regulatory organizations; proposed rule changes: American Stock Exchange, Inc.,

[Federal Register: September 17, 1998 (Volume 63, Number 180)]

[Notices]

[Page 49720-49722]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr17se98-94]

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40428; File No. SR-AMEX-98-23]

Self-Regulatory Organizations; Proposed Rule Change by the American Stock Exchange, Inc. Relating to Integrated Market Making for Fund Shares

September 10, 1998.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934,\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that on June 30, 1998, the American Stock Exchange, Inc. (the ``Amex'' or the ``Exchange'') filedwith the Securities and Exchange Commission (the ``Commission'') the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

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

\2\ 17 CFR 240.19b-4.

1. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

   The Amex proposes to amend Exchange Rules 175 and 958 to allow the trading of Fund Shares, options on Fund Shares and related index options at the same location on the Exchange's trading floor and by the same specialists and registered traders.

2. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

   In its filing with the Commission, the Amex included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed

   [[Page 49721]]

   rule change. The text of these statements may be examined at the places specified in Item IV below. The Amex has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.

   1. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

      (1) Purpose

      Since 1992, the Exchange has listed and traded, pursuant to its equity trading rules, a number of products that derive their value from indexes or portfolios of other equity securities. These products include Exchange-listed securities representing interests in open-end unit investment trusts or open-end management investment companies that hold securities based on an index or a portfolio of securities (These products are collectively referred to hereinafter as ``Fund Shares'').\3\

      \3\ Currently, the Exchange trades unit investment trust securities known as Portfolio Depository Receipts ‹SUP›SM‹/SUP› (``PDRs'') based on the Standard & Poor's 500‹Register› Composite Stock Price Index, the Standard & Poor's MidCap 400 Index ‹SUP›TM‹/SUP› and the Dow Jones Industrial Average. In addition, the Exchange trades fund shares which are issued by an open-end management investment company consisting of seventeen separate series known as World Equity Benchmark Shares ‹SUP›SM‹/SUP› (``WEBs'') based on seventeen foreign equity indexes. PDRs and WEBs are listed on the Amex pursuant to Rule 1000, et seq. and rule 1000A et seq., respectively, and trade like shares of common stock. The Exchange is developing other fund shares for listing and trading which will have structures similar to PDRs and WEBs and proposes to trade options on many such securities. (See, Securities Exchange Act Release No. 36947 (March 8, 1996), 61 FR 10606 (March 14, 1996) for Fund Shares and Securities Exchange Act Release No. 31591 (December 11, 1992), 57 FR 60253 (December 18, 1992) for PDRs).

      The Exchange proposes to amend Exchange Rules 175 and 958 to allow the trading of Fund Shares, options on Fund Shares and related index options at the same location or adjacent locations on the Exchange's trading floor and by the same specialist units and registered traders (hereinafter referred to as ``Exchange-wide fund share market making''). Amex believes that Exchange-wide fund share market making will provide a climate in which reduced customer trading costs will result from narrower spreads, cross product arbitrage, integrated risk management, increased liquidity and depth, higher trading volume and more effective and efficient servicing of customer order flow while assuring that there will be no undue advantage or preference among participants in the marketplace. Recent and expected future growth in the listing and trading of Fund Shares and the anticipated approval of the Exchange's proposed filing concerning the trading of options on Fund Shares will permit customers and market makers to manage risks and coordinate related positions with lower trading costs and more effective and efficient execution of their investment strategies.\4\

      \4\ On July 1, 1998, the Commission approved a proposed rule change which permits the trading of options on Exchange-Traded Fund Shares. Securities Exchange Act Release No. 40157 (July 1, 1998), 63 FR 37426 (July 10, 1998).

      The Exchange believes the proposed rule change will promote market efficiency by allowing the same specialist unit and registered traders to trade a number of related products, realizing the cost reducing advantages of cross product arbitrage and integrated risk management. Such advantages will result in narrower spreads, increased liquidity and depth, and higher trading volume in the markets for risk-related Fund Shares, options on Fund Shares and index options. Most importantly, the Exchange believes the proposed rule change will result in more effective and efficient servicing of customers' orders at lower expected transaction costs to the customers.

      The Exchange believes that the proposed integration of market making in Fund Shares, options on Fund Shares and their related index options can increase market quality and will provide both price and operational efficiencies while raising minimal issues of informational advantage due to the derivative nature of all of these products.\5\ Such informational advantages are minimal because pricing of the Fund Shares is not based on supply of and demand for the Fund Shares, but on the value of the underlying index or portfolio of securities. For example, unlike stocks, prices of which are based in part on information regarding the performance of the issuer and the supply of and demand for the stock in the secondary market, Fund Shares are priced according to the current market prices of the underlying components held in the Fund Shares' portfolio trust. The specialist for the Fund Shares is privy to information that indicates the supply of and demand for the Fund Shares themselves, but the specialist cannot rely upon such information when pricing Fund Shares since the index or basket of securities upon which the Fund Shares are based may not move in the same manner that the supply of and demand for the Fund Shares indicates. Accordingly, the Exchange does not believes that knowledge of limit orders on the specialist's book for the Fund Shares themselves provides an informational advantage to the specialist when pricing or trading the Fund Shares. The fund share market is a derivative market of underlying stocks and the markets for index options and fund share options is, correspondingly, a further derivative of this underlying market.

      \5\ At the Commission staff's request, the Exchange researched the issues of integrated market making and side-by-side trading. A letter setting forth the results of that research and an analysis of such activities with respect to Fund Shares and the overlying options was forwarded to the Commission staff. The letter reviews and analyzes Commission precedent for (and against) integrated market making as well as statements made by the Commission in the Report of the Special Study of the Options Markets, H.R. Rep. No IFC3, 96th Cong. 1st sess. (Committee Print 1978) (referred to hereinafter as the ``Options Study''). See, Letter from Claire P. McGrath, Vice President and Special Counsel, Derivative Securities Division, Amex, to Howard Kramer, Senior Associate Director, Division of Market Regulation, Commission, dated June 2, 1998.

      The Commission has stated that ``[t]he integration of trading in options and their underlying securities on an exchange floor may create opportunities to engage in manipulative and other improper trading activities that do not presently exist.''\6\ In order for the integration of market making in fund shares and their overlying options to create opportunities for the specialist and registered options traders to engage in manipulative activity, market making in both products must yield information that can be used in such an endeavor. As discussed in the previous section, the Exchange believes that neither the specialist nor the traders in any or all of these products are privy to exclusive market information that is useful in pricing the fund shares. Like all market participants, they have access to last sale information for each of the component securities, the current quotes for the components and price information for any other products such as a futures contract that may be used in pricing the fund shares. What little market information the specialist and traders are able to glean on the Exchange floor is more than likely known by other market participants and already factored into prices and quotes. In addition, given the enhanced surveillance systems that monitor all trading floor activity today, attempts to manipulate the market by a specialist or trader will be readily detected.

      \6\ Options Study at 885.

      Among other reasons why limit orders in Fund Shares are not a source of informational advantage is the number of Fund Shares issued and outstanding may be increased or decreased at a very low cost in response to changing demand for the Fund Shares. A defining characteristic of all Amex-listed unit

      [[Page 49722]]

      investment trust and management investment companies that hold securities based on an index or a portfolio of securities is that they are open-ended. New Fund Shares in these products may be created on any business day in response to an offer to purchase such shares. Accordingly, the ability of the seller of a call option on any such Fund Share to deliver upon exercise is a function of the availability of all the shares of the components represented in the trust, not just the share held by the fund itself. As a result, there is substantially less potential for manipulation of a Fund Share's price, since. unlike the market in a thinly traded corporate stock, the market for Fund Share's cannot be successfully squeezed or cornered because the potential supply to Fund Shares is, for all practical purposes, unlimited.

      Lastly, although the Exchange believes that the proposed rule change will not increase the potential for trading abuse or manipulation, the Exchange currently has in place safeguards to detect and prevent any such abuse or manipulative activities. The Exchange believes its existing surveillance pro endures are more than sufficient to detect any improper trading activity, deter any potential manipulative or improper trading activity and minimize the regulatory risks of integrated market making. The concentration of related product trading activity helps in the surveillance that assures that a customer receives a price appropriate to the state of the market when his order arrives on the trading floor. The Exchange conducts regular surveillance to detect any abuse or attempted manipulations and to insure compliance with its safeguards. The Exchange believes that the proximity of trading activity in related products will increase the effectiveness of these safeguards.\7\

      \7\ In addition to the foregoing, in recent months the Commission has approved rule changes by other options exchanges which will permit these exchanges to list and trade, under unlisted trading privileges, some or all Fund Shares now listed on the Amex or which might be listed on the Amex or some other exchange in the future. In contrast to Amex rules which currently place limitations on option and equity trading locations and specialists' affiliations, the Amex believes that the rules of some of the other U.S. options exchanges impose no such limitations on trading locations, specialists' affiliations or market maker participation on these or related products. The proposed rule change will permit the Amex to conduct its business without unnecessary fetters not imposed on competitive markets. The changes will permit Amex specialists and market makers to use other related products traded on the Amex in the same way that specialists and market makers on other exchanges will be able to use related products traded on their exchanges in their market making and risk management activities in Fund Shares and related options products.

      (2) Statutory Basis

      The proposed rule change is consistent with Section 6(b) of the Act \8\ in general and furthers the objectives of Section 6(b)(5) \9\ in particular in that is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in facilitating transactions in securities, and to remove impediments to and perfect the mechanism of a free and open market and a national market system.

      \8\ 15 U.S.C. 78f.

      \9\ 15 U.S.C. 78f(b)(5).

   2. Self-Regulatory Organization's Statement on Burden on Competition

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

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

      No written comments were solicited or received with respect to the proposed rule change.

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

   Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the Exchange consents, the Commission will:

   (A) by order approve such proposed rule change, or

   (B) institute proceedings to determine whether the proposed rule change should be disapproved.

4. 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 should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filedwith 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 in the Commission's Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549. Copies of such filing will also be available for inspection and copying at the principal office of the Amex. All submissions should refer to File No. SR-Amex-98-23 and should be submitted by October 8, 1998.

   For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\10\

   \10\ 17 CFR 200.30-3(a)(12).

   Margaret H. McFarland, Deputy Secretary.

   [FR Doc. 98-24885Filed9-16-98; 8:45 am]

   BILLING CODE 8010-01-M