[Federal Register Volume 60, Number 26 (Wednesday, February 8, 1995)]
[Notices]
[Pages 7607-7613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3037]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35303; International Series Release No. 778; File No.
SR-CBOE-94-19]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 2 to the Proposed Rule Change by the Chicago Board
Options Exchange, Inc., Relating to the Listing of Options and Long-
Term Options on the CBOE Emerging Markets Index and Long-Term Options
on a Reduced-Value CBOE Emerging Markets Index
January 31, 1995.
I. Introduction
On June 30, 1994, the Chicago Board Options Exchange, Inc.
(``CBOE'' 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 provide for the listing and
trading of index options on the CBOE Emerging Markets Index (``Emerging
Markets Index'' or ``Index''). The Exchange filed Amendment No. 1 to
the proposed rule change on August 18, 1994.\3\ Notice of the proposal,
as amended, appeared in the Federal Register on August 26, 1994.\4\ The
Exchange subsequently filed Amendment No. 2 to the proposed rule change
on January 26, 1995.\5\ 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 24.19b-4 (1992).
\3\In Amendment No. 1, the Exchange proposed to treat the Asian
Markets Index as a narrow-based index for purposes of margin,
position limits, and exercise limits. Pursuant to CBOE Rule 24.4A,
the position limits for the Index will initially be set at 10,500
contracts. See Letter from Eileen Smith, Director, Product
Development, Research Department, CBOE, to Brad Ritter, Senior
Counsel, Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated August 18, 1994.
\4\See Securities Exchange Act Release No. 34552 (August 19,
1994), 59 FR 44203 (August 26, 1994).
\5\In Amendment No. 2, the Exchange proposed: (1) to reduce the
number of components in the Index from 25 to 23; and (2) several
amendments, as discussed more fully herein, regarding the
maintenance criteria for the Index. See Letter from Joseph Levin,
Vice President, Research Department, CBOE, to Brad Ritter, Senior
Counsel, OMS, Division, Commission, dated January 26, 1995
(``Amendment No. 2'').
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II. Description of Proposal
A. General
The CBOE proposes to list for trading options on the Emerging
Markets Index, a new securities index developed by the
[[Page 7608]] CBOE. The Emerging Markets Index is composed of the
securities issued by 23 closed-end mutual funds\6\ that are traded on
the New York Stock Exchange (``NYSE'') and that invest in the stocks of
firms in emerging Asian (excluding Japan) and Latin American
economies.\7\ The CBOE also proposes to list either long-term options
on the full-value Index or long-term options on a reduced-value Index
that will be computed at one-tenth of the value of the Emerging Markets
Index (``Emerging Markets LEAPS'' or ``Index LEAPS'').\8\ Emerging
Markets LEAPS will trade independent of and in addition to regular
Index options traded on the Exchange,\9\ however, as discussed below,
for purposes of position and exercise limits, positions in Index LEAPS
and regular Index options will be aggregated.
\6\Id.
\7\The components of the Index are: the Latin America Discovery
Fund; Argentina Fund; Brazilian Equity Fund; Brazil Fund; Chile
Fund; Emerging Mexico Fund; Mexico Equity and Income Fund; Mexico
Fund; Asia Pacific Fund; Asia Tigers Fund Inc.; China Fund Inc.;
Greater China Fund Inc.; Jardine Fleming China Region Fund Inc.;
Morgan Stanley India Fund; Jakarta Growth Fund Inc.; Korea Fund
Inc.; Korea Equity Fund Inc.; Malaysia Fund Inc.; First Philippine
Fund Inc.; Singapore Fund Inc.; ROC Taiwan Fund; Taiwan Fund Inc.;
and Thai Fund Inc.
\8\LEAPS is an acronym for Long-Term Equity Anticipation
Securities. LEAPS are long-term index option series that expire from
12 to 36 months from their date of issuance. See CBOE Rule
24.9(b)(1). The Commission notes that the Exchange has submitted a
proposed rule change to allow the CBOE to list Index LEAPS that
expire up to 60 months from their date of issuance and to allow up
to 10 expiration months to be outstanding at any one time. See
Securities Exchange Act Release No. 35278 (January 25, 1995).
\9\According to the CBOE, the Emerging Markets Index represents
a segment of the U.S. equity market that is not currently
represented in the derivative markets and as such, the CBOE
concludes, should offer investors a low-cost means of achieving
diversification of their portfolios toward or away from emerging
Asian and Latin American market securities. The CBOE believes the
Index will provide retail and institutional investors with a means
of benefiting from their forecasts of the performance of emerging
Asian and Latin American market securities. The Exchange further
believes that options on the Index also can be utilized by portfolio
managers and investors as a means of hedging the risks of investing
in emerging Asian and Latin American market securities either
directly or through mutual funds that invest primarily in Asian and
Latin American market securities.
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B. Composition of the Index
The Index was designed by the Exchange and is based on the
securities issued by 23 closed-end mutual funds that invest in the
stocks of firms in emerging Asian (excluding Japan) and Latin American
economies. The shares of each of the closed-end funds contained in the
Index trade in the U.S. on the NYSE. The Index is price-weighted and
will be calculated on a real-time basis using last sale prices of the
shares of the closed-end funds comprising the Index.
As of the close of trading on January 4, 1995, the Index was valued
at 125.49. Also as of that date the market capitalizations of the
individual closed-end fund securities in the Index ranged from a high
of $824.31 million to a low of $46.36 million, with the mean and median
being $224 million and $155 million, respectively. The total market
capitalization of the securities in the Index on that date was $5.2
billion. The price per share of the closed-end fund securities
comprising the Index on January 4, 1995, ranged from a high of $45.88
to a low of $8.63, with an average price per share of $17.35.\10\
\10\See Amendment No. 2, supra note 5.
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The average daily trading volume of the shares of the closed-end
funds contained in the Index, for the period from July 1, 1994, through
December 31, 1994, ranged from a high of 284,048 shares per day to a
low of 9,984 shares per day. As of January 4, 1995, no single closed-
end fund security contained in the Index accounted for more than 11.50%
of the Index's total value and the percentage weighting of the five
largest issues in the Index accounted for 37.56% of the Index's value.
The percentage weighting of the lowest weighted securities issued by a
closed-end fund contained in the Index was 2.16% of the value of the
Index and the percentage weighting of the five smallest closed-end fund
securities contained in the Index accounted for 12.53% of the Index's
value.\11\ Based on the aggregate holdings of the mutual funds
represented in the Index, as disclosed in the most recent semiannual
reports of the component closed-end funds filed with the Commission
prior to August 16, 1994, the CBOE represents that securities from no
single country accounted for more than 15.18% (Mexico) nor less than
2.47% (China) of the weight of the Index. Based on the same semiannual
reports, by aggregating the holdings of the closed-end funds comprising
the Index, the CBOE represents that no single security held by one or
more of the component mutual funds accounted for more than 1.57% of the
weight of the Index.\12\ Finally, more than 14 emerging Asian and Latin
American countries are represented through the holdings of the
component funds comprising the Index.\13\
\11\Id.
\12\For example, three of the 23 component funds held shares of
Coteminas based on these semiannual reports. By aggregating the
positions of these three mutual funds, Coteminas accounted for 0.25%
of the weight of the Index. See Letter from Eileen Smith, Director,
Product Development, Research Department, CBOE, to Brad Ritter,
Senior Counsel, OMS, Division, Commission, dated August 16, 1994
(``August 16 Letter'').
\13\Id.
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C. Maintenance
The Index will be maintained by the CBOE. The CBOE may change the
composition of the Index at any time, subject to compliance with the
maintenance criteria discussed below, to reflect the conditions in the
emerging Asian (excluding Japan) and Latin American securities markets.
If it becomes necessary to replace the securities issues by a closed-
end fund contained in the Index, the Exchange represents that every
effort will be made to add only replacement securities issued by
closed-end mutual funds that preserve the character of the Index and
that are listed on either the American Stock Exchange (``Amex'') or the
NYSE, or that are Nasdaq National Market (``Nasdaq/NM'')
securities.\14\ In considering securities of closed-end mutual funds to
be added to the Index, the CBOE will take into account the
capitalization, liquidity, volatility, and name recognition of the
particular closed-end funds and the securities issued by those mutual
funds. Further, a closed-end fund represented in the Index may be
replaced in the event of certain events, such as a change in the
investment objectives of the mutual fund. The Exchange will most likely
maintain securities representing 23 closed-end funds in the Index.\15\
In addition, in choosing securities issued by closed-end funds as
replacements for or additions to the Index, the CBOE will not make a
composition change that would result in less than 75% of the weight of
the Index or 75% of the number of closed-end funds represented in the
Index satisfying the listing criteria for standardized options trading
set forth in CBOE Rule 5.3, Interpretation and Policy .01 (for mutual
fund securities that are not then the subject of standardized options
trading)\16\ and [[Page 7609]] CBOE Rule 5.4, Interpretation and Policy
.01 (for mutual fund securities that are then the subject of
standardized options trading).\17\ Additionally, at least twice each
year the CBOE will review the Index to ensure that not less than 75% of
the weight of the Index and 75% of the number of closed-end funds
represented in the Index continue to satisfy the criteria for
standardized options trading set forth in CBOE Rule 5.3, Interpretation
and Policy .01 (for mutual fund securities that are not then the
subject of standardized options trading) and CBOE Rule 5.4,
Interpretation and Policy .01 (for mutual fund securities that are then
the subject of standardized options trading).
\14\Additionally, the CBOE will be required to ensure that each
closed-end fund security comprising the Index is a ``reported
security'' as defined in Rule 11Aa3-1 of the Act. See Amendment No.
2, supra note 5.
\15\If the CBOE determines to increase the number of components
to greater than 30 or to decrease the number of components to less
than 16, the Exchange will be required to submit a rule filing
pursuant to Section 19(b) of the Act. Id.
\16\Id. The CBOE'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 CBOE Rule 5.3, Interpretation and Policy .01.
\17\See Amendment No. 2, supra note 5. The CBOE's options
maintenance 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 6,300,000 shares; (2) there must be a minimum of
1,600 stockholders; (3) trading volume in the U.S. must have been at
least 1.8 million over the preceding twelve months; and (4) the U.S.
market price must have been at least $5.00 for a majority of the
business days during the preceding six calendar months. See CBOE
Rule 5.3, Interpretation and Policy .01.
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Moreover, at least twice each year, based on the most recent
Commission filings by the closed-end funds represented in the Index,
the CBOE will review the holdings of each of the closed-end funds and
will promptly notify the Commission if it becomes aware that: (1) Any
security held by one or more mutual funds represented in the Index, in
aggregate, accounts for more than 5% of the weight of the Index; or (2)
securities from any one country held by one or more mutual funds
represented in the Index, in aggregate, account for more than 25% of
the weight of the Index.
Finally, the CBOE will promptly notify the Commission staff at any
time that the CBOE determines that the securities of a closed-end fund
contained in the Index account for more than 15% of the weight of the
Index if: (1) The shares of the mutual fund do not satisfy the listing
eligibility requirements in CBOE Rule 5.3, Interpretation and Policy
.01 (if the mutual fund does not then have standardized options trading
on its shares); or (2) the shares of the mutual fund do not satisfy the
maintenance eligibility requirements in CBOE Rule 5.4, Interpretation
and Policy .01 (if the mutual fund has standardized options trading on
its shares).\18\
\18\See Amendment No. 2, supra note 5.
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The CBOE will promptly notify the Commission staff at any time that
the CBOE determines that either the Index or the securities issued by
the closed-end funds comprising the Index fail to satisfy any of the
above maintenance criteria. Further, in such an event, the Exchange
will not open for trading any additional series of Index options or
Index LEAPS unless the Exchange determines that such failure is not
significant, and the Commission staff affirmative concurs in that
determination, or unless the Commission specifically approves the
continued listing of that class of Index options or Index LEAPS
pursuant to a proposal filed in accordance with Section 19(b)(2) of the
Act.\19\
\19\Id.
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D. Applicability of CBOE Rules Regarding Index Options
Except as modified by this order, the rules in Chapter XXIV of the
CBOE Rules will be applicable to Index options and full-value and
reduced-value Index LEAPS. In accordance with Chapter XXIV of CBOE's
rules, the Index will be treated as a narrow-based index for purposes
of applicable position and exercise limits, policies regarding trading
halts and suspensions, and margin treatment.\20\
\20\See infra Section II.H.
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E. Calculation of the Index
The CBOE Emerging Markets Index is a price-weighted index and
reflects changes in the prices of the closed-end mutual fund securities
comprising the Index relative to the Index's base date of December 31,
1991. Specifically, the Index value is calculated by adding the prices
of the mutual fund securities comprising the Index and then dividing
this summation by a divisor that is equal to the number of the closed-
end funds represented in the Index in order to obtain an average price.
To maintain the continuity of the Index, the divisor will be adjusted
to reflect non-market changes in the prices of the closed-end fund
securities comprising the Index as well as changes in the composition
of the Index. Changes that may result in divisor adjustments include,
but are not limited to, certain rights issuances.
The Index will be calculated continuously and will be disseminated
to the Options Price Reporting Authority (``OPRA'') every fifteen
seconds by the CBOE, based on the last-sale prices of the closed-end
fund securities comprising the Index.\21\ OPRA, in turn, will
disseminate the Index value to other financial vendors such as Reuters,
Telerate, and Quotron.
\21\For purposes of dissemination of the Index value, if the
shares of a mutual fund included in the Index have not opened for
trading, the CBOE will use the closing value of those shares on the
prior trading day when calculating the value of the Index, until the
shares of the mutual fund open for trading.
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The Index value for purposes of settling outstanding regular Index
options and full-value and reduced-value Index LEAPS contracts upon
expiration will be calculated based upon the regular way opening sale
prices for each of the closed-end fund securities comprising the Index
in their primary market on the last trading day prior to
expiration.\22\ In the event that a closed-end fund security traded as
a Nasdaq/NM security is added to the Index, the first reported sale
price for those shares will be used for determining a settlement value.
Once the shares of all of the mutual funds represented in the Index
have opened for trading, the value of the Index will be determined and
that value will be used as the final settlement value for expiring
Index options contracts, including full-value and reduced-value Index
LEAPS. If any of the closed-end fund securities contained in the Index
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 value calculation. In this regard, before
deciding to use Thursday's closing value for a closed-end fund security
contained in the Index for purposes of determining the settlement value
of the Index, the CBOE will wait until the end of the trading day on
Expiration Friday (as defined herein).
\22\As noted above, the current primary market for each of the
closed-end fund securities comprising the Index is the NYSE.
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F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\23\ Standard options trading hours (8:30 a.m. to 3:15
p.m.\24\ Central Standard time) will apply to the contracts. The Index
multiplier will be 100. The strike price interval will be $5.00 for
full-value Index options with a duration of one year or less to
expiration.\25\ In addition, pursuant to CBOE Rule 24.9, there may be
up to six expiration months outstanding at any [[Page 7610]] given
time. Specifically, there may be up to three expiration months from the
March, June, September, and December cycle plus up to three additional
near-term months so that the two nearest term months will always be
available. As described in more detail below, the Exchange also intends
to list several Index LEAPS series that expire from 12 to 36 months
from the date of issuance.\26\
\23\A European-style option can be exercised only during a
specified period before the option expires.
\24\Telephone conversation between Eileen Smith, Director,
Product Development, Research Department, CBOE, and Brad Ritter,
Senior Counsel, OMS, Division, Commission, on January 27, 1995.
\25\For a description of the strike price intervals for reduced-
value Index options and long-term Index options, see infra, Section
II.G.
\26\See supra note 8.
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Lastly, the options on the Index will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). Accordingly, because options on the Index will settle based
upon opening prices of the closed-end fund securities comprising the
Index on the last trading day before expiration (normally Expiration
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).
G. Listing of Long-Term Options on the Full-Value or Reduced-Value
Emerging Markets Index
The proposal proves that the Exchange may list long-term Index
options that expire from 12 to 36 months from listing based on the
full-value Index or a reduced-value Index that will be computed at one-
tenth of the full-value Emerging Markets Index.\27\ Existing Exchange
requirements applicable to full-value Index options will apply to full-
value and reduced-value Index LEAPS.\28\ The current and closing Index
value for reduced-value Emerging Markets LEAPS will be computed by
dividing the value of the full-value Index by 10 and rounding the
resulting figure to the nearest one-hundredth. For example, an Index
value of 125.46 would be 12.55 for the reduced-value Index LEAPS and an
Index value of 125.44 would be 12.54 for the reduced-value Index LEAPS.
The reduced-value Index LEAPS will also be European-style and will be
subject to the same rules that govern the trading of Index options,
including sales practice rules, margin requirements and floor trading
procedures. Pursuant to CBOE Rule 24.9, the strike price interval for
the reduced-value Index LEAPS will be no less than $2.50 instead of
$5.00.
\27\Id.
\28\See CBOE Rule 24.9(b).
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H. Position and Exercise Limits, Margin Requirements, and Trading Halts
Exchange rules governing margin requirements,\29\ position and
exercise limits,\30\ and trading halt procedures \31\ that are
applicable to the trading of narrow-based index options will apply to
options traded on the Index. The proposal further provides that, for
purposes of determining whether given positions in full-value and
reduced-value Index LEAPS comply with applicable position and exercise
limits, positions in full-value and reduced-value Index LEAPS will be
aggregated with positions in the regular Index options. For these
purposes, ten reduced-value contracts will equal one full-value
contract.
\29\Pursuant to CBOE Rule 24.11, 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.
\30\Pursuant to CBOE Rules 24.4A and 24.5, respectively, the
position and exercise limits for the Index options will be 10,500
contracts, unless the Exchange determines, pursuant to such rules,
that a lower limit is warranted.
\31\Pursuant to CBOE Rule 24.7, the trading on the CBOE of Index
options and Index LEAPS may be halted or suspended whenever trading
in underlying mutual fund shares whose weighted value represents
more than 20% of the Index value are halted or suspended.
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I. 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 full-value and reduced-value
Index LEAPS. These procedures include complete access to trading
activity in the shares of the mutual funds comprising the Index.
Further, the Intermarket Surveillance Group Agreement will be
applicable to the trading of options on the Index.\32\
\32\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 market. 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 CBOE; the Chicago Stock
Exchange, Inc.; the National Association of Securities Dealers, Inc.
(``NASD''); the NYSE; the Pacific Stock Exchange, Inc.; and the
Philadelphia Stock Exchange, Inc. Because of potential opportunities
for trading abuses involving stock index features, 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 features exchanges (e.g., the Chicago
Mercantile Exchange and the Chicago Board of Trade) joined the ISG
as affiliate members in 1990.
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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).\33\ Specifically, the
Commission finds that the trading of Emerging Markets Index options,
including full-value and reduced-value 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 emerging Asian and
Latin American market securities.\34\
\33\15 U.S.C. 78f(b)(5) (1988).
\34\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 full-value and reduced-value Index LEAPS will provide
investors with a hedging vehicle that should reflect the overall
movement of Asian and Latin American market securities, excluding
Japanese securities, represented through the holdings of closed-end
mutual funds traded in the U.S.
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The trading of options on the Emerging Markets Index, including
full-value and reduced-value Index LEAPS, however raises several issues
related to index design, customer protection, surveillance, and market
impact. The Commission believes, for the reasons discussed below, that
the CBOE has adequately addressed these issues.
A. Index Design and Structure
The Commission finds that it is appropriate to treat the Emerging
Markets Index as a narrow-based index under CBOE rules for purposes of
applicable position and exercise limits, trading halt and suspension
procedures, and margin treatment. Although the closed-end funds
represented in the Index, in aggregate, hold in excess of 270
individual Asian and Latin American market securities,\35\ the Emerging
Markets Index is composed of securities representing only 23 closed-end
mutual funds.\36\ Accordingly, in light of the number of closed-end
fund securities contained in the Index, the Commission believes it is
proper to treat the Emerging Markets Index as narrow-
[[Page 7611]] based for the regulatory purposes noted above.
\35\See August 16 Letter, supra note 12.
\36\The narrow-based Emerging Markets Index, which consists of
the same component mutual fund components as the Index and is
calculated by dividing the Index value by ten, is identical to the
Emerging Markets Index.
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The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the close-end fund securities
comprising the Index significantly minimizes the potential for
manipulation of the Index. First, the overwhelming majority of the
closed-end fund securities comprising the Index are actively traded,
with an average daily trading volume for all such mutual fund shares
for the period from July 1, 1994 through December 31, 1994, of
approximately 64,335 shares per day. Second, the market capitalizations
of the closed-end fund securities in the Index are large, ranging from
a high of $824.31 million to a low of $46.36 million as of January 4,
1995, with the mean and median being $224 million and $155 million,
respectively. Third, although the Index is composed of securities
representing only 23 closed-end mutual funds, no particular security or
group of closed-end fund securities dominates the Index. Specifically,
as of January 4, 1995, no closed-end fund security contained in the
Index accounted for more than 11.50% of the Index's total value and the
percentage weighting of the five largest closed-end fund securities in
the Index accounted for 37.56% of the Index's value.
Fourth, the proposed maintenance criteria will serve to ensure
that: (1) The Index remains comprised substantially of closed-end
mutual funds that are highly capitalized and that have liquid markets
for their issued securities; and (2) the Index is not dominated by any
one mutual security that does not satisfy the Exchange's options
listing criteria, any one security held by one or more of the mutual
funds represented in the Index, or securities from any one country held
by one or more of the mutual funds represented in the Index.
Specifically, in considering changes to the composition of the Index,
75% of the weight of the Index and 75% of the number of closed-end
mutual funds represented in the Index must comply with the listing
criteria for standardized options trading set forth in CBOE Rule 5.3,
Interpretation and Policy .01 (for mutual fund securities that are not
then the subject of standardized options trading) and CBOE Rule 5.4,
Interpretation and Policy .01 (for mutual fund securities that are then
the subject of standardized options trading).\37\ Additionally, the
CBOE is required to review the composition of the Index at least
semiannually to ensure that the Index continues to meet these ``75%''
requirements.
\37\Additionally, mutual fund securities contained in the Index
must be ``reported'' securities and must be traded on the Amex or
the NYSE or must be Nasdaq/NM securities. The CBOE is also limited
in the number of mutual funds that can be represented in the Index
without having to obtain Commission approval. See supra notes 14 and
15.
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Further, at least semiannually, based on the most recent Commission
filings by the closed-end funds represented in the Index, the CBOE will
review the holdings of each closed-end fund and will promptly notify
the Commission if: (1) Any security held by one or more of the closed-
end funds represented in the Index, in aggregate, accounts for more
than 5% of the weight of the Index; or (2) securities from any one
country held by one or more of the closed-end funds represented in the
Index, in aggregate, account for more than 25% of the weight of the
Index. Similarly, the CBOE will promptly notify the Commission staff at
any time that it determines that the shares of a closed-end fund
contained in the Index account for more than 15% of the weight of the
Index if the shares of the mutual fund do not satisfy the listing
eligibility requirements in CBOE's rules.\38\
\38\See supra notes 16 and 17.
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Finally, the CBOE will promptly notify the Commission staff at any
time that it determines that either the Index or the shares of one or
more of the closed-end funds comprising the Index fail to satisfy any
of the above maintenance criteria. In such an event, the Exchange will
not open for trading any additional series of Index options or LEAPS
unless the Exchange determines that such failure is not significant,
and the Commission staff affirmatively concurs in that determination,
or unless the Commission specifically approves the continued listing of
that class of Index options or Index LEAPS pursuant to a proposal filed
in accordance with Section 19(b)(2) of the Act.
For the above reasons, the Commission believes that these criteria
minimize the potential for manipulation of the Index and eliminate
domination concerns.
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 Emerging Markets Index
options, including full-value and reduced-value Emerging Markets LEAPS,
can commence on a national securities exchange. The Commission notes
that the trading of standardized exchange-trading options occurs in an
environment that is designed to ensure, among other things, that: (1)
the special risks 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 index options currently traded on the
CBOE, the Commission believes that adequate safeguards are in place to
ensure the protection of investors in Emerging Markets Index options
and full-value and reduced-value Emerging Markets Index LEAPS.
C. Surveillance
The Commission notes that predominantly because of the lack of
relevant market information sharing agreements, the shares of only one
of the closed-end funds contained in the Index (Asia Pacific Fund) are
eligible for standardized options trading.\39\
\39\Options on the securities by international funds are
eligible for standardized options trading where those securities
meet or exceed the Exchange's established uniform options listing
standards (see supra note 16) and (1) the Exchange has a market
information sharing agreement with the primary home exchange on
which each of the foreign securities comprising the fund's portfolio
trade, (2) the fund is classified as a diversified fund, as that
term is defined by Section 5(b) of the Investment Company Act, 15
U.S.C. Sec. 80a-5(b), and the fund's portfolio is composed of
securities from five or more countries, or (3) the listing of a
particular international fund option is specifically approved by the
Commission. See Securities Exchange Act Release No. 33068 (October
19, 1993), 58 FR 55093 (October 25, 1993) (``Country Fund Approval
Order'').
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The Commission believes, however, that based on the maintenance
criteria discussed above, the CBOE has addressed the concerns that the
Commission expressed in approving the listing of options on individual
country funds.\40\ These maintenance criteria, among other things,
ensure that the Index will not become a surrogate for trading options
on either the closed-end mutual funds represented in the Index or
individual Asian or Latin American market securities held by those
component mutual funds for which standardized options could not
otherwise be traded and minimize the potential for manipulation of the
value of the Index.\41\
\40\Id.
\41\See supra Section III.A.
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Second, in approving the listing of options on individual country
funds, the Commission determined that if a fund is ``diversified,'' as
defined in the Investment Advisers Act of 1940
[[Page 7612]] (``Advisers Act''),\42\ and holds securities from five or
more countries, a surveillance sharing agreement is not required
between the Exchange and the primary foreign markets for the securities
held by the closed-end fund. In that case, it was determined that the
portfolio of such a closed-end fund would be significantly diverse so
as to reduce the likelihood that the price of the securities issued by
the closed-end fund could be manipulated. Even though the shares of
only one of the closed-end funds contained in the Index is classified
as ``diversified,'' the Commission believes that by combining the
securities of these mutual funds together in the Index, the Index, as a
whole, replicates essentially a ``diversified'' fund. Specifically, the
Index consists of securities representing 23 closed-end mutual funds
with those mutual funds holding positions, in aggregate, in more than
270 different stocks from more than 14 emerging Asian and Latin
American markets.\43\ The Commission believes, therefore, that the
Index as a whole achieves the diversity of holdings that the Commission
found to be sufficient in the Country Fund Approval Order to minimize
the Commission's concerns about potential manipulation. As a result,
for the reasons stated herein and in the Country Fund Approval
Order,\44\ the Commission believes that the lack of market surveillance
sharing agreement does not raise substantial regulatory concerns.
\42\15 U.S.C. 80b-1 et seq. (1988).
\43\See August 16 Letter, supra note 12.
\44\See Country Fund Approval Order, supra note 39.
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Third, because the Index is composed solely of the securities
issued by closed-end mutual funds, the Commission's concerns regarding
potential manipulation of the Index are further reduced. As discussed
in the Country Fund Approval Order, in contrast to other foreign
securities products, international closed-end mutual funds hold
portfolios of securities chosen by portfolio managers.\45\ Although the
composition of the portfolio of each mutual fund represented in the
Index is published on a semiannual basis, the securities held by each
mutual fund represented in the Index can be changed at any time at the
discretion of the portfolio managers, as long as their investment
decisions are consistent with the stated investment objectives and
policies of the particular closed-end fund. For these reasons, the
Commission believes that it generally would be difficult for someone to
use options on the Index to attempt a manipulation of the market for
any particular security issued by a closed-end fund represented in the
Index or to attempt a manipulation of the Index through a manipulation
of the shares of the mutual funds comprising the Index.
\45\Id.
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The Commission notes that generally the only people who could
attempt such a manipulation would be people who have access to
``inside'' information about the composition of the portfolio of a
closed-end fund and the trading activities of the mutual fund's
portfolio manger. The Advisors Act, and the rules promulgated
thereunder, contain provisions designed to detect and deter certain
advisory employees and affiliates from trading in any securities based
on ``inside'' information about the investment decisions of a closed-
end fund. Rule 204-2(a)(12) under the Advisers Act requires an
investment adviser to make and keep accurate records of every
transaction in a security in which the investment advisor or any
advisory representative has a beneficial interest. Accordingly, the
Commission believes that the Advisers Act gives it the authority to
review the trading activities of anyone who is likely to have access to
the information necessary to use options on the Index to attempt a
manipulation of the relevant markets.
Finally, even though the CBOE does not in this case have market
information sharing agreements with each of the relevant foreign
markets, the CBOE, NYSE, Amex, and NASD are all members of the ISG,
which provides for the exchange of all necessary surveillance
information regarding the trading of the mutual fund securities
comprising the Index.\46\ The Commission believes that this arrangement
ensures the availability of information necessary to detect and deter
potential manipulations and other trading abuses, thereby making the
Index options and full-value and reduced-value Index LEAPS less readily
susceptible to manipulation.\47\
\46\See supra note 32.
\47\See, e.g., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (October 5, 1992) (order approving
the listing of index options and index LEAPS on the CBOE Biotech
Index).
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D. Market Impact
The Commission believes that the listing and trading on the CBOE of
Emerging Markets Index options, including full-value and reduced-value
Index LEAPS, will not adversely impact the markets, for the securities
issued by the closed-end funds represented in the Index.\48\ First, as
described above, the securities or no one closed-end fund or group of
closed-end funds represented in the Index dominates the weight of the
Index. Second, the maintenance criteria for the Index ensure that: (1)
The Index will be substantially comprised of closed-end fund securities
that satisfy the Exchange's listing standards for standardized options
trading; and (2) no individual security held by one or more of the
mutual funds represented in the Index and no individual country
represented by those holdings will dominate the Index.\49\ Third,
because the securities issued by each of the closed-end funds
comprising the Index must be ``reported securities'' as defined in Rule
11Aa3-1 of the Act, the securities issued by these closed-end funds
generally will be actively-traded, highly-capitalized securities.
Fourth, the 10,500 contract position and exercise limits applicable to
Index options and Index LEAPS will serve to minimize potential
manipulation and market impact concerns.
\48\In addition, the CBOE has represented that the CBOE 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 Memorandum from Joe Corrigan, Executive
Director, OPRA, to Scott Lyden, CBOE, dated June 27, 1994.
\49\See supra Section III.A.
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Lastly, the Commission believes that settling expiring Emerging
Markets Index options, including full-value and reduced-value Index
LEAPS, based on the opening prices of the closed-end fund securities
comprising the Index 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 the closed-end fund securities underlying
options on the Index.\50\
\50\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice of filing
thereof in the Federal Register. Specifically, Amendment No. 2 provides
objective maintenance criteria which, for the reasons stated above,
should minimize the potential for manipulation of the Index and the
closed-end mutual fund securities comprising the Index. Further, as
discussed above, the Commission believes that these maintenance
criteria significantly strengthen the customer protection and
surveillance aspects of the proposal, as originally proposed.\51\
Moreover, the [[Page 7613]] Commission believes that reducing the
number of component funds in the Index by two is not a material change
that raises regulatory concerns not already addressed by the proposal.
Accordingly, the Commission believes it is consistent with Sections
6(b)(5) and 19(b)(2) of the Act to approve Amendment No. 2 to the
proposed rule change on an accelerated basis.
\51\See supra Section III.A.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street NW., 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. 552, will be available for inspection and
copying at the Commission's Public Reference Section, 450 Fifth Street
NW., Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the above-mentioned
self-regulatory organization. All submissions should refer to the File
Number SR-CBOE-94-19 and should be submitted by March 1, 1995.
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\52\ that the proposed rule change (SR-CBOE-94-19), as amended, is
approved.\53\
\52\15 U.S.C. 78s(b)(2) (1988).
\53\The Commission notes that prior to listing Index options or
Index LEAPS, the CBOE will be required to review the then most
recent semiannual reports filed with the Commission by each of the
closed-end funds represented in the Index to ensure that the closed-
end fund securities comprising the Index, as well as the holdings of
each of the closed-end funds represented in the Index, satisfy, at
the time of listing, the listing criteria discussed above.
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\54\
\54\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-3037 Filed 2-7-95; 8:45 am]
BILLING CODE 8010-01-M