[Federal Register Volume 59, Number 34 (Friday, February 18, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-3701] [[Page Unknown]] [Federal Register: February 18, 1994] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-33610; File No. SR-Phlx-93-37] Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating to the Exercise Cut-Off Procedure for Equity Options Contracts February 9, 1994. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December 20, 1993, the Philadelphia Stock Exchange, Inc. (``Phlx'' 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 Phlx. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change The Phlx, pursuant to Rule 196-4 of the Act, proposes to amend Phlx Rule 1042 (Exercise of Option Contracts) by incorporating a new exercise cut-off procedure. Specifically, the Exchange proposes to require that an option holder's final exercise decision (i.e., whether or not to exercise an expiring equity option)\1\ be indicated to the Exchange by either submitting a Contrary Exercise Advice (``Advice'') form (to a designated place at the Exchange or to the Options Clearing Corporation (``OCC'') pursuant to OCC procedures) or by choosing to rely on OCC's exercise-by-exception procedure, which automatically makes an exercise determination for applicable option holders.\2\ The deadline for the submission of a final exercise decision would remain at 5:30 p.m. Eastern Standard Time on the business day immediately preceding the expiration date (``exercise cut-off time''). --------------------------------------------------------------------------- \1\The term ``final exercise decision'' would generally replace the term ``exercise instructions'' in the amended rule. \2\Specifically, exercise-by-exception is the system which allows OCC clearing members to exercise in-the-money options at expiration which are at or above the predetermined threshold without submitting input entries into OCC. See OCC Rule 805. --------------------------------------------------------------------------- To implement this new procedure, proposed Rule 1042(b) would require members and member organizations to take steps to ensure that final exercise decisions respecting their proprietary positions, and the positions of members and non-members for whom the responsibility to make such indications has been accepted by them, are properly indicated to the Exchange. In addition, to allow time for processing, each member organization would be required to establish a deadline prior to the exercise cut-off time after which it will no longer accept final exercise decisions in expiring equity options from customers. Rule 1042(b) will continue to provide the following exceptions to the exercise cut-off procedure: (i) To remedy mistakes made in good faith; (ii) to respond to a failure to reconcile an unmatched Exchange option transaction; and (iii) where exceptional circumstances restricted either a customer's ability to inform the respective member organization or a member organization's ability to receive final exercise decisions before the exercise cut-off time.\3\ The current exception respecting foreign currency options is proposed to be deleted and replaced with Commentary .03 to Rule 1042, which provides that Rule 1042(b) does not apply to foreign currency options or index options. In this regard, the following new title to Rule 1042 is proposed: ``Exercise of Equity Option Contracts.'' --------------------------------------------------------------------------- \3\Under the current rule, only a customer's ability to send and a member's ability to receive final exercise decisions could serve as an exception. Because a customer can submit exercise decisions to a member organization who in turn submits them to OCC, that member organization's ability to receive the customer's decision can also qualify as an exemption under the rule. Under the proposal, a member's ability to send decisions could also qualify as an exception. --------------------------------------------------------------------------- In addition, Rule 1042 as amended would require that a memorandum setting forth the circumstances surrounding the exercise be prepared and a copy filed with the Exchange's Market Surveillance Department in any instance of an equity option exercise not submitted ``automatically'' through OCC's exercise-by-exception procedure, and for which a Contrary Exercise Advice was either not timely submitted or amended after the exercise cut-off time. Each such memorandum must reflect the time the final exercise decision was made, or in the case of a customer, the time the final exercise decision was received, and must be kept in accordance with SEC Rules 17a-3(a)(6) and 17a-4. Under the proposal, all of the exceptions listed in Rule 1042(b) would require a written memorandum setting forth the circumstances giving rise to the exception.\4\ --------------------------------------------------------------------------- \4\Rule 1042 currently only requires a memorandum with respect to the first and third exception to the Rule. See Rule 1042, Commentary .02. --------------------------------------------------------------------------- Pursuant to the proposed rule change, the burden of establishing an exception would rest solely on the member or member organization seeking to rely on one of the exemptive provisions. Current procedure requires clearing organizations to record the receipt of exercise decisions in connection with the exercise cut-off rule. The proposed procedure would allow members to either submit Contrary Exercise Advices directly to the Exchange or to the firm responsible for processing such Advices on their behalf. Thus, since members would have the ability to submit Advices directly to the Exchange, it is the member (and not necessarily the clearing agent) who must establish that an exception relied upon by that member is consistent with the rule. To address possible instances where no Advice is submitted while an exercise notice is nonetheless tendered for a strike price outside the exercise-by-exception parameters and where none of the exceptions apply, Commentary .02 specifies that such exercises would be deemed conduct inconsistent with just and equitable principles of trade if effected on the basis of material information obtained after the exercise cut-off time. The Exchange notes that the exercise cut-off time as well as the actual exercise procedure remain unchanged, including the submission of exercise notices to OCC contained in Rule 1042(a), which would still be governed by OCC rules.\5\ In this regard, Commentary .01 as amended expressly states that the reporting of final exercise decisions pursuant to Rule 1042 does not serve to substitute as the effective ``exercise notice'' to OCC regarding the exercise or non-exercise of expiring equity options. A technical amendment changing several references in Rule 1042(a) to read ``OCC'' is also proposed herein. --------------------------------------------------------------------------- \5\See generally OCC rules and Phlx Rules 1002, 1004, and 1005. --------------------------------------------------------------------------- The text of the proposed rule change is available at the Office of the Secretary, the Phlx, and at the Commission. 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 Phlx 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 the Statutory Basis for, the Proposed Rule Change Phlx Rule 1042 governs the exercise of option contracts traded on the Exchange. Specifically, Rule 1042(a) refers to OCC rules and procedures regarding the actual exercise of option contracts as well as the submission of exercise notices to OCC for trade dates prior to the last day of business prior to expiration. Rule 1042(b) concerns the exercise cut-off time and submission of exercise instructions to the Exchange for expiring options on the last day of trading in such options. At this time, the Phlx proposes to incorporate a new exercise cut-off procedure into Rule 1042, featuring the use of a Contrary Exercise Advice for the submission of final exercise decisions and the ability to submit such Advices directly to the Exchange. The Exchange represents that the purposes behind these amendments are to bolster the audit trail requirements of Rule 1042, to incorporate a more convenient process for members to indicate exercise intentions to the Exchange, and to further ensure that the exercise cut-off time efficiently provides a level playing field among market participants with respect to final exercise decisions. The new procedure would enable option holders to bypass the clearing firm when submitting a Contrary Exercise Advice directly to the Exchange. The Exchange will designate a place on the trading floor for the submission of these Advices, similar to the current procedure for the submission of index option exercise notices.\6\ In those instances where a member holding an expiring option submits an Advice directly to the Exchange, the responsibility for the timely and proper submission of such Advice shifts from the option holder's clearing agent to the option holder himself. For example, a Registered Option Trader's (``ROT'') clearing agent would not be held responsible for direct submissions by the ROT to the Exchange. --------------------------------------------------------------------------- \6\See Phlx Rule 1042A and Floor Procedure Advice G-1. --------------------------------------------------------------------------- Under the proposal, Exchange members would still be able to submit their final exercise decisions, on a Contrary Exercise Advice, to the respective clearing member. The clearing member would then be required to either submit the Advice directly to the Exchange at the designated place or to OCC pursuant to OCC procedures, and would be required to do so prior to the exercise cut-off time. Regardless of to whom the submission is made, the Exchange believes that the proposed changes would result in an efficient audit trail being generated for purposes of identifying late entries. The Exchange believes the proposal would constitute an important change in current procedures by enabling a self-regulatory organization (``SRO'') to confirm the timeliness of option exercise instruction submissions. The Exchange further believes that the proposed memorandum requirement of Rule 1042 should also bolster the Exchange's audit trail by requiring that a memorandum be prepared and filed with the Exchange's Market Surveillance Department detailing the circumstances surrounding any non-automatic exercise that was not submitted on a Contrary Exercise Advice in a timely manner. In addition, with respect to the exceptions to the exercise cut-off procedure, the Exchange believes that the proposed change expressly stating that the burden of establishing such an exception lies with the person seeking the exception should also improve the Exchange's ability to surveil for violations of the procedure. The Exchange believes that the proposed changes to the exercise cut-off procedure for expiring equity options reflect a coordinated effort among the options exchanges and OCC. Accordingly, because the Phlx expects similar proposed rule changes to be filed with the Commission in the near future,7 uniformity among options exchanges should help option holders and other members adjust to the new procedure and incorporate the changes into their respective procedures. In this regard, the Exchange will recognize Contrary Exercise Advices submitted to other national options exchanges for any option listed both on the Phlx and that other exchange. --------------------------------------------------------------------------- \7\See, e.g., File No. SR-Amex-94-01. --------------------------------------------------------------------------- The Exchange believes that the proposed rule change is consistent with section 6 of the Act in general, and with section 6(b)(5), in particular, in that it is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, and to protect investors and the public interest. Specifically, the Exchange believes that consistent with section 6(b)(5) of the Act, the proposed change to Rule 1042 should improve the Exchange's ability to surveil for violations of the exercise cut-off time because the submission of Contrary Exercise Advices directly to the Exchange as well to OCC should provide an accurate audit trail to identify late entries. In addition, the Exchange believes that the proposed procedure should reduce the onus on clearing firms of collecting exercise instructions, because the new procedure will enable option holders to bypass the clearing firm by submitting a Contrary Exercise Advice directly to the Exchange. In summary, the Exchange believes that Phlx investigations into late entries of exercise decisions should ensure compliance with Rule 1042, and, accordingly, promote just and equitable principles of trade. (B) Self-Regulatory Organization's Statement on Burden on Competition The Phlx does not believe that the proposed rule change 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 self-regulatory organization 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. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 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 in the Commission's Public Reference Section, 450 Fifth Street, NW., Washington, DC. Copies of such filing will also be available for inspection and copying at the principal office of the Phlx. All submissions should refer to File No. SR-Phlx-93-37 and should be submitted March 11, 1994. For the Commission, by the Division of market Regulation, pursuant to delegated authority.8 --------------------------------------------------------------------------- \8\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-3701 Filed 2-17-94; 8:45 am] BILLING CODE 8010-01-M