that basing the
settlement value of expiring index options upon the opening prices of
the component securities on the primary market on which they are listed
and traded may help contain the volatility of related markets upon
their expiration.
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\24\ 17 CFR 240.11Aa3-1.
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The Commission further notes that ISE's rules that are applicable
to narrow-based index options, including provisions addressing sales
practices, floor trading procedures, position and exercise limits,
margin requirements, and trading halts and suspensions, will continue
to apply to any narrow-based index listed pursuant Rule 19b-4(e) under
the Act.
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. The Commission believes that 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. When a new derivative securities product based upon
domestic securities is listed and traded on an exchange pursuant to
Rule 19b-4(e) under the Act, the exchange should determine that the
markets upon which all of the U.S. component securities trade are
members of the Intermarket Surveillance Group (``ISG''),\25\ which
provides information relevant to the surveillance of the trading of
securities on other market centers.\26\ In this regard, all of the
registered national securities exchanges, including the ISE, as well as
the National Association of Securities Dealers, Inc. (``NASD''), are
members of the ISG.
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\25\ 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.
\26\ See Securities Exchange Act Release No. 40761 (December 8,
1998), 63 FR 70952 (December 22, 1998) (File No. S7-13-98).
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For new derivative securities products based on securities from a
foreign market, the SRO should have a comprehensive Intermarket
Surveillance Agreement with the market for the securities underlying
the new securities product.\27\ Accordingly, the Commission finds that
the requirement that no more than 20 percent of the weight of the index
may be comprised of ADRs that are not subject to a comprehensive
surveillance sharing agreement between the particular U.S. exchange and
the primary market of the underlying security will continue to ensure
that the Exchanges have the ability to adequately surveil trading in
the narrow-based index options and the ADR components of the index.
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\27\ Id.
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IV. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\28\ that the proposed rule change, as amended, (File No. SR-ISE-
2003-05) be, and it hereby is approved.
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\28\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-22236 Filed 8-29-03; 8:45 am]
BILLING CODE 8010-01-P