[Federal Register Volume 65, Number 74 (Monday, April 17, 2000)]
[Notices]
[Pages 20501-20503]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-9488]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42655; File No. SR-Phlx-00-25]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc. Eliminating the Restriction on Exercise Prices for FLEX 
Equity Call Options to Those Prices That Apply to Standardized Equity 
Call Options

April 10, 2000.
    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 March 15, 2000, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change.
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    \1\ 15 U.S.C. 78(s)(1).
    \2\ 17 CFR 240.19b-4.
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1. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx proposes to delete the provision in Exchange Rule 
1079(a)(3) that limits exercise prices for FLEX equity call options to 
those that apply to standardized equity call options.\3\
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    \3\ The Commission notes that the proposed rule change would 
also eliminate the requirement that FLEX equity call options follow 
the exercise price intervals set out for standardized options in 
Phlx Rule 1012.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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
    The Exchange proposes to amend Phlx Rule 1079(a)(3) to eliminate 
the limitation of the exercise prices available for FLEX equity call 
options to those prices that are available for standardized equity call 
options. Under Phlx Rule 1079, FLEX call options allow certain terms to 
be customized, such as the underlying security, the type of option, the 
exercise price, the exercise style, and the expiration date. The 
Exchange, however, restricted the strike prices for FLEX equity call 
options to those prices that are available for standardized equity call 
options because of a concern that the flexible strike price feature 
could result in an available standardized equity call option that would 
not be classified as a ``qualified'' covered call under the Internal 
Revenue Code (``Code''). The Exchange represents that this would 
jeopardize the modest tax treatment enjoyed by writers of standardized 
equity call options.
    Currently under Section 1092(c)(4)(B) of the Code, writers of such 
qualified covered short positions in equity call options receive 
advantageous tax treatment if the options are exchange-traded and not 
``deep-in-the-money.'' An option is ``deep-in-the-money'' if the strike 
price of the option is lower than the lowest qualified benchmark price 
for stock.\4\ The Code defines this benchmark price as generally the 
highest strike price available for trading

[[Page 20502]]

that is less than the current price of the underlying stock.\5\
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    \4\ Section 1092(c)(4)(C) of the Code.
    \5\ Section 1092(c)(4)(D) of the Code.
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    The Exchange implemented Phlx Rule 1079(a)(3) to remove uncertainty 
concerning what constitutes a qualified covered call under Section 
1092(c)(4) of the Code. If the exercise prices of FLEX equity call 
options were not subject to the same prices and intervals that apply to 
standardized equity call options, this could raise the question of 
whether the existence of a series of FLEX equity call options with a 
strike price of, for example, $58 when the price of the underlying 
stock is $59, would disqualify a standardized equity call option with a 
strike price of $55, which would otherwise be the lowest qualified 
benchmark price, i.e., the highest strike price available for trading 
that is less than the price of the stock. The Exchange represents that 
it was concerned that the Internal Revenue Service (``IRS'') may 
interpret the short covered standardized call equity option with a $55 
strike price as deep-in-the-money and not grant it qualified covered 
call treatment under Section 1092(c)(4) of the Code.
    On January 25, 2000, the IRS resolved this question by issuing a 
final rule which states that strike prices established by the equity 
options with flexible terms will not be taken into account when 
determining whether standardized equity call options are deep-in-the-
money and therefore do not receive qualified covered call treatment.\6\ 
Therefore, the Exchange now proposes to modify Phlx Rule 1079(a)(3)(B) 
to lift the restriction on exercise prices for FLEX equity call 
options. The Exchange represents that the effect of the IRS regulations 
and the Exchange's proposal is to permit certain taxpayers, 
particularly institutional and other large Exchange's proposal is to 
permit certain taxpayers, particularly institutional and other large 
investors, to engage in transactions in FLEX equity call options with a 
wider range of exercise prices (as was originally intended) without 
affecting the applicability of Section 1092 of the Code for qualified 
covered call options involving equity call options with standard terms.
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    \6\ See Department of Treasury, IRS REG-104641-97, 65 FR 3812 
(January 25, 2000).
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b)(5) of the Act \7\ in general, and furthers the 
objectives of Section 6(b)(6)(5) \8\ in particular, in that it is 
designed to facilitate transactions in securities, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, as well as to protect investors and the 
public interest by eliminating the restriction on FLEX equity call 
options that has limited their usefulness as a risk management tool.
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    \7\ 15 U.S.C. 78f(b).
    \8\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The proposed rule change has become effective pursuant to Section 
19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder because the 
foregoing proposed rule change: (1) Does not significantly affect the 
protection of investors or the public interest; (2) does not impose any 
significant burden on competition; and (3) does not become operative 
for 30 days after the date of filing or such shorter time as the 
Commission may designate if consistent with the protection of investors 
and the public interest; provided that the Exchange has given the 
Commission written notice of its intent to file the proposed rule 
change at least five business days prior to the filing date of the 
proposed rule change, or such shorter time as designated by the 
Commission. The Exchange has requested that the Commission accelerate 
the operative date of the proposed rule change so that the Exchange may 
implement this proposal as quickly as possible and allow FLEX options 
to be used as they were originally intended.
    The Commission finds that it is appropriate to designate the 
proposal to become operative upon filing, because the immediate 
implementation of the proposed rule change is consistent with the 
protection of investors and the public interest. Specifically, the 
Commission previously approved virtually identical proposals by three 
other exchanges.\9\ The Commission notes that the proposed rule change 
concerns issues that have previously been the subject of a full comment 
period pursuant to Section 19(b) of the Act.\10\ The Commission does 
not believe that the proposed rule change raises any new regulatory 
issues.\11\
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    \9\ See Securities Exchange Act Release No. 42371 (January 31, 
2000), 65 FR 5921 (February 7, 2000) (Order approving SR-CBOE-99-
63); see also Securities Exchange Act Release No. 42389 (February 7, 
2000), 65 FR 8224 (February 17, 2000) (Order approving SR-PCX-00-01 
and SR-Amex-00-02).
    \10\ 15 U.S.C. 78s(b).
    \11\ The Commission notes that the discussion of the same 
restrictions on exercise price intervals and exercise prices for 
FLEX equity call options has been eliminated from the October 1996 
Supplement to the Options Clearing Corporation options disclosure 
document. See Securities Exchange Act Release No. 42491 (March 2, 
2000), 65 FR 13351 (March 13, 2000) (Order approving SR-ODD-00-01).
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    The Commission also believes that immediate implementation of the 
proposed rule change is beneficial to investors. The Commission 
believes that the proposal allows sophisticated high net-worth 
investors to take full advantage of FLEX options. In part, FLEX options 
were created to allow these investors to manage their risks by having 
the ability to negotiate exercise prices, contact terms for exercise 
style (i.e., American, European, or capped), and expiration dates. 
However, because of the adverse tax effect on qualified covered calls, 
the Exchange limited FLEX equity call options exercise prices to those 
prices available for standardized equity call options. Now that the tax 
issue has been clarified, the Exchange is removing this restriction. 
With the removal of this limitation, the Commission believes that 
sophisticated, high net-worth investors will better be able to take 
advantage of the risk-management mechanisms provided by FLEX equity 
call options.
    At any time within 60 days of the filing of such proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is necessary or appropriate 
in the public interests, for the protection of investors or otherwise 
in furtherance of the purposes of the Act.\12\
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    \12\ In reviewing this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions

[[Page 20503]]

should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-Phlx-00-25 and 
should be submitted by May 8, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3 (a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-9488 Filed 4-14-00; 8:45 am]
BILLING CODE 8010-01-M