23584 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules

1 15 U.S.C. 78a et seq.

2Section 3(a)(26) of the Exchange Act, 15 U.S.C.

78c(a)(26), defines SRO to mean any national

securities exchange, registered securities

association, registered research agency, and for

purposes of Section 19(b) of the Act, 15 U.S.C.

78s(b), and other limited purposes, the Municipal

Securities Rulemaking Board (‘‘MSRB’’).

3 17 CFR 240.19b–4.

4 15 U.S.C. 78f(b)(5).

5Sections 3(a)(26), 3(a)(27), 15 U.S.C. 78c(a)(27),

3(a)(28), 15 U.S.C. 78c(a)(28) and section 3(b), 15

U.S.C. 78c(b), of the Act provide that the

Commission may promulgate rules regarding,

among other things, ‘‘stated policies, practices and

interpretations’’ of SROs. Section 19(b) authorizes

the Commission to promulgate rules regarding

‘‘proposed rule changes’’ of SROs. Section 23(a), 15

U.S.C. 78w(a), of the Act provides that the

Commission shall have power to make such rules

and regulations as may be necessary or appropriate

to implement the provisions of the Exchange Act for

which it is responsible or for the execution of the

functions vested in it by the Exchange Act, and may

for such purposes classify persons, securities,

transactions, statements, applications, reports and

other matters within its jurisdiction, and prescribe

greater, lesser or different requirements for different

classes thereof. (See e.g., Securities Exchange Act

Release No. 34140 (June 1, 1994), 59 FR 29393 (June

7, 1994)). In addition, in 1996, Congress granted the

Commission the authority, under section 36(a), 15

U.S.C. 78mm(a), to exempt any class of person,

security or transaction from any provision of the

Act. Pub. L. 104–290, 110 Stat. 3416 (1996).

6 17 CFR 240.19b–4(b).

7 17 CFR 240.19b–4(c).

8 17 CFR 240.19b–4(d). 9See Text of the Proposed Rule, infra.

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Parts 240 and 249

[Release No. 34–39885; File No. S7–13–98]

RIN 3235–AH39

Proposed Amendment to Rule 19b–4,

Under the Securities Exchange Act of

1934, That Would Deem the Listing and

Trading of New Derivative Securities

Products by Self-Regulatory

Organizations To Not Be Proposed

Rule Changes

AGENCY: Securities and Exchange

Commission.

ACTION: Proposed rule.

SUMMARY: The Securities and Exchange

Commission proposes to amend Rule

19b–4 under the Securities Exchange

Act of 1934. The amendment would

expand the scope of SRO matters that do

not constitute proposed rule changes to

include the listing and trading of new

derivative securities products pursuant

to existing SRO trading rules,

procedures, surveillance programs and

listing standards.

DATES: Comments should be submitted

by May 29, 1998.

ADDRESSES: All comments should be

submitted in triplicate and addressed to

Jonathan G. Katz, Secretary, Securities

and Exchange Commission, Mail Stop

6–9, 450 Fifth Street, NW., Washington,

DC 20549. Comments also may be

submitted electronically at the following

e-mail address: rule-comments@sec.gov.

All comments should refer to File No.

S7–13–98; this file number should be

included in the subject line if e-mail is

used. Comment letters will be available

for public inspection and copying at the

Commission’s Public Reference Room at

the same address. Electronically

submitted comment letters will be

posted on the Commission’s web site

(http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

Sharon M. Lawson, Senior Special

Counsel at (202) 942–0182 or Marianne

H. Duffy, Special Counsel at (202) 942–

4163, Office of Market Supervision,

Division of Market Regulation,

Securities and Exchange Commission,

Mail Stop 10–1, 450 Fifth Street, NW.,

Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

A. Purpose of Amendment

The Securities and Exchange

Commission (‘‘SEC’’ or ‘‘Commission’’)

is proposing to amend Rule 19b–4 under

the Securities Exchange Act of 1934, as

amended (‘‘Exchange Act’’ or ‘‘Act’’) 1 to

expand the scope of self-regulatory

organization (‘‘SRO’’) 2 matters that do

not constitute proposed rule changes,

pursuant to section 19(b) of the Act and

Rule 19b–4 3 thereunder, to include the

listing and trading of certain new

derivative securities products, as

defined below, pursuant to existing

trading rules, procedures, surveillance

programs and listing standards.

B. Description of Proposed Amendment

Section 19(b) of the Exchange Act

requires every SRO to file with the

Commission any proposed rule or any

proposed change in the rules of the

SRO. In the past, the Commission has

considered the listing and trading of

new derivative securities products by an

SRO to constitute a proposed rule

change. In order to approve these

changes, the Commission must find that

the listing and trading of the new

derivative securities product will serve

to promote the public interest and help

to remove impediments to a free and

open securities market.4 Further, the

trading of such new derivative securities

products must serve to protect investors

and promote efficiency, competition

and capital formation.

The Commission has exercised its

rulemaking authority 5 by promulgating

paragraphs (b),6 (c) 7 and (d) 8 of Rule

19b–4 under the Act, which interpret

the terms ‘‘stated policy, practice or

interpretation’’ and ‘‘proposed rule

change.’’ Paragraph (c) of Rule 19b–4

provides that certain stated policies,

practices and interpretations of SROs do

not constitute proposed rule changes.

Specifically, a ‘‘stated policy, practice or

interpretation’’ of an SRO is not a

proposed rule change if it is reasonably

and fairly implied by an existing SRO

rule. The Commission now proposes to

amend Rule 19b–4 so that the listing

and trading of new derivative securities

products would not be proposed rule

changes so long as there are existing

SRO trading rules, procedures,

surveillance programs and listing

standards. Specifically, the Commission

proposes to add a new paragraph (e) to

Rule 19b–4 which states:

the listing and trading of a new derivative

securities product by (an SRO) shall not be

deemed a proposed rule change, pursuant to

paragraph (c)(1) of (Rule 19b–4), if the

Commission has approved, pursuant to

section 19(b) of the Act ( ), such (SRO’s)

trading rules, procedures and listing

standards for the product class that would

include the new derivative securities

product, and the SRO has a surveillance

program for the product class.9

In proposing new paragraph (e), the

Commission preliminarily believes that

when the Commission has approved,

pursuant to section 19(b) of the Act, an

SRO’s trading rules, procedures and

listing standards for the product class

that would include the new derivative

securities product, the listing and

trading of the new derivative securities

product is reasonably and fairly implied

by the SRO’s existing trading rules,

procedures and listing standards. The

Commission preliminarily believes it is

therefore appropriate to deem the listing

and trading of new derivative securities

products to not be proposed rule

changes pursuant to Rule 19b–4(c)(1)

under certain conditions.

II. Background

A. Current Procedures for Submission

and Approval of SRO New Derivative

Securities Product Rule Filings

Over the years, the Commission has

sought to revise the rule filing

requirements to meet the changing

needs of the SROs in a competitive

international marketplace. The

Commission has developed streamlined

filing procedures to ease the regulatory

burden in many circumstances. Today,

the Commission is proposing to expand

the scope of SRO matters that do not

constitute proposed rule changes to

include the listing and trading of new

derivative securities products pursuant

to existing SRO trading rules,
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23585

10 15 U.S.C. 78s(b)(1).

11See generally, Senate Comm. on Banking,

Housing & Urban Affs., Report to accompany S. 249:

Securities Acts Amendments of 1975, S. Rep. No.

94–75, 94th Cong., 1st Sess. 22–38 (Comm. Print

1975), reprinted in (1975) U.S. Code Cong. & Ad.

News 179, 200–15 (except on ‘‘Self-Regulation and

Sec Oversight’’).

12 15 U.S.C. 78s(b)(2).

13Section 19(b)(2)(B) of the Act, 15 U.S.C.

78s(b)(2)(B).

14See e.g., Securities Exchange Act Release No.

39011 (September 3, 1997), 62 FR 47841 (September

11, 1997) (order approving Chicago Board Options

Exchange’s, Incorporated (‘‘CBOE’’) proposal to list

and trade options based upon the Dow Jones

Industrial Average) and Securities and Exchange

Act Release No. 38693 (May 29, 1997), 62 FR 30914

(June 5, 1997) (order approving American Stock

Exchange’s, Incorporated (‘‘Amex’’) proposal to list

and trade options based on the the Tobacco Index).

15See e.g., Securities Exchange Act Release No.

39079 (September 15, 1997), 62 FR 49543

(September 22, 1997) (order approving Amex

proposal to list and trade warrants based on the ING

Barings, Inc.’s BEMI Latin American Index).

16Securities Exchange Act Release No. 31591

(December 11, 1992), 57 FR 60253 (December 18,

1992) (order approving Amex rules to provide for

the listing and trading of portfolio depositary

receipts (‘‘PDRs’’), and specifically PDRs based on

the Standard and Poors Corporation (‘‘S&P’’) 500

Index known as SPDRs). See also, Amex Rule

1000(b)(1).

17See e.g., Securities Exchange Act Release No.

36505 (November 22, 1995), 60 FR 61277

(November 29, 1995) (order approving Philadelphia

Stock Exchange’s, Incorporated (‘‘Phlx’’) proposal to

list and trade dollar-denominated delivery foreign

currency options on the Japanese Yen).

18See e.g., Securities Exchange Act Release No.

37533 (August 7, 1996), 61 FR 42075 (August 13,

1996) (order approving Amex proposal to list and

trade indexed term notes based upon a portfolio of

the top ten dividend yielding stocks in the Dow

Jones Industrial Average).

19See e.g., Securities Exchange Act release No.

32950 (September 23, 1993), 58 FR 50985

(September 29, 1993) (order approving New York

Stock Exchange’s, Incorporated (‘‘NYSE’’) proposal

to list and trade Debt Exchangeable for Common

Stock issued by the American Express Corporation

and linked to the performance of First Data

Corporation).

20 15 U.S.C. 78s(b)(3).

21 15 U.S.C. 78s(b)(3)(A)(iii).

22 17 CFR 240.19b–4(e).

23Securities Exchange Act Release No. 34157

(June 3, 1994) 59 FR 30062 (June 10, 1994) (order

approving generic narrow-based index options

listing standards for the Amex, the CBOE, the

NYSE, the Pacific Exchange, Inc., (‘‘PCX’’), and the

Phlx (‘‘Generic Narrow-Based Index Option

Approval Order’’)). Moreover, as of April 28, 1997,

the NYSE transferred its options business to the

CBOE. See Securities Exchange Act Release Nos.

38541 and 38542 (April 23, 1997) 62 FR 23516 and

23521 (April 30, 1997) (orders approving proposed

rule changes by the CBOE and NYSE, respectively,

regarding the transfer of the NYSE’s options

business to the CBOE). These SROs are the only

U.S. exchanges that list standardized options

products, which are issued, cleared, and settled

through the Options Clearing Corporation.

24Securities Exchange Act Release Nos. 37007

(March 21, 1996) 61 FR 14165 (March 29, 1996)

(Amex, CBOE, and Phlx) and 37445 (July 16, 1996)

61 FR 38494 (July 24, 1996) (NYSE) (orders

approving uniform listing and trading guidelines for

narrow-based stock index warrants (‘‘Generic

Narrow-Based Index Warrant Approval Orders’’)).

25Securities Exchange Act Release Nos. 36165

(August 29, 1995) 60 FR 46653 (September 7, 1995)

(NYSE); 36166 (August 29, 1995) 60 FR 46660

(September 7, 1995) (PCX); 36167 (August 29, 1995)

60 FR 46667 (September 7, 1995) (Phlx); 36168

(August 29, 1995) 60 FR 46637 (September 7, 1995)

(Amex); and 36169 (August 29, 1995) 60 FR 36169

(CBOE) (September 7, 1995) (orders approving

uniform listing and trading guidelines for index,

currency and currency index warrants). See also,

Securities Exchange Act Release No. 36296

(September 28, 1995) 60 FR 52234 (October 5, 1995)

(order approving the National Association of

Securities Dealers’, Incorporated (‘‘NASD’’)

proposed to adopt uniform listing and trading

guidelines for broad-based index warrants on the

NASD’s Automated Quotation Stock Market).

26Supra notes 23 and 24.

procedures, surveillance programs and

listing standards.

1. Standard Statutory Procedures

Section 19(b)(1) 10 of the Act requires

an SRO to file with the Commission its

proposed rule changes accompanied by

a concise general statement of the basis

and purpose of the proposed rule

change. Once a proposed rule change

has been filed, the Commission is

required to publish notice of it and

provide an opportunity for public

comment. The proposed rule change

may not take effect unless it is approved

by the Commission or is otherwise

permitted to become effective under

section 19(b) of the Act.11 Section

19(b)(2) 12 of the Act sets forth the

standards and time periods for

Commission action either to approve a

proposed rule change or to institute and

conclude a proceeding to determine

whether a proposed rule change should

be disapproved. Generally, the

Commission must either approve the

proposed rule change or institute

disapproval proceedings within 35 days

of the publication of notice of the filing

or within a longer period as the

Commission finds appropriate or to

which the SRO consents. The

Commission must approve a proposed

rule change if it finds that the rule

change is consistent with the

requirements of the Act and the rules

and regulations thereunder applicable to

the SRO proposing the rule change. If

the Commission does not make that

finding, it must institute proceedings to

determine whether to disapprove the

proposed rule change. The Commission

also may approve a proposed rule

change on an accelerated basis prior to

30 days after publication of the notice

if the Commission finds good cause for

so doing and publishes its reasons for so

finding.13

SROs have submitted proposals under

section 19(b)(2) to list and trade various

derivative securities products, including

stock options, broad-based and narrowbased stock index options14 and

warrants,15 unit investment trusts,16

foreign currency options,17 indexed

term notes18 and other hybrid derivative

equity and debt securities.19

2. Streamlined Procedures for Certain

New Derivative Securities Product Rule

Filings

Section 19(b)(3) of the Act 20 provides

that, in certain circumstances, a

proposed rule change may become

effective immediately upon filing with

the Commission and without the notice

and approval procedures required by

section 19(b)(2). Paragraph (A) of

section 19(b)(3) permits certain types of

proposed rule changes to take effect in

this manner if appropriately designated

by the SRO as: (1) Constituting a stated

policy, practice or interpretation with

respect to the meaning, administration,

or enforcement of an existing rule of the

SRO; (2) establishing or changing a due,

fee, or other charge imposed by the

SRO; or (3) concerned solely with the

administration of the SRO. Section

19(b)(3)(A)(iii) 21 also gives the

Commission the authority to expand, by

rule, the scope of proposed rule changes

that may become effective under section

19(b)(3)(A) if the Commission

determines that the expansion is

consistent with the public interest and

the purposes of Section 19(b). Currently,

Rule 19b–4(e) under the Act 22 details

the scope of proposed rule changes that

may be filed under section 19(b)(3)(A) of

the Act.

For the past several years, the

Commission has worked with the SROs

to develop procedures to streamline the

review process of new derivative

securities product rule filings. As a

result, SROs can submit a proposed rule

change in accordance with section

19(b)(3)(A) of the Act for certain

proposed new derivative securities

products. For example, on June 3, 1994,

the Commission approved proposed

rule changes submitted by several SROs

to establish generic listing standards for

options on narrow-based stock indices

and to adopt streamlined procedures for

introducing trading in options that

satisfy these listing standards.23 In

addition, certain SROs have in place

rules similar to the streamlined

procedures for listing warrants on

narrow-based stock indices.24

Furthermore, the Commission has

approved rules for certain SROs that

allow for the listing of specific broadbased 25 and narrow-based 26 stock

index warrant issuances without further

Commission approval pursuant to

section 19(b) of the Act, as long as the

listing complies with the SRO’s generic

warrant listing standards and the

Commission has already approved the

underlying stock index for warrant or
23586 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules

27Supra note 25.

28The Commission notes that currently with

regard to equity issues, once an SRO has received

approval for its trading rules, procedures and listing

standards, the listing and trading of a specific new

equity issue is not deemed a proposed rule change

that requires a filing under Rule 19b–4 of the Act.

Rather, an SRO can immediately list and trade a

new equity issue so long as that equity issue

satisfies the Commission approved trading rules,

procedures and listing standards of the SRO.

29 In order to further promote competition, the

Commission proposes, in a separate release issued

today (Securities Exchange Act Release No. 39884

(April 17, 1998)), to permit SROs to operate new

trading systems subject to certain conditions, for a

period not to exceed two years, without submitting

a Rule 19b–4 filing. 30 15 U.S.C. 78(c)(1)(j).

31 Id.

32Furthermore, the proposal will only apply to

securities SROs. It will not apply to entities that

seek designation as contract markets for futures

trading on an index or group of securities or to

foreign boards of trade that apply to the Commodity

Futures Trading Commission (‘‘CFTC’’) for

certification to sell their futures contracts to U.S.

persons. Under the amendments to the CEA effected

by the Futures Trading Act of 1982 (Pub. L. 97–444,

96 Stat. 2294), Section 2(a)(1)(B) of the CEA (7

U.S.C. 2(a)(1)(B)) prohibits any person from offering

or selling a futures contract based on ‘‘any group

or index of such securities or any interest therein

based on the value thereof’’ except as permitted

under Section 2(a)(1)(B)(ii) of the act. The CFTC is

required to seek the views of the SEC regarding

each such application concerning a stock index and

the SEC may object to the designation on the

ground that any of the statutory criteria have not

been met. The proposal would not alter these

procedures nor does the Commission believe that it

is appropriate to do so. The Commission notes that

it would have the ability to inspect the securities

SROs in order to ensure that they comply with the

terms of the proposed amendment when they do

not submit proposed rule changes to list and trade

new derivative securities products. Moreover, the

Commission could take appropriate measures,

including, but not limited to, ordering the SRO to

remediate the deficiency or prohibiting opening

transactions in or discontinuing the listing of new

derivative securities products if the new derivative

securities product did not comply with the terms

of the proposed amendment. In contrast, for stock

index futures contracts, neither inspection nor

enforcement authority is available to the

Commission. Consequently, the Commission

believes that it is important for the Commission to

continue to review the terms of any proposed stock

index futures contract before it commences trading.

options trading. In addition, the

Commission has approved rules

allowing for the listing of warrants

overlying a single currency without a

section 19(b) rule filing provided that

the underlying currency has been

approved for options trading.27 The

Commission also has approved rules

allowing for the listing of warrants

overlying a currency index without a

section 19(b) rule filing provided the

index previously has been approved by

the Commission pursuant to a section

19(b) rule filing.

B. Reasons for Expanding the Scope of

SRO Matters That Do Not Constitute

Proposed Rule Changes

Over the years, the Commission has

approved numerous SRO trading rules,

procedures and listing standards for

various classes of new derivative

securities products. The Commission

preliminarily believes that when it has

approved, pursuant to section 19(b) of

the Act, an SRO’s trading rules,

procedures and listing standards for the

product class that would include a new

derivative securities product, the listing

and trading of the new derivative

securities product should therefore be

reasonably and fairly implied by the

SRO’s existing trading rules, procedures

and listing standards.28

SROs are facing increasing

competition from overseas and over-thecounter (‘‘OTC’’) derivatives markets.29

The Commission believes that SROs

should be able to bring new derivative

securities products to market quickly to

provide investors with tailored products

that directly meet their evolving

investment needs. Although the generic

rules have helped to speed the process

of reviewing new derivative securities

product proposals, the Commission

preliminarily believes that further

changes are warranted. The Commission

preliminarily believes that expanding

the scope of SRO matters that do not

constitute a proposed rule change to

include the listing and trading of certain

new derivative securities products will

significantly speed the introduction of

new derivative securities products and

enable SROs to maintain their

competitive balance with the overseas

and OTC derivative markets. The

proposal should foster innovation and

create a streamlined procedure for SROs

to promptly list new products subject to

appropriate trading rules, procedures, a

surveillance program and listing

standards.

At the same time, SROs have had over

20 years of experience with SEC review

of new derivative securities product

proposals. SROs that have sought

approval from the Commission to list

and trade such new derivative securities

products should be familiar with the

factors discussed in this release that the

Commission believes should be

considered when listing and trading

such new derivative securities products.

Thus, the Commission believes that

there is less need for SEC review, notice

and approval prior to an SRO trading a

new derivative securities product

pursuant to existing trading rules,

procedures, a surveillance program and

listing standards. Nonetheless, the

Commission preliminarily believes that

the proposed procedures discussed in

this release will enable the Commission

to continue to effectively protect

investors and promote the public

interest.

III. Discussion

A. Definition of ‘‘New Derivative

Securities Product’’

For the purposes of section 19(b) of

the Act and Rule 19b–4 thereunder, the

Commission proposes to define ‘‘new

derivative securities product’’ as any

type of option, warrant, hybrid

securities product or any other security

whose value is based upon the

performance of an underlying

instrument.

1. New Derivative Securities Product

Must Be a ‘‘Security’’ as Defined in

Section 3(a)(10) of the Act

The SROs have the authority to list

and trade ‘‘securities’’ as defined in

section 3(a)(10) of the Exchange Act.30

The term ‘‘security’’ as defined in

section 3(a)(10) of the Exchange Act,

includes, among other instruments,

‘‘any put, call, straddle, option, or

privilege on any security, certificate of

deposit, or group or index of securities

(including any interest therein or based

on the value thereof), or any put, call,

straddle, option, or privilege entered

into on a national securities exchange

relating to a foreign currency, or in

general, any instrument commonly

known as a ‘security’.’’ 31 Because SROs

currently do not have the authority to

trade non-securities, the proposed

amendment does not provide SROs with

any new authority to list a new

derivative product that is not a

‘‘security’’.32

2. Scope of Proposal

As stated above, SROs have sought

Commission approval to list and trade

various new derivative securities

products, including, among others,

stock index options and warrants, unit

investment trusts, foreign currency

options and warrants, and indexed term

notes. The Commission proposes to

make the proposed amendment

available to SROs seeking to list these

classes of new derivative securities

products and other classes, provided

that such classes are subject to existing

trading rules, procedures, a surveillance

program and listing standards.

An SRO seeking to list a completely

new class of derivative securities

product without existing trading rules,

procedures, a surveillance program and

listing standards would still be required

to submit a proposed rule change

pursuant to section 19(b)(2) of the Act

in order to adopt appropriate trading

rules, procedures and listing standards

for such class. These requirements are

intended to ensure that there are
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23587

33The Commission notes that several exchanges

have adopted listing standard categories termed

‘‘other securities.’’ These standards were adopted to

allow the listing of securities that contain features

borrowed from more than one category of currently

listed securities, such as hybrid new derivative

securities products that have characteristics of both

common stock and debt securities. The Commission

has clearly stated and reiterates its belief that such

standards ‘‘are not intended to accommodate the

listing of securities that raise significant new

regulatory issues, and, therefore, would require a

separate filing with the Commission pursuant to

Rule 19b–4 under the Act.’’ Securities Exchange Act

Release No. 28217 (July 18, 1990) 55 FR 30056 (July

24, 1990). In other words, the ‘‘other securities’’

category is not intended to permit an SRO to list

a new derivative securities product that does not

fall under another listing category of the SRO.

Accordingly, an SRO could not avoid the

requirement of adopting appropriate listing

standards in order to rely on the proposed

amendment for a novel new derivative securities

product by simply listing such product under the

‘‘other security’’ category.

34As discussed in Section IV. G. Ensuring Proper

Use Of The Proposed Amendment, a failure to

comply with the standards could compromise an

SRO’s reliance on the proposed amendment.

35The Commission believes that a comprehensive

ISA should require that the parties provide each

other, upon request, information about market

trading, clearing activity and the identity of the

ultimate purchasers and sellers of securities. See

Securities Exchange Act Release No. 31529

(November 27, 1992) 57 FR 57248 (December 3,

1992).

36See ISG Agreement, dated July 14, 1983,

amended January 29, 1990. The ISG members are:

the Amex; the Boston Stock Exchange,

Incorporated; the CBOE; the Chicago Stock

Exchange, Inc.; the NASD; the NYSE; the PCX; and

the Phlx. The major stock index futures exchanges

joined the ISG as affiliate members in 1990.

37An MOU provides a framework for mutual

assistance in investigatory and regulatory matters.

Generally, the Commission has permitted an SRO

to rely on an MOU in the absence of a

comprehensive ISA only if the SRO receives an

assurance from the Commission that such an MOU

can be relied on for surveillance purposes and

includes, at a minimum, the transaction, clearing

and customer information necessary to conduct an

investigation. See Securities Exchange Act Release

No. 35184 (December 30, 1994) 60 FR 2616 (January

10, 1995) (order approving the listing and trading

of warrants on the CBOE overlying the Nikkei Stock

Index 300 where there was no comprehensive ISA

between the CBOE and the underlying market, the

Tokyo Stock Exchange but there was an MOU

between the SEC and the Japanese Ministry of

Finance). In addition, an SRO should endeavor to

develop comprehensive ISAs with foreign

exchanges that trade the underlying securities of an

index even if the SRO receives prior Commission

approval to rely on an MOU in place of a

comprehensive ISA.

38 If, however, a foreign security had more than

50% of its global trading volume in dollar value in

U.S. markets, the Commission, in the past, has

treated such security as a U.S. security.

adequate SRO rules to provide for fair

and orderly trading for the class of

securities. Thus, in order to rely on the

proposed amendment, an SRO must

have in place trading rules, procedures

and listing standards for the specific

class of new derivative securities

product prior to the listing and trading

of the class.33 Procedures include, but

are not limited to adequate procedures

relating to sales practices (including

suitability), margin and disclosure

requirements. The SRO also must have

a surveillance program adequate to

monitor for abuses in the trading of the

new derivative securities product,

including trading in the underlying

security or securities. Once an SRO has

submitted, and the Commission has

approved, a section 19(b)(2) proposal to

establish an appropriate regulatory

framework to support trading of a new

class of new derivative securities

product, the SRO would qualify under

the proposed amendment for further

new derivative securities products

under the same class. For example, if an

exchange without any options rules

sought to trade options, it would first

need to file a rule change, pursuant to

Rule 19b–4, to adopt appropriate trading

rules, procedures and listing standards

that apply to options. In addition, the

proposed amendment does not relieve

an SRO from its obligation to submit a

proposed rule change to amend its

existing listing standards for particular

classes of securities.

B. Standards for All New Derivative

Securities Products

The proposal is premised upon the

experience that the Commission has

obtained through its review of new

derivative securities product proposals

by the SROs. Over the years, the

Commission has identified the factors it

believes new derivative securities

product proposals should meet in order

to be consistent with the Act. In order

to rely on the proposed amendment, an

SRO should ensure that the new

derivative securities product meets the

criteria discussed below in the areas of:

Design and maintenance of the

instruments or index underlying the

new derivative securities product;

customer protection rules; surveillance

of the component securities; and the

potential market impact of the new

derivative securities product.34

Specifically, an SRO should have

adequate information sharing

agreements, clearance and settlement

procedures, systems capacity and

transaction reporting procedures for

underlying securities.

1. Information Sharing Agreements

In designing a new derivative

securities product, the SRO should

ensure that it has adequate information

sharing procedures to detect and deter

potential trading abuses. It is essential

that the SRO have the ability to obtain

the information necessary to detect and

deter market manipulation, illegal

trading and other abuses involving the

new derivative securities product.

Specifically, there should be a

comprehensive information sharing

agreement (‘‘ISA’’) in place between the

SRO listing or trading a derivative

product and the markets trading the

securities underlying the new derivative

securities product that covers trading in

the new derivative securities product

and its underlying securities.35 Such

agreements provide a necessary

deterrent to manipulation because they

facilitate the availability of information

needed to fully investigate a

manipulation if it were to occur.

For new derivative securities products

based upon domestic securities, the

SRO should ensure the markets upon

which all of the U.S. component

securities trade are members of the

Intermarket Surveillance Group

(‘‘ISG’’).36 The ISG was formed to

coordinate, among other things,

effective surveillance and investigative

information sharing arrangements in the

stock and options markets.

For new derivative securities products

based on securities from a foreign

market, the SRO should have a

comprehensive ISA with the market for

the securities underlying the new

derivative securities product. The SRO

should ensure there are no blocking or

secrecy laws in the foreign country that

would prevent or interfere with the

transfer of information under the

comprehensive ISA. If securing a

comprehensive ISA is not possible, the

SRO should contact the Commission

prior to listing the new derivative

securities product. In such instances,

the Commission may determine that it

is appropriate instead to rely on a

Memorandum of Understanding

(‘‘MOU’’) between the Commission and

the foreign regulator.37

For a new derivative securities

product overlying an instrument with

component securities from several

countries, the Commission recognizes

that it may not be practical in all

instances to secure comprehensive ISAs

with all of the relevant foreign markets.

Generally, foreign countries’ securities

or American depositary receipts that are

not subject to a comprehensive ISA

should not represent a significant

percentage of the weight of such an

underlying instrument.38

2. Clearance and Settlement

The calculation of the settlement

value for the new derivative securities

product should be clear, fixed and

objective. In order to minimize market

impact concerns, a new derivative

securities product overlying an index of

U.S. securities generally should be
23588 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules

39Such a classification is essential because

regulatory requirements such as position limits and

margin levels are different for narrow-based and

broad-based index options. See e.g., CBOE Rules

24.4, 24.4A and 24.11.

40See Generic Narrow-Based Index Option

Approval Order, supra note 23 and Generic NarrowBased Index Warrant Approval Orders, supra note

24.

41Securities Exchange Act Release No. 39244

(October 15, 1997) 62 FR 55289 (October 23, 1997).

settled based on opening prices of the

component stocks. If opening price

settlement is not utilized, the SRO

should ensure that the settlement value

reflects the last available closing prices

prior to settlement for the underlying

securities or some alternative objective

settlement measurement. If the new

derivative securities product is settled

in foreign currency, the SRO should

ensure that a recognized exchange rate

is used to convert the settlement value

into U.S. dollars. In addition, the SRO

should ensure that adequate clearance

procedures have been established for

the new derivative securities product.

3. Systems Capacity

It is essential that the SRO and the

applicable price reporting authority

have adequate systems processing

capacity to accommodate the listing and

trading of a new derivative securities

product. The SRO should, prior to

listing a new derivative securities

product, ensure that it has adequate

systems processing capacity to

accommodate the new listing and obtain

a representation from the applicable

price reporting authority that such price

reporting authority also has adequate

systems processing capacity.

4. Transaction Reporting of Underlying

Securities

In order to prevent manipulation and

ensure liquidity of securities underlying

a new derivative securities product,

underlying equity securities should be

listed on a national securities exchange

or traded through the facilities of a

national securities association or

otherwise subject to real-time public

transaction reporting. For securities that

are not subject to transaction reporting

(e.g., municipal securities), there should

be an objective means of capturing price

information through disseminated

quotations. For foreign securities

underlying a new derivative securities

product, an SRO should ensure that

those securities satisfy and maintain all

other criteria described in this release

when relying on the proposed

amendment.

C. Index Based Products

In addition to the items discussed

above, SROs should ensure that if a new

derivative securities product is index

based: The index is classified properly

as broad-based or narrow-based; the

index is constructed according to

established criteria for initial inclusion

of new component securities; the index

is maintained so that it measures the

same segment of the market as originally

intended; the index value is

disseminated frequently; component

securities that fail to meet the

maintenance criteria are replaced

according to established policies and

procedures; and when the index is

maintained by a broker-dealer, a

functional separation exists between the

broker-dealer’s trading desk and

research department.

1. Designation of Index as Broad-Based

or Narrow-Based

An SRO should first classify the

underlying index as narrow-based (i.e.,

containing securities from a specific

industry sector or comprised of a small

group of securities) or broad-based (i.e.,

a larger group of securities that is

representative of the entire market or a

substantial portion of the entire

market).39 In order to make a

determination that an index is broadbased, the SRO should identify how the

index represents the overall stock

market or a substantial portion thereof.

The SRO should undertake an analysis

of the basis for such a determination. A

mere conclusion by the SRO that an

index has been designated as broadbased is not determinative of the status

of the index.

2. Index Construction

The index underlying a new

derivative securities product should be

constructed according to established

criteria for initial inclusion of new

component securities. SROs seeking to

rely on the proposed amendment should

employ objective index construction

standards that include a minimum

number of component securities and a

fixed and objective weighting

methodology (e.g., capitalization

weighted, price weighted or equal-dollar

weighted).40 In addition, SROs should

use index construction standards that

ensure that the underlying securities

have sufficient liquidity so as to help

reduce the potential for manipulation of

the index’s component securities. For

example, the index construction criteria

should include, among other things, a

minimum price, available capitalization,

average daily trading volume and value

of each component security and set a

maximum relative weight for the top

component and the five largest

components.

3. Maintenance Criteria

Maintenance criteria should be

designed to ensure that an index that

has derivative products overlying it

continues to measure the same segment

or sector of the market as originally

intended, remains composed of liquid

securities, and does not become

dominated by one (or a few)

component(s). As a result, an SRO

seeking to rely on the proposed

amendment should ensure the index

meets reasonable maintenance

standards.

4. Dissemination of the Index Value

In most circumstances, the index

value should be disseminated frequently

and, if based on U.S. equities only,

should reflect last-sale prices. If an

index is comprised of both U.S. and

foreign securities, prices for all

securities that trade on markets that are

open during U.S. trading hours should

be disseminated, if practicable, at least

every 15 seconds. Dissemination of an

index value based in whole or in part on

closing prices of component securities

should occur only for those component

securities where the underlying markets

are closed during U.S. trading hours (the

disseminated index value may still be

adjusted for currency fluctuations) or

the underlying component value itself is

not calculated real-time (e.g., indices of

open-end mutual funds that report net

asset value at the close of trading).41

Certain indices may use quotes (e.g., a

bond index) if last sale prices are

unavailable and the quotes are reliable

and spread across several dealers.

5. Component Changes

Component securities that fail to meet

the index maintenance standards should

be replaced within the index according

to established policies and procedures

for reviewing and replacing such

component securities. Automatic

rebalancing of index components also

should occur according to established

policies and procedures (e.g., annually,

semi-annually or quarterly). Notice of

component changes should be

disseminated to news vendors and the

public. SROs should ensure that

components are replaced promptly in

the event of specified circumstances

such as corporate mergers or spin-offs.

6. Functional Separation Letter

When the index is maintained by a

broker-dealer or an affiliate of a brokerdealer, the SRO should assure, prior to

the listing of a new derivative securities

product, that there will be a functional
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23589

42 17 CFR 239.20. Form S–20 is used to register

classes of options under the Securities Act.

43 15 U.S.C. 77a et seq.

44 17 CFR 240.9b–1.

45Standardized options’’ are options contracts

trading on a national securities exchange, an

automated quotation system of a registered

securities association or a foreign securities

exchange which relate to options classes the terms

of which are limited to specific expiration dates and

exercise prices or such other securities as the

Commission may, by order, designate. 17 CFR

240.9b–1(a)(4).

46Options market’’ means a national securities

exchange, an automated quotation system of a

registered securities association or a foreign

securities exchange on which standardized options

are traded. 17 CFR 240.9b–1(a)(1).

47The ODD identifies the issuer and describes the

uses, mechanics and risks of options trading and

other matters in language that can be easily

understood by the general investing public.

48The ODD may be used as a substitute for the

traditional prospectus.

49See Securities Exchange Act Release No. 31920

(February 24, 1993) 58 FR 12280 (March 3, 1993)

(order approving CBOE proposal to list and trade

FLEX Options based on the S & P’s 500 and 100

Stock Indices).

50See e.g., Investment Company Act Release No.

21802 (March 5, 1996) (exemptive order under the

ICA permitting the trading of Countrybasket Index

Funds on the NYSE).

51 15 U.S.C. 80a et seq.

52Although the NYSE transferred its options

business to the CBOE, supra note 23, the NYSE still

has listing standards for narrow-based index

options in its rules.

53See e.g., Amex Rules 900c through 980C; CBOE

Rules 24.1 through 24.8; and PCX Rules 7.1 through

7.18.

separation between the trading desk of

the broker-dealer and the research

persons responsible for maintaining the

index through a fire wall. A fire wall is

a mechanism by which employees

responsible for constructing and

maintaining the index are separated

from employees involved in the sale and

trading of securities. In accordance with

the broker-dealer’s fire wall mechanism,

the persons responsible for maintaining

an index should be subject to certain

procedures limiting the dissemination

of index information within the brokerdealer and particularly should be

prohibited from relaying any

information concerning a potential

change to the components of the index

to anyone not responsible for

maintaining the index, including

employees of the sales and trading

department.

D. Compliance With Other Federal

Securities Laws

The Commission notes that the

proposed amendment does not relieve

SROs from any other obligation under

the federal securities laws, or rules or

regulations thereunder, except the

requirement of filing a proposed rule

change pursuant to section 19(b) of the

Act and Rule 19b–4 thereunder. For

example, Form S–20 42 under the

Securities Act of 1933, as amended

(‘‘Securities Act’’) 43 and Rule 9b–1 44

under the Exchange Act establish a

disclosure framework specifically

tailored to the informational needs of

investors in ‘‘standardized options’’ 45

that are traded on an ‘‘options

market’’ 46. Under Rule 9b–1, brokerdealers must provide an updated copy

of the options disclosure document

(‘‘ODD’’) 47 to each customer at or prior

to the approval of the customer’s

account for trading in standardized

options.48 Accordingly, when trading a

new standardized option, an SRO must

determine if it should change the ODD

to reflect specific characteristics and

risks associated with the new derivative

securities product not currently set forth

in the ODD and submit such changes to

the Commission. In addition, a

particular new derivative securities

product may need to be designated as a

standardized option under Rule 9b–1 in

order to utilize the ODD.49 If the

proposing SRO and the issuer of the

new derivative securities product

determine that such steps are necessary,

they are required to submit proposals to

the Commission, under Rule 9b–1, prior

to listing the new derivative securities

product.

The Commission preliminarily notes

that the proposed amendment to Rule

19b–4 may still be available if an SRO

determines that the above steps are

necessary. So long as all conditions to

the proposed amendment are met,

including the existence of appropriate

current listing standards for the new

product, the SRO may immediately list

the new derivative securities product

without a Section 19(b) rule filing after

the Commission designates the

particular new product as a

‘‘standardized option’’ and approves the

Rule 9b–1 filing of amendments to the

ODD.

In addition to Form S–20 and Rule

9b–1, the Commission notes that other

federal securities laws must be

complied with even when an SRO relies

on the proposed amendment to Rule

19b-4. For example, issuers of new

derivative securities products must

continue to comply with, among other

things, the registration requirements of

the Securities Act and in addition, if a

product is an investment company 50

regulated under the Investment

Company Act of 1940, as amended,

(‘‘ICA’’) 51 the product must comply

with the ICA.

E. Existing Trading Rules, Procedures,

Surveillance Programs and Listing

Standards

An SRO wishing to list a new

derivatives securities product should

have in place trading rules, procedures,

a surveillance program and listing

standards that pertain to the class of

securities covering the new product. For

example, the Amex, CBOE, NYSE,52

PCX, and Phlx are the only SROs that

currently have in place trading rules,

position limits, margin requirements

and internal surveillance programs that

pertain to the listing and trading of

narrow-based stock index options.53

Should another exchange desire to trade

narrow-based index options, it would

first have to submit a proposed rule

change to the Commission adding

relevant trading rules, procedures and

listing standards to its rules. Procedures

include, but are not limited to adequate

procedures relating to sales practices

(including suitability), margin and

disclosure requirements. Otherwise, the

SRO would be in violation of sections

6(b) and 19(b) of the Act in order to

assure fair and orderly trading markets.

The SRO also must have a surveillance

program adequate to monitor for abuses

in the trading of the new derivative

securities product, including trading in

the underlying security or securities.

SROs that have the appropriate

regulatory framework in place for a

specific class of new derivative

securities product could immediately

list such class of new derivative

securities product, provided the

particular SRO satisfies the conditions

for the proposed amendment. If an SRO

sought to alter position limits, margin

requirements, or any other rules or

procedures for a new derivative

securities product class, however, it

would be required to submit a section

19(b)(2) rule filing for Commission

review. The SRO could apply such

proposed rule changes to a new product

only after the Commission has reviewed

and approved the proposal pursuant to

section 19(b)(2). For example, if an

options exchange wanted to list

immediately a new narrow-based index

option it could do so under its existing

applicable rules. In particular, the SRO

could immediately list the new narrowbased index option and impose its

existing position limits and margin

requirements.

If the SRO wanted to impose different

position limits or margin requirements,

or alter other existing trading rules or

procedures for the new derivative

securities product class, it would still be

required to submit to the Commission a

rule filing proposing such changes to its

existing rules pursuant to section

19(b)(2) of the Act. This framework

would not prevent an SRO from using
23590 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules

54The Commission does not anticipate that every

proposed change in an SRO’s existing trading rules

to accommodate a new derivatives securities

product will require a Section 19(b)(2) rule filing.

An SRO will not be required to submit a rule filing

for a stated policy, practice or interpretation of the

SRO that is reasonably or fairly implied by an

existing rule of the SRO or is concerned solely with

the administration of the SRO and is not a stated

policy, practice or interpretation with respect to the

meaning, administration or enforcement of an

existing rule of the SRO. 17 CFR 240.19b–4(c),

supra note 7. For example, if an SRO has rules that

merely delineate each new derivative securities

product covered by a particular existing trading

rule, the SRO need not submit a rule filing pursuant

to Section 19(b) of the Act and Rule 19b–4

thereunder merely because it is adding a new

derivative securities product to the list. See e.g.,

CBOE Rule 24.9(a)(3) and (4).

55 17 CFR 240.17a–1. SROs may also destroy or

otherwise dispose of such records at the end of five

years according to Rule 17a–6 under the Act, 17

CFR 240.17a–6.

56See section 19(h) of the Act, 15 U.S.C. 78s(h).

57 17 CFR 249.819.

58The Commission anticipates that the proposed

amendment will eliminate approximately 45 SRO

filings each year pursuant to Rule 19b–4 and Form

19b–4. In addition, the Commission believes that

the proposed amendment reduces the

recordkeeping and reporting requirements,

purusant to Rule 19b–4 and Form 19b–4, on the

SROs by permitting them to submit a one page

summary form after they list a new derivative

securities product instead of filing a complete

proposed rule change for Commission review prior

to listing such new derivative securities product.

59Section 3(f) of the Act, 15 U.S.C. 78c(f),

requires the Commission, when it is engaged in

rulemaking and is required to consider or determine

whether an action is necessary or appropriate in the

public interest, to also consider, in addition to the

protection of investors, whether the action will

promote efficiency, competition and capital

formation.

the proposed amendment to

immediately list a new derivative

securities product under its existing

rules, and then impose different

position limits, margin requirements, or

any other trading rule for the new

product once the Commission has

approved the Section 19(b)(2) rule filing

proposing such rule changes.54

F. Form of Notification to the SEC of

New Derivative Securities Product

Listing Pursuant to the Proposed

Amendment

In order for the Commission to

maintain an accurate record of all new

derivative securities products traded on

the SROs, it is proposing that an SRO

file a new form, proposed Form 19b–

4(e), to notify the Commission when an

SRO begins to trade a new derivative

securities product that is not required to

be submitted as a proposed rule change

to the Commission for approval.

Proposed Form 19b–4(e) should be

submitted within five business days

after an SRO begins trading a new

derivative securities product that is not

the subject of a proposed rule change.

G. Ensuring Proper Use of the Proposed

Amendment

The Commission contemplates that its

Office of Compliance Inspections and

Examinations (‘‘OCIE’’) will review SRO

compliance with the proposed

amendment through its routine

inspection process of the SROs. In order

for OCIE to determine whether an SRO

has properly availed itself of the

proposed amendment, it is necessary

that the SRO maintain, on-site, relevant

records and information pertaining to

each new derivative securities product

for which the SRO relied on the

proposed amendment. Such records

should be maintained for a period of not

less than five years, the first two years

in an easily accessible place, according

to the recordkeeping requirements set

forth in Rule 17a–1 under the Act.55

Such records available for OCIE

review would include, among other

things, a copy of proposed Form 19b–

4(e) under the Act and whether the

factual and numerical information

regarding the new derivative securities

product’s characteristics meet the

conditions of the proposed amendment.

The SRO should be able to provide the

listing standard under which the new

derivative securities product falls as

well as, but not limited to, such other

things as the details of its surveillance

program, records of adequate

information sharing procedures and

index construction and maintenance

standards. In short, the Commission

believes that when an SRO relies on the

proposed amendment, such SRO should

ensure that its regulatory framework

adequately supports the listing and

trading of any new derivative securities

product. Failure to comply with this

requirement would mean that the SRO

could be in violation of the Act. If so,

appropriate measures would be taken,

including, but not limited to, ordering

the SRO to remediate the deficiency or

prohibiting opening transactions in or

discontinuing the listing of new

derivative securities products.56

IV. Technical Changes

Because the Commission proposes

that a new paragraph (e) be added to

Rule 19b–4 under the Act, Form 19b–4

under the Act 57 is amended by revising

the phrase ‘‘subparagraph (e) of Rule

19b–4’’ to read ‘‘subparagraph (f) of Rule

19b–4’’ and the phrase ‘‘subparagraph

(e) of Securities Exchange Act Rule 19b–

4’’ to read ‘‘subparagraph (f) of

Securities Exchange Act Rule 19b–4’’ in

Exhibit 1, III. (B); and in Exhibit 1, IV.

revise the first sentence to read

‘‘Interested persons are invited to

submit written data, views and

arguments concerning the foregoing,

including whether the proposed rule

change is consistent with the Exchange

Act.’’

V. Conclusion

For the reasons discussed above, the

Commission preliminarily believes that

an amendment to Rule 19b–4 under the

Act that deems the listing and trading of

new derivative securities products

pursuant to existing SRO trading rules,

procedures, surveillance programs and

listing standards, to not be a proposed

rule change will reduce significantly the

SROs’ regulatory burden and help SROs

maintain their competitive balance with

the overseas and OTC derivatives

markets. The proposed amendment to

Rule 19b–4 will provide guidelines for

SROs seeking to rely on it but removes

the need for SEC review, notice and

approval prior to an SRO trading a new

derivative securities product pursuant

to existing SRO trading rules,

procedures, surveillance programs and

listing standards.58

The Commission preliminarily

believes that the proposed amendment

offers potential benefits for investors. If

adopted, the proposed amendment will

facilitate the listing and trading of new

derivative securities products by

permitting SROs to bring such products

to market quickly to provide investors

with tailored products that directly meet

their evolving investment needs. The

Commission does not anticipate that the

proposed amendment will result in any

costs for U.S. investors or others. The

Commission preliminarily believes that

the proposed amendment would reduce

the cost of offering new derivative

securities products to investors because

it will foster innovation and create a

streamlined process for SROs to list and

trade such new derivative securities

products subject to existing trading

rules, procedures, surveillance programs

and listing standards. Thus, the

Commission has considered the

proposed amendment’s impact on

efficiency, competition and capital

formation and preliminarily believes

that it would promote these three

objectives.59 Finally, the Commission

believes that the SROs will spend

significantly less time filling out the

form to be used under the proposed

amendment than they do now when

submitting a complete proposed rule

change for Commission review, notice

and approval pursuant to Rule 19b–4

under the Act.
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23591

60See supra note 58. As previously stated, the

Commission believes that the proposed amendment

reduces the recordkeeping and reporting

requirements, pursuant to Rule 19b–4 and Form

19b–4, on the SROs by eliminating the requirement

of filing a complete proposed rule change for

Commission review prior to trading a new derivate

securities product. The Commission estimates that

the annual aggregate burden and annual aggregate

cost for all respondents under Form 19b–4 would

be reduced by 2,295 hours and $152,786,

respectively. The cost per hour and per filing is

derived from information supplied by the SROs. We

have valued related overhead at 35% of the value

of legal and clerical work combined. See GSA Guide

to Estimating Reporting Costs (1973).

The annual aggregate burden was derived as

follows: 30 routine filings at 25 hours legal review

time per filing equals 750 hours; 15 significant

filings at 100 hours legal review time per filing

equals 1,500 hours; and 45 total filings at 1 hour

of clerical work per filing equals 45 hours. The total

of the three sums equals 2,295 hours.

The annual aggregate cost was derived as follows:

2,250 hours of in-house legal work at $50 per hour

equals $112,500; 45 hours of clerical work at $15

per hour equals $675; and overhead equals $39,611.

The total of the three sums equals $152,786.

A routine filing is one that takes the Commission

approximately 90 days to approve and a significant

filing takes more time. See infra note 61.

61The Commission estimates that under current

procedures, a proposed rule filing for a new

derivative securities product takes 90 days, on

average, from the date of the original submission,

to be approved. In contrast, the proposed

amendment permits SROs to immediately list and

trade a new derivative securities product so long as

such product is in compliance with proposed Rule

19b–4(e) under the Act.

62The Commission estimates that the $88 cost

will be broken down as follows: 1 hour in-house

professional work at $50 per hour; 1 hour of clerical

work at $15 per hour; and overhead (telephone,

copying and postage) at $23 per Proposed Form

19b–4(e).

We have valued related overhead at 35% of the

value of legal and clerical work combined. The cost

per hour and per Form 19b–4(e) is derived from the

information supplied by the SROs used to compute

the SROs’ burden under Form 19b–4, see note 60,

supra.

63See 15 U.S.C. 78w(a)(2).

64The Commission also believes that the

proposed amendment will benefit broker-dealers.

See VII. Summary of Regulatory Flexibility Act

Analysis, infra.

VI. Request for Public Comments

The Commission seeks comments on

adopting proposed Rule 19b–4(e) and

Form 19b–4(e) under the Act.

Commentators are asked to consider

whether the proposed amendment

provides appropriate review of the

listing and trading of new derivative

securities products subject to existing

trading rules, procedures, surveillance

programs and listing standards.

Specifically, comments should address

whether more or less information is

needed on Form 19b–4(e) in order to

enable the Commission to comply with

its statutory obligations to help remove

impediments to a free and open

securities market, protect investors and

promote the public interest. For

example, should Form 19b–4(e) require

the SRO to cite its relevant standards

under which it has listed a new

derivative securities product?

Commentators also may wish to discuss

whether there are any legal or policy

reasons why the Commission should

consider a different approach in

regulating new derivative securities

products. For purposes of the Small

Business Regulatory Enforcement

Fairness Act of 1996, the Commission is

also requesting information regarding

the potential impact of the proposed

amendment on the economy on an

annual basis. If possible, commentators

should provide empirical data to

support their views. Finally,

commentators should consider the

proposed rule amendment’s effect on

competition, efficiency and capital

formation. Comments should be

submitted by May 29, 1998.

VII. Costs and Benefits of the Proposed

Amendment and its Effects on

Competition, Efficiency and Capital

Formation

To assist the Commission in its

evaluation of the costs and benefits that

may result from the proposed

amendment, commentators are

requested to provide analysis and data,

if possible, relating to costs and benefits

associated with the proposal herein. The

Commission preliminarily believes that

the proposed amendment will reduce

SRO compliance burdens under Rule

19b–4.60 The proposal would reduce

significantly the SROs’ regulatory

burden and help SROs maintain their

competitive balance with the overseas

and OTC derivative markets.61

Moreover, the Commission believes that

the proposed amendment will foster

innovation and create a streamlined

procedure for SROs to promptly list new

derivative securities products subject to

appropriate listing standards.

The individual hour burden for each

respondent to the collection of

information requirements of proposed

Rule 19b–4(e) and Form 19b–4(e) under

the Act is estimated to be two hours per

proposed Form 19b–4(e). The annual

aggregate burden for all respondents to

the recordkeeping collection of

information requirements of proposed

Rule 19b–4(e) and Form 19b–4(e) under

the Act is estimated to be 90 hours. This

burden is computed by estimating that

an SRO will utilize 1 hour of in-house

legal processing time to prepare the

substantive information for proposed

Form 19b–4(e) and 1 hour of clerical

time to process proposed Form 19b–4(e)

for filing. The Commission estimates

that an SRO will incur a cost of $88 for

each proposed Form 19b–4(e) that it

submits.62 Thus, the total cost per year

to all SROs to comply with proposed

Rule 19b–4(e) and Form 19b–4(e) is

estimated to be $7,920 (90 hours at $88

per hour). When the annual aggregate

SRO burden of preparing proposed

Form 19b–4(e) (positive 90 hours) is

added to the reduction in SRO burden

hours under Form 19b–4 (negative 2,295

hours), the Commission estimates that

the SROs would receive an aggregate net

savings of 2,205 burden hours per year.

In addition, section 23(a)(2)63 of the

Act requires that the Commission, when

promulgating rules under the Exchange

Act, to consider the impact any rule

would have on competition and to not

adopt any rule that would impose a

burden on competition that is not

necessary or appropriate in the public

interest. The Commission has

considered the proposed amendment in

light of the standards cited in section

23(a)(2) of the Act and believes that it

would not likely impose any significant

burden on competition not necessary or

appropriate in furtherance of the

Exchange Act. Indeed, the Commission

believes that the proposed amendment

will reduce compliance cost and will

enable SROs to compete more

effectively with overseas and OTC

derivatives markets. The Commission

preliminarily believes that SROs should

be able to bring new derivative

securities products to market quickly to

provide investors with tailored products

that directly meet their evolving

investment needs.64 SROs have had

over 20 years of experience with SEC

review of new derivative securities

product proposals. SROs that have

sought approval from the Commission

to list and trade such new derivative

securities products should be familiar

with the factors discussed in this release

that the Commission believes should be

considered when listing and trading

such new derivative securities products.

Thus, the Commission preliminarily

believes that there is less need for SEC

review, notice and approval prior to an

SRO trading a particular new derivative

securities product pursuant to existing

SRO trading rules, procedures, a

surveillance program and listing

standards. The Commission

preliminarily believes that the proposed

procedures discussed in this release will

enable the Commission to continue to

effectively protect investors and

promote the public interest.

Nonetheless, the Commission solicits

comments on the costs, benefits and

competitive effects of the proposed rule

amendment, in general, and the

potential competitive effects across
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65 17 CFR 240.0–10(c).

66The Commission bases its estimate on the

information provided in Form X–17A–5—Financial

and Operational Combined Uniform Single Reports

pursuant to section 17 of the Act and Rule 17a–5

thereunder. 67 44 U.S.C. 3501 et seq. 68See supra note 61.

markets, in particular. Specifically, the

Commission requests commentators to

address whether the proposed

amendment would generate the

anticipated benefits or impose any costs

on U.S. investors or others.

VIII. Summary of Regulatory Flexibility

Act Analysis

The Commission has prepared an

Initial Regulatory Flexibility Analysis

(‘‘IRFA’’) in accordance with 5 U.S.C.

605(b) regarding the proposed

amendment to Rule 19b–4 and Form

19b–4(e) under the Exchange Act. The

following summarizes the IRFA.

The IRFA sets forth the statutory

authority for the proposed amendment

to Rule 19b–4. The IRFA also discusses

the effect of the proposed amendment

on broker-dealers that are small entities

as defined in Rule 0–10 under the

Exchange Act.65 A broker-dealer that

has total capital of less than $500,000 on

the date in the prior fiscal year as of

which its audited financial statements

were prepared, or, if not required to

prepare such statements, a broker-dealer

that had total capital of less than

$500,000 on the last business day of the

preceding fiscal year is deemed to be a

small entity for purposes of the IRFA.

The IRFA states that the proposed

amendment would enable brokerdealers that are small entities (such as

certain options market makers and

options specialists) to trade new

derivative securities products pursuant

to existing trading rules, procedures,

surveillance programs and listing

standards approximately 90 days earlier,

on average, because the proposed

amendment will permit SROs to

immediately list these new derivative

securities product without prior

Commission approval. As a result,

broker-dealers will have additional days

to earn income through trading such

new derivative securities products. As

of December 31, 1996, the Commission

estimated that there were over 900

options market makers and specialists

that may be considered small entities.66

The IRFA states that the proposed

amendment would not impose any new

reporting, recordkeeping or compliance

requirements on broker-dealer small

entities. Any new reporting,

recordkeeping or compliance burdens

rest with the SROs, not broker-dealer

small entities.

The IRFA discusses the various

alternatives considered by the

Commission in connection with the

proposed amendment that might

minimize the effect on small entities,

including: (a) The establishment of

differing compliance or reporting

requirements or timetables that take into

account the resources of small entities;

(b) the clarification, consolidation or

simplification of compliance and

reporting requirements under the rule

for small entities; (c) the use of

performance rather than design

standards; and (d) an exemption from

coverage of the proposed rule

amendment, or any part thereof, for

small entities. The Commission believes

that different compliance or reporting

requirements for small entities are not

necessary because the proposed rule

amendment does not establish any new

reporting, recordkeeping or compliance

requirements for small entities. In

addition, the Commission has

concluded that it is not feasible to

further clarify, consolidate or simplify

the proposed rule amendment for small

entities. The Commission also believes

that it would be inconsistent with the

purposes of the Act to use performance

standards to specify different

requirements for small entities or to

exempt broker-dealer small entities from

being able to trade new derivative

securities products that are covered by

the proposed rule amendments.

The IRFA includes information

concerning the solicitation of comments

with respect to the IRFA generally, and

in particular, the number of small

entities that would be affected by the

proposed rule amendment. A copy of

the IRFA may be obtained by contacting

Marianne H. Duffy, Special Counsel,

(202) 942–4163 at Office of Market

Supervision, Division of Market

Regulation, SEC, Mail Stop 10–1, 450

Fifth Street, NW., Washington, DC

20549.

IX. Paperwork Reduction Act

Certain provisions of the proposed

amendment to Rule 19b–4 contain

‘‘collection of information

requirements’’ within the meaning of

the Paperwork Reduction Act of 1995 67

through the use of proposed Form 19b–

4(e) under the Act. The Commission has

submitted the collection to the Office of

Management and Budget (‘‘OMB’’) in

accordance with 44 U.S.C. 3507 and 5

CFR 1320.11. Persons should note that

an agency may not conduct or sponsor,

and a person is not required to respond

to, a collection of information unless it

displays a currently valid control

number. The title for the collection of

information is: ‘‘Form 19b–4(e) Under

the Securities Exchange Act of 1934.’’

A. Summary of Collection of

Information Under Proposed Rule 19b–

4(e) and Form 19b–4(e)

The collection of information would

require SROs to prepare a one-page

summary sheet of nine questions that

requests factual information regarding

the characteristics of the new derivative

securities product and the underlying

securities. Such questions do not

require any analysis or exhibits.

B. Proposed Use of the Information

Currently, in order to list and trade a

new derivative securities product, an

SRO must submit a proposed rule

change to the Commission pursuant to

section 19(b) of the Exchange Act and

Rule 19b–4 thereunder. Paragraph (c) of

Rule 19b–4 provides that certain stated

policies, practices and interpretations of

SROs do not constitute proposed rule

changes. Specifically, a ‘‘stated policy,

practice or interpretation’’ of an SRO

shall be deemed to be a proposed rule

change unless it is reasonably and fairly

implied by an existing rule of the SRO.

The Commission proposes to not deem

the listing and trading of new derivative

securities products as proposed rule

changes pursuant to Rule 19b–4(c)(1)

because, if the Commission has

approved, pursuant to section 19(b) of

the Act, such SRO’s trading rules and

procedures and listing standards for the

product class that would include the

new derivative securities product, the

listing and trading of the new derivative

securities product is reasonably and

fairly implied by the existing trading

rules and procedures and listing

standards.

Under current procedures, a proposed

rule filing for a new derivative securities

product takes approximately 90 days

from the date of the original submission

to be ordered.68 In contrast, the

proposed amendment permits SROs to

immediately list and trade a new

derivative securities product so long as

such new derivative securities product

is in compliance with proposed Rule

19b–4(e) under the Act. However, in

order for the Commission to maintain an

accurate record of all new derivative

securities products traded on the SROs

and to determine whether an SRO has

properly relied on the proposed

amendment, it is necessary that the SRO

file proposed Form 19b–4(e) with the

Commission when such SRO begins

trading a new derivative securities

product pursuant to the proposed

amendment. In addition, an SRO must
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23593

69Supra note 62.

70Supra note 60.

71SROs may also destroy or otherwise dispose of

such records at the end of five years according to

Rule 17a–6 under the Act, supra note 55.

maintain, on-site, a copy of proposed

Form 19b–4(e). The Commission

contemplates that it will ensure SRO

compliance with the proposed

amendment through its routine

inspection process of the SROs.

C. Respondents

The proposed amendment may be

used by any SRO. Currently, there are

ten such SROs for which it is estimated

that the proposed amendment would be

used, in the aggregate, approximately 45

times a year.

D. Total Annual Reporting and

Recordkeeping Burden

The individual burden for each

respondent to the collection of

information requirements of proposed

Rule 19b–4(e) and Form 19b–4(e) under

the Act is estimated to be two hours per

proposed Form 19b–4(e). The annual

aggregate burden for all respondents to

the collection of information

requirements of proposed Rule 19b–4(e)

and Form 19b–4(e) under the Act is

estimated to be 90 hours. This burden

is computed by estimating that an SRO

will utilize 1 hour of in-house legal

processing time to prepare the

substantive information for proposed

Form 19b–4(e) and 1 hour of clerical

time to process proposed Form 19b–4(e)

for filing. The Commission also

estimates that an SRO will incur an

additional cost of $23 for overhead,

including telephone, copying and

postage, for each proposed Form 19b–

4(e) that it submits.69 Thus, the total

operation and maintenance cost per

year, in addition to the burden hours, to

all SROs to comply with proposed Rule

19b–4(e) and Form 19b–4(e) is estimated

to be $7,920 (90 hours at $88 per hour).

In addition, as previously stated,

because SROs will no longer be required

to file a lengthier Form 19b–4, the

Commission estimates that the annual

aggregate costs and annual aggregate

burden for all respondents under Form

19b–4 would be reduced by $152,786

and 2,295 hours, respectively.70 As

previously stated, when the annual

aggregate SRO burden of preparing

proposed Form 19b–4(e) is added to the

reduction in SRO burden hours under

Form 19b–4, the Commission estimates

that the SROs would receive an

aggregate net savings of 2,205 burden

hours per year.

E. Retention Period for Recordkeeping

Requirements

The SROs would be required to retain

records of the collection of information

for a period of not less than five years,

the first two years in an easily accessible

place, according to the current

recordkeeping requirements set forth in

Rule 17a–1 under the Act.71

F. Collection of Information Is

Mandatory

Any collection of information

pursuant to proposed Rule 19b–4(e) and

Form 19b–4(e) under the Act would be

mandatory as a means for the

Commission to maintain accurate

records of new derivative securities

products that are traded.

G. Responses to Collection of

Information Will Not Be Kept

Confidential

Any collection of information

pursuant to proposed Rule 19b–4(e) and

Form 19b–4(e) under the Act would not

be confidential and would be publicly

available from the Commission upon

request.

H. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B),

the Commission solicits comments to:

(i) Evaluate whether the proposed

collection of information is necessary

for the performance of the functions of

the agency, including whether the

information shall have practical utility;

(ii) Evaluate the accuracy of the

agency’s estimate of the burden of the

proposed collection of information;

(iii) Enhance the quality, utility and

clarity of the information to be

collected;

(iv) and minimize the burden of

collection of information on those who

are to respond, including through the

use of automated collection techniques

or other forms of information

technology.

Persons wishing to submit comments

on the collection of information

requirements should direct them to the

following persons: (i) Desk Officer for

the Securities and Exchange

Commission, Office of Information and

Regulatory Affairs, Office of

Management and Budget, Room 3208,

New Executive Office Building,

Washington, D.C. 20503; and (ii)

Jonathan G. Katz, Secretary, Securities

and Exchange Commission, 450 Fifth

Street, N.W., Washington, DC 20549

with reference to File No. S7–13–98.

OMB is required to make a decision

concerning the collection of information

between 30 and 60 days after

publication, so a comment to OMB is

best assured of having its full effect if

OMB receives it within 30 days of

publication.

X. Statory Basis

The amendment to Rule 19b–4(e)

under the Exchange Act is being

proposed pursuant to 15 U.S.C. 78a et

seq., particularly sections 3(a)(27), 3(b),

19(b), 23(a) and 36(a) of the Act, unless

otherwise noted.

Text of the Proposed Rule

List of Subjects in 17 CFR Parts 240 and

249

Reporting and recordkeeping

requirements, Securities.

In accordance with the foregoing,

Title 17, Chapter II of the Code of

Federal Regulations is proposed to be

amended as follows:

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934

1. The general authority citation for

part 240 is revised to read, in part, as

follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,

78c, 78d, 78f, 78i, 78j, 78j–1, 78k, 78k–1, 78l,

78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w,

78x, 78ll(d), 78mm, 79q, 79t, 80a–20, 80a–23,

80a–29, 80a–37, 80b–3, 80b–4 and 80b–11,

unless otherwise noted.

* * * * *

2. Section 240.19b–4 is amended by

redesignating paragraphs (e), (f), (g), and

(h) as paragraphs (f), (g), (h) and (i) and

adding new paragraph (e) to read as

follows:

§ 240.19b–4 Filings with respect to

proposed rule changes by self-regulatory

organizations.

* * * * *

(e) For the purposes of this paragraph,

new derivative securities product means

any type of option, warrant, hybrid

securities product or any other security

whose value is based upon the

performance of an underlying

instrument.

(1) The listing and trading of a new

derivative securities product by a selfregulatory organization shall not be

deemed a proposed rule change,

pursuant to paragraph (c)(1) of this

section, if the Commission has

approved, pursuant to Section 19(b) of

the Act (15 U.S.C. 78s(b)), the selfregulatory organization’s trading rules,

procedures and listing standards for the

product class that would include the

new derivative securities product and

the self-regulatory organization has a

surveillance program for the product

class.

(2) Recordkeeping and reporting:
23594 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules

(i) Self-regulatory organizations shall

retain at their principal place of

business a file, available to Commission

staff for inspection, of all relevant

records and information pertaining to

each new derivative securities product

traded pursuant to this paragraph (e) for

a period of not less than five years, the

first two years in an easily accessible

place, as prescribed in § 240.17a–1.

(ii) When relying on this paragraph

(e), a self-regulatory organization shall

submit Form 19b-4(e) (17 CFR 249.820)

to the Commission within five business

days after commencement of trading a

new derivative securities product.

* * * * *

PART 249—FORMS, SECURITIES

EXCHANGE ACT OF 1934

3. The authority citation for part 249

continues to read in part as follows:

Authority: 15 U.S.C. 78a, et seq., unless

otherwise noted;

* * * * *

4. Form 19b–4 (referenced in

§ 249.819) is amended as by revising the

phrase ‘‘subparagraph (e) of Rule 19b–

4’’ to read ‘‘subparagraph (f) of Rule

19b–4’’ and the phrase ‘‘subparagraph

(e) of Securities Exchange Act Rule 19b4’’ to read ‘‘subparagraph (f) of

Securities Exchange Act Rule 19b–4’’ in

Exhibit 1, III. (B); and in Exhibit 1, IV.

revise, the first sentence to read

‘‘Interested persons are invited to

submit written data, views and

arguments concerning the foregoing,

including whether the proposed rule

change is consistent with the Exchange

Act.’’

5. Section 249.820 and Form 19b–4(e)

are added to read as follows:

§ 249.820 Form 19b–4(e) for the listing and

trading of new derivative securities

products by self-regulatory organizations

that are not deemed proposed rule changes

pursuant to Rule 19b–4(e) (§ 240.19b–4(e)).

This form shall be used by all selfregulatory organizations, as defined in

Section 3(a)(26) of the Act, to notify the

Commission of a self-regulatory

organization’s listing and trading of a

new derivative securities product that is

not deemed a proposed rule change,

pursuant to Rule 19b–4(e) under the Act

(17 CFR 240.19b–4(e)).

BILLING CODE 8010–01–P
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23595
23596 Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules
Federal Register / Vol. 63, No. 82 /Wednesday, April 29, 1998 / Proposed Rules 23597

By the Commission.

Dated: April 17, 1998.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–10946 Filed 4–28–98; 8:45 am]

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