[Federal Register Volume 61, Number 4 (Friday, January 5, 1996)]
[Notices]
[Pages 434-436]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-169]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36657; File No. SR-NASD-95-56]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc., Relating to an Extension and
Expansion of the NASD's Equity Option Position Limit Hedge Exemption
Pilot Program
December 29, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on November 21, 1995, the National Association of Securities Dealers,
Inc. (``NASD'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I and
II below, which Items have been prepared by the self-regulatory
organization. The NASD has requested accelerated approval for the
proposal. This order approves the NASD's proposal on an accelerated
basis and solicits comments from interested persons.
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.18b-4 (1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing to amend Article III, Section 33(b)(3)(A)(5)
of the NASD Rules of Fair Practice to extend, until December 31, 1997,
the NASD's equity option position limit hedge exemption pilot program.
The NASD is also proposing to expand the hedge exemption pilot program
to permit the establishment of hedged positions up to three times the
applicable basic position limit.
In addition, the NASD is requesting that the Commission find good
cause, pursuant to Section 19(b)(2) of the Act, to approve the proposed
rule change prior to the thirtieth day after publication in the Federal
Register.
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 NASD 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 III below. The NASD has prepared summaries, set forth in Sections
A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
On February 9, 1990, the Commission approved a NASD proposal \3\ to
implement a two-year pilot program during which certain fully hedged
equity option positions would be automatically exempt from established
position \4\ and exercise limits.\5\ On March 18, 1994, the Commission
extended the NASD's hedge exemption pilot program through December 31,
1995.\6\
\3\ See Securities Exchange Act Release No. 27697 (February 9,
1990), 55 FR 5535 (February 15, 1990).
\4\ Position limits impose a ceiling on the number of option
contracts in each class on the same side of the market (i.e.,
aggregating long calls and short puts and long puts and short calls)
that can be held or written by an investor or group of investors
acting in concert. Article III, Section 33(b)(3)(A) of the NASD
Rules of Fair Practice currently provides that equity option
position limits are 4,500, 7,500, or 10,500 contracts, depending
upon the trading volume and number of outstanding shares of the
underlying stock. In addition, the NASD has recently submitted to
the Commission a rule proposal that would add a 20,000-contract
position limit tier and a 25,000-contract position limit tier. See
File No. SR-NASD-95-55.
\5\ Exercise limits restrict the number of options contracts
which an investor or group of investors acting in concert can
exercise within five consecutive business days. Under NASD Rules,
exercise limits correspond to position limits, such that investors
in options classes on the same side of the market are allowed to
exercise, during any five consecutive business days, only the number
of options contracts set forth as the applicable position limit for
those options classes. See Article III, Section 33(b)(4) of the NASD
Rules of Fair Practice.
\6\ See Securities Exchange Act Release No. 33783 (March 18,
1994), 59 FR 14229 (March 25, 1994).
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The NASD's hedge exemption provides for an automatic exemption from
equity option position limits for accounts that have established one of
the four most commonly used hedged positions \7\ and where each option
contract is either (i) hedged by 100 shares of stock, (ii) hedged by
securities that are readily convertible into, or economically
equivalent to, such stock,\8\ or (iii) in the case of an adjusted
options contract, hedged by the number of shares represented by the
adjusted contract.
\7\ The four exempted hedge positions are: (1) Long stock and
short calls; (2) long stock and long puts; (3) short stock and long
calls; and (4) short stock and short puts.
\8\ The Commission notes that the NASD determines on a case-by-
case basis whether an instrument that is being used as the basis for
the underlying hedged positions is readily convertible into, or
economically equivalent to, the security underlying the
corresponding option position. In this regard, the NASD generally
finds that an instrument that is not presently convertible into a
security, but which will be at a future date, is not a
``convertible'' security for purposes of the hedge exemption. In
addition, the NASD notes that if a convertible security used to
hedge an option position is called for redemption by the issuer, the
security would have to be converted into the underlying security
immediately or the corresponding option position would have to be
reduced accordingly.
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Under the NASD's current hedge exemption, the largest options
position (combining hedged and unhedged positions) that may be
established may not exceed twice the basic position limit (i.e., 9,000,
15,000, or 21,000 contracts, respectively). In addition, the hedge
exemption does not change the exercise limits contained in Article III,
Section 33(b)(4) of the NASD Rules of Fair Practice. Therefore, market
participants are allowed to exercise, during any five consecutive
business days, the same number of options contracts as set forth in the
position limit for that option, including those options positions that
are hedged (i.e., if the position limit for an option is 10,500
contracts and an investor has established a position of 21,000
contracts (10,500 unhedged and 10,500 hedged), the investor may
exercise all 21,000 contracts during five consecutive business days).
The NASD is currently proposing two amendments to its hedge
exemption pilot program. First, the NASD is
[[Page 435]]
proposing to extend the pilot program until December 31, 1997. Second,
the NASD is proposing to modify the hedge exemption to permit the
establishment of hedged equity option positions up to three times the
applicable basic position limit (i.e., 13,500, 22,500, or 31,500
contracts).\9\ As noted above, the hedge exemption rule currently
permits the establishment of hedged equity option positions up to twice
the applicable basic position limit.
\9\ The NASD notes that if File No. SR-NASD-95-55 is approved by
the Commission, market participants could establish hedged positions
of up to 60,000 contracts or 75,000 contracts, respectively, in
those securities that qualify for the 20,000-contract position limit
tier or the 25,000-contract position limit tier. In addition, under
the OTC Collar Exemption, market participants could establish OTC
collars where each ``leg'' of the collar is 50,000 contracts, in the
case of a security eligible for the 20,000-contract position limit,
or 62,500 contracts, in the case of a security eligible for the
25,000-contract position limit.
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2. Statutory Basis
The NASD believes that the proposed rule change is consistent with
Section 15A(b)(6) of the Act.\10\ Section 15A(b)(6) requires that the
rules of a national securities association be 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, to remove impediments to and perfect the mechanism of a
free and open market and a national market system and, in general, to
protect investors and the public interest.
\10\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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In particular, the NASD believes that the proposed expansion of the
equity option position limit hedge exemption pilot program is warranted
for the following reasons. First, permitting market participants,
particularly investors with sizeable holdings, accounts, or assets, to
establish larger hedged equity option positions will afford them
greater flexibility to employ larger options positions when effecting
their hedging strategies. Second, the higher hedged position limit
exemption will likely facilitate greater activity in exchange-listed
options and conventional equity options, thereby enhancing liquidity in
the markets for exchange-traded options, conventional equity options,
and the securities underlying those options. Third, by conforming the
NASD's equity option hedge exemption rule to the hedge exemption rules
in place at the options exchanges, there will be no confusion by market
participants concerning applicable position and exercise limits.\11\
\11\ See Securities Exchange Act Release Nos. 36371 (October 13,
1995), 60 FR 54269 (October 20, 1995) (order approving File No. SR-
CBOE-95-42); and 36409 (October 23, 1995), 60 FR 55399 (October 31,
1995) (order approving File Nos. SR-NYSE-95-31, SR-PSE-95-25, SR-
Amex-95-42, and SR-Phlx-95-71).
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In addition, the NASD believes that the proposed expansion of the
equity option position limit hedge exemption will not compromise the
integrity of the options markets or jeopardize the stability of the
securities markets underlying exchange-traded equity options or
conventional equity options. As options positions established pursuant
to the hedge exemption pilot program will continue to be hedged on a
one-for-one basis with the underlying stock, the NASD does not believe
that the proposed expansion of the hedge exemption pilot program will
have an adverse impact on the market. In this regard, the NASD notes
that the higher position limits currently available by virtue of the
NASD's hedge exemption pilot program have not resulted in disruptions
of the underlying stock market. Moreover, the NASD will continue to
monitor the use of the position limit hedge exemption to ensure that
NASD members comply with the requirements of the exemption, as well as
to monitor the exemption's effect, if any, on the market.\12\
\12\ In addition, should the NASD seek permanent approval of its
hedge exemption pilot program, the NASD is aware of and will comply
with the Commission's request for a request on the operation of the
program.
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B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will impose
any inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Comments were neither solicited nor received with respect to the
proposed rule change.
III. 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, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule changes that are filed
with the Commission, and all written communications relating to the
proposed rule changes 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. 20549. Copies of such filings also will be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to File No. SR-NASD-95-56 and should
be submitted by January 26, 1996.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
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 association, and, in
particular, with the requirements of Section 15A(b)(6). Specifically,
the Commission believes that the proposed extension and expansion of
the NASD's equity option position limit hedge exemption pilot program
will accommodate the needs of investors and market participants while
at the same time furthering investor protection and the public
interest.
The Commission also believes that the proposed rule change will
increase the potential depth and liquidity of the equity options market
as well as the underlying cash market without significantly increasing
concerns regarding intermarket manipulations or disruptions of the
market for the options or the underlying securities.
In addition, to the extent the potential for manipulation does
increase due to the expanded hedge exemption, the Commission believes
that the NASD's surveillance programs will be adequate to detect as
well as to deter attempted manipulative activity. Moreover, the
Commission will continue to monitor the NASD's surveillance programs to
ensure that problems do not arise.
The Commission finds good cause to approve the proposed rule
changes prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. Specifically, by
accelerating the approval of the NASD's rule proposal, the Commission
is conforming the NASD's equity option hedge exemption to identical
proposals that were recently approved for the options exchanges by the
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Commission.\13\ Accelerated approval of the proposed rule change will
thereby provide for the desired uniformity of equity option hedge
exemptions within the exchange traded options market. Any other course
of action could lead to unnecessary investor confusion. In addition,
the Chicago Board Options Exchange, Inc.'s (``CBOE'') proposal was
noticed for the entire twenty-one day comment period and generated no
negative responses.\14\ Lastly, accelerated approval of the rule
proposal will allow the NASD's hedge exemption pilot program to
continue on an uninterrupted basis. Accordingly, the Commission
believes that it is consistent with Section 15A(b)(6) of the Act to
approve the proposed rule change on an accelerated bais.
\13\ See supra note 11.
\14\ Id.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) \15\ of the
Act that the proposed rule change (File No. SR-BASD-85-56) is hereby
approved on an accelerated basis, and, accordingly, the hedge exemption
pilot program as expanded herein is extended until December 31, 1997.
\15\ 15 U.S.C. Sec. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
\16\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-169 Filed 1-4-96; 8:45 am]
BILLING CODE 8010-01-M