[Federal Register Volume 59, Number 177 (Wednesday, September 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-22731]
[[Page Unknown]]
[Federal Register: September 14, 1994]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-3647; International Series Release No. 712; File No.
SR-PSE-94-15]
Self-Regulatory Organizations; Order Approving and Notice of
Filing and Order Granting Accelerated Approval of Amendment No. 3 to a
Proposed Rule Change by the Pacific Stock Exchange, Inc., Relating to
the Listing of Options and Long-Term Options on the Telegraph Ltd.
Israel Index
September 8, 1994.
I. Introduction
On June 13, 1994, the Pacific Stock Exchange, Inc. (``PSE'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for the listing and
trading of index options on the Telegraph Ltd. Israel Index (``Israel
Index'' or ``Index'').\3\ The Exchange filed Amendment No. 1 to the
proposed rule change on June 27, 1994, and Amendment No. 2 on June 28,
1994.\4\ Notice of the proposal and of Amendment Nos. 1 and 2 appeared
in the Federal Register on July 26, 1994.\5\ On September 6, 1994, the
Exchange filed Amendment No. 3 to the proposed rule change.\6\ No
comment letters were received on the proposed rule change. This order
approves the Exchange's proposal, as amended.
---------------------------------------------------------------------------
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\The name of the Index, as originally proposed, was the ``PSE
Israel Index.'' See Amendment No. 3, infra note 6.
\4\In Amendment No. 1, the Exchange proposed to: (1) reconfigure
the Index so that it is initially composed of 12 components; (2)
provide that the Index will be equal dollar-weighted instead of
capitalization-weighted, as originally proposed; and (3) provide
that any security added to the Index must be a security that is
traded in the United States either on a securities exchange or as a
National Market security traded through Nasdaq. See Letter from
Michael Pierson, Senior Attorney, PSE, to Brad Ritter, Attorney,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated June 24, 1994. In
Amendment No. 2, the PSE proposed: (1) to maintain the Index so that
at least 85% of the Index, by weight, and at least 80% of the number
of components of the Index are eligible for standardized options
trading pursuant to PSE Rule 3.6; (2) to clarify that any
replacement securities will be securities representing Israeli
companies; and (3) to consider the market capitalization, liquidity,
volatility, and name recognition of proposed replacement securities
for the Index. See Letter from Michael Pierson, Senior Attorney,
PSE, to Brad Ritter, Attorney, OMS, Division, Commission, dated June
28, 1994.
\5\See Securities Exchange Act Release No. 34410 (July 20,
1994), 59 FR 38007 (July 26, 1994).
\6\In Amendment No. 3, the PSE proposes to: (1) change the name
of the Index to the ``Telegraph Ltd. Israel Index;'' (2) clarify
that all present and future components of the Index will be subject
to last sale reporting pursuant to Rule 11Aa3-1 of the Act; (3)
provide that the Index will be initialized at a level of 150 as of
the close of trading on May 31, 1994, rather than at 200 as
originally proposed; and (4) change the Index cycle from the January
cycle to the March cycle. See Letter from Michael Pierson, Senior
Attorney, Market Regulation, PSE, to Brad Ritter, Attorney, Office
of Market Supervision, Division of Market Regulation, Commission,
dated September 6, 1994 (``Amendment No. 3'').
---------------------------------------------------------------------------
II. Description of Proposal
A. General
The PSE proposes to list for trading options on the Israel Index, a
new securities index developed by the PSE and based on Israeli stocks
and ADRs\7\ that are traded on the American Stock Exchange (``Amex''),
the New York Stock Exchange (``NYSE''), or are National Market (``NM'')
securities traded through Nasdaq. The PSE also proposes to list long-
term options on the full-value Index (``Israel LEAPS'' or ``Index
LEAPS'').\8\ Israel LEAPS will trade independent of and in addition to
regular Israel Index options traded on the Exchange,\9\ however, as
discussed below, position and exercise limits of Index LEAPS and
regular Index options will be aggregated.
---------------------------------------------------------------------------
\7\An ADR is a negotiable receipt which is issued by a
depositary, generally a bank, representing shares of a foreign
issuer that have been deposited and are held, on behalf of holders
of the ADRs, at a custodian bank in the foreign issuer's home
country. See discussion of standards for ADR components, infra notes
10 and 27.
\8\LEAPS are long-term index option series that expire from
twelve to thirty-six months from their date of issuance. See PSE
Rule 6.4(d).
\9\According to the PSE, the Israel Index represents a segment
of the U.S. equity market that is not currently represented in the
derivative markets and, as such, the PSE concludes, should offer
investors a low-cost means of achieving diversification of their
portfolios toward or away from Israeli securities. The PSE believes
the Index will provide retail and institutional investors with a
means of benefitting from their forecasts of the performance of
Israeli securities. Options on the Index also can be utilized by
portfolio managers and investors as a means of hedging the risks of
investing in Israeli securities.
---------------------------------------------------------------------------
B. Composition of the Index
The Index was designed by the Exchange and is presently based on
securities representing 12 Israeli companies that the Exchange believes
are representative of the Israeli economy, all of which trade in the
U.S. as either stocks or ADRs. Ten of these securities currently trade
through Nasdaq as NM securities, one trades on the NYSE, and one trades
on the Amex. The Index is equal dollar-weighted and will be calculated
on a real-time basis using last sale prices.
As of May 31, 1994, the market capitalizations of the individual
securities in the Index ranged from a high of $1.22 billion to a low of
$59.03 million, with an average capitalization of $386 million. The
market capitalization of all the securities in the Index was $4.63
billion. The total number of shares outstanding for the securities in
the Index ranged from a high of 60.74 million shares to a low of 9.37
million shares. The average monthly trading volume in the U.S. of the
securities in the Index, for the six-month period between December 1,
1993, and May 31, 1994, ranged from a high of 9.98 million shares per
month to a low of 726,667 shares per month. Lastly, because the Index
is equal dollar-weighted, each component accounts for 8.33% of the
Index's total value and thus, no five components accounted for more
than 41.65% of the total weight of the Index.
C. Maintenance
The Index will be maintained by the PSE. The PSE may change the
composition of the Index at any time, subject to compliance with the
maintenance criteria discussed herein, to reflect the conditions in the
market for Israeli securities. If it becomes necessary to replace an
Index component, the Exchange represents that it will only add new
Israeli component securities that are traded in the U.S. securities
markets and will take into account a security's capitalization,
liquidity, volatility, and name recognition of the proposed
replacement. Further, Index components may be replaced in the event of
certain corporate events, such as takeovers or mergers, that change the
nature of the security. If, however, the Exchange determines to
increase the number of Index component securities to greater than 16 or
reduce the number of Index component securities to fewer than nine, the
proposal provides that the PSE will submit a rule filing with the
Commission pursuant to Section 19(b) of the Act. In addition, in
choosing replacement securities for the Index, the PSE will be required
to ensure that at least 85% of the weight of the Index and at least 80%
of the number of components continues to be made up of securities that
are eligible for standardized options trading.\10\ Finally, the PSE
will be required to ensure that each component of the Index is subject
to last sale reporting pursuant to Rule 11Aa3-1 of the Act.\11\
---------------------------------------------------------------------------
\10\The PSE's options listing standards, which are uniform among
the options exchanges, provide that a security underlying an option
must, among other things, meet the following requirements: (1) the
public float must be at least 7,000,000 shares; (2) there must be a
minimum of 2,000 stockholders; (3) trading volume in the U.S. must
have been at least 2.4 million over the preceding twelve months; and
(4) the U.S. market price must have been at least $7.50 for a
majority of the business days during the preceding three calendar
months. See PSE Rule 3.6. With respect to ADRs, in addition to the
above standards: (1) the Exchange must have in place a comprehensive
surveillance agreement with the primary exchange in the home country
where the security underlying the ADR is traded; or (2) the trading
volume for the three month period preceding the date of listing in
the U.S. markets for ADRs overlying any class of the foreign
issuer's common stock (on a share-equivalent basis) is at least 50%
of the sum of the (i) combined world-wide trading volume for all
classes of the foreign issuer's common stock, and (ii) combined
trading volume for all ADRs overlying any of these classes of stock;
or (3) the SEC must otherwise authorize the listing. In addition,
the percentage of the world-wide trading volume for the security
underlying an ADR that occurs in the U.S. ADR market must meet a
maintenance standard of 30% or more in order for options on that
particular ADR to continue to be traded.
\11\See Amendment No. 3, supra note 6.
---------------------------------------------------------------------------
D. Applicability of PSE Rules Regarding Index Options
Except as modified by this order, PSE Rules 6 and 7 will be
applicable to Israel Index options and Index LEAPS. Those rules
address, among other things, the applicable position and exercise
limits, policies regarding trading halts and suspensions, and margin
treatment for narrow-based index options.
E. Calculation of the Index
The Israel Index is an equal dollar-weighted index and reflects
changes in the prices of the Index component securities relative to the
Index's base date of May 31, 1994.
The Index will be calculated using an ``equal dollar-weighting''
methodology designed to ensure that each of the component securities
are represented in approximately ``equal'' dollar amounts in the Index.
In calculating the initial ``equal dollar-weighting'' of component
securities, the PSE, using closing prices on May 31, 1994, calculated
the number of shares that would represent an investment of $83,333 in
each of the securities contained in the Index (to the nearest whole
share). The value of the Index equals the current market value (i.e.,
based on U.S. primary market prices) of the assigned number of shares
of each of the securities in the Index portfolio divided by the current
Index divisor. The Index divisor was initially calculated to yield a
benchmark value of 150 at the close of trading on May 31, 1994.\12\
Each quarter thereafter, following the close of trading on the third
Friday of January, April, July and October, the Index portfolio is
adjusted by changing the number of shares of each component security so
that each company is again represented in $83,333 ``equal'' dollar
amounts. If necessary, a divisor adjustment is made to ensure
continuity of the Index's value. The newly adjusted portfolio becomes
the basis for the Index's value on the first trading day following the
quarterly adjustment.
---------------------------------------------------------------------------
\12\Id.
---------------------------------------------------------------------------
The Exchange does not believe that there will be investor confusion
regarding the adjustments because they will be done on a regular and
timely basis, with adequate advance notice given. An information
circular will be distributed to all Exchange members notifying them of
the quarterly changes. This circular will also be sent by facsimile to
the Exchange's contacts at the major options firms, mailed to
recipients of the Exchange's options-related information circulars, and
made available to subscribers of the Options News Network. In addition,
the Exchange will include in its promotional and marketing materials
for the Index a description of the equal dollar-weighting methodology.
The number of shares of each component security in the Index
portfolio will remain fixed between quarterly reviews except in the
event of certain types of corporate actions, such as the payment of a
dividend, other than an ordinary cash dividend, stock distributions,
stock splits, reverse stock splits, rights offerings, or a
distribution, reorganization, recapitalization, or some such similar
event with respect to an Index component security. The number of shares
will also be adjusted in the event of a merger, consolidation,
dissolution or liquidation of an issuer of a component security. When
the Index is adjusted between quarterly reviews, the number of shares
of the relevant security in the portfolio will be adjusted, to the
nearest whole share, to maintain the component's relative weight in the
Index at the level immediately prior to the corporate action. In the
event of a component security replacement, the average dollar value of
the remaining portfolio components will be calculated and that amount
invested in the new component security to the nearest whole share. In
both cases, the divisor will be adjusted, if necessary, to ensure Index
continuity.
The Index value for purposes of settling outstanding regular Index
options and Index LEAPS contracts upon expiration will be calculated
based upon the regular way opening sale prices for each of the Index's
component securities in their primary market on the last trading day
prior to expiration. In the case of securities traded through Nasdaq,
the first reported sale price will be used. Once all of the component
securities have opened, the value of the Index will be determined and
that value will be used as the final settlement value for expiring
Index options contracts. If any of the component securities do not open
for trading on the last trading day before expiration, then the prior
trading day's (i.e., normally Thursday's) last sale price will be used
in the Index calculation. In this regard, before deciding to use
Thursday's closing value of a component security for purposes of
determining the settlement value of the Index, the PSE will wait until
the end of the trading day on expiration Friday.
F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\13\ Standard options trading hours (9:30 a.m. to 4:15
p.m. Eastern Standard time) will apply to the contracts. The Index
multiplier will be 100. The strike price interval will be $2.50 for
Index options with a duration of one year or less to expiration. If,
however, the value of the Index rises to 200 or greater, the Exchange
will use strike prices at $5.00 intervals. In addition, pursuant to PSE
Rule 6.4, there may be up to six expiration months outstanding at any
given time. Specifically, there may be up to three expiration months
from the March, June, September, and December cycle\14\ plus up to
three additional near-term months so that the two nearest term months
will always be available.
---------------------------------------------------------------------------
\13\A European-style option can be exercised only during a
specified period before the option expires.
\14\See Amendment No. 3, supra note 6.
---------------------------------------------------------------------------
Furthermore, the options on the Index will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). Accordingly, since options on the Index will settle based
upon opening prices of the component securities on the last trading day
before expiration (normally a Friday), the last trading day for an
expiring Index option series will normally be the second to the last
business day before expiration (normally a Thursday).
Finally, the proposal also provides that the Exchange may list
long-term Index options that expire from 12 to 36 months from listing
based on the full-value Israeli Index. Exchange rules regarding strike
price intervals bid/ask differentials, and continuity shall not apply
to such series until the time to expiration is less than 12 months.\15\
---------------------------------------------------------------------------
\15\See PSE Rule 6.4(d).
---------------------------------------------------------------------------
G. Position and Exercise Limits, Margin Requirements, and Trading Halts
Exchange rules that are applicable to the trading of options on
narrow-based indexes will apply to the trading of Israel Index options
and Israel Index LEAPS. Specifically, Exchange rules governing margin
requirements,\16\ position and exercise limits,\17\ and trading halt
procedures\18\ that are applicable to the trading of narrow-based index
options will apply to options traded on the Index.
---------------------------------------------------------------------------
\16\Pursuant to PSE Rule 7.16, the margin requirements for the
Index options will be: (1) for short options positions, 100% of the
current market value of the options contract plus 20% of the
underlying aggregate Index value, less any out-of-the-money amount,
with a minimum requirement of the options premium plus 10% of the
underlying Index value; and (2) for long options positions, 100% of
the options premium paid.
\17\Pursuant to PSE Rules 7.6 and 7.7, respectively, the
position and exercise limits for the Index options will be 7,500
contracts, unless the Exchange determines, pursuant to Rules 7.6 and
7.7, that a lower limit is warranted.
\18\Pursuant to PSE Rule 7.11, the trading on the PSE of Index
options may be halted or suspended whenever trading in underlying
securities whose weighted value represents more than 20% of the
Index value are halted or suspended.
---------------------------------------------------------------------------
H. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in regular Index options and in Index LEAPS. These procedures
include complete access to trading activity in the underlying
securities. Further, the Intermarket Surveillance Group Agreement,
dated July 14, 1983, as amended on January 29, 1990, will be applicable
to the trading of options on the Index.\19\
---------------------------------------------------------------------------
\19\The Intermarket Surveillance Group (``ISG'') was formed on
July 14, 1983 to, among other things, coordinate more effectively
surveillance and investigative information sharing arrangements in
the stock and options markets. See Intermarket Surveillance Group
Agreement, July 14, 1983. The most recent amendment to the ISG
Agreement, which incorporates the original agreement and all
amendments made thereafter, was signed by ISG members on January 29,
1990. See Second Amendment to the Intermarket Surveillance Group
Agreement, January 29, 1990. The members of the ISG are: the Amex;
the Boston Stock Exchange, Inc.; the Chicago Board Options Exchange,
Inc.; the Chicago Stock Exchange, Inc.; the National Association of
Securities Dealers, Inc. (``NASD''); the NYSE; the PSI; and the
Philadelphia Stock Exchange, Inc. Because of potential opportunities
for trading abuses involving stock index futures, stock options, and
the underlying stock and the need for greater sharing of
surveillance information for these potential intermarket trading
abuses, the major stock index futures exchanges (e.g., the Chicago
Mercantile Exchange and the Chicago Board of Trade) joined the ISG
as affiliate members in 1990
---------------------------------------------------------------------------
III. Findings and Conclusions
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5).\20\ Specifically, the
Commission finds that the trading of Israeli Index options, including
Index LEAPS, will serve to promote the public interest and help to
remove impediments to a free and open securities market by providing
investors with a means of hedging exposure to market risk associated
with Israeli securities.\21\
---------------------------------------------------------------------------
\20\15 U.S.C. 78f(b)(5) (1988).
\21\Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument is in the public
interest. Such a finding would be difficult for a derivative
instrument that served no hedging or other economic function,
because any benefits that might be derived by market participants
likely would be outweighed by the potential for manipulation,
diminished public confidence in the integrity of the markets, and
other valid regulatory concerns. In this regard, the trading of
listed Index options and Index LEAPS will provide investors with a
hedging vehicle that should reflect the overall movement of Israeli
securities in the U.S. securities markets.
---------------------------------------------------------------------------
The trading of options on the Israel Index, including Index LEAPS,
however, raises several concerns, namely issues related to index
design, customer protection, surveillance, and market impact. The
Commission believes, for the reasons discussed below, that the PSE
adequately has addressed these concerns.
A. Index Design and Structure
The Commission finds that the Israeli Index is a narrow-based
index. The Israel Index is composed of only 12 securities, all of which
represent Israeli companies. Accordingly, in light of the limited
number of securities in the Index, the Commission believes it is proper
to classify the Israeli Index as narrow-based and apply PSE's rules
governing narrow-based index options to trading in the Index
options.\22\
---------------------------------------------------------------------------
\22\See supra notes 16 through 18, and accompanying text.
---------------------------------------------------------------------------
The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the Index's component securities
significantly minimize the potential for manipulation of the Index.
First, the overwhelming majority of the components that comprise the
Index are actively traded, with an average monthly trading volume for
the period from December 1, 1993 through May 31, 1994, ranging from a
high of 9.98 million shares per month to a low of 726,667 shares per
month. Secondly, the market capitalizations of the securities in the
Index are very large, ranging from a high of $1.22 billion to a low of
$59.03 million as of May 31, 1994, with an average capitalization of
$386 million. Third, although the Index is only composed of 12
component securities, no one particular security or group of securities
dominates the Index. Specifically, because the Index is equal dollar-
weighted, each component security accounts for only 8.33% of the total
weight of the Index. Fourth, at least 85% of the securities in the
Index, by weight, and at least 80% of the number of components of the
Index, must be eligible for standardized options trading. This proposed
maintenance requirement will ensure that the Index is substantially
comprised of options eligible securities. Fifth, if the PSE increases
the number of component securities to more than 16 or decreases that
number to less than nine, the PSE will be required to seek Commission
approval pursuant to Section 19(b)(2) of the Act before listing new
strike price or expiration month series of Israeli Index options and
Index LEAPS. This will help protect against material changes in the
composition and design of the Index that might adversely affect the
PSE's obligations to protect investors and to maintain fair and orderly
markets in Israeli Index options and Index LEAPS. Sixth, the PSE will
be required to ensure that each component of the Index is subject to
last sale reporting pursuant to Rule 11Aa3-1 of the Act.\23\ This will
further reduce the potential for manipulation of the value of the
Index. Finally, the Commission believes that the expense of attempting
to manipulate the value of the Israeli Index in any significant way
through trading in component stocks, ADRs, or securities underlying
ADRs (or options on those securities) coupled with, as discussed below,
existing mechanisms to monitor trading activity in those securities,
will help deter such illegal activity.
---------------------------------------------------------------------------
\23\See Amendment No. 3, supra note 6.
---------------------------------------------------------------------------
In addition, the Commission does not believe that the fact that the
Index is equal dollar-weighted instead of market-weighted or price-
weighted results in the Index being readily susceptible to
manipulation. Because the use of an equal dollar-weighting method could
give securities with relatively small floats or prices a greater weight
in the Index than if the Index were capitalization weighted or price
weighted, the Commission is concerned that this calculation method
could make the Index more readily susceptible to manipulation. The PSE,
however, has developed several composition and maintenance criteria for
the Index that the Commission believes will minimize the possibility
that the Index could be manipulated through trading in less actively
traded securities or securities with smaller prices or floats. First,
after each quarterly rebalancing, the PSE proposal requires that 85% of
the weighting of the Index and 80% of the number of components of the
Index be accounted for by securities that are eligible for standardized
options trading. The Commission believes that this requirement will
ensure that the Index will be almost entirely made up of securities
with large public floats that are actively traded, thus reducing the
likelihood that the Index could be manipulated by abusive trading in
the smaller securities contained in the Index. Secondly, the Commission
believes that the quarterly rebalancing of the Index will further serve
to reduce the susceptibility of the Index to manipulation. Through the
quarterly rebalancing, any ``overweight'' component security\24\ will
be brought back into line with the other securities, thus ensuring that
less capitalized securities do not become excessively weighted. Third,
because the Index is narrow-based, the applicable position and exercise
limits and margin requirements will further reduce the susceptibility
of the Index to manipulation. Lastly, the PSE will only add new
component securities to the Index that are representative of the
Israeli economy, are traded in the U.S., are subject to last sale
reporting pursuant to Rule 11Aa3-1 of the Act, and, as discussed above,
the PSE will take into account a security's capitalization, liquidity,
and volatility before adding the security to the Index.
---------------------------------------------------------------------------
\24\A security would be ``overweight'' if its weight in the
Index were greater than the average weight of all of the securities
in the Index. This would occur, for example, if the price of a
component security significantly increased relative to the other
securities in the Index during a particular quarter and prior to the
rebalancing.
---------------------------------------------------------------------------
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as Israeli Index options
(including Israel LEAPS), can commence on a national securities
exchange. The Commission notes that the trading of standardized
exchange-traded options occurs in an environment that is designed to
ensure, among other things, that: (1) The special risk of options are
disclosed to public customers; (2) only investors capable of evaluating
and bearing the risks of options trading are engaged in such trading;
and (3) special compliance procedures are applicable to options
accounts. Accordingly, because the Index options and Index LEAPS will
be subject to the same regulatory regime as the other standardized
options currently traded on the PSE, the Commission believes that
adequate safeguards are in place to ensure the protection of investors
in Israel Index options and Israel Index LEAPS.
The Commission also has some concern that the quarterly rebalancing
of the Index could result in investor confusion because the number of
shares of each component security in the Index could fluctuate each
quarter. Such fluctuation, among other things, could make it difficult
for investors to maintain any corresponding cash positions in the
securities underlying the Index. The Commission, however, does not
believe that the quarterly rebalancing will result in dramatic changes
in the weightings of the component securities. Moreover, the Commission
believes the benefits to be derived from using a quarterly rebalancing
will more than offset the potential confusion for investors.
Specifically, the Commission believes the quarterly rebalancing will
ensure that no security or group of securities will have a
disproportionate impact on the Index. Additionally, the Commission has
approved several indexes that use an equal dollar-weighting system and
has not been made aware of any problems with respect to investor
confusion arising from the use of this weighting method.\25\
---------------------------------------------------------------------------
\25\See, e.g., Securities Exchange Act Release Nos. 31245
(September 28, 1992), 57 FR 45844 (October 5, 1992) (options on the
Amex Biotechnology Index); and 33720 (March 7, 1994), 59 FR 11630
(March 11, 1994) (options on the Amex Natural Gas Index).
---------------------------------------------------------------------------
Finally, the PSE has developed procedures to ensure that investors
are adequately notified of any changes due to the quarterly rebalancing
of the Index. In particular, the PSE represents that it will send
informational circulars to its members notifying them of any changes to
the Index as a result of the quarterly rebalancing prior to the
implementation of those changes. In addition, the PSE has stated that
it will include a description of the equal dollar-weighting methodology
in all its promotional and marketing materials for the Index. The
Commission believes these procedures should help to avoid any investor
confusion, while providing important information about the special
characteristics of the Index.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a security index derivative
product and the exchange(s) trading the securities underlying the
derivative product is an important measure for surveillance of the
derivative and underlying securities markets. Such agreements ensure
the availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the security
index product less readily susceptible to manipulation.\26\ In this
regard, the PSE, NYSE, Amex, and NASD are all members of the ISG, which
provides for the exchange of all necessary surveillance
information.\27\ Further, as to present and future ADR components of
the Index,\28\ either the Exchange will have comprehensive surveillance
sharing agreements with the primary foreign markets for the securities
underlying the ADRs or the U.S. will be the relevant market for
surveillance purposes.\29\
---------------------------------------------------------------------------
\26\Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\27\See note 19, supra. If the prices of the ADR components, or
the composition of the Index, should change so that greater than 20%
of the weight of the Index would be represented by ADRs whose
underlying securities were not the subject of a comprehensive
surveillance sharing agreement with the CBOE, then it would be
difficult for the Commission to reach the conclusions reached in
this order and the Commission would have to determine whether it
would be suitable for the Exchange to continue to trade options on
this Index. The CBOE should, accordingly, notify the Commission
immediately if more than 20% of the numerical value of the Index is
represented by ADRs whose underlying securities are not subject to a
comprehensive surveillance sharing agreement. Such a change in the
current relative weights of the Index or in the composition of the
Index may warrant the submission of a rule filing pursuant to
Section 19 of the Act. In determining whether a particular ADR is
subject to a comprehensive surveillance sharing agreement see, e.g.,
Securities Exchange Act Release Nos. 31531 (November 27, 1992), 57
FR 57250 (December 3, 1992); and 33554 (January 31, 1994), 59 FR
5622 (February 7, 1994).
\28\Presently, Teva Pharmaceuticals is the only ADR component of
the Index.
\29\See Securities Exchange Act Release Nos. 31530 (November 27,
1992) 57 FR 57262 (December 3, 1992); and 33551 (January 31, 1994),
59 FR 5631 (February 7, 1994).
---------------------------------------------------------------------------
D. Market Impact
The Commission believes that the listing and trading of Israel
Index options, including Index LEAPS, on the PSE will not adversely
impact the underlying securities markets.\30\ First, as described
above, for the most part, no one security or group of securities
dominates the Index. Second, because at least 85 of the numerical value
of the Index and at least 80% of the components of the Index must be
accounted for by securities that meet the Exchange's options listing
standards, and because each of the component securities must be subject
to last sale reporting pursuant to Rule 11Aa3-1 of the Act, the
component securities generally will be actively-traded, highly-
capitalized securities. Third, the 7,500 contract position and exercise
limits applicable to Index options and Index LEAPS will serve to
minimize potential manipulation and market impact concerns.
---------------------------------------------------------------------------
\30\In addition, the PSE has represented that the PSE and the
OPRA have the necessary systems capacity to support those new series
of index options that would result from the introduction of Index
options and Index LEAPS. See Letter from Michael Pierson, Senior
Attorney, Market Regulation, from Michael Pierson, Senior Attorney,
Market Regulation, PSE, to Brad Ritter, Attorney, OMS, Division,
Commission, dated August 10, 1994; and Memorandum from Joe Corrigan,
Executive Director, OPRA, to Kim Koppien, PSE, dated August 5, 1994.
---------------------------------------------------------------------------
Lastly, the Commission believes that settling expiring Israeli
Index options (including Index LEAPS) based on the opening prices of
component securities is consistent with the Act. As noted in other
contexts, valuing options for exercise settlement on expiration based
on opening prices rather than closing prices may help reduce adverse
effects on markets for securities underlying options on the Index.\31\
---------------------------------------------------------------------------
\31\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
---------------------------------------------------------------------------
The Commission finds good cause for approving Amendment No. 3 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register in
order to allow the Exchange to list without delay options on the Index.
Specifically, the Commission believes that the proposal changing the
name of the Index to the Telegraph Ltd. Israel Index, initializing the
value of the Index at a level of 150, and changing the Index cycle to
the March cycle, are non-substantive changes that will not alter the
terms of the Index options, as discussed herein, and will not cause
investor confusion because the changes are being made prior to the
beginning of dissemination of the Index value and prior to trading of
the Index options and Index LEAPS. Additionally, the clarification that
all components of the Index must be subject to last sale reporting
pursuant to Rule 11Aa3-1 of the Act should help to ensure that current
pricing information regarding the components of the Index will be
available, thereby minimizing any potential for manipulation of the
Index. Accordingly the Commission believes that good cause exists for
approving Amendment No. 3 to the proposed rule change on an accelerated
basis.
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 3. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. Sec. 552, will be available for inspection and
copying at the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the PSE. All
submissions should refer to the File Number SR-PSE-94-15 and should be
submitted by [insert date 21 days after the date of this publication].
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\32\ that the proposed rule change (SR-PSE-94-15), as amended, is
approved.
---------------------------------------------------------------------------
\32\15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\33\
---------------------------------------------------------------------------
\33\17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-22731 Filed 9-13-94; 8:45 am]
BILLING CODE 8010-01-M